Will an oral agreement override a written one that expressly prohibits oral modification? No. The UK Supreme Court in Rock Advertising Ltd - v - MWB Business Exchange Centres Ltd[1] brings welcome clarification to the English common law on “no

Will an oral agreement override a written one that expressly prohibits oral modification? No. The UK Supreme Court in Rock Advertising Ltd – v – MWB Business Exchange Centres Ltd[1] brings welcome clarification to the English common law on “no oral modification” (NOM) clauses. The courts will now uphold them.

Unless very particular circumstances are involved, the only means to vary a contract with a NOM clause is by doing so in writing. The Court’s judgment is interesting for its divergent views on the philosophy of what it means to have freedom of contract. But with conceptual objections now swept aside, the construction industry will take note of this judgment given widespread use of NOM clauses in bespoke construction contracts.

The Concept of Party Autonomy

Resonating through common law jurisprudence is the “celebrated dictum” of Cardozo J on the subject of freedom of contract. One hundred years ago he stated in the New York Court of Appeals:

“Those who make a contract, may unmake it. The clause which forbids a change, may be changed like any other. The prohibition of oral waiver, may itself be waived… What is excluded by one act, is restored by another. You may put it out by the door, it is back through the window. Whenever two men contract, no limitation self- imposed can destroy their power to contract again…”[2]

In recent years a small number of English Court of Appeal decisions have considered the thorny question of whether a contract could be varied orally or by conduct even though it contained a NOM clause. Although the results have not been uniform, the cases culminated in a 2016 Court of Appeal judgment where Moore-Bick LJ stated:

“The governing principle in my view, is that of party autonomy. The principle of freedom of contract entitles parties to agree whatever terms they choose, subject to certain limits imposed by public policy. The parties are therefore free to include terms regulating the manner in which the contract can be varied, but just as they can create obligations at will, so also can they discharge or vary them, at any rate where to do so would not affect the rights to third parties.” [3]

And there the matter largely stood, until the UK Supreme Court received the appeal in the case of Rock Advertising Ltd – v – MWB Business Exchange Centres Ltd.

Rock v MWB

The facts were that in 2011, Rock Advertising Ltd (“Rock”) agreed a 12-month licence with MWB Business Exchange Centres Ltd (“MWB”) for use of office space. The fee was £3,500/month for the first three months and £4,333/month thereafter. Clause 7.6 of the licence stated:

“This Licence sets out all of the terms as agreed between MWB and Licensee. No other representations or terms shall apply or form part of this Licence. All variations to this Licence must be agreed, set out in writing and signed on behalf of both parties before they take effect.”

Rock immediately fell behind in its payments and in late February 2012 owed £12,000. It proposed to MWB’s credit controller a revised schedule of payments, which consisted of deferring fees for part of February and March 2012 and spreading the balance of its existing debt over the remainder of the licence term. The parties fell into dispute over whether MWB’s credit controller had accepted the proposal. She denied this and claimed to have taken it to her superior who rejected it. There would appear not to have been any discussion of the NOM Clause 7.6, almost certainly because neither party representative knew of its existence. On 30 March 2012, MWB locked Rock out of the premises, terminated the licence and sued for arrears. Rock counterclaimed damages for wrongful exclusion.

The court at first instance found that there was an agreement between the parties but that it was ineffective because it was not recorded in writing. The Court of Appeal found that not only was there an oral agreement, but it also amounted to an agreement to dispense with the restriction in Clause 7.6.

A New Approach by Majority Decision of The Supreme Court

However, the Supreme Court disagreed. Lord Sumption gave the majority judgment and held, among other things, that the agreed variation was not valid due to the absence of writing and signatures prescribed by Clause 7.6. He considered that the law should give effect to a contractual provision requiring specified formalities to be observed for a variation of the contract. This approach was, he said, entirely consistent with certain statutory exceptions to the English common law. Contracts for the sale of land, for example, are required to be in writing. There is no principled reason why the parties could not adopt the same principle by agreement. It made commercial sense to do so, and NOM clauses are respected in a number of other common law jurisdictions, just as they are in contractual codes widely applied internationally such as UNIDROIT. Oral variations will therefore be invalid where the parties have previously agreed that any variations must be in writing.

For Lord Sumption, it was a fallacy to proclaim that the fundamental concept of party autonomy meant that the parties could not validly bind themselves as to how future changes in their legal relations could be achieved – no matter how clearly they expressed their intention to do so. He said:

“Party autonomy operates up to the point when the contract is made, but thereafter only to the extent that the contract allows. Nearly all contracts bind the parties to some course of action, and to that extent restrict their autonomy. The real offence against party autonomy is the suggestions that they cannot bind themselves as to the form of any variation, even if that is what they have agreed.”

Lord Briggs’ Dissenting View

Lord Briggs gave a dissenting judgment, agreeing with the outcome of Lord Sumption’s judgment based on the facts of the case but arriving there by a different, narrower, and more cautious route. His starting point was that NOM clauses are indeed frequently encountered in commercial agreements: in many different jurisdictions and the common law should in principle uphold what had been agreed by the parties to a contract. However, there was still that valid conceptual objection espoused by Cardozo J.

Lord Briggs squared this particular circle by drawing a distinction between an oral variation to the substantive terms of the contract and an oral variation of the NOM clause itself. He required the NOM clause to be the subject of express amendment if the oral amendment of the substantive terms of the contract were to be allowed to stand. He stated:

“The NOM clause will remain in force until they both (or all) agree to do away with it. In particular it will deprive any oral terms for a variation of the substance of their obligations of any immediately binding force, unless and until they are reduced to writing, or the NOM clause is itself removed or suspended by agreement. That fully reflects the autonomy of parties to bind themselves as to their future conduct, while preserving their autonomy to agree to release themselves from that inhibition.

“What is to my mind conceptually impossible is for the parties to a contract to impose upon themselves such a scheme, but not to be free, by unanimous further agreement, to vary or abandon it by any method, whether writing, spoken words or conduct, permitted by the general law.”

Lord Briggs considered that oral modification of the terms of a written contract was indeed possible, provided that the parties turned their attention to the impediment presented by the NOM clause and expressly agreed to deal with that. That express agreement could be oral. However, it could not be readily implied, although he conceded that there might be circumstances where it could be implied. On the facts of Rock v MWB, the outcome was in any event the same because the party representatives did not address at all the existence of the NOM clause.

For Lord Briggs, his alternative approach preserved the commercial benefits of certainty. Problems of alleged agreements and abusive litigation were also thereby minimised. Furthermore, his approach, he thought, represented an incremental development of the English common law, rather than a “clean break” with the current consensus across several international, common law jurisdictions.

Lord Briggs was alone in his dissension. His views have found some support in published commentaries but the law on the subject is now the decision held by the majority of the Supreme Court.

The Court avoided dealing in detail with the role that an estoppel might play in overruling a NOM clause, because the facts of the case did not require them to explore that question. However, in circumstances where one party reasonably relies on the words or conduct of another which unequivocally represents that an oral variation was valid despite a NOM clause, the court indicated that the doctrine of estoppel may still be available to prevent an injustice.

The last word must however go to Lord Sumption:

“The law should and does give effect to a contractual provision requiring specified formalities to be observed for a variation… There is no conceptual inconsistency between a general rule allowing contracts to be made informally and a specific rule that effect will be given to a contract requiring writing for a variation to be valid.”

Comment

This case has considerable implications for construction contracts governed by English law where they contain NOM clauses or require that amendments comply with specific formalities. There are very understandable reasons for this. Projects can be fast moving, leading to pragmatic responses to developments at site or elsewhere, involving any number of participants. All of this provides fertile ground for disputes, and managers of the parties will generally wish to restrict the scope for unauthorised oral agreements to a written contract. They will derive comfort from the judgment in Rock v MWB. Arguments that a NOM clause was overridden by an ad hoc oral agreement are now likely to fail.

Please get in touch at joanne.clarke@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [2018] UKSC 24 (16 May 2018).

[2] Alfred C Beatty V Guggenheim Exploration Company (1919) 225 NY 380.

[3] Globe Motors Inc and others v TRW Lucas Varity Electric Steering Limited and another [2016] EWCA Civ 396 (20 April 2016).

A penalty is now to be regarded as: “a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.” The UK Supreme

A penalty is now to be regarded as:

“a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”

The UK Supreme Court has reviewed the English law of penalties and re-formulated the test in a landmark judgment on two unrelated appeals heard together:

• Cavendish Square Holding BV – v – Talal El Makdessi (“Cavendish”); and
• ParkingEye Ltd – v – Beavis (“Beavis”).[1]

The two appeals did not involve construction matters. The judgment will nevertheless be of great interest to construction industry practitioners, including lawyers, when considering whether a liquidated damages clause is valid and so fixes the sum payable in the event of a breach of contract, or alternatively, is an unenforceable penalty. If it is a penalty, the innocent party will need to prove his damages at common law.

Practitioners should note that the distinction has just become rather more clouded. The test provided 100 years ago has been replaced by more subjective considerations on which more guidance will inevitably be required from the courts. It may transpire that those certain types of construction employer, in seeking to protect a wide interest, may now seek greater sums in liquidated damages than previously.

Penalties are Secondary Obligations

The law regarding penalties is a rule of contract law based on public policy. A contract may not “punish” a contract-breaker. Penal provisions will therefore not be enforced by the courts. They have for a long time acknowledged that the law regarding penalties does not apply to primary contractual obligations. Save for circumstances involving illegality, duress, or questions of consent and the like, primary obligations are matters for the parties alone. The courts will generally not interfere; to do so would run counter to the parties’ freedom of contract.

Only secondary obligations that respond to a breach of contract may be subject to the law on penalties. The most obvious example of a secondary obligation is one whereby the contract-breaker must pay money in the form of liquidated damages to the innocent party. But, as we shall see, other secondary obligations may be equally amenable to the test for a penalty. For example, the requirement to transfer property or shares may also qualify as a penalty in the appropriate context.

Former Distinction Between Liquidated Damages and Penalty

In 1915, the House of Lords decision in Dunlop[2] famously underlined the dichotomy between a penalty and a liquidated damages provision in a contract. It was said to be ultimately a question of construction.

Dunlop held that the essence of a penalty was the payment of money stipulated as in terrorem of the offending party i.e. intended to deter a breach. In contrast, Dunlop also held that the essence of a valid liquidated damages provision was “a genuine, covenanted, pre-estimate of damage”. Anything that was not a genuine pre-estimate was at risk of being found penal after Dunlop. If the sum stipulated was “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”, it was definitely penal according to Dunlop.

Now, whilst the dichotomy between a penalty and a valid liquidated damages clause still exists as a matter of law, the boundary between the two has moved.

Cavendish v Makdessi

The Supreme Court case of Cavendish concerned an agreement for the sale of a majority shareholding by Mr Makdessi to Cavendish at a price per share that reflected very valuable goodwill. The agreement provided for stage payments; an initial payment to Makdessi followed by further payments calculated to reflect company profits when they were known. There was an anti-competition covenant that was later broken by Makdessi. In such circumstances, the agreement provided that Makdessi forfeited entitlement to the further payments and that he could also be required to transfer his remaining shareholding to Cavendish at a price per share stripped of the value of goodwill. Makdessi contended that the provisions, including that for the transfer of his remaining shareholding, were penalties and unenforceable.

The Supreme Court resisted a submission for the penalty rule’s complete abolition. However, it recognised many problems inherent in Dunlop. For example, secondary obligations following the breach of a primary obligation, particularly in modern commercial contexts, were said not always to be confined to the payment of money, contrary to the test set out in Dunlop. They might involve the forfeiture of a deposit in money or even the transfer of property e.g. in shares. It was said to depend on the nature of the right which the contract-breaker was being deprived of and the basis on which he was being deprived of it. The courts should be free to examine such secondary obligations to determine whether they are penal and therefore unenforceable, the Supreme Court said.

The Court was not unanimous in its categorisation of the provisions for the treatment of goodwill under Makdessi’s agreement. A minority decided that the provisions regarding loss of entitlement to further payments were not secondary obligations by Makdessi but were in fact part of a conditional primary obligation to pay by Cavendish. They were no more than a price adjustment mechanism whereby Makdessi, as the seller, effectively earned his future goodwill payments by not competing with the company he was selling. Goodwill was part of his consideration for the sale.  If it was not provided, Cavendish was not required to pay for it. Non-payment under the agreement did not amount to damages for breach of the anti-competition covenant. The law regarding penalties could not therefore apply, according to the minority. A majority of the Court however considered the forfeited payments were indeed secondary obligations on the part of Makdessi but were not penal for other reasons.

The distinction between what is a primary and a secondary contractual obligation and the prospect of “disguising” the true position in complex arrangements is therefore a potential problem for the future. Equally problematic may be the potential overlap between the common law right of an innocent party to withhold something otherwise due under an agreement, and the equitable remedy of relief against forfeiture available to a contract breaker.

The Law Lords in Cavendish also found the Dunlop concept of in terrorem, or deterrence, to be unhelpful. They said that an innocent party might have a legitimate interest in the performance of the contract by the other party which went well beyond the simple right to recover damages (i.e. financial compensation for breach) even if the damages could readily be calculated. There might be a wider purpose to the bargain; deterrence might be reasonable and appropriate to protect it.

Particularly in cases where the parties have access to legal advice and can negotiate on equal terms (as was the case with Cavendish and Makdessi), the Court considered that they should have the freedom to agree terms that were a deterrent to breach. Here the Court found that Cavendish and Makdessi placed a very high value on Makdessi’s accumulated goodwill. It was central to the bargain and Cavendish wanted to acquire it. Cavendish had a legitimate interest in protecting it. Once Makdessi had breached the anti-competition covenant, “the wolf was in the fold” as the lower court judge expressed it. The goodwill was effectively lost. Makdessi accordingly lost the entitlement to payment.

Furthermore, once this had happened, Cavendish had a legitimate interest in severing the relationship between the parties as quickly as possible. It could not proceed with a disaffected minority shareholder in Mr Makdessi. It was entitled to acquire the balance of Makdessi’s shareholding immediately and without the goodwill component, as provided for in the agreement. The requirement for the share transfer did not amount to a penalty.

For similar reasons the Supreme Court in Cavendish also thought unhelpful Dunlop’s requirement for a valid liquidated damages provision to be a genuine pre-estimate of loss that might flow from the breach.

Circumstances might mean that the amount to be paid following breach or other secondary obligation could not satisfy that strict test. As stated above, Dunlop had referred to a penalty in terms of the sum paid being “extravagant and unconscionable.” Similar phraseology is to be found in the review of more than 100 years of case law helpfully set out in Cavendish. One sees phrases such as “exorbitant”, “wholly disproportionate”, “gross excessiveness”, “unreasonable”, “manifest excess”, “extravagant disproportion” (and combinations of most of them) all used to describe a penalty provision over the years.

From this raft of egregious terms, the Supreme Court has distilled down the essence of a penalty. It has now approved the following succinct re-statement of the test. The test for a penalty now is:

“whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.”.

ParkingEye v Beavis

ParkingEye managed the car park of a retail centre containing many individual stores. Signs throughout the car park stated that the first two hours’ parking by customers was free but those who parked for anything longer would incur an £85 single charge. The signs also stated that, by parking in the facility, motorists were agreeing to the above terms. Mr Beavis overstayed by almost one hour and was charged £85. In court proceedings brought by ParkingEye to recover the charge, Beavis alleged that it was unenforceable at common law because it was a penalty. He also alleged that it was unfair and unenforceable by virtue of the Unfair Terms in Consumer Contracts Regulations 1999 (“Regulations”).

The Supreme Court heard the scheme described as a “traffic space maximisation scheme”. The £85 charge clearly had nothing to do with compensating ParkingEye for Beavis’s breach. Its predominant purpose was in terrorem – to deter over-stayers – prohibited by Dunlop. The entire scheme benefitted the retailers who relied on the offer of two hours’ free parking to attract potential customers to the retail centre and on the £85 charge then to repel them, so ensuring that there was a regular turnover of visitors. The subsidiary purpose of the charge was to fund the scheme.

That benefited ParkingEye by allowing it to make a reasonable profit. Even the car park’s users benefitted from the scheme through having access to parking space that might otherwise be clogged up with vehicles not belonging to customers of the retail centre.

ParkingEye therefore was found to have a legitimate interest in the enforcement of the charge which was not out of line with those of other such schemes elsewhere in the UK. The charge was therefore not wholly disproportionate to that legitimate interest and not a penalty. Neither was it unfair under the Regulations.

Conclusion on the Implications of Cavendish and Beavis

The concept of penalty remains, but the point at which it is reached has become more elastic. It would seem that with the disappearance of the emphasis on requiring a genuine pre-estimate of loss, there is now scope for liquidated damages to exceed previous levels. Some deterrence is in principle now acceptable.  So long as there is a legitimate interest in enforcement of the original obligation and the sums stipulated are not “out of all proportion” and unconscionably so, the courts are likely to tolerate the level of damages agreed. Much uncertainty, however, remains:

• The distinction between primary and secondary obligations was unclear even to the seven-member bench assembled in Cavendish. For complex commercial matters, further guidance will be required on this question and on how one may identify a penalty masquerading as a primary obligation. In the commercial arena, one can now expect to see obligations framed as primary obligations so far as possible to render them immune from
• In the field of construction, a simple obligation to pay liquidated damages for completion after an agreed date is unlikely to be regarded as primary in nature. However, where differences in performance of the final product attract liquidated damages, depending upon how the provisions are drafted when looked at overall, there might be greater scope for such a finding.
• A further problem lies in the identification of what a legitimate interest is, and on its distinction from an “illegitimate” one. May an employer, say, a high-profile authority with responsibilities towards the general public, now argue that its interests entitle it to enforce a contractor’s obligation to pay liquidated damages for delay or under-performance far exceeding the “genuine pre-estimate of loss” which formerly it would have demanded?
• If so, the importance of an Employer’s “legitimate interests” in performance and the potential effects of a breach on those interests are best declared at the outset and set out clearly within the contract
• Given the considerations of the Supreme Court in Cavendish, in those circumstances it would also be sensible to include a declaration that the parties are of comparable bargaining power and have had access to legal

A still further problem resides in determining what constitutes a detriment “out of all proportion” to a legitimate interest. Which, if any, of the superlatives may still be relied upon now for further guidance? Lord Mance considered them to be “extravagant, exorbitant or unconscionable”, at least in cases where the parties were not of equal bargaining power and properly advised.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [2015] UKSC 67.

[2] Dunlop Pneumatic Tyre Company Ltd v New Garage & Motor Company Ltd [1915] AC 79 (“Dunlop”).

The purpose of the 1958 New York Convention is to facilitate, so far as possible, the international recognition and enforcement of foreign arbitral awards. Nevertheless, it provides that a court may refuse to do that if such an award has

The purpose of the 1958 New York Convention is to facilitate, so far as possible, the international recognition and enforcement of foreign arbitral awards. Nevertheless, it provides that a court may refuse to do that if such an award has already been set aside or suspended at its “seat”. The English courts have interpreted this word “may” as giving themselves a wide discretion. But in practice, it is likely to result in a refusal to enforce.

When an award has been set aside at the seat of the arbitration, the enforcing court will first have to consider the status of the award. From an international perspective one finds different views on that status:

• On the one hand it has been argued that an award already set aside at its seat has no legal status at all and therefore there is nothing to enforce.
• The opposing view is that the annulment of the award does not necessarily affect its validity before the enforcing
• The English Courts Pragmatic View

The English courts have been pragmatic in this matter. They have rejected any absolutist approach based on legal theory and instead applied a test to determine whether such an award should or should not be enforced.

In the case of Dowans and another v Tanzania Electric Supply Co Ltd.[1] Burton J. held that there was no question of an automatic refusal to enforce the award simply because one of the grounds for setting it aside had been satisfied. He held that “the English courts still retain a discretion to enforce the award, though that jurisdiction will be exercised sparingly.”

The more recent case of IPCO (Nigeria) Ltd v Nigerian National Petroleum Ltd[2] is consistent with this. Gross J. held that there was no doubt that s.103 of the

Arbitration Act 1996 is pre-disposed to the enforcement of New York Convention awards, reflecting the underlying purpose of the New York Convention itself. Therefore, even when a ground for refusing enforcement is established, the court will still retain a discretion to enforce.

Gross J. then went on to look at how the discretion would be used. He referred to Lord Mance’s opinion in Dallah Estate and Tourism Holding Company v The Ministry of Religious Affairs, Government of Pakistan.[3] Paraphrasing that review, Gross J concluded that:

• The enforcing court could, if necessary, consider the circumstances in which both the original arbitration award was made and the circumstances in which it had later been annulled.
• The enforcing court would not be prevented from forming its own view on whether the foreign entities involved had complied with the appropriate legal rules.

In Yukos Capital SARL v OJSC Rosneft Oil Company[4] both the English and Dutch courts had to address the question of whether they could enforce an award that had been set aside at the seat of the arbitration. Four awards were made in favour of Yukos Capital on 19 September 2006.

The seat of the arbitration was Russia. On 23 May 2007, the Moscow Arbitrazh Court (which was the relevant supervisory court) annulled each of the awards in judgments which were later upheld on appeal. Despite being set aside at the seat of the arbitration, Yukos Capital tried to enforce the awards in the Netherlands.

In a decision dated 28 April 2009, the Court of Appeal in Amsterdam enforced the awards and held that:[5]

“[S]ince it is very likely that the judgments by the Russian civil judge setting aside the arbitration decisions are the result of a dispensing of justice that must be qualified as partial and dependent, said judgment cannot be recognized in the Netherlands. This means that in considering the application by Yukos Capital for enforcement of the arbitration decisions, the setting aside of the decision by the Russian court must be disregarded.”

The importance of an enforcing court’s views

An enforcing court’s views on the soundness of the judicial system at the seat of the arbitration are therefore highly relevant to the exercise of a discretion to enforce, as far as the Court of Appeal in Amsterdam is concerned. It is a judgment that has been criticised by AJ van den Berg[6] from a theoretical perspective. He has asserted that, if the award is invalid under the law of the seat of the arbitration, it cannot have any validity in any other jurisdiction.[7] The English courts would however later side with the Amsterdam Court of Appeal.

OJSC Rosneft Oil then failed to pay Yukos Capital despite the decision of the Court of Appeal in Amsterdam. Yukos Capital therefore commenced proceedings in the High Court in England in March 2010. As a preliminary question, the court was asked to decide whether the common law prevents enforcement of arbitral awards that have been set aside by the courts at the seat. Simon J. held that the answer was to be found in a “test” asking whether the court can in the circumstances treat the award as having legal effect. He stated:[8]

“In applying this test, it would be both unsatisfactory and contrary to principle if the Court were bound to recognise a decision of a foreign court which offended against basic principles of honesty, natural justice and domestic concepts of public policy.”

Summary

• Under principles of comity, an English enforcing court should not normally enforce a foreign award that has already been set aside at the seat of the arbitration.
• English common law nevertheless accepts that such an award may survive and be enforced if the court at the seat of the arbitration, when setting aside the award, can be shown to have offended basic principles of honesty, natural justice and domestic concepts of public policy.
• Adducing evidence and convincing the English court of those transgressions in a foreign jurisdiction is of course possible. But it must represent a substantial hurdle to a party seeking to enforce such an award in England.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.il:

[1] [2011] EWHC 1957 (Comm).

[2] [2014] EWHC 576 (Comm); [2008] EWCA Civ 1157; [2008] EWHC 797 (Comm); [2005] EWHC 726 (Comm).

[3] [2010] UKSC 46 at [67-68].

[4] [2014] EWHC 2188 (Comm).

[5] Cited by AJ van den Berg, Enforcement of Arbitral Awards Annulled in Russia Case Comment on Court of Appeal Amsterdam, April 28, 2009 JIA 27(2): at 187, 2010.

[6] Ibid.

[7] In the recent case of Maximov v OJSC Novolipetsky Metallurgichesky Kombinat (2011) 491569/KGRK 11-1722, the district court of Amsterdam refused to enforce an award which had been set aside by the Moscow Arbitrazh Court because there was no proof of any violation of the principle of proper judicial procedure. The Amsterdam Court of Appeal has affirmed this decision (2012) 200.100.508/01.

[8] Yukos Capital SARL v OJSC Rosneft Oil Company [2014] EWHC 2188 (Comm) (03 July 2014) para 20.

There is a substantial difference between the payment provisions of the FIDIC 1999 Red and Yellow Books compared with the Silver Book. This article explores how a court in Queensland (Australia) dealt with the Silver Book’s provision. Contractors have good

There is a substantial difference between the payment provisions of the FIDIC 1999 Red and Yellow Books compared with the Silver Book. This article explores how a court in Queensland (Australia) dealt with the Silver Book’s provision. Contractors have good cause to be wary.

Role of Interim Payment Certificate

In Dawnays Ltd v F G Minter and Trollope & Colls Ltd,[1] the English Court of Appeal judge, Lord Denning, expressed the view that: “an interim certificate is to be regarded virtually as cash, like a bill of exchange.” This bold statement was however quickly rejected by the higher English courts.

Viscount Dilhorne of the House of Lords held in Gilbert Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd[2] that there was “no scintilla of authority” for Lord Denning’s opinion. Viscount Dilhorne went on to say that treating a certificate as conclusive could easily cause injustice. Lord Diplock added that, although a correctly issued interim certificate does create a debt due from the employer to the contractor, it does not stop the employer from raising a set-off or cross claim to the sum due.

The Irish judiciary was equally dismissive. In John Sisk & Son v Lawter Products BV[3] the Irish High Court disagreed with Lord Denning’s “dogmatic proposition” and considered that the correct approach was to ascertain whether the terms of the particular contract were inconsistent with the exercise of a right of set-off by the employer.

The position in England has since changed with the introduction of the payment provisions within the Housing Grants, Construction and Regeneration Act 1996, as amended by the Local Democracy, Economic Development and Construction Act 2009. Now a paying party must pay the notified sum unless it has served a “Pay Less Notice”. In summary, the payer must now give notice of what it intends to set off and loses its right of set off if the notice is not given. FIDIC’s Silver Book has a very different regime.

Set-Off and Deduction Under FIDIC

The payment provisions in FIDIC’s Red and Yellow Books are dealt with in Clause 14. The contractor submits an application for payment and the engineer, under Sub-Clause 14.6, “fairly” determines what is due. Sub-Clauses 14.6 (a) and (b) allow the engineer to make certain deductions where the work done is not in accordance with the Contract, or the contractor has failed to perform its obligations. Under Sub-Clause 14.7, the employer is required to pay the amount certified in each Interim Payment Certificate.

Under FIDIC’s 1999 Silver Book the contractor submits an application for payment and the employer is required to give notice to the contractor within 28 days of any item which he disagrees with. Similar to the Red and Yellow Books, Sub-Clauses 14.6(a) and (b) allows the employer to make certain deductions where the work done is not in accordance with the Contract or the contractor has failed to perform its obligations. Sub-Clause 14.6 then states, “Payments due shall not be withheld“.

Silver Book’s ‘Payment Due’ Provisions Under Court Scrutiny

In Sedgman South Africa (Pty) Ltd and Ors v Discovery Copper Botswana (Pty) Ltd,[4] the Supreme Court of Queensland analysed the meaning of Sub-Clause 14.6 of FIDIC’s Silver Book and, in particular, what was meant by the words “payments due”.

The facts of Sedgman were that Sedgman contracted to design and construct parts of the Boseto Copper Project in Botswana for Discovery Copper. The contract was under an amended FIDIC Silver Book. Sedgman applied for an interim payment of USD 20 million. Sub-Clause 14.6 (as amended) required Discovery Copper to give notice within seven days if they disagreed with any items in the application for payment. Discovery Copper failed to give the notice within seven days and did not contest the application until fourteen days later. Sedgman applied to the Court for payment of the sum claimed.

Discovery Copper challenged Sedgman’s right to payment on three grounds:

• The claim was not served in the format specified by the contract.
• According to the proper interpretation of the contract, the absence of a specific notice within seven days challenging the claim did not automatically entitle the applicants to the amount claimed.
• The application to the Court for payment should be stayed to arbitration as the contract contained an arbitration clause.

Sedgman sought to argue that it was clear that they were entitled to payment and that there could be no genuine dispute over the sum claimed.

Only payments ‘due’ need be paid

The Court dismissed Sedgman’s application for payment, holding that there was a genuine dispute which was apt for determination under the dispute resolution provisions and that Sedgman’s interpretation of the contract was incorrect. The Court held that:

“This contract did not entitle the applicants to be paid the sum which they now claim, simply from the fact that there was no response to their interim claim within the period of seven days stipulated in the contract.”

McMurdo J in his judgment considered the words “payments due shall not be withheld” at Sub-Clause 14.6 of the contract. The Judge stated that these words were “different from saying that a payment will become due if a notice of disagreement is not given,” as Sedgman contended. The Judge then held:

“The alternative view of Sub-Clause 14.6 is that it does not make a payment due. Rather, it governs payments which, by the operation of another term or terms, have [already] become due.”

The Judge stated in his reasoning that that operation of the various clauses of the contract to determine claims and variations could otherwise be displaced by the operation of Sub-Clause 14.6, if Sedgman were correct. If the contractor included a claim in his application for payment which was inconsistent with, for example, a DAB’s determination, and the employer did not give notice of disagreement, the outcome would be that the DAB’s determination would be displaced.

The conclusion reached by McMurdo J was that Sub-Clause 14.6 had to be read in the context of the whole contract. He fundamentally disagreed with the assertion by Sedgman that if the notice of disagreement was not given within seven days, then “everything that had occurred between the parties about these components of the present claim was made irrelevant.” The Judge therefore rejected the idea that claims which may have been disallowed or in contention between the parties could become debts simply because the notice was not given on time.

Silver Book payment provisions favour the employer

There is therefore a substantial difference between the payment provisions of the Red and Yellow Books compared with the Silver Book. While Sub-Clause 14.6 of the Red and Yellow Books obliges the employer to pay to the contractor the “amount certified in each interim payment certificate”, the Silver Book only requires the employer to pay “the amount which is due in respect of each statement.” The amount which is due is not the sum claimed by the contractor, but the sum which is determined by applying all the provisions relating to payment. The sum claimed is therefore open to dispute.

Conclusion

The decision in Sedgman has a number of practical consequences. One example relates to termination. Under Sub-Clause 16.2(c) of the Red and Yellow Books, a contractor may terminate the contract where it does not receive the amount due under an Interim

Payment Certificate. Under Sub-Clause 16.2 (b) of the Silver Book, the contractor may terminate where it does not receive the amount due in the period which payment is to be made.

However, a contractor must now be extremely careful because the amount due can only be determined by applying all the provisions relating to payment. Under the Silver Book, an employer is in a much stronger position if it wishes to withhold money. There is no quick way for the contractor to get paid without going through the dispute resolution provisions. If, as stated by Lord Denning, “cash flow” is the very “lifeblood” of the construction industry, then a contractor needs to be wary of the Silver Book’s payment provisions.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [1971] 1 WLR 1205.

[2] [1973] 3 All ER 195.

[3] [1976-1977] 204.

[4] [2013] QSC 105.

There have been two High Court cases within the last 15 months that lift the lid off what some perceive to be questionable practices (particularly in relation to the Eurocom case) that have developed over the last few years in

There have been two High Court cases within the last 15 months that lift the lid off what some perceive to be questionable practices (particularly in relation to the Eurocom case) that have developed over the last few years in the world of adjudication and arbitration in the UK. The first, in November 2014, was a decision of Ramsey J sitting in the Technology and Construction Court in Eurocom v Siemens PLC[1], and the second, which is the focus of this article, was a decision of Hamblen J, in the Commercial Court in Cofely Limited v Anthony Bingham and Knowles Limited[2].

Both cases illustrate the lengths to which some parties will go to steer the nomination process to secure the tribunal of their choice. Some view these practices as innocent forum shopping; others see them as tantamount to forum shoplifting. What is becoming increasingly clear is that these practices have become by no means exceptional or even unusual.

Hopefully, the outcome of these cases will act as a real deterrent to these practices in the future.

The Eurocom Decision

Eurocom made an application to the Court to enforce an adjudication decision of Mr Anthony Bingham against Siemens: the judge had to determine whether there were natural justice reasons why enforcement should not be granted.

What persuaded Ramsey J in the Eurocom case to refuse enforcement of Mr Bingham’s adjudication decision was certain statements made by an employee of Knowles to the nominating body (the RICS) in that case during its application to the appointment of an adjudicator. Ramsey J found that this individual had deliberately or recklessly misrepresented the existing conflicts of interest relating to a number of those on the nominating body’s panel of adjudicators. The purpose of making those representations was presumably to persuade the nominating body not to nominate those individuals, thereby increasing the prospects of appointment for other members of the panel, including Mr Bingham.

The Cofely Case: The Background to The Section 24 Application

Cofely, in an arbitration that it had commenced against Knowles, applied to the court under  Section 24(1)(a) of the Arbitration Act 1996 to have Mr Bingham removed as arbitrator, on the basis that circumstances existed which gave rise to justifiable doubts about Mr Bingham’s impartiality.

Mr Bingham had been appointed as arbitrator by the Chartered Institute of Arbitrators (‘CIArb’) in response to an application made by Knowles. What lay at the heart of Cofely’s concerns regarding Mr Bingham’s impartiality was the nature of the professional relationship between Mr Bingham and Knowles. It was, Cofely contended, so close that it gave rise to an inference of apparent bias sufficient for the purposes of Cofely’s application.

It appears from the judgment that it was the publication of the Eurocom decision that prompted Cofely’s advisers to start raising several questions, firstly with Knowles and then with Mr Bingham, regarding the conduct of the arbitration proceedings at that time, and in particular the nature of the professional relationship between Knowles and Mr Bingham.

One important distinction between these two cases is that, whereas in the Eurocom case, Knowles was acting as a party representative, in the Cofely case, Knowles was a party to the proceedings. Those proceedings related to a dispute that had arisen under an agreement between Knowles and Cofely called “the Success Fee Agreement” (‘the SFA’) under which Knowles had been engaged to provide dispute resolution services in connection with disputes that had arisen under a major concession agreement to which Cofely was a party.

Having become dissatisfied with Knowles’ performance, Cofely terminated the SFA. The ensuing dispute concerned Knowles’ fee entitlement for services provided pre-termination. Knowles’ fee claim fell into two parts, a defined element and an undefined element. The arbitration proceedings commenced in February 2013. Mr Bingham disposed of the defined element of the claim relatively quickly in a partial award in August 2013, awarding Knowles £1,000,000 plus interest.

Cofely then applied to Mr Bingham for a further partial award concerning the proper interpretation of the SFA apparently designed to reduce the scope of the factual enquiry that would be required in order to dispose of the claim for the undefined element of the fee. It was at that point that the controversial Eurocom decision became public.

The Cofely Case: Enquiries About the Professional Relationship

The enquiries that Cofely’s advisers now raised firstly with Knowles and then with Mr Bingham amounted to an in-depth inquest into all aspects of their professional relationship. In particular, the initial list of questions sent to Mr Bingham covered the following grounds:

• on how many occasions over the last three years had Mr Bingham acted as adjudicator or arbitrator in disputes with which Knowles was involved either as party or as party representative?
• in how many of those cases had Mr Bingham made a decision favourable to Knowles or the party it was representing?
• what proportion of Mr Bingham’s professional income over the last three years was accounted for by such cases? and
• what action, if any, did Mr Bingham take in this arbitration to satisfy himself that there was no information that he should disclose to Cofely that “could reasonably be interpreted (on an objective basis) as undermining your apparent impartiality?”.

Mr Bingham’s response to continuing pressure from Cofely’s advisers to provide this information was to call a meeting, ostensibly to explore whether the tribunal had been properly constituted. This meeting took place at Knowles’ offices: on the night before, Knowles had served a skeleton argument and Mr Bingham informed the parties that he would be making a ruling on the issue in hand.

It is clear from the Judgment that the meeting was fractious and did little to advance matters in a positive direction. No less than 3.5 pages of Hamblen J’s decision is a verbatim transcript of exchanges between Mr Bingham and Cofely’s barrister in which Mr Bingham was attempting to persuade the latter to “come clean” about the actual purpose and significance of the information that Cofely was seeking. Cofely’s barrister’s position was that it was impossible to answer questions of that nature until the totality of the information had been made available. Matters became so heated that at one stage Knowles’ barrister offered to act as mediator.

Broadly speaking, there were two issues that the court was called upon to consider in determining if Mr Bingham ought to be removed as arbitrator under Section 24 of the Arbitration Act 1996:

• the extent of the professional relationship between Mr Bingham and Knowles revealed by the information before the court regarding the number of cases in which Mr Bingham had acted as adjudicator or arbitrator in which Knowles had represented one of the parties, the number of cases decided in favour of the party Knowles had represented, and the income derived by Mr Bingham from such cases and the Eurocom decision itself (“the Relationship Issues”); and
• Mr Bingham’s conduct both during the arbitration proceedings, and in particular at the meeting, and thereafter in the context of the Court proceedings which, it was alleged, showed that he had sided with Knowles and was “aggressive and unapologetic” about his previous conduct (“the Conduct Issues”).

The Judge’s Decision: The Relationship Issues

The Judge considered that the key aspect of the evidence concerning the professional relationship between Mr Bingham and Knowles was that, over the last three years, 18% of his appointments and 25% of his income had been derived from cases involving Knowles. He dismissed as irrelevant Mr Bingham’s point that all these appointments had been made by a nominating body rather than by Knowles directly.

On the nominating body side of the matter, the Judge mentioned Rule 3 of the CIArb Code of Professional and Ethical Conduct for Members (October 2000) which provides:

“Both before and throughout the dispute resolution process, a member shall disclose all interests, relationships and matters likely to affect the member’s independence or impartiality or which might reasonably be perceived as likely to do so.”

The Judge felt that it was “notable” that, in the form he had completed for the CIArb prior to his appointment in this case, Mr Bingham had failed to respond to an item requiring the disclosure of “any involvement, however remote” with either party over the last five years.

The Judge also referred in this connection to General Standards 2 and 3 of the IBA Guidelines on Conflicts of Interest in International Arbitration, and in particular what is known as the ‘Orange List’ of situations which might give rise to doubts about an arbitrator’s impartiality or independence. He observed that this document represented “accepted good arbitral practice generally”.

He then observed that, even though Knowles does not actually appoint adjudicators/arbitrators directly,

“it is able to influence and does influence such appointments, both positively and negatively. It does so positively by putting forward the name of the chosen appointee either on his/her own or with others. It also does so more indirectly by identifying required characteristics that will only be shared by a small pool of people. It does so negatively by putting forward a list of those potential appointees that it does not wish to be appointed and who are said to be inappropriate. These practices would be apparent from the appointment forms which, as was common ground, would have been forwarded to Mr Bingham. Their significance is highlighted by the Eurocom case which provides a striking example of Knowles steering the appointment process towards its desired appointees and doing so as a matter of general practice.”

Crucially, the Judge considered that Knowles’ appointment “blacklist” was of itself “a matter of significance” because it meant that potential appointees would be aware that how they handled a particular reference might lead to them “falling out of favour” and being placed on the list. The Judge considered that this would be “important for anyone whose appointments and income are dependent on Knowles related cases to a material extent, as is the case for Mr Bingham.”

The Judge considered that, in the light of the Eurocom decision, it was reasonable for Cofely to pursue enquiries into the nature of the relationship between Mr Bingham and Knowles. Whereas Cofely had pursued those enquiries “in a courteous manner”, he considered that Mr Bingham’s “essential response…. involved avoiding addressing the requests and instead giving the appearance of seeking to foreclose further inquiry by demonstrating their irrelevance and, moreover, doing so in an aggressive manner.”

The Judge’s Decision: The Conduct Issues

It has already been noted that the Judgment contained no less than 3.5 pages of the transcript from the meeting that Mr Bingham convened in order to make a ruling on the validity of his appointment. The Judge considered that this extract – although reflecting only a part of the business conducted at the hearing and highly repetitive in content – “reflected the tone of the hearing” at which Mr Bingham had “aggressively questioned” Cofely’s barrister concerning that party’s question about the proportion of Mr Bingham’s professional income that was attributable to cases involving Knowles.

The Judge’s concerns about the hearing were twofold. Firstly, he considered that Mr Bingham was using the meeting as a means by which he could arrive at a “ruling” on apparent bias which, he observed, neither party had asked him to make, and which was, in his opinion, inappropriate. Second, “the manner in which this was done” – involving Mr Bingham effectively cross-examining Cofely’s barrister in an aggressive and hostile way – had led to him “descending into the arena in an inappropriate manner.”

The third feature of Mr Bingham’s conduct that the Judge criticised related to the witness statement that he had prepared for Court proceedings. That statement, the Judge commented, demonstrated a continuing lack of awareness regarding the relevance of the relationship issue and the potential inappropriateness of his conduct at the hearing that “demonstrates a lack of objectivity and an increased risk of unconscious bias”.

Finally, the Judge noted that Mr Bingham considered that Cofely’s requests for information amounted to “aggressive, challenging, perhaps even bullying behaviour” and an unwarranted attack on him and that this view was consistent with his own assertive conduct at the time. Nevertheless, the judge felt that Cofely’s enquiries had been reasonably made and expressed: Mr Bingham’s response – one of attack being the best from of defence – had inevitably led to him “descending into the arena” himself.

The Verdict

For Cofely to succeed in its application for a Section 24 Order removing Mr Bingham as arbitrator in this case, it had to persuade the Judge that “the fair minded and informed observer, having considered the facts, would conclude that there was a real possibility that the tribunal was biased”.

The Judge was careful to stress that there was no question of any actual bias having occurred in this case. However, he was satisfied that the evidence before him was sufficient to require Mr Bingham’s removal. He directed that, if Mr Bingham did not resign, an order for his removal would be made.

The significance of these decisions for nomination practice

It is inevitable that, with a case such as this, involving a well-known figure in the sphere of construction dispute resolution and one of the best-known claims consultancy companies in the sector, much of the attention will focus upon the personalities.

That would be a mistake. The big issue that emerges from these two decisions, and with which nominating bodies are now going to have to wrestle, is where the boundary should lie between legitimate steering of the nomination process by applicants for nomination and unacceptable manipulation of the nomination process.

One imagines that few people would seek to defend practices such as deliberate or reckless misrepresentation of the position regarding the existence of conflicts of interest by an applicant for nomination.

On the other hand, some degree of steering is not only desirable but is encouraged by nominating bodies. As a general rule, nominating bodies do seek to accommodate reasonable requests from applicants. For instance, most will tend to nominate an individual who has dealt with previous disputes on the project in question – such an appointment generally makes good sense – and most will listen to the views of the applicant – if not actually invite them as, for instance, TeCSA does – on the need for individuals with particular qualifications and/or expertise. Issues concerning the existence of a genuine conflict of interest are obviously something that should be raised with the nominating body at the outset.

Where the boundary becomes blurred is in the context of practices designed to secure the nomination of a particular individual from the panel of the nominating body in question. The most obvious example of this type of practice involves the use of blacklists, which in some extreme cases seek to cut down a panel list of hundreds of nominees to maybe four or five. This sort of blacklist may or may not give reasons why the remaining individuals have been excluded, but often lack of competence or personal issues are given as the reason.

What makes this type of practice unacceptable to this author is that it is designed to circumvent the standard nominating procedures of the nominating body which may operate on a cab-rank principle or some other similar process with a list of individuals all of whom will have satisfied the nominating body regarding their competence. What this can lead to in effect is the applicant, rather than the nominating body, deciding who should be appointed to manage the dispute.

It is probably fair to attribute these practices to the introduction of statutory adjudication. In the days pre-adjudication, arbitrators were appointed by agreement between the parties, failing which a presidential nomination would take place. The process was relatively straightforward and uncontroversial. It is the speed of the adjudication process, and the requirement to get an adjudicator on board in a matter of 2-3 days, that has left the nominating body with no alternative but to decide the identity of the adjudicator based on the information provided by the applicant.

What this case tells us is that those practices have now spread to the appointment of arbitrators. Perhaps this is not surprising given the fact that the parties will often be the same as will the dispute resolver and the nominating body whichever technique is involved.

The situation is complicated by the fact that nominating bodies have in the past often made a selling point of the fact that their policy is to make the applicant’s preferences a priority in terms of appointing a tribunal. The fact is that cases like Eurocom and Cofely do no favours for the UK dispute resolution sector; it is to be hoped that the nominating bodies will respond to the challenge.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] [2014] EWHC 3710 (TCC).

[2] [2016] EWHC 240 (Comm).

The Hong Kong Court of Appeal now supports engineers requesting evidence of original tender build-up and disallowing loaded rates if substantial quantity differences justify it. This article explores that new guidance, which finds contract rates to be neither immutable nor sacrosanct.

Introduction

A contractor who has loaded a tender Book of Quantities (‘BoQ’) rate in the expectation of a windfall will be interested to learn that recent guidance from the Hong Kong Court of Appeal supports the engineer’s request for evidence of the original tender build up and, among other things, will disallow all loading if substantial differences in actual quantities would make it reasonable to do so under the contract. This article explores that new guidance, which finds contract rates to be neither immutable nor sacrosanct in such circumstances.

The ‘loading’ of BOQ tender rates is common practice when a contractor feels that quantities may have been underestimated. “Intelligent pricing” is how it was described (without any disapproval) by the Judge at first instance in Henry Boot Construction v Alstom Combined Cycles.[1]

There the contract rate had contained an inadvertent error to the great benefit of the contractor. The judge nevertheless went on to find that it was ‘immutable and sacrosanct.’ The English Court of Appeal endorsed the judge’s decision in 2000. Now however the Hong Kong Court of Appeal has given guidance on when it may be justified to unpick a contract rate and fix a reasonable alternative.

Adjustment Of BoQ Rates Under the Contract

A re-measurement contract is unlikely to see final quantities of work items match those originally estimated in the BoQ. Re-measurement contracts frequently provide that when a quantities mismatch is substantial and certain criteria are met, the engineer is required to fix a new rate. In doing so he is to rely on concepts of reasonableness and/or appropriateness. The FIDIC 1999 Red Book, for example, adopts this approach.

But what may the engineer take account of in such a rate-fixing process? Must he for example confine himself strictly to the existing components of the rate under review? Or can he consider also the manner in which the contractor compiled or perhaps “loaded” that rate at tender stage and then set about reversing those additions? Can he correct an error in the original compilation? All these questions were considered by the High Court of Hong Kong (Court of Appeal) in the case of Maeda Corporation v Government of the Hong Kong SAR.[2] Details of the decision were released earlier this year.

Facts of Hong Kong Dispute Over Rate Review by Engineer

The form of contract was the Government of Hong Kong General Conditions of Contract for Civil Engineering Works (1999 Edition) (‘the HKGCC’). Clause 59(4)(b) required only that the quantities be substantially different before they acted as a trigger for the engineer to embark on a rate review. The clause states:

‘Should the actual quantity of work executed in respect of any item be substantially greater or less than that stated in the Bills of Quantities … and if in the opinion of the engineer such increase or decrease of itself shall render the rate for such item unreasonable or inapplicable the engineer shall determine an appropriate increase or decrease of the rate for the item using the Bills of Quantities rate as the basis for such determination and shall notify the contractor accordingly.’

The contractor had performed substantially  greater quantities of a particular work item than estimated and the dispute over his entitlement to payment was referred to arbitration. It emerged that he had spotted a pricing opportunity whilst compiling his tender. He regarded the employer’s BoQ estimates for this work item as a considerable underestimate. He took advantage by transferring into his tender rate for that item an additional preliminary sum that had originally formed part of another unconnected rate. The additional preliminary sum had once been intended to cover miscellaneous items of unrelated costs, on-costs, contingencies and risks. These unrelated fixed costs would not have increased along with an increase in quantities of the new work item in question. The contractor was therefore set to make a large ‘windfall’ profit. To the arbitrator that made the contract rate for the item unreasonable and therefore inapplicable. He held in his award that the preliminary sum transferred across should be excluded. It was his view that in cases where a rate was a “composite” one involving a number of activities, he could adopt such a position.

Contractor’s Defence of Rate Loading

The contractor appealed to the Court ,claiming that as a matter of law it was permissible only for the arbitrator to consider the elements of the final rate and it was not for him to enquire how those elements had come to be compiled for purposes of the tender. He also said the final (contract) rate itself was not relevant in determining reasonableness. Pointing to the English Court of Appeal decision in Henry Boot v Alstom Combined Cycles[3], the contractor argued that the contract rate was immutable and sacrosanct. It was a contractually agreed unitary price and must be used. He said the only consideration justifying a re-rating exercise was if there had been an increase in the work activities. If there had been such an increase, then only fixed costs related to that work could be considered. Other fixed costs, such as the ones that had been “transferred across,” could not be re-opened and reconsidered, he said.

Hong Kong Court of Appeal’s Guidance

The Court of Appeal endorsed the arbitrator’s findings and held that:

• Where a rate is being examined to determine whether increased quantities had caused it to become unreasonable or inapplicable under the contract, there is no rule of law or evidence to prevent consideration of the tender build-up. It was relevant. Even if ‘rate loading’ is common in the industry, the arbitrator was permitted to ask for and consider such
• In cases of increased quantities involving a rate for a single activity, a change in the work method or economics of working would be sufficient to cause that rate to become unreasonable or
• Where however there was a ‘composite rate’ involving several activities, all elements of fixed and variable costs may need to be identified and understood in order to determine the impact of the change in
• No distinction is to be drawn between a rate’s preliminary items that had direct connection with the work in question and those that did not. Both could be re-opened if they caused the overall rate to become
• Whilst the English Court of Appeal decision of Henry Boot had found even an erroneous rate to be ‘immutable and sacrosanct’, the Hong Kong Court of Appeal distinguished that case from the present one. No deliberate rate loading had occurred in Henry Boot as had occurred here. The Hong Kong Court also relied on the fact that the Henry Boot contract expressly prevented the rectification of errors, omissions or wrong estimates in order to make its distinction.
• The very significant additional amount that would inure to the appellant, in effect as a windfall, by the application of the original rate to the changed quantity of work … demonstrates why, simply as a matter of fairness, [the Clause] ought to be applied in the way the arbitrator ’

It seems that therefore the Hong Kong Court of Appeal had based its decision on an overriding need for “fairness”. However, it had little to say regarding the potential for unfairness to the employer in Henry Boot, which had not embarrassed the English Court of Appeal at all.

Conclusion

A contractor who has loaded his tender rates in the expectation of a windfall if BoQ quantities should prove to be a substantial under-estimate should be aware that, as far as the Hong Kong Court of Appeal is concerned, his contract rates and their individual components are neither immutable nor sacrosanct. The engineer may request details of the tender build-up and disallow anything that he finds would make a rate unreasonable.

This decision relates directly to the use of the HKGCC. However, practitioners in other jurisdictions using international contracts that make similar provision for the engineer to determine a reasonable new rate after substantial changes in quantities will find this decision of particular interest.

Please get in touch at victoria.tyson@howardkennedy.com with your thoughts or to discuss any concerns.

[1] Henry Boot Construction Ltd v. Alstom Combined Cycles Ltd (formerly GEC Alsthom Combined Cycles Ltd) [1999] EWHC Technology 263 – http://www.bailii.org/ew/cases/EWHC/TCC/1999/263.html

[2] Maeda Corporation, Hitachi Zozen Corporation, Yokogawa Bridge Corporation, Hsin Chong Construction Co Ltd v. HKSAR [2012] HKCA 587; [2014] 1 HKLRD 1; CACV 230/2011 – http://www.hklii.hk/cgi- bin/sinodisp/eng/hk/cases/hkca/2012/587.html

[3] Henry Boot Construction v Alston Combined Cycles [2000] EWCA Civ 99 –http://www.bailii.org/ew/cases/EWCA/Civ/2000/99.html