The United Kingdom Supreme Court recently considered the question of whether the performance standard or the design standard prescribed in the contract took precedence. In MT Hojgaard AS v E.ON Climate and Renewables UK Robin Rigg East Ltd & Anor [2017] UKSC 59, the court held that the performance requirement took precedence and that the contractor was liable when the structure failed soon after erection although the structure was built according to the design standard which had an error in it.

This decision generally follows the principle adopted by Canadian courts in holding contractors liable for the structure’s failure to perform as required by the contract even though the structure was built according to specifications issued by the owner.

Background

The contractor MT agreed with the owner E.ON to build the foundations for proposed offshore wind turbines. The technical requirements (“TR”) issued by the owner to bidders stated that “[t]he Works elements shall be designed for a minimum site specific ‘design life’ of twenty (20) years without major retrofits or refurbishments; all elements shall be designed to operate safely and reliably in the environmental conditions that exist on the site for at least this lifetime.”

The TR stated that they were minimum requirements and that the contractor was “to identify any areas where the works need to be designed to any additional or more rigorous requirements or parameters” and that “[t]he design of the foundations shall ensure a lifetime of 20 years in every aspect without planned replacement. The choice of structure, materials, corrosion protection system operation and inspection programme shall be made accordingly.”

The TR required the contractor to prepare the detailed design of the foundations in accordance with an international standard for the design of offshore wind turbines published by an independent classification and certification agency. An equation in that standard was later shown to be erroneous by a factor of 10, leading to the subsequent failure.

The contract between the parties incorporated the TR, which were attached to the contract. The contract required MT “in accordance with this Agreement, [to] design, manufacture, test, deliver and install and complete the Works” in accordance with a number of requirements, including

“(iv)    in a professional manner in accordance with modern commercial and engineering, design, project management and supervisory principles and practices and in accordance with internationally recognised standards and Good Industry Practice; …

(viii)   so that the Works, when completed, comply with the requirements of this Agreement …;

(ix)      so that [MT] shall comply at all times with all Legal Requirements and the standards of Good Industry Practice;

(x)       so that each item of Plant and the Works as a whole shall be free from defective workmanship and materials and fit for its purpose as determined in accordance with the Specification using Good Industry Practice; …

(xv)     so that the design of the Works and the Works when Completed by [Mt] shall be wholly in accordance with this Agreement and shall satisfy any performance specifications or requirements of the Employer as set out in this Agreement. …”

The contract provided that MT was responsible for making good any defects arising for defective materials, workmanship or design which appeared within 24 months of E.ON taking over the works from MT. E.ON was required to produce a Defects Liability Certificate once the Defects Liability Period has expired and MT had satisfied all its obligations. Within 28 days of the issue of a Defects Liability Certificate, MT was entitled to apply for a Final Certificate of Payment, and to accompany the application with a final account. A Final Certificate of Payment was then to be issued which was conclusive. This regime is referred to as the “Defect Liability regime” in this article.

MT proceeded with the design and construction of the two wind farms. The international certifying authority evaluated and approved MT’s foundation designs. MT began the installation of the foundations in December 2007, and completed the Works in February 2009. During 2009 a serious problem came to light at another wind farm. The certifying authority carried out an internal review during late summer 2009, and discovered the error in the equation in the international design standard that had been prescribed by the owner. The foundations were re-built and litigation was commenced to determine which party was responsible for the additional costs.

The trial judge found in favour of E.ON on the grounds that: the contract required the foundations to be fit for purpose; fitness for purpose was to be determined by reference to the TR; and the TR also required the foundations to be designed so that they would have a lifetime of 20 years.

The Court of Appeal reversed the trial judgment. It held that the contract stipulated that the foundations must be constructed in accordance with the international design standard prescribed by the owner, and the other elements of the contract did not render MT liable for an error in that standard.

Decision of the U.K. Supreme Court

The U.K. Supreme Court reversed the decision of the Court of Appeal and re-instated the decision of the trial judge. The elements of its decision may be divided as follows:

  1. The effect of the Defects Liability regime was that “any claim by E.ON in respect of a defect appearing thereafter was barred, and….. there was no room for claims outside the 24-month period….. In my opinion, there is no answer to that analysis so far as it is directed to the effect of [the Defects Liability regime]….Clause 42.3 makes it clear that the provisions of clause 30 (and any other contractual term which provides for remedies after the Works have been handed over to E.ON) are intended to operate as an exclusive regime. And that conclusion appears to…. tie in very well with the notion that there should be no claims after the Final Certificate, which is to be issued very shortly after the 24-month period.”
  2. This reading of the Defects Liability regime helped to resolve the tension between the 20 year performance standard and other parts of the contract:

“In the light of the normal give and take of negotiations, and the complex, diffuse and multi-authored nature of this contract, it is by no means improbable that [MT] could have agreed to a 20-year warranty provided that it could have the benefit of a two-year limitation period, save where misconduct was involved. It would simply mean that the rights given to E.ON by paras 3.2.2.2(ii) were significantly less valuable than at first sight they may appear, because any claim based on an alleged failure in the foundations which only became apparent more than two years after the handover of the Works would normally be barred by clause 42.3. In this case, of course, there is no problem, because the foundations failed well within the 24-month period.”

  1. The true meaning of the 20-year performance term was, not that the structures would last for 20 years, but that they would be designed to last for 20 years:

“….there is a powerful case for saying that, rather than warranting that the foundations would have a lifetime of 20 years, para 3.2.2.2(ii) amounted to an agreement that the design of the foundations was such that they would have a lifetime of 20 years. In other words, read together with clauses 30 and 42.3 of the Contract, para 3.2.2.2(ii) did not guarantee that the foundations would last 20 years without replacement, but that they had been designed to last for 20 years without replacement. …… Rather than the 20-year warranty being cut off after 24 months, E.ON had 24 months to discover that the foundations were not, in fact, designed to last for 20 years. On the basis of that interpretation, E.ON’s ability to invoke its rights under para 3.2.2.2(ii) would not depend on E.ON appreciating that the foundations were failing (within 24 months of handover), but on E.ON appreciating (within 24 months of handover) that the design of the foundations was such that they will not last for 20 years.

   It is unnecessary to decide whether para 3.2.2.2(ii) is a warranty that the foundations will have a lifetime of 20 years or a contractual term that the foundations will be designed to have such a lifetime. The former meaning has been taken as correct by the parties and by the courts below, but, for the reasons given in paras 28 to 31 above, I am currently inclined to favour the latter meaning…… However, it is clear that, if para 3.2.2.2(ii) is an effective term of the Contract, it was breached by [MT] whichever meaning it has, and therefore the issue need not be resolved.

  1. The legal resolution of the tension between the prescribed performance (which the court called the “prescribed criteria”) and the prescribed design may be resolved as follows:

“Where a contract contains terms which require an item (i) which is to be produced in accordance with a prescribed design, and (ii) which, when provided, will comply with prescribed criteria, and literal conformity with the prescribed design will inevitably result in the product falling short of one or more of the prescribed criteria, it by no means follows that the two terms are mutually inconsistent. That may be the right analysis in some cases…… However, in many contracts, the proper analysis may well be that the contractor has to improve on any aspects of the prescribed design which would otherwise lead to the product falling short of the prescribed criteria, and in other contracts, the correct view could be that the requirements of the prescribed criteria only apply to aspects of the design which are not prescribed. While each case must turn on its own facts, the message from decisions and observations of judges in the United Kingdom and Canada is that the courts are generally inclined to give full effect to the requirement that the item as produced complies with the prescribed criteria, on the basis that, even if the customer or employer has specified or approved the design, it is the contractor who can be expected to take the risk if he agreed to work to a design which would render the item incapable of meeting the criteria to which he has agreed.” (underlining added)

In arriving at its conclusion, the U.K. Supreme Court relied upon two Canadian decisions, The Steel Company of Canada Ltd v Willand Management Ltd., [1966] S.C.R. 746 and Vancouver Water District v North American Pipe & Steel Ltd., 2012 BCCA 337. In both those cases, the contractor was held liable when the work failed to live up to the performance standard in the contract even though the contractor used the specifications provided by the owner.

  1. In applying this principle in the present case and in finding in favour of the owner, the Court of Appeal concluded as follows:

“The opening provision of Section 3, para 3.1, (i) “stresse[s]” that “the requirements contained in this section … are the MINIMUM requirements of [E.ON] to be taken into account in the design”, and (ii) goes on to provide that it is “the responsibility of [MT] to identify any areas where the works need to be designed to any additional or more rigorous requirements or parameters”. In those circumstances, in my judgment, where two provisions of Section 3 impose different or inconsistent standards or requirements, rather than concluding that they are inconsistent, the correct analysis by virtue of para 3.1(i) is that the more rigorous or demanding of the two standards or requirements must prevail, as the less rigorous can properly be treated as a minimum requirement. Further, if there is an inconsistency between a design requirement and the required criteria, it appears to me that the effect of para 3.1(ii) would be to make it clear that, although it may have complied with the design requirement, [MT] would be liable for the failure to comply with the required criteria, as it was [MT’s] duty to identify the need to improve on the design accordingly.” (underlining added

  1. Having arrived at this interpretation of the contract as being the proper one, the Court of Appeal did not accept a number of submissions of the contractor as to why that interpretation should not be accepted, including:
    1. The “diffuse and unsatisfactorily drafted nature of the contractual arrangements, with their ambiguities and inconsistencies, [which] should be “recognised and taken into account”;
    2. The fact that the “onerous obligation” upon which the court’s interpretation rested “is found only in a part of a paragraph of the TR, essentially a technical document, rather than spelled out in the Contract.”
    3. This interpretation would or would not render the requirements in the TR redundant having regard to the terms of the contract itself.

Discussion

The MT Hojgaard decision contains a fascinating and important analysis of the factors which may assist a court to resolve the apparent conflict between a prescribed criteria (which I have called a performance standard) and a design criteria in a contract, or in the event of conflict, to determine which standard should takes precedence. The court stated the principle that, and the reasons why, the prescribed criteria will generally be given precedence over a design criteria, even a design criteria by the owner.

In the course of its decision, the U.K. Supreme Court considered almost all the conceivable factors relating to the interpretation of these sorts of contractual provisions. The decision provides, therefore, a good check-list for persons drafting or litigating these provisions.

The fact that the U.K. Supreme Court relied upon two Canadian decisions is significant. However, the court did not refer to any Canadian decisions on the other side of the ledger. There are many cases in which the owner’s claim against the contractor has been dismissed on the basis that the contractor had not given a warranty of the life or other criteria of the structure, or that the owner had not relied upon the contractor’s skill and judgment for the design of the structure. One of the leading Canadian decisions to this effect is CCH Canadian Ltd. v. Mollenhauer Contracting Co., [1976] 1 S.C.R. 49.

The debate in Canadian cases often turns on whether the owner relied upon the contractor’s skill and judgment, and whether the agreement of the contractor truly represents a warranty of performance. These elements of the usual Canadian analysis are not evident in the MT Hojgaard decision of the U.K. Supreme Court. Perhaps they were inherent in the court’s interpretation of the performance standard. But if reliance on the contractor’s skill and judgment is something that can be shown objectively from the parties’ conduct, and not merely from the words of the contract, it may be doubtful in this case that the owner really relied upon the contractor’s skill and judgment in relation to the international design standard contained in the TR issued by the owner.

In addition to resolving the tension between the design and performance standards in the contract, there are two other interesting aspects of the MT Hojgaard decision.

The first is the court’s interpretation of the term relating to “20 years without replacement” and its finding that this term “did not guarantee that the foundations would last 20 years without replacement, but that they had been designed to last for 20 years without replacement.”

The second is the court’s interpretation and use of the Defect Liability regime. The court held that this regime meant that, while the “20 years without replacement” term existed in the contract, it could only be enforced during the 2 years after the owner took over the project after which the owner’s rights terminated. The court relied upon this interpretation to resolve the tension between the performance and design criteria.

It can be predicted that Canadian courts will pay close attention to both these approaches.

Heintzman and Goldsmith on Canadian Building Contracts, 5th ed. Chapter 4, sections 3(i) and 5 and Chapter 7, section 7(c)(ii).

MT Hojgaard AS v E.ON Climate and Renewables UK Robin Rigg East Ltd & Anor [2017] UKSC 59

Building Contracts –performance and design standards and defects – warranty period

Thomas G. Heintzman O.C., Q.C., LL.D. (Hon.), FCIArb                   August 24, 2017

This article contains Mr. Heintzman’s personal views and does not constitute legal advice. For legal advice, legal counsel should be consulted.