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Danger of accepting penalty for late completion in subcontract

Danger of accepting penalty for late completion in subcontract

By Edwin Giesteira

The JBCC suite of documents makes no provision for penalties and clearly stipulates for damages for any failure to meet completion dates. There is very good reason for this and some brief thoughts follow to assist subcontractors in understanding the difference.

The International Federation of Consulting Engineers (FIDIC) subcontract does not provide for an alternative to penalties, but allows for capping the potential delay damages for which a subcontractor is liable. The reasoning behind such capping lies in the requirement that a contractor cannot just sit back and allow a default to continue unchecked, but must mitigate its damages by taking the steps available to the contractor by bringing in others to rectify the defective performance. The capping, therefore, provides additional justification for taking any such steps as early as possible.

The NEC3 Engineering and Construction Subcontract (June 2005) provides for predetermined delay damages under options X7 and X17, and these would qualify as a penalty in terms of S1 of the Conventional Penalties Act, 1962 (Act No. 15 of 1962). Option X18 provides a limitation of damages clause.

The Joint Building Contracts Committee (JBCC) suite refers to ‘Interim Completion Date’ as the date when the subcontract works are complete in the opinion of the contractor, and the term has been used in this article.

PENALTIES AND THE ACT

A penalty stipulation can take many forms and case law shows various instances where parties have agreed a forfeiture, only to find that the courts have then interpreted it as a penalty that falls under the Act.

The case of van Staden v Central SA Lands and Mines 1969 4 SA 349 (W) 351 put the purpose of the Act into perspective, namely:

  1. By providing that contracted penalty clauses are enforceable.
  2. By preventing excessive penalties and the application of both penalties and damages to a default.

ENFORCEABILITY OF PENALTIES

The Constitutional Court has also made clear in a series of judgments that the principle of pacta sund servanda [contracts will be enforced] is alive and applicable in South Africa. In Barkhuizen v Napier 2004 5 SA 323 (CC) at 341C-E (para [57]) wherein a forfeiture clause was being appealed, the court pointed out that “Self-autonomy, or the ability to regulate one’s own affairs, even to one’s detriment, is the very essence of freedom and a vital part of dignity.”

Penalty clauses in subcontract agreements will be enforced.

PENALTY AMOUNT

The value of a penalty can be inclusive of “everything that can reasonably be considered to harm or hurt, or be calculated to harm or hurt the creditor, his property, his person, his work, his activities, his convenience, his mind, or in any way whatever interferes with his rightful interests as a result of the act or omission of the debtor... The test as to all this is, in my view, a subjective test of prejudice. It seems to me that there can be no room for the concept that the prejudice suffered must, as in damages cases, be within the contemplation of the parties; nor is the date of the infliction of the harm or hurt relevant.” (Van Staden v Central SA Lands and Mines 1969 4 SA 349 (W) 352-353)

This definition is extremely wide and includes ‘prejudice’, which the Court distinguished from ‘damage’ as envisaged by common law.

Penalty precludes damages

S2(1) of the Act provides that where there is a penalty stipulation attached to any breach, the claimant is limited to the deduction of the penalty and cannot also claim damages resulting from that breach. (“A creditor shall not be entitled to recover in respect of an act or omission which is the subject of a penalty stipulation, both the penalty and damages…”)

Unless otherwise stipulated for in the contract, the creditor is also not entitled to opt to claim damages in lieu of penalties (s 2(1)). Therefore, where a penalty is less than the actual damage caused, it is not possible to correct or adjust the penalty upwards by reverting to damages without a contractual provision allowing it.

However, damages that do not result from a delay to the completion date (for example a delay caused to external scaffolding of a building but that does not delay completion of the works), may fall outside the scope of this section and be claimable in addition to penalties for late completion. This will depend on specific circumstances. It is suggested that, where a penalty has been deducted, a case could well be made that such prejudice falls within the ambit of the prejudice resulting from late completion and should have been included therein.

GROUNDS FOR REDUCTION OF A PENALTY

Where the penalty exceeds the actual prejudice caused, the debtor can apply to court for a reduction of the penalty in terms of section 3 of the Act. Section 3 reads:

If upon the hearing of a claim for a penalty it appears to the court that such penalty is out of proportion to the prejudice suffered by the creditor by reason of the act or omission in respect of which the penalty was stipulated, the court may reduce the penalty to such extent as it may consider equitable in the circumstances: provided that in determining the extent of such prejudice the court shall take into consideration, not only the creditor’s proprietary interest, but every other rightful interest which may be affected by the act or omission in question.

In Plumbago Financial Services (Pty) Ltd t/a Toshiba Rentals v Janap Joseph t/a Project Finance 2008 3 SA 47 (T) 56E, the Court found that the best way of establishing whether a penalty was excessive would be to compare the penalty to the position the creditor would be in had the debtor not breached its contract.

The full burden of showing that the penalty is excessive is on the debtor. The creditor does not have to assist the debtor in any way. Therefore, in contrast to a damages claim, the subcontractor has to build a prima facie case that it was not the cause of any or part of the prejudice claimed as penalties, that is, prove a negative. Only after this has been done does the creditor have to allege the different elements of its prejudice as part of its evidentiary burden. This is because, as Jafta JA put it at paragraph [10], “The creditor does not have to prove any prejudice because the penalty clause he seeks to enforce is in his favour.”

The importance of discharging the burden of proof is succinctly explained in paragraph [28] of Murcia Lands CC v Erinvale Country Estate Home Owners Association by reference to Maiden v David Jones (Pty) Ltd 1969 (1) SA 59 (N) 64E-G:

If in this matter we are left in doubt as to whether or not the penalty is markedly or unfairly out of proportion to the prejudice, then the penalty falls to be enforced as agreed. If, therefore, in this case, we are left with no data enabling us to establish that there was a disproportion or the extent of such disproportion, then the Magistrate correctly awarded the creditor the full amount of the agreed penalty.

meeting 1019761 webPenalty clauses in subcontract agreements will be enforced.
Image credit: Pixabay

Subcontractors do not readily have the essential tools, such as the contractor’s programmes with critical paths, costs, negative factors, resources applied, and alternatives available, to assist them in proving what the contractor’s position would have been if they had completed their work on time. Even though the court still has power and a duty to assess the suitability of the penalty (see Steinberg v Lazard 2006 (5) SA 42 (SCA)), the difficulty is evident from Western Credit Bank Ltd v Kajee 1967 4 SA 386 (N) 391, wherein the meaning of ‘out of proportion’ was explained as:

What is contemplated ... is that the penalty is to be reduced if it has no relation to the prejudice, if it is markedly, not infinitesimally, beyond the prejudice, if the excess is such that it would be unfair to the debtor not to reduce the penalty; otherwise, if the amount of the penalty approximates that of the prejudice, the penalty should be awarded.


The FIDIC subcontract does not provide for an alternative of penalties, but allows for capping the potential delay damages for which a subcontractor is liable.


In concluding his analysis of the allegations of prejudice, Snyman J steered away from the rigorous assessment of the prejudice as for damages and said at 354H, “On the view I take of the section of the Conventional Penalties Act I need not undertake the meticulous analysis which [the debtor] wants me to. I propose to approach the matter on the broad basis I have already indicated.”

A similar very broad approach was taken by the court in Maiden v David Jones (Pty) Ltd 1969 1 SA 59 N at 64G: “We think, however, that there is information on which one can, in a very general manner, appraise the fairness of the penalty in relation to the prejudice which we have found that the defendant suffered.” In the Murcia Lands case at paragraphs [38] to [53], the court, although finding the penalty out of proportion to the prejudice, still went on to identify and award non-pecuniary prejudice.

WAIVER OF S3 IS UNENFORCEABLE

In Portwig v Deputation Street Investments (Pty) Ltd 1985 1 SA 83 (D), Booysen J found that a waiver of the right to apply for reduction of a penalty was contrary to public policy if included in a contract (‘waiver in anticipando’), but would be effective if agreed after the breach (for example a settlement agreement).

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Trigger for penalties

Liability for penalties arises from a contract provision; that is, it is triggered by the happening of the triggering event. In building contracts and subcontracts, a date for completion is set in the signed document and if it is not met, the subcontractor is liable for the stipulated penalties. If it has failed to claim revisions to the completion date or if it has applied for revision of the completion date and the revision has not been granted, the subcontractor is liable for the penalty until an extension is granted. In other words, in the context of certain amendments to contract provisions, a subcontractor could find itself liable for penalties not only for failing to meet interim and practical completion dates, but also for failing to meet stage completion dates and would then have to discharge the burden of proving that no penalty is applicable:

  • Because it was entitled to a revision of the date for completion which it must then prove (revision of date based on legitimate claims that were compiled in accordance with the extension provisions); and/or
  • That it was out of proportion to the actual prejudice caused (for example that the contractor was late and did not actually suffer damages or that it did not suffer such damages as a consequence of the breach). As stated, the claimable prejudice is broader in scope than damages.

Regarding the time at which the penalty becomes effective, if a date is specified in the contract, that date will be applied, subject to extensions of time claimed by the subcontractor and granted by the contractor. When the date is not specified, it needs to be capable of clear deduction. In Alfred McAlpine & Son (Pty) Ltd v Transvaal Provincial Administration 1977 (4) SA 310 (T), the court looked at the use of a building programme as a basis for establishing a definite date for performance and rejected it. It is doubtful that the average programme could serve to establish a date from which penalties are due as, besides not being intended to fix the date for performance, they are normally neither accurate enough nor are they so detailed as to allow the conclusion to be made.

CLAIMS FOR REVISION OF INTERIM COMPLETION DATES

It is often alleged that the subcontractor must claim revisions to the date for interim completion of its subcontract works. This is a very questionable assertion, because very few, if any, subcontractors can actually arrive on site and complete their works on their own programme. The reality is that the subcontractors’ works are generally dependent on the progress of the contractor’s works — the sequence and timing of which is also not a constant.

With the level of information normally given to the subcontractor regarding the true status of the programme and the critical path to completion, most subcontractors will find it virtually impossible to properly apply for a revision of the completion date for the subcontract works, because the subcontract works activities are so interwoven with the contractor’s works activities over which the subcontractor has neither control nor any insight. Contractors sometimes actually refuse to share this information with the subcontractor to prevent the subcontractor from claiming delays/revisions to interim completion dates.

CASH FLOW PROTECTION

The above challenges can further be tainted by the contractor’s desire to find ways of withholding subcontractors’ funds to protect its cash flow. In such an environment, allowing a penalty clause is extremely ill-advised because the burden of proving any loss falls on the subcontractor to not only prove revisions to the date of subcontract works completion, but also to prove that there was no ‘prejudice’ or that it was less than the penalty.

Look out for Part 2 of this article where we look at damages and examples.


ABOUT THE AUTHOR

Edwin Giesteira graduated with a BSc Quantity Surveying at the University of Pretoria in 1978 and an MSc Real Estate in 2011. He became a Fellow of the Association of Quantity Surveyors (Southern Africa) in April 2013. He has worked for various building contractors, and was a director of Stocks Leisure Developments for five years. He has lectured on Builders’ Quantities to BSc Honours Construction Management students at the University of Pretoria for a semester. He consulted to project managers and contractors for 10 years, but now only consults on construction disputes or acts as adjudicator or arbitrator in disputes.


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