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Keep an eye on the small print

Law Contract

In the first of NCE's regular law articles, the Lovells projects and engineering team introduces the basics of contract law.

To most people outside the legal profession, the law appears to be a baffling system that hinges on a mind-boggling array of highly specific but often equally subjective rules and precedents. Certainly there are many pitfalls awaiting the inexperienced, but the reality is that, armed with a few basic rules, the common problems can be avoided.

With apologies to the cognoscenti, it is worth starting by explaining these basics. For the construction industry these amount simply to contract law and tort. Next month we will tackle tort, but we begin with a rapid explanation of contract law.

Contract law - the basics This important area of the legal system provides a framework of rules to facilitate and regulate deals. It covers everything from domestic purchases to complex corporate transactions but engineers should particularly have in mind the following:

lA contract can be concluded by word of mouth. Don't do it this way - it is a recipe for argument about who said what to whom. Always make clear that there is no deal until it is recorded in a written contract signed by all the parties - there must be two, there can be more.

lThe obligations under a contract depend on express and implied terms. Make sure the written contract contains clear definition of all the commitments, and only the commitments, that each party is making. Set these out clearly avoiding vague and elastic phrases. These will constitute the express terms. A contract should set out what is to be done, when and how. Follow the stated approach; following a different approach can lose the protection of the contract.

lImplied contract terms mainly come from various Acts of Parliament depending on whether goods, services or both are being provided. They set minimum standards. Terms implied as to the standard of services and quality of goods have been around for a long time. It is good practice to cover these issues in express terms in the contract to avoid surprises.

Everyone should be particularly careful about the effects of the more recent Housing Grants, Construction & Regeneration Act 1996 (on payment terms and dispute resolution) and the Contracts (Rights of Third Parties) Act 1999 (potentially giving rights to others to sue the contract parties).

lContracts can be 'under hand' (ie merely signed by someone appropriate on behalf of a party) or a more formal deed (needing special wording and usually requiring two directors - or one and the company secretary - of a company or the partners of a partnership to sign). The key difference is you are usually on the hook for twice as long with a deed (12 years) as under hand (six years).

lIf you fail to do what is required by the contract you are in breach.

You then have to pay the losses suffered by the other parties (damages) unless the contract limits your exposure. Limitations have to be particularly clearly expressed and, broadly, fair.

lCertain types of breach allow the innocent party to terminate and recover damages. It is best to have a provision in the contract defining the circumstances which allow termination.

lInsurance is a vital backup to most contracting arrangements. It is essential to specify clearly who provides it, to what level, who it covers and its effects on liability.

lSadly, you must recognise that you may fall out. Specify clearly how, where and by whom disputes will be resolved (taking account of the Housing Grants etc Act). In the teeth of a major substantive dispute, it is galling to spend time and money arguing about how the dispute should be resolved rather than its merits.

Pitfalls The basics may be obvious but it is chastening how often the courts, adjudicators and arbitrators have to deal with disputes about the basics. Parties who think they have a contract but have not. Parties who have a contract but each thinks it says something or contains something it does not.

Parties who have a contract but it does not apply because of their conduct.

It is worth highlighting some real life examples of people getting the basics wrong.

Handshakes A director of a large UK contracting company was zealously pursuing a contract in the face of keen international competition. He attended a lunch with his client counterpart to discuss the bid, armed with information from colleagues.

Handshakes were clasped before dessert. The director, reporting by phone to his office, learned that his estimator had under priced a major subcontract component.

Returning to the lunch table he told his American client that the deal was off. The client gave the contract to a competitor. Although nothing was signed and loose ends remained to be tied up, the UK company had to pay US$1M for breaking the contract effected by the handshake.

Exchanging letters An architect was keen to be appointed on a large development scheme. He was prepared to do a significant amount of preliminary work on a semi-contingent basis and was aware that procurement rules might ultimately require another architect to be engaged on the final scheme. The client wrote appointing the architect for the preliminary work setting out its version of the contingency payment. This did not give the comfort the architect was seeking, so he wrote back accepting the appointment and enclosing a document setting out provisions that entitled him to greater payment if he did not obtain the final scheme appointment.

Comforted by the document, the architect did a considerable amount of work but did not get the final appointment. Nor did he recover more than the low contingency payment stipulated in the client's letter. His letter did not contradict the terms offered by the client and did not do enough to make the critical document part of the contract. A lesson here: if your contract is to be contained in letters rather than a more formal written document it is better to set out everything in one letter and get the other party to countersign a copy. An exchange of different letters can introduce inconsistencies and ambiguities.

Scope of work A contractor went into liquidation leaving unfinished work. The client engaged a new contractor to take over and complete the work. The client thought the new contractor was taking responsibility for the entire project. When defects appeared in the part of the work that the insolvent contractor had done, the client sued the replacement contractor. He failed because the new contract had not clearly placed responsibility for existing defects onto the new contractor. (An arbitrator thought it had done so but the court overruled him). The express terms were not clear enough on this key point.

Excluding liability An IT company supplied computer systems to a manufacturing company. The parties negotiated a compromise contract distilled from their respective standard terms.

These included exclusion clauses which the IT company thought (and priced and insured accordingly) protected it against loss of profits suffered by the manufacturer and against any claim more than two years after it had done something wrong. The systems were hopeless and the manufacturer sued for £23M (including a large chunk for loss of profit) several years after the initial supply. The IT company admitted the system was no good but relied on the exclusion clauses to reduce the amount it had to pay. The court applied standard legal rules (which reduce the effect of exclusion clauses unless they are very clearly worded) and referred to the Unfair Contract Terms Act 1977 (which can reduce exclusion terms' effectiveness even if clearly worded). The result was that the IT company remained exposed to the full £23M.

Terminating a contract A contractor received a payment certificate showing an amount that had clearly been wrongly calculated by the client's certifying consultant. The contractor pointed this out to the client and demanded payment of the correct amount. The client refused. The contractor took this as a refusal by the client to comply with the contract which entitled the contractor to terminate so he left the site. The client took the contractor's departure as reason for him to terminate so he engaged another contractor to finish the work. Both parties thought they had justifiably terminated but the contractor had not. He had lost the right to further payment and was exposed to the extra costs of the completion by the new contractor. He had not read the contractual termination provisions carefully enough and did not follow the rules.

Recent cases involving contract law Barry Urquart v East Surrey Brama Brown & Root v Aramark CJ Pearce Developments v Oakbridge I-Way v World Online Stuart v Balme For details and Lovells case studies visit www. nceplus.co.uk/legal Next month: To r t

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