Omissions, prices and spirit of mutual trust and cooperation: The Van Oord UK Limited v Dragados appeal

In this article, Andrew Croft and Kevin Henderson review the Scottish appellate court decision in Van Oord UK Limited v Dragados UK Limited[1] which considered when an instruction to omit works and give them to others will amount to breach of contract, how an instruction to omit works is assessed under the NEC, and the application of the NEC duty to act “in a spirit of mutual trust and cooperation”.

Background

In May 2018, Dragados UK Limited (‘Dragados’) engaged Van Oord UK Limited (‘Van Oord’) as subcontractors to effect dredging works. The subcontract was based on the standard form NEC3 Engineering and Construction Subcontract (ECS) using Main Option B (Priced Contract with Bill of Quantities).

During the project, Dragados transferred approximately one third of the works to different subcontractors on the basis that they were less-complex parts of the works. Dragados then issued Van Oord with numerous Contractor’s Instructions which omitted certain areas of soft dredging from its works.  These instructions were then followed by a reduction in the rate of the remaining subcontract works via the “compensation event” provisions of ECS. Dragados sought to reduce the rate from £7.48/m³ to £5.82/m³ in June 2019 with a further reduction to £3.80/m³ in September 2019.

Van Oord refused to accept the reductions, arguing that Dragados had breached the subcontract in omitting the works and awarding them to third parties.  Dragados then terminated the subcontract.  Van Oord commenced proceedings against Dragados in the Scottish Court of Session for breach of the subcontract.

Court of Session Outer House Decision

The court found that Dragados had breached the subcontract. However, the ECS compensation event mechanism was held to apply to the valuation of the remaining works, since clause 63.10 allowed the total Defined Cost to be reduced following a change to the Subcontract Works Information. Consequently, the first instance decision significantly reduced the sums payable to Van Oord. Van Oord appealed to the Inner House of the Court of Session.

The Inner House agreed with the court of first instance regarding the breach of contract by Dragados. The issue before the Court was whether the instructions given in breach of the contract could still be a compensation event under clause 60.1(1) and whether Dragados was entitled to reduce the Prices for the remainder of the works, in-turn reducing the sums owed to Van Oord?

The Appeal Decision

The court confirmed that pursuant to ECS clause 63.1, all compensation events are valued equally. However, as clause 63.2 states that a compensation event will not reduce the total Defined Cost “except as stated in the subcontract”, a compensation event which is a breach of contract would not reduce the total Defined Cost.

The court clarified that while clause 63.10 permitted the reduction in Prices when there is a change to the Subcontract Works Information, any instructions made in breach of contract are invalid and cannot alter the Subcontract Works Information as they are inconsistent with the subcontract. As a result, the court held that the correct interpretation of the ECS is that clause 63.10 is only applicable for lawful changes and could not apply in Dragados’ favour.

In coming to these decisions, the Inner House gave consideration to the requirement under clause 10.1 that parties must act “in a spirit of mutual trust and co-operation”. This is similar to a “good faith” obligation which, in this case, was held to be entwined with the notion that a party cannot seek to enforce a contractual term in their favour if it results from it having breached another obligation.

The court stressed that all breaches are to be treated equally under the ECS and that none will have the impact of reducing the Prices. In addition, the court dismissed the suggestion that Van Oord was bound to obey a “breach instruction”.

The Impact of the Decision

The court’s decision cements the need for project parties to ensure that their contracts are drafted in a way that clearly reflects their commercial intentions, regardless of whether the contracts are amended standard forms or bespoke. This includes addressing the impact an instruction to omit will have on the price, and what will happen if the employer instructs an omission of works or services for the purposes of transferring it to a third party.

On the other hand, the instruction to omit works and transfer it to others would have qualified for a compensation event under clause 60.1(1), permitting a reduction to the fee in accordance with clause 63.10, if the ECS had been amended to include an express right for an instruction to omit works or services for the purposes of transferring them to third parties.

Where an ECS does not include an express right to omit works or services in order to transfer them to a third party, any instruction to omit with such intention will be in breach of contract without the ability to rely on clause 63.10 to reduce the fee.

In addition, this decision is a useful reminder that the NEC duty to act “in a spirit of mutual trust and co-operation” is an overarching duty which will be considered when interpreting NEC3 clauses.  The English courts (in Costain Ltd v Tarmac Holdings Ltd[2]) had stated that this duty might prevent a party acting to convince the other into believing certain contractual rights do not exist or would not be relied on and may also include a duty to correct a false assumption obviously made by the other party. The Inner House in this case went further by suggesting that the duty extended to preventing one party from benefiting from its own breach.  It will be interesting to see if the English courses take a similar approach to the Inner House going forwards.

[1]You can read our brief summary on the first instance decision here.

[2] [2017] EWHC 319 (TCC).