UK: Securing Performance In Commercial Contracts - How To Ensure Contractual Performance

Last Updated: 14 September 2009
Article by Jonathan Riley

In contracting terms, we cannot always choose our perfect partners. Sometimes we go with the best that is on offer and sometimes we weigh the risks against the benefits and decide to take a chance. If we have doubts as to whether the party we are contracting with will meet our expectations, or live up to its contractual promises, how can we structure the contract to try to secure the performance that we want? Financial obligations aside, what sort of provisions might be found in a typical commercial contract which are relevant to securing the performance of a party's obligations? And are those provisions always helpful to the party looking to secure performance?

Express Terms

The obvious starting point is to make sure that the contract clearly sets out what each party is expected to do. After setting out the performance obligations, then think about the performance standards that might also be required, for example:

  • to provide the services in a first-class professional manner; or
  • to provide the services in accordance with all applicable laws and regulations and in accordance with best industry practice.

Customer Obligations

It is important to bear in mind that the performance obligations are not going to be all one way. Whilst the customer will naturally expect to be under a payment obligation, there can be other obligations which will directly impact upon the customer.

The first is a provision which runs along the lines that: 'The customer will provide such assistance and facilities as the supplier may reasonably require in the performance of its Services, including such materials and data as may be available to the customer, and access to the customer's personnel and premises'. Whilst this might seem reasonable, a provision in this form imposes a very general and open-ended obligation on the customer, which the customer should consider carefully.

The contract may also contain a provision to the effect that if the customer fails to perform any of its obligations or is late in the performance of any of its obligations and that failure impacts on the supplier's performance, then the supplier is not in breach of its obligations to the extent that the failure or delay in its own performance was caused by the customer. Again, that provision may seem fair enough, but when combined with the open-ended obligation on the customer to provide assistance etc to the supplier, the two together can provide plenty of opportunity to excuse the seller from a failure to perform.

Implied Terms

Other than those terms implied into contracts by legislation, for any term to be implied into a contract it must be:

  • reasonable and equitable;
  • necessary to achieve business efficacy;
  • obvious – ie it 'goes without saying';
  • capable of close expression; and
  • it must not contradict an express term. A recent Privy Council case, A-G of Belize v Belize Telecom (2009), boiled it down to a simple statement: the test as to whether a term needs to be implied into a contract to reflect the parties' intentions is whether that term would spell out in express words what the contract, read against the relevant background, would reasonably be understood to mean.

A further implied term to be aware of was highlighted in Anglo Group v Winther Browne (2000). In that case, the Court said that: "It is well understood that the design and installation of a computer system requires the active co-operation of both parties". This is regarded very favourably by suppliers, and it can be very contentious as to what this involves for a customer. Later cases have said that the principle that parties must co-operate with each other in order to allow each party to fulfil its obligations under the contract is essentially a rule of construction of the particular contract, rather than a rule on implied terms. Nevertheless, Winther Browne should still be borne in mind because a key point made by the Court was that whilst the supplier may be the IT specialist, the customer knows its own business and, particularly in a larger project with bespoke work, it is incumbent upon the customer clearly to communicate its needs to the supplier.

Pro-Customer Provisions?

So what happens when the customer has looked at the express performance obligations on the supplier, considered the likelihood of any implied terms, and still isn't getting the performance that he expected? Two additional contractual provisions may be of assistance.

Change Control

Change control means providing for changes to be addressed in a controlled environment. A change control provision typically provides for either party to request or propose a change, whether to the contract terms or to the products or services being provided, and for that change and its consequences to be considered in an agreed forum and under an agreed procedure and, if and when agreed, to be implemented as a contract variation.

A longer-term contract may well provide for basic variations, for example pricing changes based on RPI or some other formula; but a change control provision typically goes further than that and allows almost anything to be the subject of a change request provided that all ramifications of implementing that change can be taken into account – including, of course, the cost.

Some change control provisions provide a forum and a procedure for considering changes but still ultimately require the change to be agreed by the parties before it is implemented. Others go a stage further and treat a change request which is not agreed as a form of dispute and so move on to a dispute resolution procedure so that ultimately the outcome is determined by a third party whose decision is then implemented as a contract variation.

Benchmarking

Benchmarking is a process used to measure the performance of a contractor against the market. Although contractors exposed to this process will complain about the difficulty in finding suitable comparators and in ensuring that you compare apples with apples, bench-marking is fairly common in longer-term contracts such as an outsourcing contract where things can be expected to change over time.

The contract usually provides that if the outcome of the benchmarking exercise is that the contractor is shown to have fallen behind the market, then in the first instance the contractor has to raise its game back to the market standard. If the contractor is unable to do so for whatever reason then the contract may well need to go on and provide a right of termination either for the whole contract or at least for those services which have fallen behind the market.

Pro-Supplier Terms?

A commercial contract will also typically contain a number of provisions which at first sight might be regarded as just standard boilerplate clauses, but which can actually have an impact on the ability of one party to secure the performance of the other.

Force Majeure

The consequence of a force majeure event is to excuse the affected party from performance – he neither has to perform nor be liable for a failure to perform – for as long as the event continues. There is no legal definition of force majeure and accordingly the definition given to this term in the contract can be very important.

The principle is that it is an event beyond the parties' reasonable control, but what that constitutes can be drafted narrowly – for example by reference to weather conditions and similar Acts of God, war and conflicts etc – but equally may actually be defined simply as an event beyond a party's reasonable control with certain events listed as included but actually leaving the possible events open-ended.

That wider form of definition leaves open the prospect for a supplier to claim force majeure based, for example, on non-performance of its sub-contractors, or changes in economic conditions – matters which the customer may well have expected the supplier to be responsible for managing.

In Channel Island Ferries Ltd v Sealink (1988), the Court of Appeal said that a force majeure clause which included language referring to events 'beyond the control of the relevant party' could only be relied on if that party had taken all reasonable steps to avoid its operation or mitigate its results. So the party seeking to claim the benefit of this protection cannot simply throw his hands up in the air upon the occurrence of an event.

A similar point is that the event should be genuinely independent and beyond the control of the affected party. In Okta Crude Oil v Jetoil (2003), the Court held that a governmental authority's request to a party not to perform its contract did not fall within the force majeure clause in the contract because the affected party had instigated the procurement of the request from the governmental authority.

The force majeure event suspends the affected performance obligation, but the contract should also provide what happens thereafter. If the force majeure event continues, for how long does the contract remain on foot before one party is allowed to terminate; and can either party terminate, or only the party which has not claimed the force majeure relief?

Liquidated Damages

Certain types of contracts, such as outsourcing contracts, may well be accompanied by a separate service level agreement with a service credits regime. Service credits are a form of liquidated damages, ie a fixed payment which the parties agree will be payable to the customer to compensate it for the loss or damage that it will suffer if the supplier fails to perform its services to the contracted standards.

A contract can provide for liquidated damages to be paid for breaches of contract other than a service level failure, with the benefits to the recipient being that they do not need to go to Court to prove (a) the level of loss that they have suffered, or (b) that they have suffered any loss at all. If the defaulting party fails to do what the contract provides then that party should just write out a cheque for the agreed amount.

However, life is not always that simple. If the defaulting party does not want to pay the agreed liquidated damages, it may argue that the sum does not represent a genuine pre-estimate of the loss likely to be suffered by the other party. Instead, that party may argue that the sum is a penalty. In English law, penalty clauses are not enforceable. So when providing for liquidated damages – including service credits – it is important to set out that this is a genuine pre-estimate and to be able to back up that statement.

Breach And Termination

The ultimate remedy where there is a performance failure is to claim that the defaulting party is in material breach and to terminate the contract. A material breach is one that has a serious effect on the benefit that the innocent party would otherwise derive from the performance of the contract in accordance with its terms, without necessarily amounting to a repudiatory breach. The materiality of the breach depends on all the circumstances, including the terms and duration of the contract, the nature of the breach, and the consequences of the breach.

Unlike in the case of a repudiatory breach, the law does not give the innocent party the automatic right to terminate for material breach. If the parties want this right to arise, they must provide in their contract for an express right of termination in the event that a material breach occurs. However, what is a 'material breach' in any given situation may ultimately need to be decided by the Court, and the Courts themselves have sometimes expressed different and conflicting views.

Best practice therefore suggests that one should include a right to terminate for material breach in the contract, but also provide an express right of termination for breach of particular performance obligations. These should of course include the key performance obligations under the contract, but might also include, for example, repeated breaches where any one breach on its own may not be regarded as material but where the cumulative effect is prejudicial to the innocent party.

Limitations On Liability

Limitations on liability provisions should not, of themselves, allow a party to avoid performing its contractual obligations, but care needs to be taken to ensure that the loss most likely to be suffered as a result of a failure to perform a key obligation is not excluded under a limitation of liability provision. For example, a clause which says that the parties exclude liability for indirect and consequential loss and for loss of profit, loss of business, loss of opportunity, and loss of anticipated savings, may look like a standard 'no consequential loss' provision, but is actually seeking to exclude loss of profit in all circumstances and not just to the extent that the lost profits are classed as indirect losses.

ADR

In Cable & Wireless v IBM (2002) the contract contained an escalating dispute resolution clause, providing first for negotiation, then alternative dispute resolution (ADR), then litigation. The ADR element was quite vague as to the procedure to be followed: "The Parties shall attempt in good faith to resolve the dispute or claim through an Alternative Dispute Resolution procedure as recommended to the Parties by the Centre for Dispute Resolution".

Cable & Wireless had commenced proceedings against IBM and did not want to go through an ADR procedure. IBM sought to enforce the clause and applied for a stay of the litigation to enable the ADR procedure to take place. The Court held that the clause was enforceable and adjourned the proceedings, citing public policy as one of the factors, as well as the fact that CEDR's mediation procedure provided sufficient clarity at least as to what the parties had to do and when the process would be over.

So whilst ADR certainly has its place, ideally such a provision should still provide for a party to be able to opt out of the process and go to Court if it feels that the process is going nowhere or if that will best serve its interests; for example, if urgent action is required. A party should have the choice of taking its chances of incurring the Court's displeasure and possible costs sanction rather than being locked into a mediation process no matter what the consequences of the other party's failure to perform.

www.lg-legal.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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