In a recent case, the High Court decided that a contract containing a notice of default provision, which permitted a party to terminate for a failure to comply with the notice of default, allowed the court to apply a lower standard to the severity to breaches needed for termination than if the clause had simply allowed termination for “any default” without notice. The court also gave guidance to the parties on when a default notice may properly be issued.

Although only a first instance decision, the court’s decision will be of interest to participants in the oil and gas sector that use similar termination provisions.

As the case related to a FIDIC Yellow Book contract, it also provides a useful illustration of how the courts may interpret the termination provisions in the FIDIC Yellow Book slightly differently to those in certain LOGIC model form contracts (seeLOGIC – remedying default to the innocent party’s satisfaction). 

Facts

The proceedings were between Obrascon Huarte Lain SA (“OHL”), a substantial Spanish civil engineering contractor, and the Government of Gibraltar (“GOG”), in relation to a contract for the design and construction of a road and tunnel under the eastern end of the runway of Gibraltar Airport.

After over 2½ years of work on the 2 year project and when little more than 25% of the work had been done, the contract was terminated. Issues arise as to who was legally and factually responsible.

Subject to some relatively minor changes, the contract was (amongst other things) based on the FIDIC Conditions of Contract for Plant and Design-build for building and engineering works designed by the Contractor 1st Edition 1999, sometimes known as the FIDIC Yellow Book.

The termination clause at Clause 15.1 of the General Conditions of Contract required that:

“15.1 If the Contractor fails to carry out any obligation under the Contract, the Engineer may by notice require the Contractor to make good the failure and to remedy it within a specified reasonable time.

15.2 The Employer shall be entitled to terminate the Contract if the Contractor:
(a) fails to comply…with a notice under Sub-Clause 15.1…
(b) …plainly demonstrates the intention not to continue performance of his obligations under the Contract,

In any of these events or circumstances, the Employer may, upon giving 14 days’ notice to the Contractor, terminate the Contract and expel the Contractor from Site.”

OHL argued that “a contract contains a provision such as Clause 15.2 which entitles an employer to terminate by reason of a failure to remedy a breach of contract which has been the subject of a Clause 15.1 notice…  the breach of contract that is relied upon must be serious and one which is analogous to a repudiatory breach of contract”.

In support of its argument, reference was made to the Antaios decision where the House of Lords held that arbitrators were plainly right to have decided that a clause in a charterparty that provided that the owners were entitled to withdraw “on any breach” only gave a right to withdraw where there was a repudiatory breach.

A breach will be a repudiatory only if it is “so grave as to go to the root of the contract” and “deprive[s] the party … of substantially the whole benefit” of the contract. It follows that it will be in relatively rare circumstances where a party commits a repudiatory breach.

The question arose as to whether the defect notice provision in at Clause 15.1, when taken together with the Clause 15.2(a) right to termination, meant that the court was entitled to apply a different (lower) standard in deciding whether termination was permitted. 

Decision

The court decided that it was entitled to apply a lower standard to the employer’s right to terminate for failure to comply with a notice than the repudiatory breach.  It further decided that GOG was entitled to terminate the contract.

In upholding GOG’s right to terminate, the court decided that a number of points that will be of interest to the oil and gas industry, where similar termination clauses can be used in some procurement contracts:

  • One needs to consider each contract on its own terms. For instance, if the termination clause allowed for termination “for any breach of contract no matter how minor”, the meaning is clear and would not require some repudiatory breach.
  • The notice provision in Clause 15.1 relates only to more than insignificant contractual failures by the Contractor.
  • The specified time for compliance with the Clause 15.1 notice must be reasonable in all the circumstances prevailing at the time of the notice. What is reasonable is fact sensitive.
  • Clause 15.1 is designed to give the Contractor an opportunity and a right to correct its previous and identified contractual failure.
  • Most of the cases, that found that “any breach” meant any repudiatory breach, did not involve contracts like the contract in this case which gives a list of grounds on which termination can take place that includes one which is not unlike the test for English common law repudiation, namely Clause 15.2 (b) (where the Contractor “plainly demonstrates the intention not to continue performance of his obligations under the Contract”).  The existence of Clause 15.2(b) might be said to indicate that Clause 15.1(a) governs something different to a repudiatory breach.
  • The cases relied upon by OHL in this context had a relatively simple right to terminate (for a, or any, breach). The contract here at least for the Clause 15.2(a) basis (failure “to comply…with a notice under Sub-Clause 15.1”) had a warning mechanism whereby termination could be avoided by the contractor’s compliance with the Clause 15.1 notice. In that sense, the contractor is given the chance to avoid termination whilst the simple termination for any breach can come out of the blue. Commercial parties would sensibly understand that this contractual chance is a warning as well to the contractor and the remedy is in its hands in that sense.

Comment

The High Court was clear that each contract and termination clause must be construed on its own terms. It is therefore important to avoid broad generalisations as to the meaning and effect of termination clauses (and contracts) of differing drafting. 

In this case, the High Court decided that the contract entitled the employer to issue a default notice provided that the breach was not “insignificant” or “trivial”. If the contractor did not then remedy the defect in a reasonable time, the employer was then entitled to terminate the contract. This seems to set the bar for termination significantly lower than material (repudiatory) breach.

In reaching this decision, the court appeared to place some weight on the fact that Clause 15.2(b) allowed termination where the Contractor “plainly demonstrates the intention not to continue performance” and suggested that giving an Antaios type meaning to the construction and interpretation of 15.1 and 15.2(a) might have the effect of robbing 15.2(b) of any meaning. However, another interpretation could be that 15.2(b) is intended to deal with a renunciation of contract and Clauses 15.1 and 15.2(a) to deal with a material, repudiatory, breach. This might be an interesting avenue to explore in any appeal.

It remains to be seen whether other courts will adopt an analogous approach to termination clauses that contain notice provisions. However, it is important to be aware that the relationship between the notice provision and the termination right might have a material impact on the parties’ rights. In this respect, the LOGIC model form contracts differ to the FIDIC Yellow Book in that they require the company to issue a notice of default in advance of terminating for “any breach”. In this context, it is arguable that the words “any breach” in the termination clause may still mean “any material breach”.    

This is a decision of the High Court (Technology and Construction Court). It is not yet known if the case will be appealed to the Court of Appeal. In the interim, parties should continue to exercise caution in relying on the termination provisions of contracts. In addition, parties should consider whether amendments should be made to model forms, used to govern contractual relationships, where the scope the termination rights remain unclear and open to debate.  

For the full case please click here.