Background
Termination of a construction contract, or more specifically a party being discharged from further performance under the contract, occurs in a number of circumstances:
- where the contract has been "repudiated", there has been an "anticipatory breach" or a breach of an essential term, and the innocent party has elected to terminate the contract;
- under the contract for convenience or for breach, following a specified procedure;
- frustration, illegality, death or other legal or equitable right;
- under statute; and
- performance of all obligations.
At common law, the traditional approach was to classify terms as either conditions or warranties, each giving different levels of redress for breach, whether damages to put the innocent party in the position it should have been, but for the breach; returning the parties to their pre-contractual positions; ordering specific performance of the contract; or termination of the contract. The point being that while the law may provide redress for breach of contract, that redress may differ.
The distinction between terms, conditions and warranties, and the consequences which follow, were largely swept away in New Zealand with the passing of the Contractual Remedies Act 1979 (now Part 2, Subpart 3, ss 33 to 59 of the Contract and Commercial Law Act 2017). Under those provisions, a party may cancel a contract if the other party repudiates it by showing that it does not intend to perform its obligations (s36); if it was induced to enter into the contract by misrepresentations, or if an essential term of the contract has been or will be breached (s37); but may not cancel if it has affirmed the contract (s38).
The concept of breach of an essential term is one which substantially reduces the benefit, or increases the burden, to the cancelling party, or which makes the benefit or burden substantially different from that represented or contracted for.
Under section 34, where a contract provides for a remedy for repudiation or breach of contract, then the above provisions take effect subject to what is provided for in the contract. The question then arises, to what extent does NZS3910 conclusively provide for termination of the contract for breach, and which provisions of the Act continue to apply?
NZS3910
Section 14 of NZS3910:2023 provides for:
- frustration (clause 14.1 - impossible of performance);
- default by the contractor (clause 14.2 - either has abandoned or is persistently, flagrantly or wilfully neglecting to carry out its obligations); and
- default by the owner (clause 14.3 - also abandoning the contract or persistently, flagrantly or wilfully neglecting to carry out its obligations).
In each case, breach by either the contractor or the owner, the party in breach must then remedy the breach within 10 working days, or run the risk of termination.
In reality, by the time a party has come to the decision to issue a notice of breach, termination is a foregone conclusion. The parties then refer questions of whether or not the notice of breach was justified; whether the termination was lawful; and what damages, if any, become payable to arbitration.
The critical point is, following termination of the contract, the parties are discharged of further performance, pending the outcome of the disputes process.
Breach of an essential term?
The question then arises, to what extent do the provisions in relation to cancellation (ss 35 to 49 of the Contract and Commercial Law Act) continue to apply in a project covered by NZS3910?
The most obvious continuing provisions, not covered by NZS3910, are those relating to misrepresentation.
However, the procedure for termination in clause 14 of the contract is notable for its failure to provide for breaches of essential terms which are incapable of rectification. Most commercial contracts recognise the concept of a "material breach", which captures obligations which are essential to the particular contract (for example, the immovable date upon which the milking season will start, or periods of constraint for electricity networks) and will more generally pick up the concept of increased burden or reduced benefit from the Act. Those provisions allow for termination for breach of a material term without the requirement for a notice to rectify.
In the construction industry, there remain many breaches of contract incapable of rectification which would reduce the benefit or increase the burden, for example breaches of the Health and Safety at Work Act or the Resource Management Act. This is a significant omission.
Under NZS3910, where there is a breach of such a term which is incapable of rectification within the 10 day time limit, then the innocent party is left to judge whether or not the breach falls within section 37, and to then elect whether or cancel or affirm the contract. The option for damages remains open, whichever election is made (s43), however the critical issue is whether or not the parties are discharged from further performance (s42).
This issue arose before the Court of Appeal in Custom Street Hotel v Plus Construction [2018] NZCA 36. In that case, the contractor issued a notice of default under NZS3910:2003, and once that notice had expired, the engineer declined to suspend the works (an apparent precondition under clause 14.3.3 to the contractor proceeding to terminate the contract).
Kós P confirmed the findings of the arbitrator and the High Court that the ability to require suspension was a right not a requirement for termination, and further that right must be read in the context that cancellation under section 7 of the Contractual Remedies Act (s37 of the Contract and Commercial Law Act) remained available. The breach in that case (failure by the owner to pay a progress payment) was capable of rectification within the specified period, but was not rectified, raising the right to suspension and to termination.
Plus Construction was held to have validly terminated the contract notwithstanding the engineer's failure to suspend the works under clause 14.3.3.
Rau Paenga v CPB Contractors
The issue of termination has become more complex following the High Court decision in Rau Paenga Ltd v CPB Contractors Pty Ltd [2023] NZHC 2974. As in Custom Street Hotel, both parties had issued default notices, and the disputes procedures were ongoing. The court issued an order restraining CPB from requiring the engineer to suspend the works and terminating the contract under its notice.
In the ordinary course, CPB would proceed to terminate the contract leaving the various claims to be resolved by the payment of damages ascertained in arbitration. As there is no common law right for the contractor to suspend work for non-payment (or any other breach), the termination provisions are of critical importance. In practical terms, there are only two opportunities for construction work to be suspended - (1) for non-payment of a scheduled amount under section 24A of the Construction Contracts Act 2002, or (2) under the terms of the contract. Failing those two courses of action, the only remaining basis for a contractor to be discharged of the obligation to complete the works is to cancel the contract.
Venning J granted the orders sought by Rau Paenga, finding that disagreement over the validity of CPB's default notice was a "dispute" which should be dealt with under the procedures under the contract, namely referral to the engineer for a formal decision, followed by arbitration and exhaustion of rights of appeal. CPB sought leave to appeal, on the basis that the decision relating to NZ's most used standard form would have a significant impact on the construction industry. Justice Venning declined leave.
Conclusion
It is unfortunate that the case did not get the benefit of consideration by the Court of Appeal, leaving the High Court decision as the only remaining authority on the point.
Where a contractor has no common law right to suspend the works for non-payment, the only protection available to a contractor at law (aside from the provisions in the contract and the specific circumstances in the Construction Contracts Act) is to issue a notice of breach, and to then terminate the contract, discharging it from any further obligation to perform the contract. The accepted approach in the industry is that the contractor is effectively taking a roll of the dice on its notice of breach; the substantive dispute is then dealt with in arbitration. Without this option, the contractor is forced to continue to perform a contract under which it believes the owner is in breach, and the owner is left having to retain a contractor it has lost faith in.
Some comfort is provided by the availability of termination under the Contractual Remedies Act / Contract and Commercial Law Act, but even in that event, following the reasoning of Justice Venning, a dispute over a notice of breach under section 37 would still comprise a dispute or disagreement which should be referred to the engineer, then to arbitration.
In practical terms, the decision in Rau Paenga leaves notices of dispute, seeking suspension and/or termination, and cancelling the contract under the Contractual Remedies Act a pointless exercise. If the parties are prohibited from acting on a notice of breach, albeit a disputed one, then they will be forced to go through arbitration and then to exhaust any rights of appeal in court, all the while having ongoing obligations under their contracts with counterparties arguably under-performing. In that circumstance, the more expedient approach may be to continue to perform under the contract, refer the underlying dispute to arbitration and to forget about issuing a notice of default.
If the decision in Rau Paenga is good law, it is a very unhappy state of affairs.