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Near enough is not good enough in contract drafting

We have been recently acting for a subcontractor negotiating departures to a design and construct for a high-rise office tower in the Sydney CBD.  Grappling with a confusing, inconsistent and untidy subcontract, one of our recommendations was that the contract defined terms should be updated to:

  • remove defined terms that were not used in the operative clauses;
  • define capitalised terms used in the subcontract, but for which no definition was provided;
  • make the defined terms consistent (sometimes two distinct defined terms were used but were intended to have the same meaning); and
  • check and update the contract definitions for changes in law.

The upstream contractor party’s counsel suggested that this work was unnecessary and would make no difference.  We strongly disagreed.

Why did these drafting issues matter?

A significant case for insurers and COVID-19 impacted businesses decided by the NSW Court of Appeal in October 2020 provides an example of how failures to update contracts for law and precisely draft terms (including updating definitions) can lead to real headaches down the line.  The decision has been widely reported in major media outlets due to the multi-billion dollar payouts that may result due to what appears to be a drafting oversight.

In HDI Global Specialty SE v Wonkana No. 3 Pty Ltd [2020] NSWCA 296 (Wonkana), a key test case funded by insurers, the NSWCA was required to decide whether a coverage exclusion applied to claims made by business owners under their insurance policies for interruption to their businesses due to COVID-19.

The exclusion was framed as follows:

‘The cover … does not apply to any circumstances involving ‘Highly Pathogenic Avian Influenza in Humans’ or other diseases declared to be quarantinable diseases under the Australian Quarantine Act 1908 and subsequent amendments.’

The problem for the insurers was that the Quarantine Act 1908 (Cth) (repealed Act) was repealed and replaced prior to COVID-19 by the Biosecurity Act 2015 (Cth) (current Act).  While COVID-19 had been determined a “listed human disease” under the current Act, it had not (and could not) been listed as a “quarantinable disease” under the repealed Act.  It appears that at the time of contract neither party knew about the change in law.

The insurer’s primary argument was that the exclusion clause should be construed as referring to ‘diseases determined to be listed human diseases under the Biosecurity Act 2015 (Cth)’ because:

  1. the current Act constituted a “subsequent amendment” (Subsequent Amendment Argument); or
  2. the references to the repealed Act were obvious mistakes which should be construed as if they were or included references to the current Act (Obvious Mistake Argument).

In summary, the NSWCA held that the exclusion clause could not be construed as referring to the current Act.  This meant that the insured businesses were prima facie entitled to a claim under their policies.

On the Subsequent Amendment Argument, the Court held that the words “and subsequent amendments”, given their natural and ordinary meaning, do not extend to an entirely new enactment[1].  The repealed Act was not a “subsequent amendment” of the current Act.

Looking at the matter objectively (as required by proper principles of contractual interpretation), if the parties intended that the clause capture an alteration to, or replacement of, the repealed Act, drafting to capture this intent would have been used[2].

On the Obvious Mistake Argument, the Court held that it was critical to apply the ordinary principles of construction to the drafting (and natural and ordinary meaning of words) to ascertain the parties’ objective intention[3].

There was no mistake by the parties in drafting which was objectively identifiable to be “corrected” or rectified.  It was not possible to correct the contract merely because the parties incorrectly assumed that the repealed Act was still in force[4].

Key Takeaways

Contracting parties sometimes rely on the words “and subsequent amendments” as an excuse not to update their contracts to deal with changes to law.  This is dangerous because if a law has been repealed and replaced prior to (or during the course of) the contract, there is clearly no guarantee that the replacement statute will apply.  These words are not a “get out of jail free card” to deal with legislative changes.

We caution against the assumption that in the event there is a later argument on interpretation, the departures table, correspondence or other extrinsic evidence will be relied upon to answer the question.  Firstly, this assumes that reliable records of the negotiation will be kept.  Disputes often arise years after the contract is executed and we all know of the knowledge and records vacuum when key personnel move on from a project or employer.  Secondly, the court will only consider extrinsic evidence if the drafting is ambiguous.  On pure questions of contractual interpretation, the court is not concerned with the subjective intentions of the contracting parties, but what the words say to the objective reader.

We strongly recommend:

  • regularly reviewing and updating your contracts for changes in law; and
  • ensuring that simple issues such as errors and inconsistencies in defined terms are taken seriously and corrected prior to execution.

[1] Per Meagher JA and Ball J at [44].

[2] Per Meagher JA and Ball J at [42].

[3] Per Meagher JA and Ball J at [64].

[4] Per Meagher JA and Ball J at [65].

Nominal liquidated damages may not keep general damages away

A Building Contract usually contains a provision for a cap on liquidated damages. In some contracts, particularly Master Builders and HIA contracts, the amount for liquidated damages is usually a default position (unless otherwise stated) at $1 a day for each day of delay from the date the builder was meant to reach completion under the Building Contract until the builder actually completes the works.

The amount set for liquidated damages is meant to represent a genuine pre-estimate of loss that would be suffered by the principal should the works be delayed. If the amount of liquidated damages is excessive, it may be argued that such a clause is a penalty and thus be held to be void.

In the recent case of Cappello v Hammond & Simonds NSW Pty Ltd [2020] NSWSC 1021, the Supreme Court of NSW considered whether a Building Contract which contained a provision for a nominal amount of liquidated damages in the amount of $1 per day excluded the homeowner from also claiming general damages for delay.

The contract was a HIA Costs Plus contract for works related to renovations to a dwelling. The homeowner alleged that the builder was approximately seven months late in completing the works. The Homeowner claimed that it was entitled to general damages, in addition to the claim for the amount of liquidated damages.

The general principle in law is that where parties agree on a rate for liquidated damages, it is taken to exclude claims for general damages.

Justice Ball stated [at paragraph 27]:

“Accepting that principle, the question remains whether by inserting a nominal amount as the amount payable by way of liquidated damages the parties intended, in effect, to exclude the operation of the liquidated damages clause or whether they intended to exclude a right to claim damages for delay altogether. The answer to that question does not depend on the application of any general principle but on the proper construction of the contract in question.” (Emphasis added)

It was also noted that Section 18B(1)(d) of the Home Building Act 1989 (NSW) implies into a residential Building Contract a warranty that the builder will complete the works within the time stipulated in the Building Contract. If the Building Contract seeks to limit a party from claiming damages in the form of nominal liquidated damages it has the effect of restricting that party’s rights in respect of the warranty and would be held to be void under Section 18G of the Home Building Act 1989 (NSW).

Justice Ball held that he preferred the interpretation that if only a nominal amount of liquidated damages is provided for under a Building Contract, it should not be interpreted as preventing a claim for general damages. Accordingly, the parties intend that general damages can be claimed rather than limiting it to the amount of the nominal amount of liquidated damages.

However, Justice Ball ultimately upheld in this case that the Home Owner was only entitled to nominal damages as the majority of the delays were due to the Homeowner’s requested variations to the works and did not appear to have suffered any additional loss.

In light of the above, it is important for liquidated damages to represent a genuine pre-estimate of loss, otherwise:

  1. it will either be held to be a penalty if it is too high and thus void; or
  2. if the amount of liquidated damages is only nominal, then it can be also be held to be either void or may not exclude general damages.

If you or someone you may know is in need of assistance or clarification regarding the above, please email us at info@bradburylegal.com.au or call (02) 9248 3450.