The Extent of Enforcement of The Penalty Clause on Public Sector Construction Contracts in South Africa

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1 The Extent of Enforcement of The Penalty Clause on Public Sector Construction Contracts in South Africa Maritz MJ and Tshikila S Department of Construction Economics, School of the Built Environment, University of Pretoria, Pretoria, South Africa tinus.maritz@up.ac.za ; simphiwet@yahoo.co.uk Abstract: Background: A perception exists that public sector construction contracts in South Africa are generally completed late. The penalty clause is included in construction contracts to dissuade the contractor from completing the works later than the approved date. The extent of delays in the public sector, factors to be considered in determining the penalty/liquidated and ascertained damage (LAD) quantum and extent of enforcement of the penalty clause are unknown. The legal consequences of non-enforcement of the penalty/lad clause, in light of the Municipal Finance Management Act 56 of 2003 (MFMA) and the Public Finance Management Act 1 of 1999 (PFMA) are also unknown. Methodology: A survey, sample obtained through the convenience sampling technique, was conducted to investigate the extent of enforcement of the penalty clause, and matters connected thereto. Opinions of clients/employers, consultants and contractors involved in the implementation of public sector contracts in Gauteng province of South Africa were sourced through a questionnaire. Findings: A need exists to develop a more scientific/sensible method to determine the penalty/lad quantum in the public sector. There is a significant difference of opinion whether the penalty/lad clause is generally enforced in delayed construction contracts implemented by the public sector in South Africa. There is a significant difference of opinion whether the type of works does influence the extent of enforcement of the penalty/lad clause. Where the penalty/lad clause is not enforced, it is mainly because clients are sympathetic to the contractor. Public sector clients are in violation of the PFMA and MFMA if they knowingly fail to recover penalties/lad when these are due. Research limitations: Using the convenience sampling technique means that the findings cannot be generalised, but provide a tentative overview of the situation. The research sample was only drawn from the province of Gauteng. The study only investigated the legal consequences of nonenforcement, and did not extend to general contractual/contract management consequences. Practical implications: Public sector clients need to be awakened to the problems consequent upon the non-enforcement of the penalty/lad clause, in regard to both contract administration and the legal consequences. Keywords: Construction contracts, liquidated and ascertained damages, penalties, public sector 1 Introduction 1.1 The penalty/lad clause in construction contracts Construction contracts normally make provision for a penalty clause (or sometimes liquidated damages/delay damages), which requires the contractor to reimburse the employer a certain predetermined amount for the period the works remain incomplete after the lapse of the scheduled, and 252

2 sometimes extended, time of completion. Damages for late completion of construction contracts are normally liquidated at the time of concluding the contract. This is because late completion of construction contracts is the most common breach normally suffered by employers in construction contracts (Eggleston, 2009). The main advantage of the penalty clause, compared to a claim for damages in construction contracts, is that the employer need not have suffered, or even alleged, any prejudice in order to be entitled to the penalties 1. The agreed time of delivery of the product by the contractor is an essentialia of the construction contract, as it must always be contained in the contract (Nagel, 2006). The inclusion of this completion date (or contract period) is a matter of economic importance, both to the employer and to the contractor (Uff, 2009). The penalty/lad clause thus becomes an incidentalia of the contract as it seeks to exclude, limit or alter the naturalia (i.e. general damages) of the contract. The penalty/lad provision is regulated, protected and enforceable in South Africa under the Conventional Penalties Act 15 of 1962 (CPA). It is worth emphasising that the CPA does not require one to differentiate between a penalty and LAD. This means that the clause is enforceable, whether it is a penalty or LAD. This is a major difference in the legal position in South Africa compared to some jurisdictions in the world, especially those whose common law is heavily influenced by the English common law, where a penalty provision is not enforceable (Eggleston). 1.2 Determination of the penalty/lad amount There is currently no sensible/scientific method used to determine the quantum of the penalty/lad in the public sector. The significance of this is that section 3 of the CPA empowers the courts to reduce a penalty if it is found to be out of proportion to the prejudice that is likely to be suffered by the employer/client. It is important to note that the CPA refers to prejudice and not the actual damages/losses. As observed by Binnington (2009), prejudice is a much wider term in law and which would embrace, consequently, far more issues than would simply be covered if the employer had to demonstrate the actual loss/damages it had suffered. In simple terms, it would be very difficult for a contractor to convince the court that the penalty is indeed out of proportion to the prejudice. This is because a contractor would find it very difficult to assess the extent of the employer s prejudice that flows from the breach. However, the need to determine the quantum of the penalty/lad still exists. Brümmer (1998) found that penalties imposed by the Department of Public Works (DPW) are substantially lower than those of the private sector. This results in public sector clients being under-compensated for damages flowing from the breach of contract. 1.3 The enforcement of the penalty/lad clause in the public sector There is a general perception that public sector clients do not enforce the penalty clause. The extent of delays, if any, in construction contracts implemented by the public sector is also unknown. It is unknown whether the type of works, i.e. civil engineering or building works, affects the enforcement of the penalty clause. Brümmer found that building projects implemented by the DPW are generally completed later than the approved date. Brümmer also found that the main contributing factor for these delays was the poor work performance by contractors. The penalty/lad clause, by its nature, is included in construction contracts in order to dissuade the contractor from completing the works late. The extent of enforcement of this clause in projects implemented by the public sector in South Africa is presently unknown. The reasons for the nonenforcement of the penalty clause are also unknown. The CPA provisions make it almost impossible for a contractor to convince the courts of that a penalty is disproportionate to the prejudice. Court challenges of a penalty/lad clause cannot therefore be the reason for non-enforcement as was the case in Ghana (Tuuli et al, 2007). In fact, there is only one reported court judgment in South Africa where a contractor successfully challenged the enforcement of a penalty clause 2. Even in that case, the penalty was reduced because the court found that the prejudice suffered by the employer 1 Steinberg v Lazard (2006) SCA 53 (RSA) 2 Afriscan Construction (Pty) Ltd v Umkhanyakude District Municipality & another [2005] JOL (D) 253

3 (Umkhanyakude District Municipality) was not caused by Afriscan Construction (the contractor) alone, but by other parties as well, whom the contractor had no control over. The court then apportioned the penalty accordingly. 1.4 Legal consequences of non-enforcement of the penalty/lad clause Two legislations were promulgated in South Africa to regulate, amongst others, the management of public funds by state organs; namely; the national, provincial and local government as well as other state-owned entities. The Public Finance Management Act 1 of 1999 (PFMA) regulates the management of public finances at national and provincial spheres of government as well as stateowned entities whereas the Municipal Finance Management Act 56 of 2003 (MFMA) regulates the management of public funds at local government level. The two legislations place a duty on public sector organisations to recover monies due to these organisations and prevent wasteful, fruitless or inefficient expenditure. The two legislations also regulate the contract management practices of state organisations. At face value, it appears that the clients failure to recover penalties/lad due to them could be a violation of the provisions of these legislations and could thus amount to financial misconduct. 1.5 The purpose of the study The purpose of the study can be summarised as follows: To investigate the extent of enforcement of the penalty/lad clause in construction contracts implemented by the public sector in South Africa, as well as matters connected thereto; To investigate whether the type of works, i.e. civil engineering or building works, has influence on the enforcement of the penalty/lad clause by public sectors clients; To investigate the reasons for non-enforcement where instances of non-enforcement of the penalty/lad clause are prevalent; and To investigate whether the non-enforcement of the penalty/lad clause by public sector clients amounts to the violation of the MFMA and PFMA. 2 Research methodology A descriptive quantitative study was undertaken to solve the research problem. Research data were collected by means of a questionnaire survey that targeted construction industry professionals in the Gauteng province of South Africa. 2.1 Research questionnaire design The research questionnaire contained seven sections (Section 1 to 7), with each section generally designed to obtain information that relates to each sub-problem. The questionnaire was designed such that open-ended questions were avoided. A combination of rating scales and checklist were used, depending on the type of question. The five-point Likert (rating) scale enabled the measurement of the intensity of the respondent s feelings about a statement, while the checklist was used to test which of the possible answers apply to the respondent. A few control questions were incorporated to detect instances where the respondents attempted to provide socially acceptable responses (Leedy & Ormrod, 2010). The University of Pretoria s Department of Statistics evaluated the questionnaire and checked for compatibility with the proposed statistical analysis methods. The questionnaire was then tested in a pilot study, with five respondents, to highlight any ambiguities and other potential problems. Minor adjustments were then made based on the comments and problems highlighted during the pilot study. The same questionnaire was used for clients, consultants and contractors. However, those sections that did not apply to one category were highlighted in the instructions to prospective respondents. 254

4 Respondents were asked to answer questions relating to projects where formal Construction Industry Development Board (CIDB) endorsed standard conditions of contract were used. 2.2 Research population and sampling The research population consisted of public sector clients, consultants and contractors operating in the Gauteng province of South Africa. The three categories also represent the main role-players in the implementation of construction contracts in South Africa. The study was restricted to those individuals that have access to , as the questionnaire was distributed only by . The population groups were obtained as follows: project/contract managers of national, provincial and local government departments that implement construction contracts in Gauteng. This group also included municipalities and stateowned entities in Gauteng; active members of the South African Institution of Civil Engineering (SAICE) and the South African Institute of Architects (SAIA); and contractors registered with the CIDB that are based in Gauteng. The minimum CIDB grade for contractors was 7. Only contractors registered in the civil engineering (CE) and general building (GB) category of works were included. The convenience sampling technique was used to select a representative sample for each category. The sample size was made up of 20 client bodies, 450 consultants and 80 contractors. 2.3 Data collection The data was collected over a period of two months. The questionnaire was distributed by to all the prospective respondents. However, respondents were at liberty to return the completed questionnaire by or fax. To address issues of internal validity of the study, the researcher s hypotheses were not disclosed to the respondents (Leedy & Ormrod). 2.4 Data analysis A total of sixty-two responses were received, fifteen from clients, thirty-six from consultants and eleven from contractors. The statistical analysis of the data was performed with assistance from the Department of Statistics and the results analysed by the researcher. Figure 1 illustrates the breakdown of the responses as a percentage of the total responses. 18% 24% 58% Figure 1: Distribution of responses received 255

5 3 RESULTS AND DISCUSSION 3.1 General particulars Section 1 of the questionnaire sought general particulars of the respondents. Responses were received from a range of professions as shown in Figure 2. The majority of respondents have a civil engineering background, followed by those with an architectural, quantity surveying and project management background. The four professions generally cover most of the civil engineering and building works implemented by the public sector in South Africa. The category of other was made up of electrical and mechanical engineers. These two professions mostly work under a principal agent, whose background is normally one of the four professions mentioned earlier. This therefore indicates that the nature of responses will be representative of the majority of work in the public sector. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Other Project Management Architecture Quantity Surveying Civil Engineering Figure 2: Professional affiliation of respondents The above indication is confirmed by the distribution of the type of work that the respondents mostly handle, as shown in Figure % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Other Building Works Civil Engineering Works Figure 3: Breakdown of type of works handled by respondents 256

6 The respondents were also asked to indicate their levels of experience in the industry. The idea was to assess the quality of the responses as they relate mainly to professional experience in the construction industry. As shown in Figure 4, the responsibility of administering construction contracts in this instance is placed on relatively well-experienced. The average working experience of the respondents is in the bracket of 10 to 20 years. The indicated experience of consultants is not surprising, as these professionals were drawn from SAICE and SAIA. Both institutions require experience in their respective professions, a minimum of five years, for an individual to be admitted as a member. appear to be, generally, the least experienced of the respondents. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% >30 years >20 to 30 years >10 to 20 years 0 to 10 years Figure 4: Breakdown of type of works handled by respondents 3.2 Penalties/LAD in construction contracts The respondents were asked if they are familiar with the CPA. This legislation regulates the enforcement of the penalty/lad clause in South Africa. Contract administrators are therefore expected to be at least familiar with the provisions of such legislation. How else do they ascertain and enforce a contractual provision whose regulatory provisions they are not familiar with? However, as shown in Figure 5 a significant proportion of clients (60%) and consultants (50%) are unfamiliar with this Act. Interestingly, most of the contractors indicated that they are familiar with the Act. Unfamiliar Familiar 0% 20% 40% 60% 80% Figure 5: I am familiar with the Conventional Penalties Act 257

7 Respondents were asked if they believe that penalty/lad provisions are still relevant in construction contracts. Binnington (2009) believes that other forms of encouraging the contractors to finish on time, instead of dissuading them from completing the works later than the approved completion date, should instead be used. 0% 20% 40% 60% 80% 100% Figure 6: Penalty/LAD provisions are a useful tool to dissuade the contractor The majority of respondents believe that penalty provisions are still relevant and are a useful tool to dissuade the contractor from completing the works later than the approved date. But are they enforced in the public sector? An enquiry was made as to whether the enforcement of the penalty clause increases the rate of production (work performance) in construction contracts. Brümmer found that building projects implemented by the DPW are generally completed late due to poor work performance by the contractor. The effectiveness of the penalty clause in speeding up the rate of production in construction contracts was, however, not investigated in that study. The respondents are in agreement that the enforcement of the penalty clause (or the threat thereof) increases the rate of production in a construction site. 0% 20% 40% 60% 80% 100% Figure 7: The enforcement of the penalty clause increases the rate of production 258

8 Respondents were asked whether there should be a relationship between the penalty/lad and the likely prejudice, as provided for in the CPA. 0% 20% 40% 60% 80% 100% 120% Figure 8: There should be a relationship between the penalty/lad likely prejudice There is agreement that there should be a relationship between the penalty and prejudice likely to be suffered by the client. Surprisingly, all clients agree that there should be a relationship between the two. Whether they actually ensure that such a relationship exists would be interesting to see. It is also worth mentioning that a number of respondents are not familiar with the CPA as indicated earlier, but merely provided their opinion as to the relationship between the penalty and prejudice. Respondents were asked to rank what they consider as the most significant factors in the determination of the penalty/lad quantum. The statistical mean of each category was then determined and the average of all the factors is as shown in Table 1. Table 1: Ranking of significant factors in determining the quantum of the penalty/lad amount Description Average of all respondents Rankings Potential loss of use of facility Construction supervision costs Interest rate on capital invested A factor of the envisaged contract value Professional fees The most significant factor is the potential loss of use of the facility. Unfortunately, Loots (1995) showed that the potential loss of use of the facility is very difficult to assess in public sector projects at tendering stage. By their nature, public sector infrastructure is not primarily income generating. In the circumstances, the second highest ranked factor, the construction supervision costs, can easily 259

9 be determined and used. Interestingly, the most common factor that is currently used in South Africa s public sector is the estimated construction cost (Brümmer). 0% 20% 40% 60% 80% 100% Figure 9: There is a need for a sensible/scientific method to determine penalty/lad Eighty percent (80%) of the respondents are in agreement that a scientific or more sensible method should be developed to determine the penalty/lad quantum. Such a method could even make provision for all the significant factors in the determination of the penalty/lad quantum, depending on the nature of the works. 3.3 The extent of enforcement of the penalty clause in the public sector Respondents were asked to indicate the percentage of their public sector contracts that are completed later than the approved date. Figure 10 shows that 94% of the respondents contracts are completed late. In fact, about 20% of the respondents indicated that more than half of their contracts are completed late. Figure 11 also shows that public sector construction contracts are generally completed late. This is a very high proportion by any standards. But is the penalty clause enforced, considering that the respondents agreed that the penalty/lad clause is useful? 260

10 >50% >30% to 50% 10% to 30% <10% None 0% 10% 20% 30% 40% 50% 60% 70% Figure 10: What percentage of your public sector contracts are completed late? 0% 20% 40% 60% 80% 100% Figure 11: Public sector construction contracts are generally completed late In the light of the above finding that public sector contracts are generally completed late, and as shown in Figure 12, a high proportion of respondents indicated that they sometimes do not enforce the penalty clause, despite their belief that, firstly, the public sector contracts are generally completed late, and secondly, the penalty is an effective tool to dissuade the contractor from 261

11 completing late. The responses, however, do not show a general practice of non-enforcement of the penalty clause, as the results show a significant difference of opinion in this regard. 0% 10% 20% 30% 40% 50% Figure 12: I always enforce the penalty/lad clause whenever applicable When asked to state their reasons for non-enforcement, the respondents highlighted the following reasons. Prior late payment by client 23% 5% 18% Client not enforcing due to sympathy with contractor Consultant neglecting to enforce penalty/lad 15% 24% Contractor successfully challenged enforcement of penalty clause in court/arbitration/mediation Insufficient or no extension of time granted during construction 8% 8% Late handover of site to contractor Fear of retribution Figure 13: Reasons for non-enforcement of penalty/lad clause 262

12 The prevailing reason for non-enforcement is that clients are sympathetic to the contractor (24%). This is the still the case despite what appears to be a legal duty on public sector clients to recover penalties as provided for in the MFMA and PFMA. It is, however, not surprising that there are fewer instances of non-enforcement due to a successful legal challenge by a contractor of the enforcement of the penalty clause. In South Africa, there is only one reported court judgment where this has happened. It is, however, possible that other challenges may have been mounted at arbitration proceedings, which, by their nature are private matters and thus not reported. Whether section 3 of the CPA also empowers the arbitrator to reduce the penalty is not clear (Binnington). 3.4 The influence of the type of works on enforcement of the penalty clause The next enquiry was whether the type of works does affect the extent of enforcement of the penalty clause. The idea was to ascertain whether in civil engineering, for example, the penalty clause tends to be enforced compared to building contracts, or vice versa. Building contracts mostly use the Joint Building Contracts Committee (JBCC) standard contracts, whereas civil engineering contracts tend to use the General Conditions of Contract for Civil Engineering Works (GCC), FIDIC conditions of contract or the NEC suite of contracts. This would therefore give an indication of, amongst others, the strictness of the different contracts. Figure 14 shows that there was a significant difference in opinion as to whether the type of works affects the extent of enforcement of the penalty clause. 0% 20% 40% 60% 80% Figure 14: The type of works affects the enforcement of the penalty clause 3.5 Legal consequences of non-enforcement of penalty clause in the public sector The respondents were also asked questions about the possible legal consequences of nonenforcement of the penalty clause, as provided for in the MFMA and PFMA. Respondents were first asked if they are familiar with the specific provisions of these legislations, especially public sector clients. The respondents generally indicated that they are familiar with these provisions. The next question was whether a public entity is in violation of the two laws if they knowingly fail to recover penalties due to that public entity. There is general agreement that a public sector client is in violation of the MFMA or PFMA (whichever is applicable to the entity) if they fail to recover penalties in their contracts. 263

13 0% 10% 20% 30% 40% 50% 60% 70% Figure 15: I am familiar with the responsibilities of accounting officers in terms of the MFMA and PFMA 0% 10% 20% 30% 40% 50% 60% 70% Figure 16: Knowingly failing to recover penalties/lad by a public entity is a violation of the MFMA and PFMA In the light of the above finding, it is surprising and disturbing that there are some public sector clients that still do not generally enforce the penalty clause. 4 CONCLUSION The CPA is a very unique piece of legislation in that it provides the legal framework upon which penalties and LAD provisions can be formulated and enforced. The legislation makes it clear that contractors are not going to find much sympathy in our courts should they attempt to escape contractual provisions that they have willingly accepted. This should serve as a major encouragement for employers/clients to enforce the penalty/lad provisions. Unfortunately, it was 264

14 found that very few clients are familiar with the legislation. It then follows that they are less likely to know about the protection they enjoy from that legislation. Interestingly, a significantly higher proportion of contractors knew about the existence of the legislation, significantly more so than the consultants and clients. It may well be that contractors regularly check the CPA provisions in order to escape the enforcement of the penalty clause. There is general agreement amongst the parties that the enforcement of the penalty clause increases the rate of production on site, which, anyway is what clients want. The clients sympathy is therefore not a good enough reason not to enforce the penalty/lad clause, let alone the consequent violation of the MFMA and PFMA, as found in this study. The study also showed that there is a need to develop a method to determine the penalty/lad quantum, and that there should be a relationship between the penalty/lad and the likely prejudice. A sensible method that takes into account the main factors should be developed. In South Africa, public sector clients tend to consider a factor of the contract value. This appears to be an easy-wayout approach because the value of the contract sometimes bears no relationship to the prejudice that the client will later suffer. Even worse, previous research showed that the penalty clause has been found not to even fully compensate the public sector clients in the event of late completion. The benefits of the proper assessment and enforcement of penalty/lad provisions cannot be overemphasised. This study highlighted the problems associated with the non-enforcement of the penalty clause. Tighter measures need to be implemented by the public sector to ensure that the penalty/lad clause is indeed enforced. There is a clear positive relationship between enforcement and rate of production. Many other secondary problems surface if public sector construction contracts are not completed on time. These include poor expenditures on government infrastructure grants, reduction in the pace of infrastructure development, deterioration of existing infrastructure as well as other consequences that a developing country like South Africa cannot afford. 5 ACKNOWLEDGEMENTS The authors gratefully acknowledge the following institutions and individuals: The University of Pretoria s Department of Statistics The South African Institution of Civil Engineering The South African Institute of Architects The Construction Industry Development Board of South Africa Fellow construction professionals in South Africa who participated in the study 6 REFERENCES Binnington, C The Application of Penalties (but which end of the donkey gets the carrot?). Binnington Copeland & Associates [online]. Available from: [Accessed: 20 January 2010] Brümmer, DG Die Bestuur van Vertragings en die Gevolglike Verlenging van Konstruksietydeperke op Bouprojekte in die Republiek van Suid Afrika. [Unpublished PhD thesis]. Pretoria: University of Pretoria Eggleston, B Liquidated Damages and Extensions of Time: In Construction Contracts, 3 rd Edition. United Kingdom: Wiley-Blackwell Fédération Internationale Des Ingénieurs-Conseils (FIDIC) Conditions of Contract for Construction of Building and Engineering Works Designed by the Employer. Switzerland: FIDIC Joint Building Contracts Committee (JBCC) Inc Principal Building ment, 5 th Ed: South Africa: JBCC 265

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