Termination and liquidated damages dispute costs subcontractor €1 million

8 minute read
28 July 2014

Construction analysis: The judgment in Bluewater Energy Services BV v Mercon Steel Structure BV & Others, highlights how complex and wide-ranging such contractual disputes can be.

Daniel Wood, partner at Wragge Lawrence Graham & Co, considers the key issues raised by the case, including termination, issuing instructions and deducting liquidated damages, and its implications for the drafting of construction contracts.

What was the outcome of this case?

This case was a hard-fought final account dispute between Bluewater Energy Services BV and Mercon Steel Structures BV (and certain other group companies).

The dispute arose out of a contract, entered into in March 2007, which related to the design, construction and installation of a soft yoke mooring system that was to be installed as part of a development of the Yuri Korchagin Field in the Caspian Sea. Bluewater had been engaged to carry out this work by a Russian oil company (Lukoil) and it sub-contracted certain fabrication elements to Mercon.

The judgment - at 240 pages and 1,535 paragraphs--contained a measure of success for both parties. The ultimate result, falling out of the final balancing of accounts, was that Mercon was obliged to pay Bluewater a sum of around EUR 1m.

What issues did this case raise?

The judgment addressed a very large number of issues in which construction lawyers are well-versed. As part of the final account determination, the judge was required to consider matters of valuation (including disputed re-measurement issues), questions relating to extensions of time (and time being at large), arguments relating to the legitimacy of termination, and defective work criticisms - not to mention a series of peripheral claims and cross-claims.

Several of the points addressed were specific to the case itself and of little interest save to the parties themselves, but the judge's legal findings in connection with termination, the form of instructions and liquidated damages (for the removal of personnel) were of wider interest.

To what extent is the judgment helpful in clarifying the law in this area?

As noted above, the judgment did help to clarify certain aspects of law.

Instructions

The contract permitted Bluewater to issue instructions, with which Mercon was then obliged to comply 'immediately'. An important question arose as to whether it was essential for any such instruction - in order for it to be binding upon Mercon - to be in a standard form 'site instruction' that was prescribed by the contract.

The judge decided that, on the words of this contract, it did not. All that was needed was for it to be clear from the terms of the document in question that it was intended to be an instruction under the relevant clause-a view consistent with other cases in the TCC recently (for example, Obrascon Huarte Lain SA v Attorney General for Gibraltar [2014] EWHC 1028 (TCC), [2014] All ER (D) 166 (Apr)).

Of course, the use of the prescribed form would remove the room for argument, but if it was nevertheless clear that a formal instruction was intended then immediate compliance would be required. That would of course be very significant if, as here, the failure to comply with the instruction was then relied upon as a ground for termination.

Termination

The termination mechanism comprised a fairly familiar two-stage process. It required a notice of default by Bluewater, followed by termination in the event that Mercon did not immediately proceed with 'action satisfactory to BLUEWATER'. The parties disagreed about whether Bluewater could simply rely upon its own dissatisfaction about the steps taken, or whether it had to objectively justify its position.

The judge took the view that the question was simply whether Bluewater could show that it was dissatisfied, albeit that this view could not be held on any basis. The judge decided that a termination could only be capable of challenge if Mercon should show that Bluewater's position was not held honestly, in good faith or genuinely, or if it was held arbitrarily, capriciously, perversely or irrationally. In essence, as long as Bluewater's 'dissatisfaction' was held fairly, the termination would stand. In connection with what was a dramatic step, this was obviously a fairly low bar.

Liquidated damages

While one often sees liquidated damages directed at questions of delay, or plant performance, one occasionally finds them directed at the unauthorised removal and replacement of key personnel. The contract here contained such a provision.

Bluewater claimed a fairly significant sum from Mercon as compensation for a series of unauthorised staff replacements. While the damages levels had been negotiated at the outset, Mercon sought to argue that the agreed figures in fact operated as a penalty-ie a deterrent against staff replacement - and that the figures were not otherwise commercially justifiable.

After reviewing the relevant law, the judge rejected these arguments. He was of the view that the authorisation regime provided an important safeguard for Bluewater, and he accepted that the replacement of a key member of the project team could cause a great deal of disruption to the project. While he noted that it was not open to him to form a view on whether the agreed damages were a genuine pre-estimate of loss, he was happy that this is clearly what the parties were trying to achieve at the outset.

Deciding that the figures in question (EUR 20k - EUR 50k) were not exorbitant, the judge therefore found that Mercon had not come close to demonstrating that the figures were penalties and they were enforced against them accordingly.

What are the implications for practitioners? What will they need to be mindful of when advising clients?

The contract contained certain provisions which required Bluewater to exercise its discretion. The instance concerning termination is one example. As noted above, the judge found that, in exercising discretion, Bluewater was simply required to show that it was not acting irrationally.

Parties may wish to consider imposing upon a decision maker, in such a context, an obligation to reach a decision that is reasonable in all the circumstances and which would then be capable of objective review by a tribunal in the event that the decision was not accepted. This would be likely to improve the quality of the decisions, and make them fairer overall, but it would potentially deprive the decision of finality and thereby add a layer of uncertainty to the process.

The decision in relation to liquidated damages for personnel is equally important in that it shows that the courts will be prepared to enforce provisions aimed at breaches of this nature. More broadly, however, the decision also indicates that the courts are increasingly interested in whether agreed figures for liquidated damages are commercially justified.

On the facts of this case, the judge was unable to form a view on whether the agreed figures were a genuine pre-estimate of loss but nevertheless, given the context in which they were agreed and the role that they were intended to perform, he was happy to enforce them.

Do you envisage any practical or technical difficulties or unintended consequences arising from the decision?

The judgment does not contain any significant changes in the law, but it does reinforce a number of principles. That a party charged with making decisions-decisions that could seriously affect the rights of the other party - does not need to come to the right decision, simply a fair one, is an important point to consider.

Construction and engineering contracts often provide for one or other party to make decisions, exercising their discretion, but without recording the standard with which that decision is to be made. This includes, for instance, decisions made in the context of certification and payment. One questions whether the approach in this case will have a wider impact. Given the potential significance of such a point, it may be that we do not need to wait long to find out.

This article was first published on Lexis®PSL Construction on 23 July 2014.


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