Hess Corporation v Stena Drillmax III Ltd & Ors

This appeal concerns an issue as to how to calculate the remuneration to be paid by the charterer of a mobile offshore drilling unit (or “MODU”), the “Stena Forth”, to its owner. The contract in question is called a Mobile Offshore Drilling Unit Contract and it is dated 21 September 2007. The owner under the contract was named as Stena Drillmax III Limited, and the charterer is Hess Corporation. The contract refers to the owner as the “Contractor” and to the charterer as the “Company”. There was a novation of the contract which replaced Stena Drillmax III by Stena Carron (Hungary) KFT. It is unnecessary to distinguish between the two Stena companies and I will refer simply to “Stena”. Hess is an American oil and gas company, and the Stena companies are based in Bermuda and Hungary respectively.

Hess is the claimant in these proceedings and Stena the defendant. Hess succeeded in the court below, so in this court Stena is the appellant and Hess the respondent. Hess is claiming the repayment of hire (“remuneration”) on the basis that it has overpaid what was due under the contract. It was obliged under the contract to pay first and dispute later. By its clause 17.3 the contract is governed by English law and the London courts have exclusive jurisdiction.

At the time of contract, the MODU was under construction in South Korea. It was estimated in the contract that delivery (the “commencement date”) would be on 30 June 2009, but in the event operation under the contract commenced on 13 August 2009, nearly two years after the date of contract. The period of the contract is 5 years with an option in Hess to extend it by a further year. Therefore, the contract looks forward over a period of up to eight years. It is still ongoing. It is estimated that the parties’ dispute is already worth some US$5 million.

The facts are not in dispute, and the court is concerned with three preliminary issues of construction. There were originally five; four were debated before Burton J; and one of those (the fourth issue) is no longer controversial. The preliminary issues divide up the questions of construction: but essentially what separates the parties is the effect of a substantial fall in the value of Sterling against the US Dollar over the period from the time of contract to its coming into operation. Remuneration under the contract, a daily rate or fee, is expressed and to be invoiced in dollars: but part of that remuneration, reflecting operating costs, is subject to an adjustment mechanism (the “Day Rate Adjustment”) designed to take into account actual costs incurred, be they higher or lower, as distinct from the estimated costs which, looking forward from the contract date, are itemised in the contract. About two-thirds of those operating costs are expressed in sterling, the balance in dollars. The total of those costs is $152,869, comprising $67,009 and £42,930. Although the contract does not say so, it can be calculated that the £/$ conversion rate used by the contract is £1 = $2. However, by the commencement date the rate of exchange had become £1 = $1.61. The rate has not changed very much since then. A clause in the contract, clause 13.3.5, states that for invoicing purposes the rate to be used shall be determined by reference to the Financial Times’ London edition published immediately before the date of invoice. The essential issue for the parties is whether that new rate applies to the whole of the sterling components of the operating costs (or what the contract calls the “operating cost element”), in which case Hess has overpaid by some $5 million already, or whether it only applies to the difference created by the variation between the sterling costs anticipated in the contract and the costs actually incurred, in which case Hess has paid the correct amount.

The provisions of the contract which are arguably relevant to this essential point of construction are lengthy, and the thoughtful submissions which have been expended on the question have become possibly over-refined. It will be necessary at all times to focus on the matter in contention that I have identified in the above paragraph, for otherwise the purpose of the submissions may be lost sight of. However, to elucidate the point it may also be necessary to ask questions such as: Was the daily remuneration rate fixed, in whole or only in part? What are the risks which the contract was aiming to allocate by permitting adjustment of the operating cost element by reference to actual costs incurred? What, in the context of the contract as a whole, does business sense suggest? Does form point the way to substance, or is it a distraction?

I will set out the relevant contractual provisions in the Annex to this judgment. I will cite in the judgment itself only the most critical of the provisions. First, however, I will attempt to set the scene, so that the reader will be alerted to what he or she needs to look out for.

The relevant daily fee depends first, on an option which reflects patent rights (see clause 16.4 of the main contract), and secondly, on what the MODU is doing at any one time. It is common ground that Hess opted for “Option A”. That means that the basic Operating Rate is $498,500 per day. However, there are other rates, mostly expressed as a percentage of the Operating Rate, for times when the MODU is being used in different from standard conditions: thus there is a moving rate, a standby rate, a repair rate, a demobilization rate, a force majeure rate, a zero rate and so on. Some of these rates are at 98% of the Operating Rate. The zero rate applies when Stena is at fault.

The Operating Rate is made up of “two elements”: the capital element and the operating cost element (the latter of which I have already introduced). The capital element “shall remain firm and fixed for the entire TERM of this CONTRACT”; but the operating cost element “is subject to adjustment” (clause 3.14.1 of Schedule III). The operating cost element, as I have said, totals $152,869, from which it can be calculated (but the calculation is not expressly set out in the contract) that the capital element is $345,631. The operating cost element is itself broken down into dollar and sterling denominated costs which are itemised in a table at the end of clause 3.14 of Schedule III (the “operating cost components itemized below”, as the contract refers to them). Thus personnel, travel, a part of shore base costs, and administration are costed in sterling (totalling £42,930); while catering, freight, insurance, repair and maintenance, and the major part of shore base costs are costed in dollars (totalling $67,009). Those operating cost components had been costed as of 14 September 2007, a week before the contract was dated.

All this is explained in clause 3.14 of Schedule III, headed Day Rate Adjustment, which also contains a description of the process by which those operating cost components, or what are also referred to as the “base line operating cost element”, are to be revisited, first as of the commencement date, and thereafter on a calendar quarterly basis, so as to “encompass all actual cost changes commencing as of 14 September 2007”, with the exception of certain components whose costs are to be recalculated on a more conventional basis by reference to certain applicable indices. There is also an adjustment cap of 8% per year for personnel costs. Thus, all in all, the operating cost element is dealt with by the parties in their contract in a sensitive and detailed way, in a plain desire to reflect actual costs, but also to control changes in cost by reference in part to indices and to a cap. Thus there is also a general obligation on Stena to use reasonable endeavours to maintain the operating cost components at reasonable levels, in accordance with industry standards (see clause 3.14.7 of Schedule III).

Other costs are not within the operating cost element of the Operating Rate, even though that rate is also referred to as an “all inclusive” price or rate (clause 1.1 of Schedule III). For instance “Reimbursible costs” itemised within Schedule IV are to be reimbursed at cost but subject to a “handling charge” of 7.5% (clause 1.2 of Schedule III); and new costs which might arise out of either “Amendments to Law” (clause 2.2 of the main contract) or “Changes from the Basic Program Area” (clause 11.2 of the main contract) have to be separately agreed. The basic program area is defined as the US Gulf, but if Hess wants to take the MODU elsewhere, then “any documented increase in actual, lump sum costs (as distinguished from ongoing operating costs…)” have to be separately agreed for reimbursement. Nevertheless, the applicable doctrine for all such costs is essentially the reimbursement of actual costs incurred, even if in the case of some of them there is an additional handling charge.

Clause 13 of the main contract (“Terms of payment”) and clause 3 of Schedule III (“Remuneration”, to which I have already made reference) are the provisions with which we are most concerned. The actual remuneration figures are set out in Schedule III, but clause 13 of the main contract, in looking ahead to Schedule 13, has a number of general points to make about payment. One is about invoicing (clause 13.3.1) and makes provision for the clear itemisation of “the respective amounts invoiced for the capital and operating cost elements, including the respective components contained therein”. Another is about currencies of account and exchange rates (clause 13.3.5, to which I have already referred, with its reliance on the Financial Times London edition immediately prior to the relevant invoice).

Before the trial judge, Burton J, the fourth issue was concerned with whether clause 13.3.5 was applicable to the Day Rate Adjustment exercise explained within clause 3.14 of Schedule III. Hess submitted that it was, but Stena submitted that it was not, and that Stena was therefore entitled to adopt any fair and reasonable exchange rate, such as the average £/$ conversion rate over the applicable period of each of its invoices. Stena now accepts that clause 13.3.5 provides the relevant exchange rate. That by itself, however, would not affect the disputed figures all that much. The exchange rate has been hovering around the £1 = $1.60 mark over the relevant period. What makes the difference, as I have already emphasised, is whether the current rate needs to be applied to the whole of the operating cost element to the extent that its components are expressed in sterling, or only to the variation from the contract’s base line figures for such components.

With that introduction I set out below (repeated in the Annex within a longer citation of relevant terms) the critical provisions over which the parties have argued before Burton J and in this court.

By virtue of clause 2.3 of the main contract, its terms take precedence over the terms of its Schedules. I begin with extracts from clause 13 of the main contract.

“13 TERMS OF PAYMENT

…13.3.1 Each invoice shall show separately the individual amounts owing under each of the headings in SCHEDULE III - REMUNERATION (including, with regard to each of the various applicable day rates, itemizations of the respective amounts invoiced for the capital and operating elements, including the respective components contained therein, as particularly described in SCHEDULE III, Clause 3.14, and also including references to the indexed rate changes utilized in calculating the adjustments to the ADMINISTRATION and REPAR AND MAINTENANCE cost components…

13.3.5

Except as specifically otherwise provided herein, all invoices shall be rendered in United States Dollars, and invoices for expenses incurred in other currencies shall state the currency in which the expense was incurred and the rate of exchange used to convert to U.S. Dollars. All rates of exchange shall be determined by reference to the London Financial Times edition published immediately prior to the date of the invoice. For expenses incurred by the CONTRACTOR and reimbursable by the COMPANY, the COMPANY reserves the right to reimburse the CONTRACTOR in the same currency in which any expense was incurred.”

I now turn to Schedule III – Remuneration. In setting out parts of its clause 3.14 (here and in the Annex), like the judge I have interpolated my own numbering of its seven paragraphs in place of the bullet-points which introduce some of those paragraphs:

“3.2

Operating Rate

● The respective Operating Rates listed below shall apply, as particularly provided for in Clause 2 of this SCHEDULE III and in Clause 16.4 of this CONTRACT, except when the Moving Rate, Standby Rate, Repair Rate, Force Majeure Rate, or Zero Rate is applicable for such period, unless otherwise expressly provided in this CONTRACT.

3.2.1

Option A Operating Rate: $498,500 USD/Day…

3.14

Day Rate Adjustment

3.14.1

The Operating Rate is comprised of two elements: (1) the capital element, which, dependent upon the application of the relevant Operating Rate in accordance with Clause 3.2 above, shall remain firm and fixed for the entire TERM of this CONTRACT; and (2) the remaining part, the operating cost element, including the operating cost components itemized below, which operating cost element totals USD 152,869 (comprised of USD 67,009 and GBP 42,930) as of September 14, 2007, being the date of CONTRACTOR’s commercial proposal for the provision of WORK utilizing the MODU pursuant to this CONTRACT. The operating cost element (including its respective components) is subject to adjustment as defined below:…

3.14.5

The base line operating cost element, including its itemized cost components, forming part of the Operating Rate as of September 14, 2007, are set out below and shall be verified or corrected on or about the COMMENCEMENT DATE and thereafter as subsequent adjustments occur, subject to COMPANY’s audit rights pursuant to Clause 23 of the CONTRACT. The first amendment/variations of the operating cost element shall be effective as of the COMMENCEMENT DATE and shall encompass all actual cost changes commencing as of September 14, 2007, with regard to each of the respective cost components other than ADMINISTRATION and REPAIR and MAINTENANCE costs, for which the initial set of cost changes shall be measured from the applicable indices for September 2007, as referenced above.

3.14.6

On a calendar quarterly basis following the COMMENCEMENT DATE, the operating cost element referred to above and forming part of the Operating Rate will be increased or decreased, on the basis of actual costs incurred during the preceding calendar quarter with regard to all of the operating cost components other than ADMINISTRATION and REPAIR and MAINTENANCE costs, for which the initial set of changes shall be measured from the applicable indices for September 2007, as referenced above, all in order to reimburse either the CONTRACTOR or COMPANY as appropriate. The final quarter payment to CONTRACTOR under this CONTRACT in respect of operating costs shall take the form of a lump-sum payment within three (3) months from termination of the CONTRACT.”

The preliminary issues stated for decision can be summarised in the way in which I introduced the essential question in this case: whether the whole of the adjusted sterling costs forming components of the operating cost element are to be converted at the commencement date and each quarterly invoicing date to dollars at the clause 13.3.5 exchange rate; or whether that exchange rate applies only to the sterling cost components within a separate sum representing the increase (or decrease) in the operating cost element, a sum which Stena has described as the “Day Rate Adjustment” itself, and which it submits is required to be separately invoiced pursuant to clause 13.3 of the main contract. Of course it follows that the variation of such operating cost components will necessarily be much smaller than the total of such components as adjusted. The issues are as follows –

“Issue 1: From 13 August 2009 to 30 September 2009 (and so prior to any calendar quarterly Day Rate Adjustment), at what rate was the Claimant liable to pay the First or Second Defendant per day. In particular:

Was the applicable day rate a fixed rate in USD; or

Did the applicable day rate include a variable element?”

Stena submitted that the answer was as in issue 1.1, while Hess campaigned for the answer in issue 1.2. The judge agreed with Hess and in his order stated “No” in answer to issue 1.1 and “Yes” in answer to issue 1.2.

“Issue 2: If the applicable day rate contained a variable element, were the GBP elements of the variable element to be calculated:

on the basis of £1 : $2;

Stena contended that the answer to issue 2.1 was “Yes” (on the basis that conversion had already taken place as part of a fixed Operating Rate) and the answer to issue 2.2 was “No”. Hess contended that the answers were the other way around. The judge agreed with Hess and answered issue 2.1 “No”, issue 2.2 “Yes” and issue 2.3 “No”.

“Issue 3: Following the first Day Rate Adjustment on 1 October 2009:

Hess contended in favour of the solution in issue 3.1, and Stena contended for the solution in issue 3.2. The judge agreed with Hess and answered issue 3.1 “Yes” and issue 3.2 “No”.

“Issue 4: What was the rate referred to in issue 3 above to be:

the FT rate;

the average exchange rate over the previous quarter?”

Hess contended in favour of the solution in issue 4.1, and Stena contended for the solution in issue 4.2. The judge agreed with Hess and answered issue 4.1 “Yes” and issue 4.2 “No”. Stena has not contended otherwise on this appeal.

The submissions of the parties below, advanced by Mr Jonathan Hirst QC on behalf of Hess and by Mr Mark Templeman QC on behalf of Stena, have been fully set out by the judge at [11] to [14] of his judgment, [2011] EWHC 1340, [2011] 2 All ER (Comm.) 1011. They have been repeated in essentially the same form, if with some additions, on this appeal. It is unnecessary to repeat them here. I would merely seek to summarise the main points made by the respective parties as follows.

On behalf of Stena, Mr Templeman has stressed these points: (i) that the contract is a fixed day rate contract, rather than a cost reimbursement contract: Hess was therefore wrong to render the daily Operating Rate a variable rate as each quarter produced a new calculation of the operating cost element; (ii) that if the Operating Rate’s daily sum was intended to change, the contract would, and could very easily, have said so expressly, for instance in the critical clause 3.2 of Schedule III (“The respective Operating Rates listed below shall apply”); (iii) that both Stena and Hess accounted in dollars (as the agreed facts demonstrated), and the contract required invoicing in dollars, and the parties must therefore be regarded as being adverse to speculating on exchange rates – other than to the limited extent created by the sterling elements within any quarterly adjustment required by an increase or decrease of the operating cost components; (iv) that clause 13.3.1 of the main contract, in requiring each invoice to show separately “the individual amounts owing under each of the headings in Schedule III”, necessitated the invoicing of a separate sum constituting the “Day Rate Adjustment”, since that was one of the headings of Schedule III, viz the heading of the critical clause 3.14 itself: whereas Hess would lose that separate figure, that Adjustment, within the constantly changing Operating Day Rate; (iv) that the reference to the “base line” operating cost element at the beginning of clause 3.14.5 of Schedule III was a reference to the enduring operating cost element written into Schedule III itself, whereas Hess would change that base line with every quarter: that was the base line against which a Day Rate Adjustment figure had to be derived for each quarter; (v) that it was a mistake to read clause 3.14.5 as requiring a Day Rate Adjustment to be carried out as of the contract’s commencement date in any way which would change the enduring quality of that base line by reference to current cost, for all that was required was a retrospective verification of the proposed, and contractually enshrined, operating cost components as of the original date, 14 September 2007, in case any mistake had been made in that forecast; (vi) that it was a mistake to regard the contract as based on reimbursable operating costs: such reimbursable costs were found outside the Day Rate Adjustment provisions, for instance in Schedule III clause 1.2’s reference to “Reimbursible Costs” and Schedule IV, or in the main contract’s clauses 2.2 and 11.2 regarding changes in cost due to amendments of law or to a change in location, changes which had to be specifically dealt with by agreement and amendment to the contract; (vii) so that for all these reasons it was plain that the Operating Rate and the Day Rate Adjustment are separate figures, and thus it was only to the limited Adjustment figure that a current exchange rate had to be applied.

On behalf of Hess, however, Mr Hirst has stressed the following matters: (i) that the terms of clause 3.14 of Schedule III made it clear that the operating cost element within the Operating Rate was itself subject to adjustment as its cost components changed, and it therefore followed that to that extent the Operating Rate itself had to change; (ii) that whereas the capital element of the Operating Rate was, as clause 3.14.1 said, “firm and fixed for the entire TERM”, that did not apply to the operating cost element which was adjustable to reflect actual costs over the contract period; (iii) that such a distinction made entire sense where the remuneration was agreed some two years ahead of the expected commencement date, and where the contract itself would last from 5 to 6 years, a total period lying in the future of 8 years; (iv) clause 3.2 did not state that the Operating Rates were themselves fixed and firm, but said that they “shall apply…unless otherwise expressly provided in this CONTRACT”; (v) that the Day Rate Adjustment was not a sum of money, let alone a separate sum from the Operating Rate, but a process whereby the operating cost element was adjusted: and the workings of that process could be shown, as indeed clause 13.3.1 of the main contract provided that they should be, separately in the invoices which had to be prepared; (vi) that as for the “base line”, that was indeed the base from which the adjustments had to be calculated (some of those adjustments involving the application of indices, others depending on vouched costs), namely the current figures for the operating cost components written into the contract: but the necessary adjustment from that base line began with the commencement date and had to be repeated at calendar quarterly intervals thereafter; (vii) that the parties were clearly not speculating on exchange rates to the extent that clause 13.3.5 was relevant (as it was now agreed that it was relevant to the working of the Day Rate Adjustment, whatever that was); (viii) that both business common sense and the contract’s language were at one in producing a simple system for adjustment of the operating cost element, as compared with the tortured interpretative and invoicing processes to be adopted on Stena’s submissions.

The judge preferred Mr Hirst’s submissions to those of Mr Templeman, although he described the arguments of both as powerful. In a brief concluding passage (at [15] of his judgment) he outlined three points as being particularly persuasive for him.

The first was that he regarded the process of verification or correction (“the base line operating cost element…shall be verified or corrected”) to be carried out at the commencement date as the first of a contemporaneous, and subsequently quarterly, system of adjustments of that element, leading necessarily to an adjustment of the Day Rate at the very commencement of the contract period. Secondly, the language of clause 3.14.6 relating to the quarterly process, stating as it does that “the operating cost element…forming part of Operating Rate will be increased or decreased”, demonstrated that it was the Operating Rate itself which was adjusted. Thirdly, he considered that unless the Operating Rate itself changed, then there was no express mechanism which would provide proper reimbursement of the various other rates (such as stand-by rate or moving rate) which were expressed as a percentage of the Operating Rate. As he put it: “I do not see how, if the Day Rate Adjustment is a sum (and not a mechanism) Stena would become entitled to a percentage of that sum”.

I agree with the judge’s decision and his reasons, and it only remains for me to express the matter in my own words, probably less well than he has already done.

I start by referring to the overall structure and context of the contract. It was a medium to long term contract, extending up to eight years into the future from the date of contract. It was in those circumstances that, whatever be the precise mechanism to be found in the contractual language, it was plain that the parties wished to make provision for allowing changes in operating costs to be reflected in the remuneration provisions. It did this by distinguishing between two different elements making up the total daily Operating Rate, namely a capital element and an operating cost element (clause 3.14.1 of Schedule III: “The Operating Rate is comprised of two elements…”). Only the capital element is described as fixed (“shall remain firm and fixed”): the operating cost element is not so described, and that cannot be counted for error or bad draftsmanship. It follows that the operating cost element is not “firm and fixed”. Of course it is not, for the contract goes on to state expressly (in the self-same clause (3.14.1) that “The operating cost element (including its respective components) is subject to adjustment as defined below”. It is because it (the operating cost element of the Operating Rate) is “subject to adjustment” that it is not “firm and fixed”. If, therefore, one of two constituent elements of the Operating Rate is subject to adjustment, even if the other element is fixed, it inevitably follows that, contrary to Stena’s essential position, the Operating Rate itself is not, and cannot be, firm and fixed. That is a critical starting point. I will refer below to the detailed provisions of how the operating cost element is to be “subject to adjustment”, but the starting point is that it is the operating cost element itself which is subject to adjustment. It is because the process of adjustment results in an adjustment to the operating cost element, and thus inevitably to the Operating Rate as well, that the adjustment process is called “Day Rate Adjustment”. What is the Day Rate? It is the generic term used to cover the various daily rates, all of which are premised on the apposite Operating Rate: see clause 2.4 of Schedule III. Thus it is entirely natural to think of the process as adjusting the Operating Rate.

This is consistent with clause 1.1 of Schedule III, which (a) is entirely general and says nothing separate about the rates referred to therein being fixed or otherwise, and (b) makes an express exception of inter alia clause 3.14 of Schedule III (“Excepting as otherwise provided in…SCHEDULE III, Clause 3.14 and any other applicable provisions of this CONTRACT”). This is also consistent with clause 3.2 of Schedule III (“Operating Rate”) which applies the apposite Operating Rate but ends “unless otherwise expressly provided in this CONTRACT”. Whatever the function of that exception, about which the parties made conflicting submissions, a further exception is unnecessary in the light of the leading clause 1.1, and in any event the language of clause 3.2 is consistent with clause 1.1.

Mr Templeman referred to clauses 2.2 and 11.2 of the main contract as illustrating the concept that cost changes within those clauses have to be separately agreed. However, in my judgment, those clauses support Hess. They are talking about entirely new costs which, because they arise out of changes in law or location, cannot in any practical sense have been anticipated. Even so, the distinction is made within those clauses between such new costs which are entirely additional, and those which, because they fall within the operating cost element, will have already been accounted for “in the dayrate adjustments provided for in Clause 3.14 of SCHEDULE III”.

Mr Templeman also relied on clause 23 of the main contract for the submission that the Operating Rate itself, unlike the “Adjustment” sum for which he contends, cannot fall within Hess’s “right to audit”, which is preserved for the purposes of clause 3.14 of Schedule III by clause 3.14.5’s “subject to COMPANY’s audit rights pursuant to Clause 23”. Thus he points to the distinction drawn in clause 23 between “all invoiced charges for reimbursable items” or “obligations, the performance of which is capable of being verified by audit” on the one hand, and the prohibition on auditing the make-up of rates to be found at the end of clause 23 where it states: “In this respect, the COMPANY shall not be entitled to investigate the make-up of rates and lump sum fees included in this CONTRACT”. However, I would reject this submission. Clause 13.3.1-5 of the main contract makes it crystal clear that the operating cost element, as well as its adjustment, component by component, is subject to audit, even though it is an element in the Operating Rate. Therefore the last sentence of clause 23 is dealing with the Day Rates only to the extent that they contain a fixed and firm capital element (which of course is the element which contains Stena’s essential profit).

As for exchange rates, clause 13.3.5 of the main contract (and its position in the main contract shows its importance) is clear: it demonstrates that to the extent of its application the parties are not tying themselves to a particular exchange rate. Whether that is called speculation or the absence of speculation may depend on what a party’s underlying arrangements may be: but since the clause is expressly only concerned with “expenses incurred in other currencies” (ie other than US dollars) the effect should be neutral. If, for instance, an expense is incurred in £ sterling, then, because “Except as specifically otherwise provided herein, all invoices shall be rendered in dollars”, the invoice translates the other currency expense into dollars at the exchange rate current to the invoice. That limits exchange rate risks to within the period of each invoice. The express option given in the last sentence of clause 13.3.5 to Hess to pay expenses incurred by Stena “in the same currency in which any expense is incurred” again demonstrates that the purpose of the contract in this regard is to aim at neutrality in matters of exchange risk. Exchange rates are a factor of, among other things, the respective inflation occurring in different currencies, and therefore for that reason as well are reflective of cost.

The next question is whether a current, rather than historical, exchange rate is intended by the parties to apply to expenses in the form of operating cost element components. It has always been common ground (subject to the essential dispute in this litigation) that such is the intention of the parties’ contract. There was originally a dispute which was not of much financial moment as to how the current rate was to be found: but it is now common ground that the rate is to be found in the provisions of clause 13.3.5 and that that clause applies to the expenses involved in what is described as the Day Rate Adjustment (however those are to be found, described or quantified). The acknowledgment that a current exchange rate (of some or other kind) has to be applied in this context is not surprising seeing that the Day Rate Adjustment clause goes out of its way to explain that some of the operating cost element components are incurred in sterling, and to identify the relevant components and the “base line” figures for each component. Although the expression “operating cost components” is the common expression in clause 3.14, it is plain that these are examples of expenses, even if different from Schedule IV and other kinds of possible expenses: see clause 1.1 of Schedule III with its reference to the contract rates including “all costs, expenses, profits…” etc. (emphasis added).

If, therefore, clause 13.3.5 applies to the Day Rate Adjustment, whatever it is, as it is now agreed that it does, it seems to me to follow, at any rate prima facie and subject to compelling language otherwise, that it should apply to the sterling components of the operating cost element as a whole, and not only to a part of them, as Stena contends. As clause 3.14.6 states: the process required by the Day Rate Adjustment clause is to adjust the “operating cost element” (the whole of that element) by increasing or decreasing it “on the basis of actual costs incurred during the preceding calendar quarter with regard to all of the operating cost components” save for those of such components which are subject to adjustment by reference to respective indices (or subject to a cap). Such a process requires that, where such components have been incurred in sterling in a contract where invoices are in dollars, it is necessary to apply a current rate of exchange. That is what clause 13.3.5 achieves by reference to the Financial Times. It is after all entirely appropriate that the sterling components of the operating cost element should be translated as a whole into current rates of exchange for sterling and dollars: for that reflects the essence of the contract that such operating costs should be adjusted on a quarterly basis to actual costs, including actual costs in £/$ exchange terms.

So two questions emerge: (1) What is the Day Rate Adjustment? And (2) To what is the (now agreed) exchange rate in question to be applied?

(1) What is the Day Rate Adjustment? In my judgment, it is not a sum, but a process, the process described in clause 3.14. I have already expressed the view that the expression describes an adjustment to the day rate, ie to the Operating Rate. It is an essential plank of Mr Templeman’s submissions that it is a sum, separate from the Operating Rate which itself remains unchanged and to no part of which the exchange rate is applied. However, in the course of argument Mr Templeman seemed half to abandon this plank by agreeing that it was both a process and a sum. I think it is a process, explained throughout the whole of clause 3.14 and in particular at clause 3.14.5/6, which operates to adjust the Day Rate by adjusting the operating cost element within it. It follows that the Operating Rate changes from quarter to quarter, based on its recalculation depending on “actual costs incurred during the previous quarter”, as stated in clause 3.14.6. It is only the final quarter payment which has to be dealt with in “the form of a lump-sum” (clause 3.14.6, final sentence): that is because adjustment is quarterly in arrears, and therefore cannot be achieved by adjusting the Operating Rate for the future at the end of the contract, but only by a lump sum.

There are some difficulties about this final sentence of clause 3.14.6, but these difficulties arise on either party’s interpretation. What is to my mind striking about this sentence is that, contrary to Stena’s case, it is only in respect of the final quarter that the contract refers to a “lump-sum payment”. Yet on Stena’s case, every quarter’s Day Rate Adjustment, is a separate, lump sum, the so-called “Adjustment”. Therefore, Stena has to say, I think, that the “Adjustment” is spread over the ensuing quarter in the form of a daily increment. It is also by dividing its “Adjustment” sum into daily increments that Stena seeks to provide a mechanism by which a percentage of that daily increment can be ascribed to rates other than the Operating Rate. However, the contract makes no express allowance for such additional calculations.

As for the process at the time of the commencement of the contract, that is dealt with in clause 3.14.5: but clause 3.14.5 also looks forward to the quarterly repetition, thereby demonstrating that the commencement date verification or correction is the first stage in an iterative process. As clause 3.14.5 states: “and thereafter as subsequent adjustments occur”. What are the “subsequent adjustments”? They are the quarterly adjustments for which provision is made in clause 3.14.6. But the commencement date adjustment is the first such adjustment, as clause 3.14.5 states: “The first amendment/variations of the operating cost element shall be effective as of the COMMENCEMENT DATE…”. Whether the words are “corrected” or “amendment/variations” or “adjustment” or “increased or decreased”, they are referring to the same process. Stena’s suggestion that the commencement date verification or correction is something different, a retrospective revisiting of the proposals for the operating cost element, but to be carried out as of 14 September 2007, is to my mind far-fetched, unbusinesslike, and simply not what the clause says. On the contrary, the “base line operating cost element” is that which is “forming part of the Operating Rate as of September 14, 2007” but has to be “either verified or corrected” with consequential “amendment/variations” so as to “encompass all actual cost changes commencing as of the COMMENCEMENT DATE” (emphasis added).

Moreover the final sentence of clause 3.14.5 goes on to make clear that the process of verification or correction has to include, for the relevant operating cost components, the application of the relevant indices: as the clause states of such components – “for which the initial set of cost changes shall be measured from the applicable indices for September 2007”. Thus those components themselves need to be adjusted, just as clause 13.3.1 of the main contract speaks of “calculating the adjustments to the ADMINISTRATION and REPAIR AND MAINTENANCE cost components”. In other words, the adjustment is not a separate sum, but a process whereby the underlying components are themselves adjusted by reference to current cost (whether actual or governed by applicable indices).

(2) To what is the clause 13.3.5 exchange rate to be applied? In my judgment, it follows that it is to be applied to the sterling components of the adjusted operating cost element. As clause 13.3.1 emphasises, the “individual amounts” owing have to be separately shown on each invoice. That is not a reference to some separate adjustment sum (as Mr Templeman submits): the fact that “Day Rate Adjustment” is a heading within Schedule III does not mean that it is an “individual amount” that has to be shown separately. What have to be shown separately are the “individual amounts owing under each of the headings” of Schedule III (emphasis added). The clause continues with particular reference to – “itemizations of the respective amounts for the capital and operating cost elements, including the respective components contained therein, as particularly described in SCHEDULE III, Clause 3.14, and also including references to the indexed rate changes…”. (Moreover the invoice has to be fully vouched (see clause 13.3.4).)

What is not referred to in clause 13.3.1 is any express requirement to show some separate “Day Rate Adjustment” sum. It would follow from Stena’s submissions that if, for the sake of argument, there was absolutely no change at any quarterly invoicing date in the cost of the operating cost components from the figures put forward in Schedule III, then there would be a zero adjustment sum and there would be nothing to which any clause 13.3.5 exchange rate could be applied. However, this is simply not consistent with the repeated language of the contract clauses, which emphasise that regard has to be had to the concept of actual costs incurred. Thus clause 13.3.1, as I have said above, requires every component of the operating cost element to be separately shown, with accompanying vouchers. If the cost is incurred in sterling, then the cost has to be exchanged into dollars for accounting purposes (but Hess can still opt to pay in the original currency). Clause 3.14.5 of Schedule III says that the “operating cost element…shall “encompass all actual cost changes”. That is the operating cost element as a whole. Clause 3.14.6 refers to “actual costs incurred”.

In sum, what is required by clause 3.14 of Schedule III is the adjustment of the operating cost element of the Operating Rate, and therefore the adjustment of the daily Operating Rate (the “Day Rate”) itself. It is to the sterling components of the operating cost element as a whole, as adjusted from time to time, that a current exchange rate must be applied, to translate such sterling costs into an invoice figure that is required to be in dollars.

It was for these reasons that at the time of the hearing of this appeal, I was for dismissing Stena’s appeal.

I agree.

I also agree.

From the main contract: