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Interpreting contractual obligations: A test that’s fit for purpose?

A recent case involving an offshore North Sea wind farm provides guidance as to how fitness-for-purpose obligations will be interpreted.

Important guidance has been obtained on the interpretation of fitness-for-purpose obligations, which will be of relevance to anyone involved in the supply or purchase of goods.

Should such an obligation be assessed by an objective test that requires the court to determine whether the goods will be capable of satisfying their intended purpose, or could a subjective test involving an element of acceptability ever be relevant?

The revised guidance will be particularly welcomed by purchasers of goods, of whatever nature, under contracts where a seller has given a fitness-for-purpose obligation.

Fitness for purpose means that when completed, the goods supplied will be fit for their intended use. This should effectively be guaranteed by the supplier.

This is a high standard to satisfy and higher than an obligation to use reasonable skill and care.

The case

The extent of the fitness-for-purpose obligation came to be considered in Fluor Ltd v Shanghai Zhenhua Heavy Industries Ltd [2016] EWHC 2062 (TCC), another recent case about an offshore wind farm.

Fluor was engaged to engineer, procure and construct the foundations and infrastructure to support 140 wind turbine generators for the Greater Gabbard wind farm in the North Sea. In turn, Fluor signed a €234m contract with Shanghai Zhenhua Heavy Industries Ltd (ZMPC) to fabricate the steel monopiles and transition pieces for the project.

In the contract between them, ZMPC warranted, among other obligations, that the goods supplied would be fit for purpose.

Following delivery by ZMPC of the first three shipments, Fluor carried out tests on the steelwork, which revealed cracks in the welding. Substantial rounds of costly retesting and repairs then followed, which delayed the installation works at sea. The parties subsequently agreed that further testing would not be necessary.

Although Fluor and ZMPC agreed a form of settlement between them, Fluor subsequently sought US$400m in damages.

Fit for purpose?

One of the many issues for consideration by the court in the following litigation was whether the monopiles and transition pieces were fit for purpose upon delivery and, if not, whether that was caused by ZMPC’s breach of contract.

Although the existence of a fitness-for-purpose obligation was not in dispute, the parties disagreed about the effect of that obligation.

Fluor’s case was that the monopiles and transition pieces had to meet the contractual requirements at the time of delivery. The goods had to be delivered in a condition such that a reasonable buyer could install them in the seabed without further examination, and would satisfactorily perform in service for 25 years.

Fluor justified the retesting and repair works not on the basis of non-conformance reports received, but from its own belief that such cracking was unacceptable and should be repaired. In contrast, ZMPC argued that fitness for purpose is an objective test, and therefore the court should determine whether the goods were actually fit for their intended purpose.

Whether or not a buyer thinks the goods are fit for purpose is irrelevant – either they are or they are not. In this regard, ZMPC was mindful that Fluor did not advance any positive case that the goods were not actually capable of serving a 25-year period. The court acknowledged there was no authority on this point.

Providing guidance

The closest relevant authorities considered the extent of a merchantable quality obligation.

In this context, it had been accepted that when considering whether or not goods were of merchantable quality, some knowledge acquired later should be brought in, otherwise it would never be possible to hold that goods were unmerchantable by reason of latent defects (Henry Kendall & Sons v William Lillico & Sons [1969] 2 AC 31).

The monopiles and transition pieces in this case only had one use, so previous case law on the extent of a merchantable quality obligation would be relevant to interpreting the scope of the fitness for purpose warranty.

The court held that where a buyer knows of the true condition of goods but is uncertain as to whether that condition affects that use, a buyer would impose a condition that necessary investigations ought to be carried out before agreeing to purchase them. That would amount to the imposition of a special term, namely the satisfactory outcome of those investigations.

“The guidance will be particularly welcomed by purchasers of goods under contracts with fitness-for-purpose obligations, as it clarifies the extent of a seller’s liability and the basis on which such claims can be brought”

Applying those principles to this case, the result was that ZMPC was liable to Fluor for certain costs of additional testing and repairs to its welding.

This case is important, as it provides guidance as to how fitness-for-purpose obligations will be interpreted. Similar issues can arise on any contracts for the supply of goods, whatever their nature, and so this decision will have relevance wider than the wind farm industry.

Parties can often become aware of the condition of goods on delivery but remain uncertain as to whether such conditions might affect their use.

That guidance will be particularly welcomed by purchasers of goods under contracts with fitness-for-purpose obligations, as it clarifies the extent of a seller’s liability and the basis on which such claims can be brought.

Barry Hembling is a partner in the construction and engineering team at Fladgate

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