04 November, 2015
Introduction
In Adapt Constructions Pty Ltd v Whittaker & Anor (Adapt Constructions) a builder of a residential building in the Australian Capital Territory applied to the Supreme Court seeking leave to appeal an arbitral award.
In the arbitration, the owners were awarded damages for the cost of demolishing and rebuilding an entire building as a result of the builder’s defective work, which exceeded the total contract sum paid by the owners to the builder. The arbitrator also awarded the owners damages for the builder’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 and the corresponding note provided ‘if nothing stated, zero’.
The Court refused to grant the builder leave to appeal the awards. The reasons for this result are worth exploring.
Background
The facts are relatively straightforward.
The owners of property in Urriarra in the ACT engaged Adapt Constructions Pty Ltd, the builder, to construct a four bedroom home for a lump sum of $480,000.
Construction commenced early in 2012, and the building was completed later that year. Before completion, disputes arose between the parties, including in relation to allegations by the owners that the builder’s work was defective.
In February 2013 the owners referred the dispute to arbitration. The owners alleged, among other things, that the builder had failed to construct the concrete slab and footings in accordance with the specification or relevant standards, resulting in cracking in the slab (with further cracking anticipated). The concrete slab was a polished concrete floor and was not a structural element of the house.
The owners claimed damages for the cost of demolishing and reconstructing the entire building which, along with related losses, comprised about $540,000.
The arbitrator issued an interim award in April 2014. The arbitrator determined that the footings and concrete slab were not constructed in accordance with the specification, the Building Code of Australia or the relevant Australian Standard. The arbitrator further determined that the only practical way to rectify the defects was to completely demolish and reconstruct the building. The arbitrator accordingly awarded the owner almost $490,000 for the cost of reconstruction, $15,000 for demolition and about $41,000 as damages for late completion.
In September 2014, the arbitrator issued a final award and the builder applied to the Supreme Court seeking leave to appeal the two awards.
Decision
Requirements for leave
The builder made its application for leave to appeal the two arbitral awards under section 38 of the Commercial Arbitration Act 1986 (ACT) (the Act). Under the Act, there is no automatic right to appeal an arbitral award, and a finding of fact cannot be appealed at all.
The effect of sections 38(4) and (5) are that the Court can grant a party leave to appeal a question of law, but only if it considers that:
(a) having regard to all the circumstances, the determination of the question of law concerned could substantially affect the rights of one or more parties to the arbitration agreement; and
(b) there is –
(i) a manifest error of law on the face of the award; or
(ii) strong evidence that the arbitrator or umpire made an error of law and that the determination of the question may add, or may be likely to add, substantially to the certainty of commercial law.
Accordingly, the builder was required to demonstrate not only that the determination of the question of law could substantially affect its rights, but also that one of the two limbs of section 38(5)(b) of the Act was satisfied.
Before considering whether those requirements had been met, the Court considered the meaning of the phrase ‘manifest error of law on the face of the award’. The Court referred to two cases in which the phrase had been considered. In Commonwealth v Rian Financial Services and Developments Pty Ltd (1991) 105 FLR 239 Miles CJ held that ‘it is necessary that the error be so obvious or so perceptible to the judge as to be manifest…’, and in Westport Insurance Corporation v Gordian Runoff Ltd (2011) 244 CLR 239 a majority of the High Court said ‘… what is required here is that the existence of error be manifest on the face of the award, including the reasons given by the arbitrator, in the sense of apparent to that understanding by the reader of the award’.
It is worth noting that in other States and Territories, including New South Wales, commercial arbitration legislation which, like the Act, was enacted in the 1980s and contained sections on identical or materially equivalent terms as section 38(5) of the Act, has been repealed and replaced by new legislation which uses the UNCITRAL Model Law as its foundation. Under the Commercial Arbitration Act 2010 (NSW) the requirement to show ‘a manifest error of law on the face of the award’ has been replaced by a requirement to show that ‘the decision of the tribunal on the question is obviously wrong’.
Was it reasonable to order damages for demolition and reconstruction?
The usual measure of damages
As a general rule, a person who has suffered loss as a result of another’s breach of contract is entitled to be restored to the position that the person would have occupied had the breach not occurred.
If the breach is a failure to carry out building work to the required standard, application of the general rule will typically result in an award of damages for the cost of making the defective work comply with the required standard. However, for the general rule to apply in this context, the rectification work must be ‘necessary’ to achieve conformity with the required standard, and must be a ‘reasonable’ course to adopt.
The basis for the general rule is Bellgrove v Eldridge (1954) 90 CLR 613 (Bellgrove). In Bellgrove, an owner engaged a builder to construct a home. The foundations did not comply with the contract specification with the result that the building was not structurally sound. The High Court upheld the first instance decision awarding the owner the cost of demolishing and reconstructing the building.
The High Court held (at 617-618):
In the present case, the respondent was entitled to have a building erected upon her land in accordance with the contract and the plans and specifications which formed part of it, and her damage is the loss which she has sustained by the failure of the appellant to perform his obligation to her. This loss cannot be measured by comparing the value of the building which has been erected with the value it would have borne if erected in accordance with the contract; her loss can, prima facie, be measured only by ascertaining the amount required to rectify the defects complained of and so give to her the equivalent of a building on her land which is substantially in accordance with the contract.
The High Court later added that:
The qualification, however, to which this rule is subject is that, not only must the work undertaken be necessary to produce conformity, but that also, it must be a reasonable course to adopt … As to what remedial work is both “necessary” and “reasonable” in any particular case is a question of fact.
Builder’s arguments
The builder argued that the arbitrator’s award of damages to cover the cost of demolition and rebuilding was so unreasonable that it amounted to manifest legal error.
The builder sought to distinguish Bellgrove. In Bellgrove, of course, the foundations were defective, and the Court held that:
… the question of whether demolition and re-erection is a reasonable method of remedying defects does not arise when defective foundations seriously threaten the stability of a house and when the threat can be removed only by such a course.
In particular, the builder relied on the finding that the cracking did not meet the definition of defect in the ‘Guide to Standards and
Tolerances’ (which the parties’ respective experts agreed applied to concrete slabs) and the absence of any evidence that the deficiencies compromised the structural integrity of the house or its fitness as a residential premises.
Other arguments raised by the builder included 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 this regard, the builder relied on Ruxley Electronics v Forsyth [1996] 1 AC 344 (Ruxley). In Ruxley a pool had been construed at a lesser depth than contracted for, but was otherwise fit for use. The House of Lords held that it was unreasonable to award damages for the cost of demolishing and rebuilding the pool as the
owner would not have used the damages to rebuild the pool.
Decision
The Court noted that the builder acknowledged that the arbitrator applied the correct test as set out in Bellgrove.
While the Court recognised that in Bellgrove, unlike in the present case, the building was structurally unsound, the Court held that ‘there are a number of principles referred to by the High Court [in Bellgrove] that do not depend on the finding of structural unsoundness’.
The Court further observed that it was not suggested that the deficits in the home did not result in the construction of a lesser house than the one the builder contracted to build, and that the deficits were not ‘mere cosmetic deviation from the contractual specification, but are such that cracking to the slab has occurred and is likely to worsen’.
Accordingly, the Court held that the arbitrator’s application of the test in Bellgrove was correct with the result that there was no error of law manifest on the face of the award or strong evidence of an error in law. Perhaps fatally for the builder’s case, the Court observed that, as the High Court stated in Bellgrove, the qualifications to the general rule – that is, whether demolition and rebuilding was necessary to cure the defective work – involved factual findings and were therefore not susceptible to challenge.
Did the arbitrator err by awarding damages for delay?
Liquidated damages
As a general rule, contracting parties can agree a fixed sum of damages payable in the event
of breach.
Unless the amount is a penalty, because, for instance, the specified amount is not a genuine pre-estimate of loss, or, on the flipside, is extravagant or unconscionable in amount, it will be upheld by the courts and will be held to be the parties’ exclusive remedy or liability irrespective of whether the actual provable loss is more or less than the fixed amount.
Adapt Constructions
In Adapt Constructions, the parties’ contract contemplated that liquidated damages would be payable if the builder failed to complete on time. Clause 8 provided, among other things:
(a) …
(b) If the Builder defaults under Clause 8(a) the pre-estimated liquidated damages for that default is a sum calculated using the rate in Item 17 of Appendix A for the period from the Date for Practical Completion until Practical Completion is achieved under clause 23.
Item A17 of Appendix A stated:
Rate of Liquidated Damages Per Week $________________ (if nothing stated, Zero).
Essentially, because the rate of liquidated damages was not specified, the arbitrator determined that there was no mechanism for calculating agreed liquidated damages, and further that this did not prevent the owners from seeking damages at common law for delay because the parties did not clearly express an intention to exclude that common law right.
The builder alleged that the arbitrator’s finding amounted to a manifest error of law on the face of the award.
Decision
The Court noted that ‘similar situations have arisen in earlier cases’ and turned to consider them.
The first decision the Court considered was Temloc Ltd v Errill Properties Ltd (1987) 39 BLR 30 (Temloc). In 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.
Next, the Court turned to the Australian decision of Baese Pty Ltd v RA Bracken Building Pty Ltd (1990) 6 BCL 137 (Baese) in which Temloc was distinguished. In Baese, the rate of liquidated damages was specified to be ‘nil dollars’. However, unlike in Temloc where the builder’s liability to pay liquidated damages for delay was expressed in mandatory terms, in Baese, the builder’s liability to pay liquidated damages only arose if the architect (as the owner’s agent) issued a default notice to the builder.
Giles J held in Baese that clear words were required to extinguish the parties’ right to seek common law damages for breach of contract and distinguished Temloc on the basis that the owner in Baese was left with the choice of initiating the process leading to the builder’s obligation to pay liquidated damages. Accordingly, the Court held that the owner could recover damages for delay at common law.
Finally, the Court referred to the decision of the Supreme Court of Western Australia in J-Corp Pty Ltd v Mladenis [2009] WASCA 157 (J-Corp). In J-Corp the parties entered into a lump sum contract for the construction of a house. The contract provided that if the builder failed to complete the house within the period specified in the contract the builder ‘shall be liable to pay the Proprietor liquidated damages at the rate of NIL DOLLARS ($0.00) per day’.
At first instance, the Court held that this clause did not exclude the owner’s right to claim damages at common law for delay. On appeal, this decision was upheld. The Court of Appeal observed that clear words are needed to exclude the right to damages for breach of contract and that this had not been done here.
More generally, the Court emphasised 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.
Overall, the Court 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 Court held that 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.
The Court was not satisfied that there was manifest error, or strong evidence of such an error.
Overall decision
For reasons including those explored above, the Court was not satisfied that the builder had demonstrated any manifest error on the face of the award, or strong evidence that the arbitrator made an error of law.
Leave was refused.
WHAT THIS DECISION MEANS FOR YOU
A significant benefit of domestic arbitration is that the ability to appeal an award is limited. This brings welcome finality in most cases. Not only are appeals on questions of fact unavailable, but the hurdles a party must surmount to appeal a question of law are set high.
However, as this case demonstrates, the outcomes of construction disputes can often turn on factual findings, and the legal position on many issues is unsettled or subject to seemingly conflicting decisions which may turn heavily on the terms of the contract under consideration in a given case. This reduces the likelihood of arbitral awards on construction issues being challenged. Parties contemplating pursuing arbitration as a dispute resolution option need to be aware of this.
The award of damages for the cost of demolishing and rebuilding an entire building because a polished concrete floor was defective provides a pertinent example of the potential difficulties in challenging an arbitral award. The need for the proposed or actual rectification to be ‘reasonable’ and ‘necessary’ safeguards and limits the application of the general rule that demolition and rectification costs will be recoverable for defective building work. The absence of appeal rights on such significant findings illustrates the need for parties to appreciate the potential finality of an arbitral process, and the prospect of it being the party’s ‘one shot’ at determination.
For further information, please contact:
Hamish Macpherson, Partner, Herbert Smith Freehills
hamish.macpherson@hsf.com
