Chris Kidd Head of Shipbuilding and Offshore Construction, Joint Head of Energy & Infrastructure, Partner
Contract in need of a CATS scan? Interpretative treatment of lengthy long-term contracts
In Teesside Gas Transportation Ltd v CATS North Sea Ltd and others EWHC 1220 (Comm), the Commercial Court has provided guidance on the principles of contractual interpretation which apply to lengthy, complex and long-term contracts.
The Central Area Transmission System (“CATS”) is a gas pipeline and transmission system which transports natural gas from several production fields in the North Sea to an onshore processing terminal in Teesside.
In 1990, Teesside entered into an agreement with the CATS owners by which it reserved capacity in CATS over a 25 year period beginning in 1993 when CATS became operational. Teesside was to pay a fee for the reserved capacity which was fixed for the first 20 years and calculated by reference to a contractual formula for the latter 5 years (“Capacity Fee”).
In essence, the Capacity Fee was calculated by apportioning the operating and capital expenses payable by Teesside on the basis of the proportion of total pipeline capacity reserved to it under the contract and then applying a 15% uplift.
The dispute concerned the calculation of the Capacity Fee, specifically the meaning and content of various elements of the contractual formula, including:
- The scope of the defined term “CATS Transportation Facilities” (or “CTF”) as it related to various elements of operating and capital expenditure in the contractual formula;
- Categorisation of expenditure components of the formula;
- How the total pipeline capacity was to be calculated for a given year; and
- The right of the CATS owners to restate the Capacity Fee and Teesside’s good faith, or lack of it, in contesting the Capacity Fee.
Resolving these issues required the court to consider the principles of contractual interpretation which apply to long, complex commercial contracts, and those unique to contracts which govern the parties’ obligations over an extended period.
Principles of interpretation
Before considering the individual issues of construction, the court set out several points that would guide its approach, in particular:
- The contract was a lengthy and complex document (which had been subject to multiple rounds of amendment) and even though expert advisers were engaged in the drafting process, it should not be assumed that:
- “[E]very phrase in such a document is as elegantly crafted or as logically integrated with every other as it might be desired”; or
- “[T]he drafters will have envisaged every possible factual scenario which might arise under the contract over the course of the” contract term.
- The contract could be categorised as long-term, meaning it was appropriate for the court to adopt what it described as a “flexible approach” to the issues of interpretation “to give effect to the reasonable expectations of the parties.”
- The court considered the flexible approach would extend to “a certain (and fact-sensitive) degree of co-operation between the parties” (per Globe Motors v TRW Lucas Varity Electric Steering  EWCA Civ 396) but did not go so far as to “give rise to a more generalised duty of good faith on both parties” as suggested in Yam Seng Pte v International Trade Corp EWHC 111 (QB) in connection with similarly long-term relational contracts.
- The “ordinary principles of construction” require the court to engage in a “unitary” construction exercise by which it tests rival meanings of particular words and phrases against alternative meanings, the remainder of the contract, the contract’s commercial purpose and the background to its formation (per Lord Hodge in Wood v Capita  UKSC 24).
The individual points of interpretation are too numerous to recite individually, however the following two illustrate the court’s approach to construction under the contract.
The first issue the court considered was the scope of the CTF, namely whether it included four categories of equipment or components of the facilities. Only expenditure incurred in connection with the CTF formed part of the Capacity Fee.
The CTF was defined as “the facilities to be constructed, owned and operated by the CATS [owners], as described in Schedule I.” The CATS owners argued that the categories in dispute also formed part of the CTF as they were nevertheless “ancillary” to or “associated” with the transportation of gas within the pipeline.
The court was not persuaded by this argument, largely on the basis that extending the definition in this way would mean that items of equipment such as pig receivers would also be considered part of the CTF. This was held to be “unlikely to have been the intention of the parties”.
The final issue for the court concerned whether Teesside had an obligation to act in good faith in disputing the invoiced Capacity Fee. The contract provided a right for either party “to dispute, in good faith, any amount specified in an invoice”.
The court found that the existence of this clause meant that it was not possible to imply a duty of good faith (per Legatt LJ in Globe Motors) as the contract “exhaustively” defined the extent of any good faith obligations. In respect of the contractual obligation, it was found that by withholding certain sums after an audit had been completed and reviewed, Teesside’s board were in breach of the express term by acting in bad faith in continuing to dispute the relevant parts of the Capacity Fee invoices.
Although the court adopted a clear and pragmatic approach parties should always take care when drafting long-term contracts, particularly where obligations arise late in the contract term, as it may be that the court will apply a more flexible approach than might be the case in other types of contract. Similarly, if during the performance of a long-term contract the parties develop an understanding of how it is to be operated which is not reflected in the original wording, it would be prudent to record this in an addenda to the contract.
The court’s comments in relation to the duty of good faith in long-term relational contracts are also worthy of note: the various references to good faith in the contract were sufficient to defeat an argument that a separate, generalised duty of good faith should be implied. The English courts therefore continue to be reluctant to imply duties of good faith into contracts except in limited circumstances.
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