FIDIC Update: Termination and the Employer’s Obligations under the Red Book

By Mike R. Stewart, Mary E. Lindsay, and Nita Mistry, K&L Gates, London

A Privy Council case last year provided some important guidance on the provisions in the FIDIC Red Book in relation to Employer’s financial arrangements and claims.  Whatever your perspective might be, when negotiating or managing a contract based on the FIDIC Books, employers and contractors should be aware of the Privy Council’s findings in NH International (Caribbean) Ltd v National Insurance Property Development Company Ltd (Trinidad and Tobago) [2015] UKPC 37.

The Contract
National Insurance Property Development Company Ltd (Trinidad and Tobago), the Employer, employed NH International (Caribbean) Ltd, the Contractor, to construct a hospital in Tobago under a contract in the form of the FIDIC Red Book.

On 2 November 2006, the Contractor terminated the contract pursuant to Clause 16.2.  The Employer did not agree the termination was valid but the parties proceeded as if the contract had been terminated.  A number of issues arose during the Engineer’s assessment of the work to the date of termination and these matters, including the validity of the termination, were referred to arbitration.

The arbitrator’s decisions in relation to Clauses 2.4 and 2.5 and Clause 16.1 were later appealed first to the High Court and the Court of Appeal in Tobago and then to the Privy Council.

FIDIC Red Book Clause 2.4 and the Privy Council Judgment
Clause 2.4 provides that the Employer “shall submit within 28 days after receiving any request from the Contractor, reasonable evidence that financial arrangements have been made and are being maintained which will enable the Employer to pay the Contract Price … in accordance with clause 14”. Clause 16 allows the contractor to suspend and terminate if reasonable evidence is not provided within certain timescales.

Pursuant to that provision, the Contractor made a request under clause 2.4 for evidence of the Employer’s financial arrangements incuding evidence that the funding for the project had Government approval.  The Employer confirmed that it was able to pay but, when the Employer would not confirm that payment had been approved by the government, the Contractor suspended work.  The Employer later confirmed that  the money was available and that the Contractor would be paid.  However, the Employer still failed to answer the Contractor’s request for confirmation that the government had specifically approved funds.  Consequently the Contractor terminated pursuant to Clause 16.2.

In relation to Clause 2.4, the arbitrator found that, in order to comply with the provisions of the clause, the Employer was required to do more than show “the employer is able to pay” and “was enthusiastic about the project”.  The Privy Council agreed with the arbitrator that the Contractor’s termination of the contract in these circumstances was valid.

FIDIC Red Book Clause 2.5 and the Privy Council Judgment
Clause 2.5 provides that:

1. If an employer “considers itself to be entitled to any payment under any Clause of these Conditions or otherwise in connection with the Contract”, it should, subject to certain specified exceptions “give notice and particulars to the Contractor”;
2. “The notice shall be given as soon as practicable after the Employer became aware of the event or circumstances giving rise to the claim”;
3. “The particulars shall specify the Clause or other basis of the claim, and shall include substantiation of the amount … to which the Employer considers [it]self to be entitled”, that the amount should be assessed by the Engineer, and that it “may be included as a deduction in the Contract Price and Payment Certificates”;  and
4. The amount so determined “may be included as a deduction in the Contract Price and Payment Certificates” but that the Employer should only be entitled “to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this sub-clause”.

Clause 16.4 entitles a contractor to claim loss of profit or other loss or damage suffered as a result of the termination.  In response to the Contractor’s claims under Clause 16.4, the Employer counterclaimed a right to set-off its claims pursuant to the provisions of Clause 2.5.  The arbitrator decided that the wording of Clause 2.5 was not sufficiently clear “to exclude common law rights of set-off and/or abatement of legitimate cross-claims”.  The Employer’s “counterclaims” should be allowed.

The Privy Council, however, disagreed with the arbitrator.  The Privy Council said, at paragraph 38 of the judgment, that the purpose of Clause 2.5 “is to ensure that claims which an employer wishes to raise, whether or not they are intended to be relied on as set-offs or cross-claims, should not be allowed unless they have been the subject of a notice, which must have been given “as soon as practicable””.  Otherwise, if “the Employer could rely on claims which were first notified well after that, it is hard to see what the point of the first two parts of clause 2.5 was meant to be””.

The Consequences for Employers
In its interpretation of Clause 2.4 and of Clause 2.5 the Privy Council decided upon the interpretation that favours best that giving both parties’ full knowledge of circumstances.

For good reason, the Privy Council held that it was not sufficient under a re-measurement contract to simply say that it has access to funds and an intention to pay.  Instead, the employer must, in response to a Clause 2.4 request, provide “evidence of ’positive steps’ on the part of the employer which showed that ’financial arrangements’ had been made to pay sums due under the Agreement”.

An employer’s obligation to give full financial information, as described above, follows the obligation to pay the contract price.  It is ultimately fair that a contractor under a re-measurement contract should be entitled to confirmation and comfort that it will be paid in the event of a variation.  The time period to do so, 28 days, may not be long enough for many employers and particularly so for larger employers who often have complex financial reporting requirements.  It was not enough time for the Employer in NH International (Caribbean) Ltd v National Insurance Property Development Company Ltd (Trinidad and Tobago).  Thought should be given at the outset of a contract as to how an employer will respond to a Clause 2.4 request, if the clause is to remain unaltered.  Alternatively, the parties might consider amending the clause so as to satisfy a requirement for financial information at the outset.

Similarly, the Privy Council was clear that Clause 2.5 applies to any claims which an employer might wish to bring.  In addition, the clause meant that the  employer must make its claim “promptly and in a particularised form” otherwise it will not be able to bring the claim.

The Privy Council noted also that, to allow otherwise and permit claims that were made late, these claims could not be determined by the Engineer.  The Engineer’s function in this regard is linked to the particulars which must be contained within the notice given as soon as practicable.

Again, employers must be wary of delay in making any claims and so should manage the contract so as to be able to make any such claims as soon early as possible.