Are you sure that you know the true meaning of all the terms that govern your contractual relationship?
In this blog post we explore the recent decision of the Technology and Construction Court, in Network Rail Infrastructure LTD v ABC Electrification LTD  EWHC 1769 (TCC), which illustrates how important it is for clients and their contractors to define key words in their contracts, or run the risk that the courts will apply a meaning that one of the parties did not intend. In this case the court applied the ordinary and natural meaning resulting in a loss of £13m to the contractor.
The background and the contract
Network Rail (‘NR‘) engaged Costain as contractor under a cost reimbursable contract, the ICE Target Cost Contract, first edition. The contract was subsequently novated so that ABC became the contractor, replacing Costain.
For carrying out the works, in addition to the fee, ABC was to receive its “Total Cost” (essentially all of its costs incurred for the works, less the fee and any “Disallowed Cost”). “Disallowed Cost” was defined in the contract to include costs due to “negligence or default on the part of the Contractor”. Such amounts were disallowed because they were not recoverable by the contractor from the employer.
When the project was in considerable delay with costs escalating (NR’s representative had calculated the value of Disallowed Cost at approximately £13m), NR sought a declaration from the court on the meaning of “Disallowed Cost” and “default”. Unlike “Disallowed Cost”, “default”, was not a defined term in the contract but was included in the definition of “Disallowed Cost”, by NR’s contract amendment.
The contract included a typical gain/pain sharing mechanism, so that:
- if ABC completed the works for less than the Target Cost (the amount the parties had agreed the works would cost when they entered into the contract) there would be an overall saving (or gain) to the project from which both parties would benefit; and
- if the cost of the works exceeded the Target Cost, there would be a loss to the project, to which ABC would have to contribute (the pain).
The Target Cost and the percentage gain/pain share were set out in the contract.
The parties’ view of the meaning of the contract provisions
NR’s view was that “default” was any failure by ABC to fulfil a legal requirement or obligation, and blamed ABC’s lack of due expedition in completing the works (a contractual obligation) as the cause of the delay to completion which resulted in the Disallowed Cost. ABC’s view, on the other hand was that NR’s interpretation could never have been the parties’ intention when they signed the contract, and “default” had a narrower meaning than NR contended.
The judge’s view
The judge explored the true interpretation of the clause which referred to “Disallowed Cost”, in the light of four key factors:
- the meaning of the language used (the judge said it was clear and unambiguous);
- the clause in its contractual context, i.e. as against the background of the contract as a whole (the judge stated that there was no proper basis for concluding that the parties must have intended the word ‘default’ to carry a different meaning from its ordinary and natural meaning);
- the purpose of the contract (the judge stated that the fact that the contract was a target cost contract was irrelevant to its approach to interpretation); and
- commercial common sense (the judge rejected ABC’s argument that, as a matter of commercial common sense and/or commercial reality, the word ‘default’ cannot have been intended to cover any failure by ABC to comply with its contractual obligations, no matter how small and insignificant).
The judge concluded that “Disallowed Cost” did indeed include any cost due to any failure by ABC to comply with its obligations under the contract, accepting Network Rail’s submissions that the word ‘default’ carried its natural and ordinary meaning, commenting that ABC’s position on the meaning of the words changed three times during the proceedings, and this was illustrative of its difficulty in articulating the objective intentions of the parties.
It is clear from this decision how important it is not just for parties to agree on the meaning of key words in their contracts but also to ensure they both understand the overall commercial agreement between them so that possibly unintended consequences do not result if the courts are asked to intervene.
Why did ABC take the position it did? Presumably because the contract was intended to be cost reimbursable, subject to the gain/pain mechanism, i.e. the gain/pain mechanism and the target cost regulates the risk of overspend in the case of failure by the contractor, rather than being a contract where costs incurred by failures by the contractor are simply excluded altogether from the operation of the pain/gain mechanism.