PFI ‘good faith’ obligations under scrutiny

Project iStock 000000224397XSmall 146x219The Technology and Construction Court has recently issued a ruling on a 'good faith' obligation contained in a PFI contract where a local authority was one of the parties. Leah Horn examines the judgment.

This briefing highlights the key issues relating to “good faith” from the Portsmouth City Council (PCC) v Ensign Highways Limited [2015] EWHC 1969 Technology and Construction Court (TCC) decision handed down by Mr Justice Edwards-Stuart in the TCC.

The decision should be considered against a backdrop of budget cuts faced by local authorities and on-going press criticism of private finance initiatives (PFI) which, recent reports claim, will cost the public purse £10bn a year by 2017/18.

Facts

PCC and Ensign entered into a PFI contract in 2004. Ensign was to bring the existing highways infrastructure surrounding Portsmouth up to a defined standard, within the first five years of the contract, and thereafter maintain the infrastructure it had constructed for a period of 20 years.

Ensign would be entitled to a monthly fee, less any deductions made by PCC for breaches of the contract to recoup its initial investment in the construction period. These deductions would be calculated by reference to a series of “service points” which were set out (albeit not exhaustively) in Schedule 17 of the contract (Schedule 17).

Until this point, PCC had treated the service points set out in Schedule 17 as being a discretionary range with a minimum and maximum level (to reflect the severity of the breach) and had deducted those service points at regular monthly intervals. Cost-cutting reviews around this time revealed that PCC did not have sufficient budget to continue operating the contract in the manner it had to date for the lifetime of the project.

Following the appointment of an external consultant to review its spending in December 2013, PCC employed tactics of awarding the maximum permitted service points in respect of every breach, failing to reply to enquiries and saving up the notification of those points over a series of months so that, when collectively notified they triggered the termination thresholds under the contract.

Unsurprisingly, this led to a dispute between the parties as to the correct interpretation of the contract and PCC eventually brought a claim against Ensign seeking various declarations as to its obligations under the contract. The court was asked to consider:

1. whether or not an express obligation to act in “good faith” at clause 44 of the contract (clause 44) applied to the whole contract; and

2. if not, whether there could be an implied duty of “good faith” on PCC in operating the service points mechanism under the contract.

Express duty of good faith

As is commonly accepted, there is no overarching principle of "good faith" under English law. Clause 44 governed how PCC discharges its statutory duty under the Local Government Act 1999 to deliver its best value duty to the taxpayer. The clause is drafted widely to allow the parties to work together to establish the network board to assist in operating the agreement over the 20 years.

Clause 44.4.1 of the contract specifically stated that:

“PCC and [Ensign] shall deal fairly, in good faith and in mutual co-operation with one another and Interested Parties”.

The express “good faith” provision was found not to apply to the whole contract between the parties because there were a number of other express provisions to act in good faith throughout the contract. It was clear therefore that the parties had agreed express terms of good faith should apply to specific parts of the contract only.

Mr Justice Edwards-Stuart placed importance on the following quote from the Court of Appeal judgment in Mid Essex Services NHS Trust v Compass Group (Mid Essex):

“… care must be taken not to construe a general and potentially open ended obligation such as an obligation to ‘co-operate’ or ‘to act in good faith’ as covering the same ground as other, more specific provisions, lest it cut across those more specific provisions and any limitations in them”.

Having dispensed with any arguments that clause 44 should apply to the service points mechanism, Mr Justice Edwards-Stuart was asked to consider whether or not there should be an implied term duty which was more generally applicable to all aspects of the contracting parties’ conduct.

Implied duty of good faith

First, Mr Justice Edwards-Stuart decided upon whether or not the service points table set out in Schedule 17 was indicative of a range of numbers from which PCC could then select depending on the severity of the breach or a fixed figure PCC must apply in the event of a breach by Ensign.

This was because, by reference to the decision in Mid Essex on the same point of law, a “good faith” obligation can only be implied into a contract where:

  • the contract provides for one party to exercise discretion that involves a balancing exercise; and
  • the implied term was intrinsic, and the contract would therefore not make sense without it.

In both Mid Essex and PCC v Ensign the local authority had the discretion as to whether or not to exercise its absolute contractual right to apply service points for a breach of contract. This was a yes or no decision and no balancing exercise was required.

Importantly on the facts of this case, Schedule 17 was found to represent a range of service points that PCC could award in the event of such a breach. To do so would require PCC to exercise discretion (a balancing exercise) because the number selected from the range would vary depending on the severity of the breach.

Mr Justice Edwards-Stuart found in favour of Ensign that Schedule 17 represented a range because (among other reasons) the column was headed “Maximum Event Value" which on plain interpretation implies a range and the service points were to be “calculated” in accordance with the schedule, which implies the total is not absolute in the event of a breach. 

Mr Justice Edwards-Stuart went on to make a declaration that the following term should therefore be implied into clause 24:

“When assessing the number of Service Points to be awarded under clause 24.2.1(c) of the Agreement, PCC’s Representative is to act honestly and on proper grounds and not in a manner that is arbitrary, irrational or capricious”.

He favoured this wording, which was taken from the Mid Essex decision over the suggested wording by both parties. This was largely out of a preference to follow existing authorities, but Mr Justice Edwards-Stuart did state that, in practice, there was very little distinction between how all three suggested implied terms might operate. It will be interesting to see how a breach of this clause is established and evidenced by Ensign.

Comment

This dispute was undoubtedly a product of the current economic climate, with public authorities under increasing budget constraints. Affordability of payments under PFI and PPP contracts is a hot topic in the press and one not likely to go away. We are likely to see more of this sort of case and particularly cases involving contract interpretation on clauses that require parties to conduct their contractual relationship fairly or in a “partnering” way. It is therefore reassuring to see some consistency of approach by the TCC judges on this topic. It will also be interesting to monitor developments in this area in respect of the contracting and supply side of the PFI/PPP chain.

Leah Horn is an associate at Nabarro. She can be contacted on 020 7524 6359 or This email address is being protected from spambots. You need JavaScript enabled to view it..