Liquidated Damages Under Shipbuilding Contracts

Azimut – Benetti SpA v. Healey [2010] EWHC 2234

The High Court has recently looked at issues arising where one party seeks to enforce a liquidated damages clause incorporated into a shipbuilding contract, and the defaulting party contends that liquidated damages are not payable because they constitute a "penalty".

Facts

The claimant was a luxury yacht builder which agreed to construct and sell a super yacht to a special purpose company incorporated in the Isle of Man. The buyer's liabilities were guaranteed by the defendant.

Under the termination clause within the contract it was agreed that, in the event of a default by the buyer, the builder was entitled to recover an amount equal to 20% of the contract price by way of liquidated damages and, subject to that retention, would then promptly return the balance of any sums paid by the buyer up to the date of termination.

The price for the super yacht was €38 million and, following the buyer's default, the builder claimed liquidated damages of €7.6 million from the defendant under the guarantee. The defendant resisted this claim on the basis that the liquidated damages provision constituted an unenforceable penalty clause.

The builder denied that the liquidated damages clause constituted a penalty but also raised another argument. That, even if the liquidated damages did amount to an unenforceable penalty, the defendant was nonetheless liable under the guarantee on the basis of a provision stating that the guarantee would not be rendered unenforceable by reason of any "irregularity, illegality, unenforceability or invalidity" in the underlying construction contract.

Was the liquidated damages provision a penalty?

Mr Justice Blair reviewed the line of authorities discussing penalty clauses.

The essence of a liquidated damages clause is that it should represent a genuine pre-estimate of the loss that the innocent party will suffer upon the termination of the contract. By contrast a penalty clause is one which provides for the payment of money from the defaulting party, the predominant contractual function of which is to deter a party from breaking the contract rather than to compensate the innocent party for any breach. The hallmark of a penalty clause is that it is designed to function as a deterrent rather than to provide compensation for a loss. The question of whether an agreement to pay a specified sum is a penalty or an agreement to pay liquidated damages is a question of construction to...