Round-up of recent cases (July 2016)

Reformulated test for contractual penalties

The Supreme Court decision in Cavendish Square Holdings BV¹ v Makdessi has received much attention from construction practitioners since it was issued at the end of 2015 because it revisits the question of liquidated and ascertained damages ("LADs") and what constitutes a contractual penalty.

The test before Makdessi was one that those in the industry are familiar with: an LAD clause will only be enforceable if it represents a genuine pre-estimate of the loss of the innocent party and, if it does not, it amounts to a penalty and will be unenforceable, leaving the innocent party entitled to a remedy under the general law but not under contract. The Makdessi case was not a construction case as it involved the sale by Mr Makdessi of shares in his advertising business. However, the same question arose: did certain provisions in Mr Makdessi's share purchase agreement amount to a penalty?

The Supreme Court indicated a greater receptiveness towards LAD provisions, noting that the penalty rule in England "has not weathered well". The leading judgment endorsed the view that the main purpose of the law relating to penalty clauses was to prevent the innocent party recovering a sum of money bearing little or no relationship to the loss actually suffered but was not intended to mitigate the consequences of an onerous or imprudent bargain. In practice, this means that if a court is required to consider such a clause it has jurisdiction to review the remedy (the secondary obligation) but it does not have jurisdiction to regulate the fairness of the contractual obligation itself (the primary obligation).

Assuming the obligation is secondary, then, following Makdessi, the test for determining whether a clause is a penalty will be whether it imposes on the contract-breaker consequences which are "out of all proportion to any legitimate interest of the innocent party". Therefore, the fact that a clause does not contain a genuine pre-estimate of loss does not automatically mean it is a penalty. As long as a legitimate business interest is served and protected by the clause and the provision is not 'extravagant, exorbitant or unconscionable' it will be upheld.  

The leading judgment endorsed the view that the parties are best placed to determine what the consequences of a breach of contract should be where the provision is part of a negotiated contract between properly advised parties of comparable bargaining power. The courts will therefore examine the contract as a whole and will take into account the circumstances and context in which it is made.

The Makdessi decision has enhanced contractual certainty and reduced the likelihood that LAD clauses will be held to be unenforceable because they are not a genuine pre-estimate of loss. In the future, greater reliance will be placed on the 'legitimate interest' test. Drafting a remedy as a 'primary' obligation may also help avoid it being unenforceable, but it is the substance of the clause rather than its form that is conclusive.

Clarification of the law on implied terms

The Supreme Court in Marks & Spencer Plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd² has resolved uncertainty in relation to the law on implied terms. Prior to this case the position had been clouded by an earlier judgment, in 2009, Attorney General of Belize v Belize Telecom Ltd.³

 Before the Belize case, the classic position was that a term could be implied to give effect to the presumed intentions of the parties which were to be identified by considering whether the implied term was necessary in order to give business efficacy to the agreement. Allied to this was the 'officious bystander' test: in order to imply a term into a contract it had to be one that, if it had been suggested to the parties when they entered into their agreement, they would have agreed to.

Belize muddied the waters when Lord Hoffmann, in the Privy Council, suggested a looser approach that arguably side-lined the 'officious bystander' test. Much legal debate on the decision followed. Now, in the Marks & Spencer decision, the position has been settled. The majority judgment bypassed Belize and set the law back to how it stood before.

Consequences of inadequate payment provisions

Construction industry experts have given a lot of attention recently to disputes involving contractual payment provisions. In the case of Grove Developments Limited v Balfour Beatty Regional Construction Limited⁴ the contract contained a schedule of 23 valuation and payment dates over a two year period, ending in July 2015 (which was when the project was due to be completed). The works were delayed and Balfour Beatty issued a 24th application for payment. Grove did not pay and Balfour argued that Grove had not issued a valid payment or pay less notice and that they were therefore entitled to the payment sought under application number 24. Balfour sought payment through adjudication proceedings and the adjudicator awarded in their favour. Grove took the matter to the Technology and Construction Court, which found that Balfour were not entitled to issue application number 24 because the contract only provided for 23. The judge found that the parties had concluded binding contractual provisions that were compliant with the Construction Act 1996 and there was no need to incorporate any other provisions. The result of this decision was that Balfour had no entitlement under the contract to the money they sought under the 24th application.  The judge noted that Balfour should have protected themselves at the time the contract was negotiated, by seeking terms giving them the right to further interim payments in the event of non-culpable delay.  As in the Makdessi case, the fact that a bargain is commercially harsh for one of the parties is not a matter the courts will interfere with.⁵

Another recent case on payment provisions is Manor Asset Limited v Demolition Services Limited⁶. In contrast to Grove v Balfour Beatty, the contract did not comply with the Construction Act and the court was willing to imply provisions to make it compliant. The court's willingness to imply a term into a contract's payment mechanism has subsequently caused some concern, however, in Bouygues (UK) Limited v Febrey Structures Limited⁷ the judge declined to follow the Manor Asset decision. Instead, it was held that, from the facts, it was evident that there had been a "clear and obvious error" in the parties' payment provisions which, if construed correctly, gave effect to the express provisions of the contract.

The lesson to be learned from these cases is that mistakes in the payment schedule can be extremely costly. Careful drafting is required to ensure that the interim payment provisions are correct, compliant with the Construction Act and that the contract provides for overruns in the schedule.

Exclusion clauses: clear wording will be enforced

There has been a theme in this round-up on the importance of clear wording and on the court's willingness to contextualise contracts when interpreting them. The same themes are apparent in Transocean Drilling UK Limited v Providence Resources Plc,⁸ a case that concerned drilling operations off the southern coast of Ireland. 

When operations were suspended following an incident, the owner of the rig sought damages from the contractor, Transocean, and the High Court awarded them. The contractor appealed, arguing that the contract contained a 'knock for knock' arrangement, whereby each party agreed to indemnify the other and hold each other harmless in respect of their own consequential losses. Consequential loss was specifically defined in the contract with a non-exhaustive list that included the loss of use of property, equipment, materials and services.

The Court of Appeal overturned the High Court decision by finding that the contractual wording was clear and unambiguous. Transocean was held not to be liable to the owner of the rig for the consequential losses claimed.

This case should reassure drafters of construction contracts that clear wording will be enforced by the courts. Parties can assist themselves, where they wish to exclude consequential or indirect losses, by defining the relevant types of loss as fully as possible. Like the Supreme Court in Makdessi, the Court of Appeal in this case displayed a reluctance to interfere in highly negotiated, complex commercial contracts between properly advised parties of comparable bargaining power. However, ambiguous clauses or contractual arrangements where the parties have unequal bargaining power will continue to be interpreted restrictively based on the contra proferentum principle (whereby if there is any doubt about the meaning of a provision, it will be construed against the party seeking to rely on it).

Loosening of the law on variations

Anti-oral variation clauses are included in agreements for good reason: it makes sense to ensure that the parties (a) know what they have to do to vary the agreement and (b) have to do so in writing so that there is no dispute about oral discussions at a later stage. Until recently there was uncertainty about whether such anti-oral variation clauses are binding but in MWB Business Exchange Centres Limited v Rock Advertising Limited⁹ the Court of Appeal decided that such clauses do not prevent parties to a contract from subsequently agreeing to vary it orally or by conduct. 

This judgment confirmed obiter comments in Globe Motors, Inc & Ors v TRW Lucas Varity Electric Steering Limited¹⁰ where, despite a clause in the agreement stating that any amendment to the contract had to be made in writing and signed by both parties, the court indicated that the principle of freedom of contract meant that an anti-oral variation clause would not prevent the parties to a contract from later making a new agreement varying the original contract either orally or by conduct.

On the subject of variations other than in writing, the court in C&S Associates UK Limited v Enterprise Insurance Company Plc¹¹ confirmed that email exchanges would be sufficient to vary an agreement containing an anti-oral variation clause, provided that the other requirements of contract formation and variation are complied with.

Notes

1.[2015] 3 WLR 1373.
2.[2015] UKSC 72; [2015] 3 WLR 1843.
3.[2009] 1 WLR 1988.
4.[2016] EWHC 168 (TCC).
5. This case is going to appeal and is due to be heard shortly. 
6.[2016] EWHC 222 (TCC).
7.[2016] EWHC 1333 (TCC).
8.[2016] EWCA Civ 372.
9. [2016] EWCA Civ 553.
10.[2016] EWCA Civ 396.
11.[2015] EWHC 3757 (Comm).