What Are Liquidated Damages?
Liquidated damages are damages or compensation whose amount has been agreed and determined in advance by the parties in a contract before the agreement is signed. Such amount becomes payable by the party in breach of the contract (wanprestasi), commonly as a result of a delay in completing the works. Under Articles 1239 and 1243 of the Indonesian Civil Code liquidated damages may be understood as a form of compensation determined and agreed upon by the parties from the outset of the contractual relationship. With such a provision, the party seeking compensation generally needs to establish the occurrence of a contractual breach and the satisfaction of the conditions required under the contract, without necessarily having to separately calculate and prove the exact amount of actual loss incurred. This mechanism differs from a claim for damages arising from an unlawful act under Article 1365 of the Indonesian Civil Code, as liquidated damages arise from a breach of contractual obligations agreed upon by the parties.
How Do Liquidated Damages Work?
One way in which a construction contract allocates risk in the event of project delays is through a liquidated damages clause. The amount or rate of liquidated damages is agreed upon from the outset and clearly stated in the contract, for example, as a certain percentage of the contract value for each day of delay. With such a provision, the party suffering the breach generally does not need to separately prove the exact amount of actual loss incurred, provided that the party can establish the occurrence of a contractual breach and that the requirements for applying the clause have been satisfied. However, liquidated damages are generally intended to provide compensation for potential losses rather than to operate as punitive damages. Therefore, the agreed amount should have a reasonable basis and reflect an estimate of the losses that may arise from the contractual breach.
In construction contracts, liquidated damages are generally calculated based on a formula agreed upon by the parties. For example, a project may have a contract value of IDR 100 billion, with a liquidated damages provision of 0.1% of the contract value for each day of delay. However, the application of liquidated damages does not depend solely on mathematical calculation. The parties should consider several important elements of the clause, including the trigger event, which determines the event or condition that causes liquidated damages to become applicable; the calculation method, whether calculated on a daily or monthly basis; notice requirements; Extension of Time (EOT) provisions; force majeure provisions; and other relevant contractual terms. Therefore, before imposing or responding to a liquidated damages claim, the parties should review the contract as a whole and examine the circumstances that caused the delay. An accurate calculation should be based not only on the number of days of delay, but also on which party is responsible for the delay and whether there is a contractual basis for an Extension of Time or any applicable exemption.
Common Drafting Mistakes in Liquidated Damages Clauses
A liquidated damages clause that is not clearly drafted may lead to different interpretations and increase the risk of disputes in the future. Common drafting mistakes include failing to clearly establish when liquidated damages begin to apply, failing to provide a measurable calculation method, failing to specify a maximum cap, and failing to address the relationship between delay, Extension of Time (EOT), and force majeure. Provisions concerning notice procedures, deadlines for submitting claims, and circumstances that may exclude or reduce the obligation to pay liquidated damages should also be drafted consistently with the other provisions of the contract.
Mistakes in drafting these provisions may create uncertainty regarding the rights and obligations of the parties, particularly when a construction project experiences delays. Therefore, a liquidated damages clause should be drafted by taking into account the characteristics of the project, the allocation of contractual risks, the applicable dispute resolution mechanism, and the laws and regulations applicable in Indonesia.
Need Legal Advice on a Construction Contract or Liquidated Damages Clause?
If your company is entering into a construction contract, dealing with project delays, or facing a liquidated damages claim, obtaining legal advice at an early stage can help clarify contractual rights, obligations, and potential liabilities.
Schinder Law Firm provides legal services to assist clients with various aspects of construction law, including Construction Contract Drafting and Review, Legal Opinions, Contractual Risk Assessment, Liquidated Damages Claims, Extension of Time, Construction Disputes, and Negotiation, Mediation, and Arbitration. For further information or legal assistance, please contact Schinder Law Firm at info@schinderlawfirm.com for further consultation.
Author:
Budhi Satya Makmur