FIDIC Yellow Book: Termination for Convenience

Summary

In Water and Sewerage Authority of Trinidad and Tobago v Waterworks Ltd the Privy Council Judicial Committee (the PCJC) unanimously upheld the Court of Appeal of Trinidad and Tobago's decision that a contractor's liabilities to pay cancellation charges to a third party equipment supplier did not fall within clause 19.6(c) of the FIDIC General Conditions of Contract (Yellow Book), as they were not reasonably incurred.

Background

Waterworks Ltd (the Contractor) and the Water and Sewerage Authority of Trinidad and Tobago (the Employer) entered into two FIDIC Yellow Book (1999) contracts for the design and build of water treatment plants. The Contractor completed its preliminary design reports in March 2008. In March 2009 the Contractor issued purchase orders in April 2009 by which Maak Technologies Group Inc (MAAK) would supply equipment for building both plants; the MAAK contracts each provided for a minimum cancellation charge equal to 30% of the quoted price of the equipment.

Clause 19.6 of the FIDIC Yellow Book 1999 allows the Employer to terminate the contract for 'convenience', i.e., for no fault by the Contractor. The 2017 FIDIC Yellow Book has similar provisions. If the contract is terminated for convenience, the Contractor is not entitled to claim for loss of profit, but instead entitled only to compensation for the value of the work done and any costs or liability reasonably incurred by the Contractor in the expectation of completing the Works.  

Here, the Employer terminated the D&B Contracts for convenience before the plant designs had been finalised and any construction had begun. The MAAK contracts were terminated when the D&B Contracts were terminated. Following termination the Contractor claimed, inter alia, the 30% cancellation charges for the two MAAK contracts.

The court was then asked to consider whether the Contractor's liability to pay the cancellation charges "reasonably incurred by the Contractor in the expectation of completing the Works" so as to fall within clause 19.6(c).

The Contractor succeeded in its claim for cancellation charges before the High Court. However, the Court of Appeal then overturned the trial judge's ruling, siding with the Employer. The Contractor appealed to the PCJC.

Privy Council ruling

The PCJC agreed with the Court of Appeal's findings. In particular, it held that, whilst a contractor is expected to proceed with works on the assumption that the contract will be completed and without anticipating early termination, it is unreasonable for a contractor to purchase equipment before it is needed and before final designs are approved. Issuing purchase orders prior to approval of  the final designs  was premature and, on the face of it, unreasonable.

The burden of proof was on the Contractor, which had failed to adduce evidence to explain its decision and to displace the inference that it was unreasonable to enter into unconditional equipment purchase contracts when only preliminary designs were completed, which were not detailed enough to justify ordering equipment. The Contractor had made a "very bad bargain" and shown no good reason for undertaking obligations to pay cancellation charges equal to a minimum of 30% if the purchase orders were later cancelled, regardless of whether at the time of such cancellation MAAK had taken any steps whatever to perform the contracts.

Analysis and implications

Rulings by the PCJC are not binding, but can have significant persuasive value. In this case, the Committee comprised five judges of the UK's Supreme Court, and it is likely that a lower English court would, without distinguishing factors, follow the decision.  

The PCJC decision indicates that whether a contractor's liabilities to pay cancellation charges to a third party is a recoverable cost following termination for convenience is fact dependent. The PCJC  noted that they may have allowed recovery of the charges had the Contractor been able to adduce evidence explaining its decision to enter into the MAAK contracts, and why it was thought at the time to be in the Contractor's interests. Such evidence might have included an explanation of the Contractor's decision to enter into the contracts at the time that it did, and/or on the terms that it did, including for example evidence as to any negotiations or other communications between the parties.

A contractor should consider its position very carefully before entering into contracts with substantial cancellation charges. Consideration both of the terms and of the timing of any such contract, set in the context of the particular project and circumstances, will obviously be vital. If there is a reason why such a particular contract needs to be entered into at what might otherwise be considered to be a premature stage of the project, then parties should carefully document the reasons and the decision-making process in case of future challenges. Contractors using the FIDIC forms should exercise caution when entering into supplier or subcontractor contracts which contain early termination liabilities. This decision reinforces the  need to document meticulously any negotiations or decisions made to accept onerous terms, along with the rationale behind these choices.