The valuation of omissions under the NEC – appellate guidance 

United Kingdom

A recent Scottish appeal decision has considered the valuation of omissions under an NEC3 contract. Reversing the original decision at first instance, the decision finds that the right to reduce the Prices for the remaining work depends on the omission being validly instructed and also on compliance with the obligation of mutual trust and cooperation. This is the first time a court has considered such matters under the NEC form and also the first time the obligation of mutual trust and cooperation has been held to qualify other express terms.

Van Oord UK Limited v Dragados UK Limited: a recap

Dragados was the main contractor on the Aberdeen Harbour Expansion Project. Van Oord was subcontracted to carry out dredging works. The contract between the parties was an NEC3 Engineering and Construction Subcontract (April 2013 edition) with bespoke amendments, with main Option B (priced contract with bill of quantities).

The subcontract provided that a change to the Subcontract Works Information was a compensation event under clause 60.1(1) of the compensation event provisions. A compensation event is assessed as the effect on the Defined Costs of carrying out the works and the resulting Fee (discussed further below). Main Option B provides at clause 63.10 that if the effect of a “change to the Subcontract Works Information” is to reduce the total Defined Cost, the Prices can be reduced – but they are not otherwise to be reduced (per clause 63.2). The change in Prices is then reflected in the Bill of Quantities in the form of a changed rate, a changed quantity or a changed lump sum.

This approach is unlike a traditional Bill of Quantities contract, in that the Bill of Quantities is not used to evaluate variations but change in Defined Cost, based on actual past costs and forecast future costs, is used instead. The principle underpinning this approach is to ensure that both parties are no better or worse off as a result of a compensation event.

Van Oord commenced proceedings in the Scottish Court of Session claiming that Dragados had omitted works from its subcontract and transferred those works to others in breach of the subcontract. Dragados denied any breach of contract, but also argued that even if its instruction to omit works was in breach, it was nevertheless effective to reduce the scope of the work and the consequences of that reduction were to be valued under the compensation event provisions of the subcontract. In the circumstances of this case, Dragados argued that those provisions required the bill of quantities to be reduced to reflect the work omitted and also a reduction to be made to the bill rates for the remaining items of work. That was because the omitted work was said to have been under-priced by Van Oord by comparison to the rates quoted in the Shorter Schedule of Cost Components (used to assess Defined Cost), meaning the reduction in Defined Cost exceeded the value of the relevant work in the Bill of Quantities.

The Outer House partially resolved the question of breach in favour of Van Oord, except for factual allegations that Van Oord agreed to and/or acquiesced in the omission of the works, which remain live issues to be determined at proof (trial). In particular, Dragados claimed that Van Oord had refused to carry out certain parts of the works which were to be omitted and that it co-operated with and facilitated transfer of the relevant works to the new contract. However, on the valuation question, the Outer House found in favour of Dragados. The court agreed that, even assuming a breach of contract, the instruction to omit works had still changed the Subcontract Works Information as Van Oord would no longer carry out the omitted works. The Outer House therefore agreed that the compensation event provisions should be applied as normal and that the Prices should be reduced under clause 63.10 as submitted by Dragados.

For a more detailed summary of the Outer House decision, please see our earlier Law-Now here.

Appeal decision

The appeal to the Inner House proceeded on the same assumption as to breach as in the Outer House i.e. that the instruction to omit works had been in breach of contract, albeit that this has yet to be determined as a matter of fact. On this assumption, the Inner House reversed the Outer House decision and found in favour of Van Oord, holding that if Dragados had acted in breach, a breach of contract could not give rise to a reduction in Prices, even if the effect of the compensation event was to reduce the total Defined Cost. The words “a change to the Subcontract Works Information” in clause 63.10 could only apply to a lawful change. In the Inner Court’s judgment, the clause:

“excludes instructions issued in breach of contract. They are invalid, because they are not given “in accordance with this subcontract” (see clauses 14.3 and 27.3). The natural synonym for “in accordance with” is “consistent with”. A breach is plainly inconsistent with the contract.”

Mutual trust and cooperation

The Inner House also concluded that a party’s entitlement to seek a reduction of the Prices under Clause 63.10 depended on whether it had acted in a spirit of mutual trust and cooperation, in accordance with clause 10.1 of the subcontract. In the court’s view, clause 10.1 was not “merely an avowal of aspiration” but “reflects and reinforces the general principle of good faith in contract”. Citing the doctrine of mutuality, the court considered clauses 10.1 and 63.10 were “counterparts” such that the rights under clause 63.10 were to be dependent on compliance with clause 10.1. Whether there had been any breach of clause 10.1 was a question of fact which was not before the court.

In support of its conclusions as to clause 10.1 the court cited McBryde’s authoritative textbook, The Law of Contract in Scotland; however that text only considers examples of where the concept of a duty of good faith has played a role in Scottish cases, and stops short of asserting a general duty of good faith in contract. Indeed, such a duty was expressly disavowed by the Inner House in Sipp Pension Trustees v Insight Travel Services Limited, with the court noting that “parties enter into contracts for their respective benefit … there is no general rule that a contract requires to be fair”. The court also cited three general propositions from English law cases as supporting the rule in clause 10.1, including the rule that a party will not normally be able to take advantage of its own breach of contract. However, these three rules concern either implied terms or rules of contractual interpretation and do not involve a general duty of good faith.

Conclusion

The two issues considered by this decision are of significant importance to those involved in construction contracts let under the NEC form. The court’s finding that an omission of work which is subsequently found to be in breach of contract will be invalid raises a number of practical issues. In such cases the parties will often have “moved on” by the time of any court decision and, practically speaking, there will be little opportunity for the contractor or sub-contractor to carry out the work which is found to have been omitted in breach of contract.

The court’s comments as to the obligation of mutual trust and cooperation under clause 10.1 are potentially of very broad application. The court’s reasoning may lead parties to argue that other clauses are also “counterparts” to clause 10.1 and are to be conditioned upon a party’s adherence to the obligation of mutual trust and cooperation. Such an approach is at odds with that taken in England. For example, the English Court of Appeal in Mid Essex Hospital Services NHS Trust v Compass Group commented on the relationship between general good faith clauses and other specific contractual provisions as follows (per Beatson LJ):

The contract in the present case is a detailed one which makes specific provision for a number of particular eventualities. … In a situation where a contract makes such specific provision, in my judgment care must be taken not to construe a general and potentially open-ended obligation such as an obligation to “co-operate” or “to act in good faith” as covering the same ground as other, more specific, provisions, lest it cut across those more specific provisions and any limitations in them.”

Also of note is the Inner House’s suggestion that a principle of good faith may exist generally in the law of contract in Scotland. As noted above, this principle is by no means clear from previous cases and the court’s suggestion is likely to be relied upon by parties in future cases.

References:

Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd [2013] EWCA Civ 200

Sipp Pension Trustees v Insight Travel Services Limited [2015] CSIH 91

Van Oord UK Limited v Dragados UK Limited [2021] ScotCS CSIH 50