Assignment of sub-contracts on termination: contractors beware 

A recent TCC decision has considered the effect of provisions which require contractors to assign sub-contracts on termination for default by an employer. The court’s decision meant that the contractor in this case had no recourse to sub-contractors in respect of claims from the employer following termination and was limited in the respects in which it could seek contribution under the Contribution Act. Similar assignment provisions appear in the JCT, NEC and FIDIC forms of contract, making the court’s findings of broad application.

Assignments on termination: an introduction

Construction contracts commonly provide for the assignment of sub-contracts to an employer upon termination for contractor default. All of the major standard forms include such rights. For example, the JCT Design & Build 2016 edition states at clause 8.7.2.3 that the Contractor shall:

“if so required by the Employer within 14 days of termination, assign (so far as assignable and so far as he may lawfully be required to do so) to the Employer, without charge, the benefit of any agreement for the supply of materials or goods and/or for the execution of any work for the purposes of the Contract”.

Similarly, the NEC4 ECC states at clause 92.2, P2:

“The Client may instruct the Contractor to leave the Site, remove any Equipment, Plant and Materials from the Site and assign the benefit of any subcontract or other contract related to performance of the contract to the Client”.

The position under the FIDIC forms is similar, although rather than conferring an absolute right to instruct assignments, the Contractor need only comply with “reasonable instructions … given by the Employer … for the assignment of any subcontract” (see, for example, Clause 15.2.3 of the Yellow Book, 2017 Edition).

Despite the ubiquity of such provisions, their scope and operation has rarely been tested. A particular point of ambiguity concerns how the contractor’s legal relationship with its sub-contractors is affected by such assignments. Having terminated for default, the employer will typically make large claims against the Contractor for the cost of completing the works, delay and other termination losses. A contractor would usually seek to pass such claims onto its supply chain where possible, but what of the assignments made to the employer? May the contractor still pass on liabilities under sub-contracts which have been assigned to the employer?

If the contractor is unable to pass on such liabilities, its exposure to employer claims may be much greater than expected. That was the position which befell a contractor in recent TCC proceedings discussed below.

Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd

In 2015 Energy Works (Hull) Ltd (“EWHL”) appointed MW High Tech Projects UK Ltd (“MW”) as its main contractor for the design, procurement, construction, commissioning and testing of a waste to energy plant in the north of England. In turn, MW subcontracted certain elements of the project to Outotec (USA) Inc (“Outotec”).

The project ran into difficulty, suffering significant delays, and EWHL purported to terminate MW’s contract for a “contractor default” being that the delays to completion of the works (including works to remedy defects) were such that the delay damages exceeded the contractual cap on delay damages for which MW could be liable.

MW argued that it was entitled to additional time for completion and that EWHL was not entitled to terminate for breach, and that the termination took effect as one for convenience. However, a consequence of the termination was that MW was required to assign its subcontract with Outotec, which it duly did by way of notice.

MW sought to pass on to Outotec any liability it might be found to have to EWHL. Outotec objected on the basis that its contract with MW had been assigned to EWHL. In response, MW argued that (i) the assignment of the subcontract was an assignment of future rights only (and not past or accrued rights) or (ii) alternatively that if past and accrued rights were assigned, MW could claim a contribution from Outotec under the Civil Liability (Contribution) Act 1978 (the “Contribution Act”).

Assignment

In considering whether both accrued and future rights had been assigned, the TCC emphasised the use of the expression “assign the subcontract” and followed previous caselaw which had taken that term to mean the assignment of accrued and future rights. The court noted that whilst it would be possible to limit an assignment to future rights only, clear words would be required in order to do so.

As to MW’s argument that it would be an “implausible and uncommercial interpretation” to find that the contractual intention was for MW to lose its right to sue Outotec, the TCC disagreed and remarked that this was simply the assumption of a commercial risk by MW, and an extension to the risk that it might lose or limit its right to sue Outotec for other reasons, such as Outotec’s insolvency or as a result of a contractual limit of liability.

Contribution

Having divested itself of any direct rights to claim against Outotec, MW sought contribution from Outotec in respect of its liability to EWHL. Claims for contribution may be made under the Contribution Act where two parties are liable for the “same damage” suffered by a third party. The third party is able to claim in full against either of the wrongdoers, who will then be entitled to “contribution” from the other on a just and equitable basis having regard to the extent of each party’s responsibility for the damage. Contribution claims are often bought in construction disputes between designers and contractors in relation to allegations of defective work caused both by design and workmanship issues.

Outotec resisted MW’s claim for contribution on the basis that any damage caused by breaches of its sub-contract were suffered at the sub-contract level and were distinct from the damage suffered by EWHL under the main contract. MW claimed that defects in Outotec’s work under the Subcontract were the cause of delay under the main contract for which EWHL had terminated and were accordingly for the “same damage” as that suffered under the main contract.

The court came to different conclusions on this issue for different heads of claim:

• In relation to delay damages claimed by EWHL, the court found the answer depended on the extent to which the periods of delay overlapped under the main contract and sub-contract. Overlapping periods of delay would be for the “same damage” whereas distinct periods would not – they would concern “the same type of harm but not the same harm”.
• The termination losses claimed by EWHL (i.e. additional costs of completion) were held not to be the “same damage” as any liability Outotec may have under the sub-contract. Outotec had no obligation to satisfy MW’s time obligations under the main contract and there was therefore no route by which EWHL as assignee of the sub-contract could claim the additional costs of completion from Outotec.
• EWHL’s claim for defects against MW was held to represent the “same damage” as the parallel claim it had as assignee under the sub-contract. Although the claims arose at different contractual tiers, they related to the same damage or harm i.e. a defective plant.

Conclusions and implications

This is a significant decision which is likely to be of wide application. As noted above, provisions requiring the assignment of sub-contracts on termination for default are common within the industry and it is difficult to distinguish the wording used in the JCT and NEC forms from that considered by the court in this case. The decision may be less easily applied to the FIDIC form, given the presence of a reasonableness requirement: it might be argued, for example, that the distinction advanced by MW in the present case between the assignment of future rights of performance and accrued rights represents a reasonable balance between the interests of the employer in securing future performance of sub-contractors post-termination and the interests of the main contractor in preserving rights against its supply chain in respect of the employer’s termination.

The court’s findings as to contribution are complex and pose a number of issues for consideration in future cases. For example, the importance given to overlapping of periods of delay under the main contract and sub-contract is not articulated in any detail by the court. There is also little analysis of the employer’s position and whether its claims under the main contract and sub-contract could be cumulative in certain circumstances. For example, at least part of the delay claims under both contracts in this case were liquidated. MW’s assignment to EWHL of this claim under the sub-contract appears to be a simple assignment of a debt, which might be thought to be recoverable by EWHL in addition to the liquidated damages payable by MW under the main contract. Such a conclusion, however, is difficult to reconcile with the court’s analysis of MW’s rights under the Contribution Act.

What is clear from the decision is that assignment provisions such as those considered in this case represent a significant exposure to main contractors in the event of a termination for default. Such parties may wish to consider amendments allowing for the assignment of future rights only, or to adopt the FIDIC position of allowing the employer to instruct only such as assignments as are reasonable.

The decision may also lead to an increase in non-assignment clauses being included in sub-contracts. Such provisions effectively put the assignment of the sub-contract out of the contractor’s reach and may avoid the position which the contractor faced in the present case. Whether contractors will be at liberty to propose such restrictions themselves will depend on the terms of the applicable main contract, as some will require the contractor to ensure the assignability of sub-contracts where possible.

References:

Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd [2020] EWHC 2537 (TCC).