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Claiming contractual breakdown of machinery: An onerous task

When complex payment provisions stop being followed under pressure, can an employer or contractor claim that there has been a “breakdown of machinery”, so the target cost provisions fall away? A recent case says no.

It’s not hard to imagine: a target cost contract, complex payment provisions, the pressure of a big project, and the provisions stop being followed.

What happens then?

Can an employer or a contractor claim that there has been a “breakdown of machinery” and the target cost provisions fall away?

In this latest case, Secretary of State for Defence v Turner Estate Solutions Ltd (2015), the answer was a resounding no. 

The contract

The case concerned design and construction works at Faslane.

The Secretary of State for Defence (SSD) employed Turner Estate Solutions (TES), using a maximum price target cost contract.

The complex payment provisions comprised a target cost which could be adjusted where there were “changes”: open book accounting; milestone payments; a final price payable arising by a pain/gain mechanism comparing actual costs with the target cost; and a maximum price which could be adjusted but not exceeded.

The issue

What happened in practice however, was that the parties stopped implementing the change proposal procedure and therefore the target cost adjustment procedure

That meant, TES said, that when it came to calculating the final price payable, the contractual machinery had broken down.

So the target cost, maximum price and pain/gain mechanism fell away.

Added to that, adjustments of the target cost and the final price payable could not happen after completion of the works so the pain/gain mechanism again became redundant. 

How should the contract operate instead?

Target cost should become cost plus, TES said.

So it claimed its actual costs plus an allowance for profit (which came to almost £70m above the maximum price agreed in the contract), without any restrictions, caps or loss sharing.

Not surprisingly, SSD disagreed.

It said there was nothing in the contract that meant that failing to operate the change procedure resulted in the target cost and final price payable provisions breaking down. 

The decision

The issue came before the Technology and Construction Court, where TES’s arguments did not get far.

The court thought that the arguments ignored parts of the contract.

Replacing the original pain/gain agreement with a cost plus contract changed the whole basis of the bargain between the parties.

It was a “radical position” for TES to take.

After looking at the key principles of interpretation of contracts – business common sense, looking at the context of the document as a whole, leaning towards an interpretation which validates the contract and giving effect to all parts of it where possible – the court sided with SSD.

It found the payment provisions were still in place and that the target cost could still be adjusted in respect of changes.

Plus, that adjustment could continue after completion of the works. 

The conclusion

Claiming a breakdown of contractual machinery is tricky.

In this case the contractor argued a target cost contract should become a cost plus contract, because the provisions were not fully followed.

As the court said, “anyone with any experience of these contracts of this sort knows that, in the scurry and scramble of a major construction project, these kinds of procedures can often fall into disuse”.

But translating that into a breakdown of machinery is, as the court put it, an onerous task.

Jane Fender-Allison is a senior associate at CMS Cameron McKenna

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