BE CAUTIOUS OF ‘FITNESS FOR PURPOSE’ CLAUSES IN CONTRACTS

By Tyron Theessen, Partner & Hannah Milner, Candidate Attorney at Webber Wentzel

A fitness for purpose obligation is important in allocating design risk, but its appropriateness is often challenged.

Risk can be allocated to ensure the work achieves the intended outcome while ensuring contractors and consultants are able to absorb this risk and meet the demands of the professional indemnity insurance industry.

A fitness for purpose undertaking in a contract, whether express or implied, imposes an obligation on consultants or contractors to ensure the works they design and/or build are fit for their intended purpose. Liability in the event of a breach is strict: it arises whether there was any negligence, or failure to act responsibly, on the contractor’s part.

The notion of strict liability poses considerable challenges in an insurance context, as most professional indemnity policies will cover holders only if the claim arises from their professional negligence. When there is a defect, and no allegation of negligence is made or proven, the policy is unlikely to pay out for the claim. This leaves the designer or contractor uninsured against a contractual claim for a breach of a fitness for purpose obligation.

Not only do many professional indemnity policies expressly exclude risk associated with fitness for purpose, but the inclusion of fitness for purpose obligations could, depending on the language of the policy, render the entire policy voidable by the insurer, leaving the consultant or contractor with no cover whatsoever.

Robin Rigg’s case

South Africa has no immediate equivalent local jurisprudence that we are aware of, but international practice suggests how such claims may play out locally. Those decisions are influential.

The UK Supreme Court case of MT Højgaard A/S v E.ON Climate & Renewables UK Robin Rigg East Limited and another [2017] UKSC 59 highlights the difficulties fitness for purpose clauses pose in a professional indemnity insurance context. E.ON Climate and Renewables (“E.ON”) engaged MT Højgaard A/S (“MTH”) to design and install 60 offshore wind turbines. The contract between the parties provided that these functions would be completed with the due care and diligence expected of appropriately-qualified contractors, so that the works “shall be fit for its purpose as determined in accordance with the Specification using Good Industry Practice”. The employer’s requirements referred to a minimum site-specific design life of 20 years and required that “the design of the foundations shall ensure a lifetime of 20 years in every aspect without planned replacement”.

Although MTH exercised reasonable skill and care and followed what was ostensibly best industry practice, the foundations were ultimately found to be defective in that they were not able to sustain the prescribed design life. The defect occurred because the universally-accepted industry standard used by MTH in the design was incorrect, not because there was negligence. E.ON alleged that MTH was in breach of its overriding fitness for purpose obligations, while MTH argued that any fitness for purpose obligation was qualified by its duty to comply with the standard. The issue was whether the terms of the contract imposed a strict obligation to achieve a service life of 20 years, or merely an obligation to design the foundations on the basis of a 20-year design life in accordance with the standard.

The Supreme Court found that a contract may impose a “double obligation” on contractors. They have both an absolute obligation to achieve a particular result, and an obligation to comply with a particular standard. Contractors may be held liable for failing to achieve the promised result, even if they complied with a contractual duty to exercise reasonable skill and care. MTH was accordingly liable to satisfy the fitness for purpose obligations in relation to the service life of the contract.

Who bears the risk?

One solution to the challenges associated with fitness for purpose warrants may be to remove them from the contract entirely. This, however, simply shifts the allocation of risk and still leaves one of the contracting parties (in this case, the employer) with the proverbial hot-potato.

The allocation of risk is a function of agreement between the parties. The old construction law adage has always been that the risk should be allocated to the party that is best able to manage it. Removal of fitness for purpose warrants simply shifts the whole risk to the procurer. However, the inverse creates an obvious tension between the contractor’s or consultant’s liability and their ultimate upside for performing the work. It has been said that as risk forms an important element in costing projects, an unlimited liability demands an unlimited price.

In design-build contracts, the contractor receives an overall upside for the entire design and construction scope and is often afforded a separate limit of liability provision (typically 100% of the contract price, with some exclusions) to limit its entire risk exposure under the agreement. This shifts the liability onto the client. The client is thus left with a situation which contradicts the adage that the risk should lie with the party best placed to take it on. In such instances, shifting further risk to the client seems inappropriate.

Common practice in South Africa

In South Africa, fitness for purpose-type obligations appear as a matter of course.  For instance, they are included as express terms in the FIDIC and NEC standard forms endorsed by the Construction Industry Development Board and are part of a limited series of agreements which the state can use to procure construction services.

A greyer area exists in professional services contracts, particularly those drafted in South Africa, where the contract clearly intends to limit the consultant’s obligation to reasonable skill, care and diligence. The South African standard form agreements, such as PROCSA, CESA and the FIDIC white book, do not contain express fit for purpose undertakings.

The omission leaves an unanswered question: who bears the risk associated with design work in the absence of such a clause? There is certainly merit and precedent for parties to agree that the consultant bears this risk. Where the contract is silent on the subject, it can be argued that there is an implied fitness for purpose obligations, and thereby strict liability for the consultant. If the contract contains no express fitness for purpose obligation, and one cannot be inferred, the common law duty of reasonable skill and care applies. But, as the Robin Rigg case demonstrates, even where the consultant meets the common law standard of reasonable care and skill, the design may fail to achieve the intended purpose.

Take care in drafting contracts

It is crucial that both parties consider all aspects of risk and responsibility when negotiating contracts involving design. Absolute obligations linked to fitness for purpose should be approached with caution, as reasonable skill and care clauses may not offer much protection against the absolute obligation to meet certain standards of work. For contractors, the risk of warranting fitness for purpose must be identified. If necessary, it can be counterbalanced by limiting liability under the contract or even pricing it into the agreement. For employers, the need to ensure that completed works meet their requirements and that its

consultants and contractors are held accountable for their deficiencies must be balanced against the possibility of imposing obligations that will result in an undue risk-premium, pushing otherwise competent away from tendering, are not insurable or are in any event not recoverable against the balance sheet of the defaulting party.