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Clarifying the many confusions that lie behind financial charges

legal matters

We have seen how contractors' claims for loss and expense may appear, on the face of it, to be the worst form of Voodoo; but that, with the application of the talisman of the general principles of the common law, the magic fades to reveal a fairly ordinary, and usually inflated, claim for damages for delay.

A loss and expense claim would not be complete without a claim for interest, but just to maintain the confusion, it uses the term 'finance charges' instead.

Nevertheless, the idea behind a claim for finance charges is a simple one. If contractors are delayed and have to increase their borrowings to maintain progress, they will bear the cost of additional interest until their claim is resolved and paid. This may not be until agreement of the final account, and if disputed, may not be until a court or arbitrator gives a decision months or years later. What may start out as insignificant costs can, on large projects, amount to huge sums.

As Ian Duncan Wallace, the well-known construction law commentator, has observed: 'The high gearing element of contract turnover relative to capital employed in construction contracts will mean that a relatively small pricing error as to the financing factor may make the vital difference between overall profit and loss, even in cases where disputes, and so delays, in making payments have not occurred.' Whether contractors are entitled to recover financing charges and, if so, at what rate, will depend upon the express terms of the contract and the rather arcane workings of the common law.

The starting point is the arcane one, that the law traditionally will not allow recovery of interest as damages where the only breach is late payment. Thus, if the contract does not provide for interest to be paid on sums paid late, there is no common law right to interest at all. There are two exceptions to this basic rule: if a particular statute empowers the tribunal to award interest; and lif interest can be recovered as special damages where the late payer has had notice of the potential loss.

As to statutory powers, even though interest is recoverable under statute, it is usually calculated at a rate below what might be called the commercial rate; and always as simple, rather than compound, interest. Here the 1996 Arbitration Act steals something of a march as it expressly empowers arbitrators to award compound interest. This distinct commercial advantage of arbitration over litigation is all the more remarkable since the House of Lords has recently confirmed that the courts do not have such a power.

For the commercially minded, there could be no greater incentive to refer disputes to arbitration than the prospect of recovering compound interest on the disputed sums.The Law Commission is concerned that arbitrators currently enjoy wider powers than the courts and are considering whether the law should be changed to redress the balance. * The second exception provides that interest can be recovered as special damages under the text book case of Hadley v Baxendale, which seeks to distinguish between losses flowing naturally from a breach and those that occur as a result of factors of which the party in breach has been given notice.

When these rather dry principles are applied to the blood-life of a building contract, they give rise to the rather anomalous result that contractors who expressly inform the employer that their company runs an overdraft on which the bank charges them interest at two per cent over base, compounded monthly, may recover interest, while those who make no mention of this rather commonplace fact may not.

Assistance for contractors came in the form of the two cases of Minter v Welsh Health Technical Services Organisation (1980) and Rees and Kirby v Swansea Corporation (1985) which decided that financing charges are recoverable where the breach is something more than late payment.

Which brings us back to our starting point, and explains why many contractors include a claim for financing charges as part of their loss and expense claim.

View the Law Society consultation paper on compound interest at www. lawcom. gov. uk

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