An “appropriate deduction”: Whatever circumstances demand

This Article considers the TCC decision of Mul v Hutton Construction Limited [2014] EWHC 1797 (TCC), which provides authority on the meaning of an “appropriate deduction” in the JCT standard forms and the possible consequences of that decision for parties to such contracts.

In this case, Akenhead J was asked to decide, as a preliminary issue, the correct basis for quantifying an “appropriate deduction” to be made under Clause 2.30 of the JCT Intermediate Form of Contract (2005).

The facts of the case are that Mrs Mul contracted with Hutton in April 2008 for Hutton to carry out substantial extension and refurbishment works to her large country house.  Practical Completion was certified on 14 May 2010 (albeit that the certificate had attached to it a substantial list of works said to have been incomplete of defective). The Rectification Period was 12 months. The Employer subsequently claimed to have identified further significant defects in the work, for which the Contractor denied liability. In March 2011, the Contract Administrator wrote to the Contractor stating that the Employer was arranging for the defects to be remedied by third party contractors.

After correspondence between the parties, proceedings were issued by Ms Mul for damages for the defects which had been remedied by other contractors and an alleged overpayment for a sum in excess of £1,000,000. In defence of the claim, the Contractor argued that it had always been ready, willing and able to repair the defects as envisaged by Clause 2.30. It was argued on behalf of the Contractor that if (and it was a big if on the basis that, in fact, it was not agreed between the parties that a proper instruction had been given in order to engage clause 2.30) a “appropriate deduction” was to be made under clause 2.30, then such a deduction should be based on the schedule of rates contained in the contract. 

In summary, Clause 2.30 of the JCT Intermediate Form of Contract (2005) permits the Contract Administrator to make an “appropriate deduction” from the Contract Sum in respect of “defects, shrinkages or other faults not made good…which are due to materials or workmanship not in accordance with this Contract”, where (i) the Contract Administrator has notified the Contractor of the same not later than 14 days after the expiry of the Rectification Period and (ii) with consent of the Employer, he has instructed the Contractor not to make the defects good at his own expense, as the Contract Administrator would otherwise be entitled to do. In such circumstances, the Employer will invariably instruct another contractor to complete the Works.

The term “appropriate deduction” appears in other clauses in the JCT standard forms and so the judgment is of wider application than clause 2.30 of the Intermediate Form. The other clauses include clause 2.30 of JCT Intermediate Form of Contract (2011) the successor to the 2005 edition, clause 2.35 of the JCT Design and Build Contract 2011 edition and clause 2.38 of the Standard Building Contract (2011), which is set in the same terms as the clause in dispute in Mul, as well as clause 3.18 and clause 3.11 of the 2011 Standard Building Contract, which deals with non-compliance with instructions, and states:

“Subject to clause 3.10, if within 7 days after receipt of a notice from the Architect/Contract Administrator requiring compliance with an instruction the Contractor does not comply, the Employer may employ and pay other persons to execute any work whatsoever which may be necessary to give effect to that instruction. The Contractor shall be liable for all additional costs incurred by the Employer in connection with such employment and an appropriate deduction shall be made from the Contract Sum.”

In Mul, Akenhead J held that:

“… an ‘appropriate deduction’ … means a deduction which is reasonable in all the circumstances and can be calculated by reference to one or more of the following amongst other factors:

a.    The Contract rates/priced schedule of works/Specification; or
b.    The cost to the Contractor of remedying the defect (including the sums to be paid to third party sub-contractors engaged by the Contractor); or
c.    The reasonable cost to the Employer of engaging another contractor to remedy the defect; or
d.    The particular factual circumstances and/or expert evidence relating to each defect and/or the proposed remedial works.”

The judgment refers to specific methods of calculation essentially because, having been asked a specific question, he answered it terms. However, the judgment makes clear that the method of calculation of an “appropriate deduction” did not have to take any prescribed form and that the sums that could be included are limited only by the circumstances of the particular case at hand.

He gave some specific examples of how the particular circumstances of the case might affect the valuation of an appropriate deduction. For instance, where the price of a piece of defective work is high in the schedule of rates (because a large profit element has been included) but the cost of the remedial work is low, the cost of remedial work is likely to be the starting point for an appropriate deduction, since that represents the actual loss to the Employer. An example given was plastering a wall which is 1mm thicker at the bottom than the top; the plastering may have cost £100 but the remedial work (sanding the plaster with an electric sander) may cost only £40. On that basis, the Employer would not be entitled to the higher figure in the contract rates, but instead the lower actual cost of the works was appropriate.

However, where the remedying of a defect will cost much more than the price in the contract rates, the starting point is likely be the cost to remedy the defect. The judge’s example was a situation where finishing work is done over the defective work (e.g. floor coverings or book cases placed on or over defective work). The book cases and floor coverings would need to be removed before remedial work could be undertaken. The cost of such removal would not be included in the contract price so the priced document would not be an appropriate starting point. An appropriate deduction will include all those “extra” costs.

Significantly, Akenhead J made clear that where an Employer fails to give a Contractor a proper opportunity to remedy works, an “appropriate deduction” would only be, in those circumstances, the cost to the Contractor of remedying the defect. This restriction on recovery stems not from special construction of the JCT contract but rather from the trite principle that the Employer is not entitled to an increased sum, where that increase is due to his or her failure to mitigate his or her loss. Furthermore, he found that having failed to mitigate his or her loss, “I do not see a peculiar difficulty in the CA doing the independent exercise of valuing the “appropriate deduction” under Clause 2.30 by reference to fairly well known rules about mitigation of damage”. Therefore, at the root of Akenhead J’s decision is the principle that, when valuing an “appropriate deduction”, the CA is permitted, and indeed expected, to value the loss to the Employer by simply applying general legal principles.

There is nothing to say that the Contract Administrator will not, therefore, be called upon to apply potentially complicated, or at least probably strongly contested, legal principles such as those arising the second limb in Hadley v Baxendale, pertaining to loss “such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract, as the probably result of the breach of it”, which depend on additional special knowledge by the defendant.

An inquisition into such losses may require a lot more of the Contract Administrator than is most often required at the stage of merely valuing interim certificates and, necessarily so, because certificates that relate to remedial works required during the course of the Works are unlikely to gives rise, for example, to a issues of loss of profit because the Employer will not have possession of or even access to the unfinished Works.

However, support for this expansive interpretation is found in the explicit wording of Clause 3.11 of the 2011 JCT standard form, which says that where the clause is engaged, “The Contractor shall be liable for all additional costs incurred by the Employer in connection with such employment and an appropriate deduction shall be made from the Contract Sum”. Where “appropriate deduction” is equated to “all additional costs incurred … in connection with such employment”. Save, perhaps, for the potentially restrictive use of the word “costs” (as opposed to the more permissive term “losses”), there is no limit placed on the scope of the potential sums to be claimed as there is, for example, in Clause 4.23 of the 2011 Standard Form, which permits the Contractor to recover “direct loss and/or expense” incurred as a result of the occurrence of matters that are under the control of the Employer of the Architect. The Court of Appeal in F.G. Minter v WHTSO (1980) 13 B.L.R. 1, CA held that that meant loss and expense which arises naturally and in the ordinary course of things, as comprised in the first limb in Hadley v Baxendale (1854) 9 Ex. 341. This formulation of the definition of direct damage was approved by the court in Saint Line Ltd v Richardson [1940] 2 K.B. 99 as “that which flows naturally from the breach without other intervening cause and independently of special circumstances, where indirect damage does not so flow”.

Therefore the decision in Mul, as the first authority on the meaning of “appropriate deduction” under the JCT standard forms, offers only loose guidance of the parties and, indeed the Contract Administrator, should take when valuing such a deduction. It might be that in some cases, a disgruntled Employer is encouraged to throw everything into a purported “appropriate deduction”, such that deductions made, where disputed by the Contract (or even not accepted by the Contract Administrator), will be brought more frequently before the courts. However, only time will tell on that point.