Collateral damage of a sledgehammer cracking a nut

NSW Supreme Court finds a Choice of Law Clause void as an exclusion of the operation of the NSW Security of Payment Act

A clause in contracts relating to construction work in New South Wales conferred exclusive jurisdiction on the English Courts to determine any disputes between the parties in accordance with English law. This clause was struck out as void in its entirety (i.e. the sledgehammer cracking the nut) on the basis that it offended section 34 of the Building and Construction Industry (Security of Payment) Act 1999 (NSW) (SOP Act). Section 34 bars parties from excluding the operation of the SOP Act.

A potential consequence of the decision is that an exclusive jurisdiction clause in a contract for construction work in New South Wales which confers jurisdiction on a foreign court will be found void. The decision is likely to be followed by the courts in Victoria, South Australia, Tasmania, Western Australia and the Northern Territory when interpreting the same or similar provisions of their SOP Act.

Careful drafting of jurisdiction clauses in construction contracts will now require parties to carve out the operation of the SOP Act so that the relevant Australian court retains jurisdiction to hear claims under the SOP Act regardless of the forum chosen in the jurisdiction clause.

Proactive Building Solutions –v- Mackenzie Keck [2013] NSWSC 1500

The facts

A subcontractor, Proactive Building Solutions (PBS), sued the upstream contractor, Mackenzie Keck (MK), for the sum of $846,000 under 19 separate contracts. Each contract was a "construction contract" for the purposes of the SOP Act. The construction work was carried out in New South Wales. PBS gave a tax invoice for each contract. Each tax invoice specified that it was a payment claim for the purposes of section 13 of the SOP Act. MK did not provide a payment schedule in response to any of these payment claims pursuant to section 14 of the SOP Act.

PBS sought recovery of the claimed amount by any one of three means:

  1. In the absence of a payment schedule, PBS was entitled to judgment by the summary judgment procedure set out in s15(2)(a)(i) of the SOP Act.
  2. PBS was entitled to judgment for work done and materials supplied, regardless of the effect of the SOP Act.
  3. That following such a judgment, PBS was entitled to the issue of a debt certificate under the Contractors Debts Act 1997 (NSW) (the CD Act), which it could serve upon MK's principal in order to claim the amount due out of amounts outstanding under the head contract.

MK sought a permanent stay of proceedings on the basis that each of the relevant contracts had incorporated a set of "subcontract purchase order terms and conditions" (the Conditions), including the following clause 27.2:

"This contract is governed by and is to be determined in accordance with the law of England. The courts of England shall have the exclusive jurisdiction to determine any disputes between the parties, enforcement of which determination may be through the courts of any appropriate jurisdiction."

The extent to which each contract had incorporated the Conditions was contested, but was not relevant to the conclusion of the case.

The decision

The Court considered the application of section 34 of the SOP Act. Section 34 provides that any clause in an agreement that purports to exclude, modify or restrict the operation of the SOP Act, or that has that effect, or that "may reasonably be construed as an attempt to deter a person from taking action under this Act", is void.

The Court found that clause 27.2 was void as it had the effect of excluding the operation of the SOP Act. Clause 27.2 conferred jurisdiction on the English courts and provided that the English courts would apply English law as the proper law of the contract. The English courts would not apply New South Wales legislation (including the SOP Act). As a result, the operation of the SOP Act was excluded. In short, clause 27.2 shut out PBS from its rights under the SOP Act to recover the unpaid portion of the claimed amount in the New South Wales court.

The Court observed that even if PBS had taken the alternate route of proceeding to adjudication under s15(2)(a)(ii) of the SOP Act, and then sought to have a Court give judgment for the amount in the resulting adjudication certificate, clause 27.2 would have the effect of preventing effective recovery, as it would be "illusory" to expect an English Court to enforce adjudication determinations granted under the SOP Act.

As a result, Clause 27.2, to the extent that it was incorporated in all 19 contracts between the parties, was held to be void.

The effect

The decision of McDougall J was made ex tempore (at or shortly after the actual hearing) because his Honour considered the matters argued in the case were of “some importance… to the construction industry generally”.

The extensive experience of McDougall J in the field of security of payment claims will render this decision influential outside New South Wales.

As a result of the Proactive decision, any exclusive jurisdiction clause conferring jurisdiction on foreign courts in a construction contract in New South Wales, and possibly other States and Territories, is at risk of being rendered void. Such clauses will need to be examined in the context of private international law principles to determine whether or not the foreign court will apply the SOP Act. Even then, there remains the further risk of challenge based on an infringement of section 34 due to prohibitive legal costs in raising SOP issues in foreign jurisdictions.

It is possible that claimants may use the SOP Act to avoid a foreign jurisdiction clause. By invoking the SOP Act, the claimant would be able to bring its claims for payment before the relevant Australian court to consider the payment claims. That application may have very real and practical consequences for the party which had insisted on the inclusion of the choice of law and choice of jurisdiction clause being incorporated in the contract in the first place.

It is surprising that it has taken so long for section 34 of the SOP Act to be considered in the context of a clause such as clause 27.2. This might be because it was clear that the SOP Act applied regardless of choice of law. Section 7(1) of the SOP Act (which is not mentioned in the Court's judgment) states:

Subject to this section, this Act applies to any construction contract, whether written or oral, or partly written and partly oral, and so applies even if the contract is expressed to be governed by the law of a jurisdiction other than New South Wales.

This allows a Court to construct a choice of law clause in such a fashion that voiding it is not necessary. In the Proactive case, however, the choice of law clause was combined with an exclusive jurisdiction clause which took the clause outside of section 7(1). This virtually necessitated the Court using the blunt instrument of section 34 to void the entire clause – the “sledgehammer cracking a nut”.

Similar provisions to section 34 exist in Victoria, South Australia, Tasmania, Western Australia and the Northern Territory. The Queensland and Australian Capital Territory equivalents only render offending clauses void “to the extent of” the breach.

Drafting of exclusive jurisdiction clauses in relation to contracts for New South Wales construction work could avoid the outcome in the Proactive decision by expressly excluding from the scope of the jurisdiction clause any matters relating to the SOP Act and the CD Act. Similar exclusions could be made in such clauses on contracts for construction work in other Australian States.

Possible implications of the decision in respect of construction contracts which contain an international arbitration clause would need to be thought through. Would such an arbitration agreement be at risk of being void because it offended section 34? It may be argued that in contrast to the English courts, an arbitral tribunal seated in London, for example, may apply the SOP Act. Arbitral tribunals seated elsewhere may also apply the SOP Act. The real question is whether the object of the Act may still be achieved through the arbitral process. The wording of the clause, the circumstances of the case involved, and the constitutional priority of Federal over State legislation in the event of conflict between laws would all be relevant considerations by the Australian courts if a payment claim under the SOP Act is brought with respect to a construction contract that provides for international arbitration.

The wording of section 34, and equivalent provisions in a number of other States, is very broad, arguably in a way which is unnecessary to achieve its limited purpose of preventing parties frustrating the application of security of payment legislation through their contractual arrangements. A case can be made for State legislatures amending these “sledgehammer to crack a nut” provisions to a form more in line with that seen in the Queensland and ACT legislation.

Western Australia Supreme Court clarifies interpretation of indirect or consequential loss

Recent developments

A recent Western Australian case decided that the meaning of "indirect" or "consequential" loss in the context of an exclusion of liability clause should be interpreted in line with the normal rules of contractual construction by construing the clause according to its natural and ordinary meaning read in light of the contract as a whole.

Given the present uncertainty in Australian law as to a definitive statement of what is and is not "indirect" or "consequential" loss, clients should ensure that limitation or exclusion of liability clauses define which losses constitute indirect or consequential losses.

What the case says

In the recent decision in Regional Power Corporation v Pacific Hydro Group Two Pty Ltd (No 2) [2013] WASCA 356 (Regional Power), Kenneth Martin J of the Supreme Court of Western Australia found that the words "consequential" and "indirect" loss, commonly found in limitation or exclusion of liability clauses, must be interpreted in the same manner as other contractual terms and not according to a predisposition towards referring to only certain kinds of loss.

In the case, under the agreement between Regional Power and Pacific Hydro, Pacific Hydro was to build a power station and then supply power to Regional Power. Following a flooding incident at the power station, Regional Power arranged for alternative power (through diesel generators) and then sought to recover some of the costs from Pacific Hydro. The issue was whether or not the claims fell within a limitation of liability clause which provided: "Neither the Project Entity nor [Regional Power Corporation] shall be liable to the other party in contract, tort, warranty, strict liability, or any other legal theory for any indirect, consequential, incidental, punitive or exemplary damages or loss of profits."

The decision made three important comments on the interpretation of "consequential" loss and exclusion and limitation of liability clauses under Australian law:

  1. Courts must follow the authority in the High Court of Australia judgment in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 (Darlington Futures) which said: "the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole".
  2. Wrong to approach the meaning of "indirect" or "consequential" loss by assuming those words refer to loss falling under the second limb of Hadley v Baxendale (1854) 156 ER 145 (Hadley v Baxendale). The second limb of Hadley v Baxendale refers to losses as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract as the probable result of the breach, as opposed to losses within the first limb which are those arising according to the usual course of things from the breach of contract itself.
  3. The judgment of the Supreme Court of Victoria Court of Appeal in Environmental Systems Pty Ltd v Peerless Holdings Pty Ltd (2008) 19 VR 358 (Peerless), which was widely accepted as setting down a new rule as to the meaning of "consequential" loss, should be interpreted as simply restating the rule in Darlington Futures. Further, the Court in Regional Power said it is doubtful that the observation in Peerless that consequential loss constitutes "everything beyond the normal measure of damages, such as profits lost or expenses incurred through breach" was intended to establish a new generic meaning of "consequential" loss which would apply in every case.

The Court held that the losses claimed by Regional Power for arranging alternative power (through diesel generators) were direct losses and not excluded by the limitation of liability clause.

The case is only a trial level decision of preliminary issues by the Supreme Court of Western Australia and is not binding on other Courts. However, Kenneth Martin J's reasoning offers a persuasive explanation of the Supreme Court of Victoria Court of Appeal's reasoning in Peerless and the method of interpreting the term "consequential" loss. This judgment represents further evidence that Australian Courts are moving away from the Hadley v Baxendale approach (which assumes that "consequential" loss refers to loss within the second limb of that case).

Actions to consider

As a response to this new case, clients should consider the following actions:

  1. When entering into a contract, clients should carefully consider which heads of loss they would like to be claimable and which they require limited or excluded in the event of a breach.
  2. When drafting contracts containing limitation or exclusion of liability clauses, phrases such as "indirect loss" or "consequential loss" should be defined as exhaustively as possible by including those heads of loss which the parties agree constitute indirect or consequential loss.

Conclusion

Limitation or exclusion of liability clauses provide an effective means for parties to a contract to allocate risk in the performance of the obligations by limiting or excluding liability for loss suffered by the other party upon breach. The Regional Power judgment highlights the need for clients to:

  1. Understand that Courts' views of the meaning of "indirect" and "consequential" loss are not fixed according to a meaning given in a previous case, but will likely depend upon the contract before them. Clients' drafting needs to take this into account.
  2. Consider which specific heads of loss should and should not be available upon breach.
  3. Ensure the heads of loss which should not be available are explicitly excluded or limited under the contract.