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Validity of contractual notices and valuation of variations – Maeda v Bauer

The Hong Kong High Court judgment in Maeda and China State v Bauer, handed down on 9 April 2019, deals with two issues that arise regularly in practice but are rarely the subject of judicial consideration.

The issues, in short, are:

  • Will a notice be valid where it has been given on the basis of one ground of dispute under the contract but the claimant succeeds on a different ground? (Notices Issue).
  • If work is to be valued using fair and reasonable rates, should the valuation be based on market rate or cost? (Valuation Issue).

Background

The project related to the construction of tunnels for the Hong Kong to Guangzhou Express Rail Link. Maeda and China State, acting in joint venture (JV), had been hired as main contractor by the employer, MTRC. The JV had, in turn, employed Bauer as subcontractor to undertake the diaphragm wall works.

Disputes between the JV and Bauer were referred to arbitration. The arbitrator’s second interim award was then appealed by the JV on a point of law to the Hong Kong High Court (Hon Mimmie Chan J). The test by which the appeal was considered required the JV to establish that the arbitrator had misdirected himself in law, or that the decision was such that no reasonable arbitrator could reach. The arbitrator’s findings of fact were assumed to be correct and could not be revisited.

Notices Issue

The first point of appeal related to the validity of a contractual notice.

The discovery of unforeseen ground conditions meant that the scope of works had to be varied. The contractor needed to give notice as a condition precedent to claiming loss and expense, but questions arose as to whether that notice should refer to the variation or the unforeseen ground conditions. And further, whether a notice referring to the wrong event was fatal to the claim?

It is important to remember that construction contracts typically have two separate regimes which trigger entitlement to extra money – variations and claims:

  • Entitlement for a variation is normally triggered by an instruction to undertake different work.
  • Entitlement to be paid for a claim normally requires a notice to be served by the contractor. This is because the events that given rise to claims simply happen or are discovered. For example, lack of access, late design information and unforeseen ground conditions.

While the contractor’s entitlement to be paid for the direct costs of carrying out a variation will normally only require an instruction, the indirect loss and expense will often fall under a different claims regime, requiring the service of a notice. Therefore, if the contractor wants to be paid loss and expense arising from varied work then it will need to serve a separate notice.

Although claims and variations often arise in distinct circumstances, the two can sometimes overlap. One such event is the discovery of unforeseen ground conditions. A contractor may have a right to be paid its additional costs as a result of bad ground. But the ground conditions may also result in the contractor having to undertake changed works; in other words, a variation.

In this case, unforeseen ground conditions meant that Bauer had to excavate additional quantities of rock. It wanted to trigger its entitlement to the additional loss and expense that would arise as result and it needed to give a notice under clause 21. The clause listed various grounds on which Bauer could rely including (under different sub-clauses) variations and other claims entitlements under the contract. One of these was unforeseen ground conditions.

Bauer gave notice of its loss and expense entitlement, referring specifically to the variation, being the additional excavation. It did not refer to an entitlement arising under the ground conditions provision.

The difficulty for Bauer was that the arbitrator decided that it had no entitlement to be paid as a variation because no instruction had been issued. The contractor, having experienced difficulties with the ground conditions, proceeded with the extra work required without securing an instruction first.

When it came to the arbitration itself, Bauer put its claim on two alternative bases: both as a variation and as a ground conditions claim. The arbitrator decided that the circumstances gave rise to a valid ground conditions claim but there was the small difficulty of the notices provision. Bauer had not given notice under clause 21 for loss and expense by reference to this event. Its notice referred to its entitlement arising from the variation only.

The arbitrator neatly sidestepped this problem by deciding that the clause 21 notice Bauer had given was equally valid as a notice based on unforeseen ground conditions. The arbitrator stated in his award:

“I consider that both as a matter of sympathy and as a matter of construction, the contractual basis of the claim stated in the Clause 21.2 notice does not have to be the contractual basis on which the party in the end succeeds in an arbitration.  First, to expect a party to finalize its legal case within the relatively short period and be tied to that case through to the end of an arbitration is unrealistic.  Secondly, what is important from the point of view of the Contractor is to know the factual basis for the claim so that it can assess it and decide what to do…

It therefore follows that the fact that Bauer have made its claims on the basis of the relevant claim being a Variation or Sub-Contract Variation does not preclude Bauer from making the claim on a new legal basis based on notices given by reference to a different legal basis.”

It is important to note that the arbitrator’s award determined that for the loss and expense claim to be brought under the ground conditions provision rather than in reliance on the variation represented a new and different legal basis.

The judge decided that the arbitrator’s conclusion was misguided because it failed to give effect to the express wording of clause 21. Importantly, the clause contained the following provision:

“21.2.    If the Sub-Contractor wishes to maintain its right to pursue a claim for additional payment or loss and expense under Clause 21.1, the Sub-Contractor shall as a condition precedent to any entitlement, within twenty eight (28) Days after giving of notice under Clause 21.1, submit in writing to the Contractor:

21.2.1.  the contractual basis together with full and detailed particulars and the evaluation of the claim…”

The judge concluded that it was clear from clause 21.2.1 of the contract that Bauer was specifically required to give details of the contractual basis of the claim. Therefore, a notice that referred to a variation being the contractual ground could not be interpreted as a valid notice for a claim based on unforeseen ground conditions.

Many will find the judge’s analysis overly technical and the effect very harsh. The logic is, in many ways, hard to question. But the purpose of such provisions is to give the employer, or main contractor, notice of events giving rise to a claim so it can take remedial measures. The precise legal ground relied upon is unlikely to have any effect on how the employer would react to the notice, even if the relevant clause requires this information to be provided. In this case, unforeseen ground conditions was the event which then necessitated undertaking the variation. They were therefore simply two sides of the same coin.

Valuation Issue

The second point forming the grounds for appeal was the valuation of a variation. The variation in question was the deferment of certain work on the diaphragm wall and the arbitrator’s valuation included the standby costs of plant and equipment.

The contract stated that valuation should be on the basis of “a fair and reasonable rate or price” and according to the JV the arbitrator had been in error because he had included sums in the valuation that Bauer had not actually incurred. The dispute boiled down to whether “a fair and reasonable” valuation should be assessed by reference to the costs that the contractor has actually incurred or by reference to the market price. The judgment helpfully brings together a number of passages from English cases and the commentary from leading textbooks dealing with the point.

Taken together, the passages referred to in the judgment indicate that the courts typically take the view that a fair and reasonable valuation does not require the contractor to establish its costs. The valuation will typically be based on establishing what a fair and reasonable price would be, which may be quite different from what the contractor actually spent in carrying out the change.

The following passage from the judgment in Laserbore Limited v Morrison Biggs, quoted in the Hong Kong High Court judgment, illustrates the difficulties that would arise if one used the costs based valuation method:

“I am in no doubt that the costs plus basis… is wrong in principle even though in some instances it may produce the right result.  One can test it by example… If a contractor provides two cranes of equal capacity and equal efficiency to do an equal amount of work, should one be charged at a lower rate than the other because one crane is only one year old but the other is three years old?”

The judge in the Maeda case emphasised that the arbitrator had received and considered the evidence before making his valuation of the fair and reasonable rate, without regard to actual cost. The judge did not come to a fixed conclusion as to whether the cost-based or market-based approach was correct. But she concluded that it could not be said that the arbitrator had misdirected himself because on a review of the authorities his decision was permissible in the context of the solutions open to him.

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