Background
This dispute concerned five Engineering, Procurement and Construction (“EPC”) contracts for the design and construction of solar generation power plants in the south of England.
The claimants (“GPP”) were special purpose limited liability partnerships and were together or individually the Employers under each of the EPC contracts. The defendant was the Spanish parent company of the named contractor for all five of the EPC Contracts, Prosolia UK Ltd. The defendant was also party to four of the five EPC contracts as guarantor for the contractor’s obligations.
GPP’s claims were to recover liquidated damages for Prosolia’s failure to commission the solar plants by the date specified in each contract.
By the time proceedings were commenced, the contractor had become insolvent and thus the claimants sued Solar as guarantor and/or indemnifier under four of the EPC contracts. Solar counterclaimed for the balance of the sums it asserted were due under all five EPC contracts.
The issues for the High Court to determine included, amongst other more fact-specific issues, the following:
(1) Did the liquidated damages clause in each of the EPC contracts constitute an unenforceable penalty?
(2) Did GPP’s entitlement to liquidated damages survived termination of the EPC contract by GPP?
(3) Was Solar was liable as an indemnifier or as guarantor, and was any such liability discharged such that no damages were payable by Solar?
Liquidated damages and the rule against penalty clauses
The judgment considers and applies the Supreme Court decision in Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67. It was common ground between the parties that the obligation to pay liquidated damages was a secondary obligation arising on non-performance of the contractor’s primary obligation to carry out the works and therefore the clause was capable of constituting an unenforceable penalty.
The crux of the issue between the parties was therefore whether the obligation to pay liquidated damages in each case was “out of all proportion” or “exorbitant or unconscionable” (see Lords Neuberger and Hodge respectively in Cavendish Square). The judgment serves as a helpful touchstone for the factors that a Court will address when seeking to determine this issue.
In finding that the clause did not constitute a penalty, the High Court noted that liquidated damages clauses were commonplace in construction contracts and that all parties were experienced and sophisticated commercial entities. This approach to judicial non-intervention in commercial contracts follows the trend of recent decisions in the law of contract, such as Persimmon Homes v Ove Arup [2017] EWCA Civ 373 on the contra proferentem principle.
It was also held that the fact that the underlying loss which the fixed sum liquidated damages sought to address might fluctuate (for instance where the plant would have operated sub-optimally during the first weeks of operation) was not a reason to consider the clause a penalty. The judgment therefore reinforces that the purpose of such liquidated damages provisions is to provide certainty for both parties as to the consequences of a failure to deliver a project on time and does not merely serve to benefit the Employer.
Liquidated damages following termination
In respect of one of the EPC contracts, Solar argued that GPP’s entitlement to liquidated damages ceased when GPP terminated the contract. The underlying principle of this argument is that upon termination the contractor is no longer able to influence the progress of the contract works in order to make up time, and thus may be liable for liquidated damages for delayed completion in excess of that which would have been incurred but for the termination.
The Court decisively rejected this argument and relied upon the judgment of Coulson J (as he then was) in Hall v Van Den Heiden (No 2) [2010] EWHC 586 (TCC). The reason for rejecting the principle outlined above is that if the contractor is able to escape liability for liquidated damages, the Employer is essentially punished for its decision to terminate the contract and seek to complete the project expeditiously.
In many circumstances, the decision to terminate a contract, especially in large infrastructure projects, is taken as a last resort where a contractor has shown an inability or unwillingness to complete and it would be an unsatisfactory position if the Court were to act in a manner that would delay further the provision of a completed project to the Employer. This decision therefore supports an Employer’s right to terminate and ensures that a contractor is not unduly rewarded for poor performance.
However, the doctrinal basis for this decision can be called into question. It is a principle of contract that termination will discharge a party’s primary obligations. Where the primary obligation to progress and complete works is discharged, it is therefore difficult to see how an employer can have recourse to a secondary obligation to pay liquidated damages, an obligation that is inherently parasitic upon the primary obligations under the contract. The view that liquidated damages clauses cannot be relied upon after termination was endorsed by Edwards-Stuart in Shaw v MFP Foundations and Pilings Ltd [2010] EWHC 1839 (TCC).
As there are now conflicting High Court decisions on this issue, it would be helpful if the Court of Appeal were given an opportunity to provide guidance on an important point of principle.
Liability of parent companies as indemnifier and guarantor
As noted above, Solar was a party to four of the EPC contracts and provided guarantees set out at Clause 6 of the relevant contracts as follows:
”6.1 [Solar] guarantees the due and punctual performance by the Contractor of the Contractor’s duties and obligations to [GPP] under this Agreement.
6.2 If the Contractor fails to observe and perform any of its duties or obligations to [GPP], [Solar] (as a separate and independent obligation and liability from its obligations and liabilities under this Agreement) shall indemnify [GPP] against all loss, debt, damage, interest, cost and expense incurred by [GPP] by reason of such failure or breach and shall pay to [GPP], without any deduction or set-off, the amount of that loss, debt, damage, interest, cost and expense.”
Solar’s defence to GPP’s claims under Clause 6 was that it was a guarantee and not an indemnity, and as GPP had failed to comply with two principles relating to guarantees then Solar’s liability was discharged.
The two principles were relied upon were: (i) the doctrine of “unusual features” that a creditor is obliged to disclose to a surety any contract or other dealing between the creditor and debtor which changes the position of the debtor from what the surety might naturally have expected; and (ii) the rule in Holme v Brunskill that any variation of the underlying contract which is not manifestly insubstantial or incapable of prejudicing the guarantor will discharge the guarantee.
The Court held that, following the trend of the dicta, assumptions and decisions in recent and historic decisions of the Courts, the equitable protections relied on by Solar only apply to contracts properly characterised as contracts of guarantee, and do not apply to contracts of indemnity. However, the extensive review of relevant authorities at paragraphs 127 to 149 identified that the issue of law is “not clearly settled” and it will be interesting to note if this issue is subject to an appeal in due course or is addressed soon in another dispute.
Given the Court’s determination on the principle of the obligations of indemnifiers, the primary issue between the parties was accordingly whether the obligations in Clause 6 were truly guarantees at law, or whether they merely constituted an indemnity for GPP’s losses arising due to a contractor’s breach.
The court concluded that notwithstanding “pointers in each direction”, Clause 6.2 created an indemnity rather than a guarantee. It reached this conclusion on the basis that the clause created a separate and independent obligation, was a promise to “indemnify” and is written in language characteristic of indemnities by being focused on remedying loss rather than containing step-in rights of performance.
The Court further noted that the nomenclature used to refer to a party’s right within a contract is only an indicator of its effect, rather than being conclusive and therefore describing a clause as a “guarantee” is insufficient in and of itself to alter the effect of a clause.
Finally and notwithstanding the Court’s determination on the principles, it is noted that the Court further held that even if it was wrong and indemnifiers were entitled to rely upon the equitable doctrines relating to guarantors, Solar had failed to identify any “unusual features” or any variations that breached the rule in Holme v Brunskill and therefore Solar’s attempts to establish that its liability was discharged failed in any event.
Disputes concerning the effect of guarantee obligations are very common as they require interpretation of the underlying contract as well as a consideration of the conduct during the carrying out of works to consider whether any acts of the parties constitutes a variation sufficient to discharge obligations.
Contractors and parent companies should take notice of this judgment as a warning of the effects of poorly-worded drafting that may give rise to wider obligations than originally intended, and also to note the pitfalls of seeking to negotiate a bespoke contract rather than relying upon the more predictable standard forms.