The importance of clarity in contract terms

JuLi Lau, Sharpe Pritchard

Juli Lau, associate in the procurement team at Sharpe Pritchard, explores Portsmouth City Council v Ensign Highways Ltd [2015] EWHC 1969 (TCC) (14 July 2015) and explains why it provides a reminder that a written agreement is just that, and that the courts take a strict approach when interpreting ambiguous provisions.

Background

Portsmouth City Council and Ensign Highways Ltd agreed a 25-year PFI contract for the financing and provision of routine maintenance of Portsmouth’s highway network.

The contract contained a mechanism which allowed the council to award service points against ‘default events’. Schedule 17 set out in respect of each default event a maximum event value. Between the start of the contract in July 2004 and December 2013, this appeared to be treated by both parties as the upper limit of a range of points which could be awarded against each default.

Clause 24 dealt with service points. Upon the council becoming aware of a breach by Ensign, it was entitled to serve a notice to remedy within a stated period. Failure to remedy would allow the council to award service points “calculated” by reference to Schedule 17.

Clause 44 of the contract related primarily to the council’s best value duty. Clause 44.4.1 required the parties to deal fairly, in good faith and in mutual co-operation with one another.

In December 2013, a consultant looked at the commercial aspects of the contract on behalf of Portsmouth, and the council began taking a harsher approach with Ensign, including awarding the maximum event value for every default.

In February 2015, an expert was appointed who determined that the council had acted in bad faith without mutual co-operation and unfairly in its use of the service points.

The council then brought proceedings seeking the court’s declarations on various terms of the contract.

Interpreting ‘maximum event value’

Edwards-Stuart J adopted the approach taken in Rainy Sky v Kookmin Bank [2011] 1 WLR 2900 at [21] in interpreting the service points mechanism in the contract:

“It does not in my view make commercial sense to have a system which requires the authority to impose the same number of points irrespective of the gravity or duration of the breach. In the absence of any specific indications to the contrary, one would expect the parties to have agreed a system that provided or permitted some flexibility in relation to the number of points to be awarded for any particular breach.”

He disagreed with the council’s interpretation of the maximum event values and found instead that these were maximum (in accordance with the natural meaning of the word) values rather than fixed tariffs.

Does Clause 44.4.1 impose a duty of good faith on the council in relation to the service points?

The judge found a number of reasons why Clause 44.4.1 does not apply to the rest of the contract:

  • nothing indicated that Clause 44.4.1 was intended to apply more widely than solely to Clause 44;
  • a number of other clauses imposed obligations of good faith in relation to specific activities, suggesting that the parties had considered the specific situations in which good faith was necessary and did not intend to have an overarching duty of good faith; and
  • no other clause required the implication of a duty of good faith in order to make it work.

He quoted the following part of the judgment in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (t/a Medirest) [2013] EWHC Civ 200:

“… care must be taken not to construe a general and potentially open-ended obligation such as an obligation to ‘co-operate’ or ‘to act in good faith’ as covering the same ground as other, more specific provisions, lest it cut across those more specific provisions and any limitations in them.”

He further explained that the service points did not require cooperation from either party in order to work. The rights afforded to Portsmouth upon being aware of a breach by Ensign arose automatically under the contract, whether notified by Ensign or not. Therefore he disagreed with Ensign’s argument that the duty of good faith in Clause 44.4.1 applied to the service points regime.

Is the council subject to an implied duty of good faith?

Both parties were agreed that if the court decided that Clause 44.4.1 did not apply to the service points, there had to be a term implied into Clause 24 governing the manner in which points could be awarded. The Judge followed the approach in Mid Essex, and declared the following to be the implied term:

‘When assessing the number of Service Points to be awarded under clause 24.2.1(c) of the Agreement, PCC’s Representative is to act honestly and on proper grounds and not in a manner that is arbitrary, irrational or capricious.’

Implications

Commercial common sense
This case was heard a few days before judgment was given in Arnold v Britton and others [2015] UKSC 36, which also discussed the use of commercial common sense in interpreting contracts. In particular, Lord Neuberger drew some important principles from the case authorities:

  • it is important not to undervalue the language of the contract provision which is to be construed, since this is most likely to identify what the parties meant;
  • the less clear the drafting, the more ready the court will be to depart from its natural meaning;
  • commercial common sense is not to be invoked retrospectively, even if the provision has led to disastrous consequences for the parties;
  • it is not for the court to interpret a contract in such a way as to assist an unwise party or to penalise an astute party; and
  • where an event subsequently occurs which was plainly not contemplated by the parties, judging from the language of the contract, the court will give effect to the parties’ deemed intention.

In interpreting Clause 24, Edward-Stuarts J seemed to use commercial common sense as his starting point, as per Rainy Sky. However, he accepted that Clause 24:

“… is not happily drafted, but I consider that it can be construed in this way without doing any violence to its language and thereby be given a meaning that accords with commercial common sense and what I consider to have been the true intention of the parties.”

His approach was therefore not at odds with the caution advised by Lord Neuberger in adopting a commercial common sense approach. It serves as a reminder to contracting parties to ensure that any service credit regimes (and other complex contractual mechanisms) are clearly worked through and reflected in the written terms.

Implied duty of good faith
Edward-Stuarts J avoided implying a duty of good faith, but rather focused on honesty and rationality, which is consistent with the approach generally taken by the courts, as demonstrated most recently in D&G Cars v Essex Police Authority [2015] EWHC 226 and Myers and another v Kestrel and others [2015] EWHC 916.

It remains to be seen whether the council will be found to have contravened the implied duty of honesty as declared by the court, in its manner of awarding service points post-December 2013.

For further information, contact Juli Lau in the procurement team at Sharpe Pritchard on 020 7405 4600 or email jlau@sharpepritchard.co.uk.