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Asia Pacific – English Court Of Appeal: The Valuation Of Omitted Works Should Not Account For Any Breach Of Contract.

5 September, 2014

 

Legal News & Analysis – Asia Pacific 

 

This is the second case between MT Hojgaard A/S (“MTH“) and E.ON concerning the construction of the Robin Rigg East offshore wind farm in the Solway Firth, Scotland. The first case dealt with issues arising from a fitness for purpose obligation, in particular where the applicable standards stated to apply in the specification were found to be incorrect. This second case1 provides valuable Court of Appeal guidance on the correct approach to valuing omissions under the variation provisions of construction contracts, in particular that the valuation should not account for any breach of contract that might have necessitated the variation.

 

The Omitted Work And The Parties’ Positions On Valuation

 
Under the Contract, MTH was to install and commission the foundations for 60 wind turbine generators. The Contract also provided that MTH was to provide a jack-up barge called the “LISA” which was to be used for the installation work. In the event, the LISA proved to be inadequate for the tasks she was required to perform. In order to resolve the problem, the Engineer issued Variation Orders which resulted in the substitution of the LISA with the “Resolution”, a vessel far more suitable for the task. Curiously, whereas the Contract originally required MTH to be responsible for hiring and providing the LISA, the Variation Orders provided that E.ON would hire the Resolution and provide it to MTH on a “free-issue” basis. The effect of the Variation Order was to omit part of the Works that was associated with the LISA, and require MTH to carry out additional work in relation to the Resolution.

 

The parties agreed that the Contract Price needed to be varied to reflect the fact that the LISA was no longer required, and that there should be some addition to the Contract Price to reflect the new work attributable to MTH working with the Resolution, but the parties disagreed as to how this should be done in the circumstances.

 
The Contract set out a number of approaches to be taken if there was a disagreement over the valuation of a Variation Order (including omissions of scope), including that the Engineer should establish the rates to be applied which should reflect the level of pricing in Schedule L1.3, which the parties agreed should apply. Schedule L1.3 contained a schedule of labour rates for various grades of staff and a percentage mark-up for the actual cost by the Contractor for the provision of material plant and specialist sub-contract services.

 
MTH’s position was that the omissions should be based upon the original contribution of the omitted work to the Contract Price, as indicated in Schedule L1.1 of the Contract. E.ON, on the other hand, submitted that the deduction should be a product of applying a rate (or cost) to the amount of time it alleged that the LISA would have taken to carry out the works if it had done so. Given that the LISAhad proved to be inadequate, MTH would have taken a very long time to install all the foundations using her. Consequently, applying a rate or a cost to the time that MTH would have taken if it had completed the contract using the LISA would result in far greater deductions than MTH had derived using its approach.

 
The Courts’ Approach

 
The Judge at first instance rejected E.ON’s arguments. The Contract Price was a fixed lump sum and, whilst the constituent elements listed in Schedule L1.1 did not comprise individual contracts for each of those elements, it did show what amounts had contributed to the Contract Price. Overall, the Contract recognised the principle that discrete parts of the Works made up discrete contributions to the Contract Price. E.ON’s approach also ignored the fact that the sums MTH was entitled to be paid under the Contract would be the same however long it took MTH to execute them: the contractual mechanism for dealing with delay was by way of liquidated damages and not an adjustment of the Contract Price. The Judge agreed with MTH’s view that E.ON was attempting to achieve additional remedies for breach of contract under the guise of adjustment of the Contract Price.

 
On appeal, E.ON submitted that the Judge was in error. E.ON’s case was that the use of the Resolution instead of the LISA was to be regarded as a method change, rather than an addition and an omission. Accordingly, the proper approach is to assess the financial effect of the change by valuing the work if carried out by the LISA and if carried out by the Resolution, and the difference results in the reduction in the price. This would have been the method of valuation had MTH been instructed to substitute the Resolution for the LISA at its cost, so it followed that the same method should be used to value an omission of scope. The fact that E.ON had agreed to pay for the Resolution did not justify a different approach.

 
The Court of Appeal did not agree and upheld the entirety of the first instance Judge’s reasoning. The substitution of the Resolution for the LISA relieved MTH of both the obligation to continue to pay for the LISA and the risk of a continuing claim for liquidated damages for delays attributable to working with the LISA. The essential fallacy of E.ON’s case was that it ignored the fact that by the Contract MTH had: (a) agreed to carry out the work for a fixed price and (b) assumed the risk that the pricewould, in the event, not be enough to cover the work which it had promised to do. The logical conclusion to be drawn from E.ON’s approach was that if, for example, pursuant to a Variation Order, half the contract works were omitted then the deduction from the contract price could be 100% if the time that MTH would have in fact taken to perform the omitted works would have been so long as to justify a valuation equivalent to the whole of the contract price. This exposed the flaw in E.ON’s argument. It was not necessary or appropriate to work out how many days it would, in fact, have taken to complete the installation using the LISA. It was not necessary to consider the reason for the variation and account for that in its valuation.

 

Conclusion

 
This was a somewhat peculiar situation where the variation orders issued by E.ON had the effect of changing the parties’ original contractual obligations with regard to the hiring of the jack-up barge. The consequence of this was that MTH was relieved of the risk exposure to liquidated damages for delay that would likely have arisen if it had continued to use the LISA.E.ON’s view was that MTH should nonetheless bear the burden of that risk through a reduction in the contract price for the omitted work. The Court of Appeal rightly, in our view, dismissed E.ON’s approach to valuing the omitted works. To have allowed such an approach would be precedent for allowing owners a remedy for breach of contract by way of a reduction in the contract price, in circumstances where the appropriate remedy is liquidated damages for delay (if, indeed, there is an actual delay). It is now clear, certainly under English law, that the correct approach to valuing omitted work is, where possible, to take the prices allocated to various elements of work as set out in the contract and then establish a suitable deduction from the Contract Price based on those prices.

 

End Notes:

 

1 MT Hojgaard a/s v E.ON Climate and Renewables [2014] EWHC Civ 710.

 

herbert smith Freehills

 

For further information, please contact:

 

Peter Godwin, Partner, Herbert Smith Freehills
peter.godwin@hsf.com

 

Dominic Roughton, Partner, Herbert Smith Freehills
dominic.roughton@hsf.com

 

David Gilmore, Partner, Herbert Smith Freehills
david.gilmore@hsf.com

 

Emma Kratochvilova, Partner, Herbert Smith Freehills
emma.kratochvilova@hsf.com

 

James Doe, Partner, Herbert Smith Freehills
james.doe@hsf.com

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