Sydney, 30th October 2009

The effectiveness of various contractual approaches at delivering the intention of the contract draftsman in the event that something goes wrong with the project 

Speaker: Robert Fenwick Elliott

Summary

There have been a number of reports around the world urging less reliance on contracts as a means of achieving required project deliveries.  A review of a number of significant projects that have in fact gone wrong, and which have ended in dispute, suggests that bespoke contract documents are indeed much less effective than their draftsmen hope and expect in protecting the drafting party’s position in such circumstances.  That mismatch is at its most acute in long, one-sided bespoke contracts.

This paper illustrates how principles of misrepresentation, quantum meruit, negligence, breakdown in contractual machinery, the principles of construction, the doctrines of penalties and prevention and the practical exigencies of delay analysis can and do intervene, such that the end result of disputes is often markedly different from that envisaged by the express words of the contract.

The paper also considers the extent (particularly in the area of responsibility for design) to which the courts will pay regard to a contractual risk sharing regime, and to what extent the courts are loath to allow one party to impose on another risks which that other is unable realistically to price, manage and/or afford.  There is some degree of match between the principles of effective risk sharing as a matter of management (particularly where there is a long term relationship between the parties) and the way the law is in practice applied.

The conclusions to be drawn from this analysis include suggestions that shorter contracts have often proved to be more effective under fire than longer contracts, that contractual provisions that are concerned with project management procedures are particularly prone to ineffectiveness and that contractual provisions which govern the management of disputes at an early stage are useful in practice.

Consensus ad idem – voluntary assumption of risk

It is not the intention of this paper to dwell overmuch on jurisprudential theory.  Suffice it to note that the legal principles which underpin the enforcement of contractual obligations is based upon the concepts of a consensus ad idem between the parties, and a voluntary assumption of duties.

In the area of consumer law, the law often recognises what an individual faced with a contract of adhesion may not, in any real sense, have consented to the small print, or voluntarily assumed the contractual duties that flow from an inequality of bargaining position.

In the commercial context, particularly in the case of contracts for substantial projects between two competent commercial organisations, the courts are much more willing to allow party autonomy.  But as this paper seeks to show there is, even in this environment, a significant extent to which the courts can and do regularly circumvent a literal reading of one sided or onerous contract conditions.  It may be that this approach is based upon a recognition that, in practice, commercial parties often have little more real practical choice as to contract conditions than consumers; if you are in the business, for example, of providing control systems for pipelines, you either have to accept the subcontract conditions that are imposed by pipeline contractors, or to cease doing business altogether.  It may be that, regardless of such considerations, the courts are inherently loathe to see unfair results.  Whatever the jurisprudential basis, the practical reality is that, the more onerous a contractual regime, the more likely a court or arbitrator is to circumvent it.

This paper considers some of the means adopted for this purpose.  A feature in common of these legal avenues is that they are not to be found within the contractual wording itself, and a lawyer who focuses all of his attention on the express words of the contract is likely to miss the point.

Misrepresentation

The impact of misrepresentation in the common law world took off in 1967, when the English Court of Appeal handed down its decision in Esso Petroleum v Mardon and the English legislature enacted the Misrepresentation Act.  Esso v Mardon was a petrol case; Esso tied Mardon into a Solus Agreement for a retail petrol outlet.  The Court of Appeal drove a coach and horses through that agreement by reference to pre-contract predictions negligently made by Esso as to throughput.  The decision somewhat anticipated the passing into law of the Act, which contains some fairly severe restrictions on contracting out: contractual provisions to the effect that the parties warrant that they have not relied upon any representations are thus more or less completely ineffective.  The UK Act has been followed in South Australia by the Misrepresentation Act 1972 in the ACT by the Law Reform (Misrepresentation) Act 1977, and these are in similar form. It is hard to avoid the impression that judges on the East Coast have been leaning towards a treatment of the Rules against deceptive and misleading conduct under the Trade Practices Act so as to achieve a similar result.

Even in States where there is no Misrepresentation Act as such, two points are noteworthy:

  • The common law allows the victim of a misrepresentation to rescind the contract, including any clause in the contract that would stand in the way of his misrepresentation claim.  Anti-misrepresentation clauses are thus an attempt by the draftsman to pull himself up by his own bootstraps.
  • Secondly, the more onerous a contract, the greater is likely to be the reliance of a party on representations made to him.  Take the case, for example, of a project which requires the removal of ground.  The more onerous an obligation on a contractor to do his work without additional payment regardless of the difficulty of the ground conditions, the more likely it is that a contractor will have relied upon any pre-contract representations as to the likelihood of encountering such difficulties.

For an example of the Trade Practice Act application of these principles, see Abigroup Contractors Pty Ltd v Sydney Catchment Authority [2004] NSWCA 270. The contract provided:

The Principal does not represent that information made available to Tenderer/Contractor shows completely the existing site conditions as it may contain errors, omissions or be misleading. Notwithstanding that the Principal has provided or provides to the Tenderer/Contractor information concerning the Site, the Existing Facility, the concept design, detail design of the Works, or other information attached hereto, this information could be incomplete or include errors.

The Tenderer/Contractor must not rely upon the information but must independently check the accuracy or otherwise of all information including design elements provided by the Principal which should be checked against errors and/or discrepancies and advise the Superintendent accordingly. The Principal is not responsible for any interpretation, deductions and conclusions made by the Tenderer/Contractor from the information made available and the Tenderer/Contractor shall accept full responsibility for any such interpretations, deductions or conclusions.

The Principal shall not be liable for any incorrect, misleading or inaccurate information provided.

 

These provisions did not protect the owner from a misrepresentation claim.

Quantum meruit

Onerous contract conditions sometimes seek to deny a contractor the right to payment by variations, by stating that in certain circumstances (often to do with notices) no payment is due under the contract.

The owner’s intention in these cases can sometimes be circumvented by application of the Doctrine of Quantum Meruit.  If the contract disavows any contractual obligation to pay for work, that may open the way for a quantum meruit recovery for that work.  Thus in Liebe v Molloy (1906) 4 CLR 347 the court said:

The law on the subject may be very briefly stated. There was a written contract between the parties, and these items cannot be brought within its terms in face of the express stipulation that `no extra shall be paid for unless ordered by an order in writing by the architect endorsed by the employer;’ but that stipulation does not exclude altogether the implied doctrine of law that, when one man does work for another at his request, an implied obligation arises to pay the fair value of it. The question therefore is whether, notwithstanding the absence of written orders, the contractor is entitled to recover these sums, or in other words, whether under the circumstances of the case an implied contract to pay for them is to be inferred. That is inference of fact to be drawn by the tribunal which is called upon to determine the matter, that is, the umpire.

Years later, this principle remains very much alive. Thus, for example, In Gigliotti Constructions Pty Ltd v Jalili [1998] NSWSC 182, the court applied Liebe v Molloy in declining to overturn an arbitrator’s allowance of a quantum meruit.

Negligence

The common law has occasionally played with the notion that there is no room for tortious obligations in negligence to be imposed where there is an existing contractual regime, but that approach does not reflect the present law in Australia.

There are numerous ways in which the law of negligence can sometimes provide a means of circumventing contractual intention.  Esso v Mardon was decided on the basis of a negligent misstatement.  The present approach of the courts is to impose liability in negligence for economic loss only in cases where there is the necessary ingredient of vulnerability of the plaintiff.  The more onerous a contract, the more likely it is that a court will find that the party on whom such a contract is imposed is vulnerable.

There is a particularly interesting application of the law of negligence insofar as it impacts with certification.  A party seeking to exercise undue control over a project process will sometimes provide for matters to be conclusively determined by the certificate of an individual who is in their own camp, sometimes an employee.  There are numerous ways in which this technique may be unwound.  One is through the law of negligence; if the certifier negligently fails to certify what should have been certified, his employer may be vicariously liable in damages which will sound, dollar for dollar, in the amount that ought to have been certified .

Breakdown in contractual machinery

Certification issues are particularly susceptible to the doctrine of breakdown in contractual machinery.  There have been several notable applications of this principle. For example, in Northern Regional Health Authority v. Derek Crouch Construction Co. Ltd. and Another [1984] 2 W.L.R. 676 the English Court of Appeal said:

The position might well be different if the machinery in clause 35 had broken down and was incapable of operating. In such a case the agreement of the parties on a matter of machinery (as opposed to substantive obligation) having been frustrated, the court could and would substitute different machinery.

Similarly Finnegan v Sheffield (1988) 43 BLR 124

I am driven to the conclusion that it is only when what I perhaps may call the architect procedure has broken down that the court is empowered to open up and review the architect’s certificates or opinions and substitute its own machinery.

And by way of an Australian example, Saloma Pty Ltd v Big Country Developments Pty Ltd [2006] NSWSC 652:

The authorities in cases such as Hall v Busst (1960) 104 CLR 206 which go back to the judgment of Sir William Grant in Milnes v Gery (1807) 14 Ves Jun 400 ; 33 ER 574, indicate that when one gets a situation such as the present, equity uses its powers to supply the machinery that has broken down.

It is not just in relation to certification, however, that the principle is applied. For example the following attempt at throttling variation claims by a consultant on a recent engineering project:

6.3       Variations

a)               The Client may direct the Consultant to do any one or more of the following;

increase, decrease or omit any part of the Services; or

execute additional lawful Services.

b)               The Consultant is bound to comply with that direction even if agreement has not been reached or a determination has not been made in relation to the value of the variation.

c)               The Consultant has no entitlement to any adjustment to the Fee or to any other monetary compensation if it varies the scope of the Services without first receiving a direction from the Client under this clause to vary the Services in one or more of the respects set out in this clause 6.3.

d)               Upon receipt of a notice in writing from the Client notifying the Consultant of the proposed variation, the Consultant shall notify the Client of the effect the Consultant anticipates that the variation will have on the delivery of the Services and provide an estimate of the cost of the proposed variation.

e)               Any adjustment to the Fee payable to the Consultant as a consequence of a direction issued by the Client under this clause must be agreed between the Client and the Consultant, before the Consultant proceeds with the variation direction, failing which the Consultant shall have no entitlement to an adjustment to the Fee whether under this Agreement or otherwise, unless the Consultant has obtained from the Client a direction to vary the Services pursuant to this clause 6.3, without agreement being reached on the adjustment to the Fee.

f)               Where the parties fail to agree, the Client shall value the variation and adjust the Fee as follows;

(i)              if the Agreement prescribes specific rates or prices to be applied in determining the value, those rates or prices shall be used;

(ii)        if paragraph (i) above does not apply, reasonable rates or prices shall be used;

and shall give notice to the Consultant of the Client’s valuation and adjustment to the Fee.

g)               If the Consultant disputes the Client’s valuation, the Consultant may within 21 days of the valuation give notice in writing to the Client and Clause 8, Dispute Resolution, shall apply. If the Consultant fails to give written notice within that 21 day period, the Client’s valuation of the variation and adjustment to the Fee shall apply and shall be finally binding upon the parties and conclusive of the amount payable by the Client to the Consultant in respect of the variation concerned.

h)               In reaching agreement the parties shall negotiate in good faith having regard to a fair and reasonable interpretation of the Consultancy Services Agreement and shall use their best endeavours to reach agreement.  The Consultant shall provide the Client with reasonable assistance to support the Client in securing payment of variations under the Head Agreement in relation to Consultant’s Services.

i)                The Consultant shall not be entitled to delay or disruption costs in connection with any direction issued by the Client under this Clause.

j)                If the Consultant requests the Client to approve a variation for the convenience of the Consultant the approval may be conditional and shall not include an extension of time for the completion of the Services or extra payment in respect of the variation or anything arising out of the variation had it not been approved.

k)               The Client shall not be obliged to approve a variation for the convenience of the Consultant.

It was found that that machinery had broken down, because the client had failed to give the written notices required by sub-clause (d), and thereby lost all the protection intended by his draftsman.

The principles of construction

It is beyond the scope of this paper to consider in detail the principles of construction which are applied by the courts in construing commercial contracts.  Suffice it to say that a number of principles, including the contra proferentem rule, have the practical effect that the more onerous a contract, the more likely it is that a court will pick holes in it as a matter of construction.

Penalties

It is futile to seek to load the contractual dice by imposing a contractual consequence of breach that is commercially excessive.

This principle is well known in the context of damages for delay.  The principle applies equally in other areas.  By way of example, the author was involved in the successful defence of a claim for some tens of millions of dollars in the ICC for liquidated damages for the admitted failure of a large power station to achieve the stipulated performance parameters.  The case was settled for a very small fraction of the sum claimed following argument that the somewhat convoluted calculation mechanism was subject to a number of alternative readings, and that on a number of these, the liquidated damages provided for were penal.

Prevention

Onerous contracts frequently require a party to do or to take responsibility for something which is, as a matter of practice, outside his control.  In these circumstances, it is often open to argue that the doctrine of prevention will excuse that party from performance.

This principle has often been deployed where a contract imposes a time stipulation, but does not provide for extension of that time for events in the control of the employing party – in those circumstances, time is said to be at large, and the contractor is relieved of his obligation to meet the stipulated date.  The principle is by no means limited to this example.

The practical exigencies of delay analysis

Sometimes, a failure by an owner, or a certifier appointed by an owner, to deal with claims for extension of time on a logical basis will have the effect of dismantling the whole of the contractual machinery insofar as it deals with delay issues. Thus for example in John Barker Construction v London Portman Hotel (1996) CILL 1152 the English High Court said:

[the architect] did not carry out a logical analysis in a methodical way of the impact which the relevant matters had or were likely to have on the Plaintiffs’ planned programme… He made an impressionistic, rather than a calculated, assessment of the time which he thought was reasonable for the various items individually and overall…

I recognise that the assessment of a fair and reasonable extension involves an exercise of judgment, but that judgment must be fairly and rationally based…

All in all, I am satisfied that the plaintiffs have established that, although there was no bad faith or excess of jurisdiction on the part of the architect, his determination of the extension of time due to the plaintiffs was not a fair determination, nor was it based on a proper application of the provisions of the contract, and it was accordingly invalid.”…

It seems to me that this is a case in which the contractual machinery established by the parties has become frustrated or, put in other words, has broken down to such an extent that it would not now be practicable or just for the matter to be remitted to the architect for re-determination; and that in those circumstances the Court must determine on the present evidence what was a fair and reasonable extension of time.

Contractual risk sharing

There is some evidence that, whilst courts are typically hostile to onerous contractual provisions, they are rather more amenable to risk sharing provisions.  On one analysis, of course, this distinction is one of presentation, but it is of importance nevertheless.  A provision that says, “Thou shalt be responsible for …”, where that thing is entirely beyond the control of that party, presents itself as unpalatable.  Conversely, a clause that says, “The parties acknowledge a number of risks, and agree to bear them as follows…” is much more likely to be seen as reasonable and palatable.  By way of example, an insurer accepts the risk of, for example, fire albeit that he is in no sense likely to be able to have any control over that fire.

But a contract of insurance is one thing, and a commercial contract to do work or provide materials is another.  After an extensive examination of detailed facts, a court or arbitrator is bound to be drawn, not so much to the wording of the contract, but to the more practical and compelling question: “Whose fault was it that things went wrong here?”  For this reason, a contractual regime which follows the sound management wisdom that risks are best placed with the party able to control and manage them, is most likely to receive a sympathetic treatment from a court or arbitrator.

Conclusions

A number of conclusions are offered from this brief survey:

Do you need a contract at all?

In practice, the value of contracts is typically greatly overrated. Sir John Egan’s Report “Rethinking Construction” made this pertinent observation:

Contracts can add significantly to the cost of a project and often add no value to the client. If the relationship between the constructor and employer is soundly based and the parties recognise their mutual interdependence, then formal contract documents should gradually become obsolete. The construction industry may find this revolutionary. So did the motor industry, but we have seen non-contractually based relationships between Nissan and its 130 principal suppliers and we know they work…

Shorter the Better

Long experience shows that the toughest contracts to pick holes in are the short ones.

Prevention is not better than cure if it is ineffective

Anecdotal experience over many years suggests that the more money that is spent with the lawyers preparing a “watertight” contract, the more likely a project is to end up in litigation. In a sense, there nothing more to this than the observation that the more time you spend in hospital, the more likely you are to be ill.  But there remains an underlying point: that adversarial and onerous contract conditions typically do not work in practice, at any rate against a determined and well-advised party.  It is perhaps no coincidence that the recent prevalence of onerous contract condition has been matched by an increased interest in radical alternative procurement routes solutions such as alliancing. A more moderate and less risky solution would be to foreswear onerous contract conditions, and for the parties to work together in the context of contract terms that are fair and reasonably workable.

This provides:

7—Damages for misrepresentation

(1)         Where a contracting party is induced to enter into a contract by a misrepresentation made—

(a)         by another party to the contract; or

(b)         by a person acting for, or on behalf of, another party to the contract; or

(c)         by a person who receives any direct or indirect consideration or material advantage as a result of the formation of the contract,

and any person (whether or not he or she is the person by whom the misrepresentation was made) would, if the misrepresentation had been made fraudulently, be liable for damages in tort to the contracting party subjected to the misrepresentation in respect of loss suffered by him or her as a result of the formation of the contract, that person is, subject to subsection (2), so liable to that contracting party, in all respects as if the misrepresentation had been made fraudulently and were actionable in tort.

Thus the anti-avoidance provision:

(2)         It is a defence to an action under subsection (1)—

(a)         that the person by whom the representation was made had reasonable grounds to believe, and did believe, that the representation was true; or

(b)         that the defendant was not the person by whom the representation was made and did not know, and  not reasonably be expected to have known, that the representation had been made, or that it was untrue.

See eg Balfour Beatty v Docklands Light Railway (1996) CILL 1143

In an expert determination by an experienced arbitrator.

Robert Fenwick Elliott

Barrister and Solicitor of the Supreme Court of South Australia, Lawyer of the Supreme Court of New South Wales and Solicitor of the Supreme Court of Judicature of England and Wales, Partner of Fenwick Elliott Grace, Adelaide, and Consultant to Fenwick Elliott LLP, London.