10 October 2019

Grounds for suspension: business-like approach to “reasonable cause”

This article was written by Scott Watson and Aisling Scott.

In the recent decision of Galileo Miranda Nominee Pty Ltd v Duffy Kennedy Pty Ltd [2019] NSWSC 1157, one of the issues the NSWSC was asked to consider was whether a Contractor had "reasonable cause" to suspend works under a contract for the failure by the Principal to pay what was described a ‘miniscule’ amount of outstanding interest on late progress payments.  Perhaps unsurprisingly, the Court approached the question of what constituted “reasonable cause” by reference to an objective test.  On that approach, the Court determined that the Contractor’s suspension of works was “completely disproportionate” in the circumstances. 

The decision comes as a reminder that the rights and liabilities of parties under a commercial contract will be construed in a “business-like” way, having regard to all of the circumstances, and the seriousness and nature of the alleged breach.  

The works were ultimately taken out of the hands of the Contractor on the basis of the suspension of the works without reasonable cause.  In that context, the Court also provided some practical guidance around the obligations of the Principal’s Representative to act reasonably and in good faith in the administration of a “contractor event of default regime”.  The Court also briefly considered whether the Contractor’s performance security could be retained by the Principal once the works were taken out of the Contractor’s hands.

Background

Duffy Kennedy Pty Ltd (“DK”) and Galileo Miranda Nominee Pty Ltd (“Galileo”) were parties to a contract under which DK (as Contractor) agreed to design and construct the project for the lump sum price of $66 million.

A progress payment of $323,000 was due in March, in respect of which, Galileo was 3 days late in making payment.  As a result, DK became entitled to interest.  Upon making the late payment, Galileo did not include an amount for interest.  DK gave notice of the suspension of works stating that Galileo had “not made full payment as required under the Contract and the Act”.

A default notice was issued by Galileo in relation to, among other things, the suspension of works by DK “without reasonable cause” (“default notice”). 

DK responded to the default notice by making a “show-cause” submission in response to the default notice (“show-cause response”).  The show-cause response “consisted of a series of arguments to the effect that [DK] was not in breach”, rather than detailing DK’s proposed steps to remedy the alleged defaults.

The Principal’s Representative was not satisfied by the show-cause response, and Galileo subsequently issued a notice taking the remaining works out of DK’s hands (“take-out notice”).  DK disputed the validity of both the default notice and the take-out notice, and asserting that Galileo had repudiated the contract.

Decision

As to whether DK was entitled to suspend the works:

  • Parker J held that DK was not entitled to suspend the works for the failure by Galileo to pay interest.  Parker J stated that the right to suspend under section 27 of the Act ends when the claimant “receives payment for the amount that is payable”. 
  • His Honour went on to state that reference in section 27 to an “amount that is payable…refers to the amount specified in the payment schedule only” (ie it does not extend to unpaid interest on the scheduled amount). 
  • Accordingly, once the principal component of the progress payment was made by Galileo, DK was not entitled to suspend the works.

As to whether DK had suspended with "reasonable cause” (notwithstanding that the Court found that the right to suspend did not in fact accrue):

  • Parker J’s approach confirmed that the test was not whether DK, subjectively considered that it had "reasonable cause" to suspend the works. But rather, whether or not DK objectively had “reasonable cause” to suspend the works. 
  • His Honour stated that the Galileo had no means of knowing about the “internal deliberations” of DK, and parties should not have to resort to litigation to determine their counterparty’s subjective “reasoning process”. 
  • On an objective and “business-like” approach, Parker J determined that Galileo’s failure to pay an amount of $177.20 in interest (in the context of a $66million contract) was “miniscule in the scheme of things” and did not constitute “reasonable cause” for suspension. 
  • Accordingly, the Court held that DK’s suspension of works was “completely disproportionate” in the circumstances.

As to whether the Principal’s Representative acted reasonably and in good faith in assessing the show-cause response, the Court considered both the default notice and the take-out notice.

  • Parker J considered that the Principal’s Representative was required to keep “an open mind on DK’s response to the show cause notice, but not a blank one”.  His Honour found that there was no breach of the obligations of good faith and reasonableness by virtue of Galileo making plans in advance of receiving DK’s show-cause response in case that show-cause response was unsatisfactory.  The relevant question remained whether the Principal’s Representative acted in good faith and reasonably in endorsing the issue of the take-out notice, having regard to the opinion the Principal’s Representative was obliged to form.
  • The Court found that, by the show-cause response, DK asserted that it had no obligation to remedy the relevant defaults.  The Principal’s Representative was aware of DK’s position and was aware that Galileo’s lawyers had advised, by implication, that Galileo was justified in issuing a take-out notice on the basis of DK’s continuing default.  In the circumstances, the Court held that that was sufficient basis for the Principal’s Representative to conclude, in good faith and reasonably, that the show-cause response was unsatisfactory and the default by DK was continuing.  Parker J did not consider that it was necessary for the Principal’s Representative to obtain its own advice as it had no reason to question the advice given by Galileo’s lawyers to Galileo. 

As to whether DK was entitled to the return of the performance security:

  • The Contract did not expressly provide for what was to happen to the performance security if the works were taken out of the hands of the DK prior to practical completion.  The relevant clause describes the security as “provided as security for the performance of the Contractor’s obligations under the Contract”.
  • DK’s position was that the security provided did not apply once a take-out notice was issued as DK was no longer performing any obligations under the contract. Alternatively, DK argued that it was an implied term that, upon the issue of a take-out notice, that DK was entitled to the return of the security.
  • Parker J did not accept DK’s position.  His Honour reasoned that, while DK’s obligation to execute the physical works had ceased, it was “still in contractual relations with Galileo” and that DK still had ongoing obligations.  His Honour also found that the performance security covers liabilities that had accrued before, and after, the issue of the take-out notice.  While there is an implication that the security would only be retained for “a time which is reasonable in the circumstances”, Galileo intended to pursue additional claims for such liabilities against DK, such that Galileo remained entitled to hold the security.




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