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17 May, 2016
It is trite to say that a contract sets out various rights and obligations that the parties to it have. Generally, contracts will specify when these rights have to be exercised or obligations have to be performed. But what if the contract is silent on this? Last Friday the Court of Appeal handed down a significant decision on this question of contract law.
Background to the dispute: take up arms against a sea of troubles
Back in 2007, the Commonwealth Government began a process of updating the Royal Australian Navy’s conventional naval combat capabilities, which included the construction of three “Hobart Class” air warfare destroyers. These ships were to be constructed domestically by an entity established by the Commonwealth, being ASC AWD Shipbuilder Pty Ltd (ASC). ASC then entered into a number of subcontracts with other companies to construct various “blocks” for the ships. These blocks were to be constructed and then shipped to ASC, who would assemble the ships.
One of the subcontracting parties was Donau Pty Ltd, formerly Forgacs Engineering Pty Ltd (Forgacs), a Newcastle based civil and defence shipbuilder. Forgacs and ASC entered into a contract in 2009 for the construction of various blocks. The contract also provided for a formula by which Forgacs’ fees for the project were to be calculated. The project was fraught with complications and delays, and it became impossible for the parties to use the mechanism under the original contract to calculate Forgacs’ entitlement to its fees.
To try to remedy this issue, in October 2012, ASC and Forgacs executed a new contract, being the “Second Heads of Agreement” (SHOA) which, inter alia, provided for a new mechanism for calculating Forgacs’ fees. The SHOA also contained various clauses that required the parties to “re-baseline” the various performance metrics of the project. Finally, the SHOA also gave ASC a unilateral right to terminate the agreement (the effect of this being that the parties would revert back to the regime under the original contract). Critically, the SHOA was silent on when this right to terminate had to be exercised by.
The parties were unable to reach agreement on the “re-baseline” and in June 2013, ASC purported to exercise its right to terminate the SHOA. Further disputes arose as to entitlement to fees, which led to proceedings being commenced before the Supreme Court of NSW in 2016 after the completion of the project. The parties were orders of magnitude apart on the question of fees, with ASC claiming overpayment of over $20,000,000 and Forgacs claiming underpayment for a similar amount.
Multiple issues were ultimately ventilated before the Courts, including whether the SHOA came into effect, what date it substantively came into effect or “transitioned” (the two available dates on the construction of the document being in December 2012 and February 2013), and the correct construction of the SHOA as to its effect on Forgacs’ entitlement to fees. However, one key issue was whether ASC lawfully terminated the SHOA in June 2013. That is, did ASC fail to exercise their right to terminate within a reasonable time? The matter was heard at first instance before the Supreme Court of NSW by Ball J, who considered this issue.
A clock with no face: how do you work out how much time is reasonable?
It is an accepted part of contract law that where a clause of a contract does not stipulate a time frame by which something is to be done, then it must be done within a reasonable time. This has been described by the High Court of Australia in Reid v Moreland Timber Co Pty Ltd (1946) 73 CLR 1 and Canning v Temby (1905) 3 CLR 419 as the implication of performance within a reasonable time. Following this approach, the rules of implying terms into a contract are seemingly invoked.
One question that necessarily arises is what is a reasonable time? Ball J, citing Cavallari v Premier Refrigeration Co Pty Ltd (1952) 85 CLR 20, noted that this was a question of fact to determine in light of the facts of the case. Critically, it was his Honour’s view that the analysis of the factual circumstances is to be conducted with reference to the facts that existed “at the time of the exercise of the right”.
On Ball J’s construction of the SHOA, it came into effect and transitioned in February 2013. On his Honour’s construction, this was also the date that the right to terminate arose. His Honour then looked at the conduct of the parties after this date. He considered that the parties had genuinely continued to attempt to negotiate the “re-baseline” between February 2013 and when ASC purportedly terminated in June 2013. His Honour found that this period of time was reasonable and that Forgacs was not prejudiced by the delay. Accordingly, his Honour found that ASC had exercised its right to terminate within a reasonable time.
Drawing a line in the sand: the Court of Appeal on measuring reasonable time
The question of reasonable time, among others, was the subject of an appeal by Forgacs (and other matters were the subject of a cross-appeal by ASC).
Last week the Court of Appeal handed down its judgment, being Donau v ASC AWD Shipbuilder Pty Ltd [2019] NSWCA 185, reversing the decision of the trial judge and finding for Forgacs on each of its key grounds of appeal. The Court of Appeal’s judgment provides for some developments in contract law on the question of reasonable time.
The President’s approach: the bell tolls for ASC’s termination
The President of the Court of Appeal agreed with Forgacs that, on the correct construction of the SHOA, it in fact transitioned in December 2012 and not February 2013. Bell P noted that, whilst the right to terminate did not arise until February 2013, the fact that the contract transitioned back in December 2012 was relevant in that it meant that the SHOA had been operating for almost six months before ASC purported to terminate. This finding necessarily impacted Bell P’s analysis of whether a reasonable time had passed.
However, Bell P also clarified the legal process with respect to an implied term for reasonable time. The President stated that the authorities do not support Ball J’s proposition that the limit of what is a reasonable time is to be determined based on what is fair to both of the parties at the time the contractual right is exercised. Rather, the factual question of what is a reasonable time is determined at the time that the right is “first capable of being exercised” (that is, when it accrues).
Bell P also considered whether there was any distinction between whether the authorities varied on the question of a reasonable time passing for the performance of an obligation as distinct from an exercise of a right. Ultimately, his Honour noted that this is a “question of fact and law” which may vary based on the nature of the obligation or the right, but no special rules apply for rights as opposed to obligations per se.
After considering the authorities, Bell P neatly summarised the legal position as:
“The legal meaning of what is a reasonable time is to be ascertained as at the date of the contract, although what will be reasonable as a matter of fact will inevitably fall to be assessed by reference to the circumstances as at the date on which the right is first capable of being exercised (or the date on which the obligation falls to be performed), viewed in the context of the contract as a whole.”
The effect of this is that any conduct of ASC and Forgacs after February 2013 (namely, their continued negotiations to re-baseline) was not relevant to the question of determining whether a reasonable time had passed.
His Honour observed the following:
- it was open to ASC to reserve its right to terminate or negotiate a “standstill” agreement to the SHOA. ASC did neither;
- the parties had been operating under the SHOA since it transitioned in December 2012, nearly six months before the purported termination;
- there was a need to terminate quickly as the longer the regime under the SHOA operated the more difficult it was to revert back to the original contract; and
- the parties had an obligation to use “reasonable endeavours” to “re-baseline” by December 2012 and failing this ASC had the unilateral right to terminate (which meant that negotiations could go on indefinitely at ASC’s discretion).
Bell P concluded that:
“A commercial party such as Forgacs, involved in a multimillion-dollar procurement contract, and having negotiated the [SHOA] in a manner that required, by implication, ASC’s right to terminate the [SHOA] to be exercised within a reasonable time of that right arising … was entitled to hold ASC to that promise.
… A “reasonable time” had long since passed when ASC purported to exercise its right to terminate.”
Emmett AJA agreed with Bell P on this issue, meaning that this part of the judgment forms part of the majority of the reasoning of the Court of Appeal.
Basten JA’s approach: a bastion for orthodox contractual interpretation
Basten JA reached the same conclusion as Bell P (and Emmett AJA) on the issue of reasonable time, but did so using a different methodology to Bell P.
His Honour found that there are two approaches to the basis of requiring an exercise of a contractual right (or obligation) within a reasonable time. The first is implying such a term, which is the approach that Bell P appears to have taken. The second is to treat the exercise as simply a matter of contractual interpretation.
His Honour recognised there may be a degree of artificiality in this distinction, but emphasised that framing the question as one of implication “is to remove the focus of attention from the [objective] intention of the parties at the time of entering into the agreement”. The contract is to be interpreted as it would be understood by an independent observer and “at least where there is uncertainty” by reference to the context and information available to the parties.
This leads to a situation where it is not appropriate to take post contractual events into account, and his Honour noted that this is what Ball J did by referring to continued negotiations between Forgacs and ASC after February 2013.
His Honour then turned to the question of construction of the SHOA, Basten AJA agreed with Bell P that the SHOA transitioned in December 2012 and proceeded to note the following:
- there was a six week period between execution of the SHOA and the transition date in December 2012 which, had the parties “re-baselined”, could have brought the transition date forward;
- the parties had to use “reasonable endeavours” to “re-baseline” by December 2012, which indicates that it may not have be achieved by that date. ASC’s unilateral right to terminate arose in February 2013, which leads to an inference that ASC would only commit to a new fee regime if “re-baselining” was achieved by February 2013 and they accordingly held a right to terminate if the “re-baseline” was not achieved;
- ASC’s right was unilateral and entirely within its discretion. ASC did not need to make any further enquiries or obtain further information. It was up to ASC to make an assessment when its right to terminate arose whether it wanted to terminate or proceed; and
- the terms of the contract and the circumstances indicated that the right to terminate must have been exercised promptly.
Accordingly, his Honour held that ASC ought to have elected to use their right to terminate, if they were going to do so, by no later than April 2013 (giving time for board approval for termination).
Where does this leave us on the details? Between the devil and the deep blue sea
So how to do we resolve this dilemma? Where does this leave the methodology on determining reasonable time?
At first glance the distinction drawn by Basten JA between implication and interpretation may be a false dichotomy: there will still be some element of “implying” in the requirement of reasonable time. As Basten JA acknowledges, his distinction is more to emphasise the importance of keeping the focus of the exercise on the objective intention of the parties at the time the contract was entered into. That is the orthodox approach to contractual interpretation: you use the four corners of the contract to objectively determine what a reasonable time is (subject to referring to external material to resolve ambiguities).
Bell P’s approach gives much more room to reference external factors, but not to those that arose after the relevant right accrued or obligation crystallised. Noting Emmett AJA’s agreement with Bell P on this point, the case can be said to stand for the following on the issue of reasonable time:
- the legal meaning of what is a reasonable time is determined as at the date the contract was executed;
- the factual question of whether a reasonable time has passed is considered as at the date the right accrued; and
- the context of the contract as a whole must be considered.
Time will tell whether there is wind in the sails of the distinction raised by Basten JA, or whether it is more of an academic distinction to try and keep the focus on orthodox principles of contractual interpretation.
McCabes acted for Forgacs throughout the dispute with ASC, including at first instance before the Supreme Court and before the Court of Appeal.
