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RESTRICTED-COMMERCIALAND POLICY
LEGALLY PRIVILEGED
HM Treasury
Parliament Street. London SWLP 3AG
Tet 01712701660 Fax 0171 270 1668.
From the Legal Adviser
Hamish Sandison Esq : 11 December 1998
Bird and Bird
90 Fetter Lane
LONDON
EC4A [JP
Dex frat
HORIZON: BA/POCL
lattach a copy ofa fetter of today’s date from Richard Heaton, Legal Secretariat to the Law
Officers, which records the Solicitor General’s views. Also enclosed is a copy of a note from
Treasury Counsel Jonathan Crow. .
2. May J draw to your attention and to the attention of copy addressees the convention that
Law Officers’ advice (or the fact that it has been obtained) should not be disclosed outside
“Government, other than, in this case, the public sector parties and their representatives who need
to secit.
Copy addressees as attached
Hamish Sandison Bird and Bird
{ (Please copy to Catherine Milton - Bird and Bire
RNRICKS : Jeff Triggs _ Slaughter and May
. - (Please copy to N Gray -Slaughter and May)
Sarah Graham - DSS :
Ron Powell DSS
Clive Osbome - DTI Solicitors
Catherine Churchard - Post Office
Jonathan Evans - Post Office -
David Sibbick Director Post DTI
George McCorkell = BA,
Geoff Mulgan - No.10 Policy Unit
Chris Wood ~ Cabinet Office
: RESTRICTED - COMMERCIAL
i : LEGALLY PRIVILEGED
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THE LEGAL SECRETARIAT TO THE LAW OFFICERS
ATTORNEY GENERALS CHAMBERS
8 BUCKINGHAM GATE
LONDON SWi1E 6uP
Goneral enquiries 0171-271 2600
Direct fine
O17 1 SU ae
Robert Ricks Esq I
HM Treasury
Parliament Street
London SW1P 3AG
11 December 1998
HORIZON PROJECT
The Solicitor General has now considered this matter, and I am writing to
record his views. As you know, he has had the benefit of advice from
Jonathan Crow, Treasury counsel (copy attached}. ©The Solicitor. General
broadly endorses Treasury counsel’s reasoning, and would add the following
observations.
Intraductign™
2.
The Solicitor General, like Treasury counsel, believes that there is no
clearly correct contractual construction favouring the DSS or the POCL
approach. Both are respectable. While the DSS approach (if it operates.
successfully) offers the quickest get-out should Ministers he determined
to terminate the contract, it also carries the greater risk of ICL Pathway
alleging breach of contract. and engaging the ‘public sector parties in
uncertain and .expensive litigation. On the other hand, the POCL
approach is slower, deprives the public sector parties of the element of.
control, but is legally safer, - -
Construction of the Authorities Agreement
3
The Solicitor General has scen extracts from the Authorities Agreement
{but not from the DSS agreement or the POCL agreement). That
Agreement contains a crucial contradiction in how it sets out. the
parties’ right to terminate. The Solicitor notes the guidance offered by
Lord Hofimann in ICS v West Bromwich BS [1998] 1 All ER 98, at 115.
The words of a contract must be given their natural and ordi
meaning. But.where something has gone wrong with the language of a
contract, the law does not require judges to attribute to the parties an
intention which they plainly could not have had.
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8,
In interpreting this aspect of the Agreement, the natural place to start is
clause .902 ("Termination of Authorities Agreement’). This scts out a
variety of methods for determination such as insolvency, default which
the contractor fails to remedy after a period of notice, non-performance
of obligations specified in a time-of- the-essence notice (clause 902.2.3)
and twelve months notice.
Clause 902.1.5 preserves termination provisions elsewhere in the
Agreement. One such provision is clause 402.6.2, which allows for
termination in relation to the operational trial, although this (with
circularity) requires termination in accordance with clause 902.2. But
_ clause 402.13 provides that “in relation to failure of the operational trial
system successfully to complete the operational trial’, notwithstanding
clause 402.6.2, the Authorities must terminate in accordance with
schedules A7 and cs.
Despite suggestions to the contrary, the Solicitor General does not
regard clause 402,13 as having any independent standing. In other
‘ words, it is not a termination clause in itself,
Schedule C5, to which clause 402,13 refers, provides in paragraph 4.4
that if acceptance of the operational trial is delayed because of
Pathway’s default for: more. than thirteen weeks, the Authorities can
terminate. That paragraph refers to clause 902.1.5, which indicates
that paragraph 4.4 is an independent determination, Provision of the
Agreement.
Here, however, ‘is an ‘apparent contradiction, One provision (clause
402.6) says that “time of the essence” is the route to termination in the
event of an unsuccessful operational trial. Another provision
(paragraph 4.4 of schedule CS) says that delay in acceptance of the
operational trial because of Pathway’s default for more than thirteen
weeks entitles the Authorities to terminate. :
It has been suggested that the provisions may be reconciled if the time
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of the essence notice.can only be triggered after the thirteen week -
termination period has clapsed. . Another way of reconciling the
provisions, Suggested by Treasury counsel, is to treat paragraph 4.4 as
a particular’ instance of operational trial failure, nartnely, operation of
trial failure arising from Pathway’s default. But even this, in the
Solicitor Gerieral’s opinion, is not entirely convincing.
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Termination under Schedule C5 (the DSS approach)
10.
12.
13.
14,
Whatever reconciliation is preferred, the Solicitor General regards it as
important that the termination ronte preferred by DSS requires “that
acceptance of the operational trial is delayed because of the contractor's
_ default’. A key point, therefore, is how confident the public sector
parties can be in establishing that the delay in acceptance of the
. operational trial is attributable to Pathway’s default. The Solicitor agrees
with Treasury counsel that this introduces an element of uncertainty;
he notes that leading counsel for DSS has also described this route as
carrying “substantial litigation risk”.
The Solicitor is in no position to assess whether Pathway are in default
(or sufficient default), There is an expert report to that effect; the
Solicitor comments that-in these types ‘of disputes experts tend to
proliferate. In the ‘event of litigation, reports will almost inevitably be
produced supporting Pathway,
The Solicitor also endorses Treasury counsel's analysis of the additional
legal hurdles presented by the DSS approach, In’short, it involves the
delayed operation of a right to terminate (if any) which accrued over a
year ago, by means of a reactivating notice. This is not expressly
provided for in the Agreement but turns on the common law of waiver.
Pathway can be expected to dispute, with some force, the availability of
such a mechanism,
The “piggy-back” option is a variant of the DSS approach, It envisages
POCL terminating under clause 902.10, in reliance on a termination by
DSS under schedule C5. The Solicitor comments that this option
carries, at the very least, all the legal risks associated with the © approach:
discussed above.
The Solicitor notes Treasury counsel's necessarily Vimited observations
on quantum. He is not in a position to add to them.
Making time of the essence (the POCL approach)
_ 4S.
If a notice is served making time of the essence, the Solicitor General
. Cannot comment on whether Pathway will comply or walk away, or
whether it would still take legal action. He regards the risk of Pathway
bringing proceedings as.reduced but not insignificant. It could, for
example, allcge that the Authorities are not entitled to serve the notice
because there has not been “undue delay” by Pathway (clause 605.4).
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16.
17.
18.
From the Authorities’ point of view, however, this is a lower hurdle than
their having to establish default under schedule CS.
More dangerously, Pathway could argue that the notice sets an
‘unreasonable period and sue for anticipatory breach of contract. The
length of the period therefore becomes critical.
Those closer to the Agreement will be in a better position to assess what
period might be set; maximum safety points to prescribing the time
Pathway itself has said it needs,‘and the Solicitor General has seen
suggestions that the period might be nine months. However, he
comments that one aspect of clause 902 is that the Authorities can
terminate the entire Agreement on twelve months’ notice. Given thet,
and with the considerable period that the contract has already run,
something less than nine months might be appropriate.
Finally, the Solicitor General comments that a time of the essence notice
will.be seen, correctly, as giving Pathway.a final chance to proceed
according to contract, Ministers should therefore only embark upon
this course if they regard the performance of the Agrecment as a
satisfactory outcome. If their unequivocal wish is to terminate, the .
Solicitor believes that it would not be right to make time of the essence.
I would be grateful if you would copy this letter as necessary within the
interested departments and public sector parties, ,
* RICHARD HEATON
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~ TEL BES ASSO 1 T7239 ATTORNEY. GENERAL
PROJECT HORIZON’
NOTE oF LEGAL ADVICE - ae
Introduction
1. The Depssment of Social Security (“DSS”) and Post Office Counters Limited (“POCL”,
together “the Authorities”) are contemplating terminating Project Horizon. The contractual
relations between the. Avthorities’and Pathway under the Project are governed by three
. agreements (“the Related Agreements”). A difference has arisen between Jogal advisers to
moo the DSS (Bird & Bird and Roger Kaye QC) atid those acting for POCL (Slaughter & May
and Nicholas Strauss QC) as to the correct interpretation of the Related Agreements,
2. ‘The Project itself has had a long and net entirely heppy commercial history. Iwill assume
> thut those for whom this Nots is imended hava some familiarity with that background, and in
: _view of the time cofstraints I sball not recite it ell here. ‘The only significant event to which
I . ” Ishould refer is that the Acceptance of Operational Trial should have been achieved by the
ne ”” 91" November 1997; and itis common ground that it was not. Pathway curtenily estimates
that it will need until about Jaly 1999 to achieve Operational Trial.
I 3. The Treasury Solicitor has been asked to obtain the advice of the Law Officers, A useful
I _ Meeting was held yesterday afternoon, the 8 December 1998, between lawyera for the
I Authorities (though not including thelr Counsel) and for the Treasury, This Note records the
. matters upon which a conscasus was achieved, and also reflects the advice I gave in
I . conference on matters where there remained a difference of opinion between thosa advising
the DSS and those advising FOCL. —
4. My own familiarity with this case is limited in thst I havo only seen extracts from the
selevant contracts, and indeed T only received instructions on Friday of Isst weele I fully
1
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recognise that others are more familiar than I with the detajl. The tantending views of the
DSS and the POCL lawyers are more fillly set out in their various letters and memoranda.
ie issme
‘The issue between the DSS and POCL concerns the means by which the Related
Agreements can lawfully bs terminsted. The DSS's preferred option is to rely on the service _
ofa 13 week notice, by reference to clause 402.13 and Schedule C5 of the Authorities
Agreement. By contrast, POCL’s preferred option is to serve notice under clause 902,23
making tine of the essence for the potpose of achieving Operational Trial by a specified
date; the Iength of that notice could be as much as 9 months. Plainly, the course suggested
by the DSS provides a faster exit route, whereas the route suggested by POCL is both slower
and does not necessarily achieve the termination of the contracts. The question is to decide
Te
which route is preferable, balsncing (1) the relative risks to the Authorities of being found to
be in breach of contract, against (ii) the policy considerations of the Government,
‘The difference of opinion between the advisers to the DSS and to POCL arises from the
difference of wording between clause 402.6.2.3 and clause 402.13. Under clause 402,62.3,.
if Operational Trial is not recorded as being successful on time, the Authorities are entitled
to terminate under clause 902.2, which in tum requites the service of reasonable notice or of
notice making time of the essence (which in practice is likely to coma to the same thing). By
contrast, clause 402,13 provides that the Authoritles shall have no right of termination ofthe
Authorities Agreement in relation to a failure to achieve Operational Trial exceptin
accordance with Schedule A7 (which for theso purposes is irrelevant) or Schedule C5:
patugraph 4.4 of Schedulo CS in tum provides that, if Operational Trial is delayed for more
than 13 weeks because of Pathway’s default, the Authorities shall be entitled to terminate
under clause 902.1. — io by notice having immediate effect.
The true meaning of the contract
The Authorities both agres that nelther interpretation of the Related Agreements is plainly
rightor plainly wrong. On the face of It, there appears to be an inherent contradiction in the
2
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wording of the contracts, and it is difficult to see haw effect can be given ‘both to clanse
402.6.2.3 and to clause 402.13 without doing some violence to the wording of one or the
other.
‘The best interpretation Lean offer, which gives some effect to both provisions, is ta suggest
this: that Schedule C5 ‘was intended to deal only with the situation whera Operational Trial
had not been achieved as a result of Pathway’s default, which ls why it allows a fixed period
of only 13 weeks’ grace, aftec which the contracts can be terminated suramarily; but that
clause 402.6,2.3 was intended to provide a mechanism for terminating the agreements where
Operational Trial was not reached without Pathway being in default, which is why a
reasonable petiod of notice (je potentially something much longer than 13 weeks) is required
under clause 902.2. This interpretation 2t least gives some force to both clauses 402.13 and
402.6.2.3, and it has the value of providing a mechanism for terminating the agreements in
circumstances where Pathway is not in default.
However; it ignores the categorie wording of clause 402.13. Accordingly, Yam forced to
accept that it js imposstble to say that there is a correct and an incorrect interpretation of the -
‘agreements: the truth is thet there is simply an internal contradiction between two. Sifferent
provisions. Any decision about how to terminate the Related Agreements must take into
account that uncertainty. The decision must also be influenced by practical considerations,
which have a serious impact on the relative strengths of the Authorities’ different arguments
in the circumstances which have now arisen. Iwill now tum ta those considerations.
“Quys of proving that Pathway is in default: Tn order to rely on paragraph 4.4 af Schedule CS
the Authorities: must establish that Acceptance of Operational Trial Is delayed for 13 weeks
because of Pathway's default. This throws up two questions, in relation to both of which the
‘onus of proof will Ile on the Authorities:
10.1, First, docs it matter if (aa is likely to be the case) the Authorities have themselves not
fulfilled cach of their contractual obligations to the letter? In my view {tis likely that
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this will not matter. I consider that the precondition in paragraph 4.4 is likely to be
satisfied if the substantial cause of the delay is ‘Pathway’s default.
10.2. Secondly, is Pathway in defautt as a matter of fact? The preliminary advice from
independent contractors is thatthe ‘answer to this question is “yes”, although in
forming their view they have not seen Pathway’s documents. This provides a
considerable degree of comfort, but it has to be acknowledged that there is room for
argument. :
Waiver of breseh: Paragraph 4. A of Schedule CS entitles the Authorities to serve anotice of
termination if Acceptance of Operational ‘Trial is delayed for 13 weeks. Although the
Authorities have notified Pathway that they regard i ites being in breach of contract, no notice
of termination has yet been served, despite the fact that Operational Trial should have been
achieved by the 21* November 1997: ‘There is accordingly an argument available to
Pathway that the breach has been waived, in that all parties have continued with the Project
forthe last year. The DSS has sought to protect its position by reserving its rights, stating in
a telephone conversstion with Pathway thar i it did not regard the 13 week period as starting :
immediately after the 21" November 1997, and seeking to ‘trigger thel3 week period by
serving notice to that effect in May 1998: but that begs the question whether the DSS has
any rights to reserve other than the right to seive anotice of termination on the expiry of the
13 week period after Operational Trial should have been achieved, I
Thesight to serve a 13 week notice: On the facts, the DSS's argument is therefore wholly
dependeat on its right unilaterally to suspend the ranning of the 13 week period specified
under paragraph 4.4 of Scbedale CS, and theri to start that time ranning by serving a notice
to that effoct when it chooses. In my view itis highly questionable whether the Authorities
have such « right under the Related Agreements, There is no express provision for a 13
week notice to be served under the agreements. Tho DSS's route involves having to invent
an extra-contractual procedure, There is, however, an express contractual! provision under
Clause 605.4 for making time of the essence when It is not already so (and that Is exactly
what POCL is suggesting should be relied on). Ip the circumstances, Pathway will be able to
argue thet the original 13 week period after the 21" November 1997 hes tong since expired,
that no notice of termination was served at that point, that any default on its part was thereby
waived, that in order to put Pathway back in breach of contract the Authotities must now
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"snake time of the essence by specifying a new date by which Acceptance of Operational
~ ‘Trlal must be eehioved, and that there is an express contractual mechanism for doing so:
accordingly, on the facts as they now stand, it is not open to the DSS to invent anon
contractual mechanism for starting the clock runing. I do not deay that the DSS may be
right in their argument: but the point is very finely balanced, both as a matter of
constriction and on the facts that have occurred, and I would not want to see the Authorities
going into Court with tens, if not hundreds, of inillions of pounds at stake on an argument
that is Vory finely balanced if there Is a less risky alternative.
43. ‘Thepigey-back option: Much time has been spent by the Authorities’ lawyers discussing
the possibility of POCL terminating its participation in the Project on the back of the DSS'’s
right to terminate (‘the piggy-back option”). For present purposes, all that needs to bs said
. is that this option can be no better in law than the DSS's right to rely on the 13 week notice:
if that route is flawed, then there can be no piggy-back.
14, Conclusion: Successful reliance on a 13 week notice of termination would undoubtedly
provide bath certainty (in the sense that the period of notice is fixed) and an exit route (in the
sense that it would terminate the Agreements). However, in my view the service of a 13
week notice as suggested by the DSS would be likely to provide Pathway with ample
opportunity for contending that the Authorities were in breach of cantract,
‘The practical considerations affecting POCL"s preferred route
15, Legal considerstions: The legal considerations affecting POCL’s preferred route may be
shortly stated: : .
481, There is no need for the Authorities to demonstrate that Pathway is in breach of
contract.: The only precondition that must be satisfied undér clause 605 is to show that
there has been “undue delay” on the part of Pathway, which in light of whet Is said in
poragraph 10.2 above should be fairly casy to satisfy. *
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18,2. Serving a notice that makes titne of the essence for achieving Operational Trial bya
specified date involves the operation of an express contractual regime: itdoesnot * ,
involve inventing or implying any extra-contractual Hghts.
153, The notice must allow Pathway a seasonsble period to comply, and this introduces an
element of uncertainty: how much time is reasonable, and can the Authorities ke
into account the delay that has already occurred? ‘However, the uncertainty can be
climinated by simply giving Pathway es much time as they have said they need - je
vatil July 1999.
» 154, The only basis on which I can see that Pathway could argue that the Authorities were ©
not entitled to make time of the essence would be to tely on 402,13 as Providing the.
only route for termination: however, if that argument were Successful, it would lead
to the conclusion either that the Authorities were entitled to serve a 13 week notice
after all (evhich would bc an own-goal from Pathway’s point of view) or, if the 13
” week period had Bone, that in order to terminate the agreements the Authorities would
bave to make time of the essence Gorbich i is exactly what would have happoned).
“18S. For these reasons, I consider that the route suggested by POCL leaves Pathway with
less room for manceuvre as a matter of law.
6. Policy considerations: Equally, the volley considerations affecting POCL's preferred route
can be shortly stated:
“16.4, The most significant considerstion from a policy point of view is that the service of a
notice making time of the essence does not of itself terminats the agreements. Rather,
it gives Pathway an opportunity of fulfilling its contractual obligations. Accordingly,
if itis a fixed policy objective for tha Authorities to find an exit route as quickly as
Possible, then this does not achive that result cleanly, However, on the information
currently available it seems that Pathway is unlikely to be able to fulfill those
obligations: It would plainly not be attractive for the Authorities to decide
unequivocally thar I they ‘wished to terminare the Project and then to serve a notice
making time of the essence in tho expectation, and indeed the hope, that Pathway
‘would be unable ta complete, However, two results might follow from serving such a
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" notice: either Pathway might collapse financially, or it might find sufficient support
find complete the Project. Ifthe Authotities decided that they would be equally happy”
with cither result, then I do not consider that it could be regarded as being in any way
disingenuous to servea notice making time of the essence, and then just ses what
happened. , :
a
162, ‘The next major policy consideration is that sécving a notice making time of the
essence would mean that the Authorities would have to continue funding’ the Project
until it was completed, of until Pathway walked away from It This obviously
involves a medivm-term financial commitment on the part of the Authorities,
- 16.3, Thirdly, the service of a notice making time of the essence will not necessarily
produce any definitive resolution one way or the other: time will continue to run and
the resolution of the Project will be taken aut of the Authorities hands.
‘The common groupd between the DSS gnd POCT,
17. The legal advisers to both'Dss and POCL accept that, as a matter of construction, cither: «=: . .
view mentioned in paragraph 6 above is atguable and both arguments carry inherent
weaknesses. Although each naturally prefers its own constriction, they both accept that it is
impossible to say thet either construction is unarguably Tight or unerguably wrong.
It is common ground that the argumeat espoused by the DSS involves the operation of a
mechanism that is not expressly provided for in the contracts, and thet it throws up more
legal Hurdles for the Authorities than the route suggested by POCL; the difference of. . “
opinion between the lawyers relates to the height of those hurdles,
18,
19. itis common ground that Pathway is currently in financial difficulties, In that sense time is
on the Authorities’ side: the longer the existing ig fegime continues, the mors likely Pathway
isto ‘commit 8 breach of contract, or even to ‘walk away.
20, Itis believed that Pathway would be well funded for the purpose of taking any possible
proceedings ‘against the. ‘Authorities. It isalso common ground that, although their.
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contractual liability under the Related Agreements is capped at £5m esch, the Authorities
may be held liable for substantially greater sums, and the contractual IImitation of their
liability may be open to challenge. { have not been asked to advise on this aspect
specifically, but it is worth mentioning that, if the Related Agreements were now terminated
for convenience there would have to bo 12 months’ notice and apayment to Pathway of
about £350m, Pathway might well seek to contend that this represents its true loss, and to
seek damages in that amount ifthe Authorities act in breach of contract. On any view, there
will be a very substantial clakn by Pathway if the Authosities do act in breach of contract,
That being so, there is a powerful incentive for the Authorities to ape whichever course is
least likely to lead to their being found in breach of contract.
Conclusions
21. For the reasons given above, the legal question Is not so much whether the DSS’s or POCL's
construction of the bare wording of the contracts is correct (which would be 2 very difficult
question to answer for the reasons given in parngraphs 5-9 above), but whetlier, given the
factual situation that has developed since November 1997, the practical course suggested by
the DSS or that suggested by POCL leaves Pathway least room to assert that the Authorities
are in breach of contract, Put that way, I am in no doubt that the course suggested by the
DSS is fraught with more legal difficulties, whereas the course suggested by POCL involves
the least risk of the Authoritics being found in breach of contract, I consider that those
advising the DSS have underestimated those difficulties.
22. Itis equally plain that, if the Authorities are umequivocally resolved to terminate the Projest,
- then the route suggested by POCL would not achieve that result cleanly: indead, it could be
said that it would be disingenuous for the Authorities to serve a natice requiring Pathway to
comply with its contractual obligations within a fixed timetable if'n fact that notice was only
- being served because the Authorities hoped and intended that Pathway would be unable te
comply with it 2
23,
The only middle ground between the two courses advocated by the DSS and by POCL
respectively is for the Authorities to do nothing —ie not serve a 13 week notice and not serve
atime of the essence notice either. This would certainly be the least provocative course, in
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the sense that it would give Pathway least cause to walk away orto bring proceedings
against the Authorities. The disadvantage is that it would obviously do nathing to bring t
things to a conclusion, and any sabstantial period of inactivity might be held to constitute
waiver of the breach and of the existing notice on which the DSS would wish to rely. On
balance, I would suggest that doing nothing would inyolve all the disadvantages of serving a
notice making time of the essence, but none of the advantages.-
24,. Leaving aside the option of doing nothing, in my view there is a stark choice ‘between ono
course Which would (if it worked) provide a speedy exit route but which offers Pathway
more opportunities for arguing that the Authorities are in breach of ‘contract, and another
route which may take longer to work through in practice and will not necessarily produce =
termination of the Project, but which affords Pathway: far less opportunity to bring claims
against the Authorities. At present] do not consider that there is any neat and reliable way *
of terminating the Related Agreements quickly. My suggestion is thar, the Project having
been allowed to continue this far, the least bad sofation is for the Authorities to remsin
neutral es to whether they wish to terminate, and for them Simply to serve 2 notice making
time of the essence for the Acceptance of Operational Trial by some time next summer.
‘They can thea wait and see what happens, while fulfilling their contractual obligations in the
meantime. I canmot pretend that this is an entirely satisfactory solution: it offends agsinst all
the policy criteria requiring a speedy resolution and a cessation of Goverament finding of
the Project in the immediate future, But if it also minimises the tisk of exposing the
Authorities to very substantial claims, which would if successful reach £10m (together with
interest and costs) and could reach over £300m, then itis an option worth careful
consideration.
4 Stone Buildings
December 1998
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