backThe perfect construction project is completed on time, on budget, and in accordance with the Employers specification and/or performance requirements. In reality, delays frequently occur and with such delay the potential for costly disputes over fault and quantum increases. Parties to a construction contract can lessen this potential somewhat by agreeing upon a delay liquidated damages regime which pre-determines the financial consequences of delay. The recent decision of J Murphy & Sons v Beckton Energy Ltd ( Murphy v Beckton ) has relevance for any Employer using a FIDIC Contract governed by English law and will assist such Employer in achieving an efficient and legally certain mechanism to claim delay liquidated damages.
The decision of Murphy v Beckton is unusual in two respects; the case required the court to consider specific clauses in an amended version of the International Federation of Consulting Engineers ( FIDIC ) Conditions of Contract for Plant and Design Build for Electrical and Mechanical Plant and for Building and Engineering Works designed by the Contractor First Edition 1999 (also known as the FIDIC Yellow Book ) standard form of contract, [1] and liquidated damages. Cases dealing with either topic are uncommon, and cases dealing with both therefore even more so.
The reason for the infrequency of such cases can be explained by the fact that adoption of FIDIC standard form conditions of contract and inclusion of liquidated damages clauses in contracts are driven by the contracting parties desire to avoid resorting to court, which can be time consuming and costly. By using FIDIC standard form conditions of contract, the parties hope to minimise the risk of litigation by selecting a contract that is commonplace throughout the construction industry, tried and tested, and well-understood by the various players in the market, and a contract which refers disputes to dispute settlement boards and/or arbitration rather than litigation. By including provisions relating to liquidated damages, the parties are seeking to limit the potential for any dispute over the quantum of damages by pre-determining, and thus giving certainty to both parties about, the consequences of a breach, and to disincentivise the occurrence of a breach in the first place (though not to the extent that, if challenged, a court would find that the clause constitutes a penalty and is hence unenforceable). [2]
Whilst the subject-matter of Murphy v Beckton makes it somewhat of a rarity, in other ways it is not a novelty at all. Delays to the works in construction projects are very common and the judgment reached does not depart from previous authorities or established principles of the law relating to the interpretation of written commercial contracts or amendments to a standard form. That said, the decision serves as a useful reminder of the overarching importance that the English court affords to freedom of contract for commercial parties and its consequent reluctance to interfere with terms of contract, as well as its approach to contractual interpretation. The court will seek to discern the intention of the contracting parties whenever possible, and, where it can identify such intention, to give effect to it. Murphy v Beckton demonstrates that in determining the parties intention, the court will place more weight and importance upon terms that the parties have amended in a standard form contract than upon those that have been left in their original template form.
In Murphy v Beckton, the court also considered a secondary issue whether, if on the proper construction of the contract and in the circumstances, Beckton Energy Limited ( Beckton ) was not entitled to recover liquidated damages, a call on the on-demand bond designed to act as security for performance duly-obtained by J Murphy & Sons Ltd ( Murphy ) pursuant to the contract would be fraudulent. This case note, however, will only focus on the liquidated damages aspect of the case. To this end, the relevant facts and the courts decision on the liquidated damages-related points are set out below.
Facts
The defendant Employer, Beckton entered into a contract with the claimant Contractor, Murphy on 14 March 2013 related to design, procurement, construction, start-up, testing and commissioning of a Combined Heat and Intelligent Power Plant located in Beckton, in East London.
The contract was based on the FIDIC Yellow Book. The parties chose to include Sub-Clause 2.5 and the first part of Sub-Clause 3.5, which relate to claims for payment by the Employer and determinations by the Engineer respectively, in unamended form ( i.e. exactly as they appear in the FIDIC Yellow Book) but made changes to other Sub-Clauses, including Sub-Clauses 4.2 [Performance Security], 8.2 [Time for Completion], 8.7 [ Delay Damages] and 14.6 [Issue of Interim Payment Certificates].
The amended Sub-Clause 8.2 required Murphy to obtain Renewable Obligation ( RO ) accreditation from OFGEM [3] in accordance with the Renewables Obligation Order 2009 by 2 November 2014 at the latest, and to complete all works by 31 January 2015. The amended Sub-Clause 8.7 stated that if Murphy failed to obtain the RO accreditation in time, it must pay Beckton liquidated damages at a rate of 4,000 per day for the period from 2 November 2014 until the earlier to occur of (i) achievement of the RO accreditation, and (ii) 31 March 2015. The amended Sub-Clause 8.7 also required Murphy to pay liquidated damages at a rate of 23,000 per day if it failed to achieve taking over before 31 January 2015 from such date until the taking over date. Further, Sub-Clause 8.7 provided that the delay damages should be deducted from the next applicable Notified Sum. Notified Sum was defined in Sub-Clause 14.6 of the contract, which had also been adapted from its original FIDIC Yellow Book form to remove any reference to determination of the amount payable by the Engineer appointed under the contract, as meaning simply the sum specified by Murphy.
Murphy did not obtain the RO accreditation by 2 November 2014. On 23 December 2014, Beckton sent a letter to Murphy notifying Murphy of its entitlement to delay damages in accordance with Sub-Clause 2.5 but stating that it would defer its right to claim, set-off or otherwise deduct such damages. Murphy also missed the completion date of 31 January 2015 so Beckton issued another letter in similar terms on 31 March 2015. On 25 January 2016, Beckton demanded payment of the sums of 592,000 for the accreditation delay and 7,682,000 for the completion delay within 30 days. Murphy did not pay such sums.
On 22 February 2016, Murphy submitted that it was entitled to a taking over certificate for a large part of the works which, if Beckton were entitled to damages (which Murphy denied), would result in the amount of damages payable being significantly reduced. Murphy asked the Engineer to issue the taking over certificate on 8 March 2016 and, the following day, applied to the court for a declaration that an agreement of determination by the Engineer appointed under the contract was a necessary prerequisite for Beckton to claim delay liquidated damages. Until such agreement or determination was reached, Murphy contended that it was not obliged to pay such liquidated damages.
Decision
The first question before the court was whether Murphy was obliged to pay Beckton the 8,274,000 of liquidated damages claimed. Murphy submitted that Sub-Clause 2.5 applied to the entirety of the contract and, as such, an agreement or determination by the Engineer was necessary in order to give rise to an obligation to pay damages. Beckton argued that it was entitled to the damages under Sub-Clause 8.7 and that Murphys obligation to pay arose independently of Sub-Clauses 2.5 and 3.5, such that it was unaffected by the lack of agreement or determination by the Engineer.
Considering this issue, the court was guided by the usual principles of interpretation of written contracts summarised in Arnold v Britton. [4] The court must try to identify the intentions of the parties by reference to what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean.[5] As such, the court must have regard to the meaning of the relevant words in (i) the natural and ordinary meaning of the clause, (ii) any other relevant provisions, (iii) the overall purpose of the clause and the contract, (iv) the facts and circumstances known or assumed by the parties at the time that contract was made, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party's intentions. [6]
The court noted, by way of background, that the parties had chosen to include some provisions in the exact same form as the FIDIC Yellow Book but to amend others. This suggested that where the parties had elected to make changes to the FIDIC Yellow Book, the changes had been made deliberately and with specific purpose, and that accordingly more weight should be placed on the amended terms. By removing the words subject to Sub-Clause 2.5 [Employers Claims] from the Sub-Clause 8.7 inserted into the contract, the parties can, to the extent that the court can make assumptions based on deletions, be said to have evidenced a clear intention that their Sub-Clause 8.7 should, unlike the equivalent sub-clause in the FIDIC Yellow Book standard form, operate separately to Sub-Clause 2.5.
Turning to the wording of the amended Sub-Clause 8.7 itself, the court emphasised that it contained precisely and expressly fixed sums for the damages payable and the timeframe in which they should be paid. As such, the amended Sub-Clause 8.7 did not expressly or impliedly (by leaving details unstipulated so as to suggest that they should be settled by reference to other terms in the contract) signpost Sub-Clause 2.5, 3.5 or any other Sub-Clauses. Further, Sub-Clauses 2.5 and 3.5 did not specifically set any sum or timeframe so overlaying these provisions that would cut across an important part, indeed most, of the amended Sub-Clause 8.7. In addition, Sub-Clause 2.5 states that any amount payable may be included as a deduction in the Contract Price and Payment Certificatesbut Sub-Clause 8.7 provided for deduction from the Notified Sum.
The court found that all the inconsistencies could be resolved by interpreting Sub-Clause 8.7 as a standalone and self-contained regime and that this appeared to have been the intention of the parties when drafting the contract. It appeared that the parties had not thought out Sub-Clause 2.5 in the full context of the rest of the contract and that this error diminished the substance of the provision so less weight should be attached to it. Accordingly, based on the proper construction of Sub-Clause 8.7, the court held that Beckton was entitled to claim damages to Murphy without agreement or determination by the Engineer.
Comment
The purpose of liquidated damages in general
The court determined that the fixed sums for damages payable specified in Sub-Clause 8.7 of the contract should stand and take precedence over the mechanism for deciding what should be payable ( i.e.the reference to the Engineer) under Sub-Clause 2.5 in light of important and substantive inconsistencies between the two. However, the same conclusion could be reached based on the purpose of liquidated damages in general. Though not discussed in the judgment, the general purpose of liquidated damages is likely to have been in the judges minds and to have played a part in their consideration of the overall purpose of the clause, the facts and circumstances known or assumed by the parties at the time that contract was made, and commercial common sense.
The overriding purpose of a liquidated damages clause is to provide certainty about the consequences of a breach for both parties. For the employer, liquidated damages provides a guaranteed recoverable sum in the event of a breach by the contractor which does not depend on the requirement to prove actual loss. For the contractor, it is of great consequence to know that its liability is limited to the maximum of the fixed sums specified in the liquidated damages clause in the contract, particularly as the position in case law is that the aggrieved party is under no obligation to mitigate its loss. [7]
A liquidated damages clause in a contract allows the parties to agree what damages are recoverable in the event of a breach and the level of those damages such that there is no need to resort to litigation to determine liability and/or quantify the damages. [8] Without a liquidated damages clause, the only option for an employer in the case of a breach of the contract by the contractor would be to go to court to claim general ( i.e. unliquidated) damages. General damages aim to put the innocent party in the position it would have been in, had the breach not occurred. As such, the employer would have to prove actual loss and show that the contractors breach caused that loss. The court would then examine the evidence and, if causation is established, seek to find an appropriate level of damages to adequately compensate for that loss. Court proceedings can be time consuming and costly, and there is no guarantee of success. For a construction employer that as a result of delays by the contractor is struggling to fund a construction project to late completion (as was the case for Beckton), the time lag caused by court proceedings to claim its money could diminish its liquidity and its ability to source funding, and, in the worst case, ultimately cause its collapse.
Time and cost are not the only disadvantages to litigation. In Cavendish Square Holding BV v Talal El Makdessi, the most recent decision in this line, the court noted that in a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach.[9] Judges are not construction experts and may not quantify the losses correctly. It is in both parties interests to carry out the quantification exercise themselves by pre-estimating their losses at the outset; the actual loss suffered may be more or less but, if the parties have made accurate calculations and negotiated effectively, the liquidated damages payable under the contract should at least be in the right ballpark. Further, a court decision is binding whereas drafting a contract is a negotiation process. Where the parties are of comparable bargaining power, there will be more flexibility with a liquidated damages clause.
The parties failure in Murphy v Beckton to consider the effect of an amendment to one standard form clause on the rest of the contract, in effect, left them with two different, and irreconcilable, mechanisms for calculating the sum of liquidated damages payable. Having two competing mechanisms undermined the overriding purpose of certainty. The courts recognise the importance of certainty and have been keen to uphold this practical commercial purpose. If Sub-Clause 8.7 were held to be subject to the provisions of Sub-Clauses 2.5 and 3.5, it would undermine certainty and the freedom of contractual parties to agree what damages should be recoverable in the event of a breach.
Other cases relating to disputes arising from amendments made to standard form contracts
In Murphy v Beckton, the court cited another case, Homburg Houtimport BV v Agrosin Private Ltd (the Starsin),[10] which considered the situation in which a standard form contract has been amended and a dispute has arisen between the parties with regard to that amendment, albeit outside of the construction sphere.
In that case, the House of Lords held that where specific terms are added by the parties to a standard form contract and there is a conflict between the added terms and the standard form ones, the added terms will usually prevail. Lord Steyn concluded that a reasonable person, versed in the shipping tradewould give greater weight to words specially chosenrather than standard form printed conditions.[11] Further, he observed that to give effect to the boilerplate clauses over those that had been inserted by the parties would, in his view, have an adverse effect on international trade, creating traps for the unwary and eroding commercial certainty. Lord Bingham of Cornhill cited the earlier case of Glynn v Margetson & Co[12] as support for its proposition that [w]ords which the parties have themselves chosen and written into the contract should have greater effect than printed standard terms. [13] In Glynn v Margetson & Co, the parties had made a handwritten addition to the deviation clause in a printed, standard form bill of lading. The court emphasised that a standard form contract is designed to be applicable to a range of transactions and is not specially agreed upon between the parties in relation to the particular matter at hand. As such the words in the printed standard form are general and only intended to apply to the extent that they can be to the particular circumstances of an individual contract. In order to ascertain the extent to which the standard terms are applicable, due regard should be given to the main object and intent. As already discussed, the main object and intent of liquidated damages provision is to set a pre-determined sum that is automatically payable upon a breach occurring.
In Balfour Beatty Civil Engineering Limited v Docklands Light Railway Limited,[14] the parties deleted the dispute resolution clause to the ICE General Conditions of Contract 5th Edition in their agreement. This had the effect of removing the power given to an arbitrator to 'open up, review and revise' decisions on extensions of time and payment. The court held that the parties had made an express decision to delete that clause and so, giving effect to the intention that the act of deletion evidenced, refused to 'open up, review and revise.' The fact that that the parties had, most likely, failed to properly analyse the consequences of removing the dispute resolution clause did not justify the court re-writing the contract.
Inconsistencies in the standard form FIDIC contract
The unamended FIDIC Yellow Book Conditions of Contract contain their own inconsistencies. [15] The unamended Sub-Clause 8.7 expressly states that payment of delay damages is subject to Sub-Clause 2.5. Sub-Clause 2.5 then requires the Engineer, in accordance with Sub-Clause 3.5, to determine the amount that the Employer is entitled to be paid by the Contractor. However, as already highlighted in this note, the nature of liquidated damages is that they are a pre-agreed, fixed sum.
Additionally, the mechanism requires deferral to a third party, the Engineer, albeit one under an obligation to make a fair determination pursuant to Sub-Clause 3.5. The object of certainty is defeated because the damages recoverable are unknown to both parties until the Engineer has made its determination, and there is no fixed timeframe for the Engineer to make its determination under Sub-Clause 3.5. This creates a risk of delay, thereby compounding the original delay for which the delay liquidated damages are a remedy.
Conclusions
There are many advantages to using standard form conditions of contract; as already mentioned, tried and tested wording that the parties are familiar with reduces the risk of future disputes, and the resultant time delay and costs that such a disagreement would entail. It also reduces the time and cost of negotiation. At the most basic level, there is a reason that these contracts became accepted as standard; they generally reflect a fair and reasonable market position. Standard form contracts in general, and the FIDIC Conditions of Contract in particular, are carefully drafted by industry professionals who have significant experience and understanding of that type of contract and the common problems that arise. The contracts are developed in such a way that they enshrine lessons learned and best practice from both projects that have succeeded and those that have failed, projects that have resulted in disputes, and projects in which sound drafting has provided clarity and effective solutions to problems.
However, no standard form contract can provide for the idiosyncrasies of every project and its parties, or for every possible eventuality that might occur. For example, different types of power project require different testing provisions, and leaps in industry technology, as well as changes in the law since the last iteration of the form, may render some standard terms obsolete and require new ones to be introduced. Amending some terms potentially allows for the best of both; parties can enjoy these benefits of standard wording in the majority of the contract but also tailor terms to meet more specific requirements.
It is in this situation that Murphy v Beckton should serve as a tale of caution; amending FIDIC contracts has its own hazards. A change made to a standard form contract is not easily unmade. Freedom of contract remains king and the English court will not re-write terms, even if a party, or the parties, must suffer unintended consequences as a result of the modification that they made. This viewpoint, to a certain degree, distinguishes the English court from its continental counterparts. Civil jurisdictions, such as France and Germany, have greater regard for customary/industry practice and will, where they deem it necessary, import terms based on obligations imposed by statute or, to the extent that they can be said to be written statements of common practice, standard form contracts. Standard form contracts are not so elevated in England and Wales. Making amendments can disrupt the framework that standard form contracts provide, especially as there are many interdependencies between clauses. Modifying one clause may have an impact on another, resulting in unintended consequences, changing the balance of risk and creating legal uncertainty. Indeed, for these reasons, the practice of amending to standard form contracts has its critics; the 1994 Latham Report [16] recommended the use of standard contracts without amendments and they were also criticised in Royal Brompton Hospital National Health Trust v Hammond and Others: A standard form is supposed to be just that. It loses its value if those using it or, at tender stage those intending to use it, have to look outside it for deviations from the standard. [17]
Amendments to FIDIC Contracts are nearly always necessary; one reason for this is that FIDIC contracts do not reflect the requirements of project finance. The lesson from Murphy v Beckton is that any changes should be made carefully. Parties should select the standard form that best fits their needs so as to minimise the necessity for modification. There is a wide range of standard form contracts available (in addition to the FIDIC Yellow Book, FIDIC has published the Red Book for Construction and the Silver Book for EPC/Turnkey Projects) so parties are likely to be able to find one that meets their requirements closely, if not perfectly. Parties modifying standard conditions of a FIDIC contract should exercise extra care and ensure that they fully understand the operation of the clause in the context of the contract as a whole, taking account of and making appropriate arrangements for any overlaps or interactions between clauses. Parties can also learn from others; Murphy v Beckton is an example of how not to amend Sub-Clause 8.7 of the FIDIC Yellow Book and the FIDIC Red Book.
Murphy v Beckton is also an example of how the FIDIC forms are not perfect and can be improved upon. In light of this decision, parties may wish to eradicate the inconsistencies thrown up by the FIDIC Yellow Book and FIDIC Red Book with respect to the claiming of delay liquidated damages by amending the standard form. One approach is to remove the cross-reference to Sub-Clause 2.5 in Sub-Clause 8.7 (as Murphy and Beckton did), amend Sub-Clause 2.5 so that it does not apply to liquidated damages claims, and further make clear that delay damages are a liquidated sum based on the number of days of delay and the per diem amounts for such delay, to be determined and notified by the Employer only in accordance with a procedure to be set out in an amended Sub-Clause 8.7 without any role for the Engineer. An alternative approach, which would perhaps be more palatable to contractors, would be to clarify the wording in Sub-Clause 2.5 such that the Engineers role does not require it to agree liquidated damages for delay nor determine the amount of liquidated damages payable. Rather the Engineers role would be limiting to making a determination of the relevant number of days to which delay liquidated damages would apply. Similar clarifying changes could be made in the FIDIC Yellow Book clarifying that the Engineers role in the determination of performance liquidated damages is limited to determining the extent of any relevant performance shortfalls but not agreeing or determining performance shortfall damages. Parties could also introduce timescales for the Engineer to make such determinations. The foregoing changes are in the spirit of the certainty sought by parties including liquidated damages clauses in construction contracts and, in our view, would represent a worthwhile and justifiable amendment to the FIDIC standard conditions of contract.[1] The relevant Sub-Clauses (2.5, 3.5 and 8.7) are also identical in the Conditions of Contract for Construction for Building and Engineering Works designed by the Employer First Edition 1999 (the FIDIC Red Book ).
[2] For a discussion of the recent clarification by the UK Supreme Court of the English (and Scottish) law on penalties in the (joint) appeals in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67, see Grigori Lazarev, Alex Blomfield and Kelly Nash, UK Supreme Court Clarifies the Law on Penalties, King & Spalding Energy Newsletter, January 2016.
[3] The Office of Gas and Electricity Markets (OFGEM) is the government regulator for the electricity and downstream natural gas markets in Great Britain.
[4] Lord Neuberger, paras. 14-23, Arnold v Britton [2015] UKSC 36.
[5] Lord Hoffmann, para. 14, Chartbrook Ltd v Persimmon Homes Ltd [2009] UKHL 38, [2009] 1 AC 1101.
[6] Para. 43, Murphy v Beckton.
[7] MSC Mediterranean Shipping Company SA v Cottonex Anstalt [2015] EWHC 283 (Comm).
[8] See, for example, the oft-cited para. 99, Robophone Facilities Ltd v Blank [1966] 1 WLF 1428 (CA), page 1447 (Diplock LJ): Not only does it enable the parties to know in advance what their position will be if a breach occurs and so avoid litigation at all, but if litigation cannot be avoided, it eliminates what may be the very heavy legal costs of proving the loss actually sustained.
[9] Para. 35, Cavendish Square Holding BV v Talal El Makdessi, see Note 2.
[10] Homburg Houtimport BV v Agrosin Private Ltd (the Starsin) [2003] UKHL 12.
[11] Lord Steyn, paras. 45-46, Homburg Houtimport BV v Agrosin Private Ltd (the Starsin) [2003] UKHL 12.
[12] Glynn v Margetson & Co [1893] AC 351.
[13] Lord Bingham of Cornhill, para. 7, Homburg Houtimport BV v Agrosin Private Ltd (the Starsin) [2003] UKHL 12.
[14] Balfour Beatty Civil Engineering Limited v Docklands Light Railway Limited (1996) 78 BLR 42.
[15] The FIDIC Yellow Book and FIDIC Red Book are identical in Sub-Clauses 2.5, 3.5 and 8.7.
[16] Sir Michael Latham, Constructing the Team.
[17] Para. 60, Royal Brompton Hospital National HealthTrust v Hammond and Others (No.9) [2002] EWHC 2037.