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Contract Watch: Forfeiture Clauses

Contract Watch: Forfeiture Clauses

October, 2014
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Forfeiture’ or ‘liquidated damages’ clauses feature in many commercial agreements, and more commonly in joint venture contracts in the oil and gas exploration and construction sectors. They are common in GCC contracts but the approach differs to common law jurisdictions. Most construction contracts contain a provision for liquidated damages to be paid in the event of specific breaches by a contractor, which cause a delayed completion date. However, while courts in some common law jurisdictions, like the UK, will generally uphold a liquidated damages clause provided it doesn’t constitute a penalty, the enforceability of liquidated damages under UAE law is different. This may be because state courts use different terminology. They have described liquidated damages in a number of ways including ‘delay fines’, ‘penalty clauses’ or ‘consensual compensation’.

Using forfeiture clauses has advantages. In construction contracts, for example, they seek to benefit both parties by limiting the contractor’s liability as they are assured they are only liable to pay out a fixed sum for a specific breach. They can also save costs where it’s difficult and expensive for a company to show, prove or quantify, the actual damage sustained. To ensure enforcement by the courts, parties must ensure any clause is a genuine pre-estimate of the loss which may be sustained as opposed to a mere penalty which is designed to punish the defaulting party. The contract should also refer to a definite date from which damages can run and a party must make sure they have not waived their contractual right to claim liquidated damages. Parties should also properly assess the damage which may arise, like potential loss of revenue, financing fees, replacement rental, moving costs, holdover penalties or loss in productivity, to ensure liquidated damages are proportionate to the damage. However, one important thing to note is the position in the UK or US, is different in this area. There is a longstanding rule that UK courts will be reluctant to go against the parties’ agreement where the terms have been negotiated and agreed. So provided a party has made a genuine pre estimate and the liquidated damages directly relate to the loss, the court will enforce it. If, however, the damages are seen to be a penalty or are ‘extravagant’ or ‘unconscionable’, in common law jurisdictions the clause will not be enforced.

However, under Article 390 of Federal Law No. 5/1985, parties can agree and fix the amount of damage. It therefore appears a contractor may be able to plead they are not obliged to pay liquidated damages if they dispute the level of loss incurred by the company. Article 390(2) of Federal Law No. 5/1985 also allows the court to vary the parties’ agreement to reflect the actual loss suffered. Meanwhile, in the DIFC, the courts recognise and enforce liquidated damages provisions in agreements whether or not they are applying DIFC law or a different governing law, when they adjudicate on a dispute in line with DIFC Law No. 6/2004 and DIFC Law No. 7/2005. Despite the legislative differences, the DIFC courts adopt a broadly similar approach to the UAE courts and will try and whittle a specified, pre-agreed sum down to a reasonable amount, where it is grossly excessive or manifestly disproportionate to the actual resulting harm. In Oman, it is Article 267 of Oman Sultani Decree No. 29/2013 which has important implications for liquidated damages. Its general thrust clearly confirms the generally accepted position – the Omani courts may award liquidated damages if there is an adequate provision in the main agreement, provided they represent a reasonable forecast of the damages actually suffered by a party. The courts may also seek to re-open liquidated damages provisions and vary damages so they are commensurate with what has actually been sustained. A similar approach is taken in Saudi Arabia where the courts don’t award damages for loss of profits or those related to indirect or consequential losses. When Saudi courts adjudicate on a liquidated damages clause which seeks to compensate a contracting party  excessively, they are unlikely to uphold this provision even if it has been contractually agreed. In Qatar, under Article 265 of Qatar Law No. 2/2004, the parties may agree the level of liquidated damages in advance. The law draws no distinction between penalties and liquidated damages, so the parties can agree on the levy of penalties, should a breach arise. Despite this, however the Qatari courts are known to revisit, scrutinise and even alter liquidated damages clauses to ensure unjust enrichment is prevented.

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Published: September / October 2014
Publication: Lexis Nexis Middle East
Title: Law Alert: Forfeiture Clauses
Practice: Commercial
Authors: Mamoon Ashraf

 

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