The Polyphonics in the Interpretation of Lump Sum Contracts

Introduction

The conditions of payment for contractors play a critical role in construction and engineering projects. There exist no overarching legal limitations on the scope of agreements that contracting parties may reach, hence giving rise to the emergence of various methodologies for determining the monetary compensation for services rendered. One method that might be employed is a “lump sum” or “fixed price” contract, which stands in contrast to a “cost plus” contract. However, in situations where a contractor agrees to complete the work outlined in the contract for a predetermined sum of money, complications may arise if there are no provisions in place to determine the amount owed to the contractor if they fail to fulfil the contractual obligations.

The interpretation of lump sum payment contracts has emerged as a contentious issue among contracting parties. In the event that a lump sum contract encompasses the full outstanding amount, the contractor’s entitlement to payment under common law is contingent upon completion of all work, unless the parties have mutually agreed upon early payment for completed work. Nevertheless, contracts provide the provision of progress payments for work that has been accomplished, and these payments may be contingent upon a range of variables. The principle of common and universal interpretation posits that an agreement ought to be construed in a manner that aligns with the language used therein and most accurately captures the intentions of the involved parties. Arbitral Tribunals should show prudence and discretion in the interpretation of price escalation clauses in construction contracts, as their decisions must be grounded in substantiated facts.

Deciphering the payment models of construction contracts

When and how much an individual is to be paid for performing work are two of the most crucial factors in any engineering or construction project. Typically, a contractor receives payment in the form of cash or non-cash consideration for completing construction work. Before any work is done, the parties usually agree on the terms of payment, which are then reflected in the contract. This includes deciding when the contractor is entitled to payment and how much. In terms of the amount to be paid to the contractor and the conditions under which it must be made, the parties to a construction or engineering project are free to agree upon any payment arrangements they choose under common law.

In short, freedom of contract reigns and there are no general legal restrictions on what contracting parties may agree as to the basis upon which a contractor is to be remunerated for performing work.¹ This freedom has, in the construction and engineering industry, led to the development of several ways for reckoning the price payable for work performed. One such way for determining the contract price is where the contractor agrees to perform the work described in the relevant contract for a fixed amount of money — which is abbreviated as “lump sum” or “fixed price” contract. It is antithesis of a “cost plus” contract, or where work is performed on the basis of an estimated cost.²

If the actual amount and cost of work involved turns out to be different from what the contractor first anticipated, it will not, in absolute terms, impair the contractor’s entitlement to compensation under a lump sum contract. However, as a general practice, parties entering into a contract do not invariably foresee its violation, and in cases of lump sum contracts difficult issues may arise in the absence of clauses which provide for the computation of amounts that are due to contractor in cases where it has failed to complete the work as stipulated under the contract. This leads to two sets of problems: first, is the computation of the amount which can be recovered by the contractor; and second, is to determine the claim that the employer has for damages as the risk of physical and other contingencies is with the contractor, not the owner.³

For example, if a contractor agrees to build a railway for a lump sum, and the quantity of ground works required to construct the railway turns out to be double what has been anticipated before the contract was entered into, the contractor is only entitled to the original lump sum, notwithstanding its actual costs will be significantly in excess of its expected costs.⁴ This interpretation by courts across common law has become the point of dispute among the contracting parties. Moreover, in the event that the predicted physical and other contingencies which the contractor had accounted and included in their predetermined lump sum pricing, do not materialise, the contractor may potentially gain a financial advantage since they are still eligible to receive the lump sum payment.⁵

The vicissitude in interpretation

It is perhaps academically debatable whether or not a lump sum contract is by definition an entire contract.⁶ However, subject to provisions for instalments, most lump sum or turnkey contracts are entire contract in the sense that the contractor can recover nothing on the contract if he stops work before it is completed in the ordinary sense ― in other words abandons the contract.⁷ A second school of thought is that lump sum contracts are not entire contracts in the sense that they are construed as excluding the principle of substantial performance. In a lump sum contract the employer cannot refuse to pay the contractor merely because there are a few defects and omissions, unless the contract itself specifies otherwise. Therefore, if there is substantial completion the employer must pay the contract price⁸, subject to a deduction by way of set-off or counterclaim for the defects.⁹

Conversely, where a contractor has calculated its lump sum price on a basis that involves overlapping of items of work, the lump sum is still payable for the work performed by the contractor. There is no implied term of a construction or engineering contract that the amount of the lump sum is to be reduced to take account of any overlap of double counting.¹⁰ In some circumstances, a contract may provide a modification to the contract price in the event that the contractor finds unforeseen adverse conditions at the site, resulting in an escalation of costs.¹¹ For instance, the High Court of Bombay in MMRDA v. Unity Infraproject Ltd.¹², went on to read the contract in its entirety to determine whether the contractor is entitled to payment for the extra work which was done.

The Court expressed its opinion, citing Hudson on contract¹³, that in these kinds of circumstances, the role of the Court is to determine solely the intended aim of the contract, as demonstrated by the language employed, and not the parties’ subjective intentions. Hudson highlights that the rule of evidence is that each contract should be read in its entirety before interpreting any one section. The genesis of this argument is based on the analysis provided by Lord Wilberforce in Prenn v. Simmonds¹⁴, where the Law Lord had held that it is always appropriate to apply the common and universal principle which states that an agreement should be interpreted in a way that its language permits and best reflects the parties’ intentions. Thus, holistic reading of the contract should be given more weight than any specific words that the parties’ have used to express their intent in a particular clause of the contract.

The approach used by the Bombay High Court is also grounded in Justice Cardozo’s ruling in the famous case of Utica City National Bank v. Gunn¹⁵, where the Court determined that the interpretation of the transaction should be based on the “genesis and aim of the transaction”. The judgment held in Utica City National Bank case¹⁶ became a locus classicus in the interpretation of business contracts and was later on quoted with authority by Lord Diplock in the notable case of Antaios Compania Naviera SA v. Salen Rederierna¹⁷. According to this principle, corporate common sense must be made to give way if a careful semantic and syntactical examination of the terms in a commercial contract result in a conclusion that defies it. The Delhi High Court’s recent judgment in Satluj Jal Vidyut Nigam v. Jaiprakash Hyundai Consortium interprets this principle in modern context.¹⁸ The dispute in the instant matter arose from a contract of construction where the petitioner, who was the contractor for the civil works had sought compensation for the alleged quantum increase in minimum wages payable to labour during the contract’s execution.

The construction contract contained a formula for calculating the escalation amount payable to the petitioner/contractor to cover the increase in labour cost during the contract’s execution. The respondent/claimant (hereinafter “claimant”) argued that the sudden increase in minimum wages could not have been foreseen by the respondent, was not an event taken into account in the indexing of any inputs to the formula, and that the additional cost was not considered during tendering. The claimant argued that it was entitled to reimbursement of the additional cost occasioned by the increase on the basis of Clause 70(v) of the General Conditions of Contract.

The crux of the matter herein lies in one of the petitioner’s claims in arbitration — the claimant claimed additional cost on account of increased labour wages. As per the breakdown at the time of the bid, the labour component accounted for 10% of the total value.¹⁹ However, the amount that had actually been paid to the claimant towards labour wage escalation in accordance with the price escalation formula amounted to 30% of the contract value.²⁰ The claimant argued that such amount must be notionally reduced to one-third of the value — which was accepted by the Court.²¹ Thus, through this mechanism, the claimant had benefited by being in receipt of an amount in excess of what was due to him on account of price adjustment.

Interestingly, this amount far exceeded the amount for labour wages under the bill of quantities and the amount already paid to the claimant towards price escalation, and the claimant would not have otherwise been able to raise the claim for additional cost. Further, there was no basis for accepting the notionally reduced value of the claim as the Tribunal had done — the same was completely perverse and was thus rejected by the Court. It is pertinent to note that the Tribunal accepting and proceeding with such notionally reduced value for the claim. The contract is a bargain between the parties and the same must be strictly adhered to by the Arbitral Tribunal while determining the dispute before it; the acceptance of the notionally reduced claim without any justification amounts to wholesale rewriting of the contract.

Additionally, in its statement of claims, the claimant had based the amount “actually paid” towards increases in minimum wages of an unskilled labour on a mathematical derivation and did not substantiate the same with any evidence.²² Yet, the Tribunal had accepted the amount as the actual expenditure incurred. This paves the way for setting a dangerous precedent — the arbitrator is trusted to exercise his skill and exercise and cannot act without evidence. While, it may be possible to use to the Hudson formula or the Emden formula to compute damages or overhead expenses due to the contractor, it would not be incorrect to render an award based on a mere mathematical formula, unsupported by evidence.

Modern day construction projects are riddled with complexities — unforeseen risks and delay may cause additional costs to accrue to the contractor. Hence, it is common practice to include price escalation clauses in construction contracts. However, while adjudicating disputes arising out of such disputes, due caution must be exercised to ensure that these are not misused to reap undue monetary benefits. The arbitral award in the present case serves as a cautionary tale in this regard.

Role that the Arbitral Tribunals should play in valuation

Even though a contract is expressed as a lump sum contract, the contractor may be entitled to claim amounts greater than the lump sum where the owner, or its agent, has directed pursuant to a contractual power that the contractor performs additional work, or where the contractor was otherwise directed to do the work that was not within the scope of the contract and the contractor has acceded to that request and performed the work in question.²³ The definition of the “contract sum” or “contract price” is to include the value of any changes to the work directed by the owner or the contract administrator pursuant to the terms of the contract.

The High Court of Singapore in Goh Eng Lee Andy v. Yeo Jin Kow²⁴ had the opportunity to deal with this question in detail. On the issue of valuation by the Arbitral Tribunals, the Court ruled that the contractor would not be able to pursue additional payments from the owner unless it is demonstrated by way of specific evidence that the works completed under the contract has significantly deviated from the original plan or that the owner’s breach, was the reason for the increased cost. This is because a key ingredient of the “design and build” contract is that it operates as a lump sum contract.

This position was furthered by the decision of the Privy Council in Mascareignes Sterling Co. Ltd. v. Chang Cheng Esquares Co. Ltd.²⁵ In this case, the Privy Council determined that any additional or substituted work completed within a lump sum contract may be valued and measured using the rates/prices specified in the contract bills provided three requirements are met:

(i) the work must be of a similar nature to the work described in the bills;

(ii) it must be performed under conditions similar to those described in the bills; and

(iii) it must not materially alter the quantity of the work specified in the bills.

The Privy Council also opined that the rates and prices in the bills can be used as the basis for the valuation if any or all of the second and third elements are not met, but variances in circumstances or quantities must be fairly taken into account. The valuer must employ reasonable rates and prices if the work is not of the same nature as the work described in the bills.

The way forward

If a lump sum contract covers the whole amount owed, the contractor will not be entitled to payment under common law until all of the work has been done, unless the parties have agreed that the contractor would be paid in advance for completed work.²⁶ Nonetheless, it is customary — and in fact mandated by contemporary construction contract laws in England, Australia, and Singapore — that contracts allow those who carry out building work to obtain progress payments for work that has been completed. If incremental payments are specified in a lump sum contract, the right to receive such payments may be based on a variety of factors. For example, a contract might allow the contractor to claim lump sum payments in instalments based on the value of the work completed, or it might specify fixed sums that are due on specific dates or after reaching certain “milestones,” or it might specify any other basis that the parties agree upon.²⁷