Interpretation of performance mechanism
SUTTON HOUSING PARTNERSHIP v RYDON MAINTENANCE (CA) [2017]
Many services contracts include mechanisms to measure performance and it is common, and indeed useful, to set out worked examples of how such mechanisms are intended to operate - if the wording is not clear, one party’s view of what has been agreed may be different from the other’s. In this case, the Court of Appeal found that ‘example’ figures set out in a contract in relation to a performance mechanism were intended to be binding and of general application rather than being merely illustrative.
Facts:
- Sutton Housing (“S”) engaged Rydon Maintenance (“R”) to carry out housing maintenance and repairs under a contract for five years.
- The contract contained a Key Performance Indicator (“KPI”) framework. It set out how R would be financially incentivised for exceeding its KPI targets and financially penalised for failing to achieve them. A number of example calculations were included to show how these penalties and incentives would be calculated. Those example calculations specified certain ‘MAPs’ (minimum acceptable levels of performance). This was the only place where the MAPs were detailed and in every case, the MAP was 3% below the target KPI.
- The contract contained an express right of termination which clearly referenced continued failures to achieve the MAPs across all KPIs.
- S became dissatisfied with R's service. S served a notice asserting that R had failed to meet the MAPs and giving R the opportunity to improve its performance. R did not do this satisfactorily so S issued a notice terminating the contract.
- R maintained that the contract did not actually specify any MAPs and S could not therefore terminate the contract for failure to meet them.
- The Technology and Construction Court (“TCC”) ruled in favour of R, finding the MAPs given in the contract were illustrative only and so the termination was invalid.
- S appealed. The Court of Appeal (“CA”) had to consider whether the MAPs were contractually binding or just for illustration.
Decision:
- The CA agreed with the TCC’s view that the Court should proceed with care when determining whether contractual provisions are sufficiently clear to permit the termination of a relatively long-term contract.
- However, it granted S a declaration that the figures in the tables for the MAPs headed ‘example’ were contractually binding and could be applied more generally; its termination notice was therefore valid. The following reasons were given:
- although it found that the KPI framework was a poorly drafted document, the CA commented that it was common ground that the parties must have intended to provide for MAPs. Without them the corresponding termination provision for S would have been ineffective. The CA considered that the parties can hardly have intended to “neutralise the principal contractual provision enabling [S] to terminate for poor service” (even though there were other rights to terminate);
- applying the principles on interpretation set out in Rainy Sky v Kookmin Bank (SC) [2011] and Arnold v Britton (SC) [2015], the contract must have meant that the MAPs in the ‘examples’ were binding, not just hypothetical;
- while the tables used hypothetical performance figures, the other information in them (including the MAPs) was not hypothetical;
- the ‘example’ provisions showed that the MAPs for 2013/14 were 3% lower than the contractual target performance figures. That was obviously the ratio the parties intended, so S was entitled to calculate the MAPs for 2014/15 by applying the 3% percentage to the target performance figures for that year.
Points to note:
- This decision shows the need for clear drafting especially when payment and termination provisions rely on information set out in contract schedules.
- Crucially, contracting parties should ensure that different parts of the contract make sense as a whole. Having drafted a right of termination referencing MAPs, it was essential that the service level schedule supported that.
- Contracting parties should also make sure that terminology is used consistently. For example, it became clear that whilst the contract termination right referenced ‘MAPs’, for some unknown reason the service level schedule referred to ‘Performance Profit Thresholds’ or ‘PPTs’’. The judges were prepared to say that these two terms were referencing exactly the same thing which was fortunate for S but why invite the risk?
- The CA made some useful comments about interpreting contracts generally:
- when it comes to considering the relevant words to be interpreted, the less clear they are or the worse their drafting, the more ready the Court can properly be to depart from their natural meaning. However, that does not justify embarking on an exercise of searching for drafting mistakes to facilitate a departure from the natural meaning;
- commercial common sense is not to be invoked retrospectively. The mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly, or even disastrously, for one of the parties is not a reason to depart from the natural language. Commercial common sense is only relevant to the extent of how matters would or could have been perceived by the parties, or by reasonable people in the position of the parties, as at the date that the contract was made;
- a Court should be very slow to reject the natural meaning of a provision as correct simply because it appears to be a very imprudent term for one of the parties to have agreed, even ignoring the wisdom of hindsight. The purpose of interpretation is to identify what the parties have agreed, not what the Court thinks that they should have agreed and so the language actually used in the contract is of critical importance.