REUTERS | Alex Domanski

Keeping the (good) faith: discretion advised

A case of two halves

In our last blog Katy Saunders said farewell to the World Cup whilst also discussing key personnel LDs, in Bluewater Energy Services Limited BV v Mercon Steel Structures. While any mention of liquidated damages in the TCC sparks almost as much water cooler chatter as Luis Suarez’s appetite, this post discusses another interesting outcome from Bluewater.

Bluewater also tackled the issue of a party’s right to exercise discretion, and comments on how a good faith clause might affect such a right. With good faith clauses becoming more commonplace in construction contracts, it is important to consider their effect on how we interpret the contract as a whole.

Good faith and discretion in Bluewater

Under the contract in Bluewater, Mercon had to “claim a Variation” if it was seeking additional payment or an extension of time. The contract also provided that, if Mercon did not submit records and accounts when making a claim, Mercon’s entitlement to additional time and costs could be forfeited “at the sole discretion of Bluewater”.

The court decided that Bluewater’s right to exercise this discretion was limited by common law concepts of “honesty, good faith and genuineness and the need for absence of arbitrariness, capriciousness, perversity and irrationality” as set out by the Court of Appeal in Socimer International Bank Ltd v Standard Bank London Ltd.

Ramsey J also considered clause 33.1 of the contract, which provided that the parties would:

“uphold the highest standards of business ethics in the performance of the CONTRACT. Honesty, fairness and integrity shall be paramount principles in the dealings between the parties.”

Ramsay J stated:

“Whilst I do not consider that this limitation [in Socimer] depends on the presence of clause 33.1 of the Contract, which in this respect is unpleaded, the implied limitation where a decision is left to the subjective view of one of the parties to a contract is consistent with that provision of the Contract and, in my judgement applies in this case”.

The decision goes out of its way to confirm that the “good faith” clause in the contract would apply and is consistent with the Socimer discretion principles. Given the Court of Appeal decision in Medirest, this may seem somewhat surprising.

Bluewater and Medirest

In Medirest, the Court of Appeal overturned the High Court’s decision by holding that a customer was not subject to an implied term to refrain from exercising a contractual decision in an arbitrary, capricious or irrational manner where the discretion consisted of a decision whether to exercise an absolute contractual right. The court decided that contractual discretion would only be limited by the Socimer principles where exercising discretion involved an assessment or a choice as to a range of options, in which the interests of both parties were relevant. In addition, the good faith clause in Medirest was construed narrowly to apply only to specific obligations mentioned within the good faith clause itself, and not universally across other contract terms.

Under its contract with Mercon, Bluewater arguably did not have to make an assessment or choice over a range of options. If Mercon failed to back up its claims with records and accounts, Bluewater could (if it wanted to) forfeit Mercon’s rights to additional time and cost.

It is not easy to see the difference between Bluewater and the Medirest case on the discretion point. The words “at the sole discretion of Bluewater” don’t appear to be intended as a licence to be capricious. Indeed, quite the opposite: they appear to be a genuine, if misguided, attempt to allow Bluewater to waive the condition precedent if it wished. In other words, they were included to soften the perceived harshness of the “shall forfeit” wording.

It is a simple contractual right, exactly analogous to that in Medirest. On that analysis, it is no more an “abuse of discretion” for Bluewater to rely on the condition precedent than for the client in Medirest to invoke the termination provisions. Therefore, the Bluewater analysis could be construed as going against the Court of Appeal in Medirest by applying limitations to an express contractual right.

However, Ramsey J preferred to temper Bluewater’s “sole discretion” on the basis that, unregulated, it could be open to abuse, with Bluewater able to reject Mercon’s claims at will for its own benefit:

“It would clearly be an abuse for Bluewater to reject a request for variation or to seek to forfeit Mercon’s rights to additional payment for an extension of time, merely because the information was not given without delay or some information was missing…”

Surely this is the intentional effect of any condition precedent notice requirement, such as FIDIC’s clause 20.1?

Don’t say it unless you mean it

So what we can take away from Bluewater? Parties need to clearly distinguish between an absolute right and a right to exercise a discretion. Bluewater suggests that any mention of the term “discretion” is likely to attract further regulation from common law. A party always has the right to waive a condition precedent. Adding the discretionary element to this clause served only to undermine Bluewater’s position.

It is also becoming more apparent that general good faith clauses will bite in certain circumstances. Perhaps less so at the “business end” of proceedings such as termination (see TSG Building Services plc v South Anglia Housing Ltd), but good faith clauses have a natural relevance to issues of where discretion is exercised.

While working on an NEC dispute, a client once said to me “it’s mutual trust and co-operation until someone has to put their hand in their pocket”. Although a tongue-in-cheek comment, this view of good faith clauses is not uncommon in the construction industry.

After Bluewater, my advice would certainly be: don’t say it unless you mean it.

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