“The inevitable is no less a shock just because it is inevitable.” – Jamaica Kincaid
When it comes to contract negotiation, the allocation of risk is (usually) at the forefront of the parties’ minds. Obviously in the construction sector, the allocation of risk can vary dramatically from the contractor taking on sole responsibility for the design and build of a project to individual consultants and contractors each bearing responsibility for their own package of works. Many of these risks are easily identifiable and are often accounted for within the bodies of these contracts - I don’t think I need to mention how many discussions have arisen in the last year regarding the definition of "Force Majeure" within such contracts!
It was perhaps inevitable then that a case would eventually arise looking at the allocation of risk in light of the COVID-19 Pandemic. In particular, the recent case of Westminster City Council v Sports And Leisure Management Ltd  EWHC 98 (TCC), saw the Technology and Construction Court being asked to determine where the contractual risk fell where one of the parties had incurred significant financial loss.
In June 2016, Sports & Leisure Management Ltd (SLM) entered into a leisure management contract with Westminster City Council. Under this contract, SLM paid Westminster City Council a management fee in return for keeping the revenue generated from customers attending and using the leisure facilities. The contract included methods for calculating this management fee based on income among several other factors.
Under the contract, clause 37 allowed for the financial terms of the contract to be amended where Westminster City Council was served with a local authority notice of change. Upon this being served, the local authority was required to determine the changes to be made to the services and the impact this would have on the management fee.
In addition to this, clause 39 set out the process for dealing with any amendments to the contract following any changes in the law. The contract stated that a change in law must have come into effect after the date of the contract and, in order for it to be a “Qualifying Change in Law” it had to not be foreseeable at the date of the agreement.
While initially profitable, the COVID-19 epidemic had profound impact on the business. Following several lockdowns and limitations on what activities could be carried out at the site, it became clear to SLM that the facilities were no longer profitable. Under the contract, the enforced closures and restrictions were determined to be a “Qualifying Change in Law” under the contract.
While this was agreed between the parties, neither could determine how the loss of customer revenue should be addressed under the contract. Westminster City Council subsequently sought declaratory relief from the courts as to how the provisions of the contract should be interpreted.
Westminster City Council’s primary argument was that while the management fee payable to them by SLM could be calculated as nil, the contract did not contain provisions requiring it to pay a ‘reverse management fee’ to SLM. Its main reasoning for this was that, while the contract allowed for the fee to be amended as a result of a specific change in the law, there was no express provision stating that this could become a negative sum, resulting in payment being owed by Westminster City Council to SLM. As a result, it was not required to indemnify SLM despite the difficult circumstances that had arisen.
SLM’s position was that it should not be forced to bear the financial consequences of the change in law. It reviewed the contract in line with widely used terms in other, similar concession contracts and concluded that the contract should be interpreted such that any required adjustment to the management fee resulting from a change in law should be based on a formula that allowed for a negative fee or ‘reverse management fee’ to be produced.
Sitting in the TCC, Mr Justice Kerr considered whether the management fee could be calculated in such a manner to produce a "reverse management fee". He concluded that the contract was not written in such a manner that a reverse management was intended to be payable to SLM. His reasoning for this was that:
- while the contract could be interpreted in line with similar industry contracts, it was noted that the contracts only contained provisions allowing for adjustments to be made to the management fee and risk shouldered by the parties. It did not determine how this sum was to be adjusted and nevertheless the contract had deviated sufficiently from the standard form contract to be its own agreement between the parties;
- the definition of ‘management fee’ was written such that it prevented the sum from dropping below zero, even if the calculations would result in a negative figure; and
- the payment provisions under the contract only allowed for payment to be made to Westminster City Council and not to SLM. Had it been intended for the management fee to be payable to SLM, then the Court expected the contract to be explicitly drafted to include provisions allowing for this.
The Court’s conclusion ultimately meant that, at best, the management fee for any given year could be waived but that, for SLM, no monies would be forthcoming from Westminster despite the difficulties posed to it during the pandemic.
Unfortunately for SLM and many other business’ in financial difficulty, the court’s decision was not an unusual one. The courts continue to remain hesitant to step into an established contract, particularly in order to balance what might otherwise have been a bad deal for one of the parties and it seems the pandemic provides no exception to this being the case. What does this mean, practically, going forward however?
For those entering into new contracts, it is vital that potential risks are identified and caught early on in negotiations. Precise drafting will also be key to ensuring that these risks are captured and that there is no scope for a party to avoid its obligations to the other. For those in established contracts, it is important to go back and review precisely where the balance of risk lies in order to determine if you have any form of protection under your contract. After all, where there is uncertainty or no clear guidance, it is not enough to assume that the courts will step in and offer assistance and that position certainly does not look to change anytime soon.