Obligations to accept contract changes?
Essex v UBB Waste (High Court) [2020]
Despite finding that the Private Finance Initiative (‘PFI’) contract the subject of this case was a ‘paradigm example of a relational contract’, the judge went on to explain the limits of any resulting implied duty of good faith and, specifically, that such a duty did not oblige the customer having to accept significant watering down of certain fundamental contractual requirements.
Facts:
Essex County Council (the employer) engaged UBB Waste Essex Ltd (the contractor) to design, construct, finance, commission, operate and maintain a mechanical biological waste treatment plant in Basildon to process the county's household waste. The parties agreed a 25-year contract under the private finance initiative (PFI).
Among other things, the plant was required to pass Acceptance Tests before the extended Planned Services Commencement Date of 12 July 2015. The Longstop Date was 12 January 2017 and it was common ground that the facility had not passed the Acceptance Tests by that Longstop Date.
The Agreement included an "entire agreement" clause, which stated that, " ... this Contract constitutes the entire agreement between the Parties in connection with its subject matter and supersedes all prior representations, communications, negotiations and understandings concerning the subject matter of this Contract".
The Agreement was a sophisticated and detailed commercial contract running to many hundreds of pages.
The Council alleged that because of design and construction failings it was entitled to terminate the contract. The contractor denied that the employer was entitled to terminate the contract. It argued that the employer was itself in breach of contract and counterclaimed for damages.
Decision:
The judge held that the contractor was in breach of contract and the employer was entitled to terminate. The contractor made several serious design errors, which meant that the facility it designed and built could not pass the acceptance tests.
It was "hopeless" to suggest that the employer was under a contractual obligation to agree fundamental changes to the contract and the acceptance tests in order to keep the project on track. “I reject out of hand the argument that any contractual duty of good faith could possibly stretch to requiring the Authority to renegotiate the key environmental standards at the heart of this contract or to give up its contractual right to hold UBB to the parties’ bargain”.
The court recognised that where a contract confers a contractual power or discretion on one party, the law may imply a term that the party should exercise such power or discretion in good faith and that it will not act arbitrarily, capriciously or irrationally. However, there was no scope for such an implied term where a party was exercising an absolute contractual right, such as the right to terminate.
The judge stated his conclusion that "this 25-year PFI contract is a paradigm example of a relational contract in which the law implies a duty of good faith". In reaching that conclusion, he referred to the line of cases beginning with Yam Seng and drew particular attention to the list of nine relevant factors set out in Bates v Post Office . The judge emphasised that whether a party has acted in good faith is an objective test. Dishonest conduct is a breach of the duty of good faith, but dishonesty is not of itself a necessary ingredient of an allegation of breach. The question is whether the conduct would be regarded as "commercially unacceptable" by reasonable and honest people. The existence of an [entire agreement] clause does not of itself prevent the implication of terms based upon the ordinary principles [for implying such terms].
The contractor alleged that the employer's right to terminate was subject to an implied requirement that termination must be exercised within a reasonable time. The judge rejected "the argument that there is an immutable rule of law that all rights of termination must be exercised within a reasonable time after such right first arises". The judge said that the question of whether a requirement to terminate within a reasonable time existed in each case must be established by reference to the usual principles for finding an implied term. Applying those principles, he held that the implied term was not necessary or obvious because it would mean that the employer would have to terminate without waiting to see if the project could be salvaged. Also, such an implied term was not necessary since the common law doctrine of waiver arguably barred the right to terminate if the employer's conduct amounted to a waiver of its right to rely on the termination clause.
In this case, taking the employer’s words and conduct as a whole, it may well have lost the right to terminate the contract for failure to meet the contractual Longstop Date if the plant had in fact passed the acceptance tests, say, a year after the Longstop Date. However, as the plant had still not passed the acceptance tests at the time of trial the employer was entitled to a declaration that it was still entitled to terminate.
Points to Note:
- This judgment builds on recent authorities that have accepted the special characteristics of relational contracts and provides guidance on how such contracts can be identified. Amey Birmingham v Birmingham City Council had already held that a 25-year PFI contract could be a relational contract and this judgment suggests that the Amey case was not a ‘one-off’.
- While a duty of good faith is implied in a relational contract, it is possible to exclude that implied duty through express terms. However, a simple entire agreement clause is unlikely to have this effect as such clauses tend not to exclude terms implied in fact.
- The judgment also touches on a separate issue concerning implied terms, confirming that there is no general implied term that a right to terminate must be exercised with a reasonable time. Whether such a term will be implied and what a ‘reasonable time’ might be will be very context specific. However, it would be unwise to delay for too long (even in the case of an ongoing breach) and it is sensible to continually put the other party on notice that you are reserving your rights to terminate.