The concept and mechanism of liquidated damages is well known and recognised throughout the construction industry in the Middle East.
It is unwise to rely on familiar concepts from other jurisdictions, in particular Western common law systems, when considering the effect and impact of local UAE civil law.
Furthermore, it should also be noted that direct translation of English legal terms into an Arabic form (and vice-versa) does not always produce an equivalent result, and the distinction between liquidated damages and penalties is unclear upon translation.
Where liquidated damages are concerned, the usual circumstances are familiar to most: a contractor will be looking to claim for an extension of time to the completion date on the basis that the delay is not its fault, and thereby seek to avoid liquidated damages or penalties; the employer will be looking to exercise its right to deduct a pre-determined and prescribed, liquidated amount of damages, or a penalty, from monies due to the contractor, whom it holds responsible for the delayed completion date.
‘Damages’ are the remedy that is used to put the innocent party back into the position
it would have been in had the contract been properly performed.
Damages are therefore conveniently categorised as a measure of compensation to a party that has been subjected to a breach, or breaches of, contract.
A liquidated damages provision is intended to be a pre-determined and genuine pre-estimate of the loss that will be suffered by the employer if completion is delayed by the main contractor.
As such, liquidated damages are meant to accurately and fairly reflect the measure of compensation that would be required to place the employer in a position as if the delay had not occurred.
The FIDIC Fourth Edition Red Book 1987, in its un-amended form, provides at clause 47.1 for ‘Liquidated Damages for Delay’ (and, it should be noted, not as a ‘penalty’), and the ‘new’ 1999 FIDIC Red Book provides at clause 8.7 for ‘Delay Damages’.
While English common law does not allow a penalty clause to be enforced in this situation, it will generally uphold a liquidated damages clause.
So how do the UAE’s Civil Code and the UAE courts deal with this situation?
Furthermore, is there a distinction between a penalty and liquidated damages, and what, if any, are the ramifications if a penalty is sought to be imposed, rather than liquidated damages?
Article 390 of the Civil Code states that: “(1) The contracting parties may fix the amount of compensation in advance by making a provision therefore in the contract or in a subsequent agreement, subject to the provisions of the law. (2)
The judge may in all cases, upon the application of either of the parties, vary such agreement so as to make the compensation equal to the loss, and any agreement to the contrary shall be void.”
Article 390 therefore gives the court the ultimate right (upon the application of one of the parties) to examine the level of pre-agreed, fixed compensation and increase or decrease the amount to reflect the actual loss suffered by a party.
To those familiar with English common law principals, this may come as something of a shock, as in short, the court can retrospectively change the parties’ express agreement.
However, what is not immediately clear is whether Article 390 would apply equally to a clause in a contract that specifically referred to the agreed monies payable for a delay to completion as a ‘Penalty’, and expressly referred to ‘penalties’ as the remedy.
Would that be considered in the same way as ‘compensation’ by a UAE Court and also be subject to the effects of Article 390?
It appears that a UAE Court may feel it has jurisdiction to deal with a penalty clause in a similar way to a liquidated damages clause using Article 390, if so requested by one of the parties, because UAE law will uphold a penalty and a UAE Court is unlikely to automatically exclude itself from having discretion over such matters.
Whilst every case must be assessed on its own particular facts, there is case-law in the UAE that might give some insight into how the UAE court would view the question of liquidated damages and penalties.
In the Dubai Court of Cassation judgment 138/94, a case was brought which involved a dispute between a contractor and a subcontractor regarding delay to the completion of a contract for supply and installation of doors and windows.
The contract between the parties contained an express penalty clause for delay to completion, and the penalty was sought in full by the claiming party.
The Dubai Court of Cassation confirmed its general power to reduce the amount of damages agreed to – the penalty – should it become evident that the actual loss suffered was less than the total amount of damages agreed to.
Whilst the clause was described and construed in this case as a penalty, the court upheld its own right to review the actual loss suffered.
This would indicate that the court did not draw a strict distinction between a pure penalty provision and a pure liquidated damages provision in this instance.
Indeed, the words penalty, compensation and damages appear to have been used interchangeably, without distinguishing between references to ‘penalty’ and ‘liquidated damages’.
With that in mind, it may well be that the distinction between the two phrases (that English law has sought to maintain) is in fact much less significant in the UAE because the court views its powers, under Article 390 in particular, as equally applicable to penalties and liquidated damages.
Construction Week
Here lies the problem with common law backgrounds trying to decipher the mechanics of the Civil Code insofar as “penalties” and “liquidated damages” are concerned.
UAE courts will always have jurisdiction over all contractual issues whether these may be unenforceable, voidable or void ab initio. The problem really lies when contract provisions ordinarily permissible under common law are forced into the throat of the parties under civil law. My reviews of FIDIC forms of contract reveals significant number of clauses that are unforceable or viodable in civil law jurisdictions or in gross violations of the basic tenets of contracting under civil law.
Penalty clauses are void ad initio in common law, hence the bright boys coined another idea “liquidated damages” where an estimated amount of money is agreed as “fair compensation” for the loss on account of breach. This “liquidated damages” are forced again into the throat of the contractor who must swallow this clause otherwise he wont have his dough. Will the court close its eyes against possible injustice? NO, a big NO in civil law jurisdiction such as UAE because the courts must weigh whether the amount is really a “fair compensation” or not and weigh this against basic civil law principles of “unjust enrichment”, “equity”, “justice”, and “fair dealing” to name a few.
Oftentimes, “liquidated damages” favors the employer and no such similar clause against him, and courts may step in to tilt the balance of injustice. While Art 390 of UAE civil code allows the party to fix the “damages” by making a provision in the contract, the parties must “fix” this in accordance with law, i.e. the aforesaid basic principles enshrined under the Civil Code of UAE.
One may argue that contract clauses have the force of law between contracting parties and must be complied in good faith (pacta sunt servanda), and as such, the “liquidated damages” agreed upon must be sustained by the courts. Indeed, contract clauses have the force of law between contracting parties, only if these are couched in accordance with law.
Can the parties stipulate for “panalties” and “liquidated damages”. Yes, why not, but the aggrieved party cannot recover both for the same breach. Thus, if he cannot recover for “liquidated damages” for lack of causation, he can do so under the general damages and must prove BOTH the breach and the amount of loss.