Kate Jones explores a new ruling which highlights potential issues with target cost contracts under joint ventures
A recent decision by the Technology and Construction Court (TCC) in Doosan Enpure Ltd vs Interserve Construction Ltd has provided valuable insights into the implications of joint-venture contracting under target cost arrangements.
Target cost contracts are a form of cost reimbursable contract under which the contractor is paid the “total cost” it incurs in carrying out the works, plus a fee to cover overheads and profits. The parties agree a target price at the start of the project and any savings or overrun on completion are allocated according to a predetermined formula known as a pain/gain share mechanism.
The JV parties also disagreed over whether the NEC3 contract with Northumbrian Water allowed the pain-share mechanism to be applied at an interim payment stage
Doosan and Interserve entered into a joint-venture agreement (JVA) to carry out upgrade works at the Horsley water treatment plant for Northumbrian Water Ltd. The JV parties and Northumbrian Water entered into a contract based on the NEC3 Option C form (Target contract with activity schedule), with works commencing in March 2016.
The progress of the works was delayed, with an increase in cost. From October 2018, the JV parties fell into dispute over whether interim payments under the JVA should be made on an actual cost basis or whether they should reflect the anticipated pain-share likely to result upon completion of the works. The JV parties also disagreed over whether the NEC3 contract with Northumbrian Water allowed the pain-share mechanism to be applied at an interim payment stage.
TCC proceedings were commenced to resolve the impasse between the JV parties and to determine entitlement to sums held in the JV bank account.
Pain/gain share under the NEC3
Having considered whether interim payments under the contract could include pain/gain share adjustments, the court determined that such adjustments could not be made at an interim stage. The court emphasised the terms of clause 53.3 of the contract as follows: “The project manager makes a preliminary assessment of the contractor’s share at completion of the whole of the works using his forecasts of the final price for work done to date and the final total of the prices. This share is included in the amount due following completion of the whole of the works.”
The suggestion that this provision might allow Northumbrian Water to apply the pain/gain share mechanism at an earlier stage was rejected.
In relation to interim payments, clause 8.6 of the JVA provided that: “The parties shall receive interim payments from the JV in reimbursement of the works part costs incurred by each party as shown on the parties’ interim cost statements. Works part costs shall be reimbursed in accordance with the principles set out in schedule 4.”
The “interim cost statements” were simply those applications submitted by each of the JV parties that combined together to form the joint application for payment submitted to Northumbrian Water. Schedule 4 contained reference to the pain/gain share mechanism to be applied on completion but made no specific reference to interim payments.
The only clauses dealing with the issue directly provided that where costs were likely to exceed the relevant target or where delay to completion was likely to result in the deduction of delay damages, the JV committee could be requested to, “suspend or reduce the level of interim payments to the other party […] Where the JV committee is unable to reach agreement, the matter may be referred to resolution under clause 21.”
It was determined that as the JV committee were unable to reach an agreement on the suspension of payments, the position under clause 8.6 prevailed. Clause 8.6 required the full amount of the payment from Northumbrian Water to be distributed to the parties without adjustment or suspension for anticipated pain-share.
Implications of the ruling
Although this case creates no new law, the judgment highlights that:
- Employers should seek to build into the contract the ability to make pain-share adjustments at an interim stage where the target cost has already been exceeded. Although it increases the complexity of the interim payment process, this avoids the need to recover overpayments upon completion.
- Cash flow considerations can also be seen at the JV level; this may lead to the inclusion of provisions preventing the release of funds to JV parties where pain-share adjustments are at risk, forcing the issue to be dealt with at an earlier stage by the JV parties during the course of the works.
- JV parties should consider the potential for intra-JV disputes, particularly in JV structures where decisions must be unanimous. Parties negotiating JVAs should consider the inclusion of mechanisms to enable the swift and effective resolution of disputes and deadlocks as desirable, if not indispensable, to the agreement.
Kate Jones is an associate in the infrastructure, construction and energy disputes team at CMS