A recent case in the Victorian Supreme Court of Appeal, Cole Sopov and Norma Walker v Kane Constructions Pty Ltd [2007] VSCA 257, dealt with issues of breach of contract, interpretation and repudiation.

The main issue was whether certain conduct of the Principal was repuditatory and therefore justification for the Contractor’s termination of the Contract. The relevant conduct in this case involved the Principal calling on bank guarantees, setting-off liquidated damages against a certified progress payment and insisting on an incorrect and untenable interpretation of the Contract having been informed of the correct approach. These actions by the Principal were held to be repudiatory and gave the Contractor the right to accept repudiation and terminate the contract.

This case is a good illustration of a principal’s need to understand its rights under the terms of a contract and how these terms interrelate.

Background

Kane Construction Pty Ltd (the Contractor), the respondent, was contracted to complete building works for Cole Sopov and Norma Walker (taken together as the Principal) under the Australian Standard General Conditions of Contract AS 2124 - 1992 (the Contract). On 1 August 2000, the Contractor submitted progress claim 14 in accordance with clause 42.1 of the Contract. As a consequence of the Superintendent issuing a request for further information, which was received on 21 August 2000, the Superintendent did not issue a payment certificate for the payment claim within the 14 days allocated in clause 42.1 of the Contract. In accordance with the Contract, the Contractor then issued an invoice for the amount stated in the payment certificate. The Principal paid the amount on the invoice less the amount of liquidated damages owed to the Principal due to an alleged failure by the Contractor to achieve practical completion on the required date.

In a show cause notice dated 8 September 2000, the Contractor asserted that the Principal was not entitled to deduct liquidated damages from the certified amount payable and in addition that the Principal had breached the Contract by failing to pay the full amount of the progress claim as a consequence of the Superintendent’s failure to issue a timely payment certificate. This position was reasserted in a following letter on 13 September 2000. Soon after this letter the Contractor issued a notice of suspension.

Following suspension, the Principal issued a show cause notice stating that the work had been wrongfully suspended. The Contractor proceeded to remove its equipment from the site and issued a notice saying that it was willing to continue the work if the Principal rectified the breach and made the requisite payments. The Principal asserted that this removal of equipment constituted repudiatory conduct and called on the Contractor’s bank guarantees.

The Contractor believed that the Principal’s refusal to make the payments constituted repudiatory conduct and asserted that the Principal breached the Contract by calling on the bank guarantees. Accepting this repudiation, the Contractor terminated the Contract.

Current Proceedings

Warren CJ, at first instance, found that the Contract had been terminated by the Contractor’s acceptance of the Principal’s repudiation and that the Contractor was entitled to elect to recover from the Principal on a quantum meruit basis. The repudiation was made on two grounds:

• the deduction of the liquidated damages, and
• calling up the bank guarantees which the Principal was not entitled to do.

The decision was appealed to the Victorian Supreme Court of Appeal and heard by Maxwell P, Kellan JA and Whelan AJA. The Court proposed that the repudiation issues be decided on the appeal and if it was found that the Principal did repudiate the Contract (justifying the Contractor’s acceptance and subsequent termination) then the quantum meruit claim would be referred to mediation.

The issues to be decided on appeal were whether the Warren CJ erred in:

• finding that the Contract was terminated by the Contractor’s acceptance of the Principal’s repudiation, and
• the assessment of the quantum meruit claim.

Breach of Contract

Warren CJ at first instance decided issues of breach of contract. Although they were not raised in the appeal it is worth noting that:

• the Principal was not bound to pay the full amount of the progress claim as the issue of a certificate was subject to a condition precedent that the Contractor support the claim with evidence requested by the Superintendent (Brewarrina Shire Council v Beckhaus Civil Pty Ltd (2003) 56 NSWLR 576), and
• the Principal did breach the Contract by setting-off an amount for damages under clause 35.6 of the Contract against a payment certificate under clause 42.1 of the Contract. Such a determination turns on the construction of the contract itself.

In relation to the first point and the Contractor’s show cause notice, the Court said it was not necessary to decide whether the notice was invalid. However, if it had been necessary, the Court said they would have followed FPM Constructions Pty Ltd v Council of the City of Blue Mountains [2005] NSWCA 340 which held that even if there was no actual breach of the Contract, as long as the Contractor was satisfied in good faith that there had been a breach, the notice would be valid even if show cause could be made out.

Repudiation

In deciding the repudiation issue the Court applied the principle adopted by Brennan J in Laurinda Pty Ltd v Capaluaba Park Shopping Centre (1989) 166 CLR 623 (consistent with other authorities) that the state of mind of the party in default is not the relevant issue. Rather, the relevant consideration is the conduct of the defaulting party which conveys to the other party their inability to perform the contract or an intention only to perform in such a way that is inconsistent with their obligations under the contract.

The Court noted that repudiation can be readily drawn where the interpretation relied on by the Principal is obviously untenable and the Principal:

• acts (or threatens to act) unilaterally on the basis of the interpretation, or
• persists in the interpretation in the face of communications from the Contractor pointing out the error.

The Principal’s state of mind and adopting an incorrect interpretation of the Contract

In this case, the Principal asserted that it was acting within its rights under the Contract by cashing in the bank guarantees without notice to the Contractor. Despite this assertion, the Court followed existing case law and applied the objective test of repudiation. Therefore, disregarding the state of mind of the Principal and its bona fide belief as to the accuracy of its analysis of the Contract, the Court determined that by calling on the bank guarantees the Principal had acted unilaterally on the basis of its interpretation.

In addition, the Court also referred to Vaswani v Italian Motors (Sales and Service) Ltd [1996] 1 WLR 270, and held that it was immaterial whether the alleged repudiator acted in accordance with legal advice.

Relevant conduct of the parties

The Principal submitted that even if its conduct was repudiatory, the Contractor was not entitled to terminate the Contract due to:

• the seriousness of its own breaches of the Contract (which would give rise to the Principal having the right to terminate the Contract), or
• the conduct of the Principal, which the Contractor was relying on to terminate, being a result of the breaches by the Contractor.

The Court did not agree with these submissions and instead considered the following actions to constitute repudiatory conduct:

• the Principal’s insistence that it was entitled, in accordance with the Contract, to deduct the liquidated damages from the payment certificate amount. This was said to be an untenable position that was contrary to the clear and long-standing authorities
• the Principal’s refusal to remedy the breach of Contract it had committed by setting-off these liquidated damages owed by the Contractor. By doing so the Principal was insisting upon an unjustifiable position that it did not intend to remedy, and
• calling up the Contractor’s bank guarantees. The Principal asserted that it had acted in reliance on an incorrect interpretation on the Contract. This in turn was viewed by the Court as evidence of their disregard of clause 5 of the Contract which required notice to be given to the Contractor if the bank guarantees were being called. The Court applied Byrne J’s observation in Rejan Constructions Pty Ltd v Manningham Medical Centre Pty Ltd [2002] VSC 579 that this clause was drafted specifically to avoid serious disadvantage to the Contractor if the bank guarantees were in fact called by the Principal.

As part of the decision, the Court noted that the following actions did not constitute repudiatory conduct:

• the Contractor claiming the full amount of the progress claim following the Superintendent’s failure to issue a timely payment certificate. This action did not represent an intention not to perform the Contract
• the Contractor’s suspension of the work. This was held to be a justifiable exercise of a contractual right and was not classified as repudiatory conduct. The Court further noted that this suspension was also a valid action as a consequence of the Principal’s refusal to resile from its untenable position
• the Contractor’s letter to the Principal on 28 September 2000 offering to immediately lift the suspension of the work if the Principal remedied the breaches by paying the full claim amount and correcting the wrongful deduction of liquidated damages. The Contractor went on to expressly state that it was willing to continue to perform its obligations under the Contract, and
• applying Sweet & Maxwell Ltd v Universal Services Ltd [1964] 2 QB 699, the Principal merely asserting, not insisting on, an erroneous interpretation of the Contract.

Quantum meruit

The issue of the amount payable by the Principal to the Contractor remained alive and was referred to mediation.

Held

Contrary to the Principal’s submissions the Court held that:

• the Contractor’s show cause notice was not invalid and if it were it would not change the two issues relating to the Principal, adopting positions and taking actions not justified under the Contract, which conveyed their determination to proceed in contravention of the Contract
• the Principal’s behaviour in failing to pay the amount in payment certificate 14 and calling up the bank guarantees cannot be justified under the terms of the Contract and suggest to the Contractor an intention not to perform, or to perform in a manner inconsistent with, the Principal’s obligations under the Contract
• the Principal took an unjustifiable position which was drawn to their attention, a second time with supporting authorities cited, which they refused to resile from. This together with ignoring clause 42.1 and clause 5 of the Contract indicates that the Principal was ignoring the Contract with no justifiable basis for their interpretation
• the Contractor did not convey that it would only perform its obligations under the Contract if the Principal paid the full amount of progress claim 14. Even in the event it could be held that the Contractor had conveyed this intention, it would be a justifiable (however incorrect) position under the provisions of the Contract as opposed to the positions of the Principal, and
• the Contractor did not cause the Principal to ignore clause 5 of the Contract and fail to give notice of their call on the bank guarantees, issue a show cause notice and remove work from the Contractor.

The Contract was held to be terminated as a result of the Contractor’s acceptance of the Principal’s repudiation.