Almost all infrastructure contracts incorporate numerous technical and commercial requirements, regularly forming annexures or schedules to the contractual terms.
Often, a key requirement may be buried amongst many hundreds of pages of other technical requirements. It is also quite common for industry standards to be incorporated by reference into those technical requirements.
A recent UK Supreme Court case which focused on whether a provision relating to fitness for purpose was breached, highlights the risks to both parties involved in this approach to contracting.
Key takeaways from the decision for contracting parties include:
avoiding the risk that a standard may be out of date or incorrect by specifying the standard as the ‘minimum’ requirement;
ensuring that the contract specifies a means for interpreting ambiguities (including imposing a higher standard in the case of ambiguity or inconsistency);
ensuring that the order of precedence clauses not only delineates between schedules, but (potentially) within parts of schedules; and
ensuring careful clarification of the impact (if any) of the expiry of the defects rectification period upon the enforceability of longer term warranties as to design and construction.
The Facts of the Case
The case in question concerned a design and construct contract for two offshore wind farms in the Solway Firth being developed by two companies in the E.ON group (E.ON). The wind farms were designed and installed by MT Højgaard A/S (MTH).
Shortly after completion, the foundation structures of the wind farms failed. At issue in this proceeding was the cost of remedial works.
The contract specified some key requirements which will be familiar to anyone involved with projects of this nature.
There was a Technical Requirements schedule which specified Key Functional Requirements, the Design Basis and the Design Principles for the wind farms.
The Key Functional Requirements included that the Works withstand the ‘full range of operational and environmental conditions with minimal maintenance’ and that the work elements were to be designed ‘for a minimum site specific design life of 20 years.’
The Design Basis stated that the requirements specified were the ‘minimum’ requirements of E.ON.
A section headed Design Principles included several requirements including:
that the design was to be prepared in accordance with standard J101 (an international standard for the design of off shore wind turbines published by Det Norske Varitas) (the Standard Obligation);
that the design was to ‘ensure a lifetime of 20 years in every aspect without planned replacement. The choice of structure, materials, corrosion protection system operation and inspection programme shall be made accordingly’ (the Design Life Obligation); and
an obligation to ensure that ‘all parts of the Works[…] shall be designed for a minimum service life [of] 20 years’.
In addition, there were a number of key contractual provisions, including:
an obligation that the Works be fit for purpose (Fit for Purpose Obligation), defined as fitness for purpose in accordance with and as inferred from the Employer’s Requirements; and
an obligation to make good defects arising from materials, workmanship or design for a period of 24 months from the date of take over (Defects Rectification Obligation).
Relevantly, there was an ‘entire agreement’ provision, and an order of precedence which was (in descending order):
The form of agreement;
Conditions of contract;
The Employer’s Requirements (which included the Technical Requirements schedule).
The J101 standard (the Standard) contained an erroneous equation, which ultimately led to the grouted connections failing and the transition pieces slipping down the monopiles.
E.ON argued that MTH had been negligent and breached the contract. MTH’s defence was that it had exercised reasonable skill and care and had complied with all contractual obligations.
At first instance, the Technology and Construction Court held that MTH, although not negligent in the design of the foundations, had breached the Fit for Purpose Obligation, which was to be determined by reference to the Employer’s Requirements, which included the Technical Requirements.
MTH appealed to the Court of Appeal. The Court of Appeal found that the Design Life Obligation appeared to be a warranty that the foundations would function for 20 years. However, the Court of Appeal held that the warranty was inconsistent with other provisions of the Contract, and accordingly, that the other provisions should prevail. It found that the Design Life Obligation was ‘too slender a thread’ to sustain an argument that MTH had given a warranty that the foundations would last for a 20 year lifetime.
E.ON appealed to the UK Supreme Court (the Court), and this appeal was allowed.
Does the contractor wear the risk of the error in the Standard?
Given that the Standard was incorrect, the Court needed to consider whether the Fit for Purpose Obligation was inconsistent with MTH’s obligation to construct the works in accordance with the Standard.
The Court referred to a line of cases in the UK and Canada in which it was found that a contractor was liable for a defect which was the result of a requirement or obligation that could not be fulfilled (giving the examples of a model approved by the customer, a pattern approved by the purchaser and plans and specifications provided by a principal).
The Court pointed out that where a contract requires an item to be produced in accordance with a prescribed design and with prescribed criteria, and where conformity with the design will inevitably result in the product falling short in relation to the criteria, it ‘by no means follows that the two terms are mutually inconsistent’.
Here, the Court noted that the Technical Requirements stressed that the requirements in the section were minimum requirements, and that the Technical Requirements required MTH to identify any areas where the works needed to be designed to a higher standard (and indeed, MTH was permitted to depart from the standards). Further, the Court stated that the correct way to interpret the two provisions was to conclude that the most ‘rigorous or demanding’ of the two standards must prevail.
Does the Design Life Obligation bind the Contractor?
MTH argued that the Design Life Obligation was ‘too slender a thread’ on which the important and potentially onerous obligation of ensuring a 20 year lifetime of the foundations (design or otherwise) should rest. MTH relied on a number of factors here, including:
the inelegant drafting of the contract documents;
the inclusion of an important obligation in a technical document; and
that the obligation was not given pre-eminence, but rather ‘tucked away’ in a schedule.
Lord Neuberger did not accept these contentions. His Lordship found that the natural meaning of the words were not ‘improbable or unbusinesslike’, and did not have a redundant meaning. The Court also found nothing unusual in the location of the promise.
What does the Design Life Obligation mean?
MTH argued that it could not have been intended by the parties that the Design Life Obligation constituted a warranty that the foundations would last for 20 years and that the defects rectification obligations meant that claims in relation to defects were barred after 24 months.
Ultimately, the Court found that the two provisions could sit together on the basis that the Design Life Obligation should be characterised as a promise that the design of the foundations would last 20 years without replacement.
In this way, E.ON’s ability to rely on the Design Life Obligation would not be dependent on a realisation that the foundations were failing within the 24 months defects rectification period but rather becoming aware during that period that the design of the foundations would not last for 20 years.
However, the Court decided it did not need to reach a conclusion on this issue.