Highlights from recent court decisions of interest to those managing risk in construction projects.

• The Court of Appeal reinforces the penalty test established in Cavendish v. Makdessi
• What does "reasonable endeavours" mean in the context of force majeure clauses?
• A collateral warranty is not a construction contract
• Collaborative contracting in the UK construction industry
• English Contract Law Updates

The Court of Appeal reinforces the penalty test established in Cavendish v. Makdessi

Houssein & Ors v. London Credit Ltd & Anor [2024] EWCA Civ 721 involved an appeal from the decision of the first instance judge who had found that a default interest provision was a penalty and therefore unenforceable. The decision was appealed and the Court of Appeal subsequently found that the judge had not applied the correct test as laid down by the Supreme Court in the landmark decision on penalties: Cavendish Square Holding BV v. Talal El Makdessi; ParkingEye Limited v. Beavis [2015] UKSC 67. This test was summarised by Fancourt J in Vivienne Westwood v. Conduit Street [2017] EWHC 350 (Ch) (paragraph 41):

"… The Cavendish case shows clearly that, in considering whether a contractual stipulation is or is not a penalty, one must address first the threshold issue – is a stipulation in substance a secondary obligation engaged upon breach of a primary contractual obligation; then identify the extent and nature of the legitimate interest of the promisee in having the primary obligation performed, and then determine whether or not, having regard to that legitimate interest, the secondary obligation is exorbitant or unconscionable in amount or in its effect."

You can read more about the decision in the Cavendish case here: Supreme Court unshackles the rule on penalties.

In Houssein, Lady Justice Asplin, having concluded that the first instance judge had not applied the correct test and acknowledging that "the outcome of this appeal is complicated", decided that:

"The question of whether the default rate of interest is a penalty must be remitted to the first instance judge to decide on the basis of the entirety of the evidence which he heard and applying the correct test. If he concludes that there is no penalty, the default rate of interest will apply from the Repayment Date".

The Lord Justices also gave their views on what interest rate would be payable if the contract rate was found to be a penalty. They analysed the contract to ascertain what the parties had agreed. In this case, the contract provided that the contract rate came to an end after the repayment date, meaning that no interest was payable (save for the statutory / equitable entitlement to interest which would have to be counter-claimed). As Professor Edward Peel noted in his English Contract Law Update in July 2024: "this may have come as a surprise to lenders".

In brief: Houssein provides a useful summary of the principles in Cavendish v. Makdessi (as applied in other key decisions) on determining whether a contract remedy is a penalty. Think carefully at the outset of a project about which and what level of remedy to include in your contracts.

What does "reasonable endeavours" mean in the context of force majeure clauses?

In RTI Ltd v. MUR Shipping BV [2024] UKSC 18, the Supreme Court delivered its long-awaited decision on what was meant by "reasonable endeavours" in the parties' force majeure clause. In this case, the parties to an affreightment contract were affected by sanctions imposed in the US. This meant that payment in US dollars could not be effected as required by the contract. The shipowners served a force majeure notice in response to which the charterers' offered to pay in Euros and be responsible for the difference in the conversion rate to dollars. The shipowners, however, rejected this offer and insisted on their entitlement to suspend performance.

In the subsequent arbitration, the arbitrators held that the shipowners could not rely on the force majeure clause in circumstances where the payment issue could be overcome by reasonable endeavours – in this case, by the shipowners accepting the charterers' proposed solution of payment in Euros.

On appeal, Jacobs J rejected the arbitration award on the basis that allowing flexibility of approach in such scenarios would lead to contractual uncertainty. If a contract payment term could be adjusted in this way to get around a relatively straightforward force majeure event, where might the potential for flexibility end?

Jacobs J's decision was referred to the Court of Appeal who were themselves divided on the issue. On further appeal to the Supreme Court, the Lords agreed with Jacobs J. as follows:

• the object of reasonable endeavours provisos must be kept in mind. The relevant question is whether reasonable endeavours could have secured the continuation or resumption of the contract's performance as agreed – and not a different performance as substituted by the parties;
• the principle of freedom of contract is fundamental to the English law of contract;
• clear words are needed to forego valuable contractual rights (if you want to have the option to adjust the contract, you must ensure the contract wording is explicit); and
• the importance of certainty in commercial contracts.

In brief: "reasonable endeavours" to overcome a force majeure event does not include an obligation to accept an offer of non-contractual performance. If you want contractual flexibility: provide for it at the outset (but exercise care in the drafting!).

A collateral warranty is not a construction contract

Last but not least, the Supreme court gave its long-awaited decision in Abbey Healthcare (Mill Hill) Ltd (Respondent) v. Augusta 2008 LLP (formerly Simply Construct (UK) LLP) [2024] UKSC 23. The decision addresses the issues of whether a collateral warranty could be a "construction contract" for the purposes of the Housing Grants, Construction & Regeneration Act 1996 Act (as amended) and whether adjudication could therefore be used to resolve disputes. The issues in the case were complex but the key points of the decision were summarised by Kirsti Olson in her recent article: Adjudication and collateral warranties as follows:

"A collateral warranty will not be an agreement for the carrying out of construction operations if all that it contains is a promise to perform obligations owed to someone else under a separate contract. To be a construction contract, a warranty would have to contain a separate or distinct obligation to carry out construction operations for the beneficiary. It is not a construction contract if it is merely derivative i.e. one that derives from and mirrors the obligations already set out in the building contract."

You can read more about the implications of the Abbey Healthcare decision for ADR in Kirsti's article.

In brief: a collateral warranty is not a construction contract for the purposes of the Housing Grants Regeneration and Construction Act 1996 (as amended) if it only contains a promise to perform obligations owed to someone else under a separate contract.

Collaborative contracting in the UK construction industry

In his recent article, Collaborative contracting in the UK construction industry*, Mark Macaulay welcomes the shift from the UK construction industry’s traditional adversarial relationships to collaboration and a more integrated and co-operative approach. While some standard form contracts have some way to go before they can be regarded as truly collaborative, Mark notes that:

"This transition has been influenced by various reports, contractual frameworks and industry initiatives that have recognised the benefits of collaboration in delivering successful construction projects."

Read more here.

(*First published in Construction Law.)

English Contract Law Updates

Highlights from two of the cases dealt with above (Houssein and RTI Ltd) were addressed by our guest speaker, Professor Edward Peel, in his English Contract law update on 4 July 2024. Professor Peel's webinars are scheduled twice a year. To attend future sessions, please get in touch with one of the Key Contacts.

Key Contacts

To discuss any of the issues raised by the above cases, get in touch with one of the Key Contacts.