Costs due to Negligence or Default: To allow or disallow – that is the question!

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The decision in ABC Electrification v Network Rail provides a useful reminder for contracting parties to ensure that there is a clear allocation of risk at the time the contract is entered into. Failing to do so is likely to result in a bumpy ride. Here’s why.

ABC was a joint venture company appointed by Network Rail to carry out works on the West Coast Power Supply Upgrade Project. The contract incorporated the ICE Conditions of Contract, Target Cost version subject to a set of amendments.  Entitlement to payment was based (in part) on the Total Cost that ABC incurred in carrying out the works, less any “Disallowed Cost”.

In an interim payment assessment, “Disallowed Cost” of c.£13.4million was deducted due to ABC’s breaches in failing to complete the works with due expedition, without delay and by the contractual date for completion. Inevitably a dispute arose between the parties.

Network Rail sought a declaration from the Technology and Construction Court (TCC) as to the interpretation of “Disallowed Cost” which was defined as “cost due to negligence or default on the part of the Contractor in his compliance with any of his obligations under the Contract and/or due to any negligence or default on the part of the Contractor’s employees, agents, sub-contractors or suppliers in their compliance with any of their respective obligations under their contracts with the Contractor”. [emphasis added]

ABC argued that the word “default” had a narrower meaning than contended for by Network Rail, in that it required wilful or deliberate conduct.

The TCC held that the word “default” carried its natural and ordinary meaning, i.e. a failure to fulfil a legal requirement or obligation. ABC appealed on the basis that the Court had given too much attention to the dictionary definition as opposed to the use of the word in context and gave insufficient weight to the consequences of the Court’s interpretation.

ABC argued that, under the unamended ICE Conditions, the contractor is entitled to be paid for work consequent upon a breach of contract, provided that the breach was not negligent. ABC further argued that the contract amendments were not intended to create a “wholesale shift” from this position.

The appeal was dismissed. The Court of Appeal held that the fact that the words “or default” followed the word “negligence” meant that “default” related to the manner or quality of performance, not the actual outcome.  Consequently, the term “Disallowed Cost” included any cost due to a failure by ABC to comply with its obligations under the Contract.

The aim of the Target Cost mechanism is to incentivise the contractor not only to perform but also to control costs. The parties were free to agree cost and risk allocation as they did and the contract made it plain that ABC was intended to bear the risk of its own breach of contract.

Commentary

Over the years, Target Cost contracts have become more popular as Employers have sought to incentivise Contractors to complete projects on time and within budget. Under Target Cost contracts, the contractor is reimbursed his costs (on an actual cost basis) subject to the application of a formula under which the parties share the “gain” of any savings or the “pain” of any overspend.

Therefore, whilst Target Cost contracts are intended to share risk between the parties, the minor amendments in this case substantially (and from ABC’s point of view, unintentionally) shifted the risk from Employer to Contractor.

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Link to the Judgment: Abc Electrification Ltd v Network Rail Infrastructure Ltd [2020] EWCA Civ 1645 (04 December 2020) (bailii.org)