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Conditions precedent and the rule against redundancy in contract interpretation

In Interserve Construction Ltd v Hitachi Zosen Inova AG, the court was asked to interpret the termination provisions of a contract to determine whether there was a condition precedent clause.

Interserve Construction Ltd v Hitachi Zosen Inova AG

In brief, Hitachi, the main EPC contractor for an energy from waste plant had sought to terminate the employment of its design and build sub-contractor, Interserve. Hitachi sought to terminate for contractor default under clause 43.1(h) and/or 43.1(q) of the sub-contract (which referred to Hitachi as the “Purchaser” and Interserve as the “Contractor”). The grounds of termination were as follows:

43.1(h) fails to proceed regularly and diligently with the Works…

43.1(q): the Contractor commits a material breach of this Contract;”

The notice of termination then clarified that:

“For the avoidance of doubt, [Hitachi] does not exercise its discretion to provide a 7 day period for rectification under Clause 43.1A of the Conditions.”

Interserve responded by a letter contesting the termination on the basis that neither of the grounds relied on were made out and concluding that Hitachi’s invalid termination was a repudiatory breach or renunciation of the contract, which it thereby accepted.

Part 8 proceedings

Interserve subsequently started Part 8 proceedings seeking a declaration that:

“It was a condition precedent to [Hitachi] having the right to terminate pursuant to Sub-Clauses 43.1(h) and 43.1(q) that [Hitachi] first issue a notice pursuant to Sub-Clause 43.1A…”

Sub-clause 43.1A, which Hitachi had referred to in its termination notice, stated:

“In the case of a default by the Contractor under heads (h), (p) or (q) of Sub-Clause 43.1, the Purchaser may (at its absolute discretion) notify the Contractor of the default and if the Contractor fails to commence and diligently pursue the rectification of the default within a period of seven (7) Days after receipt of notification, the Purchaser may by notice terminate the employment of the Contractor under the Contract.”

Significantly, the right to terminate for one of the grounds stated in clause 43.1 was stated to be “subject to Sub-Clause 43.1A”. Sub-clause 43.1A did not expressly refer to itself as a condition precedent.

The argument before the court focused on the interpretation and reconciliation of “subject to Sub-Clause 43.1A” and “the Purchaser may (at is absolute discretion)”. Interserve argued that the seven-day notice was a condition precedent. In contrast, Hitachi argued that the giving of a seven-day notice was at its absolute discretion, in other words it could choose to simply issue the termination notice.

The court’s interpretation of sub-clause 43.1A

Jefford J held that the objective meaning of:

  • The words “subject to clause 43.1A” was that clause 43.1A was a condition precedent to termination under 43.1(h), (p) or (q).
  • Clause 43.1A and, in particular, “at its absolute discretion” was that Hitachi was not obliged to issue a seven-day notice to commence the termination procedure, but could choose to do so if grounds 43.1(h), (p) or (q) were made out.

The cumulative effect of this interpretation was that if Hitachi did want to terminate under 43.1(h), (p) or (q) it had to first issue a seven-day notice.

Points to note – the rule against redundancy

There is little to disagree with in the court’s conclusion but its reasoning is nevertheless of interest.

Firstly, great significance (in terms of the validity of Hitachi’s purported termination, to be subject to full debate in subsequent proceedings) was placed on the words “subject to”. This decision re-emphasises that a condition precedent clause does not need to refer to itself as such (or, more glibly, it is not a condition precedent for a condition precedent to state that it is a condition precedent).

Secondly, in interpreting “subject to” the court relied in part on the principle that all parts of a contract should be given effect where possible, and no part of it should be treated as surplus, particularly for bespoke contracts (as restated by Coulson J in Secretary of State for Defence v Turner Estate Solutions Ltd).

However, one could argue that the court’s interpretation of “at its absolute discretion” did offend this principle of redundancy or surplusage. While not expressed in terms of redundancy, the analysis appears to be that “at is absolute discretion” was given effect to as it provided “emphasis or clarification”. The grammar of the clause, with “at its absolute discretion” in brackets, may be crucial.

The narrow point of principle to draw is that words may not offend the principle of redundancy if they provide clarity (the role of emphasis in a contractual document being less clearly understood). The wider significance is that the court may adopt a very broad interpretation of giving effect to each part of a contract. The wording of clause 43.1A without “at its absolute discretion” is clear enough (in particular, “may” rather than “must”) to indicate that Hitachi had a choice rather than was required to issue a seven-day notice and commence the process of termination. An argument that without this clarification, clause 43.1A required Hitachi to send a seven-day notice even if it did not want to terminate, would receive short shrift.

In essence, by analysis with other clauses, “at its absolute discretion” was given effect to as almost a verbal tick of the draftsman. This case demonstrates that, especially with bespoke contracts, it can be difficult to give full force and sense to all clauses of a contract (see paragraph 24 of the judgment for another example). In such cases, the cross-checking of clauses against one another is a vital step to find the objective meaning of the contract as a whole.

Failure to raise objection at the time

The final part of this judgment dealt with Hitachi’s argument that Interserve had not relied on Hitachi’s failure to provide the seven-day notice at the time of the termination. However, this argument was ultimately a “jury point” because Hitachi only relied on it to demonstrate how the parties had construed the contract. There was no consideration of waiver.

The arguments may have been different had Hitachi’s notice stated that the termination took effect from a future date. In those circumstances, by analogy with what has been termed the “Heisler Qualification” (see C&S Associates UK Ltd v Enterprise Insurance Company plc), Hitachi may have been able to argue that there was a waiver or estoppel. If Interserve had raised the failure to provide a seven-day notice before the time of termination, Hitachi could have rectified its position and duly complied.

Keating Chambers James Frampton

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