A recent Australian decision allowed the award of damages for the cost of demolishing and rebuilding an entire building because a polished concrete floor was defective. The court also found that even if a contract states that no (“zero” or “nil") liquidated damages are payable for a delay, a party may still be entitled to claim common law damages. The decision is significant because it demonstrates that tribunals and courts applying Australian law will not readily accept an argument by a contractor that the parties intended to exclude a claim for damages for delay without clear words to that effect.

Introduction

The decision of Adapt Constructions Pty Ltd v Whittaker & Anor ("Adapt") of the Australian Capital Territory ("ACT") Supreme Court, involved an application for leave to appeal against a decision of the Institute of Arbitrators and Mediators Australia ("arbitrator").

In the arbitration, the owners were awarded damages for the cost of demolishing and rebuilding the entire building as a result of the contractor's defective work, which exceeded the total contract sum paid by the owners to the contractor. The arbitrator also awarded the owners general damages for the contractor's late completion even though the section in the parties’ contract where the daily rate for liquidated damages should have been populated was left blank, with a corresponding note that provided ‘if nothing stated, zero’.

The contractor applied to the Supreme Court for leave to appeal the awards.

Background

The owners referred the dispute to arbitration alleging that the contractor had failed to construct the concrete slab and footings of the building in accordance with the relevant standards, resulting in cracking to the slab.

The arbitrator issued an interim award, which determined that the footings and concrete slab were not constructed in accordance with the relevant specifications. The arbitrator also determined that the only practical way to rectify the defects was to completely demolish and reconstruct the building, even though other aspects of the construction were not defective.

The arbitrator issued a final award and the contractor applied to the Supreme Court seeking leave to appeal the two awards.

Was it reasonable to order damages for demolition and reconstruction?

The usual measure of damages under Australian law and English law restores the position of a person who has suffered loss as a result of another’s breach of contract to the position he/she would have been in had the breach not occurred. In construction cases, this typically results in an award of damages for the cost of repairing defective work so that it complies with the relevant standards and specifications. In order to be compensable, the rectification work must be ‘necessary’ to achieve conformity with the required standards or specifications and must be ‘reasonable’ in the circumstances.

In Australia, the basis for the general rule is Bellgrove v Eldridge (1954) 90 CLR 613 ("Bellgrove"). In Bellgrove, a contractor constructed a home with foundations that did not comply with the relevant contract specifications, resulting in a building that was not structurally sound. The High Court upheld a first instance decision awarding the owner of the building the cost of its demolition and reconstruction.

Under English law, demolition of a building is regarded as an extreme course of action that should only be contemplated as a last resort. Courts therefore focus on "reasonableness" and whether the cost of rebuilding is out of proportion with the benefit that will be obtained. In Ruxley Electronics v Forsyth [1996] 1 AC 344, the House of Lords held that it was unreasonable to award damages for the cost of demolishing and rebuilding a pool that had been constructed at a lesser depth than was contracted for because the cost was wholly disproportionate with the benefit that would be obtained and the owner would not have used the damages to rebuild the pool.

Contractor's arguments

In Adapt, the Contractor argued that an award of damages to cover the cost of demolition and reconstruction of the house was so unreasonable that it amounted to a "manifest legal error". The Contractor sought to distinguish the decision in Bellgrove, arguing that the cracking in the slab did not meet the definition of a "defect" in the relevant standard applicable to concrete slabs and there was no evidence that the deficiencies compromised the structural integrity of the building or its fitness for purpose.

The Contractor also argued that the arbitrator erred in finding that there was a ‘strong likelihood that if rectification cost was awarded the sum so ordered would actually be spent on rectification’. In relation to this point, the contractor relied on the decision of Ruxley Electronics v Forsyth [1996] 1 AC 344. Similarly, the contractor argued that the Interim Award provided the respondents with an "unconvenanted profit" because they were not seeking compensation for a genuine loss. In relation to this point, the contractor relied on the decision of Radford v De Froberville [1978] 1 All ER 33 at 42. The contractor nevertheless conceded that there was no direct evidence before the court or the arbitrator as to whether the respondents intended to live in the building as constructed or whether they intended to demolish and rebuild it.

In relation to the blank liquidated damages clause in the contract, the contractor argued that this disentitled the respondents to compensation for late completion.

Decision

The Judge found that the principles in Bellgrove did not depend on the finding of structural unsoundness. The defects were such 'that cracking to the slab has occurred and is likely to worsen’ and this justified demolition and reconstruction. In any event, the test in Bellgrove as to whether demolition and rebuilding was necessary to cure the defective work involved factual findings that were not susceptible to challenge. Accordingly, the Judge determined that the arbitrator’s application of the test in Bellgrove was correct.

Did the arbitrator err by awarding damages for delay?

Liquidated damages

Where parties to a contract fix an amount payable on liquidated damages in the event of a breach of the agreement, that amount binds the parties in the event of breach, provided it is not out of all proportion to the breach and void as a penalty. In such a case, it does not matter whether the actual losses are greater or smaller than the amount fixed, the parties are bound by the agreement: Diestal v Stevenson [1906] 2 KB 345.

In the present case, the parties’ contract contemplated that liquidated damages would be payable if the Contractor failed to complete on time. Item A17 of Appendix A stated:

"Rate of Liquidated Damages Per Week $________________ (if nothing stated, Zero)."

In the Adapt arbitration, the arbitrator noted that as there was no rate for liquidated damages and no mechanism to calculate a sum as a pre estimated liquidated damage for late completion. If the parties intended that there be no damages for the breach of Contract in not completing the works to Practical Completion by the due date, then they would have had to express that intention clearly. The arbitrator held that the omission of a rate for liquidated damages did not prevent the owners from seeking damages at common law for delay because the parties did not clearly express an intention to exclude their common law right.

The Judge also noted that ‘similar situations have arisen in earlier cases’ in both Australia and the UK, including Temloc Ltd v Errill Properties Ltd (1987) 39 BLR 30 ("Temloc"), Baese Pty Ltd v RA Bracken Building Pty Ltd (1990) 6 BCL 137 ("Baese") and J-Corp Pty Ltd v Mladenis [2009] WASCA 157 ("J-Corp").

In the English law case of Temloc, the parties’ contract provided that liquidated damages would be payable for delay at the rate specified in the Appendix. The Appendix specified that ‘liquidated and ascertained damages’ would be awarded ‘at the rate of

£nil’. The Court of Appeal overturned the first instance decision and held that by specifying ‘£nil’ the parties intended that liquidated damages of nil would be an exhaustive agreement as to damages for failure to complete works on time. This left no room for a claim to damages in an unliquidated amount.

In the present case, the Judge noted that:

"[while] various authorities dealing with similar provisions were referred to by the parties, in the end I do not consider that any general principle can be drawn from them. The effect of such a provision cannot be determined apart from a consideration of the terms of the particular contract. Whether the effect is to exclude damages from being payable in the event of a breach or simply to exclude liquidated damages must depend upon a proper construction of the contract as a whole."

He held that Temloc could be distinguished on the facts (based on the course of dealing between the parties with respect to previous contracts). Accordingly, the arbitrator’s finding that the liquidated damages provision was inoperable, but that the owner’s entitlement to recover damages for breach at common law was not excluded, was consistent with authority.