Introduction

Energy, engineering and construction disputes often give rise to the issue of what design standard a design and build contractor should be held to. The issue is particularly marked where a contract provides that the contactor must design and build in accordance with a prescribed standard but also that the product must be fit for its intended purpose. What happens when the contractor meets the standard but, through no fault of its own, the product remains unfit for its purpose?

The Supreme Court took the opportunity to address this question in the recent case of MT Høgaard A/S v ON Climate and Renewables UK Robin Rigg East Ltd [2017] UKSC 59. The decision provides some important practical lessons for parties negotiating and drafting design and build contracts.

Background

In Højgaard, the appellants (“E.ON”, as employer) had engaged the respondent (“MTH”, as contractor) to design and install the foundation structures of two offshore wind farms in the Solway Firth. The parties’ bespoke contract contained a variety of provisions relating to the standard to which the foundations were to be designed and built by MTH. In the main contract, clause 8.2 provided:

“The Contractor shall, in accordance with this Agreement, design, manufacture, test, deliver and install and complete the Works:

(i) with due care and diligence expected of appropriately qualified and experienced designers, engineers and constructors …

(x) so that each item of Plant and the Works as a whole shall be fit for its purpose as determined in accordance with the Specification using Good Industry Practice …

(xv) so that the design of the Works and the Works when completed by the Contractor shall be wholly in accordance with this Agreement and shall satisfy any performance specifications or requirements of the Employer as set out in this Agreement ...”

The employer’s requirements included detailed technical requirements. Paragraph 1.6 of the technical requirements provided:

“The Works element shall be designed for a minimum site specific ‘design life’ of twenty (20) years without major retrofits or refurbishments …”

Paragraph 3.1 of the technical requirements included the wording:

“(i) … the requirements contained in this section … are the MINIMUM requirements of [E.ON] to be taken into account in the design.

(ii) It shall be the responsibility of [MTH] to identify any areas where the works need to be designed to any additional or more rigorous requirements or parameters.”

Paragraph 3.2 of the technical requirements dealt with design and required the contractor to prepare its detailed design in accordance with international standard DNV-OS-J101 (“J101”) for the design of offshore wind turbines. Paragraph 3.2.2.2(ii) went on to state that:

“The design of the foundations shall ensure a lifetime of 20 years in every aspect without planned replacement ...”

Unknown to either party, however, the international standard J101 contained a critical flaw. Section 9 of J101 dealt with the design and construction of grouted connections, which connect the bottom of the turbine tower to the top of the monopile. It contained a number of parametric equations, one of which calculated the fatigue strength of the grouted connection and their susceptibility to stress fractures. A constant in that equation was incorrect by a factor of 10. The effect was that using the equation as stated would significantly overestimate the grouted connection’s ability to withstand the constant stresses placed on it by the wind and sea.

MTH duly proceeded with the works and developed a detailed design for the grouted connections based on J101. Pursuant to the contract they appointed Det Norske Veritas (“DNV”), the authors of J101, as the Certifying Authority. Rubber-stamping their own standard, DNV evaluated and approved MTH’s designs.

MTH commenced the installation of foundations in the Solway Firth in December 2007 and completed the work in February 2009. Later that year a serious problem came to light in a different wind farm, Egmond aan Zee, where J101 had also been used in the design. The grouted connections had started to fail. The transition pieces, steel cylinders connecting the foundations to the towers, began to slip down the monopiles.

DNV carried out an internal review in September 2009. They discovered the error in section 9 of J101. DNV immediately sent a letter to MTH and others in the industry alerting them to the situation. Of course this alert was already too late for MTH. It was only a matter of time before the grouted connections at Robin Rigg began to fail.

This is exactly what happened from April 2010. The transition pieces began to slip down the monopiles. If this were not halted the towers would buckle and collapse into the sea. The parties agreed a scheme of remedial works in the sum of €26.5 million and started proceedings in court to determine which of them should pick up the tab. ON argued that MTH was in breach of its overriding fitness for purpose obligations, while MTH argued that it had exercised reasonable skill and care and that any fitness for purpose obligation was qualified by its duty to comply with J101.

In the High Court, Edwards-Stuart J held in favour of E.ON and found that MTH was liable for the cost of the remedial works. He held that the relevant contractual obligations were not mutually inconsistent, but rather additional to one another, and that MTH had breached a warranty that the foundations would have a service life of 20 years.

MTH appealed to the Court of Appeal, which reversed the decision. In his lead judgment, Jackson LJ’s starting point was that all of the provisions in the technical requirements, with the exception of paragraph 3.2.2.2(ii), were compatible with the proposition that the entirety of the contractor’s obligation was to construct the works with reasonable skill and care while adhering to the relevant contractual standards and specifications.

By contrast, paragraph 3.2.2.2(ii) suggested that the contractor was required to produce wind turbines with a guaranteed operational life of 20 years. Jackson LJ held that this was inconsistent with J101 and the remainder of the technical requirements and was “too slender a thread” on which to impose what was in effect a 20 year warranty on MTH.

In support of that approach, Jackson LJ appears to have relied heavily upon Re Sigma Finance, where Lord Collins held that an “over-literal interpretation of one provision without regard to the whole may distort or frustrate the commercial purpose.” He also relied on the qualification to the fitness for purpose obligation in the contract, namely that the Works were to be fit for purpose “as determined in accordance with the Specification using Good Industry Practice.” He held that MTH had met that standard and E.ON were liable to pay for the remedial works.

Decision of the Supreme Court

The case reached the Supreme Court, which unanimously reversed the decision of the Court of Appeal. Lord Neuberger gave the lead judgment along orthodox lines. His starting point was to clarify the meaning of paragraph 3.2.2.2(ii). It was not, as suggested by the lower courts, a warranty that the foundations would have a lifetime of 20 years.

Instead, it was a warranty that the design of the foundations was such that they would have a lifetime of 20 years. J101 itself required that the annual probability of failure should be in the range of one in 10,000 to one in 100,000. An absolute 20 year guarantee would be unrealistic and uncommercial. On an objective reading of the contract that was not what the parties intended.

In accordance with well-established principles of contractual interpretation, Lord Neuberger held that this natural and ordinary meaning of paragraph 3.2.2.2(ii) should be given effect to unless there was a good reason to depart from it. The foundations had not been designed to have a lifetime of 20 years and so MTH were prima facie in breach of contract.

In his view MTH had two arguments available to it as to why that paragraph should not be given its natural meaning. First, that such an interpretation results in an obligation which was inconsistent with MTH’s obligation to construct the Works in accordance with J101. Second, that para 3.2.2.2(ii) is “too slender a thread” on which to hang such an important and potentially onerous obligation.

Inconsistent obligations

Lord Neuberger considered a number of cases in which there was an obligation both to provide a product in accordance with a specified design and to ensure that the product satisfies specified performance criteria, in circumstances where those criteria cannot be achieved by complying with the design. There was no better summary of the law than the dictum of Lord Wright in Cammell Laird and Co Ltd v The Manganese Bronze and Brass Co Ltd [1934] AC 402, where he said:

“It has been laid down that where a manufacturer or builder undertakes to produce a finished result according to a design or plan, he may be still bound by his bargain even though he can show an unanticipated difficulty or even impossibility in achieving the result desired with the plans or specification.”

Lord Neuberger emphasised that the parties’ obligations would be determined in accordance with orthodox principles of contractual interpretation. He did, however, give a general reformulation of the law:

“Where a contract contains terms which require an item (i) which is to be produced in accordance with a prescribed design, and (ii) which, when provided, will comply with prescribed criteria, and literal conformity with the prescribed design will inevitably result in the product falling short of one or more of the prescribed criteria, it by no means follows that the two terms are mutually inconsistent. … In many contracts, the proper analysis may well be that the contractor has to improve on any aspects of the prescribed design which would otherwise lead to the product falling short of the prescribed criteria, and in other contracts, the correct view could be that the requirements of the prescribed criteria only apply to aspects of the design which are not prescribed.”

He went on to say that the courts are generally inclined to give full effect to the requirement that the item as produced complies with the prescribed criteria, on the basis that, even if the customer or employer has specified or approved the design, it is the contractor who can be expected to take the risk if he agreed to work to a design which would render the item incapable of meeting the criteria to which he has agreed.

Applying this to the facts of Højgaard, Lord Neuberger found that there was an insurmountable difficulty with the argument that paragraph 3.2.2.2(ii) was inconsistent with the remainder of the contract. Paragraph 3.1(i) of the technical requirements provided that the requirements, including those in J101, were the minimum requirements to be taken into account in the design. Further, the effect of paragraph 3.1(ii) was to place the burden of identifying any discrepancies in the technical requirements and improve on the design accordingly. The obligations were not inconsistent but overlapping, and in those circumstances it was appropriate to hold the contractor to the higher standard, a 20 year design life.

Too slender a thread

MTH relied on a number of factors to support Jackson LJ’s argument in the Court of Appeal that paragraph 3.2.2.2(ii) was too slender a thread on which to hang a 20 year warranty (or, more accurately, a 20 year design life requirement).

They pointed to the fact that the contract was badly drafted, with various ambiguities and inconsistencies throughout. Lord Neuberger queried the relevance of this, reminding MTH that “inelegant and clumsy” drafting of a badly drafted contract is not a reason to depart from the fundamental rules of construction of contractual documents.

MTH argued that it was surprising that such an onerous obligation would be “tucked away” in a technical document rather than spelled out in the main body of the contract. This was a point that had impressed the Court of Appeal but it was dismissed by the Supreme Court. The only question was whether the provisions in the technical requirements were intended to be of contractual effect. It was clear that they were.

Finally, MTH suggested that because a complete set of obligations with regard to design were expressly included, or impliedly incorporated, in clause 8.1 of the contract, it was unlikely that an additional further and onerous obligation was intended to have been included in the technical requirements.

Lord Neuberger’s incisive response was that while it is possible to avoid giving a redundant clause its natural meaning, especially in a diffuse and multi-authored contract, it is very different, and much more difficult, to argue that a contractual provision should not be given its natural meaning, and should instead be given no meaning or a meaning which renders it redundant.

This led the Supreme Court to find that MTH had not designed the structure to last for 20 years and were therefore liable to pay for the costs of remedying that defect.

Practical Lessons

The Supreme Court decided the case on orthodox principles of contractual interpretation. The Court of Appeal, on the other hand, seemed to be driven by sympathy for a contractor who had performed the work with reasonable skill and care, had complied with the contractual standards, and had its designs verified by an independent certifying authority.

If you happen to share some of this sympathy it is worthwhile remembering that an employer is free to propose that a contractor comply with a range of overlapping and diffuse obligations when negotiating the terms of a contract. If the contractor accepts these obligations then it ought to comply with all of them, irrespective of the variance between them.

To treat an obligation as inconsistent with another, just because it is more onerous, would deprive the employer of his bargain and relieve the contractor of the risk allocated at the point of contract.

Wherever your sympathies lie, there are some practical lessons that can be drawn from the Høgaard It is a stark reminder that parties should address the level of the contractor’s design responsibility up front and ensure that the contract clearly sets out the parties’ respective design responsibilities.

In particular, if the completed product is required to meet certain performance criteria, this should be set out clearly in the contract. Saying that the finished product should be fit for purpose is insufficient. The contract should clearly set out what the purpose is. A good example is clause 4.1 in the FIDIC 1999 Yellow Book, which provides:

“When completed, the Works shall be fit for the purposes for which the Works are intended as defined in the Contract.”

Following Høgaard, it is in both parties’ interests to clarify:

(i) whether compliance with a prescribed design will, of itself, be deemed sufficient to meet any separate obligation to achieve prescribed criteria (e.g. would satisfying J101 itself mean that the wind turbine was fit for purpose?);

(ii) which obligation takes priority where there is an inconsistency between the obligation to comply with a prescribed design and the obligation to achieve prescribed criteria (e.g. which obligation prevails - adhering to the contractual standards or ensuring the product is fit for purpose?); and

(iii) whether the obligation to achieve prescribed criteria only applies where the contract does not prescribe the design (e.g. only where J101 did not apply to the design would the fitness for purpose obligation bite).

At the very least, contractors should take steps to ensure they are satisfied that compliance with the contractual standards and specifications will bring about the end result that the employer is contractually entitled to expect.