Tuesday, January 20, 2015

How to Manage Contract Risk in Procurement (Part 2)

Specific Clauses and their Validity under Omani Law

Continuing our series of articles on managing risk in procurement contracts, the second installment deals with some specific legal issues arising which can, and should, be covered in written agreements entered into between the buyer and seller in order to reduce their respective risks.

This month we will look at the use of exclusion, limitation, liquidated damages, penalty, and entire agreement clauses and their treatment and validity under the Omani Civil Code pursuant to Royal Decree 29 of 2013 (the “Civil Code”).

The introduction of the Civil Code in August 2013 has confirmed, or codified, the existing position on such issues and the use of such clauses and their respective interpretation and treatment. As such, the position has not changed with the introduction of the Civil Code but, at the same time, it is not considered to be retrospective, i.e., it does not amend or take precedence over existing laws unless it is expressly stated to have done so.

The Civil Code covers particular areas which the procurement specialist should know, from contract formation, which was covered in the first installment of this series, to termination of such contracts (Articles 69 to 175) and issues such as product defects and liabilities, known as “latent defects,” purchaser obligations, and the sale and delivery of goods (Articles 401 to 427).

Contractually reducing risk

Parties attempt to minimise risk by contractual means, such as excluding particular liabilities, limiting liabilities, or limiting the financial exposure arising from such liabilities, by agreeing to a pre-determined sum in the event a party breaches certain obligations under the contract (known as liquidated damages and usually referred to by the parties as “LDs”).

Particular areas where parties frequently attempt to do so include events such as: breach of contract; performance not as expected and/or agreed; incomplete performance; negligence; products or services not corresponding with description or samples; goods not being of merchantable quality; and/or goods not fit for purpose.

The party whom the exclusion or limitation affects should be satisfied as to the reasonableness of the proposed clause. This, therefore, usually becomes an important part of the negotiation process entered into by the parties.

Exclusion and limitation clauses

Exclusion and limitation clauses are an effective means of managing risk in all contracts and, in general, are enforceable under Omani law. Given that the “law of the contract” governs the agreement between the parties (la convention fait la loi des parties or pacta sunt servanda), as long as such exclusion or limitation is not contrary to public law, it will be enforceable.

There is no legislative definition of “public law” but it was dealt with in a 1993 Supreme Court Judgment reported as 472/93, Vol 10, p 258, as follows:

“…laws which go to public law are those whereby it is intended to accomplish a public interest – political, social or economic – which goes to the higher order of society and which transcends the interests of individuals. All individuals must respect such interest and the accomplishing of it, and they may not negate it be agreements entered into between them, even where such agreements accomplish interest for them, because private interests cannot prevail over the public interest.”

However, tortious liability (personal wrongs, or “harmful acts” as expressed in the Civil Code, such as death and personal injury) can not be excluded or limited whatsoever. Article 183 of the Civil Code provides, as translated, that:

"Any condition purporting to provide exemption from liability for a harmful act shall be void.”

Although Article 183 only refers to excluding liability, it is generally accepted that this also applies to limiting liability.

Penalties and liquidated damages

Penalty clauses are frequently included in contracts to impose upon a party the obligation to pay a sum of money in the event that the party breaches the contract. As such, it could be interpreted as an incentive.

The position under Omani law, as with most civil law jurisdictions, is that, in circumstances where contractual clauses stipulate a pre-determined amount as compensation for the non-fulfillment of an obligation, or breach, the court is not required to use its discretion to decide on the amount of compensation to award. However, and similar to most common law jurisdictions (including England and Wales), the amount of compensation must not be exaggerated, or considered to be extravagant, therefore unjustly enriching the party receiving it; otherwise, the award will not be upheld.

In England this will be considered a penalty and will not be enforced. In Oman it matters not what it is classified as; it cannot be excessive to the damage actually sustained.

Article 267 of the Oman Civil Code confirms the position, providing that (as translated):

“(1) If the subject matter of obligation is not a sum of money, the contracting parties may determine the amount of compensation in advance by making a provision of same in the contract or in a subsequent agreement.

(2) In all cases, the court may, upon the application of either of the parties, amend such agreement to make the compensation equal to the damage, and any agreement to the contrary shall be null and void.”

Accordingly, Article 267 gives greater certainty to the generally accepted position that, if provided for by the contract, the Omani courts may award liquidated damages, provided they are a reasonable assessment of the financial damages actually sustained by a party.

Importantly, it also clarifies that the courts are specifically permitted to “re-open” liquidated damages clauses and award increased/decreased damages commensurate with the value of the actual damage incurred.

Article 267 of the Civil Code mirrors the equivalent provision in the UAE Civil Code (Art 390 (2)). In the UAE, the courts have increased or decreased the amount of contractual liquidated damages to reflect the actual loss sustained.

It should be noted, therefore, that there is a marked contrast in the way in which civil law and common law jurisdictions deal with the amount or value of the liquidated damages provisions in contracts when it comes to enforcement.

For example, and as noted above, liquidated damages under Article 267 of the Civil Code can be assessed by the courts in order to ascertain whether they reflect the actual damage sustained by the innocent party. The amount, therefore, can go up as well as go down.

However, in England and Wales, for example (as well as other common law jurisdictions), liquidated damages provisions are difficult to contest and can only be done so on the basis that the defaulting party can show that the amount of the liquidated damages was not a “genuine pre-estimate of loss” at the time the contract was entered into (Dunlop Pneumatic Tyre Co. Ltd v. New Garage and Motor Co. Ltd [1915] AC 79). Unlike the requirement of Article 267 of the Civil Code, the innocent party under an English governing law contract need not have suffered any loss to recover the liquidated damages previously agreed by the parties (BFI Group of Companies v. DFB Integration Systems Ltd (1997) CILL 348).

Entire agreement clauses

As discussed in an earlier article, the purpose of an entire agreement clause is to make clear that the agreement between the parties is solely what is stated in the written contract, and to prevent the parties to the contract from subsequently raising claims that statements or representations made during contractual negotiations, and prior to the signing of the written contract, constitute additional terms of the agreement or some form of side agreement.

That is, the parties include an entire agreement clause in the contract to prevent those pre-contract statements and representations from having any contractual force. The use of such clauses in procurement contracts awarded through a tender process (internal or public) therefore requires additional care and consideration.

As with personal injury and death (harmful acts), fraud cannot be limited or excluded under Omani law. The reference to fraud, not being so limited or excluded in an entire agreement clause, is, therefore, usually omitted as it is considered unnecessary.

Reviewing and effecting the contract

Once negotiations have been completed, the terms and conditions of the contract have been agreed, and a written agreement has been produced, there should be a formal review of it. All stakeholders should review the contract and satisfy themselves that risks have been adequately handled to minimise exposure to the company and, if happy that they have been, sign off accordingly.

The contract comes into effect on offer and acceptance. However, it is good business practice (and evidence of the terms agreed) for joint signatures to be made in a formal written agreement.

In next month’s article we will deal with how to identify and assess actual risk when managing a procurement contract.