Construction Contracts: Can Liquidated Damages Clauses Be Unfair?
Liquidated Damages in Construction Contracts: When Are They Unfair or Unenforceable?
Liquidated damages clauses are a common feature of construction contracts. They allow a principal to recover an agreed amount where a contractor fails to achieve practical completion by the contractual completion date.
However, the inclusion of a liquidated damages clause does not necessarily mean that it will be enforceable.
While disputes concerning liquidated damages have traditionally focused on whether the amount constitutes an unenforceable penalty, there is another important consideration: whether the clause is unfair under the Australian Consumer Law (ACL).
This is particularly relevant to contractors and subcontractors entering into standard form construction contracts, where liquidated damages provisions may operate alongside strict extension of time requirements, broad principal discretions and other provisions that substantially increase the contractor’s exposure to delay-related claims.
Importantly, a liquidated damages clause may raise concerns under the unfair contract terms regime even where the amount stipulated is not an unenforceable penalty.
When can liquidated damages clauses be challenged?
The enforceability of a liquidated damages clause may be challenged on several grounds, depending on the terms of the construction contract and the circumstances of the delay.
In particular, questions may arise as to whether:
- The clause constitutes an unenforceable penalty;
- The clause is unfair under the Australian Consumer Law;
- The contractual requirements for liquidated damages have been satisfied; or
- The contractor has an entitlement to an extension of time that affects the principal’s claim.
These issues involve different legal principles. A clause may survive a challenge under the penalties doctrine but nevertheless be susceptible to challenge under the unfair contract terms provisions.
When do the unfair contract terms provisions apply?
The unfair contract terms provisions are contained in Part 2-3 of the ACL, which forms Schedule 2 to the Competition and Consumer Act 2010 (Cth).
The provisions apply to standard form consumer contracts and small business contracts, subject to certain statutory exclusions.
For contracts entered into or renewed on or after 9 November 2023, a small business contract will generally be covered where at least one party employs fewer than 100 people or has an annual turnover of less than $10 million.
Unlike the previous regime, there is no general contract value threshold for small business contracts under the ACL.
In the construction industry, these protections may apply to contracts between:
- Principals and head contractors;
- Head contractors and subcontractors; and
- Builders and other businesses engaged to undertake construction-related works.
The fact that a contract relates to a substantial construction project does not, of itself, exclude the operation of the unfair contract terms provisions.
Is the construction contract a standard form contract?
Under section 27 of the ACL, whether a contract is a standard form contract depends on a range of considerations, including:
- Whether one party possesses substantially greater bargaining power;
- Whether the contract was prepared before negotiations commenced;
- Whether the other party was effectively required to accept or reject the terms presented;
- Whether there was a genuine opportunity to negotiate the contractual terms;
- Whether the terms take account of the particular characteristics of the other party or transaction; and
- Whether the party preparing the contract has used the same or substantially similar terms in other contracts.
Importantly, the fact that some provisions were negotiated or amended does not necessarily prevent a contract from being characterised as a standard form contract.
This is particularly relevant in construction projects, where principals and head contractors frequently use standard general conditions supplemented by project-specific schedules, special conditions and amendments.
A contractor may therefore have negotiated the contract price, scope of works and completion date without necessarily having had a genuine opportunity to negotiate the provisions allocating liability for delay.
What makes a contract term unfair?
Under section 24 of the ACL, a contractual term is unfair if:
- It would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
- It is not reasonably necessary to protect the legitimate interests of the party advantaged by the term; and
- It would cause detriment, whether financial or otherwise, to another party if applied or relied upon.
All three requirements must be satisfied.
Importantly, a term is presumed not to be reasonably necessary to protect the legitimate interests of the party benefiting from it unless that party establishes otherwise.
In determining whether a term is unfair, the Court must also consider the contract as a whole and the extent to which the term is transparent.
Section 25 of the ACL identifies examples of terms that may be unfair, including provisions that penalise one party, but not another, for breaching or terminating a contract.
However, the fact that a provision imposes a financial consequence on only one party does not automatically render it unfair. The question is whether the term satisfies the statutory test when considered in its contractual context.
The High Court’s approach to unfair contract terms
The application of the unfair contract terms regime was considered by the High Court in Karpik v Carnival plc [2023] HCA 39.
In that case, the High Court held that a class action waiver contained in a standard form consumer contract was unfair and therefore void under section 23 of the ACL.
The decision demonstrates the importance of examining whether a contractual provision creates a significant imbalance in the parties’ rights and obligations, whether it is reasonably necessary to protect legitimate interests and whether it would cause detriment if relied upon.
Although Karpik did not concern a construction contract, the statutory principles are relevant when considering whether a liquidated damages clause, or another provision affecting a contractor’s exposure to delay-related liability, is unfair.
Can a liquidated damages clause be unfair?
A principal will ordinarily have a legitimate commercial interest in ensuring that construction works are completed within the agreed timeframe.
Delay may expose a principal to financing costs, additional project expenses, lost revenue, disruption to subsequent works and other financial consequences.
A properly drafted liquidated damages clause can protect those interests by providing certainty about the financial consequences of delay.
However, the fact that a principal has a legitimate interest in recovering delay-related losses does not mean that every provision imposing liquidated damages will be reasonably necessary to protect that interest.
The critical issue is not simply the amount of liquidated damages payable, but how the clause operates within the contract as a whole.
1. Liquidated damages for delays outside the contractor’s control
A clause may raise concerns where the contractor is exposed to liquidated damages for delays that it did not cause or could not reasonably prevent.
For example, a contractor may be delayed by:
- The principal’s failure to provide access to the site;
- Late instructions, approvals or design information;
- Variations directed by the principal;
- Delays caused by other contractors engaged by the principal; or
- Circumstances for which the contractor has limited or no contractual entitlement to an extension of time.
The allocation of these risks is a legitimate subject of commercial negotiation.
However, where a standard form contract places extensive delay risk on one party without adequate contractual protections, questions may arise as to whether that allocation creates a significant imbalance in the parties’ rights and obligations.
2. Strict extension of time requirements
Liquidated damages provisions should not be considered independently of the contract’s extension of time regime.
A contract may provide that a contractor loses its entitlement to an extension of time unless it gives notice within a specified period, even where the delay is attributable to the principal.
For example, a contractor may be required to notify the principal of a delay within 2 business days, failing which its entitlement to an extension of time is lost.
If the contractor is then exposed to substantial liquidated damages despite the delay having been caused by the principal, the combined operation of those provisions may warrant scrutiny.
Strict notice requirements are not inherently unfair. They can serve legitimate purposes, including allowing a principal to investigate delays, assess their consequences and take steps to mitigate loss.
The question is whether their operation goes further than reasonably necessary to protect those interests, having regard to the contract as a whole.
3. Broad discretion to grant or refuse extensions of time
Another consideration is whether the principal or superintendent has broad discretion to determine a contractor’s entitlement to an extension of time.
Particular concerns may arise where the contract:
- Permits the principal to determine extension of time claims without sufficiently defined criteria;
- Gives the principal an unrestricted discretion to reject or reduce an extension of time;
- Allows the principal to extend time for completion but imposes no obligation to consider doing so in circumstances where the principal caused the delay; or
- Otherwise creates a substantial imbalance between the parties’ respective rights concerning delay.
Whether such provisions are unfair will depend on their precise wording, the protections available elsewhere in the contract and the legitimate interests they are intended to protect.
4. Uncapped or disproportionate exposure to liquidated damages
A liquidated damages clause may also warrant scrutiny where the contractor’s potential liability is substantial or effectively unlimited.
Relevant considerations include:
- The amount payable for each day or week of delay;
- The commercial interests the liquidated damages rate is intended to protect;
- Whether there is a contractual cap on liability;
- The circumstances in which liquidated damages cease to accrue; and
- Whether the contract permits additional recovery for the same delay.
An uncapped liquidated damages provision is not automatically unfair.
However, where the potential liability is substantial and the contractual allocation of risk is heavily one-sided, the provision may be more vulnerable to challenge under the ACL.
5. Multiple consequences arising from the same delay
A further issue arises where the contract imposes several financial consequences for the same delay.
For example, a principal may seek to:
- Deduct liquidated damages from progress payments;
- Have recourse to security;
- Recover additional delay-related losses; and
- Exercise termination rights arising from the contractor’s failure to achieve completion.
These remedies are not necessarily inconsistent or unfair.
However, the combined operation of the relevant provisions should be examined to determine whether they expose the contractor to overlapping or disproportionate consequences.
A contract that allows recovery beyond the interests the relevant provisions are intended to protect may raise concerns under the unfair contract terms regime.
How have Australian courts approached unfair terms in construction contracts?
Australian courts and tribunals have considered the application of the unfair contract terms provisions to building and construction contracts.
Although the following decisions did not determine whether a liquidated damages provision was unfair, they provide useful guidance on how the regime may apply to construction contracts.
Perera v Bold Properties (Qld) Pty Ltd [2023] QDC 99
In Perera v Bold Properties (Qld) Pty Ltd [2023] QDC 99, the Queensland District Court considered a provision in a residential building contract that permitted the builder to increase the contract price at its sole discretion where construction had not commenced by the anticipated commencement date.
The builder sought to increase the contract price by approximately $51,000.
The Court found the relevant special condition unfair under the ACL.
Of particular significance was the builder’s broad discretion to increase the contract price without objective criteria or a transparent method for calculating the increase. The provision created a significant imbalance in the parties’ contractual rights and exposed the owners to financial detriment.
Although the case concerned a price escalation provision rather than liquidated damages, it demonstrates that contractual provisions conferring substantial unilateral financial rights may be vulnerable to challenge under the unfair contract terms regime.
The decision is particularly relevant when considering liquidated damages provisions that operate alongside broad principal discretions or other provisions imposing substantial financial exposure on the contractor.
Maco Group Pty Ltd v Johns Lyng Commercial Builders Pty Ltd [2019] VCAT 1815
The potential application of the unfair contract terms regime to commercial construction subcontracts was considered in Maco Group Pty Ltd v Johns Lyng Commercial Builders Pty Ltd [2019] VCAT 1815.
The dispute arose under a construction subcontract containing a provision requiring the subcontractor to provide security for costs equivalent to 10% of the amount claimed before pursuing the contractual dispute resolution process.
The Victorian Civil and Administrative Tribunal observed that the subcontract appeared to satisfy the definition of a small business contract and that it was arguable the contract was a standard form contract.
The Tribunal also observed that the security for costs requirement appeared to fall within an example of a potentially unfair term identified in section 25 of the ACL.
Importantly, the Tribunal did not determine that the provision was unfair, as the issue had not been formally advanced by the subcontractor.
Nevertheless, the decision illustrates the potential application of the unfair contract terms regime to commercial construction subcontracts, particularly where contractual provisions impose significant financial or procedural burdens on one party.
Together, Perera and Maco Group demonstrate the importance of examining the substance and practical operation of contractual provisions, rather than assuming that terms are enforceable merely because they have been incorporated into a signed construction contract.
Liquidated damages and penalties: What is the difference?
The unfair contract terms provisions operate separately from the common law concerning contractual penalties.
A liquidated damages clause may be unenforceable as a penalty where the detriment imposed is out of all proportion to the legitimate interests the clause is intended to protect.
The amount stipulated does not need to correspond precisely with the loss ultimately suffered. The law recognises that a party may have legitimate commercial interests extending beyond compensation for readily quantifiable financial loss.
The High Court’s decision in Paciocco
In Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28, the High Court considered whether credit card late payment fees constituted unenforceable penalties.
The majority held that the fees were not penalties.
The decision confirms that the enforceability of a contractual payment provision under the penalties doctrine is not determined solely by comparing the stipulated amount with the loss ultimately suffered.
The relevant inquiry extends to the legitimate interests the provision is intended to protect, which may include interests beyond compensation for loss directly resulting from the breach.
Accordingly, a liquidated damages provision will not necessarily constitute an unenforceable penalty merely because the amount payable exceeds the loss ultimately established.
However, whether the provision constitutes a penalty is a separate question from whether it is unfair under the ACL.
Why the distinction matters
The unfair contract terms regime examines whether the provision causes a significant imbalance in contractual rights and obligations, whether it is reasonably necessary to protect legitimate interests and whether it would cause detriment if applied or relied upon.
A liquidated damages rate may be commercially justifiable and therefore not constitute an unenforceable penalty, but the provision may nevertheless raise concerns under the ACL because of its interaction with other contractual terms.
For example, a daily liquidated damages rate may be reasonable when considered in isolation. However, if the contractor is exposed to that rate for delays caused by the principal and has no effective contractual mechanism for obtaining an extension of time, the overall arrangement may warrant examination under the unfair contract terms provisions.
Accordingly, the enforceability of a liquidated damages provision may require consideration of both legal regimes.
For further information about liquidated damages, extensions of time and delay claims in construction contracts, see our Variations, Delay and Latent Condition Claims page.
What happens if a liquidated damages clause is unfair?
Under section 23 of the ACL, an unfair term in a standard form consumer or small business contract is void.
This means the term cannot be enforced, although the remainder of the contract will continue to operate if it is capable of doing so without the unfair provision.
The consequences may extend beyond the unenforceability of the term.
Since 9 November 2023, businesses can also face substantial financial penalties for proposing unfair terms in relevant standard form contracts or applying, relying on, or purporting to apply or rely on those terms.
Each unfair term may give rise to a separate contravention.
The reforms therefore create significant risks for businesses that continue to use potentially unfair provisions in their standard form construction contracts.
It is important to recognise, however, that the ACL does not automatically invalidate an entire liquidated damages regime merely because one related provision is unfair. The consequences will depend on the particular term, the structure of the contract and any orders made by the Court.
What should principals, contractors and subcontractors consider?
The enforceability of a liquidated damages clause should be assessed before the contract is executed, rather than only after a dispute arises.
For principals and head contractors, this means ensuring that liquidated damages provisions are commercially justified, clearly drafted and appropriately integrated with the contract’s broader delay and extension of time regime.
It is also prudent to retain records explaining how the liquidated damages rate was determined and the commercial interests it was intended to protect.
For contractors and subcontractors, particular attention should be given to:
- The circumstances in which liquidated damages become payable;
- The contractual date for practical completion and how it may be adjusted;
- The grounds and procedures for claiming extensions of time;
- Strict notice requirements and the consequences of non-compliance;
- The treatment of principal-caused delay;
- The discretion afforded to the principal or superintendent;
- Any cap on liquidated damages or overall contractual liability; and
- The interaction between liquidated damages, security, set-off, termination and other remedies.
A liquidated damages clause that appears reasonable in isolation may operate very differently when read together with the contract’s other provisions.
The allocation of delay risk must therefore be assessed as a whole.
Can you challenge a liquidated damages claim?
Where a principal seeks to recover liquidated damages, the contractor should not assume that the amount claimed is necessarily recoverable merely because it is expressly provided for in the contract.
Depending on the circumstances, it may be necessary to consider:
- Whether the contractual requirements for liquidated damages have been satisfied;
- Whether the contractor has an entitlement to an extension of time;
- Whether the principal’s conduct affected the contractor’s ability to achieve completion;
- Whether the clause constitutes an unenforceable penalty; and
- Whether the liquidated damages provision, or another term affecting its operation, is unfair under the ACL.
Not every contractor will be entitled to rely on the unfair contract terms provisions, and not every commercially onerous clause will be unfair.
However, where a standard form contract exposes a contractor to substantial delay-related liability, the ACL may provide an additional basis upon which the relevant contractual provisions can be examined.
How Dark Legal can assist
Liquidated damages disputes can involve significant financial exposure, particularly where the contract contains strict extension of time requirements, broad principal discretions or provisions that transfer substantial delay risk to the contractor.
At Dark Legal, we advise and represent principals, contractors and subcontractors in building and construction matters, including disputes concerning liquidated damages, delay claims, extensions of time, contractual penalties and unfair contract terms.
We assist clients with reviewing and negotiating construction contracts, assessing the enforceability of contractual provisions, pursuing and defending liquidated damages claims, and resolving disputes arising from project delays.
Whether you are entering into a construction contract, seeking to enforce a liquidated damages provision or responding to a claim for delay, contact Dark Legal to obtain advice on your contractual rights, available options and the most appropriate strategy.
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