Arguing alternatives to an agreed contract must make commercial common sense

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The Technology and Construction Court (TCC) has confirmed in the case of Secretary of State for Defence v Turner Estate Solutions [2015] EWHC 1150 (TCC) that it will interpret unclear contractual obligations using ‘business common sense’.

This case involved a Maximum Price Target Cost contract which included a mechanism for sharing costs over-runs or under-runs commonly known as a ‘pain/gain’ mechanism. At some point whilst the works under the contract were ongoing, the parties stopped implementing the adjustment process under the pain/gain mechanism.

Following completion of the works, Turner Estate Solutions’ (TES) actual costs far outstripped any likely Maximum Price under the contract.

TES argued that the parties’ failure to follow the adjustment process under the contract meant that the entire pain/gain mechanism in the contract could be ignored, and instead TES would be entitled to their actual costs and an allowance for profit, without any restrictions, caps, or loss sharing.

The Secretary of State for Defence (SSD) argued that the contractual provisions still applied despite the fact that the parties had not always followed them.

The TCC held that TES’ argument was a radical position to adopt because it changed in a fundamental way the whole basis of the bargain between the parties, replacing the original pain/gain agreement with the cost-plus contract. The Court felt it would be a very odd thing if a procedural failure suddenly meant that the commercial bargain between the parties had been fundamentally altered.

For this reason, the TCC concluded that TES’ arguments flouted business common sense.

In reaching this view, the TCC was persuaded by hypothetical examples put forward by SSD, which illustrated the potentially odd consequences of what TES argued should be the correct construction of the contract. For example, a failure to follow the change proposal procedure just once over a five-year period would change the contract from a carefully calibrated arrangement whereby cost over-runs and under-runs were shared between the parties, to a simple, straight-forward cost plus contract. This could not have been the intention of the parties.

The TCC referred to the leading case on the modern approach to the construction of contracts: Rainy Sky SA v Kookmin Bank [2011] UKSC 50: [2011] 1 WLR 2900, which held that the Court must consider the language used in a contract and ascertain what a reasonable person, that is a person who has all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract, would have understood the parties to have meant. If there are two possible constructions of a contract, the Court is entitled to prefer the construction which is consistent with business common sense and to reject the other.

The TCC also referred to the case of Barclays Bank PLC v HHY Luxembourg SARL [2010] EWCA Civ 1248 in which the Court said, if a clause is capable of two meanings, it is quite possible that neither meaning will flout common sense. In such circumstances, it is much more appropriate to adopt the more, rather than the less, commercial construction.

This case is a reminder of the need for clear drafting of contractual provisions, and for parties to operate the provisions of the contract whilst the works are ongoing. Two expensive sets of arbitration proceedings and proceedings in the TCC could have been avoided if the parties had followed the terms of the contract from the outset.

However, it is inevitable that disputes will sometimes arise over the correct interpretation of a contract. A party wishing to obtain the Court’s approval of a certain interpretation will be assisted by hypothetical examples illustrating how the proposed interpretation of the clause would work in practice, and by demonstrating that the interpretation put forward makes sense commercially.