LAD (which stands for liquidated and ascertained damages) can be an important clause to take note of, especially if there are any losses which the employer is likely to incur if a project overruns.
The liquidated and ascertained damages (LAD) clause is an important part of a construction contract. It's designed to cover any predicted losses which might occur as a result of a project overrunning or being delayed.
An important thing to remember is that LAD is not a financial penalty and neither is it implemented as a punishment for a breach of construction contracts.
It’s actually a pre-agreed part of the contract itself between an employer and contractor. Now, it’s fair to say that delays can sometimes occur in construction projects.
It might be that there's a sourcing problem with some key materials. Perhaps there was an accident in construction that delays the entire process. These things do happen.
As such, ensuring the financial obligations of such delays are clear and recorded is just a smart part of construction contracts.
This clause sets out a predetermined estimate of any losses which the employer is likely to incur if a project overrun (read: takes longer than the agreed date).
Under the LAD clause, a sum of money is agreed which will be recovered by the employer for every day of delay beyond the agreed upon completion date.
Benefits Of LAD
LAD is an important part of construction law in Malaysia, as it helps to avoid unnecessary disputes around project overruns.
By agreeing in advance what that cost might be, it provides clarity to both employers and contractors on the financial cost of a project overrun.
On the side of the employer, it means they’re confident that they won’t lose out financially if the project does go beyond its agreed completion date.
The agreed contract means that at the point where this claim crystalises, it is already contractually agreed by both parties.
From a contractor's point of view, they understand in advance what the costs to their own business will be if they fail to deliver on time. That provides a clear financial calculation as to the potential cost of overruns.
How LAD Applies
LAD is not an automatic and legally required part of all construction contracts. Although, thankfully in standard contract law, it is almost always included!
If you’re buying a new development property in Malaysia, then the likelihood is that a LAD clause will appear in the Sale and Purchase Agreement (SPA).
This will essentially be a clause that outlines the process and financial implications if the project delivery is delayed.
If you’re buying a strata-titled property in Malaysia for example, then Schedule H, Clause 25 of the prescribed SPA notes that:
“25. (1) Vacant possession of the said Parcel shall be delivered to the Purchaser in the manner stipulated in clause 27 within thirty-six (36) months from the date of this Agreement.
(2) If the Developer fails to deliver vacant possession of the said Parcel in the manner stipulated in clause 27 within the period stipulated in subclause (1), the Developer shall be liable to pay to the Purchaser liquidated damages calculated from day to day at the rate of ten per centum (10%) per annum of the purchase price from the expiry of the period stipulated in subclause (1) until the date the Purchaser takes vacant possession of the said Parcel.”
In simple terms, that means a developer must deliver vacant possession within 36 months, or face paying compensation for the overrun.
It’s also worth noting here that a LAD does not limit the total compensation which a client receives from a contractor.
They can pursue legal remedies for additional costs, if they go above and beyond the compensation noted in the LAD clause of the contract.
Calculating The LAD clause
The cost of liquidated and ascertained damages can vary by contract, although there is a standard calculation for a SPA which can help guide your understanding.
In general terms, LAD takes into account a whole range of potential financial losses which a client might occur if the project is not delivered on time, such as:
- Loss of rent
- Loss of income
- Storage costs
- Additional rental costs
- Fees or fines from third parties
- Financing costs for loans etc
These are all foreseeable costs based on financial calculations which are made, given the promised completion date.
If, for example, a developer has rented out a commercial space to a third party from the 1st of January, but the project overruns by six months, then they have lost out on six months of agreed rent. Those are the type of calculations which LAD is designed to cover.
Now let’s take a look back at the case of stratified property in Malaysia. The standard clause stipulates that the developer shall owe compensation equivalent to 10% per annum of the property purchase price. Here’s a simple example:
SPA date = 01/07/2016
Completion date = 30/06/2019
Actual delivery of vacant possession = 31/08/2019
Days of delay (from 30/06/2019 to 31/08/2019) = 63 days
Purchase price (RM100,000) x interest (10%) x 63 days = RM1,726.03
Divided by 365
This clause relates to the point when the property is truly completed. The developer can’t throw the notice of vacant possession your way and say "DONE" if the building still has no roof!
The contract of completion is only fulfilled once the vacant possession is given and Certificate of Completion and Compliance (CCC) is issued.
Claiming LAD should be a fairly simple process. If a project runs beyond the agreed completion date before possession is given, then the clause is triggered.
A letter of demand to the developer stating the clause and agreed LAD rate should then result in the employer receiving payment.
But sometimes, not everything goes according to our wishes. If the developer fails to deliver on their obligation, then the client will have to take the developer to the Civil Court or through the Tribunal for Homebuyer Claims.
Let’s Talk About The 'Extension of Time'
You might be wondering what the relationship is between the LAD clause and the Extension of Time clause? Good question, indeed!
The Extension of Time clause is a mechanism whereby the developer can apply to have the completion date extended, if good reason is given. There are some obvious cases where that might happen:
- Government restrictions (recent COVID-19/MCO for example)
- Delays on project elements due to unforeseen circumstances
- Workforce problems through illness/injury
However, this Extension of Time is only designed to avoid additional financial penalties. It is unlikely to exempt the developer from payments as agreed under LAD.
A court ruling in the case of Cubic Electronics made in 2019 confirmed that contractors could not sidestep paying agreed compensation simply through applying for an Extension of Time.
The Case Of Cubic Electronics And LAD
The case of Cubic Electronics is actually really important for Malaysian construction law, so it’s worth taking a look at it as an example of how this damage clause can apply.
In Cubic Electronics vs. Mars Telecommunications Sdn Bhd, the court was asked to rule on the interpretation of section 75 of the Contracts Act 1950. Section 75 states:
When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.
That seems pretty simple right? If the contract states you pay, then you pay. There shouldn't be any hiccups to getting your rightful compensation.
But prior to the Cubic Electronics case, the courts had placed the burden of evidence on the claimant to prove the damages. In other words, you had to show you’d lost out.
Let’s take our simple example noted above. Client A and Contractor B have a contract to construct some shops. The contract states Contractor B will complete and hand over possession on 1st January.
Client A has rental agreements with third-parties to take possession of the shops from 1st January. Unfortunately, the project overruns by six months, causing loss of rental income for Client A.
In order to make a claim on LAD prior to this case, Client A would have to prove those rental agreements existed.
Following the Cubic case, the Federal Court indicates that reasonable compensation can be awarded, regardless whether losses or damages have been proven or not.
The burden of proof still does remain on the client to show that the breach of contract date has occurred.
If this is proven, it leads to triggering of agreed contractual payment. The contractor/developer will then have to dispute that claim and show it is unreasonable.
Partial Possession And Sectional Completion
Contracts MAY have a clause for partial possession or sectional completion, that can impact on liability under liquidated and ascertained damages in Malaysia.
These clauses essentially set out a point where one element of construction is complete, and possession can be handed over to the client, even though the full development is not yet finished!
This could, for example, be a large mixed development, where a commercial area of shops is complete and can be given over to the new owners, while a large mall section is still under construction.
Since the commercial shops are accessible, safe, and complete, then possession may be granted. In this case, partial possession or sectional completion clauses can enable handover of the property.
Since construction is ‘complete’ and possession has been transferred to the new owner, no obligation will be due under a LAD clause.
These can be complex contractual situations, and a clearly defined contract which sets out obligations around completion dates and LAD liability is vital.
Comparing The Damage
Remember folks: Liquidated and ascertained damages, despite the name, are not defined as a ‘penalty’ clause!
It’s an agreed compensation for costs incurred by the client as a result of the developer not delivering on an agreed completion date. So how does that compare to general damages?
General damages are a claim against losses caused by the contractor failing to meet their obligations.
Unlike LAD, general damages are not predetermined, meaning they need to be quantified and evidenced at the point of claim.
LAD clauses benefit from a pre-agreed value of the claim, based on the time overrun of a project. That’s a simple, and agreed, calculation which is relatively easy to administer and deliver.
General damages, on the other hand, often include lengthy and complex negotiations, and sometimes even legal disputes.
There’s an obligation on the buyer/client to prove all losses, which the contractor can then dispute.
LAD clauses are designed to save time, avoid disagreement, and provide certainty upfront. General damages are a more complex, and often more confrontational process, to recover costs. And after all, we all want a little bit of certainty in our lives!
This article was contributed by PropertyGuru.