FIDIC Yellow Book under the spotlight again: beware amendment to the standard forms

Written on 15 Apr 2016

A recent English High Court judgment provides a cautionary tale for contractors accepting draconian amendments to standard form contracts at tender stage – which can come back to bite when it really matters.

Here, significant amendments to the FIDIC Yellow Book meant that an employer was entitled to recover delay damages from a contractor without any prior agreement or determination by the engineer. The same amendments meant that a contractor was unable to prevent a call on a bond by the employer after it failed to pay the delay damages – despite disputed claims for an extension of time. Instead, the courts upheld the established principles regarding on-demand bonds – pay now, argue later.

Background

The FIDIC rainbow suite contracts are the preferred choice for international construction and engineering projects, and are also increasingly used on projects in the UK. They include standardised general conditions with options for particular conditions; aiming to streamline the complexities of contract conditions and achieve balanced risk sharing between the parties. Of course, the standard conditions are often amended – sometimes having been negotiated, but often handed to contractors on a ‘take it or leave it’ basis. This can significantly change the balance of risk between the parties.

J Murphy & Sons Ltd v Beckton Energy Ltd: what was the dispute about?

The contract was based on the FIDIC Yellow Book and related to the design and build of a combined heat and intelligent power plant at Beckton, East London. The plant is to run off waste vegetable oils and tallow as well as leftover cooking oil and food fat collected from restaurants and food manufacturers. It is set to produce a 130 GWH a year of renewable electricity – enough to run 39,000 averaged sized homes.

The contract value was in the region of £70 million. The project had been funded on the basis that all relevant parties provided upfront funding to take it through to the point of taking over. As part of this arrangement, the employer’s lender required, on a non-negotiable basis: (1) a conventional on-demand bond; and (2) that any claim on the bond should not be subject to any kind of restriction or procedure that would give rise to delay in payment of the bond.

In keeping with the lenders’ insistence on an unrestricted on-demand bond, the parties agreed to remove the standard provisions in the Yellow Book which otherwise restricted the employer’s right to call the bond for failure to pay an amount due until after the engineer had made a determination. In particular, the standard prerequisite to follow the contractual claims procedure (clause 2.5) had been removed from the performance security (clause 4.2) and delay damages (clause 8.7) provisions. The interim payment procedure (clause 14.6) had also been amended to remove any involvement on the part of the engineer.

The time for completion of the works was 31 January 2015. The works were 409 days late. The contractor had claimed extensions of time but the engineer had not granted them, on the basis the contractor had not demonstrated any entitlement.

The employer requested the contractor to pay delay damages of c. £8,274,000, said to be payable within 30 days. The contractor failed to do so and was thereby in breach of contract. On 2 February 2016 the employer notified the contractor of its intention to make a demand under the bond for the breach in failing to pay delay damages. The contractor pre-empted that action by applying to the court for:

  • a declaration that it was not obliged to pay any delay damages until after there had been a determination by the engineer; and
  • an injunction preventing a call on the bond.

What did the court decide?

The contractor had argued that the engineer’s determination under clause 2.5 and 3.5 of the contract was a necessary precursor to the call on the bond. It pointed to the draconian consequences of a call on the bond in circumstances where there was a genuine dispute but no recourse to the engineer to settle those disputes prior to a call.

The court, however, held that the central issue was the precise construction of the contract and, in particular, the wording of clause 4.2, which established the requirements for a call on the bond.

After providing some useful guidance on the interpretation of contracts, the court found that the agreed form of contract was substantially different to the equivalent clauses in the standard FIDIC Yellow Book. The lender had required, and got, the security of an on-demand bond. The parties had agreed to amend the contract so that the obligation to pay delay damages arose independently from clause 2.5 and 3.5 and any limitations on the call on the bond were limited to establishing a breach of the contract.

In this way, the court said, the parties had removed one of the key checks and balances through the role of the engineer and had created a very different balance of risk under the contract.

Clause 2.5 of the FIDIC Yellow Book has been subject to judicial scrutiny previously – see NH International (Caribbean) Limited v National Insurance Property Development Limited [Privy Council Appeal no. 0031]. In the present case, the court noted the broad drafting of clause 2.5 but found that, by virtue of the agreed amendments, the right to delay damages under clause 8.7 was not subject to the mechanism set out in clause 2.5 or clause 3.5.

In practice, the parties had divided the claims procedure from a call on the bond. In doing so, the court went so far as to say that the parties’ amendments to the relevant clauses had “not been properly thought out”.

The contractor’s application for a declaration and an injunction was refused. In reaching its decision, the court recognised that there would at some stage be a further accounting in respect of the bond monies. Until then, however, in the event of an allegation made in good faith of a breach of contract which led to a claim for delay damages, the call on the bond could not be prevented.

What does this mean for contracting parties?

The decision is consistent with established principles regarding on-demand bonds (see MW High Tech Projects Ltd v Biffa Waste Services Ltd (2015 EWHC 949 (TCC)) – that the court will not interfere with the call of an on-demand bond unless there has been an obvious fraud or it is clear that the underlying contract prevented the call.

This case emphasises the need to establish whether or not the underlying contract prevents a call on the bond without proper protections. Moreover, it shows the need for parties to be aware that amending a standard form contract may upset the balance of risk and have severe consequences down the line.