Application of penalties hinder?

Chris Binnington attempts to answer a frequently asked question: If and when is an employer entitled to deduct penalties?

A question which is often asked at our seminars is whether or not an employer is entitled to deduct penalties in the face of a claim for an extension of time to the completion date or whether the extension of time must first be evaluated by the principal agent and, if rejected, the dispute resolution procedures under the contract must then be completed before the employer’s rights to deduct the penalty can arise.

Employer’s right

Since our common law does not deal with issues such as extensions of time and penalties, the answer to the question must invariably be found within the terms of the contract. In general, the specific terms of the various forms of contract in common use allow the employer to deduct penalties as soon as the contractual completion date has been exceeded, irrespective of any rights the contractor may have to claim an extension of time. Neither do our standard forms of contract provide for the suspension of this right to deduct penalties, pending evaluation of a claim by the principal agent. Alternatively, the submission of the extension-of-time claim to the dispute resolution mechanism in the contract. It accordingly follows that. subject to the specific wording of the contract, the normal position is that the employer has a right to deduct and may set off such amounts due by way of a penalty from any monies in its possession. Alternatively claim under the guarantee.

This precise situation became the subject matter of an application to the High Court in the Cape Provincial Division in the case of Basil Read (Ply) Ltd v Beta Hotels (Ply) Ltd 2001 (2) 54760(C).

In this case, Basil Read was contracted to carry out alterations and additions to the Vendome Hotel in London Road, Sea Point. The contract was carded out under the Joint Building Contracts Committee (JBCC) 1991 form of contract and Basil Read had duly provided a construction guarantee in an amount of just under R3-million. The works were scheduled to be completed on August 3, 1998 and the contract provided a penalty of R8 000 per day for any period after August 3, 1998 during which practical completion was not achieved. Basil Read obtained an extension of the date for practical completion to December 15, 1998 but subsequently applied for a further extension until August 13, 1999 on which date the architect certified practical completion of the works. The architect did grant an extension to February 26, 1999 and certified that Basil Read was liable for penalties for the period up to and including August 13, 1999 and issued the relevant statement indicating that the employer could recover penalties amounting to R840 000 from Basil Read.

To court

Basil Read brought an application before the court to interdict and restrain the employer from demanding and the guarantor from paying any sums due in terms of the guarantee in respect of the penalties certified as being due and payable, pending the determination of the dispute under the procedures provided in the contract.

After a review of the Conditions of Contract, the court came to the conclusion that this particular form of contract did not entitle the contractor to any suspension of the employer’s rights to deduct penalties and that the employer was accordingly entitled, and the guarantor was therefore obliged, to make payment of the penalties notwithstanding the pending dispute in regard to the extension of time.

Although this was a contract under the JBCC conditions, it is submitted that a similar position would obtain under general conditions of contract (GCC) 2004. This contract provides, at Clause 43, for a penalty for delay in the amount stated in the contract data for every day which shall elapse between the due completion date and the actual date of practical completion. There is however a mechanism for reduction of the penalty if portions of the work are certified by the engineer as complete or alternatively are occupied by the employer prior to the issue of the certificate of practical completion for the whole of the works. Under these circumstances, the penalty for delays is reduced by an amount determined by the engineer as being appropriate in the circumstances.

Most unusually, and regrettably, the deduction of the penalty under GCC 2004, which traditionally has been at the election of the employer, has now been made an obligation of the engineer. Under Clause 49 Interim Payments, the engineer is required to certify the amount which he considers to be due to the contractor taking into account, inter alia, a deduction for penalties imposed in terms of Clause 43, thus effectively removing the employer’s discretion since the penalty will now\be deducted on the face of the certificate.

While it could be argued that employers are still free to make payment on the certificate plus any penalties deducted, it is highly unlikely that any employer presented with an interim certificate will pay anything more than the bottom line obligation. This departure from traditional and conventional arrangements, insofar as the certifier’s authority is concerned, is to be regretted.

Chris Binnington is Managing Director of Binnington Copeland & Associates.