The appeal in ABC Electrification Ltd v Network Rail Infrastructure Ltd  EWCA Civ 1645, concerned the proper construction of a Target Cost Contract based upon the standard Institute of Civil Engineers Conditions of Contract, Target Cost Version, First Edition (ICE Conditions) and subject to standard amendments commonly used in the rail industry, known as Network Rail 12 (N12 Amendments). The appeal concerned the proper interpretation of the word “default”, as appearing in the wider definition of the term “Disallowed Costs”. The Court of Appeal affirmed the decision of the Court below that the ordinary and natural meaning of the word “default” (a word commonly used in construction as well as other commercial contracts) is “a failure to fulfil a legal requirement or obligation”. There was nothing, the Court of Appeal concluded, arising from the wording of the amendment itself, any other provisions of the Contract, the overall context of the Contract or by way of commercial background, that militated towards a different construction than that of the natural and ordinary meaning of the word “default”.
For the background to this case and decision of the Court below, please refer to our previous article. To briefly recap, Network Rail’s N12 Amendments to the standard form contract had added the word “default” to the definition of “Disallowed Cost”, so that it read: “any cost due to the negligence or default on the part of the Contractor in his compliance with any of his obligations under the Contract”. Network Rail argued that “Disallowed Cost” included any cost due to a failure by ABC to comply with its obligations under the Contract. ABC argued that “Disallowed Cost” included any cost incurred due to default on the Contractor’s part if, and only insofar as, the default constituted, a wilful and deliberate failure to comply with its obligations under the Contract.
The Court held that “Disallowed Cost” included any cost due to any failure by ABC to comply with its obligations under the Contract.
ABC appealed, arguing that the judge below had erred in law and should have found that on a proper construction, a cost is only to be treated as “Disallowed Cost” if there has been some element of fault on the contractor’s part, in the sense of blame or culpability (as opposed to a breach of contract for which there has been no such blame or culpability). It argued that the judge below had given too much attention to the dictionary definition, as opposed to the use of the word in context, and insufficient weight to the consequences of her interpretation.
Network Rail’s Stance
Network Rail’s case (as it was in the Court below) was that the word “default” is commonly used in construction and other commercial contracts and its natural and ordinary meaning is “a failure to fulfil a legal requirement or obligation”. It argued that since the word “default” was added by amendment, it was evident that the parties intended to add something to the unamended clause. The starting point for the interpretation of the clause, as amended, it said, was that the language used, which was clear and unambiguous, should be given its natural and ordinary meaning and there was no basis to conclude from the terms of the Contract, its factual matrix and commercial context, that the parties’ intention was that the word “default” should bear something other than its ordinary meaning. The consequence of giving the word “default” its natural and ordinary meaning, it said, was clear and straightforward and a commercially sensible outcome.
Relevant principles of interpretation
The Court of Appeal summed up the relevant principles of construction to be applied and said that the Court’s concern was to identify the parties’ intention by reference to what a reasonable person, having all the background knowledge which would have been available to the parties, would have understood them to be using the language in the contract to mean. The Court’s task, it said, was to ascertain the objective meaning of the language which the parties had chosen to express their agreement. This was not, the Court said, a literalist exercise; the Court must consider the contract as a whole and, depending on the nature, formality, and quality of the drafting of the contract, give more or less weight to the elements of the wider context in reaching a view as to the objective meaning. The interpretative exercise is a unitary one, the Court said, involving an iterative process by which each suggested interpretation is checked against the provisions of the contract and its commercial consequences investigated.
Court of Appeal Ruling
The Court of Appeal unanimously upheld the decision of the Court below, holding that “default” in Network Rail’s NR12 Amendments had its natural and ordinary meaning of “a failure to fulfil a legal requirement or obligation” and rejected ABC’s argument that “default” in this context required some element of blame or culpable behaviour. It said:
Having identified the natural and ordinary meaning of the word “default” in the Contract, the Court then considered the wider context, the exercise that lay at the heart of ABC’s challenge. As the Court said, any contractual clause, however clear, is not to be read in a vacuum and its meaning has to be assessed in the light of not only its natural and ordinary meaning, but also any other relevant provisions of the contract, the overall purpose of the clause and the contract, the facts and circumstances known or assumed by the parties at the time the contract was executed and commercial common sense. After considering these matters, the Court concluded that although it would have been clearer if other clauses in the Contract had been amended to reflect the amendment in question more accurately, that did not justify interference with the natural and ordinary meaning of “default”, which the parties specifically chose to introduce by amendment. Even if the other clauses were no longer necessary in light of the relevant amendment, none of the clauses identified were inconsistent with Network Rail’s construction.
The Court also said that the fact that the Contract was a Target Cost Contract did not militate in favour of ABC’s construction, as the Contract made it plain that the contractor was intended to bear the risk of its own breach of contract. “Disallowed Cost” is deducted from the Total Cost before the contractor’s share is calculated. The parties were free, the Court said, to agree cost and risk allocation as they did. There was also little, if any scope, for submissions by reference to commercial common sense that could assist ABC. The Court said that where the words used are unambiguous, the Court’s task is to apply them, but in any event, Network Rail’s construction did not offend commercial common sense. The aim of the Target Cost mechanism, namely to provide incentive to the contractor not only to perform but also to control costs, is achieved, the Court said, if costs due to breach of contract by the contractor are “Disallowed Costs”.
As mentioned in our previous article, both the decisions of the Court of Appeal and at first instance highlight the importance of careful use of wording in contract drafting, especially amendments in standard form contracts. The subject contract was a Target Cost contract. An unintended meaning of an amendment by either one or both parties can have the effect of shifting the distribution of risk in the Target Cost mechanism, especially in this case where the Contract was cost reimbursable subject to the gain/pain mechanism. It should be noted, that the standard NEC contracts (Target Cost) do not refer to “default” in their definition of “Disallowed Cost.”