A recent decision of the NSW Court of Appeal provides guidance in relation to the timeframe a party must work within when exercising contractual termination rights where the contract is silent.
Donau Pty Ltd, formerly Forgacs Engineering, and ASC AWD Shipbuilder Pty Ltd entered into a subcontract in 2009 (the Original Contract). In 2012, after the Original Contract became increasingly unworkable due to a series of formal and informal variations, the parties entered into a “Second Heads of Agreement” (2HA). The 2HA was created in furtherance of promoting cost and performance efficiencies. It also sought to provide the parties with protection where changes to the Original Contract left them exposed. The 2HA conferred a unilateral contractual right upon ASC to terminate.
| The Court of Appeal found the right to terminate includes an implied term that it must be exercised within a reasonable timeframe once accrued. Bell P provides practical guidance on what factors may be considered to assess what a reasonable time means.
In 2007, the Commonwealth began the procurement process for air warfare destroyers (AWD). ASC subcontracted the construction of various component parts of the ships, known as “Blocks”, to four subcontractors including Donau. These proceedings concern competing and contested payment entitlements under the Original Contract and subsequent agreement.
The 2HA sought to re-baseline the performance metrics of the project, in light of the Original Contract’s frustrations, and restructure the mechanism used to calculate fees. It provided a new calculation method for assessing when payment should occur and granted ASC a unilateral contractual right to terminate if the Baseline True Up was not agreed by 28 February 2013.
The 2HA Effective Date was 26 October 2012. Clauses in the 2HA stipulated payment would follow the Transition Date. The parties were to use all reasonable endeavours to complete the Baseline True Up by 14 December 2012 or reach agreement over the Baseline True Up by 28 February 2013. The Transition Date was said to be the earlier of the two. If agreement could not be reached, ASC purported to terminate on 7 June 2013.
Dispute arose as to entitlement to fees, leading to proceedings being commenced in the NSW Supreme Court in 2016. Multiple issues were ventilated in the Court regarding fees and the validity of termination, coupled with dispute as to when the 2HA came into effect and the correct construction of the 2HA.
In considering whether ASC had validly exercised its right to terminate, the Court considered whether ASC had lost its right on the basis that it elected to affirm the 2HA by way of its conduct; or if ASC had lost its contractual right on the basis that it did not exercise its right within a reasonable time.
Donau Pty Ltd (formerly Forgacs Engineering Pty Ltd) v ASC AD Shipbuilder Pty Ltd [No 2]  NSWSC 1589
In the first instance, the question for the Court was whether Donau was entitled to recover fees in accordance with the 2HA. This raised multiple issues:
- When did the relevant provisions of the 2HA come into effect?
- Did ASC validly terminate the 2HA?
- If termination was effective, what effect does the 2HA have on the parties?
- Whether ASC was forced to enter into the 2HA as a consequence of the misleading or deceptive conduct of Donau and, if so, whether ASC is entitled to recover damages calculated as the difference between the amount for which ASC is liable and the amount for which it would have been liable if it had not entered into the 2HA.
The primary judge, at first instance, found:
- Achievement of Baseline True Up was not required for the Transition Date to occur and the Transition Date was 28 February 2013;
- ASC had not lost its contractual right to terminate and the 2HA operated to release Donau from ASC’s claim for liquidated damages; and
- ASC was entitled to over $25 million with respect to its various fees claims.
Both ASC and Donau appealed the NSW Supreme Court’s decision on varying grounds.
The issues on appeal were:
- Whether the Transition Date had occurred and if so, when
- If the Transition Date occurred, did ASC validly exercise its right to terminate? Or had ASC elected to affirm the 2HA or failed to terminate within a reasonable time
- If the Transition Date had occurred, what was the effect on the Original Contract during the period which the 2HA was in force with respect to:
– The liquidated damages release in the 2HA, and
– The regime for calculation of fees.
The Court found the Transition Date was 14 December 2012. It also determined ASC had not lost its right to terminate by election. Rather, there was an implied term that the right must be exercised within a ‘reasonable time’ and ASC had failed to do so. A ‘reasonable time’ did not conclude on 28 February 2013 nor the period shortly thereafter. Per Basten JA, a reasonable time would expire by April 2013, however this is not necessarily the position of the majority. ASC’s continued attempt to reach agreement up until June 2013, absent a clear reservation of its termination rights, rendered its conduct unequivocal in that it had surpassed a reasonable time to invoke its right to terminate.
Bell P stated in considering what constitutes a reasonable time, ‘the longer the parties operated under the new regime, the more difficult it would be to revert to the former regime’. Further, ASC was not waiting on more information pending exercising its right and notice that the Baseline True Up may not be agreed was taken to be received when reasonable endeavours failed to return results on 14 December 2012.
Regarding liquidated damages and the calculation of fees, as the 2HA was terminated invalidly, this contention was not strictly dealt with.
What does this mean for determining a reasonable time?
What constitutes a ‘reasonable time’ remains debateable given the distinction between Bell P and Basten JA’s approaches. This may impact the way and extent to which external factors may be considered.
Per Bell P, reasonable time is to be ascertained at the date of the contract with reference to circumstances present at the date the right first accrues. These may include the nature of the right, the commerciality of the parties, and whether the party holding the right has time to consider the implications of invoking that right. Conversely, Basten JA, while reaching the same conclusion as Bell P, evaluates reasonable time as an issue of contractual interpretation. This has the effect of rendering any conduct post February 2013 as irrelevant in determining the question at hand.