Liquidated damages (sometimes referred to asagreed damages) are a fixed sum of money which has been agreed in advance of a contract breach to compensate the ‘innocent party’ for a breach of contract such as delay in completion of a project.
They are fairly common in the building industry and players in the industry should be aware of them.
They are different from ‘general damages’ or 'damages at large.' General damages are to be assessed by the court at a hearing of the matter, and could be for any amount from $1 up to an unlimited amount.
The trick with an agreed amount of damages is to make what is called a ‘genuine pre-estimate’ of the damages that are likely to be suffered in the event of a breach of contract. If you make the incorrect estimate, by not specifying an amount that is reasonably reflective of the loss that may be suffered, a court may strike it out of the contract in effect and may instead award general damages. The court would then say that the 'agreed damages' clause was in effect a penalty.
And it is to that issue that we now turn.
If the amount of agreed damages is not a real, genuine or reasonable estimation of the loss that may result from a contract breach, and so is excessive, it can be struck down by a court. The result of this is that the clause would be classified as a ‘penalty’ particularly if the amount is grossly excessive or what can be termed ‘unconscionable’ or exorbitant in amount.
The issue of whether an amount of liquidated damages is or is not a penalty came before the High Court in 2005 in a case called Ringrow Pty Ltd v BP Australia Pty Ltd  HCA 71. The case of Andrews v Australian and New Zealand Banking Group Limited  HCA 30 also has profound implications for this area of construction law.
The court in the Ringrow case said it is important to remember that merely because there is a difference in value between an agreed damages clause and a genuine estimation of loss, that a penalty doesn’t necessarily result. What has to have occurred is that the differences are gross, or ‘out of all proportion’ to each other.
Other methods of avoidance
Sometimes a party to a building contract may wish to avoid the agreed or liquidated damages clause (or indeed any damages) from applying in the particular case. One way to do this for a contractor is to, in the case of a contractor being late in achieving practical completion, apply for an extension of time within the prescribed time after the event occurs which caused the delay.
It is critical that an extension of time is applied for within the prescribed time (which can sometimes be as short as three business days). Otherwise, the agreed damages clause may still operate.
Agreed or liquidated damages in the case of delays (often a daily amount) are a very common thing in the construction industry.
When they apply - that is, when they are not struck down as a penalty - they are the owner's only entitlement to damages for the contractor's breach of the obligation to achieve practical completion by the due date. Also, when they apply, they apply regardless of whether actual damages are more or less than the 'agreed amount' unless of course, they are 'out of all proportion.'
As mentioned, they can be avoided by ensuring there are no delays in a project or by applying correctly for an extension of time or by a variation applying in a particular case.
As always, if in doubt, legal advice should immediately be sought regarding this complex issue.