Sharing the pain: Considerations for joint venture participants
Both contractors and developers often enter into joint ventures to carry out a specific project. It enables parties to bid on larger projects, pool their resources, including specialised knowledge, and spread risk across the participants. The recent Technology and Construction Court (England and Wales) decision in Doosan Enpure Ltd v Interserve Construction Ltd  EWHC 2497 serves as a reminder to participants in construction joint ventures of the potential pitfalls of intra-JV disputes.
Target Cost contracts
Under an NEC 3 Option C Contract, a target cost or price is agreed between the parties which includes the contractor’s estimate of its “Defined Costs” to carry out the works, plus a fee for its costs, overheads and profit. The contractor is entitled to these costs and its fee, less any “Disallowed Costs”, which becomes the final “Price for Work Done to Date”. Upon completion, an assessment is made of the “Price for Work Done to Date” and the target cost, as adjusted, and any cost saving or overrun is allocated according to a predetermined formula, commonly known as a “pain/gain share” mechanism. The parties share in any saving against the target or pay their agreed share of the excess, as the case may be.
Payments from the joint venture account
Doosan Enpure Limited (Doosan) and Interserve Construction Limited (Interserve) entered into a joint venture agreement (JVA) to upgrade the Horsley Water Treatment Works in Northumberland for Northumbrian Water Limited (NWL). NWL and the JV parties entered into a contract based on the NEC3 Engineering and Construction Contract (ECC), including Option C (Target contract with activity schedule).
Throughout the project, the JV parties submitted a consolidated application for payment to NWL, which consisted of a spreadsheet setting out each of the parties’ costs separately. In accordance with the JVA, monies paid under the contract with NWL were held in a joint venture account, to be allocated between the JV parties as interim payments. In practice, those interim payments made no assessment of the pain/gain share under the contract’s target cost mechanism.
A dispute arose between the JV parties part way through the project when Interserve refused to sign-off the release of funds from the joint venture account. The parties disagreed over whether interim payments under the JVA should be made on an actual cost basis or whether they should take into account the potential pain/gain share to be assessed upon completion of the works. Interserve argued that the JVA required consideration of the pain/gain share in relation to each interim payment and, therefore, Doosan had already been paid more than its entitlement.
Doosan sought summary judgment on the basis that the JVA did not permit suspension of payment in this way.
Interim payments under NEC3 Option C
The court first considered how interim payments under the NEC3 contract with NWL operated. Did it permit interim pain/gain share adjustments? The court held that it did not. Clause 53.3 of an unamended NEC3 Option C provides that the pain/gain mechanism can only be applied at completion of the works:
“The Project Manager makes a preliminary assessment of the Contractor’s share at Completion of the whole of the works using his forecasts of the final Price for Work Done to Date and the final total of the Prices.”
The court emphasised that there was no opportunity for NWL to apply the pain/gain share mechanism at an earlier stage.
Pain/gain share adjustments under the Joint Venture Agreement
The court then considered whether the JVA permitted pain/gain share adjustments at an interim stage and in particular looked at clause 8.6 of the JVA, which provided that:
“The parties shall receive interim payments from the JV in reimbursement of the Works Part Costs incurred by each party as shown on the parties’ Interim Cost Statements. Works Part Costs shall be reimbursed in accordance with the principles set out in Schedule 4.”
Each JV party separately submitted “Interim Cost Statements” which formed part of their consolidated application for payment to NWL. The court noted that Schedule 4 addressed what happened at “the end of the project in terms of pain/gain”, but made no specific reference to principles applicable to interim payments.
Clause 8.9 of the JVA also dealt with interim payments. It provided that, where that part of the works for which a JV participant was responsible, was delayed and was likely to delay completion to the contract resulting in potential deduction of damages, the JV Committee could be asked to “suspend or reduce the level of interim payments to the other Party to take account of the anticipated damages.”
The JV Committee had been unable to reach agreement on the suspension of payments. Accordingly, the parties had continued to receive interim payments pursuant to clause 8.6, without taking into account any ‘pain-share’ adjustments.
Interpretation and operation of the JVA
The court considered that the first sentence of clause 8.6 of the JVA was the operative one. It required the full payment from NWL under the head contract to be distributed between the JV parties without any assessment of the potential pain/gain share. Although the court reviewed a number of the JVA provisions, it was unable to establish any agreement to apply the pain/gain share mechanism to the interim payments or that deductions should be made from the interim payments.
The court therefore granted declarations that Interserve had breached the JVA by refusing to authorise the release of interim payments and declared that Doosan was entitled to the release of over £5 million from the joint venture account.
Considerations for JV participants
While this case turns on the precise wording of the JVA, it demonstrates the potential pitfalls of target cost contracting for participants in construction joint ventures. Considerations for parties looking to enter into a joint venture under a target cost contract include:
- Bear in mind the fundamental nature of the NEC Target Cost contract. Under an unamended NEC3 Option C contract, any potential adjustments under the pain/gain share mechanism will only become operative on completion (even where the target cost is exceeded before that time). The parties may agree to amend the standard form to allow pain/gain share adjustments to be made for interim payments, reducing the need to recover certain overpayments upon completion. However, this brings an added and considerable administrative burden to the payment process at each interim stage.
- Ensure the JVA terms are consistent with the construction contract and include an order of precedence provision in the event of inconsistency. The court found here that the terms of the contract with NWL were relevant to the JVA as definitions from the head contract were carried over into the JVA.
- Clearly delineate the works to be carried out by each JV member. Here the JVA effectively provided that, as between each other, each party was liable to the other for satisfactory performance of those works that each party was required to undertake. This arrangement can give rise to disputes where the works to be carried out by each party interface and potentially overlap and where any delay to one JV member's works may adversely impact the works of the other.
- Outline the authority of any JV committee and include efficient dispute resolution provisions to avoid deadlocks so far as possible. In this case, decisions by the JV Committee in respect of payments to the JV parties required the consent of both parties and a unanimous decision of the JV Committee. This type of provision can block decision making, resulting in escalation of the dispute, as occurred here.
A version of this article was published as a blog by Practical Law Construction on 14 November 2019.
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