Do you have a right to finish your scope?
Sarah Fox, Contract Strategist, 500 Words
IN our February issue, Frances Garratt discussed how the Scottish case of Van Oord v Dragados dealt with the issue of good faith in construction contracts and particularly the spirit of mutual trust and cooperation under NEC. The case also reinforces the legally binding nature of a contract. A contract does not just oblige the supplier to provide a specific scope of goods, works and services. It also entitles them to provide that scope in its entirety.
Background
As noted in the previous article, the acrimonious project was the expansion of Aberdeen harbour. Van Oord was contracted under an amended NEC3 subcontract to carry out dredging works and caisson filling. The subcontract – through an express clause introduced by amendment to the standard form – only allowed the contractor to omit works from the subcontract scope to the extent those works were also omitted from the main contract scope.
The contractor, Dragados, had included certain dredging works in the scope of three of its subcontractors, with the intention of moving elements of it between the three subcontractors as the project progressed. None of the subcontractors were aware of this. One of those, Van Oord, challenged Dragados’ right to omit part of its scope of works and sought redress in adjudication and in the courts to overturn the omission of their scope.
Change for change’s sake?
There has always been a sound legal argument that the client cannot simply remove parts of the contracted scope without an express contractual right to do so. The whole point of a contract is to legally bind both parties to everything they promise to do.
This includes the client’s promise to pay the price for a defined scope of goods, works and/or services and the supplier’s promise to carry out that defined scope of goods, works and/or services. The client cannot also unilaterally change how much it is prepared to pay mid-way through the task, while the supplier cannot unilaterally decide to provide different goods, works or services. Changes to the contract terms and to the contract scope require mutual agreements, often by following a clear change mechanism. The Scots court confirmed these principles and said:
- A contract for the execution of work confers on the contractor not only a duty to carry out the work by a corresponding right to complete that work.
- A change mechanism must be interpreted carefully, so it does not deprive the contractor of its right to complete the work and realise the related profits.
- Clear words would be needed if the client is entitled to omit work from the scope of one contractor to pass it to another contractor.
Changes under NEC
Interestingly, there has been little discussion in the legal press about this case from the perspective of the standard NEC wording on variations. In the NEC ‘change’ is not a defined term, and the core conditions refer simply to a change in the scope (NEC4) or works information (NEC3). As such the NEC suite does not clarify whether a change would include addition, omission, or substitution to the works. The NEC3 subcontract change mechanism does not define a change. It does not expressly include omissions in ‘changes to the scope’. Arguably, an unamended NEC contract does not allow instructions to omit works.
The mechanism in the Van Oord subcontract had been amended to provide a clear right for the contractor to omit works but only to the extent those works were also omitted from its scope. It did not set out clear words which allowed the contractor to omit works with a view to having them carried out by an alternative subcontractor. The court decided that the contractor’s instruction to omit works was invalid and in breach of contract.
Motive for the change
In Van Oord, the court was faced with a contractor who, in no uncertain terms, had been gaming its subcontracts – hiding these actions behind a veil of confidentiality and leaving its subcontractors at their mercy. The decision in Van Oord considered the rights of the client (in this case the contractor) to instruct the supplier to omit works and reduce the agreed scope. The court decided that the motive for omitting works was irrelevant. The NEC3 clause 10.1 requiring the parties to ‘act in a spirit of mutual trust and cooperation’ was therefore also irrelevant to deciding the validity of the instruction to omit the dredging works.
Is good faith enough?
The subcontractor continued to argue, in the Scots appeal court, that Dragados sought to manipulate the contract in its own favour. The court had to consider whether the contractor’s motive was relevant when considering how to value the impact of that instruction.
The NEC requirement for mutual trust and cooperation reflects and reinforces the general principle of good faith in contracts, including these general legal principles:
- A party cannot take advantage of its own breach.
- A subcontractor does not have to follow any invalid instruction.
- Clear language is needed to place a contracting party at the other’s mercy.
The court said that the contractor could not ‘take advantage of its own breach’ by relying on the change valuation provisions under clause 60 of the NEC3 subcontract. Instead, the contractual valuation mechanism only applied to validly instructed changes – to hold otherwise would effectively have placed the subcontractor at the contractor’s mercy on both the scope of works and how those works were ultimately valued (and whether they would be profitable). Accordingly, NEC3 clause 10.1 was relevant to deciding the compensation due to the subcontractor for the contractor’s invalid instruction.
No fault divorce?
This may seem like a storm in a harbour to you, but the right to finish works or the right to omit works is critical to stable contractual relationships. An unrestricted right to reduce the scope of a contract is tantamount to allowing termination without default, also known as termination at will or for convenience. Ending a contract is a serious step and the court is reluctant to interfere with the supplier’s right to finish the contracted scope and realise the associated profits. If a contract can be ended on a whim, what use is it?
English law does not recognise any implied right to end future obligations under a contract willy-nilly – either by omitting all future works or terminating those future obligations. To end a contract, you either need (1) acts which clearly demonstrate a contractual party is unwilling to treat the contract as legally binding on them from this point on, or (2) an express contractual right to end future obligations.
Freedom comes with consequences
Of course, based on freedom to contract the parties can agree to express terms allowing both omissions and termination without default. But that should come with consequences as it deprives the supplier of future profits. A commercially astute supplier will insist that such rights for the client should be balanced by compensation relating to the omitted scope. It should also insist that the client deletes any clauses which exclude their right to recover lost profits. Personally, I favour a liquidated damages provision as that avoid tricky calculations of loss – the client gets scope flexibility, and the supplier gets a reasonable level of compensation.
The Van Oord case not only reinforces the duties of good faith between contracting parties, but also strengthens the binding nature of contracts. Parties and their contract drafters would do well to remember that trust and fair terms are two sides of the same coin.
Sarah Fox, Contract Strategist, 500 Words