Breach! What to do?
Introduction
As I look out the window from my Chambers, what used to be a view of the Waitemata harbour is now obscured by the unclad and empty floors of the incomplete Seascape apartment tower. While the owners and the construction contractor work out what happens next, no work is ongoing.
When a party to a construction contract, whether the owner or contractor, is in breach or more accurately breach is alleged, the options available are becoming increasingly unclear. For the innocent party, whose patience may be increasingly wearing thin, the first choice may be to enforce the contract, and use whatever is available to force the defaulting party to perform; failing that, they may come to a parting of the ways.
Recent judgments appear to have made both options more difficult.
Enforcing the contract
Most construction contracts have some means of encouraging performance, whether through a parent company guarantee or the threat of calling the performance bond. Failing that, contrary to popular belief, specific performance can be available to force a contracting party to comply with its obligations in certain circumstances, as outlined by Harrison J in Downer Construction v Silverfield Developments [2006] NZHC 486, at para [63]:
Specific performance is an equitable and thus fact specific and discretionary remedy. Its exercise is governed by well settled principles which are flexible and adaptable to achieve the ends of equity; that is, to ‘do more perfect and complete justice’ between the parties than leaving them to their common law remedies (Argyll Stores at 9F-G). Building contracts present special features “of a practical nature” (Argyll Stores at 11H) in the areas of sufficient particularity and superintendence of work. But provided the Court is satisfied they can be accommodated by the imposition of appropriate terms within the order, as the arbitrator was here, there is no principled reason why such contracts should not be the subject of awards for specific performance.
Specific performance, however, is less likely to be available where "appropriate terms" are more difficult to define.
Where the owner simply fails or refuses to pay and the works are suspended by the contractor (as appears to be the case in the Seascape development), the choices seem limited. The contractor can obtain a charging order over the property, and may also constrain the owner from awarding another contract in conflict with its existing obligations under the original contract, but forcing a recalcitrant owner to proceed with the project would be difficult.
Conversely, once a contract has been awarded, the contractor has an obligation to proceed with the works on the agreed terms. If the owner fails to pay, the contractor may suspend performance (see section 24A of the Construction Contracts Act) and may terminate the contract (either under its own terms or sections 36 & 37 of the Contract and Commercial Law Act 2017).
Calling a bond
A bond is an undertaking by a third party, typically a bank, to pay an agreed sum once certain conditions are met; most commonly a demand by the bond holder.
Where a bond is "on-demand", the bond issuing bank or other surety must pay on demand (see Edward Owen Engineering v Barclays Bank [1978] Q.B. 159).
Conversely, where the bond is conditional as in previous versions of NZS3910, default and loss must first be proven, and all appeal rights exhausted to establish finality (see Trafalgar House Construction v General Surety [1996] A.C. 199). In most cases, performance bonds are now effectively "on-demand", though that demand may be conditioned by an engineer's certificate (see Custom Street Hotel v Plus Construction [2017] NZCA 36).
The critical point in these distinctions is that, provided the formal requirements of demand have been met, following the Edward Owen decision, a bank cannot be constrained from paying on receipt of a demand.
The only recourse, therefore, for a contractor to prevent a bond from being called is to restrain the owner from making demand. This was the issue considered in Custom Street Hotel, where it was held that the engineer's certification relied upon by the owner to make demand was not properly issued, and more recently in Hawkins v Elizabeth Properties [2024] NZHC 561. In both cases, the courts held that demand could not, or should not, have been called, but for radically different reasons.
In Custom Street Hotel, there were competing termination notices, and the court held that the first notice, issued by the contractor, was valid, with the result that the owner could not rely on the engineer's certificate that the contractor was in breach of the contract and that the amount demanded was "properly due".
Conversely, in Hawkins the court was persuaded that while the delay dispute was being adjudicated, the bond could not be called there being an implied term in the contract that the bond would not be called unless a breach of contract had been established. In assessing the balance of convenience, the court came to the conclusion that the adverse impact on Hawkins of having the bond called warranted the grant of an injunction.
There is a significant problem with the High Court reasoning in Hawkins. Calling a bond will always have an adverse impact on the contractor providing the bond; that is rather the point.
The purpose of bonds in the common law construction world is to meet the owner's immediate costs of getting the contractor off the site, and another contractor engaged. It is for that reason that they are (1) on demand, and (2) for a sum typically in the region of 5% of the contract price. As is apparent from the Hawkins case, liquidated damages of over $20 million were arguably due. If the bond could not be called, then following the decision in Trafalgar House, the owners could not call the bond until liability had been settled. At that stage, the bond proceeds would cover little more than the litigation costs.
The moral, it seems, of the current case law is to ensure that the circumstances in which a bond can be called is explicitly set out in the contract, and the procedure for making demand is consistent with those provisions. If, as appears from the High Court decision in Hawkins, liability and loss must be established before demand can be made, bonds will need to secure considerably more than is currently the case.
Termination
The position in relation to termination is also far from clear following the case of Rau Paenga v CPB Contractors [2023] NZHC 2974. While there have been attempts to downplay the significance of the case, limiting to its facts, the High Court has ruled that a disputed termination notice must be dealt with in accordance with the disputes provisions of the contract. Much like an owner being unable to call a bond in exactly the circumstances for which the bond is intended, a contractor may be unable to held to perform a contract while its termination rights are arbitrated.
Both are unsatisfactory outcomes.
There is some relief in that CPB does not appear to have terminated the contract for breach of an essential term or repudiation (under sections 36 & 37 of the Contract and Commercial Law Act, both of which remained available following the Court of Appeal decision in Custom House Hotel). While section 14 of NZS3910 deals only with remedial breaches, more egregious breaches which cannot be rectified (for example, health and safety prosecution, environmental contamination or repudiation) can clearly still warrant immediate termination, with the risk of an adverse finding in arbitration. That is the commercial decision of the terminating party.
There will always be adverse consequences for the contractor if the bod is called, or for the owner if the contract is terminated. That is what damages are for.
Conclusion
The recent assessments by the courts of balance of convenience in granting interim relief have been questionable. What is more worrying is that they have defeated the commercial protections of the parties, negotiated in a clear understanding of how the construction industry works.
In the case of Hawkins, the owner was denied the ability to demand payment of a sum significantly less than what was claimed to be due. No regard appears to have been had by the court that the point of such bonds is to provide payment immediately, while the underlying dispute is yet to be determined.
In Rau Paenga, the contractor was held to perform a contract which was clearly in dispute.
Both cases failed to recognise that calling a bond or terminating a contract are simply interim measures, subject to resolution in the substantive hearing of the underlying dispute.
While the wind whistles through the empty floors of the incomplete Seascape, it is hard to draw any conclusions as to what happens next. I was at university in Wellington when the last steel frame building, the BNZ headquarters, sat rusting in the gentle Wellington wind for 10 years. I hope we are spared that.