Courts provide guidance on “reasonability” in compensation on termination recovery

Many construction contracts, particularly those for energy and infrastructure projects, set out detailed provisions around the recovery of supply chain costs upon termination for convenience or employer default.

A new decision from the Privy Council has provided some guidance on the limits of those provisions. Below, we discuss that decision and the impact for employers and contractors in their own contracts.

A common feature of construction contracts, including FIDIC, IChemE and JCT/SBCC, is the right for a contractor to recover its committed downstream costs upon termination. 

For example, Clause 18.5 of the FIDIC Yellow Book 2017 provides:

“After the date of termination the Contractor shall, as soon as practicable, submit detailed supporting particulars… of the value of the work done, which shall include…
(c)        any other Cost or liability which in the circumstances was reasonably incurred by the Contractor in the expectation of completing the Works…”,

while Clause 93.1 of the NEC4 Engineering and Construction Contract includes the following:

“The amount due on termination includes…
•    other Defined Cost reasonably incurred in expectation of completing the whole of the works…”.

The Privy Council has, in its recent appeal decision in Water and Sewerage Authority of Trinidad and Tobago v Waterworks Ltd (Trinidad and Tobago) [2025] UKPC 9, provided guidance on what is “reasonable”, and therefore recoverable, in this context. Whilst Privy Council decisions are not strictly binding in Scottish or English courts, they carry persuasive value and so are important to consider for UK projects.

Facts

The Contractor, Waterworks Ltd, entered into binding contracts with the Employer, Water and Sewerage Authority of Trinidad and Tobago based on the 1999 version of the FIDIC Yellow Book for the design and build of water treatment plants, which included the supply of equipment. The clause on recovery of costs on termination in these contracts was substantially the same as the 2017 FIDIC wording above.

The Contractor in turn entered into subcontract arrangements for design and construction supervision services with a Canadian company which, crucially, contained a 30% cancellation charge in relation to the cost of equipment anticipated to be supplied under that contract. These contracts were entered into before the relevant designs for the treatment plants had been finalised. 

Due to the Employer’s termination of the main contract, no equipment was ever shipped or delivered or invoiced, and the 30% cancellation charge was applied.

A dispute arose on the question of whether the Contractor would be able to recover the cancellation charges as ‘reasonably incurred’ costs.

The decision

On appeal, the Privy Council decided that in the circumstances, when only preliminary designs for the projects had been completed, it was premature of the Contractor to have entered into unconditional supply contracts for most of the equipment for the plants. The only potential benefit of entering into the contracts at such an early stage to which the Contractor could properly point, was a protection against subsequent price increases. However, no evidence was provided by the Contractor to demonstrate that this played any part in its thinking when issuing the purchase orders for the equipment at such an early stage or accepting the cancellation charge. The Contractor had argued that they were just trying to comply with their obligations to complete the works at a fixed price within a specified time and took a “forward-looking” approach "in the expectation of completing the Works", as per the wording of the 1999 Yellow Book contract.

Additionally, the court decided that it was on the face of it unreasonable for the Contractor to accept to pay cancellation charges when the supplier was not incurring any costs or liabilities for which the charge would compensate. The Contractor was not able to provide evidence to the contrary, such as any negotiations or communications that had taken place before accepting the cancellation charge. 

Therefore, the Contractor was unable to recover the costs from the Employer. 

Take aways

The decision provides real food for thought for employers and contractors alike and should be considered in the context of any contracts which include significant compensation on termination values, including in relation to cancellation costs. 

• Consider your supply chain strategy: will there be significant upfront commitments, either in terms of upfront payments, or cancellation charges upon the project not completing? These may be reasonable in the circumstances, but a terminated contractor might be called upon to justify them.
• Records, records, records: contractors should ensure that, if the reasonability of those commitments is open to challenge, that they can demonstrate that those are in line with market norms (e.g. multiple tenderers offering similar or worse terms) and necessary to secure capacity. Better still to have evidence that those upfront costs were subject to negotiation rather than accepted without challenge.
• If in doubt, draft for it: if the employer and contractor agree that those upfront commitments are required to book a vital fabrication slot or maintain programme, expressly agree within the main contract that those particular commitments are “reasonable” (or include back-to-back recovery rights within the main contract).

The issues raised by the decision may also be seen as applying to drafting around costs “properly” incurred (such as in IChemE and JCT/SBCC contracts); in other words, that it would be “improper” to incur costs that cannot be justified by market conditions or the programme. In that case, this guidance is likely to be relevant outside of FIDIC and NEC-based projects.

Our construction and projects team regularly advises on the drafting and negotiation of construction contracts across all sectors, and on the resolution of disputes arising from them. If you would like to discuss the issues arising from this article and the impact on your business, please get in touch with us.

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