In a case that will be closely followed by the
users of LOGIC contracts, the High Court recently decided the
standard to be applied to a contractor’s obligation, upon
notice, to remedy a defect to the “satisfaction of” the
company/employer or risk termination by the company/employer.
The High Court decided that the company/employer
was largely entitled to take a subjective view of what it
considered satisfactory. It did not require the court to carry out
an after the event review of the company/employer’s decision
based on an objective standard of reasonableness. However, the
company/employer must act honestly, in good faith and genuinely. An
arbitrary, capricious, perverse or irrational decision by the
company/employer would amount to a breach of
contract.
Facts
On 26 March 2007, Bluewater entered into a
sub-contract with Mercon for the fabrication of a tower based soft
yoke system (“SYMS”) for installation as part of the
development of the Yuri Korchagain Field in the Caspian Sea.
The termination provisions of the sub-contract
followed those found in certain of the LOGIC model form contracts
and stated:
“30.1 BLUEWATER shall have the right by
giving notice to terminate all or any part of the WORK or the
CONTRACT at such time or times as BLUEWATER may consider necessary
for any or all of the following issues:
(a) To suit the convenience of BLUEWATER
(b) Subject only to Clause 30.2 in the event of any
default on the part of the CONTRACTOR; or
30.2 In the event of a default on the part of the
CONTACTOR and before the issue by BLUEWATER of an order of
termination of all or any part of the WORK of the CONTRACT,
BLUEWATER shall give notice of default to the CONTRACTOR giving the
details of such default. If the CONTRACTOR upon receipt of such
notice does not immediately commence and thereafter continuously
proceed with action satisfactory to BLUEWATER to remedy such
default BLUEWATER may issue a notice of termination in accordance
with the provisions of Clause 30.1.”
Various disputes arose between the parties in
relation to alleged defects and delays. On 23 January 2009
Bluewater served a Notice of Default, which was followed by a
Notice of Termination on 3 February 2009. Mercon claimed that
Bluewater’s Notice of Termination amounted to a repudiatory
breach of contract.
An issue arose as to the standard to be applied
under Clause 30.2 to determine whether or not action taken by
Mercon was satisfactory. Bluewater argued that the words
“action satisfactory to BLUEWATER” meant the subjective
view taken by Bluewater and there was no objective reasonableness
to be imported. It argued that it was not open to the court to
retrospectively superimpose its own view on what Bluewater may or
may not have found to be satisfactory.
Mercon argued that Bluewater’s actions had to
be objectively reasonable, so that it was not a question of the
subjective satisfaction of Bluewater. In this regard, Mercon relied
upon Clause 33.1 of Section 2 (a) of the sub-contract that
provided:
“Both the CONTRACTOR and BLUEWATER shall
uphold the highest standards of business ethics in the performance
of the CONTRACT. Honesty, fairness and integrity shall be paramount
principles in the dealings between the parties.”
It also relied upon an existing Court of Appeal
decision of Socimer International Bank Ltd (in liquidation) v
Standard Bank London Ltd [2008] EWCA Civ 116 to argue that the
exercise of contractual discretion should not be abused and must be
exercised within boundaries of rationality.
Decision
The High Court decided that Clause 30.2 was not one
which is required to be construed by reference to an objective
standard. The Clause did not permit a review, after the event, of
whether the action taken to remedy the defect was or was not
objectively satisfactory. However, there was a limitation on the
ability of Bluewater to come to a decision on whether the action
was satisfactory. That limitation, as expressed in Socimer,
is a limitation by reference to concepts of honesty, good faith,
and genuineness, and the need for the absence of arbitrariness,
capriciousness, perversity and irrationality. The court did not
consider that this limitation depended on the presence of Clause
33.1 of Section 2(a) of the Contract. However, it was consistent
with the inclusion of such clause.
The question of whether the action taken by Mercon
was satisfactory to Bluewater was therefore a matter for the
subjective view of Bluewater, subject to the implied limitation
summarised in Socimer.
On the facts, Bluewater was able to establish that
one, or more, of the grounds relied upon was a situation where
Mercon had failed to remedy a defect to its satisfaction, and that
it was therefore entitled to terminate.
Comment
The decision of the High Court is a useful reminder
that where a contract confers discretion on one party, it will
usually be implicit that the discretion must be exercised honestly
and rationally and for the purpose for which it was
conferred.
Absent, the High Court’s decision that
discretion is limited in the manner identified in Socimer, the
proper issuing of a notice of default would simply amount to an
option to terminate for any reason once the remedy period had
expired. Objectively ascertained, this is unlikely to be the
intention of the parties.
It follows that in terminating contracts, or
exercising other contractual discretion, in the absence of express
wording, parties should keep in mind that discretion is likely to
be fettered.
In drafting contracts, parties should consider
whether they are content that the implied restriction alluded to in
this case is appropriate, or whether express wording of the same,
or a differing, standard should be agreed.
For the full case please click here.