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Section 45 Arbitration Act 1996: a little known but useful tool

Secretary of State for Defence v Turner Estate Solutions Limited [2015] EWHC 1150 (TCC): A Case Study

Introduction

This article examines the procedure under section 45 of the Arbitration Act 1996 for referring a preliminary question of law arising in arbitral proceedings to the Court. It also touches on some of the specific issues raised by the questions of law referred to the Court in Secretary of State for Defence v Turner Estate Solutions Limited [2015] EWHC 1150 (TCC).

Section 45

S45 provides two circumstances in which parties may refer a preliminary question of law to the court that arises in arbitral proceedings and substantially affects the rights of the parties; first, if there is agreement and second, where the arbitral tribunal grants permission.

Where there is agreement the court will automatically have jurisdiction to deal with the question of law. Where there is no agreement but the tribunal has granted permission, the court’s jurisdiction is dependent on it being satisfied that the determination of the question is likely to produce substantial savings in costs and that the application was made without delay.

Unsurprisingly, the section 45 procedure is seldom used given that parties are usually content to allow their chosen tribunal to determine any questions of law arising in the arbitration whilst taking the benefit of the privacy and confidentiality that goes with it. However, where there is a question of law on which there is no previous authority or, for some reason, it is felt that the court is better placed to determine the question, s45 is an invaluable and surprisingly little known tool. Moreover, where there is a history of parties challenging decisions made by an arbitral tribunal, using the s45 procedure can be of benefit as the route of appeal from the court’s decision is extremely limited thereby providing the parties with precious finality after the court’s decision.

Background

The dispute between the Secretary of State for Defence (“SSD”) and Turner Estate Solutions Limited (“TES”) arose out of construction works carried out by TES under a Maximum Price Target Cost (“MPTC”) contract.

TES had brought an arbitration to determine the Final Price Payable (“FPP”). There was a disagreement over how the FPP under the contract was to be calculated in circumstances where variations to the work had occurred during the currency of the project but in respect of which no contemporaneous adjustment had been made to the Target Cost or Maximum Price.

Broadly, TES’ case was that as a result of the failure to agree changes contemporaneously it had been deprived forever of the opportunity to beat a target in respect of those changes. It argued that as a matter of construction of the contract, it was impossible for adjustments to be made to the target cost after the end of the design and construction period for the works. TES contended that, as a result of just one change not being agreed, the FPP should be based purely on its actual costs for carrying out the works; in other words, the contract should become a costs reimbursable contract with no need to assess any changes that occurred on the project.

SSD argued that the MPTC provisions in the contract could still be adjusted to account for changes after the passage of the design and construction period. It argued that there was nothing in the contract to support the alternative basis of calculating the FPP suggested by TES.

With the permission of the arbitral tribunal, SSD referred two questions of construction to the Court under Section 45 Arbitration Act 1996 (“s45”) asking, broadly, whether the Target Cost under the contract could still be adjusted to take account of changes and, if not, how the FPP was to be determined pursuant to the contract. TES did not agree to the Court determining the questions of law.

Precedent

Prior to the decision in Secretary of State for Defence v Turner Estate Solutions Limited [2015] EWHC 1150 (TCC), there was only one reported case on s45: Taylor Woodrow Holdings Ltd and Another v Barnes and Elliott Ltd [2006] BLR 377. However, in the Taylor Woodrow case, the parties had agreed that the court should determine the question of law, thereby giving it jurisdiction.

As such, there is little by way of guidance in terms of how the court should determine its jurisdiction in the absence of an agreement.

Thus, in order to determine jurisdiction, Coulson J had to deal with whether the questions referred substantially affected the rights of the parties and whether there would be a substantial saving in costs[1]. His reasoning provides valuable guidance for future cases.

The Jurisdictional Requirements

  • No alternative case: on the face of the pleadings TES had no alternative case which would only leave SSD’s Counterclaim for determination in the arbitration if SSD’s construction of the Contract was correct
  • Preparing to meet several cases: answering the questions up front would prevent the parties from having to prepare for trial on alternative bases

In essence then, when determining his jurisdiction under s45 Coulson J took account of some of the same factors as would be relevant to an application for a preliminary issue in court. 

Substantial saving in cost

For much the same reasons as above, Coulson J was satisfied that there would be a substantial saving in cost. In this regard, the main focus of the Court’s reasoning was on how far answering the questions of law would be determinative of the parties’ respective cases. Again, the absence of an alternative case and the benefit of not having to prepare on two fronts were the key factors.

Interestingly, the wording of section 45 does not require that there be a substantial saving by comparison with the costs that would be incurred if the arbitral tribunal was to determine the questions of law. It merely requires that the determination of the questions is likely to produce a substantial saving in costs generally.

As such, in determining whether he had jurisdiction Coulson J did not consider in any great detail whether asking the Court to answer the questions was likely, in and of itself, to be cheaper than if the arbitral tribunal was to determine them. Nonetheless, he did say that the likelihood of there being an application for permission to appeal from any decision that the arbitral tribunal might make was a relevant factor (albeit of less importance). Of course, getting permission to appeal from a decision of the Court under section 45 is far more difficult, requiring that the question of law be one of general importance or one that for some other special reason should be considered by the Court of Appeal. 

Coulson J’s reasoning on the appeal point was similar to that of the Court in Toyota Tsusho Sugar Trading Ltd v Prolat SRL [2014] EWHC 3649 (TCC) (under sections 32 and 33 of the Arbitration Act 1996). However, this does not necessarily indicate a more interventionist approach from the Court as under section 45 it only ever has to consider whether there would be a substantial saving where the application has, by definition, already been made with the permission of the Tribunal at the request of at least one party.

The Decision on the Questions of Law

TES’ position was that the Change mechanism for adding to the Target Cost under the contract could no longer be operated as a matter of construction of the contract. It therefore argued that it was entitled to payment of all its actual costs at FPP and that the MPTC mechanism did not apply at all. TES contended that this interpretation accorded with business common sense which dictated that where the contractor had lost the opportunity of beating a target for variations it should still be entitled to payment for the changed work on the basis of actual costs.

In fact, the failure to operate the Target Cost is a relatively common occurrence on target cost contracts and the argument that the contractor should be entitled to full costs reimbursement is relatively common too. In a 2011 paper for the Society for Construction Law titled “Do Target Cost Contracts deliver value for money”, Ian Heaphy remarked that:

“It is essential that the Target Cost is ‘maintained’: that changes are agreed as soon as they occur, if not in advance. This enables the target cost to continue to reflect the current scope of the works and allows the gain share/pain share calculation to remain valid. Unfortunately, in practice a large number of target costs are not actively maintained, and changes are not managed and agreed contemporaneously with the events. An undesirable consequence of this is that the target cost may in some cases become ineffectual and the project defaults to an entirely cost reimbursable basis.

The simple, though unsatisfactory, solution is to reset the target cost to match the actual cost. This is often seen as an easier, non-confrontational solution than going back and agreeing the time and cost effect of each change, which is what the contract envisages. The parties can at least take some comfort in the fact that the employer is paying what the project actually costs, and not ‘over the odds’. However, this approach removes any incentive for efficiency from the contractor and eliminates cost and time certainty for the employer: it should be strenuously avoided.”

As Ian Heaphy points out, the solution of paying a contractor his actuals is one that is sometimes adopted on construction projects so as to avoid expensive and lengthy disputes. However, it is a practical solution and (as Ian Heaphy alludes to) it would be an unusual contract indeed that automatically entitled a contractor to be reimbursed his actual cost for the entirety of the works in the event that the parties failed to agree a variation during the course of the works[2].

Nevertheless, in this instance, TES had put its case as one of contractual construction. It was only as a result of the case being put on that footing that the court had jurisdiction to deal with the dispute at all; questions of contractual construction being questions of law for this purpose, section 45 was engaged.

However, this case serves to demonstrate the dangers of trying to apply what might be termed industry practice to the construction of all contracts of a similar type. Indeed, given that this was a Maximum Price Target Cost contract as well, any comfort that an employer might take from knowing that it was not paying above the odds if the contract converted into a costs-reimbursable one, would be limited; not least as the certainty that comes with such a contract would be totally removed by such an approach.

Unsurprisingly then, Coulson J had no difficulty in dismissing TES’ case on contractual construction. He made the following points:

  • there was no provision within the contract that would entitle the contractor to rely on an alternative means of calculating the FPP;
  • SSD’s case gave effect to all parts of the contract;
  • the comparison between actuals and target cost  for the purpose of determining the final price payable and the consequent level of pain/gain share was mandatory according to the wording of the contract;
  • there was nothing in the wording of the contract that indicated that there was a guillotine for the adjustment of the Target Cost after the end of the design and construct period;
  • there was nothing in the contract to suggest that the appointed tribunal could not deal with the issue of liability and quantum of changes.[3]

Permission to appeal

TES sought permission to appeal the decision on the basis that it was a decision of relevance to Target Cost contracts generally. Again, this was easily dismissed as the contract in question was, in fact, a bespoke, one-off contract and the issues decided had been ones of construction specific to it.

Nonetheless, TES was right to argue that there is a real absence of reported cases from the TCC on what to do when variations are not agreed contemporaneously or the Target Cost in such contracts is not maintained during the course of the works.

There remains a general question, in such instances, of what the contractor should do in order to claim the element of gain share that it says it missed out on through the failure to contemporaneously agree the target cost of changes. In some ways, such a claim would be akin to a loss of a chance claim and would suffer from significant conceptual difficulties.

In reality, such a claim is one that the contractor has lost the opportunity of agreeing a variation at a price which it contends, on the balance of probability, it would have beaten. However, where there is a target cost made up of lump sum elements it would be extremely difficult to know how the failure to agree a change, one year into a four year project, was said to affect the contractor’s ability to beat the target cost for the contract overall. Further, on one view, the employer has also lost the opportunity to agree a change at a price that it believes represents a fair value for the work and gives it certainty; or, more controversially, a price that the contractor is unlikely to beat. Furthermore, the contractor would have to prove that its loss of a chance was consequent on the employer’s breach of duty which may be difficult if it is simply a case of not agreeing changes contemporaneously as is a regular occurrence on everyday construction projects.

Practically speaking, part of the answer for a contractor in trying to prove such a claim (or generally in proving the value of a change that was not agreed at the time) has to be to keep excellent cost records and ensure that, as far as possible, contemporaneous quotations are produced for changes even when the employer does not agree that a change has occurred. Further, collating evidence of its efforts to keep costs to a minimum as the contractor goes along will surely give the best footing for any claim for loss of a chance at beating a target. 

Though Coulson J’s judgment did not deal with Target Cost contracts generally, it is suggested that some of his comments may help ground a simple and age-old solution to this problem

In dismissing TES’ case on contractual construction, Coulson J went on to state that even if the change procedure under the contract in question could no longer be operated (which he found that it could), it did not follow that TES would be entitled to its actual costs of carrying out the work. Unsurprisingly, he stated that:

“…much more likely, the parties – possibly with the assistances of the DRB – would operate a simple system (derived from the principles of quantum meruit and perhaps implied terms) whereby TES received a reasonable sum in respect of any Change carried out and that such a sum would then be “plugged in” to the adjustments of the MPTC Pricing Provisions.”

With any adjustment being made to the MPTC pricing provisions on a quantum meruit basis the contractor would get the price benefit and, if he has kept his costs down, will likely get the benefit of the sharing arrangement in the end anyway as what it has actually cost him will go into one side of the equation for the purpose of comparing actual costs with the contract price and thereafter determining the extent of the pain/gain share. Contract drafters should be astute, on this basis, to ensure that their contracts provide a clear mechanism for adjusting the MPTC pricing provisions for changes after work has been carried out.

Published in TECBAR

[1] The issue of delay did not arise on these facts.

[2] Here, TES’ case was that the failure to agree just one variation was sufficient for its case.

[3] Coulson J also dealt with further points made by TES but they were of less central significance.