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Asia Pacific – Drafting With Due Diligence: Do A Contractor’s Caps On Liability Cover All Costs That An Employer Engaging A Replacement Contractor Incurs?

3 June, 2014

 

Legal News & Analysis – Asia Pacific

 

In this latest Talking Point, we examine the important lessons about proceeding with due diligence, completion costs and the scope of liability caps in the decision of the English Technology and Construction Court in SABIC UK Petrochemicals Ltd (formerly Huntsman Petrochemicals (UK) Ltd) v Punj Lloyd Ltd [2013] EWHC 2916 (TCC).

 

Valid Termination For Contractor’s Financial Deterioration And Failure To Proceed Diligently

 

SABIC, a manufacturer of petrochemical products, entered into a GBP 135m contract with a contractor, Simon Carves Ltd, to design, procure and construct a process plant. The contractor obtained in favour of SABIC a GBP 13.5m performance bond, an advance payment guarantee (pursuant to a supplemental agreement in which SABIC provided the contractor with a cash injection by paying the balance of the originally agreed contract price) and a parent company guarantee from its parent, Punj Lloyd. Under the contract, SABIC had the right to terminate if either the contractor, despite previous warning, failed to proceed with the works with due diligence, or, the contractor’s financial position deteriorated such that it jeopardised its capability adequately to fulfil its obligations.

 

After various difficulties arose on the project, SABIC exercised both rights to terminate and completed the works using the contractor’s principal subcontractors. SABIC called both the performance bond and advance payment guarantee and claimed from the contractor the costs of completing the project and losses from delayed production. The contractor became insolvent and SABIC began proceedings against Punj Lloyd under the parent company guarantee.

 

The court found that SABIC was entitled to terminate on both grounds and that the contractor was liable for GBP 11.8m to cover the costs of completing the project. A counterclaim for the return of funds paid out under the bond and advance payment guarantee was rejected.

 

When Does A Contractor Fail To Proceed With Due Diligence?

 

Mr Justice Stuart-Smith dismissed the contractor’s argument that since achieving the completion deadline was impossible and that the obligation to proceed with due diligence did not require it to achieve the impossible, the obligation should not be judged by reference to the completion deadline.

 

Whilst the contractor’s argument ultimately failed because it had not proved completion was impossible to achieve even with the appropriate allocation of resources, the court held that due diligence means carrying out works “industriously, assiduously, efficiently and expeditiously” in order to complete works by an agreed date. This meant that the contractual objective to which the works were directed, namely meeting the completion deadline, had to be considered in determining whether the contractor had proceeded with due diligence. The court found that whilst an obligation to exercise due diligence did not give rise to an absolute contractual duty to achieve a particular outcome, it did not become less onerous just because the outcome became impossible. The requirements for satisfying a due diligence obligation depend on what is required to achieve the contractual objective and may include the adoption of accelerative measures.

 

The effect of this part of the judgment is that, on projects where the contractual wording is similar to that found in this case, contractors may, depending on the wording of the contract, find themselves having to adopt accelerative measures where they have fallen behind programme and are unable to prove that even if they had adequate resources (a concept that was not expanded upon in the judgment), they would still not have been able to complete by the completion deadline.

 

What Date Is Used For Deciding Whether A Contractor’s Financial Position Has Deteriorated?

 

The court also held that, absent an express amendment or implied variation to the contrary, any change in the contractor’s financial position is judged from the original contract date, not the date of any supplemental agreement.

 

The court said that the following factors would help a court decide when a contractor’s financial position has deteriorated:

 

  • The availability of external support, although support provided by a guarantor does not mean that a contractor should be treated as if it were invested with all of the guarantor’s financial strength;
  •  The deterioration must jeopardise the fulfilment by a contractor of its obligations to a “substantial extent”; and
  • Contractual provisions requiring an employer to terminate as early as possible. In this case, there were no such clauses, rather a provision that failure by SABIC “to enforce or partially enforce any provision of the contract will not be construed as a waiver of any of its rights under the contract”.

 

The court held that the evidence was clear that the contractor in this case no longer had Punj Lloyd’s support and was not receiving funding to enable the contractor to progress or accelerate the works. The contractor’s financial position had therefore deteriorated to a substantial extent and this had directly caused the contractor’s failure to discharge its contractual obligations properly.

 

This finding means that parties negotiating supplemental agreements under which an employer is to provide a cash injection to a contractor who has fallen behind programme should consider whether the date in any provision in the original contract dealing with the determination of the contractor’s financial position also needs to be amended.

 

Following Termination, What Additional Costs Incurred By An Employer To Complete A Project Can Be Claimed From The Contractor?

 

The contract in this case also provided that where another contractor was engaged following termination of the original contractor and the total cost SABIC reasonably incurred exceeded the total that the works would have cost had they been completed by the original contractor, the difference was recoverable by SABIC from the contractor.

 

The court held that the amount “the works would have cost had they been completed by the contractor” was a calculation based on the original contract, namely the contract price SABIC would have paid had the contract not been terminated. It did not mean the actual costs the contractor would have incurred had it remained engaged to complete the works (which in this case exceeded the contract sum). This means that in contracts with similar provisions, contractors will find it difficult to claim a reduction in the employer’s entitlement for the costs of completion by reason of the contractor’s costs exceeding the contract sum.

 

Does A Liability Cap Cover Amounts Paid Out Under A Bond And The Additional Costs Paid To A Replacement Contractor To Complete The Works?

 

The contract included limitation of liability wording found in many engineering and construction contracts:

 

…the aggregate liability of the Contractor under or in connection with the Contract (whether or not as a result of the Contractor’s negligence and whether in contract, tort or otherwise at law)…shall not exceed 20% (twenty per cent) of the sum of the Contract Price…“.

 

The court considered whether the liability cap applied to limit the claim for the additional costs of completion. The court said that it did not. The cap applied only to liabilities incurred as a result of breaches of obligations in contract and tort and not to the claim for the additional costs of completion.

 

Hogan Lovells

 

For further information, please contact:

 

Timothy Hill, Partner, Hogan Lovells

timothy.hill@hoganlovells.com

 

Damon So, Partner, Hogan Lovells

damon.so@hoganlovells.com

 

Terence Wong, Partner, Hogan Lovells

terence.wong@hoganlovells.com

 

Alex Wong, Partner, Hogan Lovells

alex.wong@hoganlovells.com

 

Paul Teo, Partner, Hogan Lovells

paul.teo@hoganlovells.com

 

Patric McGonigal, Partner, Hogan Lovells

patric.mcgonigal@hoganlovells.com

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