Assigning a sub-contract on termination: which rights is the contractor giving up?

It is common in construction projects for main contractors to assign the benefit of their key sub-contracts to the employer in the event of contractor default and consequent termination of the main contract. This allows the employer to enforce the rights in the sub-contract against the sub-contractor, including rectification of the works and the performance of particular obligations. Indeed commonly used standard form construction contracts, such as JCT Design and Build, NEC and (as in this case) the IChemE form, include clauses permitting such an assignment of the sub-contract to the employer.

A recent decision in the Technology and Construction Court highlights the potential risks associated with such situations. In Energy Works (Hull) Ltd v MW High Tech Projects UK Ltd, the court found that the nature of the assignment meant that the main contractor could not pursue claims made by the employer against its sub-contractor under the sub-contract. This drastically limited the main contractor’s ability to ‘pass on’ any liability it had under the main contract to the sub-contractor.

Background

In 2015, Energy Works (Hull) Ltd (EWHL) engaged MW High Tech Projects UK Ltd (MW) as the main contractor to design, procure, construct, commission and test a fluidised bed gasification power plant. The main contract incorporated the IChemE Form of Contract for Lump Sum Contracts (Red Book) 2013, with some bespoke amendments. MW entered into a sub-contract, based on the IChemE Form of Subcontract (Yellow Book) 2013, with Outotec for the supply of key elements of the gasification plant. Outotec also entered into a collateral warranty in favour of EWHL.

The main contract was terminated in March 2019 and MW then assigned the sub-contract with Outotec to EWHL.

The parties’ claims

In July 2019, EWHL brought proceedings against MW claiming damages for: (i) the cost of rectifying defects; (ii) delay damages; and (iii) additional costs of completing the works and other losses arising from the termination. MW denied being in default and raised a counterclaim of £46.7 million based on the contractual provisions for payment following a termination for convenience.

MW sought an indemnity from Outotec, claiming it was liable for liquidated damages for delay and defects in the plant.

Issues for the court

Among other things, the court had to consider whether MW had any basis on which it could bring claims against Outotec in light of the assignment of the sub-contract, and in particular:

• Whether the assignment of the sub-contract to EWHL only assigned future rights and/or MW’s accrued (ie/ past and existing) rights. MW asserted that only its future rights were assigned;
• If all past and future rights were transferred, whether the assignment also transferred all past and future liabilities and obligations and took effect as a novation; and
• Whether MW was entitled to recover any of its losses as a contribution from Outotec under the Contribution Act 1978, on the basis that both Outotec and MW were liable to EWHL in respect of the same damage.

Assignment

There was no doubt that the sub-contract was assigned, but what was the effect of this assignment? MW argued that it would be uncommercial for it to be forced to give up all of its rights against Outotec when it may be responsible for causing MW to incur considerable losses.

The court considered the contracts and found that MW’s agreement to assign the sub-contract was an agreement to assign all of its accrued and future rights under the sub-contract. The key provision in the sub-contract (Clause 9.1 (b)) provided that “if so required by the Purchaser under the Main Contract the Contractor may assign the Subcontract to the Purchaser". This was the “natural and ordinary reading of the words used”. The parties could have limited the rights which were being transferred by the assignment, for example, by separating accrued and future rights, but they chose not to do so. Mrs Justice O'Farrell stated: “It is not for the Court to re-write the contractual arrangements entered into by the parties or to impose what it considers would be an equitable and fair commercial bargain by reference to the events that have unfolded”.

Novation

The court considered that when the parties used the word “assign” in clause 9.1 of the sub-contract (which is similar to the wording in some commonly used standard form construction contracts), it must be assumed that they meant what they said and were not referring to novation. Although it is possible, in theory, to consent in advance to novation and even if the reference to assignment could be construed as consent to novation the parties did not agree on the terms of the intended novation and, consequently, there was no novation of the sub-contract.

Contribution from the sub-contractor?

Any claim by MW for contribution or indemnity against Outotec could only be brought under the Contribution Act 1978 which states (in section 1(1)): “any person liable in respect of any damage suffered by another person may recover contribution from any other person liable in respect of the same damage”. The damage for which MW may potentially be liable to EWHL must be the “same damage” for which Outotec is potentially liable to EWHL.

The court considered the three potential heads of loss claimed by EWHL against MW and stated:

• in respect of delay to the project, even though the liquidated damages may be calculated differently or have different caps, MW and its sub-contractor, Outotec, would be liable to EWHL for the same damage. MW could claim contribution from Outotec under the Contribution Act.
• in respect of the termination loss (ie additional costs, if any, of completing the works and associated losses), the court could not identify any provisions under either the sub-contract or the collateral warranty which could form the basis of a claim by EWHL against Outotec in respect of these losses. Accordingly, MW could not claim contribution from Outotec under the Act.
• MW and Outotec had a common liability to EWHL for defective work in the plant. MW could also claim contribution from Outotec in respect of defects.

Going forward

The assignment of a sub-contract by the main contractor upon termination of the main contract may have undesirable and unintended consequences. The main contractor is at risk of liability for claims by the employer without being able to recover its loss from the supply chain. As this decision shows, even claims against the sub-contractor under the Contribution Act 1978 must satisfy the potentially high hurdle of the ‘same damage’ rule, and may be quite limited. The starting point is the wording of the contract and the natural and ordinary meaning of the words. As is this case, the court will not read something into the contractual provisions to achieve greater fairness or commerciality between the parties.

Contractors should carefully consider the assignment provisions in their contracts, perhaps seeking to limit the rights assigned to the employer and protecting their accrued rights, although many employers and funders may resist this approach.