Sir Robert Akenhead, with assistance from David Johnson, explains how a literal interpretation of wording sent a contractor’s argument off the rails in a case on disallowed costs.
While lawyers might be tempted to groan every time another authority is added to the mass of judicial guidance on the interpretation of provisions in a contract, decisions that consider the meaning of commonly used or well-known provisions are to be welcomed by practitioners and the industry alike. Such a decision has recently been handed down by Joanna Smith QC, sitting as a deputy judge in the Technology and Construction Court in the case of Network Rail Infrastructure vs ABC Electrification Ltd  EWHC 1769 (TCC). Not only does the decision confirm that courts will continue to prioritise the “natural and ordinary” meaning of words used by parties, it serves as a warning to contractors who could potentially be subject to extensive disallowed cost deductions.
Network Rail engaged Costain to carry out upgrade works on the West Coast Mainline. The contract incorporated the ICE Conditions of Contract, Target Cost Version, First Edition, together with a schedule of so-called “NR12” amendments used by Network Rail. The contract was subsequently novated from Costain to ABC. As is common in target cost contracts, ABC was entitled to be paid based on the cost of works it carried out, less any “disallowed cost”. The particular definition of disallowed cost in question was introduced by the NR12 amendments and provided that “any cost due to negligence or default on the part of the contractor in his compliance with any of his obligations under the contract and/or due to any negligence/default on the part of the contractor’s employees, agents, subcontractors or suppliers in their compliance with any of their respective obligations under the contracts with the contractor” would be disallowed.
The employer’s representative had identified more than £13m as disallowed cost, resulting from ABC’s alleged breaches in failing to complete the works on time. ABC objected, contending that, to deduct disallowed cost, the breach had to be “serious”, or “significant”, or “deliberate”, or “persistent” (though throughout the case ABC had put the argument in a number of different ways). In the end, it was Network Rail that commenced Part 8 proceedings, seeking, among other things, a declaration that the definition of disallowed cost included any failure by ABC to comply with its obligations under the contract.
Having considered the well-known authorities on contractual interpretation, including the recent decisions of the Supreme Court in Arnold vs Britton  AC 1619;  UKSC 36, and Wood vs Capita Insurance  AC 1173;  UKSC 24, the judge reiterated that the starting point was to give the words their natural and ordinary meaning. In this case, a “default” was a failure to comply with any legal requirement or obligation in the contract. Nothing in the remainder of the contract or the factual and commercial background required the court to depart from this meaning, nor was this a case where the court was faced with two conflicting interpretations that required it to identify the one that accorded with commercial common sense. In any event, the judge was unconvinced that ABC’s interpretation did reflect such common sense. The judge also noted the difficulty in pinning down the exact restrictions on the provision ABC sought, noting that a number of different alternatives had been suggested.
Network Rail was accordingly granted the declarations it sought.
Three key observations on this case can be made:
- The resulting definition of disallowed cost in the parties’ contract was a very wide one that seemingly permitted deductions, no matter how trivial or inconsequential the contractor’s breach. While that may have been consistent with the words as drafted (remember, these were Network Rail’s amendments), it is unlikely that ABC had anticipated such a result at the outset. The amendments incorporating the provision had the effect of changing the entire risk profile under the ICE Conditions, which is probably not what ABC had in mind when it accepted the novation.
- In a similar vein, it was arguably a tactical masterstroke by Network Rail to commence proceedings itself in Part 8, rather than waiting for ABC to challenge the disallowed cost. Doing so meant that the case focused solely on the interpretation of the words used, without involving consideration of some of the actual, real-life disallowed cost deductions that ABC had been subjected to.
- Does the fact that the disallowed cost provision in this case was a specific amendment to the standard form limit the application of this judgment? On one view, yes – but disallowed cost provisions are commonplace and appear in a number of standard forms, including the NEC contract suite. They are also frequently the subject of extensive negotiation and amendment by the parties, such is their importance in open-book contracting. Parties on all sides of the debate would be well advised to be aware of the potential consequences of making such amendments, given the court’s preparedness to interpret them literally.
All in all, the case does demonstrate that the more textual approach to interpretation of recent years can have actual consequences, rather than being nothing more than an abstract lawyers’ debate. At the same time, it provides a salutary reminder of the potential problems parties can store up for themselves when they conclude a contract based on both a standard form and bespoke amendments.