The Changing Nature of Risk
This article appeared in Construction Law in August 2006 and was written by Philip Norman, Barrister, Pinsent Masons.
Ignorance of the law is no defence. Someone need not know that his acts or omissions were against the law to constitute a crime; alternatively, that acts/omission which are not initially unlawful, but which later become unlawful and which continue, may result in the commission of a crime.
What has criminal jurisprudence to do with international construction projects? Simply 'Risk'.
In common usage “risk” is the exposure to danger, or the stake which is vulnerable to such danger. It is negative. However, in construction contracts “risk” is not necessarily bad and many contractors welcome it when they think they can control it.
In this sense “risk” conveys a meaning which is no different to “obligation”. Fundamentally, risk requires a party to perform promises; or, more appropriately, to assume the risk of not being able to perform its promises.
Parties attempt to assume risk in a conscious, planned and well organised way. They even plan for unforeseen risks. It is the risks which are not strictly “unforeseen” or "unclear" which result in disputes.
TRADITIONAL CONTRACTS/PROCUREMENT
Most contracts allocate risk in the written agreement. In determining risk, a tribunal construes terms strictly, giving the words used their ordinary meaning. If there is ambiguity, it construes the words used against the person who prepared the written document (contra proferentum). It is only if the words used do not disclose any clear intention, that it admits extrinsic evidence to ascertain the parties’ true intentions.
Tribunals uphold the principle of pacta sunt servanda (contracts must be performed) and if a party made a promise to do something, no matter how difficult it proves to achieve, it must do it. At common law one can contract for the impossible but on so doing one has to deliver, or failing which, be liable in damages.
In Thorn v. The Mayor and Commonality of London [1886], the House of Lords opined that contracting parties should beware of and properly investigate the extent and circumstances of the promises they make, and that responsibility for difficulties in performance is the responsibility of the party who had promised to achieve the work.
The strict application of contractual promises is mitigated by rebus sic stantibus (an understanding that performance is subject to circumstances remaining the same). If there is some later intervening event which impacts upon the contract so that obligations cannot be performed (not merely rendering them more difficult to perform), the parties may be discharged from their obligations.
This principle is labelled “force majeure” in construction contracts, and in these contracts embraces principles of frustration and common mistake in England and US (together with impossibility and impracticability in the US), imprévision in France and Wegfall der Geschäftsgrundlege und Unmöglichkeit in Germany.
No exhaustive list of force majeure events exists, however, war, hostilities, rebellion, terrorism, strikes and natural catastrophes are examples of strict force majeure.
Common mistake 'force majeure' is a more difficult subject. This principle should be contrasted with situations that merely make performance more difficult than initially envisaged. In Bottoms v City of York [1892], Bottoms agreed to construct sewers. Neither party investigated ground conditions prior to the contract being tendered for and awarded, and Bottoms submitted his tender on his assumption of the ground conditions. The ground conditions were not what he expected, making it difficult to construct the sewers as he had planned. Bottoms had to add poling boards and moulds at great expense to complete the works. He claimed an additional payment stating that the additions were a variation. The engineer rejected this, so Bottoms abandoned the work and made a claim in court. The court (confirmed by the Court of Appeal) held that there was no common mistake resulting in a variation.
By contrast, in the US case of Miller v City of Broken Arrow Miller won a contract to lay sewers according to detailed specifications prepared by the City, following investigations of ground conditions. Miller encountered extremely muddy unstable ground and no matter what he did to comply with the specification, it was impossible to do so. The City accepted this and issued a variation to add gravel to stabilise the muddy trench bottom. This however, failed. Miller’s contract was terminated by the City due to insufficient progress and the works were awarded to others – this time with a modified design. Miller successfully claimed for his costs. The court found that it was impossible (not just difficult) for him to build the sewer in accordance with the detailed designs he had been given.
In Mirant Asia-Pacific Construction (Hong Kong) Ltd v. Ove Arup & Partners International Ltd , there was a claim that Ove Arup had not exercised due care and skill when designing foundations for a boiler in a power station. These foundations failed as the ground load bearing capacity was less than envisaged by Ove Arup. Ove Arup had prepared its designs on assumptions of what the load bearing capacity was, but failed to have those assumptions verified and failed to warn Mirant that their design was based on unverified assumptions. Ove Arup unsuccessfully argued that there was no duty under the design agreement for it to verify the ground conditions. The Court of Appeal found:
The designing engineer is responsible for the design, and he should normally see to it that the necessary additional information is conveyed back to him, so that he may judge that it is sufficient for the purpose of his design.”
These cases demonstrate the courts’ reluctance to move away from the contractual agreement, save in the clearest of cases. In that way, the answer as to whose risk it is found in the contract itself.
MOOD FOR CHANGE
In Full Metal Jacket Ltd v. Gowlain Building Group Ltd [2005] , a case which considered the interpretation of a building contract, Lady Justice Arden held:
“16. The courts must keep the principles applying to the interpretation of contract up-to-date like any other branch of law. It may be that in the future the law will develop so that evidence such as subsequent conduct is admissible in interpretation of certain types of contract, or that certain types of subsequent conduct are admissible in interpretation. However, courts have not taken that step…”
When taken, this step will have the effect of reducing the rigours of strictly interpreted contracts. It envisages that the parties' intentions will be evinced by balancing the written agreement with subsequent performance. This acknowledges the reality of many construction projects; parties will produce an all-embracing contract, which is then put away until a disagreement looms.
Other jurisdictions have this approach; in Israel , a tribunal will look at all circumstances at and after the time the contract was made to ascertain the parties’ intentions and obligations.
This can lead to many unforeseen contractual consequences. If the contract is no longer to be treated as the “rulebook” or, is subject to tacit modification/variation by the way parties perform the contracts, a party may assume a risk it did not initially anticipate and for which it may not be prepared. In extreme circumstances, a party's employee (who may not have contracting authority) may vary a contract by the way he thinks it ought to be performed or by being 'helpful' to the other party by assuming one of their obligations simply for convenience's sake.
In international contracts, an individual performing the contracts may behave in accordance with customs he has learned at home, not realising that they may result in a tacit variation of contract. An actual example is where in an Israeli construction contract an employer agreed to pay for the works in Shekels, but the amount to be paid would be indexed partly to a foreign currency and partly to the Israeli RPI. The Main Contractor let the works on a subcontract on a back-to-back basis, but modifying the indexation payment to the Subcontractor to Israeli RPI and two foreign currencies.
During the course of the works the project manager issued interim payment certificates in which he wrongly set out and calculated the proportion of indexation. The Subcontractor allowed this mistake to perpetuate through the course of 18 erroneous certificates. This happened because the time for objecting to the certificates was short and because the Subcontractor expected that the payments would be balanced when the final account was agreed.
Prior to final account, a dispute arose as to the proper indexation to be applied. The Subcontractor relied upon the strict wording of the contract, whereas the Main Contractor argued that the indexation was contained in the unchallenged interim payment certificates. The Subcontractor’s case was not clear cut, by reason of the balancing between actual performance and the strict wording of the contract. In the event the dispute settled.
Of course, if a contract is performed in accordance with the written terms there is no ambiguity in the interpretation of that contract. However, the onus is on the parties to comply strictly with the written contractual words.
CHANGING FACE OF PROCUREMENT
The traditional method of procuring construction is now being challenged by new models of “Relationship Contracting” which seek to change and/or manage the parties' relationship in a different way. It seeks to establish cooperation by establishing mutual benefits or alignment of commercial interests.
It is not too difficult to speculate as to what can go wrong and how the balance of risk might shift in Relationship Contracting, in particular if the tribunal determines obligations by taking performance into account. What happens when the party not contractually responsible for an obligation is in the best position to manage it and, for convenience adopts management? Does it assume the obligation if it mismanages?
'Soft' language such as “good faith”, “best endeavours” and “best for project” are now used in contracts . Few parties stop to consider what these phrases mean, or more significantly, how they are understood by the other party. In Petromecl. v. Petroleo Brasiliera. the Court of Appeal considered a contractual term which provided: “B agrees to negotiate in good faith with P the extra cost referred to in [the Contract]” and held that despite traditional objections, it would be enforceable in this particular case.
Whilst each case turns on its own facts, use of such phrases create risks which cannot be properly or adequately quantified: Is “good faith” defined objectively or subjectively or a mixture of both? Not appreciating a meaning that can be ascribed to “soft” language is not a defence to the obligation it imposes.
Whilst Relationship Contracting is still young, many of the various models presently rest on the platform of traditional procurement methods. For example they still require third party security (e.g. performance bonds and parent company guarantees). Thus whilst the management of projects is altered, fundamentally the same structure remains: two parties make an agreement, with each bearing certain obligations to the other.
SOME CONCLUSIONS
In the same way that ignorance of the law does not afford a defence to a criminal charge, ignorance of contractual obligations does not absolve the party who is responsible, from performing it. The principles set out in Thorn still hold good.
The moving ground is ascertaining what those obligations/risks might be; Especially as tribunals are showing a willingness to accept that the interpretation of the parties’ intentions can be informed by later performance or by “soft” language.
Thus anticipating variations or assumption of obligations at the outset of the contract is made more difficult to quantifying the course of the project.
Philip Norman, LL.B(Hons). Dip.Fr. Dip. I.C.Arb. MCIArb, Barrister is a member of The International Energy and Construction Group of Pinsent Masons in London.
The State Of Israel v. Apropim Housing and Developments, Civil Appeal 4628/93, Supreme Court Decisions 49(2), page 265.
[2005] EWCA Civ 891 (15 July 2005) before Pill, Mance And Longmore LL.J also at [2006] 1 Lloyd’s Rep 121.
Possibly with the exception of Project Alliancing.
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