On 10th October 2013 the Technology & Construction Court, a division of the English High Court, decided the case of SABIC v PLL and SCL. The case addresses many of the issues which often arise upon the termination of construction contracts including: justification for terminating, the contents of a warning letter and assessing the costs of completion. The case also considered the effect of a limitation of liability clause and the effect of recovery under performance guarantees. The case should be a good starting point in future for consideration of these issues.

How to terminate contracts effectively

The facts

The case concerned a contract for construction of a plant for producing plastics. The contract had not gone well from the start and it eventually became clear that the completion date was not going to be met. A Supplemental Agreement was then entered into. This agreement identified a critical date in December 2008 which would be the new reference point for the deduction of liquidated damages. SCL, the contractor, agreed to procure the services of such subcontractors as were necessary to ensure this date was met. In return, SABIC, the employer, agreed to make payment of the whole of the balance of the existing contract price against which the contractor provided an advance payment guarantee. All claims to the date of the Supplemental Agreement were settled.

However, this did not result in an improvement in progress. A few months after the Supplemental Agreement was entered into, the employer gave the contractor a seven-day warning that it was failing to proceed with the engineering works with due diligence or was otherwise persistently in material breach of its obligations. It also asserted that the financial position of the contractor had deteriorated to such an extent that its ability to fulfil its obligations adequately had been placed in jeopardy. One month later the contract was terminated and the employer completed the project itself employing the same subcontractors. The employer claimed from the contractor the extra-over costs of completing the works, and called on the advance payment guarantee and the performance guarantee.

SCL became insolvent. SABIC commenced proceedings against PLL, SCL's parent company, under a parent company guarantee. PLL and SCL counterclaimed against SABIC, asserting that the termination was unlawful.

The Obligation of Due Diligence

The Courts concluded that the obligation to proceed "with due diligence" required a contractor to apply itself "industriously, assiduously, efficiently and expeditiously" to its obligations to meet the completion date required by the contract. The completion date was, the Court held, not impossible to achieve assuming an appropriate allocation of resources.

The Warning Letter

The contractor criticised the employer's warning letter on the basis that it did not specify the respects in which the contractor was claimed to have failed to exercise due diligence. The Court held that this was not necessary, given the terms of the contract, although in fact the letter had specified the relevant failings. It was sufficient that the notice specify the relevant obligation said to have been breached, that is the obligation to exercise due diligence.

Progress in the Warning Period

The evidence indicated that the contractor made no improvements in performance during the warning period and did not accelerate his works with the result that he would be unable to achieve the required completion date. This conduct justified the employer in terminating the contract.

The Contractor's Financial Position

This was a separate ground for termination. It was to be assessed against the position when the contract was entered into and the evidence showed that the contractor no longer had the support of its parent company and could not therefore pay for progress on the contract to be accelerated. The evidence indicated that this position was likely to continue. The employer was therefore justified on relying on this ground.

The Cost of Completion and the Approach to Completion Costs

In keeping with the proportionate approach now required in Court proceedings, the employer, while still needing to prove his claim, had justifiably adopted a "broad brush" approach to calculation of completion costs. The court took as a starting point the systems which the employer had set up to identify costs to complete. The calculation of recovery from the contractor was to be made by calculating the amount the employer spent to complete and deducting the amount the works would have cost, had the contractor completed them. The deduction was to be made by reference to the original contract price, not the amount that the contractor would actually have spent.

The Limitation of Liability and the Effect of the Bond Payment

The contract contained (as is common in process plant contracts) a limitation of liability clause to 20% of the contract sum. The Court held that it applied only to the employer's claims for damages and not to an accounting exercise, such as was called for by the termination provisions. The limitation would only be relevant if some of the employer's costs related to claims for damages for breach of contract. Had the clause applied, the Court held that the amount recovered under the performance and advance payment bonds should be deducted from the employer's loss before the limitation was applied. The effect of recovery under the bonds was to reduce the employer's loss against which the cap was to apply.

Conclusion

The case is close to a text book example of the problems that can arise upon the termination of a construction contract. Although the contract was not in standard form, many of its provisions were similar to those commonly encountered. Perhaps the most significant issue in the judgment is the interpretation of the phrase "due diligence" in relation to which the Court clearly stated that the standard against which the contractor would be judged was the completion date applicable under the contract, even if it might be difficult to achieve. The completion date was what the contractor had signed up to and it was his responsibility to ensure that progress on site was focussed on its achievement.