Levy of Liquidated Damages and Risk-cost execution of work

In a recent decision reported as J.G. Engineers Private Limited v. Union of India,

(2011) 5 SCC 758, the Hon’ble Supreme Court has delivered a landmark
judgment, which will go a long way in minimizing the problems of contractors.
Heretofore, the matter with regard to dispute regarding liquidated damages was
not open to adjudication before an arbitral tribunal because of the opening words
in standard form arbitration clauses: “Except where otherwise provided….”. The
Supreme Court had earlier in a matter reported as Vishwa Nath Sood v. Union of
India, AIR 1989 SC 952 had held that such matters on which the decision of an
authority was final and binding could not be adjudicated upon in arbitration.

On the basis of the said judgment, for as long as 21 years the contractors had
been denied recourse to arbitration when it came to claim for liquidated
damages. The only course open to the contractor in such a case was to file a suit
in a court of law claiming money since realized from him by way of liquidated
damages by the employer. In many cases, contractors would not even think of
going to the court to file a suit against the employer and those who knocked at
the door of the court sometimes got relief while on other occasions failed to get
relief since the matter involved concerned technical issues and courts could not
properly appreciate the same. Now when the same matter is under the
consideration of those arbitral tribunal which are aware of the technicalities of the
matter involved, they would be able to do justice to the parties, taking into
consideration the ground realities.

The standard clause in works contracts provided for levy of liquidated damages
as well as rescinding the contract and getting the work executed at the risk and
cost of the contractor and the same read as follows:

“Clause (2)
“The time allowed for carrying out the work as entered in the tender shall
be strictly observed by the contractor and shall be deemed to be essence
of the contract and shall be reckoned from the tenth day after the date on
which the order to commence the work is issued to the contractor. The
work shall throughout the stipulated period of the contract be proceeded
with all due diligence and the contractor shall pay as compensation an
amount equal to one per cent or such smaller amount as the
Superintending Engineer (whose decision in writing shall be final) may
decide on the amount of the estimated cost of the whole work as shown in
the tender, for every day that the work remains uncommenced or
unfinished after the proper dates. And further to ensure good progress
during the execution of the work, the contractor shall be bound in all cases
in which the time allowed for any work exceeds one month (save for
special jobs) to complete one-eighth of the whole of the work before one-
fourth of the whole time allowed under the contract has elapsed, three-
eighths of the works before one-half of such time has elapsed and three-
fourths of the work before three-fourths of such time has elapsed. However
for special jobs if a time schedule has been submitted by the contractor
and the same has been accepted by the Engineer-in-charge. The
contractor shall comply with the said time schedule. In the event of the
contractor failing to comply with this condition, he shall be liable to pay as
compensation an amount equal to one per cent or such small amount as
the Superintending Engineer (whose decision in writing shall be final) may
decide on the said estimated cost of the whole work for every day that the
due quantity of work remains incomplete. Provided always that the entire
amount of compensation to be paid under the provisions of this clause
shall not exceed ten per cent, on the estimated cost of the work as shown
in the tender.”

“Clause (3)
“The Engineer-in-charge may without prejudice to his right against the
contractor in respect of any delay or inferior workmanship or otherwise or
to any claims for damage in respect of any breaches of the contract and
without prejudice to any rights or remedies under any of the provisions of
this contract or otherwise and whether the date of completion has or has
not elapsed by notice in writing absolutely determine the contract in any of
the following cases:

(i) If the contractor having been given by the Engineer-in-charge a

notice in writing to rectify, reconstruct or replace any defective work or
that the work is being performed in any inefficient or other improper or
unworkmanlike manner, shall omit to comply with the requirements
of such notice for a period of seven days thereafter or if the contractor
shall delay or suspend the execution of the work so that either in the
judgment of the Engineer-in-charge (whose decision shall be final and
binding) he will be unable to secure completion of the work by the date
of completion or he has already failed to complete the work by that
date….

(ii) (not relevant)

(iii) If the contractor commits breach of any of the terms and conditions
of this contract.

(iv) If the contractor commits any acts mentioned in Clause (21) hereof.
 When the contractor has made himself liable for action under any of the
cases aforesaid, the Engineer-in-charge on behalf of the President of
India shall have powers:
(a) To determine or rescind the contract as aforesaid (of which
termination or rescission notice in writing to the contractor under the
hand of the Engineer-in-charge shall be conclusive evidence) upon
such determination or rescission the security deposit of the contractor
shall be liable to be forfeited and shall be absolutely at the disposal of
the Government.

(b) (not relevant)

(c) After giving notice to the contractor to measure up the work of the
contractor and to take such part thereof as shall be unexecuted out of
his hands and to give it to another contractor to complete in which case
any expenses which may be incurred in excess of the sum which would
have been paid to the original contractor if the whole work had been
executed by him (of the amount of which excess the certificate in writing
of the Engineer-in-charge shall be final and conclusive) shall be borne
and paid by the original contractor and may be deducted from any
money due to him by the Government under this contract or on any
other account whatsoever or from his security deposit or the proceeds
of sales thereof or a sufficient part thereof as the case may be.”

From the foregoing it would be clear that the Engineer-in-charge had been given
an unfettered power by the contract to take action against the contractor in the
event the work being delayed beyond what had been agreed to between the
parties. In certain cases, milestones had been fixed and the contractor was also
made liable to pay the liquidated damages in the event of failure to achieve the
agreed milestones.

In many cases, contractors had been representing that the work had got delayed
not on account of any factors attributable to him but on account of failure on the
part of the employer to fulfill its obligations as enshrined in the contract
agreement between the parties. It is worth mentioning that no Engineer-in-charge
would own responsibility for fear of being held accountable by the higher
authorities. In fact, there would be objections from the Audit as well as from the
higher authorities as to why the Engineer-in-charge failed to levy liquidated
damages when the work could not be executed in terms of the contract.
The question of rescinding the contract was another important point which called
for urgent attention of the Engineer-in-charge. Rescinding of contract should be
the last resort because it is very seldom that the employer is able to realize the
risk-cost expense involved. It is for this reason that the CPWD has omitted from
the contract, clause relating to risk and cost. However, CPWD invokes the bank
guarantees available with it in the form of security deposit and performance
guarantee.

The Supreme Court interpreted Clauses 2 and 3 as under:

“Clauses (2) and (3) of the contract relied upon by the respondents
no doubt make certain decisions by the Superintending Engineer
and Engineer-in-charge final/final and binding/final and conclusive,
in regard to certain matters. But the question is whether Clauses (2)
and (3) of the agreement stipulate that the decision of any authority
is final in regard to the responsibility for the delay in execution and
consequential breach and therefore exclude those issues from being
the subject-matter of arbitration. We will refer to and analyse each of
the “excepted matters” in Clauses (2) and (3) of the agreement to
find their true scope and ambit:

“(i) Clause (2) provides that if the work remains uncommenced or

unfinished after proper dates, the contractor shall pay as
compensation for every day's delay an amount equal to 1% or such
small amount as the Superintending Engineer (whose decision in
writing shall be final) may decide on the estimated cost of the whole
work as shown in the tender. What is made final is only the decision
of the Superintending Engineer in regard to the percentage of
compensation payable by the contractor for every day's delay, that
is, whether it should be 1% or lesser. His decision is not made final
in regard to the question as to why the work was not commenced on
the due date or remained unfinished by the due date of completion
and who was responsible for such delay.

“(ii) Clause (2) also provides that if the contractor fails to ensure
progress as per the time schedule submitted by the contractor, he
shall be liable to pay as compensation an amount equal to 1% or
such smaller amount as the Superintending Engineer (whose
decision in writing shall be final) may decide on the estimated cost of
the whole work for every day the due quantity of the work remains
incomplete, subject to a ceiling of ten per cent. This provision makes
the decision of the Superintending Engineer final only in regard to
the percentage of compensation (that is, the quantum) to be levied
and not on the question as to whether the contractor had failed to
complete the work or the portion of the work within the agreed time
schedule, whether the contractor was prevented by any reasons
beyond its control or by the acts or omissions of the respondents,
and who is responsible for the delay.

“(iii) The first part of Clause (3) provides that if the contractor delays
or suspends the execution of the work so that either in the judgment
of the Engineer-in-charge (which shall be final and binding), he will
be unable to secure the completion of the work by the date of
completion or he has already failed to complete the work by that
date, certain consequences as stated therein, will follow. What is
made final by this provision is the decision of the Engineer-in-charge
as to whether the contractor will be able to secure the completion of
the work by the due date of completion, which could lead to the
termination of the contract or other consequences. The question
whether such failure to complete the work was due to reasons for
which the contractor was responsible or the Department was
responsible, or the question whether the contractor was justified in
suspending the execution of the work, are not matters in regard to
which the decision of the Engineer-in-charge is made final.

“(iv) The second part of Clause (3) of the agreement provides that
where the contractor had made himself liable for action as stated in
the first part of that clause, the Engineer-in-charge shall have
powers to determine or rescind the contract and the notice in writing
to the contractor under the hand of the Engineer-in-charge shall be
conclusive evidence of such termination or rescission. This does not
make the decision of the Engineer-in-charge as to the validity of
determination or rescission, valid or final. In fact it does not make
any decision of the Engineer-in-charge final at all. It only provides
that if a notice of termination or rescission is issued by the Engineer-
in-charge under his signature, it shall be conclusive evidence of the
fact that the contract has been rescinded or determined.

“(v) After determination or rescission of the contract, if the Engineer-

in-charge entrusts the unexecuted part of the work to another
contractor, for completion, and any expense is incurred in excess of
the sum which would have been paid to the original contractor if the
whole work had been executed by him, the decision in writing of the
Engineer-in-charge in regard to such excess shall be final and
conclusive, shall be borne and paid by the original contractor. What
is made final is the actual calculation of the difference or the excess,
 that is, if the value of the unexecuted work as per the contract with
the original contractor was Rs. 1 lakh and the cost of getting it
executed by an alternative contractor was Rs. 1,50,000 what is
made final is the certificate in writing issued by the Engineer-in-
charge that Rs. 50,000 is the excess cost. The question whether the
determination or rescission of the contractor by the Engineer-in-
charge is valid and legal and whether it was due to any breach on
the part of the contractor, or whether the contractor could be made
liable to pay such excess, are not issues on which the decision of
Engineer-in-charge is made final.

“Thus what is made final and conclusive by Clauses (2) and (3) of
the agreement, is not the decision of any authority on the issue
whether the contractor was responsible for the delay or the
Department was responsible for the delay or on the question
whether termination/rescission is valid or illegal. What is made final,
is the decisions on consequential issues relating to quantification, if
there is no dispute as to who committed breach. That is, if the
contractor admits that he is in breach, or if the arbitrator finds that
the contractor is in breach by being responsible for the delay, the
decision of the Superintending Engineer will be final in regard to two
issues. The first is the percentage (whether it should be 1% or less)
of the value of the work that is to be levied as liquidated damages
per day. The second is the determination of the actual excess cost in
getting the work completed through an alternative agency. The
decision as to who is responsible for the delay in execution and who
committed breach is not made subject to any decision of the
respondents or its officers, nor excepted from arbitration under any
provision of the contract.

“In fact the question whether the other party committed breach
cannot be decided by the party alleging breach. A contract cannot
provide that one party will be the arbiter to decide whether he
committed breach or the other party committed breach. That
question can only be decided by only an adjudicatory forum, that is,
a court or an Arbitral Tribunal.”

It was also held by the Hon’ble Supreme Court that if the contractor was not at
fault or contributing towards the delay and the delay had occurred only on
account of omissions and commissions on the part of the employer, then the
provisions which make the decision of the Engineer-in-Charge final and
conclusive would be irrelevant. Thus, the arbitrator has been vested with the
power to try and decide all the claims of the contractor as well as that of the
Employer.

It was also held by the Hon’ble Supreme Court that after having granted
extension of time without levy of liquidated damages, the Engineer-in-charge
looses the right to levy liquidated damages for that period for which extension
had already been given.

As per the dictum of the Supreme Court, once the arbitrator records a finding on
the basis of material available before him that the contractor was not responsible
for the delay and that the termination was wrong, then it would be the employer
who would be liable for the consequences arising out of wrongful termination of
contract. Therefore, all the claims which the Employer might have filed before the
arbitrator would not be awarded in its favour.