Ever since John Reid's famous statement that the UK Home Office (his department at the time) was "not fit for purpose", this term has been heard increasingly frequently in the media, applied to a range of situations. Perhaps it is timely to consider its proper application.
One of the advantages of choosing English law as the governing law of a contract is that there are few situations where terms are implied (or where express terms are deemed inapplicable). One such situation is in relation to contracts for the provision of goods, where there is an implied term that such goods must be "fit for purpose".1
This technical area of law is of great relevance to the oil and gas industry, both because many agreements for the supply of goods and services are governed by English law, but also because the underlying issues are relevant in any contract between operator and contractor/supplier, regardless of the governing law. Such contracts frequently require the contractor to confirm expressly that it is familiar with (a) the nature and scope of the work required (including supplies, equipment, materials and facilities necessary to complete the work) or (b) the equipment. This broad approach in effect requires the contractor to acknowledge that it understands – irrespective of the statutory implied term – the fitness for purpose standard which its goods and services must attain.
The question of fitness for purpose is at the heart of the allocation of risk between operator and contractor, in circumstances where both the technical and the contractual background are frequently complex.
The complexity arises, on the technical side, from the demanding conditions in which equipment is to be used and the involvement of large multi-disciplinary teams which are required to translate the project from early design stage, through detailed specification, to development and manufacture/installation, so that it is able to meet performance criteria and tests. Frequently, these multi-disciplinary teams represent a number of parties, including operator and contractor, which may complicate what would otherwise be a clear allocation of contractual responsibility (generally imposed on the contractor) in the formal documentation.
Operators are sometimes successful in agreeing with contractors that the purpose for which their work is intended will be specified in the contract, without any discussion of the warranty of fitness for that purpose, where this is implied.
Contractors who are aware of the issue will seek to exclude the implied warranty specifically, pointing to the detailed specification to support their view that it is unnecessary. This is a key point for negotiation.
Where fitness for purpose is not excluded, breach of the implied term will enable the operator to elect to terminate the contract and claim damages. Where the contract contains an express exclusion of, or limit of liability for, fitness for purpose, this is subject to a test of reasonableness, if UCTA2 applies to the contract.
UCTA does not apply for "international supply contracts" as defined in s.26 of the Act. Broadly these are contracts for the supply of goods alone or goods and services made between parties whose places of business are in different states. Neither does UCTA apply where English law governs the contract only by choice of the parties (and failing which the law of some other country would apply). The case of Balmoral Group v Borealis (UK) Limited3 concerned whether a type of polymer used in the manufacturing of oil tanks was fit for purpose. Relying on expert evidence, the court held that the polymer was fit for the manufacture of the tanks and in any event that the fitness for purpose warranty had been excluded in the supplier's standard terms of business. One of the defendant suppliers was based in the United Kingdom and UCTA was held to apply and the exclusion of the term was subject to the test of reasonableness. The exclusion failed the test and the manufacturer's liability for the fitness of the tanks for their purpose was reinstated. In contrast, although UCTA was held also to apply to the contracts with defendant suppliers based in Scandinavia, these contracts were excluded from UCTA as being international supply contracts, so did not have to satisfy the reasonableness requirement.
Just as close work between technical teams of contractors and operators will promote alignment of expectations as to the work to be performed, effective communication between the technical teams and their legal advisers will enable contracts to reflect a risk allocation which is understood by the whole team and consistent with operational reality, thus promoting risk management and reducing the likelihood of disputes.
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Brian Gordon joined the firm as a senior lawyer in the Oil & Gas team on 7 September 2009. Brian advises clients on a wide range of energy, mining and corporate matters including upstream oil and gas, cross-border M&A, corporate finance and joint ventures.
The HFW oil & gas team has recently given seminars on legal developments in drilling contracts to a number of oil & gas clients. Please contact diana.france@hfw.com if you are interested in finding about about this.
Footnotes
1. s.14 of the Sale of Goods Act 1979 and s.4 of the Supply of Goods and Services Act 1982
2. The Unfair Contract Terms Act 1977
3. [2006] EWHC 1900 (Comm)
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