In an important decision released earlier today, the Court of Appeal has provided welcome clarification on how the termination rights under NZS3910 operate in practice.
Custom Street Hotel Limited v Plus Construction Co Limited & Anor [2017] NZCA 36
Background
Plus Construction was engaged to redevelop the former Reserve Bank building at 67 Custom Street East into a hotel and suites for a contract price of $14.5 million, under NZS3910:2003. Of particular concern to Plus Construction was that the bond secured not just the normal 10% or so of the contract price, but 25%. Initially, the bond was the standard conditional form of bond in schedule 3 to NZS3910. That proved not to be acceptable to the issuing bank, and so the bond was renegotiated.
An on-demand form was agreed, with the protection that, before any demand could be made, the Engineer was to certify, in his opinion, that the contractor was in default under the contract, had been given the opportunity to rectify the default (and failed to do so), and that the amount demanded was properly due under the contract.
The project did not go well.
In late 2014, the contractor issued an invoice outlining a number of amounts due under the contract, as previously certified by the Engineer. When the outstanding amount was not paid, the contractor issued a default notice under clause 14.3 of the contract, requiring payment within 10 working days.
Coincidentally, the Engineer had issued a notice of his own, requiring the contractor to rectify a number of safety issues on site. This culminated in the Engineer suspending work on site on safety grounds before the contractor’s default notice expired.
The owner failed to pay the amounts shown in the default notice by the due date, with the result that the contractor enquired of the Engineer (late in the day before the notice expired) whether the Engineer was going to suspend the work in terms of clause 14.3. The Engineer demurred as the work was already suspended. The contractor took this as a refusal to act as “required” under clause 14.3 and, rightly or wrongly, proceeded to terminate the next day.
The owner took this as a persistent and fragrant failure to proceed diligently with the work, and itself then purported to terminate the contract.
A disagreement then ensued over whether or not the owner could make demand under the bond. The parties agreed that the Engineer should be allowed to consider his certificate, and if issued, the funds would then be paid into a solicitor’s escrow account pending resolution at arbitration of the confined issue of whether or not the owner could make demand.
The Engineer engaged quantity surveyors within his own firm and came to the conclusion that the cost to complete was over $24 million, and certified that (1) the sum of almost $25 million was due under the contract (something he was not asked to do), (2) the contractor was in default and had not rectified that default, and therefore (3) the owner was entitled to make demand under the bond.
The bonded sum was paid out by the bank, and has been sitting in the solicitor’s escrow account since.
Arbitration
At arbitration, it was found that the contractor had validly terminated, and therefore was not in default. As a question of fact, the arbitrator also found that the contractor had not repudiated the contract, and was ready, willing and able to proceed.
The arbitrator went on to find that on a proper reading of clause 14.2, the owner was not entitled to be paid any amount based on the projected cost to complete, as it was not “properly due under the contract”.
The owner appealed to the High Court, and was unsuccessful on all grounds of appeal. It then appealed to the Court of Appeal.
Court of Appeal
Four questions were raised on appeal:
(1) Must Plus Construction’s breach be repudiated before it is disentitled from terminating the contract?
(2) Must Plus Construction validly terminate the contract under clause 14.3.3 or, if applicable, the Contractual Remedies Act 1979?
(3) Can Custom recover the additional cost of completion under clause 14.2.4 and 14.2.5 prior to completing the contract works?
(4) Can Custom recover the additional cost of completion without first having its claim admitted and determined as to liability and quantum?
The decision of the Court of Appeal was issued by Kós P on 7 March 2018.
Must Plus Construction’s breach be repudiated before it is disentitled from terminating the contract?
The first question was raised by the owners challenging the contractor’s right to terminate on the basis that the contractor was already itself in breach – the principle being that a party to a contract cannot benefit from its own breach. In this case, the owners argued that, even though time was at large, the contractor had abandoned the works prior to issuing its default notice for non-payment.
The Court of Appeal accepted the general proposition, but recognised that the arbitrator had found, as a matter of fact, that the contractor had not abandoned the work and was ready and willing to proceed.
Accepting the Supreme Court decisions of Kumar v Station Properties Ltd and Ingram v Patchcroft Properties Ltd, Kós P commented at para [28]:
The position may be stated thus: Custom was in breach of its payment obligations to Plus, a breach it only rectified after Plus gave notice of cancellation. After the adjudicator’s decision time for performance by Plus was at large. The parties had not yet resolved the new programme of works by which Plus’s further performance might be assessed. It followed that Plus was not, at the time it gave notice of termination, itself in breach of an essential term. Accordingly: (1) the question of whether giving notice amounted to taking advantage of its own wrong did not arise; and (2) it could only be disentitled from cancelling if it had repudiated the contract. The arbitrator found as a matter of fact that it had not done so. That factual finding must be respected on appeal.
Must Plus validly terminate the contract under clause 14.3.3 or, if applicable, the Contractual Remedies Act 1979?
The second question turned on the singular wording of clause 14.3.3, which provides that, having served a notice of default, the contractor “may require the Engineer to suspend the progress of the whole of the Contract Works“. The clause then goes on to say that “Following such suspension the Contractor shall be entitled … to terminate the contract“. The contractor argued that suspension could not be a precondition to termination, and the owner took the opposing view.
At paras [37] & [38], Kós P effectively concurs with the arbitrator commenting:
[37] Secondly, we consider Plus in any event entitled to terminate under cl 14.3.3 despite the absence of a suspension notice by the engineer under that clause. We do not construe cl 14.3.3 as establishing a suspension condition precedent to termination. Defaults by the principal qualifying for suspension or termination under cl 14.3.3 all concern essential terms. We do not think the intention underlying the clause is that a contractor who has notified breach of an essential term, which breach has not been remedied within the requisite 10 working days, must seek (and achieve) suspension before exercising a right to cancel. Some questions might usefully be posed. What if (as here) the engineer does not act on the notice? What if (as also here) the works are already suspended (so that the act of suspension is practically immaterial)? Is the 10-day remediation period extended by notice to suspend? If so, how long for? If not, as seems likely, then what purpose is served in any case by requiring a notice of suspension which is immediately overtaken, a scintilla of time later, by a second notice — this time of cancellation?
[38] We see the purpose of cl 14.3.3 as clear. It creates a right to suspend, after 10 working days.22 But it is a right, not a requirement. The construction of cl 14.3.3 is informed by the retained right to cancel in the CRA. It makes little sense that a contractor that wishes to exercise that cancellation right must first go through a charade of “suspending” and see its right to cancel mangled or misplaced if the engineer does not perform his or her duty to suspend. As we see it, therefore, cl 14.3.3 must be read as creating a right to cancel once the right to suspend exists. And that “following such suspension” must be read accordingly: that the right to cancel is triggered once the right to suspend is triggered. They are not true alternatives, because the contractor may suspend first, and then cancel. But it need not seek suspension before cancelling. That is the most logical construction of the contract, consonant with the reasonable expectations of the contracting parties.
This conclusion may come as a surprise to many practitioners, however it does reflect the practical reality that once a contractor has accrued the right to terminate, it should not be beholden to further consideration by the Engineer over whether or not to suspend.
Of more interest, the court also accepted that there is a residual right to terminate for breach of essential term under section 7 of the Contractual Remedies Act 1979 which is not overridden by the more detailed provisions of the contract (see para [36] of the judgment).
Can Custom recover the additional cost of completion under clause 14.2.4 and 14.2.5 prior to completing the contract works?
The third issue effectively dealt with all remaining arguments. Clause 14.2.3 gives the owner a number of options in the event of contractor default; it may expel the contractor from the site without terminating the contract; complete the works; take possession of and use plant and materials at the site to complete the works; and require the contractor to assign subcontracts and supply contracts.
Under clause 14.2.4, “on completion of the Contract Works” the engineer enquires as to the final cost of completing the works, and if that cost exceeds the contract price, the contractor is to reimburse the excess; conversely if the cost is less than the contract price, the contractor is to be reimbursed. From the plain wording of clause 14.2.4, if the owner elects to complete the works, it can only recover any additional cost once the works are actually complete.
This interpretation was confirmed by Kós P, reasonably concisely at para [45] in the following terms:
[45] First, it is what clause 14.2.4 itself says. It begins “[o]n completion of the Contract Works”. Secondly, Custom’s submission that those temporal words apply only to the first sentence would require the clause to be bifurcated, with the first sentence to be isolated and the balance applicable to a different time period. That is an awkward and unnatural interpretation, unlikely to have been intended in a contract drafted by and for practical professionals. Thirdly, we agree with Gilbert J that cl 14.2.4 follows in sequence with cl 14.2.3 and deals with a situation in which the principal resumes possession of the site to complete the works. It is, in practical effect at least, part of cl 14.2.3. There is a natural flow through clauses 14.2.3 and 14.2.4 all of which depend on the principal electing to complete the work itself. Clause 14.2.4 then provides for a wash-up, ex post completion of the works. Fourthly, the language used later in the clause anticipates the contract works have been completed, referring to enquiry into “the Cost to the Principal of completing the Contract Work” (which must then be certified), and “had the Contract Works been completed by the Contractor” rather than “if”. The tense of the scheme is in the past; that the work has been done and that definite sums are in issue. Fifthly, cl 14.2.3 states the contractor is not entitled to any further payment until the completion of the contract works. Given the certification process under cl 14.2.4 may lead to a payment being made to the contractor, that is a further indication the accounting in cl 14.2.4 takes place only on completion.
The final issue, whether the additional cost can be recovered before a claim is admitted and determined both as to liability and quantum, can only be determined under clause 14.2.4 and is therefore answered by issue three above.
Conclusion
Hopefully, this will bring these proceedings to an end. Only the passage of the appeal period will tell.
More critically, the Court of Appeal has provided what must be definitive guidance on how termination under NZS3910 works in practice. This is not the sort of judicial consideration which has come up to date.
Termination under construction contracts can be extremely messy. Both parties will feel they have legitimate causes for grievance against the other party; sticking to the contract procedures can be problematic; the views of the parties and the Engineer in conflict; and behind all that will inevitably be conflicting interpretations of the law. From today’s judgment, we can now say with some confidence:
- Where a party has effectively repudiated a contract, or is in breach of an essential term, it may be constrained from initiating the default procedures under clause 14.
- The ability to terminate under section 7 of the Contractual Remedies Act subsists, notwithstanding the reasonably complete default provisions of NZS3910.
- The contractor is not obliged to require suspension of the works before proceeding to termination under clause 14.2. Suspension is an option, not a precondition.
- If the owner decides to complete the works, following contractor default, then it must complete the work before making any claim for payment.