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January 26, 2012 | Adjudication, Construction Contracts, Dispute Resolution

Are contractors and sub-contractors subject to an implied obligation to proceed regularly and diligently with their works?

Can a withholding notice be valid if the information it is based upon has no contractual effect?

Are cost clauses in adjudication enforceable following the new Construction Act?

The recent case of Leander Construction Limited v Mulalley & Company Limited has provided important guidance on a number of keys issues.

The Facts

Leander was appointed by Mulalley as a sub-contractor to provide groundworks at a development in Lewisham. The sub-contract, which was on Mulalley’s standard terms and conditions, contained a date for commencement and completion of the sub-contract works, but it contained no provisions to deal with the interim progress of the sub-contract works.

Mulalley valued the sub-contract works at £131,078.12, but served a withholding notice on Leander stating that it was withholding the outstanding amount due to Leander’s failure to proceed with the sub-contract works in accordance with an Activity Schedule it had provided.

Leander applied to the Court seeking a declaration that Mulalley’s withholding notice was invalid as the Activity Schedule had not been incorporated into the sub-contract.

Before the hearing, the parties agreed that the Activity Schedule had not been incorporated into the sub-contract. However, Mulalley argued that the withholding notice was still valid as Leander was under an implied obligation to proceed “regularly and diligently” with the sub-contract works and had failed to do so.

Leander argued that it was not under an implied obligation to proceed regularly and diligently with its works, and even if it was under such an obligation, the withholding notice was invalid as it relied upon an Activity Schedule which had not been incorporated into the sub-contract.

An Implied Obligation to Proceed “Regularly and Diligently”

The Court stated that it would only imply a term requiring Leander to proceed regularly and diligently with the sub-contract works if it met the following criteria for implying terms into contracts:

  • the implied term must be reasonable and equitable;
  • it must be necessary to give the contract “business efficacy”;
  • the implied term must be so obvious “that it goes without saying”;
  • it must be capable of clear expression; and
  • it must not contradict any other clause of the contract.

The Court held that such an implied term was not needed in this case as the sub-contract “operates perfectly satisfactorily without the implied term”.

The Court’s reasons for its decision were threefold:-

  • Leander had to complete the sub-contract works by the completion date. Implying additional interim progress requirements was unnecessary and unhelpful.
  • The extension of time mechanism in the sub-contract only dealt with delays to the completion date, so if the Court had implied a term that would require completion of each “phase/activity” in the sub-contract works, it would also have to imply several additional terms into the extension of time provisions.
  • A number of express contractual terms, such as the power to issue instructions, allowed Mulalley to control the works. It was unnecessary to imply any term to proceed regularly and diligently because Mulalley could have issued an instruction to increase the speed of the sub-contract works if it had wanted to do so.

The Court also held that a clause which allowed Mulalley to terminate the sub-contract if Leander failed to proceed regularly and diligently with the sub-contract works did not mean there was a separate implied term to proceed with the sub-contract works regularly and diligently. In fact, this termination clause showed that the parties had thought about the consequences of not proceeding regularly and diligently with the sub-contract works and had decided to allow for termination of the sub-contract, not damages.

Withholding Notices

Leander also argued that the withholding notice served by Mulalley was invalid because it relied on Leander’s failure to meet the dates set out in the Activity Schedule, which was not a contractual document.

The Court stated that if Leander had been obliged to proceed regularly and diligently, there would have been nothing wrong with Mulalley using the dates in the Activity Schedule as a way of measuring whether or not the sub-contract works were being performed regularly and diligently, even though the dates in the Activity Schedule were not contractually binding. The problem with the withholding notice was not its reliance on the Activity Schedule, rather that it was based on the incorrect assumption that Leander had to proceed regularly and diligently.

Are Costs Clauses In Adjudication Enforceable?

Although it was not part of the dispute between the parties, the Court noted that the sub-contract contained a clause which required the referring party in any adjudication to pay both parties’ costs and expenses. As costs clauses such as this go against the “spirit” of adjudication, Parliament sought to outlaw them when it drafted the amendments to the Act, which came into force on 1 October 2011.

The relevant amendment (section 108A of the Act) states that any contractual provision which deals with the allocation of costs and expenses between the parties to an adjudication will be ineffective unless that clause:

  • is in writing;
  • is contained in the construction contract; and
  • allows the adjudicator to allocate his/her fees and expenses between the parties.

However, the wording of this section is ambiguous and there has been much debate about whether it would effectively ban adjudication cost clauses.

The position has been clarified somewhat by the Court in this case, as the Judge commented that adjudication costs clauses in contracts are now “automatically invalid” as a result of the amendments to the Act.

However, the Judge’s comments on this point are not binding as the matter was not part of the dispute between the parties. This means another Judge may come to a different conclusion with regard to costs clauses in a subsequent case. Nevertheless, it is helpful guidance as to how the Courts may proceed with costs clauses in light of the amendments to the Act.

Summary

The Court’s decision makes it clear that generally there is no implied obligation to proceed regularly and diligently. The Court held that it would only imply such a term where it was necessary for the contract to work. It is difficult to imagine a case where such a clause would be necessary.

This decision highlights that to be effective a withholding notice must be based upon a clear contractual term.

Although the comments of the Judge in this instance are not binding on the costs issue, they do provide welcome clarity on the validity of adjudication costs clauses in light of the amendments to the Act. Whether the Judge’s comments will be followed in other cases remains to be seen.

 

 

This article contains information of general interest about current legal issues, but does not provide legal advice. It is prepared for the general information of our clients and other interested parties. This article should not be relied upon in any specific situation without appropriate legal advice. If you require legal advice on any of the issues raised in this article, please do not hesitate to contact one of our specialist construction lawyers.