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Liquidated Damages — Genuine Pre-Estimate Requirement

Liquidated damages give the employer a simple, certain remedy for late completion — without proving actual loss. But a clause that imposes a sum wildly disproportionate to likely loss may be unenforceable as a penalty. The modern test is not what most practitioners remember from the old authorities.

4 min read · Updated 21/04/2026

Key takeaway

The modern penalty rule under Cavendish Square Holding BV v Makdessi [2015] UKSC 67 is more flexible and more employer-friendly than the old “genuine pre-estimate” test. An LD clause need not exactly mirror likely loss, but it must serve a legitimate commercial interest and not be out of all proportion to that interest. The best protection is documented analysis at the time of contracting.

1. Why LD rates are frequently challenged

LD clauses are often set without rigorous analysis of the employer’s actual likely loss. Employers sometimes adopt industry-standard daily rates, copy rates from previous projects, or simply set rates that feel commercially attractive as a deterrent. When those rates are challenged in arbitration or litigation, the employer must justify them — and this is often more difficult than expected, particularly on UAE projects where funding and revenue modelling may not have been committed to paper at the time of contracting.

At the same time, contractors who wish to challenge a high LD rate face a significant burden: they must demonstrate that the rate is extravagant or out of all proportion to the employer’s legitimate interest — not merely that it is higher than the actual loss suffered.

2. The modern penalty rule — Cavendish v Makdessi

This is a more flexible and more employer-friendly test than the old approach. A clause need not be a precise pre-estimate of loss — it may serve other legitimate commercial purposes, such as protecting a funder’s interest or incentivising timely completion, and still be enforceable. However, a clause that is genuinely extravagant — where the sum payable is vastly greater than any conceivable legitimate interest — will still be struck down as a penalty.

3. Documenting the rate at the time of contracting

In practice, the best protection is documented analysis at the time of contracting — showing the build-up of carrying costs, loss of revenue, management costs, and other quantifiable losses — even if the rate is ultimately a round-number estimate. The analysis does not need to be perfect, but it needs to exist. A clause defended five years later, at arbitration, with no contemporaneous workings, is much harder to enforce than one defended with a file note from the drafting stage.

4. Practical application

For employers

Conduct a proper analysis of likely daily loss at the time of setting the LD rate. Document that analysis in writing and retain it on file. The rate need not be exact, but it should have a rational basis that can be explained if challenged. Consider including in the contract recitals a statement that the parties have agreed the rate as a genuine pre-estimate of the employer’s anticipated loss.

For contractors

Challenge a high LD rate by analysing the employer’s actual likely losses at the time of contracting and demonstrating the disproportionality. The burden of proof rests on the party challenging the clause, so the analysis must be rigorous and well-evidenced. Expert evidence on the employer’s commercial interest — funding costs, revenue loss, contractual penalties downstream — is often central to the challenge.

5. Risks and mitigation

For employers, an unenforceable LD clause leaves the employer to prove general damages for delay — a more uncertain and expensive process that may recover less than the LD amount would have done. For contractors, accepting a high LD rate without challenge may result in disproportionate deductions that affect cash flow and final account settlement.

Set LD rates through a documented, rational analysis. Review LD rates on long projects periodically — if commercial circumstances change significantly, the rate should reflect that change, or at least be defensible against it. In disputes about enforceability, engage expert evidence on the employer’s actual likely losses at the time of contracting.

6. Conclusion

Liquidated damages clauses are commercially valuable, but only if they are enforceable. The protection is a rational, documented analysis at the time of setting the rate — one that demonstrates a genuine relationship between the agreed sum and the employer’s legitimate commercial interest. The analysis that takes an hour at contract stage is worth months of argument at the arbitration stage.

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We act on both sides of LD challenges — supporting enforceability for employers and framing penalty arguments for contractors. Early review of the contemporaneous drafting file often determines the outcome.

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