Acceptance testing and the deferral of termination rights

A recent TCC decision has considered the ability of an employer to defer exercising rights of termination in the event a contractor fails to satisfy acceptance testing criteria. It is often assumed that, in the absence of an express time limit, rights of termination must be exercised within a reasonable time. Such an implication was rejected in this case, allowing the employer a free hand in encouraging the contractor to continue work on acceptance testing whilst maintaining its right to terminate. The judgment also considers the implication of other terms, including a general obligation to act in good faith.

Essex County Council v UBB Waste (Essex) Ltd

Essex engaged UBB to carry out the design, construction, financing, commissioning, operation and maintenance of a mechanical biological waste treatment plant in Basildon (the “MBT Facility”). Pursuant to the terms of the contract, the MBT Facility was required to pass certain Acceptance Tests on or before the extended Planned Services Commencement Date of 12 July 2015. However, the MBT Facility failed to pass the Acceptance Tests by that date and still had not passed them by the Acceptance Longstop Date of 12 January 2017, thereby giving Essex a right to terminate the contract.

The matter came before the Technology and Construction Court in May 2019. At that time, the MBT Facility still had not passed the Acceptance Tests and Essex sought damages and a declaration that it was entitled to terminate the contract. UBB denied that Essex was entitled to terminate the contract. UBB claimed that it was entitled to an extension of time to complete the Acceptance Tests and sought damages in excess of £77 million as well as declaratory and injunctive relief on the basis of alleged breaches of contract by Essex.

The “terminate within a reasonable time” implied term

Essex claimed it was entitled to terminate the contract on grounds that failure to pass the Acceptance Tests by the Acceptance Longstop Date was a Contractor Default. In the event of a Contractor Default, the contract simply required Essex to serve a termination notice. No time limit was prescribed for the service of the notice. UBB argued for an implied term that any notice of termination must be served within a reasonable period and that it was now too late for Essex to give such a notice.

In considering whether to imply a term, the court applied the traditional principles set out in BP Refinery v Shire of Hastings and reaffirmed recently by the Supreme Court in Marks & Spencer v BNP Paribas, in particular the need for an implied term to be necessary to give the contract business efficacy. Justice Pepperall took the view that there was no absolute rule of law that a reasonable time limit must be implied, concluding instead that previous cases merely illustrated occasions on which business efficacy required such a limitation. The court went on to consider the practical effects of the implied term sought by UBB and noted that it was neither “commercial, practical or obvious” to imply a term that could give rise to a situation in which Essex could not terminate, due to delay in exercising the right to do so, but the MBT Facility could not enter the Services Period, due to its inability to pass the Acceptance Tests, leaving the parties in a “contractual stalemate” for the 25 year life of the contract. The court also noted that the implied term would have the effect of discouraging Essex from allowing UBB an opportunity to rectify the issues with the design.

The “object within a reasonable time” implied term

A separate issue between the parties concerned whether it was an implied term of the contract that Essex was required to challenge the results of Composition Tests within a reasonable time. During the commissioning period these tests were carried out by UBB and provided a mechanism for adjustments to be made to allow the Acceptance Tests to be achieved. Looking in detail at the context in which the Composition Tests took place, the general timetable for commissioning and the need for the Acceptance Tests to be passed by the prescribed date, the court took the view that a reasonable time limit was necessary for business efficacy. Clarity over the standing of the Composition Tests was needed to allow UBB to work toward the achievement of the Acceptance Tests.

Relational contracting and the implied term of good faith

One further point that will be of interest to those involved in PFI contracting, particularly long-term contracts, was the court’s finding that the contract was a “relational contract” into which the law would imply a duty of good faith. Referring to the decision of Fraser J in Bates v. Post Office (No. 3), Pepperall J considered that the length and nature of the contract (25 years) required a “close collaborative working relationship” and a high level of communication, and noted that the parties must have intended that they would fulfil their roles with “integrity and fidelity to their bargain” and trust and confidence in each other. The court also noted that the level of investment and the exclusive nature of the contract pointed towards this being a relational contract.

Conclusions and implications

In engineering contracts, failed acceptance tests present the employer with a difficult choice. Is it better to reject the works at the first opportunity and deal with the commercial and contractual fallout that typically follows termination for breach? Or should a prudent employer allow the contractor more time to attempt to meet the tests and face a possible argument that the right to terminate has been lost if not exercised promptly? The decision in this case suggests that more time can be given without the right to terminate being lost. Many of the commercial considerations which led the court to this conclusion will apply to other cases involving Acceptance Tests or Tests on Completion, although the position in any given case will depend on the terms of contract in question.

A different result was reached in a recent Scottish case: David Macbrayne Limited v Atos IT Services (UK) Limited. There, a contract for IT services allowed a right of termination where certain critical milestones were missed. Both parties accepted, and the court also agreed, that a reasonable time limitation should be implied based on the principles in Marks & Spencer. However, in determining that the right had been exercised within a reasonable period, the court took account of the fact that the parties had mutually agreed to suspend performance and to seek to resolve their differences through direct discussions and then by mediation. A notice of termination a few months after the unsuccessful mediation was still within time. This therefore suggests that even if an implied term exists, an employer may still be able to preserve its right to terminate whilst seeking to resolve any acceptance testing issues with the contractor.

Employers should also be alive to the possibility that allowing more time to the contractor may waive rights of termination. For example, an employer is unlikely to be able to terminate if the Acceptance Tests are subsequently achieved before any notice of termination is given. No waiver occurred in this case because the Acceptance Tests remained unsatisfied at the date of the court’s judgment.

Those involved in long-term PFI contracts will also want to bear in mind the court’s finding that this was a “relational contract”. The contract length and the ongoing relationship between the parties, which were both factors in the court’s decision, are common features of PFI contracting and may give rise to future findings that those in the PFI world are subject to duties of good faith that may not exist in other commercial settings.

English law’s approach to implied obligations of good faith in such contracts is a developing area of law. Some cases, such as the present, appear to imply obligations of good faith based merely on the classification of the relationship between the parties. Others (such as the Commercial Court this year in Taqa Bratani v Rockrose) maintain that any implied term must meet the requirements for the implication of terms set out in Marks & Spencer (i.e. be necessary to give business efficacy to the contract or is so obvious that it goes without saying) regardless of how the contract is classified.

References:

BP Refinery (Westenport) Pty Ltd v. Shire of Hastings (1977) 180 CLR 266 (PC).

Marks & Spencer plc v. BNP Paribas Securities Services Trust Co. (Jersey) Ltd [2015] UKSC 72.

Bates v. Post Office (No. 3) [2019] EWHC 606 (QB).

David Macbrayne Limited v Atos IT Services (UK) Limited [2018] CSOH 32.

Taqa Bratani Ltd & Ors v Rockrose UKCS8 LLC [2020] EWHC 58 (Comm).

Essex County Council v UBB Waste (Essex) Ltd (Rev 1) [2020] EWHC 1581 (TCC).