Employer claims and financial arrangements under the FIDIC Red Book

In a decision published last week, the UK’s Privy Council has considered the proper interpretation of two clauses in the FIDIC General Conditions of Contract for Construction 1999 (also known as the “Red Book”) concerning obligations of an Employer to evidence financial arrangements and as to the notification of Employer claims. The decision supports a robust approach to both of these matters and Employers operating under FIDIC terms would be well advised to give careful consideration to the court’s findings.

NH International (Caribbean) v National Insurance Property Development Company

NIPDC engaged NHIC to construct a new hospital in Tobago. The contract between the parties incorporated the standard FIDIC General Conditions of Contract for Construction 1999 (the “Red Book”). Clause 2.4 of the Red Book required NIPDC to submit, upon request by NHIC, “reasonable evidence that financial arrangements have been made and are being maintained which will enable [NIPDC] to pay the Contract Price”.

NHIC made a request under clause 2.4 and the parties fell into dispute as to whether NIPDC had submitted sufficient evidence in accordance with the clause. NIPDC had written confirming that funds were available to be used for the project, that moneys certified as due would “be paid by the Government” and that “the Government stands fully behind the project”. However, NHIC required evidence that Cabinet approval had been obtained for funding of the project, without which payments could not be made by NIPDC. Shortly before Cabinet approval was obtained, NHIC purported to terminate the contract due to non-compliance with clause 2.4.

An arbitration ensued in which the arbitrator upheld the termination. Clause 16.4 of the Red Book entitled NHIC to be paid any loss of profit or other loss or damage sustained by it as a result of the termination. In seeking to defend NHIC’s claim for such losses, NIPDC sought to set-off its own claims against NHIC. These claims had not been notified in accordance with clause 2.5 of the Red Book, which provides as follows:

“If the Employer considers himself to be entitled to any payment under any Clause of these Conditions or otherwise in connection with the Contract … the Employer or the Engineer shall give notice and particulars to the Contractor. …

The Notice shall be given as soon as practicable after the Employer became aware of the event or circumstances giving rise to the claim. … The particulars shall specify the Clause or other basis of the claim, and shall include substantiation of the amount and/or extension to which the Employer considers himself to be entitled in connection with the Contract.

The Employer shall only be entitled to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this Sub-Clause.”

NHIC alleged that this clause barred any set-off by NIPDC. The arbitrator disagreed, finding that the clause was silent as to whether set-off was permitted against NHIC’s claim for termination losses as distinct from a claim for amounts certified in a Payment Certificate. The arbitrator purported to apply the settled rule under English law (known as the Gilbert Ash line of authority) that “clear words are required to exclude common law rights of set-off and/or abatement of legitimate cross-claims”.

Privy Council Guidance

NIPDC and NHIC appealed the arbitrator’s findings as to clause 2.4 and 2.5 of the Red Book respectively. The appeals proceeded first through the High Court and Court of Appeal in Trinidad and Tobago and ultimately to the Privy Council in the United Kingdom.

The Privy Council endorsed the arbitrator’s view of clause 2.4 and upheld his finding that NIPDC’s failure to provide evidence of Cabinet approval entitled NHIC to terminate the contract. Clause 2.4 required more than evidence merely that the Employer was able to pay or that it was enthusiastic about the project. It required evidence of “positive steps” on the part of the Employer which showed that “financial arrangements” had been made to pay sums due under the Contract. The mere fact that an Employer is wealthy was not of itself sufficient for the purpose of clause 2.4.

In relation to clause 2.5, however, the Privy Council disagreed with the arbitrator finding that the clause was sufficiently clear to apply to all set-offs or cross-claims raised by an Employer, not only those made in respect of Payment Certificates. The court emphasised the concluding words of the clause – “or otherwise claim” – and noted that “the natural effect of the closing part of clause of 2.5 is that, in order to be valid, any claim by an Employer must comply with the first two parts of the clause, and that this extends to, but, in the light of the word ‘otherwise’, is not limited to, set-offs and cross-claims.” NIPDC had therefore lost any entitlement it may otherwise have had to set-off its claims from amounts due to NHIC as a result of the termination of the contract.

Conclusion and Implications

This is an important decision reached by five members of the UK’s highest court (the Privy Council is constituted from members of the Supreme Court) as to the meaning of key Employer obligations under the FIDIC Red Book. The court’s interpretation of clause 2.4 means that wealthy and large institutional Employers will still be required to take positive steps to demonstrate that adequate financial arrangements have been made for payment under the contract. This may result in Contractor’s seeking to make more probing enquiries as to any financial control mechanisms which are required to be fulfilled to allow payment by an Employer. Employers may also need to be vigilant in keeping Contractors informed. In the present case, NIPDC had requested Cabinet approval at the time of termination and the evidence showed that approval was inevitable at that stage. The court noted that NIPDC would have avoided a successful termination by NHIC if it had communicated these facts to NHIC.

The court’s findings as to clause 2.5 will also be of general application to those FIDIC based contracts which retain the clause. In contrast to the Contractor’s obligation to notify claims under clause 20 of the Red book, the court’s decision may be seen as providing a level-playing field for Employer and Contractor claims alike. Indeed, the requirements for Employer claims may on the whole be stricter. Clause 20 provides for a maximum 28 day notification period in addition to the requirement found also in clause 2.5 for notification “as soon as practicable”. However, the present decision confirms that the notification of Employer claims, if they are to be valid for the purposes of set-off or otherwise, are also required to be accompanied by particulars specifying the basis of the claim, the clauses relied upon and substantiation of any amounts claimed. This can be contrasted with the position under clause 20 where more general notifications are often sufficient. For example in Obrascon Huarte lain SA v A-G for Gibraltar, the English Technology and Construction Court upheld a Contractor’s compliance with clause 20 by reference to letters which stated merely that certain events would entitle the Contractor to an extension of time without further substantiation.

Employers would be well advised to take note of the present decision and ensure that any claims arising during the course of a project are promptly notified to the Contractor. The court’s decision does not give guidance as to how the requirement for notifications to be made “as soon as practicable” is to be interpreted in the context of Employer claims. Employers should not assume, however, that the generality of this description means that a period of 28 days or longer will be allowed (to reflect the period in clause 20). Contractors may well seek to argue that briefer periods of notification are required in certain circumstances.

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References: Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974] AC 689; Obrascon Huarte lain SA v Attorney General for Gibraltar [2014] EWHC 1028 (TCC); NH International (Caribbean) Ltd v National Insurance Property Development Company Ltd (Trinidad and Tobago) [2015] UKPC 37