Summary: In Unaoil Ltd v Leighton Offshore Offshore PTE Ltd, the High Court examined a number of issues arising from the breach of a memorandum of agreement: as well as claiming that Leighton should make certain advance payments, Unaoil claimed that it was owed $40m in liquidated damages, and further damages for loss of profits. The court’s judgment on the latter two points pushed the envelope in the law relating to both liquidated damages/penalty clauses and the calculation of damages.

What has happened?


In Unaoil Ltd v Leighton Offshore Offshore PTE Ltd, Unaoil Ltd (“Unaoil”) sued Leighton Offshore Offshore PTE Ltd (“Leighton”) for breaching a memorandum of agreement (“MOA”) by failing to appoint Unaoil as subcontractor for the construction of an oil pipeline in Iraq. Unaoil claimed certain advanced payments as a debt claim; liquidated damages of US$40m; and damages representing its loss of profits. Unaoil succeeded with its debt claim but the Court had to decide whether the liquidated damages clause was an unenforceable penalty, and how far they could go in assessing damages for loss of profits when there was little evidence to support Unaoil’s allegations.

Liquidated damages or unenforceable penalty?


The MOA provided for a fixed price of US$75m, and included a clause entitling Unaoil to liquidated damages of US$40m if Leighton breached the MOA. The parties subsequently amended the MOA to provide for Leighton to pay Unaoil “a minimum price… for construction and marketing of US$55 million…. an additional marketing fee of 5% on any amount that Leighton…receive[s] on the Project above US$500 million…Notwithstanding the above and for the avoidance of doubt the marketing fee paid to Unaoil shall not be less than US$25 million”.

It is generally accepted that the date for determining whether a clause is a penalty is the date of the contract and the Court held that the figure of US$40m was a genuine pre-estimate of loss when the contract was originally entered into. However, recognising that there was no authority on this point, the court decided that where a contract had been amended in a relevant respect, the appropriate date for this test was the date of amendment. The court held that the amendment of the contract price in the MOA was relevant to the assessment of whether the liquidated damages clause was a penalty. Pointing to the fact that Unaoil’s own evidence accepted that US$40m could not be a genuine pre-estimate of loss in light of the new contract price, the Court found that the provision was, on any objective view, extravagant and unconscionable, with the predominant function of deterring a breach of contract. It was therefore an unenforceable penalty.

Assessment of damages: a matter of guesswork?


The Court accepted that loss of profit should be assessed by taking the contract price and deducting the (putative) cost of performing the sub-contract works. In relation to the construction costs, the Court had sufficient evidence to come to a relatively easy conclusion that the loss of profit amounted to US$812,430. However, the Court had more difficulty regarding the support services element of the MOA, having very little evidence from which to assess the scale of support services that would have been required.

The Court quoted with approval Toulson LJ’s judgment in Parabola Investments Ltd and Another v Browallia CAL Ltd and others, in which he decided that this “involves a hypothetical exercise, [and] the court does not apply the same balance of probability approach as it would to the proof of past facts. Rather, it estimates the loss by making the best attempt it can to evaluate the chances, great or small (unless those chances amount to no more than remote speculation), taking all significant factors into account.” The Court held that just because it might be difficult to establish the loss of profits, that does not mean that the Court should not attempt to do the best it can. The Court went on to consider various arguments put forward as to what Unaoil’s loss of profit on the support services would have been, and arrived at a figure of US$5 million. The Court acknowledged that this figure was open to criticism but took comfort from the fact the overall loss of profit figure of US$5.8m was far below the US$12,577,500 awarded in the debt claim. Since Unaoil conceded that it would have to give credit for any sums recovered in its debt claim (so as to avoid double compensation), they received no further compensation in this regard.

Has this clarified the law on penalties?


The case makes it clear that where a contract is amended and the nature of the amendment is relevant to the consideration of whether a liquidated damages clause is enforceable, the assessment will be done at the date of the amendment, taking into account those amendments. While there was no previous authority for this, the decision is logical since it can be argued that where a contract is amended, it becomes a new bargain between the parties; and if that new bargain includes new provisions which would be relevant to the analysis of whether a clause contains a genuine pre-estimate of loss, then it is right that that exercise takes account of the new provisions.

In this respect, the case indicates that notwithstanding the judgment in El Makdessi v Cavendish Square Holdings BV and another, which indicated that Courts will be slow to strike down a liquidated damages clause as a penalty clause, there is still some scope for a challenge if the right factual circumstances exist. However, in this case it appears that Unaoil’s concession in evidence that the figure of US$40m could not be a genuine pre-estimate of loss after the amendment of the MOA assisted the Court in arriving at that conclusion.

Is your clause still valid?


When considering the amendment of a contract which contains a liquidated damages clause, you should consider how the amendments impact on that clause: what might have been valid when the contract was signed might become an unenforceable penalty once the contract is amended. This is particularly the case where the contract price is amended, either in absolute terms or because there is a change in the method of calculation of the price. In such circumstances, you should consider whether the liquidated damages clause should be amended too. At the very least, some analysis should be undertaken of the likely damages which would arise if the amended contract is breached, so there is some evidence to support the proposition that the liquidated damages figure remains a genuine pre-estimate of loss.

BLP Perspective


With regard to the analysis of a liquidated damages clause in an amended contract, the question which will arise in any future case is “has the contract been amended in a relevant respect?”. If the answer to that question is no then, notwithstanding an amendment, the relevant date for analysing whether the clause is a penalty will still be the date the contract was originally entered into, not the date of the amendment. Identifying what is a “relevant amendment” will be fact-sensitive and might change from contract to contract.

As regards damages for loss of profits, it is debateable whether the Court went too far when considering the calculation of Unaoil’s loss of profit for support services. The Court acknowledged that its decision was open to criticism, and it might have been emboldened to draw the conclusions it did because it knew that the judgment in the debt claim meant that practically speaking, the loss of profit judgment would not result in any further sums being paid over. However, the approach adopted must be better than the contrary approach, i.e. “it is too difficult to make a decision and so we will not do so”, and the breadth of the Court’s discretion in this regard should be a good incentive for parties to put their best evidence forward in support of a loss of profits claim.

This article was originally written and published on the internet by Berwin Leighton Paisner in October 2014.

 

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.

 

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