The Technology and Construction Court has handed down judgment in a recent case involving a dispute between a contractor and sub-contractor following termination of the sub-contract. This is a long and detailed judgment in which the Court considered a number of areas. This note will focus on two of these:
Lukoil employed Bluewater Energy Services BV (“Bluewater”) to design, construct and install a soft yoke mooring system (“SYMS”) for use at an oil field in the Caspian Sea. Bluewater engaged Mercon Steel Structures BV (“Mercon”) under a sub-contract on 26 March 2007 to fabricate the SYMS for installation. Mercon also sub-contracted parts of the work to a number of companies including Astrakhan Shipbuilding Production Association LLC (“ASPO”). The parts for the SYMS were produced and then shipped to ASPO in Astrakhan.
From the middle of 2008, there were delays in the transportation of components to Astrakhan and in the release of components or equipment through the Russian customs processes. There were issues between the parties as to the scope of the work which had to be completed by Mercon and also the extent to which it was possible to carry out certain work in the winter conditions in January 2009. On 23 January 2009 Bluewater served a Notice of Default followed by a Notice of Termination (both as defined under the contract) on 3 February 2009.
Bluewater claimed that by 23 January 2009 Mercon was in default and that Bluewater was properly entitled to serve the Notice of Default on that date. It claimed that Mercon did not then take the necessary action to remedy the default and therefore Bluewater contended that it was entitled to terminate the Contract on 3 February 2009 under Clause 30 of the Contract (below).
Clause 30.2:
“In the event of a default on the part of the CONTRACTOR and before the issue by BLUEWATER of an order of termination of all or any part of the WORK of the CONTRACT, BLUEWATER shall give notice of default to the CONTRACTOR giving the details of such default. If the CONTRACTOR upon receipt of such notice does not immediately commence and thereafter continuously proceed with action satisfactory to BLUEWATER to remedy such default BLUEWATER may issue a notice of termination…” [EMPHASIS ADDED]
In turn, Mercon claimed that the purported termination was in fact a repudiatory breach of contract by Bluewater which was accepted by Mercon on 24 February 2009 and the Contract was terminated at this point. It also contended that, in any event, the action it had taken following receipt of the Notice of Default (it sent to Bluewater on 30 January 2009 a programme showing that the necessary work would be carried out between 10 February 2009 and 5 March 2009) was a satisfactory response to the Notice of Default so that Bluewater was not entitled to terminate the Contract on 3 February 2009.
Bluewater submitted that the response by Mercon to the Notice of Default merely to produce a programme was an unsatisfactory response and that, in particular, under Clause 30.2 of the Contract it was a matter for Bluewater to determine whether the response was satisfactory. Bluewater claimed that it was therefore entitled to terminate the Contract.
The Technology and Construction Court had to consider the standard to be applied under Clause 30.2 to determine whether or not the action taken by Mercon was satisfactory, i.e. whether the phrase “action satisfactory to BLUEWATER” depends entirely on the subjective view taken by Bluewater or whether the action satisfactory to Bluewater had to be objectively reasonable.
The Court held that the phrase in Clause 30.2 did not permit for a review after the event of whether the action was or was not objectively satisfactory. However, it held that Bluewater did not have complete discretion and there was a limitation on the ability of Bluewater to come to a decision as a decision maker.
The Court applied the judgment of the Court of Appeal in Socimer International Bank Ltd (in liquidation) v Standard Bank London Ltd [2008] EWCA Civ 116 where it was considered that in the situation where a contract puts decision making entirely in the hands of one party (in the case of Socimer this decision was the valuation of assets) there is a concern that the discretion should not be abused. Therefore, the decision maker is not required to be objectively reasonable but there are some limitations on its discretion in line with Wednesbury –type irrationality. The decision is still to be that of the decision-maker and not of the Court and the Court could not assess whether Bluewater had acted reasonably.
The Court considered that the limitation on decision-making should be “by reference to concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality”. The Court could therefore consider this, but could not make a decision on the reasonableness of Bluewater’s decision.
On the facts it was held by the Court that Bluewater had been entitled to terminate the contract.
The contract between Bluewater and Mercon contained provision that Mercon were not to change its key personnel without the prior approval of Bluewater and if they did make a replacement Mercon would pay liquidated damages, unless otherwise agreed with Bluewater. The rate of the liquidated damages ranged from EUR20,000 to EUR50,000 per person.
Mercon submitted that the liquidated damages were in fact a penalty, rather than a genuine pre-estimate of loss, and therefore irrecoverable.
The Court stated that the finding that an agreed liquidated damage constituted a penalty was an interference with the freedom to contract. The burden was therefore upon Mercon to show that the sum was a penalty and must do so objectively in the context of the position when the contract was made.
The Court examined the circumstances in which the measure of liquidated damages had been agreed between the parties. It considered that the key personnel were integral to the successful performance of the contract and it was therefore important that Bluewater were able to approve, or otherwise, replacements as the project could be seriously disrupted if an unsuitable person were brought in.
The Court acknowledged that it was not always possible to put a precise figure on such potential loss but in this case the liquidated damages were nevertheless a genuine pre-estimate of loss, having been assessed by people experienced in the field of work.
It considered that the sums involved were not “extravagant or exorbitant” and were not viewed by Mercon as penalties at the time they sought to replace key personnel.
It was therefore held that Mercon had not “come close to demonstrating that these sums were penalties” and that on the facts Bluewater were entitled to liquidated damages for three of the four personnel in respect of which the claim was made.
This case provides useful confirmation of circumstances in which it is permissible to terminate a contract and confirms the long-standing principle that the courts are very reluctant to override liquidated damages provisions agreed between the parties.