A recent decision by Lord Tyre in the case of Van Oord UK Ltd v Dragados UK Ltd 2020 CSOH 87 provided an interesting discussion of issues relating to the omission of work, breach of contract, Compensation Events and Defined Cost Calculations under the NEC3.

The dispute

Dragados (the defender) was employed by Aberdeen Harbour Board as the main contractor in the Aberdeen Harbour Expansion Project. Dragados subcontracted certain works to Van Oord (the pursuer), an international contractor specialising in dredging works.

The subcontract incorporated the standard form NEC3 Subcontract Conditions, the clauses for main Option B, and the Shorter Schedule of Cost Components (April 2013).

The scope of the subcontract was primarily concerned with soft dredging works. Unknown to Van Oord, Dragados also entered into subcontracts with two other firms for dredging work, meaning that the scope of all three subcontracts overlapped. The defender issued instructions to the pursuer to omit certain works falling within the scope of its subcontract, and transferred the omitted work to one of the other subcontractors.

Two distinct issues were addressed in this case: whether the defender’s transfer of work was a breach of contract and, if so, whether the contract provided that the omission of works should reduce the bill rate payable to the pursuer for the work that it still had to carry out.

Issue one: was there a breach of contract?

The pursuer contended that the transfer of work falling within its subcontract to the other subcontractors was a breach of contract. In making this submission, it relied upon the unreported case of Abbey Developments Ltd v PP Brickwork Ltd [2003] EWHC 1987 (Technology). It submitted that as there was no absolute rule of law prohibiting the transfer of work, the question of whether works could be omitted was one of contractual interpretation.

In this case, the parties had agreed specific circumstances in which work could be omitted. By virtue of Clause 14.3, this was only if the employer had issued a corresponding instruction under the main contract. There was no suggestion that the employer had issued any such instruction and therefore the defender was not entitled to issue its instructions to omit parts of the subcontract works.

In reply, the defender submitted that an instruction of the omission of work was not a breach of contract. This was because NEC3 provided a fair and adequate procedure to compensate a subcontractor for omissions, ensuring that the subcontractor was neither better nor worse off as a result.

Lord Tyre began his analysis by opining that the principles outlined in Abbey Road Developments should be applied to contracts incorporating NEC3 clauses. His Lordship summarised the principles as follows:

  • a contract for the execution of work confers both a duty to carry out this work and a corresponding right to complete this;
  • clear words are required for the employer to be entitled to remove work from the contractor to have it done by somebody else; and
  • the test is whether the clause relied upon by the employer is wide enough to permit the change that was made. There is no principle of law that says in no circumstances work may be omitted. This is a matter of proper contractual interpretation.

Lord Tyre decided that, in this instance, the contract did not give a clear contractual entitlement to omit works and transfer them to another subcontractor, except as allowed in Clause 14.3. Therefore, the omission of work did constitute a breach of contract.

Issue two: should this reduce the bill rate payable to Van Oord?

Having ruled the first issue in favour of the pursuer, Lord Tyre required to decide whether the application of the Compensation Event mechanism in the contract had the effect of reducing the bill rate payable to the pursuer in respect of works that it still had to carry out.

Van Oord submitted that the defender was attempting to rely on the Compensation Event mechanism in a way that was never intended by the parties. It was self-evident that the pursuer would not have agreed to the use of Defined Cost if it had known that a significant proportion of its work would be transferred to another subcontractor. If the Defined Cost calculation applied then it would suffer detriment twice; both losing part of the work and having its bill rate reduced for work that it still had to carry out.

The pursuer also submitted that the Compensation Event mechanism could not apply to instructions issued in breach of contract, as it only applied to instructions issued in accordance with the terms of the subcontract. Further, the instruction ought not to be treated as a change to the Subcontract Works Information.

In response, Dragados submitted that the Compensation Event mechanism was appropriate for all Compensation Events, including breach of contract. The Defined Cost calculation was crucial in achieving a key purpose of the NEC3; putting the subcontractor in the same financial position as if the event had not occurred. On a proper interpretation of the relevant provisions there required to be a reduction in the Prices and this was achieved by reducing the appropriate bill rate.

Lord Tyre accepted the defender’s position. He held that, as a breach of contract was a common Compensation Event, it would be inconsistent to apply different sets of rules to valuations for breaches of contract and other Compensation Events. He also held that the pursuer’s only remedy for the breach of contract was in terms of the Compensation Event mechanism.

Thus, the calculation in Clause 63.1 had to be made. This required a three-stage process. The first was to calculate the Defined Cost of work already carried out, the predicted Defined Cost of work that the pursuer would have had to carry out but for the omission, and the predicted Defined Cost of completing the work remaining after the omission. Secondly, if the effect of the Compensation Event was to reduce the total Defined Cost and the event was a change to the Subcontract Works Information, then the Prices were reduced. Finally, the reduction in the Prices was given effect by calculating a new bill rate, so that the reduction in the Prices would be spread over the work to be done. In this instance, that would have the practical effect of reducing the rate payable for work still to be done but that was a product of operating the agreed mechanism within the contract.

Conclusions

The unreported decision in Abbey Developments is often quoted in support of the position that an employer or contractor is not entitled to omit works so that the omitted works can be passed to another contractor unless there are clear words in the contract allowing this. The decision in Van Oord UK Ltd v Dragados UK Ltd is, however, one of the few authorities to consider the decision and provides a useful analysis of its terms.

The decision also reinforces the importance of the Defined Cost calculation in this form of contract as being the appropriate mechanism to quantify loss, even for events that would typically be regarded as breaches of contract. Lord Tyre clarified that while a reduction in the bill rates may appear to have left Van Oord worse off, properly understood this was a reflection of losses that might have been incurred anyway.

If you require tailored advice on this or another related matter, please contact David Anderson, a Partner in our property and infrastructure disputes team, or your usual Shepherd and Wedderburn contact.

This article was compiled with addition reporting by Rachael Brooks.

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