REUTERS |

Supreme Court rules on diffuse design and build obligations

Construction, engineering and energy disputes often give rise to issues as to the design standard to which a design and build contractor ought to be held. In such cases, the issues often relate to how the contractor’s obligations (which may be diffuse) interrelate with one another. Disputes are particularly likely to arise where the parties’ contract:

  • Requires the contractor to design and build in accordance with a prescribed standard or specification.
  • Separately, requires the contractor to provide the employer with a product that will be fit for an intended purpose or will have a particular design or service life.

In such a case, if the contractor designs and builds in accordance with the prescribed standard or specification, but that standard or specification itself proves to have been defective so the product is not fit for purpose or does not have the required design/service life, should the contractor be held liable for the consequences?

In MT Højgaard A/S v E.ON, the Supreme Court clarified how one ought to approach the issues of interpretation that arise in cases concerned with diffuse design obligations.

The dispute

In Højgaard, the appellants (E.ON, as employer) had engaged the respondent (Højgaard, as contractor) to design and install the foundation structures of two offshore wind farms in the Solway Firth. The parties’ contract contained a variety of provisions relating to the standard to which the foundations were to be designed and built by Højgaard. Taken separately, those provisions required the foundations to be:

  • In accordance with E.ON’s Technical Requirements which, in turn, required the foundations, as a minimum to:
    • be in accordance with an international design standard document known as J101, produced by an independent Norwegian classification and certification agency known as Det Norske Veritas (DNV) (paragraph 3.2.2.2(i)); and
    • have a lifetime of 20 years (paragraphs 3b.5.1, 3b.5.6 and 3.2.2.2(ii)).
  • Designed with due care and diligence and in accordance with good industry practice (clause 8.1(i) and (iv)).
  • Fit for purpose (clause 8.1(x)).

Højgaard (via its design sub-contractor) designed the foundations in accordance with J101. Højgaard even appointed DNV to evaluate and approve its foundation designs. However, it subsequently transpired that J101 contained a mathematical error in one of its formulae relating to the strength of foundation structures. A particular value ascribed against the symbol δ was wrong by around a factor of ten. As a consequence, the axial capacity (or strength) of the foundations proved to be substantially over-estimated. Within three years of their installation, the foundations began to fail.

E.ON and Højgaard agreed to carry out remedial works to the foundations immediately, but a dispute then arose as to which of them should bear the cost associated with those remedial works (agreed to be €26.25 million):

  • E.ON argued that Højgaard should bear those costs, since the foundations did not have a service life of 20 years.
  • Højgaard contended that E.ON should bear the remedial costs, on the basis that Højgaard had designed the foundations in accordance with J101, as required by E.ON’s Technical Requirements.

First instance decision

In the High Court, Edwards-Stuart J held in favour of E.ON that Højgaard was liable for the cost of the remedial works. He held that the relevant contractual obligations were not mutually inconsistent, but rather additional to one another, and that Højgaard had breached a warranty that the foundations would have a service life of 20 years.

Reversed in the Court of Appeal

On appeal by Højgaard, the Court of Appeal reversed Edwards-Stuart J’s decision. Giving the lead judgment (with which Underhill LJ and Patten LJ agreed), Jackson LJ held that:

  • The whole scheme of J101 and the Technical Requirements pointed, not towards Højgaard absolutely warranting a 20-year service life, but rather towards Højgaard being obliged to design and build in accordance with J101, which prescribed what needed to be done in order to create a structure with a sufficiently high possibility of meeting a 20-year design life.
  • “Design life” and “service life” are not the same. If a structure has a design life of 20 years, that does not mean that it will inevitably function for 20 years, although it probably will. By contrast, if a contractor warrants a service life of 20 years, then it will be strictly liable if the article in question fails within that 20-year period.
  • If the contract were to be regarded as having contained an absolute warranty as to service life, one would expect to have seen it in clause 8.1 of the contract (that being the provision which codified Højgaard’s main contractual obligations) and not “tucked away in the Technical Requirements”.
  • Given the inconsistency between the main thrust of the contract (that is, design life) and other, discrete provisions in documents of lesser contractual status (that is, service life), it was correct to disregard those provisions of the contract which, in isolation, might otherwise have suggested the existence of a strict 20-year service life warranty. In support of that approach, Jackson LJ appears to have relied heavily upon Re Sigma Finance, where Lord Collins held that an:

    “… over-literal interpretation of one provision without regard to the whole may distort or frustrate the commercial purpose.”

  • Clause 8.1 of the contract contained no freestanding warranty or guarantee with regards to service life, and the reference therein to “fitness for purpose” was qualified by the phrase “as determined in accordance with the Specification using Good Industry Practice”.

Therefore, Jackson LJ held that, having designed and built in accordance with J101, Højgaard had not breached the terms of the contract. Accordingly, on the Court of Appeal’s analysis, E.ON was liable to pay for the necessary remedial works to the foundations.

Reversed again in the Supreme Court

E.ON appealed to the Supreme Court.

The Supreme Court’s judgment was given by Lord Neuberger, with whom the other four Justices agreed. Lord Neuberger began by noting that court’s task in such a case involves:

“… the reconciliation of the terms, and the determination of their combined effect… by reference to ordinary principles of contractual interpretation… as recently discussed in Wood v Capita.”

With that purpose in mind, Lord Neuberger cited from cases where similar issues had come before the courts, and emphasised the following strands of thought from within those authorities:

  • A contractor who bids on the basis of a defective specification provided by the employer only has himself to blame if he does not check their practicality and they turn out to be defective (Thorn v Mayor).
  • A defendant who contracts to produce a particular article: (a) pursuant to a plan provided by a claimant; and (b) so as to achieve a particular result (thinking that the result can be achieved by following the plan) cannot escape liability if the plan subsequently brings about an unavoidable defect in the article (Hydraulic Engineering v Spencer (1886) 2 TLR 554 and Gillespie v Howden (1885) 22 SLR 527).
  • An express obligation to construct a work carrying out a particular duty generally overrides an obligation to comply with plans and specifications, such that a contractor will be liable for the failure of the work to carry out the duty in question, notwithstanding that the work was carried out in accordance with the plans and specification (Steel Company of Canada v Willand [1966] SCR 746 and Greater Vancouver v North American Pipe & Steel 2012 BCCA 337).

Having regard to those cases, Lord Neuberger approved or laid down the following principles:

  • Each case must turn on its own facts:
    • in some cases, a term that requires an item to be produced in accordance with a prescribed design may be inconsistent with a term that requires the item, when provided, to comply with certain prescribed criteria (as the Court of Appeal considered to be the case in Højgaard);
    • in other cases, 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 yet other cases, the correct view could be that the prescribed criteria only apply to aspects of the design that are not prescribed.
  • Notwithstanding that the terms of each contract require careful scrutiny:
    • the general rule is that where a manufacturer or contractor undertakes to produce a finished result according to a design or plan, he may still be bound by his bargain even though he can show an unanticipated difficulty or even impossibility in achieving the result desired with the plans or specification (Cammell Laird v The Manganese Bronze and Brass [1934] AC 402); or
    • put another way, 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 employer or customer 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: [44].

Turning to the facts in Højgaard, Lord Neuberger:

  • Noted that the terms of the contract between E.ON and Højgaard made clear that in the event of any difference between the various standards, it was Højgaard’s responsibility to meet the more rigorous of those standards. It was wrong to treat the different standards as inconsistent (as the Court of Appeal had done) and the proper interpretation of the contract was that the more rigorous design standard had to prevail, with the less onerous standard simply forming a minimum criterion.
  • Rejected the notion that that conclusion ought to be affected by the fact that the 20-year service life warranty was “tucked away” in the Technical Requirements:

    “… [g]iven that it is clear from the terms of the Contract that the provisions of the TR are intended to be of contractual effect, I am not impressed with that point.”

Since Højgaard had not complied with the 20-year service life warranty, it followed that the decision of the Court of Appeal should be reversed and that Højgaard was liable to E.ON for the costs of carrying out remedial works to the foundations.

Commentary

On one hand, the Supreme Court’s judgment might be considered a rather harsh outcome for Højgaard:

  • It relied upon an international design standard document (J101).
  • It designed and built the foundations with appropriate care.
  • It even engaged DNV to verify its designs.

That notwithstanding, it ended up bearing €26.25 million of costs associated with an error in J101, brought about solely by DNV.

On the other hand, it is clear from the cases cited by Lord Neuberger that the weight of previous authority was largely with E.ON. Moreover, when viewed in the round, it is respectfully suggested that the Supreme Court’s decision gives rise to a more meritorious result than that arising from the Court of Appeal’s decision, for two main reasons:

  • The particular terms of the parties’ contract supported the notion that Højgaard was expected to deviate from design specifications such as J101 if and to the extent that those specifications did not provide an appropriate method by which to achieve the end result that E.ON was contractually entitled to expect.
  • In any event, there is inherent merit in the general rule referred to in both Højgaard and Cammell Laird:
    • in commercial negotiations, an employer is free to propose that a contractor shall comply with a range of diffuse design obligations, some of which may be more rigorous than others. If the contractor accepts such a proposal, then generally it ought to be regarded as having agreed to comply with each of those obligations in addition to one another, however great the variance between them; and
    • to treat the various distinct design obligations as strictly inconsistent, merely because they require varying degrees of rigour, is to deprive the employer of his bargain and to relieve the contractor of the risk allocated to him at the point of contract.

No matter which of the parties one sympathises with, the Supreme Court’s decision is a stark reminder of the risks that contractors take on when they accept diffuse design obligations. As Lord Neuberger held, all will depend upon the terms of the contract. Accordingly – now more than ever – it will be prudent for contractors to negotiate hard to expressly provide in their contracts:

  • That compliance with a prescribed design will, of itself, be deemed sufficient to meet any separate obligation to achieve prescribed criteria.
  • That in the event of any inconsistency between the obligation to comply with a prescribed design and the obligation to achieve prescribed criteria, the former shall prevail.
  • That the obligation to achieve prescribed criteria shall only apply to those parts of the article in respect of which there is no prescribed design.

If and to the extent that that is not possible, then, at the very least, contractors ought to take steps to satisfy themselves that compliance with contract plans and specifications (which the employer provides or with which the employer requires compliance) will bring about the end result that the employer is contractually entitled to expect.

Keating Chambers Matthew Finn

One thought on “Supreme Court rules on diffuse design and build obligations

Leave a Reply

Your email address will not be published. Required fields are marked *