In a case that will be closely followed by the users of LOGIC contracts, the High Court recently decided the standard to be applied to a contractor’s obligation, upon notice, to remedy a defect to the “satisfaction of” the company/employer or risk termination by the company/employer.

The High Court decided that the company/employer was largely entitled to take a subjective view of what it considered satisfactory. It did not require the court to carry out an after the event review of the company/employer’s decision based on an objective standard of reasonableness. However, the company/employer must act honestly, in good faith and genuinely. An arbitrary, capricious, perverse or irrational decision by the company/employer would amount to a breach of contract.   

Facts

On 26 March 2007, Bluewater entered into a sub-contract with Mercon for the fabrication of a tower based soft yoke system (“SYMS”) for installation as part of the development of the Yuri Korchagain Field in the Caspian Sea.

The termination provisions of the sub-contract followed those found in certain of the LOGIC model form contracts and stated:

“30.1 BLUEWATER shall have the right by giving notice to terminate all or any part of the WORK or the CONTRACT at such time or times as BLUEWATER may consider necessary for any or all of the following issues:

(a) To suit the convenience of BLUEWATER

(b) Subject only to Clause 30.2 in the event of any default on the part of the CONTRACTOR; or

30.2 In the event of a default on the part of the CONTACTOR and before the issue by BLUEWATER of an order of termination of all or any part of the WORK of the CONTRACT, BLUEWATER shall give notice of default to the CONTRACTOR giving the details of such default. If the CONTRACTOR upon receipt of such notice does not immediately commence and thereafter continuously proceed with action satisfactory to BLUEWATER to remedy such default BLUEWATER may issue a notice of termination in accordance with the provisions of Clause 30.1.”

Various disputes arose between the parties in relation to alleged defects and delays. On 23 January 2009 Bluewater served a Notice of Default, which was followed by a Notice of Termination on 3 February 2009. Mercon claimed that Bluewater’s Notice of Termination amounted to a repudiatory breach of contract.

An issue arose as to the standard to be applied under Clause 30.2 to determine whether or not action taken by Mercon was satisfactory. Bluewater argued that the words “action satisfactory to BLUEWATER” meant the subjective view taken by Bluewater and there was no objective reasonableness to be imported. It argued that it was not open to the court to retrospectively superimpose its own view on what Bluewater may or may not have found to be satisfactory.

Mercon argued that Bluewater’s actions had to be objectively reasonable, so that it was not a question of the subjective satisfaction of Bluewater. In this regard, Mercon relied upon Clause 33.1 of Section 2 (a) of the sub-contract that provided:

“Both the CONTRACTOR and BLUEWATER shall uphold the highest standards of business ethics in the performance of the CONTRACT. Honesty, fairness and integrity shall be paramount principles in the dealings between the parties.”

It also relied upon an existing Court of Appeal decision of Socimer International Bank Ltd (in liquidation) v Standard Bank London Ltd [2008] EWCA Civ 116 to argue that the exercise of contractual discretion should not be abused and must be exercised within boundaries of rationality.  

Decision

The High Court decided that Clause 30.2 was not one which is required to be construed by reference to an objective standard. The Clause did not permit a review, after the event, of whether the action taken to remedy the defect was or was not objectively satisfactory. However, there was a limitation on the ability of Bluewater to come to a decision on whether the action was satisfactory.  That limitation, as expressed in Socimer, is a limitation by reference to concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The court did not consider that this limitation depended on the presence of Clause 33.1 of Section 2(a) of the Contract. However, it was consistent with the inclusion of such clause.

The question of whether the action taken by Mercon was satisfactory to Bluewater was therefore a matter for the subjective view of Bluewater, subject to the implied limitation summarised in Socimer.   

On the facts, Bluewater was able to establish that one, or more, of the grounds relied upon was a situation where Mercon had failed to remedy a defect to its satisfaction, and that it was therefore entitled to terminate.

Comment

The decision of the High Court is a useful reminder that where a contract confers discretion on one party, it will usually be implicit that the discretion must be exercised honestly and rationally and for the purpose for which it was conferred.     

Absent, the High Court’s decision that discretion is limited in the manner identified in Socimer, the proper issuing of a notice of default would simply amount to an option to terminate for any reason once the remedy period had expired. Objectively ascertained, this is unlikely to be the intention of the parties.  

It follows that in terminating contracts, or exercising other contractual discretion, in the absence of express wording, parties should keep in mind that discretion is likely to be fettered.

In drafting contracts, parties should consider whether they are content that the implied restriction alluded to in this case is appropriate, or whether express wording of the same, or a differing, standard should be agreed.

For the full case please click here.