A tale of business common sense and the construction contract

11 May 2015


How to interpret a contract in line with business common sense has been considered again by the Technology and Construction Court in Secretary of State for Defence v Turner Estate Solutions which highlights the need for consistent contract administration.

The Secretary of State for Defence (SSD) has just had a resounding win in the Technology and Construction Court (TCC). The decision is interesting as it both highlights the courts' commitment to contractual interpretation that is consistent with business common sense but also, from a pragmatic perspective, even where a contract is clearly worded (as in this case) the importance of actually applying the terms of the contract agreed.

Background

Here's a brief background. In 2003, the parties entered into a "painshare/gainshare" design and build contract for works at HMNB Clyde incorporating Maximum Price and Target Cost provisions. Costs overran significantly and inevitably, arbitration followed. At the time of this case, the second arbitration was ongoing with a final hearing due to take place in June this year. In an attempt to save costs, SSD commenced this application requesting the TCC to determine two preliminary points of law under s45 of the Arbitration Act 1996.

In the second arbitration, the contractor Turner is claiming around £68 million more than the current Maximum Price on the grounds that, although the pain/gain provision was operated to start with, it then fell into abeyance and as a result (the Contractor argued) the entire pain/gain provisions became redundant.

Therefore, according to the Contractor, the parties are into a "costs plus" situation. The Contractor argued that if even one variation (Change) was not dealt with contemporaneously under the Change provisions in the contract, the entire Maximum Price and Target Cost provisions would be wiped out and of no effect.

The TCC's approach

The TCC was not impressed by the Contractor's arguments, describing some of its submissions as "somewhat one-eyed", although to be fair, with £68 million (plus interest and costs potentially) at stake, any argument may seem like a good argument.

In interpreting the contract in favour of SSD, emphasis was placed by the TCC on "the absence of any business common sense in the [Contractor's] construction of the contract" quoting the Supreme Court (SC) decision in Rainy Sky SA v Kookmin Bank [2011]:

"If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other".

In Rainy Sky, the SC was considering guarantees issued by Kookmin Bank. The SC made it clear that where the parties have used wholly clear language that is not open to interpretation, effect will be given to that wording even if that produced an "improbable commercial result".

The guarantees issued by Kookmin Bank, however, contained ambiguous wording and so, the SC decided, it was appropriate to adopt the interpretation most consistent with business common sense. So, in other words, what is the practical outcome of a particular contractual interpretation and does it make sense from a commercial perspective?

Again, adopting a pragmatic approach, the judge in SSD v Turner was particularly complimentary of the hypothetical scenarios put forward by SSD as being the natural consequence of the Contractor's interpretation of the contract.

For example, if the Contractor's approach were to be adopted, even a minor Change the day before practical completion would have the effect of completely nullifying all clauses in the contract relating to Target Cost and Maximum Price ie no more pain/gain but merely a costs plus agreement. Is that likely to have been the parties' intention? Surely not.

The TCC also drew analogies with some of the issues considered by the Court of Appeal (CA) in McAlpine Humberoak v McDermott International [1992] where the trial judge had found that the numerous alleged variations gave rise to "a kind of frustration" (adopting the description used by the TCC in SSD v Turner) which nullified the payment terms of the contract, leaving the contractor to be paid on a quantum meruit basis. On appeal, the CA rejected this approach, Lloyd LJ stating:

"If we were to uphold the judge's finding of frustration, this would be the first contract to have been frustrated by reason of matters well-known to the parties which had not only occurred before the contract was signed, but had also been expressly provided for in the contract itself…"

and using the following scenario as an example:

"… if a contractor is already a year late through his culpable fault, it would be absurd that the employer should lose his claim for unliquidated damages just because, at the last moment, he orders an extra coat of paint…..".

As the TCC highlighted, the issues in SSD v Turner are not the same as those being dealt with by the CA in McAlpine Humberoak but the principle carries through: "the contract has to be construed in accordance with business common sense" and to give effect to all parts of the contract, rather than considering one clause or specific clauses in isolation.

The TCC held that it was possible to operate the Target Cost mechanism even after the construction works had been completed. It may be argued that this is a surprising result in that, to be operated commercially, a target cost needs to be set before the cost is incurred and not after it is known. Bearing in mind the sums involved, this case may go further.

Comment

The decision in SSD v Turner of course emphasises the need for clarity in drafting but focussing practically, the drafting of the contract under consideration here was not the trigger for the dispute. During the construction phase, Changes were, it appears, effectively put on the back burner reflecting arguably no consistent commitment to actually putting the terms of the contract into effect.

It is possible that if the pain/gain provisions had been operated contemporaneously, two arbitrations and court proceedings may have been avoided. This may seem an obvious point but process can often be overlooked or sidelined in the push and shove of achieving deadlines, as happened in this case. The SSD is bound to be pleased with the outcome in this case but may also be counting the cost in terms of the internal time and resources which have had to be committed to this convoluted dispute.


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