FIDIC Update: The Employer’s Claim to Liquidated Damages and Performance Security under the Yellow Book

By Camilla de Moraes, K&L Gates, London

The English courts have recently considered a number of cases involving the FIDIC suite of contracts (see here, here, and here for our previous blog posts).  The most recent case of J Murphy & Sons Ltd v Beckton Energy Ltd [2016] EWHC 607 (TCC)arises out of a contract based on FIDIC Conditions of Contract for Plant and Design Build for Electrical and Mechanical Plant and for Building and Engineering Works designed by the Contractor First Edition 1999 (FIDIC Yellow Book) with amendments.

The court was required to consider the relationship between two clauses in the Contract, namely Sub-Clause 2.5 (Employer’s Claims) and Sub-Clause 8.7 (Delay Damages and Bonus) with reference also to Sub-Clause 3.5 (Determinations) and 4.2 (Performance Security).  The issue in dispute was whether determination by the Engineer of the contractor’s liability for liquidated damages was a pre-requisite to recovery of liquidated damages by the Employer.  The court held that the clause entitling the Employer to liquidated damages operated outside of the regime in Sub-Clause 2.5 and therefore the Engineer’s determination was not a pre-requisite to the Employer’s entitlement.  This case also confirms the traditionally held view that obtaining injunctive relief preventing a beneficiary from calling on a performance bond will rarely be possible.

The Contract

The Contract was dated 14 March 2013 and related to the design, procurement, construction, start-up, testing and commissioning of a Combined Heat and Intelligent Power Plant in East London.  It was based on the Yellow Book and the Contractor, Murphy, obtained a Bond pursuant to the requirements of the Contract.

Sub-Clause 2.5 of the Contract provided that:

If the Employer considers himself to be entitled to any payment under any Clause of these Conditions or otherwise in connection with the Contract…the Employer…shall give notice and particulars to the Contractor.  However, notice is not required for payments due under Sub-Clause 4.19 [Electricity, Water and Gas], or for other services requested by the Contractor. (emphasis added)

The particulars shall specify the Clause or other basis of the claim, and shall include substantiation of the amount and/or extension to which the Employer considers himself to be entitled in connection with the Contract.  The Engineer shall then proceed in accordance with Sub-Clause 3.5 [Determinations] to agree or determine i) the amount (if any) which the Employer is entitled to be paid by the Contractor…

…The Employer shall be entitled to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this Sub-Clause.”

Sub-Clause 3.5 provided as follows:

3.5.1 Whenever these Conditions provide that the Employer shall proceed in accordance with this Sub-Clause 3.5 to agree or determine any matter, the Engineer shall consult with each Party in an endeavour to reach agreement.  If agreement is not achieved, the Engineer shall make a fair determination in accordance with the Contract, taking due regard of all relevant circumstances.

…”

Sub-Clause 4.2 of the Contract required the Contractor to obtain an on-demand performance bond in a prescribed form.

Sub-Clause 4.2.5 and 4.2.6 provided:

“4.2.5 The Employer shall give…23 days’ prior written notice to the Contractor of its intention to make a demand under the [Bond] stating the breach the Contractor has committed…

4.2.6 If and to the extent i) the Employer was not entitled to make a claim under the Performance Security and/or ii) amounts recovered under any claim under the Performance Security exceed the entitlements and/or otherwise exceed the losses suffered and recoverable by the Employer under the Contract, the Employer shall be liable for and reimburse the Contractor such excess amounts.”

Sub-Clause 4.2 had been substantially amended by the parties, most importantly by the fact that all reference to agreement or determination under Sub-Clause 2.5 was removed so that there was no requirement for the Contractor’s failure to be a failure to pay an amount either agreed by the Contractor or determined under Sub-Clause 2.5 (as is provided in the un-amended Yellow Book).

The Contract also provided at Sub-Clause 8.7 a clear and fixed regime for the trigger and payment of delay damages, including the amount due and time for payment.

The Facts

The Contractor brought a claim against the Employer for declaratory relief in response to a threatened call on an “on-demand” performance bond by the Employer.  On 25 February 2016, the Employer gave the Contractor 23 days’ written notice of its intention to make a demand under the Bond in respect of its claim for liquidated damages in the sum of £8,274,000.  The Contractor issued a claim in the courts on 9 March 2016 seeking a declaration that until there has been an agreement or determination by the Engineer in accordance with Sub-Clause 3.5 of the amount (if any) which the Employer is entitled to be paid by the Contractor in respect of liquidated damages, the Contractor is not obliged to pay any liquidated damages to the Employer (as such an agreement or determination is a pre-requisite for any entitlement on the part of the Employer).

The Issues

The Judge was required to determine:

  1. As a matter of contractual construction whether or not the Employer is entitled to recover payment of liquidated damages from the Contractor under Sub-Clause 8.7 without agreement or determination by the Engineer of the Employer’s entitlement to liquidated damages under Sub-Clauses 2.5 and 3.5; and
  2. Whether or not, if the Contractor succeeds on the first issue, a call by the Employer on the Bond would be fraudulent and, if so, whether injunctive relief preventing such a call should be issued.

The Decision

The judge held that whilst Sub-Clause 2.5 is widely drafted and applies to “any” payment in respect of the contract, the right to liquidated damages under Sub-Clause 8.7 was not subject to the mechanism set out in Sub-Clauses 2.5 and 3.5.  Sub-Clause 8.7 set out a self-contained regime for the trigger and payment of delay damages and the obligation to pay contained therein was unqualified.  The key reasons for the decision were as follows:

  1. It was clear that there were substantive inconsistencies between Sub-Clause 2.5 and 8.7.4. The judge found that they could all be resolved by construing Sub-Clause 8.7 as an independent regime.
  2. The amount due and the time for deduction or payment were clearly fixed in Sub-Clause 8.7.1. If the payment of damages were to be subject to Sub-Clause 2.5, then the provisions relating to both the sum and the time for payment provided in Sub-Clause 8.7 could not apply.
  3. The parties had chosen to agree a different clause 8.7.4 from the standard wording and one which excluded any reference to Sub-Clause 2.5.

Therefore, the judge concluded that the Employer was entitled to recover payment of liquidated damages from the Contractor under Sub-Clause 8.7 without agreement or determination by the Engineer of the Employer’s entitlement under Sub-Clauses 2.5 and 3.5.

A decision on the second issue was not necessary given the judge’s conclusion on the first issue.  However, she found that:

  1. As the bond was a conventional “on-demand” bond, there was no requirement for any proof of the validity of the Contractor’s claim, let alone an inquiry into its correctness. If it was later established that the Employer had incorrectly made a call under the bond, then it was contractually required to account to the Contractor for any excess sums claimed;
  2. The parties had expressly rejected the standard Yellow Book form of wording that restricted the employer’s right to call on the bond only when the engineer had made a determination; and
  3. The trigger for a performance bond was belief on the part of the party making the call in its entitlement, not such entitlement having been subject to a final determination giving rise to a payment obligation.

Accordingly, even in the absence of agreement or determination by the Engineer, the Employer’s actions were not fraudulent.

Practical considerations

Whilst this judgment provides useful guidance (and highlights some of the difficulties) in respect of the relationship between Sub-Clause 2.5 and Sub-Clause 8.7, it is important to remember that Sub-Clause 8.7 had been amended from the standard form of FIDIC Yellow Book and the same conclusions cannot be drawn in respect of every contract.  The case therefore does serve as a useful reminder to be mindful when making amendments to standard form contracts as inferences may well be drawn from the bespoke changes.

The case also re-confirms the view that obtaining injunctive relief preventing a beneficiary from calling on a performance bond will rarely be possible, and that where there is a claim of fraud, an injunction will only be granted if it is seriously arguable that the beneficiary could not honestly have believed in the validity of its claim.

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