A decision of the Scottish appeal court has confirmed that NEC contracts are not charters for contract breaking - but rather they oblige parties to act in good faith.

This key clarification was required after the decision of the court at first instance in the case of Van Oord UK Limited v Dragados UK Limited in relation to the Aberdeen Harbour Expansion Project had surprisingly allowed a party to benefit from its own breach of contract.

The case is of particular interest because the standard NEC obligation to act in a “spirit of mutual trust and cooperation” has now been given some very real teeth by the court.

First Instance

At first instance, the court had decided that instructions to omit work and transfer it to others were effective instructions notwithstanding that they had been issued in breach of contract.

These “breach instructions” therefore had to be obeyed by the subcontractor and resulted in a reduction of the Prices.

Appeal

The appeal court disagreed. It has decided such “breach instructions” are not effective, need not be obeyed by the subcontractor and do not lead to any reduction in the Prices.

It has also held that there is a legally effective, and practically enforceable, good faith obligation in NEC contracts.

Background: omission and transfer of work in breach of contract

The background to this case is that Van Oord entered into an amended NEC3 Engineering and Construction subcontract Option B, with Dragados, to carry out a defined scope of soft dredging works, at fixed bill rates, in connection with the Aberdeen Harbour Expansion Project.

Unknown to Van Oord, Dragados then proceeded to let around one third of the subcontract work scope to other subcontractors. Dragados then issued various instructions to Van Oord omitting this transferred scope.

This was all despite the fact that there was a contractual amendment only permitting the omission and transfer of work in particular circumstances. Those circumstances had not occurred.

Accordingly, the court of first instance determined that the transfers of work by Dragados were in breach of the subcontract. This was not contested at appeal.

Notwithstanding that all other breaches of contract could not give rise to a reduction in Prices, the effect of the court of first instance’s earlier decision was to treat the “breach instructions” as valid such that the Prices were to be reduced.

The question for the appeal court was whether that could be correct, since that could allow parties to exploit the NEC contract by breaching it with relative impunity.

Appeal Court: Good Faith Obligation

The obligation to act in a “spirit of mutual trust and co-operation” is a well know provision of the NEC suite of contracts. Until now, this provision has not been given very clear and practical legal enforceability.

The Scottish appeal court has now confirmed that it recognises it as an obligation to act in good faith aligning, in this case, with three propositions:

• a contracting party will not in normal circumstances be entitled to take advantage of his own breach as against the other party;
• a subcontractor is not obliged to obey an instruction issued in breach of contract;
• clear language is required to place one contracting party completely at the mercy of the other.

The first of these embodies the mutuality principle: a party cannot enforce a contractual stipulation in its favour, if it is the counterpart of another obligation which it has breached.

The appeal court concluded that the good faith obligation in clause 10.1 and the right to reduce the Prices in clause 63.10 were counterparts of one another.

Practically speaking this meant that, Dragados could not seek a reduction in the Prices unless it had fulfilled its duty to act “in a spirit of mutual trust and co-operation”.

Appeal Court: No Reduction in Prices

In NEC contracts, only certain limited compensation events give rise to a reduction in Prices, including a change to the Subcontract Works Information (clause 63.10) but excluding breaches of contract (clause 63.2).

The appeal court was clear that each “breach instruction” constituted compensation events for breach of contract. The question to be resolved was whether such “breach instructions” could also constitute compensation events for changes to the Subcontract Works Information.

The appeal court was also clear that such “breach instructions” are of no effect in changing the Subcontract Works Information, because they were not consistent with, nor given in accordance with the Subcontract.

Only a “lawful change” to the Subcontract Works Information can reduce the Prices.

This interpretation of the NEC contract’s interlocking terms all makes good sense in that Van Oord was not bound to obey a “breach instruction”. The appeal court gave what it described as a “fanciful example”: Van Oord would have been under no obligation to build a hotel, if Dragados had issued such an instruction.

Practical points:

• If you want a specific right to transfer work to others the contract should expressly provide for this.
• If you want to prevent work being omitted the contract should expressly provide for this.
• Are you clear what the financial consequences of any omission of work will be (e.g. impact on blended rates)?
• Have instructions been issued in accordance with the contract, or in breach of it.
• Where a party fails to act in a spirit of mutual trust and co-operation what other rights under the contract might it not be able to enforce?

It is great news that the NEC contract is not a charter for contract breakers and that the obligation to act in a spirit of mutual trust and co-operation is not merely “an avowal of aspiration” - but rather is a practically enforceable obligation to behave in good faith.

• Chris Mackay, partner, Construction at Burness Paull
• Andrew Little, senior associate, Construction at Burness Paull