Scottish Court of Session Decisions

The dispute between the parties centred on the construction of the last paragraph of the foregoing passage.

[3] The spending limit of £500,000 referred to in the first of the paragraphs quoted from the letter of 12 October 2001 was subsequently increased by the defenders; the last authorized increase, contained in a letter of 12 September 2002, brought the maximum sum up to £5,000,000. It was a matter of agreement that the contract whose terms are contained in the letter of 12 October 2001 was intended to operate as a "stop-gap" contract pending the conclusion of a formal contract between the parties, such formal contract to be based on an amended version of the JCT 98 Conditions. In fact, however, the parties never reached agreement on the terms of a formal contract. The pursuers proceeded to carry out works in accordance with the authority conferred by the letter of 12 October 2001, and interim payments for such work were made by the defenders to the pursuers. By October 2002 it became apparent that the parties would not be able to reach agreement on the terms of a formal contract. By that time the pursuers had reached the spending limit specified in the letter of 12 September 2002, and the pursuers' authority conferred by the letter of 12 October 2001 was accordingly terminated. Thereafter the pursuers raised the present action against the defenders in which they seek payment of the sum of £863,117.35. That sum is said to represent the amount that remains due by the defenders to the pursuers for the work carried out under the contract of 12 October 2001. The defenders dispute liability to pay that sum, and have themselves lodged a counterclaim in which they seek payment of sums totalling £441,937.36; those sums represent costs which the defenders claimed to have sustained as a result of late completion and defective performance of the works by the pursuers and the loss of certain items for whose storage the pursuers were responsible. After sundry procedure the parties prepared notes of argument and the parties were allowed a debate on the matters referred to in those notes.

[4] Most of the matters in dispute in the notes of argument related to the details and specification of the parties' respective claims. In the course of the debate, however, counsel agreed that certain items would have to be deleted from their claims and that greater specification was required in respect of certain other items. That will obviously require amendment, and counsel were in agreement that I should not consider the details of the pleadings before the amendment process was complete. Nevertheless, one important issue of principle remained in dispute between the parties, and counsel asked me to reach a decision on that issue before amendment took place, because my decision would affect the basis for such amendment. That issue was the meaning of the expression "all direct costs and directly incurred losses" as it is used in the last of the paragraphs quoted above in the letter of 12 October 2001.

[5] The defenders contended that the use of that expression restricted sums due to the pursuers to costs directly attributable to the High School contract. These would include the cost of labour, plant and materials used on the particular contract. On the other hand they would exclude costs attributable to the pursuers' enterprise considered as a whole; that would exclude head office overheads. The expression would also exclude any element of profit on the contract. If the pursuers were to make a profit in respect of works carried out at the High School, that could only occur under the formal contract that was contemplated by the parties. The pursuers, by contrast, contended that the expression "all direct costs and directly incurred losses" permitted them to recover not only the cost of labour and materials expended on the High School contract together with the cost of plant and sums paid to subcontractors but also an appropriate sum to cover their head office overheads and an appropriate element of profit.

[10] If the word "losses" did not cover general overheads and an element of profit, the pursuers would have to carry their corporate overheads from other sources of income, with no contribution from the works at the High School unless a formal contract were concluded. Likewise, the pursuers would have no possibility of profit from those works unless a formal contract were concluded. I do not think that a probable construction. Indeed, the head office overheads are likely to cover such matters as accounting and bookkeeping work carried out in respect of the present contract; they will also cover the salaries of draughtsmen and surveyors employed at head office who can be expected to perform work for the purposes of the present contract. Thus part of the general overheads will be referable to work carried out on the present contract. If the defenders' construction is correct, however, no contribution towards the cost of that work would be earned from the contract, unless the salaries of draughtsmen, surveyors, accounting staff and the like can be allocated on some sort of time basis. Such a procedure would be unusual, at least for accounting staff, and complicated. I do not believe that it would have been within the parties contemplation when work started following the letter of 12 October 2001.

[11] No doubt it can be said that the pursuers would have the hope of a profit from the formal contract if it were concluded. The contractual arrangements set out in the letter of 12 October 2001, however, only operate on the hypothesis that no formal contract is concluded. If a formal contract were concluded, it is obvious, I think, that the work already done would be subsumed into the formal contract. That is clear from the fact that the letter of 12 October 2001 refers to a specific contract sum applicable to the entire contract works. Consequently the possibility of a profit on the formal contract does not appear relevant on the hypothesis on which the arrangements in the letter of 12 October 2001 operate.

Chiemgauer was of course concerned with the consequences of termination of the contract; consequently the loss could have amounted to the profit on the whole contract that would have been earned but for the termination. In the present case, by contrast, the loss of profit is much more limited, and is restricted to a reasonable percentage added to the cost of the works ordered by the defenders.

[14] Counsel for the defenders submitted that Chiemgauer should be distinguished because it was concerned with a termination that was to be treated, in terms of the parties' contract, as if it were a breach of contract. That could not be said of the present case. Consequently, if the decision in Chiemgauer were followed literally, the consequences would be that the pursuers were entitled to the whole of the profit that they would have made if the formal contract had gone ahead. That construction, counsel submitted, could not be correct. I agree that such a construction would be wrong. Nevertheless, I do not think that it is the correct construction of the present contract. As indicated in paragraph [11] above, I consider that the losses that can be claimed by the pursuers are those arising from the works instructed by the defenders in accordance with the letter of 12 October 2001. They do not include losses on the formal contract. Indeed, that would not be possible because the letter of 12 October 2001 operates on the hypothesis that no formal contract has been concluded; consequently no losses could arise under the formal contract.

[15] Counsel for the defenders further submitted that the pursuers' construction of the letter of 12 October 2001 was improbable because it gave the contractor a guaranteed profit. The parties' intention, however, was clearly that the works should ultimately be performed under a lump sum contract, which gives the contractor the possibility of making either a profit or a loss. If the formal contract had come into operation, that would undoubtedly be so. Nevertheless, the arrangements in the letter of 12 October 2001 only operate on the hypothesis that no such contract has been concluded. What they set up is in effect a cost plus contract. That form of contract is not unusual. No doubt it is true that such a contract will normally specify a fixed percentage that is to cover both general overheads and profit, whereas the letter of 12 October 2001 does not specify any such percentage. I do not think that that objection is fatal, however. What the present contract allows for is a reasonable percentage to cover general overheads and profit, and I do not think that there should be any insuperable difficulty in determining what is a reasonable percentage.

[16] Counsel for the defenders also argued that the arrangements in the letter of 12 October 2001 should be construed on the basis that they were a holding operation, pending the conclusion of a formal contract. The formal contract might fail to be concluded for a number of reasons, including financial flows under the PFI arrangements for the renovation of the High School. Moreover, the holding arrangements involved limits on authorised expenditure; initially £500,000 was authorized, but over the following year that sum was increased to £5,000,000. These features, it was said, presented a further distinction from Chiemgauer, and also indicated that the parties' intention was not to allow any general recovery of profit under the present contract but to reserve that for the formal contract. In my opinion the answer to these points is twofold. In relation to the holding or temporary nature of the arrangements in the letter of 12 October 2001, the critical point is that those arrangements only operate if no formal contract is concluded; if it is concluded the work done under the temporary arrangements will be subsumed into the formal contract. That is the significance of the lump sum price referred to in the letter. In relation to the expenditure limits that applied to the temporary arrangements, the purpose of these is in my opinion clearly to place limits on expenditure in order to achieve budgetary control. I do not think that the limits on expenditure have any wider significance. I also note that in the first paragraph of the passage from the letter quoted in paragraph [2] above it is stated that losses, including loss of profit, are to be related to the spending limit and not the entire contract sum. That confirms that any claim for losses is to be left within the operative expenditure limit.