INS IGHT

OCT OB E R 10, 2014

The value of work not carried out

Written by Rachel Chaplin - First published in Construction Law

Construction contracts generally offer rules for valuing work carried out pursuant to the
contract by reference to contract documents, such as bills of quantities or schedules of
rates. Where the work is additional, or varied, and falls outside the original scope, it may
be valued by reference to similar items within the contract scope, or where no similar
items exist, by reference to what is fair and reasonable.

But what about situations where the work to be valued has not been carried out, either because it has not been
satisfactorily completed, or because it has been omitted, and therefore falls to be deducted from the overall
contract price? There have been a couple of court decisions recently which have considered the valuation of work
which wasn't carried out as envisaged by the contract.

The Mul v Hutton Construction decision

In Mul v Hutton Construction Ltd [2014] EWHC 1797 (TCC), the TCC (Akenhead J) considered what constituted
an 'appropriate deduction' in the context of cl 2.30 of the JCT Intermediate Form of Contract 2005 (which has not
been amended in the 2011 edition) which deals with defects or faults not made good.

The project in question was a substantial extension and refurbishment to an existing home, with a contract sum
of just over GBP 3 million. Work on site started on 6 May 2008, and practical completion was certified on 14 May
2010. However, the certificate of practical completion attached a long list of incomplete or defective items, which,
whilst not unusual, is not ideal (in principle only 'de minimis' items should be outstanding if practical completion is
to be certified), causing the judge to note that the practical completion that was certified was not of the type
envisaged by the contract conditions. A final sum of GBP 4,050,000 was certified, but a review of incomplete or
defective work compiled as the end of the rectification period approached produced 20 pages of schedules
identifying numerous items which were alleged to be still incomplete or defective which Oksana Mul (Mul) wished
to have remedied by others in order to be able to occupy the property. Hutton Construction Ltd (Hutton) attributed
a number of these to shrinkage as the property had remained unheated for a period.

Mul eventually issued proceedings a couple of years later in October 2013, with a claim of over GBP 1 million in
respect of the alleged defects. Hutton responded that Mul would only be entitled to make the 'appropriate
deduction' referred to in cl 2.30 of the JCT Intermediate Form. Clause 2.30 provides as follows:

'2.30 Any defects, shrinkages or other faults in the Works or a Section which appear and are notified by the
Contract Administrator to the Contractor not later than 14 days after the expiry of the Rectification Period, and
which are due to materials or workmanship not being in accordance with this Contract, shall at no cost to the
Employer be made good by the Contractor unless the Contract Administrator with the consent of the
Employer shall otherwise instruct. If he does so otherwise instruct, an appropriate deduction shall be made
from the Contract Sum in respect of the defects, shrinkages or other faults not made good.'

The court decided that as a preliminary issue, it should decide how the 'appropriate deduction' was to be
calculated by reference to the following factors:

The contract rates/priced schedule of works/specification; or

The cost to the contractor of remedying the defect (including sums paid to Hutton's third party
subcontractors); or

The reasonable cost to Mul of engaging another contractor to remedy the defect; or

The particular factual circumstances and/or expert evidence relating to each defect and/ or the proposed
remedial works.

Mul's view was that it should not be limited or confined by reference to the contract rates or prices, and that an
appropriate deduction should be what is appropriate in all the circumstances. Hutton's view was that the valuation
of any work not made good must be by reference to the rates or prices in the priced document, as it was being
denied its contractual right to carry out the remedial work.

Akenhead J considered the hypothetical situation where there was no rectification period, and the fact that Mul
would have the right to claim damages subject to the usual rules of causation, remoteness, foreseeability and
mitigation. In particular the judge could foresee circumstances where it might be perfectly reasonable for an
employer not to allow the contractor to return, for example, where the contractor had indicated it had no intention
of returning to put the defects right, or where there had been fraudulent behaviour on the part of the contractor. In
those circumstances it would be appropriate for the employer to be able to recover the cost of employing others to
remedy the defects and not be limited to the amount it would have cost the contractor (which will often be
significantly less than bringing in new workmen).
The judge considered that 'appropriate deduction' was a relatively neutral term, justified by commercial common
sense, given that there might be valid reasons why an employer would not want a contractor to return to site. He
also noted that it would be easy to spell out what the appropriate deduction should be, if the prevailing
circumstances were not to be taken into account.

Accordingly the court held that 'appropriate deduction' under cl 2.30 means a deduction which is reasonable in
all the circumstances, calculated by reference to any of the factors noted above, and possibly other factors also.
Although Mul has been successful on the preliminary issue, she will still need to prove at trial that she acted
reasonably in employing others to complete the works, and that she mitigated her loss.

As with defective work, the valuation of variations is often a source of disagreement when parties are trying to
agree the value of the contract works. Variations of course normally encapsulate changes to the works that have
arisen during the course of construction, or additional works that did not form part of the original scope. However,
there has been a tendency more recently (particularly in PFI contracts) to use variations to omit works from the
original scope, rather than add them.

The Hjgaard ruling

In MT Hjgaard v E.On Climate and Renewables [2013] EWHC 967 (TCC) the Court of Appeal had to consider
how to value work which was omitted using a variation. The contract involved the design, manufacture, delivery
and installation of 62 monopiles to an offshore wind farm, with a value of EUR 100 million. Of this, EUR 26 million
related to the installation, which was to be done using a barge. The barge provided by M T Hjgaard (Hjgaard)
was inadequate and kept breaking down.

It was eventually replaced with a free issue barge supplied by E.On. The replacement barge ultimately installed
60 of the 62 piles. Whilst substitution of the barge was clearly a necessity, the manner of its substitution in
contractual terms was not ideal. Three variation orders were issued for consecutive periods instructing use of the
replacement barge to mitigate delays to the works.

A dispute arose when the parties failed to agree how to value the variation orders which omitted the original barge
and substituted the replacement vessel. The contract included a relatively standard variation clause which
provided, in the absence of agreement:

For an adjustment by reference to the Schedule of Rates (SOR).

Where the rates within the SOR were not directly applicable, the engineer should establish suitable rates
reflecting the pricing in the SOR.
Where there were no rates in the SOR, the amount should be what was in all the circumstances reasonable.

Hjgaard submitted the valuation should be based on the original contribution of the omitted work to the contract
price. E.ON submitted that the engineer should carry out a theoretical calculation based on what would have
been a reasonable sum for the work, adjusted to take account of the length of time it would have taken using the
original barge. The resulting figures were Hjgaard's EUR 12.9 million as compared to E.On's EUR 57 million.
The Court of Appeal viewed E.On's approach as an attempt to gain a contractual remedy for what was effectively
a breach of contract. It was E.On's choice to omit the works; they could equally have relied on the application of
damages for delay, or a default notice, or left it to Hjgaard to source an alternative barge.

By using a variation, Hjgaard had been relieved of its obligation to pay for the original vessel, and any exposure
to damages for delay. In valuing the omission, the court noted that there is a 'fundamental' difference between
valuing omitted, rather than added, works, because the omission forms part of the contract and therefore is part
of the contract price, whereas an addition is not already embraced within the contract price. The Court of Appeal
held that because Hjgaard had agreed to carry out the works for a fixed price they had assumed pricing risk of
the contract, and therefore if the installation work was wholly omitted the whole of the price properly attributable to
that work should be omitted.

In preferring Hjgaard's approach, the court noted that the logical conclusion of E.On's approach would be that
omitting, for example, half the works could result in a 100% deduction if the time taken to carry out that
proportion of the works was in fact so long it justified a valuation equivalent to the whole contract price.

Both of these cases are interesting because they reflect industry practices which are not necessarily unusual, but
problematic in terms of contract administration. It is not unusual for lengthy lists of defects to be attached to a
certificate of practical completion, because the employer wants to gain access to the property. Once a final
certificate is issued, the employer will want to deduct the value of any outstanding defects as it no longer has the
right to require the contractor to remedy them. However, the contractor will seek to argue, in order to minimise
deductions from its account, that the items are not defects or that they have arisen, for example, as the result of
subsequent fit-out works. Resolution will normally require a fair degree of compromise on both sides.

The Hjgaard case is a salutary reminder of the pitfalls of omitting work from a contract, and also that using the
variation procedure to address what is effectively a breach of contract may deprive a party of remedies which
would otherwise have been available to it. Variation clauses are not generally designed to deal with omission of
work, and as a result E.On was deprived of its remedy for delays. It could, of course, have been even worse for
E.On for example omitting work from a contract and then awarding it to another party may constitute a
repudiatory breach of contract, which would permit the contractor which had the work omitted from its contract to
treat the contract as terminated and claim for damages including loss of profit.

A useful reminder

Although both cases offer helpful guidance on how to value work that has not been completed under the
contract, or not carried out at all, they also serve as a useful reminder of the importance of prudent contract
administration, and in particular the importance of appreciating the potential consequences of adopting a course
of action which falls outside the express provisions of the contract.

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