Set-off what?

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Making sense of ambiguous contracts

The primary concern for a developer and builder closing a development agreement is to reach a commercial deal on mutually agreeable terms. If you reach a deal, do the precise words in the contract really matter? What was the real deal struck if the words of the contract are ambiguous?

In Tomkins Commercial & Industrial Builders Pty Ltd v Pacific Diamond 88 Pty Ltd [2024] QSC 321, the Supreme Court of Queensland considered how to interpret a contract with terms that were clearly ambiguous, in a dispute about the Principal’s claim to liquidated damages and right to set-off.

Facts

The applicant (Tomkins) was a family owned and operated construction company. In December 2021, Tomkins entered into a contract as builder, with the respondent (Pacific Diamond) as principal, for construction works which was later varied by a deed of variation in August 2022.

Disputes arose between Tomkins and Pacific Diamond, which culminated in Pacific Diamond issuing three certified notices to Tomkins under the contract:

  • a certificate for liquidated damages due and payable in the amount of $2.6 million;
  • a payment certificate crediting to Tomkins $394,343 for work done, but setting off $2.6 million in liquidated damages, leaving a balance payable from Tomkins to Pacific Diamond of over $1.9 million; and
  • a notice that Pacific Diamond intended to have recourse to bank guarantees provided by Tomkins under the contract as security.

Tomkins applied to the Court seeking declarations that Pacific Diamond was not entitled to set-off liquidated damages in the way it had sought to do, that notices issued by Pacific Diamond were invalid, and injunctions against Pacific Diamond preventing their recourse to the bank guarantees.

Ambiguity in the Contract

The questions before the Court required an interpretation of the clauses in the contract relating to the timing of the principal’s rights to liquidated damages, set-off and recourse to security.

When Tomkins and Pacific Diamond had originally negotiated the contract, the first drafts of the contract exchanged were an amended standard form AS4300–1995 contract. Notably, Tomkins did not agree to allow liquidated damages to be payable on demand, nor for liquidated damages to be deducted from certified amounts payable to Tomkins or from security, and deleted relevant clauses from this draft contract.

In the midst of negotiations, the parties then opted to switch and use the standard form AS4902–2000 contract as the basis of their negotiations. After further negotiations, subclause 37.2(b) was deleted from the standard form contract. The deleted subclause would usually have provided for certificates the principal could issue evidencing the assessment of retention and other moneys due to the principal from the contractor.

While subclause 37.2(b) was removed from the contract, references to subclause 37.2(b) remained. This resulted in ambiguity in the contract, particularly regarding whether Pacific Diamond had an immediate right to set-off for certified liquidated damages, or whether a claim for liquidated damages was only on account until the final payment claim at the conclusion of the contract.

Filling in the Missing Pieces

The Court found that the contract was ambiguous, and in this case was required to determine the actual legally binding agreement formed from the intention of the parties.

The Court uses an objective standard to determine the agreement that parties reach. This means the Court will assess the words and text exchanged between the parties through the eyes of a “reasonable businessperson” to determine the precise bargain of the parties.

Where there is an ambiguity in the contract, the Court will also consider relevant context (including prior negotiations) through the lens of a “reasonable businessperson” to determine the text, context and purpose of the contract.

The Court concluded that the correct and commercially sensible interpretation of the contract as amended by the removal of subclause 37.2(b) was that Pacific Diamond’s right to liquidated damages was not payable until after the final certificates had been issued, and that they could not set-off against security or against the certified payments due to Tomkins under the contract in the way they had attempted.

The Court also concluded that the balance of convenience favoured granting Tomkins the injunctions sought restraining Pacific Diamond from having recourse to the bank guarantees.

Consequently, the Court made the declarations sought by Tomkins that Pacific Diamond did not have a right to set-off liquidated damages against payments certified as due to Tomkins. Additionally, the Court ordered that Pacific Diamond could not have recourse to security on the basis of the notices it had issued, which the Court also found invalid under the contract and set aside.

Takeaway

Having ruled, the Court also recognised that Pacific Diamond’s claim to liquidated damages had not been extinguished entirely but simply delayed until a later time, with the expectation that Tomkins and Pacific Diamond might continue their dispute using the arbitration clauses in their contract.

In this case, it seems the commercial dispute between the parties had been exacerbated with a legal dispute arising from ambiguity in the drafting of the contractual terms of their agreement.

It is important when negotiating a contract, well before a commercial dispute arises, that the parties carefully and unambiguously decide on the proper contractual processes and risk allocation that will define their business relationship throughout a project. Doing so will help avoid unnecessary legal disputes when commercial resolutions are difficult to find.

Building Bill 2024: Nine Acts, One Bill – A Game-Changer or a Headache?

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The NSW building and construction industry is on the brink of a massive overhaul with the introduction of the NSW Building Bill 2024, along with the Building Compliance and Enforcement Bill 2024 and Building Insurance Bill 2024. These reforms aim to streamline regulations by consolidating nine existing Acts into one, promising greater clarity for builders, developers, and industry professionals. But is this the game-changing reform it appears to be, or could it turn into an administrative headache?

The Promise: Simplifying Regulations

At its core, the new Bill seeks to simplify the regulatory framework by repealing nine existing Acts, including the Home Building Act 1989 and the Design and Building Practitioners Act 2020, aiming to make the system more transparent. On paper, this sounds like a win, offering contractors a clearer path through their legal obligations. However, without clear supporting regulations yet in place (Building Commission NSW is expected to release these later this year), key questions remain unanswered, leaving the industry in a state of uncertainty.

Figure 1:

Repeal of existing legislation

Expansive Definitions and Ambiguity

A major concern is the Bill’s broad definitions of “building work,” which now include everything from construction to plumbing and fire safety. While the intention is to streamline regulations, these sweeping definitions could increase compliance costs and administrative burdens, particularly for specialised trades with narrower scopes, such as medical gasfitting, as well as increasing the scope of the Bill to construction work which is currently excluded under the Home Building Act 1989, such as the installation of vertical transport products. Additionally, the vagueness surrounding the definition of “design” raises significant concerns for architects, who fear that the Bill’s wide-reaching scope may obscure their broader professional role.

Licensing and Insurance Overhaul

The Bill also introduces new licensing and insurance requirements, which will affect everyone from builders to engineers. While these measures aim to ensure consumer protection, they risk complicating matters for industry professionals. Contractors may face delays in determining which tasks require licensing, and mandatory insurance could drive up costs, especially if the regulations remain unclear.

Statutory Warranties and Liability Risks

One of the more significant implications of the Bill is the expansion of existing statutory warranties to encompass additional categories of building work. If a specific type of work is reclassified as “home building work,” contractors may be required to provide warranties. While this extension of warranties is beneficial to consumers, the lack of clarity around their practical application creates uncertainty for contractors, particularly regarding the scope and duration of their obligations.

The Verdict: A Game-Changer or a Headache?

While the NSW Building Bill 2024 promises to simplify regulatory processes, the lack of finalised supporting regulations has left the industry in a state of uncertainty. Contractors may find themselves grappling with increased compliance costs, administrative burdens and legal risks. Whether this reform will prove to be a transformative shift or devolve into an administrative headache for industry professionals largely depends on how swiftly the outstanding issues are addressed. For now, we can only wait and see, as the consultation period has ended, and we await further developments.

As the full impact of these changes unfolds, we will closely monitor any developments and provide further updates.

Need help navigating these changes? Contact Bradbury Legal at (02) 9030 7400 or email [email protected] for advice.

No claim “for construction work”? No problem

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Key takeaways from EnerMech Pty Ltd v Acciona Infrastructure Projects Australia Pty Ltd [2024] NSWCA 162

In this significant judgment, the Court of Appeal overturned the decision of Justice Stevenson and the previously accepted view that a payment claim made under the Building and Construction Industry Security of Payment Act 1999 (NSW) (the Act) must specifically be “for construction work”.

Background

In 2020 the appellant, EnerMech Pty Ltd (EnerMech), entered into a subcontract with the respondent, Acciona Infrastructure Projects Australia Pty Ltd (Acciona) for electrical installation works for the construction of the WestConnex M4-M5 link. Under the subcontract, EnerMech was required to provide security. In compliance with the subcontract, EnerMech procured a bank guarantee as security in the amount of $9,230,157.40 (security).

In May 2023, Acciona called upon the bank guarantee and was paid the security.

In June 2023, EnerMech served a payment claim on Acciona in which it sought to recover the security amount obtained by Acciona in exercise of its contractual entitlement, as well as variation works.

Acciona responded with a payment schedule in which it accepted the variation work and indicated that no amount was payable as there was no claim “for construction work”.

EnerMech lodged an adjudication application, and the adjudicator determined EnerMech was entitled to its claim under the Act.

Acciona then commenced proceedings in the Supreme Court to have the adjudication determine quashed. Acciona’s position was that the payment claim was invalid because it was not a claim for payment “for construction work”, rather it sought to recover the security amount which it had obtained in exercise of a contractual entitlement.

Key issues in dispute

Acciona claimed that EnerMech’s claim was invalid under the Act as it did not meet the definition of ‘progress claim’ as defined in section 4 of the Act, as follows (emphasis added):

progress payment means a payment to which a person is entitled under section 8, and includes (without affecting any such entitlement)—

(a)   the final payment for construction work carried out (or for related goods and services supplied) under a construction contract, or

(b)   a single or one-off payment for carrying out construction work (or for supplying related goods and services) under a construction contract, or

(c)   a payment that is based on an event or date (known in the building and construction industry as a “milestone payment”).

Further, Acciona contended EnerMech’s claim fell outside the operation of the Act, and therefore the Act was not engaged and the adjudicator did not have jurisdiction to determine the claim.

In December 2023, Justice Stevenson held that the payment claim was not ‘for construction work or related goods or services’ and therefore EnerMech’s claim did not fall within the ambit of the Act. Accordingly, the adjudication determination was set aside.

Appeal

In February 2023, EnerMech appealed the decision.

The issues to be determined on appeal were:

  • whether a payment claim can only be made ‘for construction work’ and
  • whether the Court had jurisdiction to review the adjudicator’s determination.

With respect to the first issue, the Court of Appeal determined that:

  • in accordance with section 9 of the Act, the amount of a progress payment to which a person is entitled “in respect of a construction contract’ (not “for construction work”) is to be calculated in accordance with the terms of the contract;
  • in relation to section 13(1) of the Act; it does not limit the amount or nature of a payment in which a party is entitled to under a construction contract and does not create an implied condition as to the validity of a payment claim; and
  • a payment claim must be for an amount of money which is payable for work done, goods supplied, or services rendered under a construction contract.

As the Court of Appeal had found EnerMech’s claim to be valid, it did not need to address the second ground on appeal. The Court, however noted that an adjudicator’s understanding of a construction contract, even if legally incorrect, and whether the amount claimed under the contract is payable, is a matter for the adjudicator and could not be challenged.

Outcome

The Court of Appeal dismissed the Supreme Court’s decision to set aside the adjudication determination.

The Court of Appeal’s decision has in some respects, overturned the status of quo and the previously accepted view that a claim under the Act was only valid “for construction work under a construction work”. Like EnerMech, this decision may benefit claimants and provide a means to claim for a reversal of   bank guarantees or other security under construction contracts. Careful consideration will need to be given in relation to how payment claims are formulated in instances where a claimant is claiming the contractual price of construction work that may include security.

Don’t let escalating losses from defects snowball into an avalanche of avoidable (and unrecoverable) losses

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What is mitigation?

In the context of construction disputes, “mitigation” refers to the obligation of a person suffering loss to not act unreasonably in allowing loss they suffer to worsen and result in additional loss.[1]  It is not about whether there was some better or ideal way in hindsight[2], but whether what was done was reasonable.  The obligation is not overly burdensome and does not require the person suffering loss to go out of their way and against self-interest to avoid loss, merely to have acted reasonably in seeking to prevent themselves suffering avoidable losses.[3]

For example, if the owner of a building is having significant water ingress issues due to defective roof waterproofing installed by their builder, the loss directly caused by the builder is a recoverable loss for the owner.  But if that owner sat on their hands and allowed the water ingress to worsen or cause consequential damage resulting in a greater loss e.g. internal damage of floors, walls, and furniture etc., the failure to avoid that additional loss is a failure to mitigate.

The mitigation obligation will be shaped heavily by any contractual agreement between the parties and override general law principles.[4]

Avoidable losses are not recoverable

In that example, an owner failing to avoid losses that can be avoided by taking reasonable action is exposed to the risk that a court or tribunal may decide the owner themselves caused that additional, avoidable loss and will not be able to recover it.  This is the case even where the original cause of the loss is the builder or one of its subcontractors.

The reason for this is that the compensation principle only requires that the owner is restored (by rectification works or money in our example) to the position they would have been had the builder not performed defective works.[5]  Avoidable loss caused by an owner’s inaction is not caused by the builder, only consequent upon it.

Further, the person who claims the other has failed to mitigate loss is required to prove that failure.[6]  In our example, the builder bears the obligation of persuading the court or tribunal that some parts of the ongoing loss suffered due to the water ingress followed from the owner’s failure to take reasonable steps to halt the water ingress.

Costs of reasonable steps to avoid loss are recoverable

Fortunately, the costs of actions taken by an owner to prevent the suffering of avoidable loss are compensable.  However, such losses must not be too remote which refers to excluding recovery of losses that would not typically arise or would not have been foreseen by the parties at the time of entering their agreement due to the breach.[7]

Recovery is possible even where the costs of the reasonable steps exceed the likely cost of the avoided loss (with the builder having to prove steps were unreasonable).[8]  For clarity, it is not necessary for the reasonable actions taken to have actually succeeded in avoiding the loss for the costs to be recoverable.

Mitigating by allowing the original builder access to rectify

With those general points in mind, this article considers a specific type of mitigation scenario which is an owner’s obligation to allow the original builder to return to rectify defective or non-compliant work before engaging a third party to take over and then claim monetary compensation.  This obligation can exist in the contract between the parties, in statute[9], and otherwise at common law[10].

Determining whether or not an owner has acted reasonably is assessed against the factual circumstances of the dispute.  Helpfully, Justice Rees in Ceerose[11] distilled four key facts that will be relevant in determining the question:

  1. the extent and seriousness of the defects;
  2. the quality of any repairs effected by the builder;
  3. the builder’s engagement with the owner in respect of the suggested defects and proposed method of rectification, in short, has the builder responded in a timely manner, taken the complaints seriously and acted fairly; and
  4. the efficacy or perceived futility of continuing to negotiate with the builder.

In this mitigation scenario, given the obligation to prove the failure falls on the builder and the standard of what is reasonable conduct for the owner is not high, it will typically be difficult to establish a failure to mitigate with the owner being precluded from recovering the avoidable loss.  Justice Rees in Ceerose remarked on this when considering recent decisions on this specific mitigation scenario.[12]

Economic advantages to both owner and builder of rectification

The advantages to an owner of mitigating their loss by allowing the original builder to return include:

  1. Ordinarily, the original builder will undertake this work at no cost to the owner given contractual and statutory obligations[13] to do so.
  2. If certain defects or non-compliant works are worsening over time, urgent and proactive action by an owner to allow a builder access will generally be a reasonable step to mitigate avoidable loss. As mentioned above, losses that could have been reasonably avoided will not be recoverable by an owner given the true cause of those losses is the failure to avoid them.

Builders often prefer returning for the simple fact it is generally cheaper than paying the equivalent amount in money to an owner.  This is because a knowledgeable builder will have contractual rights to compel subcontractors to rectify issues in their work at no cost, or, if there is a cost, that cost is less in the original builder’s hands compared with a fresh third party builder (which will include contingencies for the cost of unknowns involved in remedial work).[14]

Provided the rectification work is performed in good faith and correctly, the parties’ interests are aligned in this scenario and resolution is achieved without protracted litigation and accompanying costs.

If you’re an owner in a situation where your losses may worsen and you need advice on what steps you can take, or you’re a builder dealing with an owner that is refusing access which is worsening any issues you may have originally caused, please contact our team on (02) 9030 7400 or at [email protected].

 

[1] The Owners – Strata Plan No 89074 v Ceerose Pty Ltd [2024] NSWSC 1494 (Ceerose) at [38]-[39] per Rees J and the references therein.

[2] Banco de Portugal v Waterlow and Sons Ltd [1932] AC 452 at [506].

[3] Karacominakis v Big Country Developments Pty Ltd [2000] NSWCA 313 at [187] per Giles JA.

[4] Ceerose at [37] per Rees J.

[5] Robinson v Harman (1848) 1 Ex 850.

[6] Ceerose at [40] per Rees J and the references therein.  See also section 18BA(3) of the Home Building Act 1989 (NSW).

[7] Wingecarribee Shire Council v Lehman Brothers Australia Ltd (in liq) (2012) [2012] FCA 1028 at [988] per Rares J.

[8] Arsalan v Rixon Nguyen v Cassim [2021] HCA 40 at [32] per Kiefel CJ, Gageler, Keane, Edelman and Steward JJ.

[9] For example, section 18BA(3) of the Home Building Act 1989 (NSW).

[10] See generally Ceerose at [53] per Rees J.

[11] Ceerose at [51] per Rees J.

[12] Ceerose at [48]-[50] per Rees J.

[13] For example, in a claim for breach of the statutory warranties contained in section 18B of the Home Building Act 1989 (NSW) or the statutory duty of care contained in section 37 of the Design and Building Practitioners Act 2020 (NSW).

[14] See also Ceerose at [41]-[43] per Rees J and the references therein.