UK: Engineering, Procurement & Construction Briefing

Transcription

1 UK: Engineering, Procurement & Construction Briefing May 2013 Contents Introduction 01 Liquidated damages vs penalty 01 causes a clear cut dichotomy? Varying the construction methods 03 to catch up how do you value that variation? Ambiguity and/or consistency on 05 different contractual documents and the application of the order of precedence clause How is using reasonable 06 endeavours to complete different from exercising diligence? Contacts 08 Guarding against contractor delay an update from recent case law Introduction Delay, liquidated damages and extension of time are some of the most common issues for any construction project. Not only are they likely to be the focus of negotiations when parties seek to conclude a construction contract, but they are frequently the major causes of disputes between the parties. Such disputes often emerge from a variety of consequential or concurrent events or causes not necessarily attributable to time management failures. This briefing note provides an overview of four recent cases in which the Courts looked at the following areas of construction law, each of which relates, either directly or indirectly, to the issue of contractor delay: liquidated damages for delay; variations (to omit certain works); ambiguity and/or inconsistency between contractual documents and the application of the order of precedence clause; and using reasonable endeavours to complete vs exercising diligence. Liquidated damages vs penalty clauses a clear cut dichotomy? The enforceability of any liquidated damages clause has traditionally rested on whether the amount of liquidated damages agreed at the time the contract is entered into represents the partiesʹ genuine pre estimate of loss which may be suffered in the future due to the relevant breach. If not, the clause could be viewed as a penalty clause and hence unenforceable under English law. In the relatively recent case of Cavendish Square Holdings v El Makdessi [2012] EWHC 3582, however, the Court confirmed and adopted a more flexible modern approach that attempts to determine the commercial justifications for the provision rather than the traditional approach of classifying and limiting the analysis to a genuine pre estimate of loss. wfw.com

2 02 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING What happened in Cavendish? In Cavendish, a dispute arose after the sale of a majority shareholding in an advertising and marketing communications company. In order to reflect the significant value placed on the ongoing involvement of the seller (as a minority shareholder and director) in the business after the sale, the relevant agreement included certain restrictive covenants which applied whilst the seller remained involved in the business and for a period thereafter. If the restrictive covenants were breached, the purchaser: (i) would be released from its obligation to pay the seller the last two instalments of the consideration; and (ii) could purchase from the seller his remaining minority stake in the company at net asset value (i.e. at an undervalue). One of the issues in question was whether these provisions were penal and hence unenforceable. Cavendish is just part of a growing body of case law that suggests that the strict classification of liquidated damages as either a penalty or a genuine pre estimate of loss is no longer applied. 1 Although on the very specific facts of the case, the provision releasing the buyer from the last two instalments of consideration was held to be a penalty on the ground of double counting, since the buyer s loss was reduced by the company having already received damages for breach of fiduciary duty from the seller. The Court enforced the provision subject to credit being given to the damages already paid to the company. What did the Court decide? In arriving at the conclusion that the provisions on their own were not penalty clauses, 1 the Court considered that one effect of such provisions was to adjust the consideration on the basis of substantial loss of goodwill, which was neither extravagant nor oppressive. Further, the right to buy out the seller s stake also served the commercial purpose of decoupling the defaulting shareholder (i.e. the seller) from the company in the event of breach. Accordingly, the relevant provisions did not have the purpose of deterring breach. The Court s decision referred to previous decisions which pointed to the focus on commercial justification in determining whether a clause is penal or not, rather than the need to ascertain whether there was a genuine pre estimate of loss. At paragraph 53 of his judgment, Mr. Justice Burton summarised the position as follows: the reality is that, in the modern approach to the concept of penalty discussed above, there is no longer the need for the dichotomy between liquidated damages and genuine pre estimate of loss, and so the relevant questions seem to me to be simply: i. Was there a commercial justification? ii. Was the provision extravagant or oppressive? iii. Was the predominant purpose of the provision to deter breach? iv. If relevant, was the provision negotiated on a level playing field? The legal trend in analysing liquidated damages clause Although Cavendish is not a construction and engineering case, it is likely that this judgment may affect how practitioners of this field negotiate, draft and analyse liquidated damages clauses in construction contracts. In fact, from the judgment of Mr. Justice Burton, Cavendish is just part of a growing body of case law that suggests that the strict classification of liquidated damages as either a penalty or a genuine pre estimate of loss is no longer a necessary or sole test. For example, in the shipbuilding case of Azimut Benetti SpA (Benetti Division) v Darrell Marcus Healey [2010] EWHC 2234, the Court upheld a liquidated damages clause despite the fact that the level of damages provided for was clearly not a genuine pre estimate of the claimantʹs losses. Such a clause was held to be commercially justifiable on the basis that its dominant purpose was not to deter breach. Our thoughts Despite the judicial trend of moving away from the concept of a genuine pre estimate of loss, is it likely that we will see any practical differences when dealing with liquidated damages clauses? Perhaps not, or at least not immediately. Many recently concluded construction contracts still contain an express reference to both parties acknowledging that the pre agreed liquidated damages payable are a genuine pre estimate of the loss. The

3 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING 03 prudent approach, in our view, is still to calculate one s entitlement to liquidated damages on this basis. After all, if the amount of liquidated damages is calculated to reflect one s genuine expectation of loss, it would be strong evidence of commercial justification for the clause, and such clause would neither be extravagant or oppressive. In summary, whilst the modern approach may discourage defaulting contractors from seeking to avoid a liquidated damages clause by arguing that it is penal and hence unenforceable, employers should, wherever possible, structure such a clause to reflect the likely losses that they may suffer in the event of breach. If a figure for liquidated damages cannot be readily determined by reference to a pre estimate of the likely losses, employers will then need to think carefully what the commercial justification for the provision is, and, not the least, ensure that there is no double recovery. Varying the construction methods to catch up how do you value that variation? Most construction contracts, whether bespoke or based on standard forms, provide for the employer s right to issue variations to vary the works during the course of a project. These may include, for example, the carrying out of additional works, employing different construction methods or materials and/or not carrying out certain works. In the context of contractor delay, especially where such a delay has not yet happened but is inevitable due to the circumstances, we have sometimes seen employers issuing variations to either vary or omit the affected works in order to avoid or mitigate the (potential) contractor delay. Variations hence can be a useful time and cost management tool. Whilst the construction contract will typically contain valuation provisions setting out how any resulting adjustment to the contract price is to be calculated, disputes can often arise when the parties are unable to agree on how such valuation provisions should be applied. This was the case in MT Hojgaard A/S v (1) E.ON Climate & Renewables UK Robin Rigg East Limited and (2) E.ON Climate & Renewables UK Robin Rigg West Limited [2013] EWHC 967. Whilst the construction contract will typically contain valuation provisions setting out how any resulting adjustment to the contract price is to be calculated, disputes can often arise when the parties are unable to agree on how such valuation provisions should be applied... What happened in Robin Rigg? In Robin Rigg, the contractor was engaged by the employer to design, manufacture, deliver, install and commission foundations for 60 wind turbine generators and two substations in the Solway Firth. Amongst other obligations, the contractor was to charter a barge for the installation of the foundations. When it was subsequently discovered that the contractor s barge was technically inadequate and would also take significantly longer than anticipated to install those foundations, the employer (through the engineer) issued a series of variations whereby the employer would (at its own cost) charter a replacement vessel to carry out the installation works. A dispute arose as to how much should be deducted from the contract price to reflect the fact that the contractor s barge was not used to carry out the installation works. The contractor argued that since the high level breakdown of the contract price reflected the cost of installing the foundations using the contractor s barge, the deduction should be based on such amount subject to some minor adjustments; whereas the employer contended that the deduction should be calculated by reference to the time the contractor s barge would have taken to carry out the works (had it done so) and multiplying that with an applicable rate. The difference between each party s position was up to approximately 44 million. What did the Court decide? Mr. Justice Stuart Smith agreed with the contractor s interpretation that the deduction should be based on the amount included in the breakdown of contract price for the Watson, Farley & Williams May 2013

4 04 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING chartering of the contractor s barge, and pointed out that words or phrases in a contract should be interpreted in the context of the contract as a whole. In line with this principle, it held that the inclusion of the breakdown meant that the contract recognised that the contract price represented the sum of the costs of the various elements of the works; accordingly, if the contractor carried out part of the works, it would be entitled to that element of the contract price, but if not, the amount accorded to those works should be deducted. Windfall gain for the contractor? What about the fact that the contractor avoided having to pay significant liquidated damages but for the employer s variations? In response to this, Mr. Justice Stuart Smith stated that:...the contractual mechanism for dealing with delay was the application of liquidated damages no reason why the additional delay which would have been incurred should be reflected in an adjustment to the Contract Price, particularly when the delay has in fact been avoided...the contractual mechanism for dealing with delay was the application of liquidated damages If the [variations] had not been issued, the delay may have been even greater, in which case the remedies provided by the Contract would have been applicable... That being so, there seems to be no reason why the issuing of the [variations] should have the result that the additional delay which would have been incurred had [the contractor] continued to work with the [original barge] should be reflected in an adjustment to the Contract Price, particularly when the delay has in fact been avoided It is correct that the effect of the [variations], on [the contractor s] interpretation, was to relieve it of the financial consequences that it might have incurred in future if it had been required to complete the contract using the [original barge]; but this is not a transfer of risk as such and is not objectionable since the purpose of the [variations] was to avoid the consequences of further delays attributable to the [original barge], which was for the benefit of both parties. The real transfer of risk arose because [the employer] elected to hire the [replacement vessel] itself without putting in place any mechanism that would transfer the cost of hire to [the contractor]. Lesson learnt The facts in Robin Rigg were arguably unusual in that the employer had agreed to pay for the cost of the replacement vessel even though the original contract sum reflected that it should have been borne by the contractor. Nevertheless, it clearly illustrated that where an employer decides to omit part of the works in order to avoid or mitigate a contractor delay, the valuation of that variation or omission, unless expressly provided for in the contract or agreed upfront between the parties, would be what the contractor has allowed for in the contract price originally for that part of the omitted work, rather than what the contractor would have incurred had the delay not been avoided/mitigated. In other words, by issuing the variation to avoid or minimise the contractor delay, the employer could not claim for what is effectively compensation for delay under the guise of adjustment of contract price due to such a variation. Our thoughts Aside from the need for an employer faced with a (potential) contractor delay to pay particular attention to its contractual options and their consequences, Robin Rigg also highlights the importance of clear and unambiguous contractual drafting in avoiding disputes, especially in the context of how adjustments to the contract price are to be determined. In particular, it would be wise to consider the following:

5 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING 05 The contract should set out in detail how and in what circumstances any adjustments to the contract price are to be calculated; worked examples may be useful where alternatives are applicable. Obvious as it may be, the parties should seek to agree any adjustments to the contract price (or failing that, the formulae for determining the adjustment) before a variation is issued and/or carried out. If adjustments to the contract price are to be calculated by reference to what is reasonable, the parties should seek to define, as far as possible, the criteria to be used to determine what is reasonable (for example what percentage of cost should treated as profit, if any). It may be useful to include a fast track mechanism, such as expert determination, for resolving disputes on valuation or other specific areas prone to disagreement between the parties. Last but not least, the parties should always follow the variation procedure set out in the contract, including the issuing of variation notices and orders. Ambiguity and/or inconsistency on different contractual documents and the application of the order of precedence clause Those working in the construction industry will be familiar with the concept that a construction contract typically consists of a whole range of legal and technical documents, such as the general and specific legal terms and conditions, the various appendices and annexures to such conditions, the technical specifications and drawings, etc. As no single document constitutes a construction contract, it is almost standard (and certainly common for most industry standard forms) to contain a priority of documents or order of precedence clause that clarifies which documents make up the construction contract and specifies their order of precedence in the event of conflict. Having an order of precedence clause, however, does not always provide the certainty the parties might have expected. In respect of delay and liquidated damages provisions, it is not uncommon for the concept of completion (i.e. the stage in the progress of the works that the contractor is to achieve by a pre agreed date beyond which liquidated damages would be payable) to be mentioned or defined in two or more contractual documents (for example, in the legal document setting out the particular conditions and in the technical document setting out the specifics of the project including the programme). The key, as illustrated by the case of RWE Npower Renewables Ltd v J N Bentley Ltd [2013] EWHC 978, is to ensure that all references or definitions of completion (or any equivalent concepts) are entirely consistent with each other. Having an order of precedence clause, however, does not always provide the certainty the parties might have expected when including such a clause in the contract. What happened in RWE? In RWE, the parties have fallen out in relation to various delays to the completion of the project and a dispute arose between the parties as to whether material ambiguity exists between the definitions of section 2 completion referred to in the various documents constituting the construction contract. Although the Court recognised that there were undoubtedly differences between the wording in the two documents in question (one requiring completion, including testing, of the intake, penstock pipeline to allow Hydro Plant to be installed and the other requiring completion, including testing, of the intakes, penstock pipelines to be completed to allow the hydro Watson, Farley & Williams May 2013

6 06 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING plant to be tested and commissioned [emphasis added]), it held that there was no material ambiguity between the two documents in question. Accordingly, the application of the order of precedence clause was held not to be necessary because the Court could interpret apparently discrepant items by construing the contract as a whole. Parties to a construction contract will frequently include an order of precedence clause with the intention of providing greater level of certainty... However the circumstances under which such a clause may be applied is not always clear cut 2 Note that a successful appeal was brought against this decision in Telford Homes (Creekside) Ltd v Ampurius New Homes Holdings Ltd [2013] EWCA Civ 577. The points of appeal, however, were concerned with whether the trial judge was correct in holding that there was a repudiatory breach by the property developer (which entitled the investor to terminate the contract). The issue of whether the developer breached both or only one of the obligations to use reasonable endeavours to complete and to carry out the works diligently was not in dispute in the appeal. Accordingly, the outcome of the appeal did not affect the discussions below. In arriving at this conclusion, the Court provided the following guidance in determining whether the order of precedence clause should be engaged or not: What one cannot and should not do is to carry out an initial contractual construction exercise on each of the material contract documents on any given topic and then, so to speak, compare the results of that exercise to see if there is ambiguity If it is possible to identify a clear and sensible commercial interpretation from reviewing all the contract documents which does not produce an ambiguity, that interpretation is likely to be the right one; in those circumstances, one does not need the order of precedence to resolve an ambiguity which does not actually on a proper construction arise at all. In support of its view, the Court pointed out that the order of precedence clause expressly provided that all the documents were ʺdeemed to form and be read and construed as part of this Agreementʺ. Accordingly, this meant that the contract should simply be construed in the usual way by reference to all the documents forming part of the contract and it is only if there is an ambiguity or discrepancy between two or more documents that one then needs to have regard to the express order of precedence. Our thoughts Parties to a construction contract will frequently include an order of precedence clause with the intention of providing greater level of certainty on which document should prevail in the case of a clash between two or more contractual documents. However, it is clear from RWE that the interpretation and application of such a clause will depend on its context. In fact, the judgment itself is contrary to (or arguably a successful appeal from) the decision made previously by the adjudicator in relation to the parties dispute, who considered that one interpretation should have precedence over the other (in line with the order of precedence clause). RWE is just one of the many cases which illustrate that clear and consistent drafting could have made all the difference, especially when drafting for important concepts such as completion, and a failure to do so can prove fatal to an employer s claim for liquidated damages. How is ʺusing reasonable endeavours to completeʺ different from ʺexercising diligenceʺ? In the last of the four cases, we consider the obligations on a contractor to carry out the works diligently and to exercise all reasonable endeavours to ensure the works are completed without delay. Neither phrase is uncommon in a construction contract. But do they mean essentially the same thing in practice, such that if the contractor satisfies one obligation, he will necessarily have satisfied the other? These were some of the questions considered in Morris Homes (West Midlands) Ltd v (1) Antony Paul Keay and (2) Jeffrey David Keay [2013] EWHC 932 which reflected the previous trial decision in Ampurius New Homes Holdings Ltd v Telford Homes (Creekside) Ltd [2012] EWHC 1820 on these specific questions. 2 What happened in Morris Homes? The claimant, Morris Homes, entered into a contract with the defendants whereby Morris Homes, amongst other obligations, was to diligently carry out the Works (the diligence obligation ), and to exercise all reasonable endeavours to ensure that the Works are completed as

7 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING 07 soon as reasonably practicable (the reasonable endeavours obligation ). Owing to financial crisis, Morris Homes subsequently unilaterally suspended the construction works. In an arbitration brought by the defendants against it, Morris Homes argued that it would have risked commercial suicide by continuing with the works, and that the reasonable endeavours obligation did not oblige it to risk financial ruin by continuing with the works. Morris Homes further submitted that, if it had satisfied the reasonable endeavours obligation, it would also have satisfied the diligence obligation. What the Court decided Both the arbitrator and the Court (in an appeal brought by Morris Homes against the arbitrator s decision) rejected Morris Homes arguments. First, the Court explained that a provision requiring a contractor to carry out works diligently relates to the way in which the works are carried out (for example, the construction methods and materials used) and the time and order in which the works are carried out. Second, the Court agreed that an obligation to carry out works diligently differs from a reasonable endeavours obligation, in that a contractor may satisfy a reasonable endeavours obligation by, as in Morris Homes, suspending the works in order to ensure that it has sufficient capital to eventually complete the works, but breach an obligation to carry out works diligently by, for example, failing to programme the works properly. What about the obligation to have funding to complete? The Court s decision therefore reinforced the previous trial decision in Ampurius, the judgment of which also covered the following in respect of the issue of having adequate funding in place to complete a contract by a certain time: 3 I do not think a ʹreasonable endeavoursʹ clause as regards the time of completion in a construction contract can extend to endeavours to have sufficient money to perform the contract [O]n an objective reading the qualification of ʺreasonable endeavoursʺ, as opposed to an absolute obligation to complete, is designed to cover matters that directly relate to the physical conduct of the works, thereby providing an excuse for delay in such circumstances as inclement weather or a shortage of materials for which the Defendant was not responsible. The clause does not, in my view, extend to matters antecedent or extraneous to the carrying out of the work, such as having the financial resources to do the work at all. In other words, if a contractor runs out of materials to complete for reasons beyond his control, this in itself might not be a breach of the reasonable endeavours obligation; however, if the contractor runs out of money to complete (which may well be for reasons beyond his control), he would be in breach of the reasonable endeavours obligation. Our thoughts Morris Homes is a useful reminder that, when drafting and negotiating obligations concerning the carrying out and completion of construction works, the concepts of using reasonable endeavours to complete and carrying the works out diligently do serve different purposes and are not to be assumed to be interchangeable. An event of contractor s delay (in absence of any justifiable reasons) may amount to a breach of one but not necessarily both obligations. That issue aside, when faced with a significant contractor delay, the most pertinent questions for an employer are likely to be, what options are available to it and what the legal and practical consequences are for each option. These questions will not only require establishing what obligations have been breached, but also an assessment of the seriousness and other circumstances of such breach. An employer would be well advised to take appropriate professional advice before responding (or even terminating the contractual relationship) too quickly....a contractor may satisfy a reasonable endeavours obligation by suspending the works in order to ensure that it has sufficient capital to eventually complete the works, but breach an obligation to carry out works diligently by failing to programme the works properly. 3 As mentioned in footnote 2 on the previous page, the developer successfully appealed against the trial judgeʹs decision that there was a repudiatory breach (due to the developerʹs delay). However, the Court of Appeal decision did not affect the trial judgeʹs statement below. Watson, Farley & Williams May 2013

8 08 UK: ENGINEERING, PROCUREMENT AND CONSTRUCTION BRIEFING Contacts Should you wish to discuss any of the matters raised in this briefing, please speak with a member of our team below, or your regular contact at Watson, Farley & Williams. Martin Lucas Partner mlucas@wfw.com Mark Lawson Partner mlawson@wfw.com Pauline Page ppage@wfw.com Jon Thursby jthursby@wfw.com Freddie Phillips fphillips@wfw.com Charlotte Corble ccorble@wfw.com James Dow jdow@wfw.com All references to Watson, Farley & Williams and the firm in this publication mean Watson, Farley & Williams LLP and/or its affiliated undertakings. Any reference to a partner means a member of Watson, Farley & Williams LLP, or a member of or partner in an affiliated undertaking of either of them, or an employee or consultant with equivalent standing and qualification. This publication is produced by Watson, Farley & Williams. It provides a summary of the legal issues, but is not intended to give specific legal advice. The situation described may not apply to your circumstances. If you require advice or have questions or comments on its subject, please speak to your usual contact at Watson, Farley & Williams. This publication constitutes attorney advertising. Watson, Farley & Williams LON KW KW 29/05/2013 wfw.com