The EPC industry has always been a risky business that requires increasingly critically-minded management, as unexpected new risks keep emerging. This article will focus on the unfortunate effects of a subcontract assignment by an EPC contractor to an owner upon termination of the main contract.

Contractual background

Once the risks of a project are identified, they are allocated between the owner and the EPC contractor in the main contract. EPC contractors in charge of the development and delivery of major projects are expected by owners to take most of the risks. Even the most “contractor friendly” standard forms allocate a tremendous amount of risk to EPC contractors.

EPC contractors rely in turn on a complex supply chain. They will pass down a large portion of their own risks on a back-to-back basis to their subcontractors. This secondary stage is crucial for most EPC contractors and any uncertainty regarding the flow of risks down the supply chain is likely to upset the fragile balance of the main contract.

There is, however, a familiar provision, found in most commonly used standard form contracts, to the effect that the owner may request the assignment of subcontracts in case of termination of the main contract, which is often overlooked in terms of risk management.

The Energy Works Case

In the case of Energy Works (Hull) Limited v MW High Tech Projects UK Limited & Others [2020] EWHC 2537 (TCC) (the “Energy Works Case”), the Technology and Construction Court has shed new light on the nature and effects of the assignment of a subcontract following termination of an EPC contract.

Facts

In 2015, Energy Works (Hull) Limited (the “Owner”) entered into an EPC contract (the “Main Contract”) with MW High Tech Projects Limited (the “Main Contractor”) for the design, procurement, commissioning and testing of a waste to energy fluidised bed gasification plant (the “Project”). The Main Contractor entered into a subcontract (the “Subcontract”) with Outotec (USA) Inc (the “Subcontractor”) for the supply of key elements of the Project.

The Main Contract was an amended version of the IChemE Form for lump sum Contracts (Red Book) and the Subcontract followed the IChemE Yellow Book Form of Subcontract. The Main Contract and the Subcontract contained brief provisions to the effect that the Owner was entitled to require the Main Contractor “to assign” the Subcontract in case of termination of the Main Contract.

The Project ran late due to causes that the Owner and the Main Contractor blamed each other for. The Owner terminated the Main Contract in March 2019, when the cap of liquidated delay damages was reached. The Main Contractor accepted the termination but argued that it was for the convenience of the Owner and not for default. The Owner requested the assignment of the Subcontract and the Main Contractor complied by issuing a simple notice of assignment to the Subcontractor in June 2019. It was common ground among all parties concerned that the assignment was valid. The subsequent dispute related to the effects of that assignment.

Procedure

In July 2019, the Owner commenced proceedings and claimed damages against the Main Contractor. The claim included the cost of remedying defects, liquidated and general delay damages, as well as for substantial losses resulting from additional costs incurred in completing the Project.

The Main Contractor denied liability for the claims of the Owner, raised a counter-claim for payments resulting from termination for convenience and added the Subcontractor as a Part 20 Defendant, arguing that the delays, the costs for remedying defects and other losses claimed by the Owner were attributable to the Subcontractor.

In turn, the Subcontractor challenged the Main Contractor’s entitlement under the Subcontract, on the basis that all benefits, including the right to sue, had been transferred to the Owner by the assignment of the Subcontract.
The Main Contractor disagreed about the scope of the transferred rights which it stated had excluded rights accruing before the assignment.

In the alternative, the Main Contractor claimed at law against the Subcontractor for contribution in respect of the same damage under the Civil Liability (Contribution) Act 1978 (the “Contribution Act”).

Questions before the Court

The main issues for the Court were to determine:

• Whether the assignment of the Subcontract to the Owner was limited to future rights or if it also included accrued rights;

• If all accrued and future rights were transferred, whether the agreement could take effect as a novation; or in the alternative,

• Whether the Main Contractor was entitled to recover any of its losses as contribution from the Subcontractor under the Contribution Act, on the basis that they were both liable to the Owner for the same damage.

The Court reviewed relevant authorities and took the opportunity to define, in context, the difference between the legal concepts of assignment and novation.

Clarification of the legal concept of assignment

The Court relied on the House of Lords’ decision of Linden Gardens Trust Ltd v Lenesta Sludge Disposals Ltd [1994] 1 AC 85 (the “Linden Gardens Case”) and held that the nature and effects of the assignment of the Subcontract could be summarised as follows:

“i) Subject to any express contractual restrictions, a party to a contract can assign the benefit of a contract, without the consent of the other party to the contract;
ii) In the absence of any clear contrary intentions, reference to assignment in the contract by the parties is understood to mean assignment of the benefit that is accrued and future rights;
iii) It is possible to assign future rights under a contract without the accrued rights but clear words are needed to give effect to such intention”.

Having reviewed the relevant provisions of the Main Contract and the Subcontract, the Court applied the above principles and found that there had been an effective assignment to the Owner of both the Main Contractor’s accrued rights and future rights under the Subcontract. The Court noted that the parties could have limited the transferred rights by separating accrued and future rights, but they chose not to. The Main Contractor therefore did not retain the benefit of any rights under the Subcontract.

Clarification of the legal concept of novation

The Court summarised the concept of novation for the transfer of a contract entered into between A and B to C as follows:

“The original contract between A and B is extinguished and a new contract is formed between A and C. All parties must consent with the novation”

Considering the above legal concept, the Court concluded that the assignment of the Subcontract did not take effect as a novation. The parties had used the word “assign” in the Main Contract and the Subcontract. This was therefore a strong indication that they were not referring to a novation. The Court also found it significant that they had entered into discussions regarding a revised subcontract but had been unable to reach agreement.

Since the Main Contractor had assigned its accrued and future rights under the Subcontract to the Owner, the Court concluded that the Main Contractor had no right to seek remedy against the Subcontractor under the Subcontract.

Limited compensation under the Contribution Act

The Main Contractor could, though, still seek compensation against the Subcontractor under the Contribution Act, provided that it could establish that its liability to the Owner for defects, delay and losses under the Main Contract was for “the same damage” as the liability of the Subcontractor to the Main Contractor under the Subcontract.

The Court concluded that even if the relevant terms of both contracts were not identical, the liabilities for delay and defects amounted to the same damage. The Main Contractor therefore had some limited recourse for compensation against the Subcontractor.

However, the Main Contractor’s liability for the substantial losses arising from termination of the Main Contract failed to meet the requirements of the Contribution Act since there was no basis under the Subcontract for such losses. The Main Contractor retained ultimately all the risk in this respect.

Such subtle contractual arrangements, to be considered and negotiated on a case by case basis, are essential for the EPC industry to keep risks and liabilities flowing down the supply chain.

Take-aways from the Energy Works Case

EPC contractors who assign their subcontracts to owners upon termination of the main contract should be aware that, they may inadvertently forfeit their entitlement to sue the subcontractors for breaches committed under such subcontracts.

Without careful qualification of the scope of the assignment, or an express requirement for a novation, an EPC contractor would therefore remain ultimately responsible to the owner for damage and losses attributable to their transferred supply chain.

In order to avoid such an uncommercial outcome, the generic wording regarding assignment of subcontracts to owners upon termination of the main contract should be adjusted accordingly. This may be easier said than done at the level of the main contract where owners – and their lenders in case of project financing – are likely to resist any proposed change. Considering the dire consequences of any vague assignment of accrued rights, the corresponding adjustments should, however, be worth fighting for.

EPC contractors should have more leverage at the level of the subcontracts and would be well advised to insert language to the effect that any assignment of the benefits of subcontracts to the owner shall not extinguish the liabilities the subcontractors may have incurred to the EPC contractor.