Louise Elmes and Tamsin Lim advised ABC Electrification Ltd and discuss the importance of this case and how the sector can learn from it.
The outcome of this appeal is significant for many contractors operating in the railway engineering industry and reinforces the importance of parties ascertaining and defining the true meaning and effect of key terms and understanding the overall commercial agreement before entering into contract.
The appeal concerned the proper construction of a Target Cost Contract based upon the standard Institute of Civil Engineers Conditions of Contract, Target Cost Version, First Edition ("the ICE Conditions") and subject to standard amendments used by Network Rail Infrastructure Limited ("Network Rail"), known as "Network Rail 12" ("the NR 12 Amendments"). Specifically, the appeal concerned the proper interpretation of the word "default" as it appears in the wider definition of the term "Disallowed Cost". The use of the ICE Conditions as amended by the NR 12 Amendments is widespread in the rail sector: it is one of the most widely used forms of contract within Network Rail's suite of contracts.
The contract concerned works to upgrade the power supply to a railway line. ABC is entitled to payment based on the costs of the works carried out; more specifically, the Total Cost, Incentive Payments, the Fee and the Contractor's Share. The Total Cost means all cost excluding Disallowed Cost (and items covered by the Fee). The Total Cost falls to be measured against the Target Cost. Broadly, if the Total Cost is lower than the Target Cost, ABC is entitled to be paid a "gain share"; if the Total Cost is higher than the Target Cost, ABC is required to pay a "pain share".
Network Rail contend that ABC has not completed the contract works in accordance with the contractual timetable and has categorised costs in excess of £13m as Disallowed Cost on the basis that this sum was incurred due to ABC's breaches in failing to complete with due expedition, without delay and by the time for completion, thereby potentially reducing the Total Cost and potential gain share. On a proper construction, Network Rail contended that the word "default" should bear its natural and ordinary meaning and, therefore, that Disallowed Cost includes any cost due to a failure by ABC to comply with its obligations.
ABC contended that, on a proper construction, a cost is only to be treated as a Disallowed Cost if there has been an element of fault on the part of the contractor in the sense of blame or culpability, as opposed to a breach of contract for which there has been no such blame or culpability, potentially preserving the Total Cost and potential gain share.
The Court of Appeal dismissed the appeal and held that the word "default" should bear its natural and ordinary meaning, namely a failure to fulfil an obligation; Disallowed Cost, therefore, includes any cost due to a failure by ABC to comply with its obligations under the Contract.
This decision underscores the importance of both defining key terms and understanding the commercial agreement before entering into contract, otherwise the parties run the risk of a Court imposing an interpretation that one or both parties did not intend: the effect of the NR 12 Amendments in this context changes the nature of the commercial agreement between the parties from that contained in the ICE Conditions. Broadly speaking, the nature of the commercial agreement contained in ICE Conditions is cost reimburseable, subject to the gain / pain mechanism – the Target Cost and gain / pain mechanism regulate the risk of overspend in the case of failure by the contractor; whereas, amended by the NR 12 Amendments, the nature of the commercial agreement is changed to exclude costs incurred by failures by the contractor from the operation of the gain / pain mechanism.
A more detailed analysis of the case and its consequences will follow.
Louise Elmes and Tamsin Lim of Trowers & Hamlins acted for ABC and instructed Marcus Taverner QC and William Webb.
