What is the delay penalty for contactors?

As quoted by Gautam Shantilal Adani, a famous Indian businessman, “infrastructure sector is all about building assets for the country. It is a part of nation building”.

As per the analysis based on the International Monetary Fund (IMF), Haver Analytics and Fitch Connect, the United Arab Emirates (UAE), surpasses other countries in its contribution of the construction sector to the national Gross Domestic Product (GDP) with an approximate value of US Dollars 33.2 billion in 2018. Currently UAE’s popular multi-billion dollar projects are construction of Reem Mall on Reem Island in Abu Dhabi, development of the Ciel Tower in Dubai Marina, the world’s tallest hotel, Dubai Cruise Terminal to be located between the Blue waters and Palm Jumeirah, construction and development of Emaar’s Marina Vista homes and construction and development of Al Falah Homes Two Four; this implies UAE as a land which is consistently undergoing ceaseless amount of mega and minor construction projects. However, the successful completion of these projects depends on various variable circumstances, beginning with entering into a valid construction contract with the contractor to ensure the completion of the projects amidst various challenges; one of the major concerns of all the developers of various kinds of projects is finishing the construction in time. 

Construction delays are one of the most common issues faced by many project developers for various foreseeable or unforeseeable reasons. In general, a construction contract involves the person entering into a contract for assigning a specific project (employer), the person undertaking the construction of the projects (main-contractor) and the person either on nomination by the employer or selected by the main contractor to aid in the construction projects (sub-contractors). Any construction contract requires various contractors for performing different tasks to meet the requirements of the project; for instance, A enters into a construction contract assigning a project to B to construct a fully furnished building; B further assigns sub-contractors, C for painting, D for fixing tiles, E for fixing the furniture. Now, the question which arises is how to tackle the losses which can be incurred if there is any delay in construction or how to deal with cases where the employer refuses to make payments to the contractor and what about the payments due unto the sub-contractors. In order to understand the concept of delay penalty in construction cases, it is vital to know the essential provisions of laws governing the construction contracts in UAE. Articles 872 to 896 of the Federal Law Number 5 of 1985 on the Civil Transactions Law covers the provisions governing the construction contracts and article 390 of the Civil Transactions Law provides with the law regulating the clause pertaining to the amount of damages in contracts. It is pertinent to note that the laws governing the construction contracts in UAE are modelled after the International Federation of Consulting Engineers (FIDIC). 

FIDIC is an internationally recognized organization which frames the standard forms and conditions required for construction and engineering contracts. It consists of different colors of books dealing with different parts and sectors of contracts. The construction projects run on the principle ‘time is money’, emphasizing the importance of completion of the projects within the time specified in the contract, lest the employer and the other investors encounter huge losses in their business. Therefore, the employer is entitled to hold the contractor liable to pay damages or delay fines in cases of non-completion of the project within the specified time period. This article intends to shed light on how the UAE Civil Law deals with such delays in the construction projects and when the delay claims can be enforceable.

In general, most of the common law jurisdictions provide for an inclusion of a clause in the contracts specifying the predetermined compensations of the foreseeable loss which is likely to be suffered on the occasion of the breach of contract, such as delay in finishing the project on time; such fixed amount of compensation is termed as liquidated damages. The liquidated damages are ex-ante, which means, they are pre-estimation of the losses which can be incurred on the breach of the contract. 

The objective of including this clause in the construction contract is to ensure that the employer is compensated by the contractor in cases of delay in the completion of project and also to act as an incentive to the contractor to complete the project in time, lest he is made liable to pay such compensations;  the liquidated damages can be charged per day or at weekly rate since the delay in the completion of the project. However, for the enforceability of the liquidated damages it is necessary that the estimated amount should be based on a genuine calculation of the damages. Liquidated damages becomes unenforceable and will be considered as a penalty when pre-estimated amount is extravagant and unconscionable when compared to the greatest loss which can be incurred from the breach of contract as ruled in the English case of Dunlop Pneumatic Tyre Co Ltd VS New Garage & Motor Co Ltd (1915) AC 79. The common law jurisdictions strictly differentiates between the liquidated damages and penalty, whereas, in the civil law jurisdiction, such differentiation is not acknowledged, and the compensation specified in the contract here is referred to as ‘delay fines or penalty’. 

Article 390 of the Civil Transactions Law states that the parties may determine the amount of compensation, either at the time of entering into a contract or subsequently in a separate agreement. On the request of either of the parties, the amount can be amended in order to ensure that such amount is not unreasonable or extravagant when compared to the actual loss and to make the amount equal to the actual damages. The FIDIC, internationally adopted standard for the forms of contract, provides in the sub-clause 8.7 of the yellow book that, the employer is entitled to claim the amount of delay damages as stated in the contract on the occasion where the contractor has failed to comply with the time period for completing the project. It further states that claiming these damages will not relieve the contractor from his obligation to complete the project, except if the contract has been terminated by the employer. The UAE’S jurisprudence has not expressly recognized the term ‘liquidated damages’ and has not given any clear differentiation between the liquidated damages and delay penalty, but, in most of the construction cases have only acknowledged the term ‘delay fines’ or ‘penalty’.

For instance, in the Dubai Court of Cassation judgement 138/94: in a dispute of delay in delivery of the work in time between a contractor and a sub-contractor, the court has exercised its power as per article 390 of the Civil Transactions Law and has reduced the pre-estimated amount of damages as it was more than the actual loss suffered and rejected the plea of the contractor to receive the amount mentioned in the contract. In this following case, the court has not drawn any difference between the terms ‘liquidated damages’ and ‘delay penalty’ but rather, it appears to have used the words compensation, damages and penalty interchangeably.

 

Enforceability of the compensation:

In the Court of Cassation number 153 of 2011, issued on 10 June 2012: The court has laid down three elements or also called as the tripartite test for the enforceability of the delay penalty clause:

1. A contractual breach must have been committed by the party who gave agreed to be pay the amount claimed;
2. Existence of actual damages incurred by the party claiming the compensation;
3. A causation link between the act of the party and the damages suffered by the other party.

These requirements for the enforceability of a claim for delay damages has been well-founded in the UAE’S jurisprudence. The court has further stated that, irrespective of if it’s a contractual or a tortious claim, the compensation cannot be sanctioned unless the three elements have been satisfied in the case. The burden of proof of the damages incurred, generally lies on the party claiming the compensation.

In Dubai’s Court of Cassation 48/2005 and 65/2005: the burden of proof to establish that the delay penalty claimed is beyond the actual damages incurred lies on the party liable to pay the compensation. The very essence of the inclusion of the delay penalty clause is to ensure that the employer is protected from the foreseeable damages.

 

Existence of primary obligation:

The UAE courts have also established a rule for the enforceability of the compensation to be successful, there should be a breach of a primary obligation. To expound further, on the termination of the construction contract, the claim for compensation automatically gets terminated too.

In the Dubai Court of Cassation, 17 June 2001, case 302/21: the court held that, ‘the delay penalty specified in the contract is considered as a penalty clause and is an ancillary obligation to the primary obligation. If the contract specifying the primary obligation, which is the completion of work has been terminated by the employer, shall lead to the ineffectiveness of the penalty clause. Thereby, the court shall not take into consideration the agreed amount of penalty, but rather, will award general or unliquidated damages, provided the tripartite test has been met by the parties.

Element of loss- High Federal Court, case 25/24 – 1 June 2004 (civil): the court interpreted the article 390 of the Civil Transactions Law and held that for the pre-fixed amount of compensation to be awarded, the element of loss must be established, apart from the breach of the obligation. On failure to establish any such actual loss incurred, the court may set aside the claim for compensation or the court may also sanction lesser damages equal to the actual loss; the burden of proof to establish in both the scenarios lies on the contractor. In practice, the court respects the parties’ agreement and would not uphold the penalty clause, except if there is an existence of strong evidence that such claim for damages exceeds the actual loss. Where the actual loss is more when compared to the agreed amount of compensation, the burden of proof lies on the employer to establish the same. In general, the court respects the claim for delay damages by the party invoking it and can sanction it, subject to the tripartite test and also if the party on whom such claim is invoked is successful in establishing that no loss has been incurred.

 

The official commentary on the Civil Codes also stated that, ‘for the purpose of application of the article 390 of the Civil Transactions Law, the part invoking the claim for compensation must be entitled to such claim of delay damages and where such compensation is not payable, it renders the article to be inoperative. The compensation payable should be equal to the damages incurred. In cases, where such compensation is more or less and not equal to the actual loss, the court may consider amending the amount of compensation claimed on the request of either of the parties.

 

Contractor’s right to claim for extension of time:

As a contractor, you have a right to claim for extension of time for in cases of reasonable circumstances which has caused the delay in the completion of the project. One of such reason is mentioned in the sub-clause 19.1 of the FIDIC red, yellow, silver books and also it has been specified in Article 273 of the Civil Transactions Law: Force Majeure or an ‘inevitable or exceptional event or circumstances’, the contractor can claim for extension of time with due procedures of  notifications to the employer or the concerned party of such reasons causing the delay. Circumstances which are beyond the party’s control, for instance, Act of God; where the party could not have reasonably perceived such circumstances before entering into the contract; where despite of party’s due diligence, such circumstance could not have been avoided or where the cause of such delay is due to the actions of the other party (untimely delivery or supply of products, delay in giving vital information). However, the FIDIC clause has not included epidemic or pandemic or a plague in the list of reasons under force majeure, but has only mentioned any natural catastrophic events.

 

In cases where the execution of the all the substantial works in been prevented for a period of eighty-four (84) days or more than one hundred and forty days (140) because of the force majeure events, then an entitlement to termination of the contract arises.However, article 273 of the Civil Transactions Law provides that on the impossibility of fulfilling the contractual obligations due to the force majeure events, the contract will be cancelled automatically. Where only there is partial impossibility of fulfilling the contractual obligation, the part which is not possible to be completed shall be extinguished. The Civil Transactions Code in article 249 further states that there is a difference between an unforeseeable emergency and force majeure, where such emergency prevents the contractual obligations from being fulfilled but, such emergency has not made the obligation impossible to be fulfilled, will not lead to the termination of the contract but rather the court or the arbitral tribunal can adjust or amend the contractual obligation.

 

Contractors’ right to receive compensation:

Article 894 of the Civil Transactions Law also provides for the right of contractor to receive the compensation equal to the value of work accomplished and expenses borne by him to carry out the performance, up to the amount of the benefit that the employer has derived from such work by the contractor, provided the contractor becomes incapable of completing the project for the reasons where he played no role in making such work impossible to complete. The remedies available on the breach of construction contracts may include a claim to receive actual or consequential damages or contractual damages as agreed; interim orders such as freezing the liquidation of performance bonds or cheques of the party liable. 

Sub-Contractors: As per article 890 (1) of the Civil Transactions Law, the main contractor has the right to delegate a whole or part of the work to another contractor (sub-contractor), except if he is prohibited or not allowed to do so as per the contract between the employer and him or where the nature of the work is such that only he can do it. It is also stipulated that a contractor shall not be allowed to delegate whole of the work to another contractor in clause 4.4 of the red book (1999) of the FIDIC. However, the contractor can still delegate the part of the works.The main contractor shall be accountable to the employer for the works delegated to the subcontractor. Clause 4.4 of the red book of the FIDIC, states that, ‘the contractor shall be responsible for the acts or defaults of any subcontractor, or his agents or his employees, and shall be deemed as the acts or defaults of the contractor; the same has been specified by the Civil Transactions Law in article 890 (2). 

The crux of the relationship between the employer, the main-contractor and the subcontractors is as follows: Generally the main-contractors, prefer to enter into back-to-back agreement with the subcontractor, which implies that due to the privity of contract between the employer and main contractor, the subcontractor, irrespective of if such subcontractor is selected by the employer or by the main contractor is not entitled to make any claim for payment against the employer; thereby, the main contractor shall be held accountable to the employer for the actions of the subcontractor. As per article 891 of the Civil Transactions Law, a subcontractor is not allowed to initiate a claim against an employer for all the amounts which are payable by the main contractor, unless the contract provides otherwise. Back-to-back contracts, reflects all the terms and conditions of the main contract between the employer and the main contractor and the main contractor generally prefers to include pay-if-paid terms in the contract with the subcontractors, therefore, it binds the subcontractors to receive money only when the main contractor has been paid the amount due unto him on completion of work by the employer. 

In the Court of Cassation number 281/95: the court has held that the subcontractor is entitled to receive payment for the completion of the work assigned to him and delivered the same to the main contractor, irrespective of it the main contractor has been paid by the employer.

In the Dubai’s Court of Cassation number 266/2008: the court held that article 890 of the Civil Transactions Law shall only be applicable to the domestic contractors selected by the main contractor but it cannot be made applicable to cases where the subcontractor has been nominated by the employer, even though the main contractor is person who has contract with the nominated subcontractors. Thereby the court held that if the delay is caused by the nominated subcontractor, then the main contractor shall not be held liable.Delay in construction projects is considered to be a barrier preventing the growth of the country’s economy. Therefore, inclusion of the penalty clause forces the contractor to comply with the time period for completing the project, lest the contractor is made liable to pay the compensations.

However, the COVID-19 has brought forth a tremendous halt in the completion of many major projects, but subject to the law, the contractor can seek for extension of time to finish the projects. The person who is most affected in cases of delay in the completion of the project is subcontractor, as most of the times the contract entered into between the main contractor and the sub-contractor includes pay-if-paid terms. Therefore, it is necessary that a subcontractor be mindful of the terms and conditions of the back-to-back agreements, to prevent falling into such a pit of not being paid for the completion of his part of work. Our law firm houses a team of efficient lawyers who have dealt with present construction related cases and will be able to provide expert guidance for all your construction claims.