In the August MCW In-Focus, we discussed the concept of novation at a theoretical level. This included highlighting the risks of giving a seemingly benign contractual warranty, which professional indemnity insurance might not cover in the event of a claim.

This month, we will illustrate some of the practical risks of a poorly documented novation, with reference to a recent case.

The facts

The facts of MWH Australia Pty Ltd v Wynton Stone Australia Pty Ltd (in liq)1 are quite complex, but for the purpose of this update can be summarised as follows:

  • MWH Australia Pty Ltd (MWH) was engaged by Nacap Australia Pty Ltd (Nacap) to carry out design of structural and civil works for two sewerage treatment plants in Victoria.
  • MWH subcontracted that structural design to Wynton Stone Australia Pty Ltd (WS).
  • After completing that structural design work, WS merged with, or was acquired by, Taylor Thompson Whiting Pty Ltd (TTW).
  • Subsequently, MWH, Wynton Stone and TTW executed a deed of novation (Deed).

The terms of the Deed included the following:

The client [MWH] releases and discharges WS from all claims and demands whatsoever in respect of the contract and accepts the liability of TTW under the contract in lieu of the liability of WS and agrees to be bound by the terms of the contract in every way as if TTW was named in the contract as a party thereto to [sic] place of WS.

The client undertakes to pay and accepts its liability to WS to pay all moneys due and owing under the contract up to the date of this deed and to TTW as and from such dates. WS acknowledges that the services to be performed under the contract by WS prior to the date of this deed have been performed in accordance with its terms.

MWH suffered loss as a result of negligent structural design by WS and sought to recover its loss via proceedings against WS.

Trial judge’s decision

His Honour Justice Byrne rejected MWH’s claim against WS for breach of contract and negligent structural design. He found that the terms of the Deed provided a complete release from all claims in respect of the contract, including negligence claims.

However, Byrne J also held that the acknowledgement above operated as a contractual warranty by WS and that WS breached that warranty.

By order dated 1 May 2007, Byrne J ordered WS to pay MWH $4,138,696 together with damages by way of interest of $2,946,601 for breach of warranty.2

The practical consequences

MWH obtained a favourable decision from the trial judge. Why then did it appeal?

The significant award of damages was a hollow victory for MWH. The order of damages against WS was in respect of a breach of warranty in the Deed. Justice Byrne held that, otherwise, WS’ liabilities in respect of the contract had been completely released.

On this basis, it was unlikely that WS’ professional indemnity insurance would cover the loss, due to the standard "assumed liability" exclusion. This was discussed in the August MCW In-Focus.

Without insurance coverage, MWH would have been required to look to recover the damages out of WS’ assets. However and unfortunately, WS was placed into liquidation on 18 August 2006. The prospect of recovering out of WS’ assets for a contractual claim appeared remote.

MWH therefore had little choice but to take the fairly unique step of appealing a decision made in its favour.

Court of Appeal

MWH appealed on a number of grounds, including in relation to whether the trial judge was correct in holding that the Deed released WS from liability for negligence.

The Court of Appeal formed a different view on the proper construction of the Deed, and held that WS remained liable in contract and negligence for all of the work that it had performed prior to the execution of the Deed.

Given that WS had already been found liable to MWH for breach of the warranty, the success of MWH’s appeal did "not affect the damages it is entitled to recover from WS".3 However, from the perspective of MWH’s ability to recover those damages, the success of the appeal is likely to have made all of the difference as the damages would now be payable under WS’ professional indemnity insurance in effect at the time the relevant claim was made.

Lessons learnt

Although it appears that MWH was ultimately successful in recovering its damages, it had to go through very costly and time consuming litigation to get there, including via a trial where it received a hollow victory.

Arguably, this could all have been avoided if the drafting of the Deed was clearer. The case is a good reminder of the need to get the all agreements right at the front end, including deeds of novation.