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Prudent planning when considering response to a show cause notice

24 March 2020

#Construction & Infrastructure

Kyle Siebel

Published by Kyle Siebel, Benjamin Mann

Prudent planning when considering response to a show cause notice

Reasonable planning by the principal about how to perform the works when considering a response to a show cause notice is not evidence of failure to exercise the obligation of good faith.

The recent case of Duffy Kennedy Pty Ltd v Galileo Miranda Nominee Pty Ltd [2020] NSWCA 25[1] presents an important reminder of the Court’s willingness to require a strict interpretation to proper compliance with contractual terms when assessing the conduct of a party seeking to suspend or terminate or take over works under a construction contract. However, prudent planning about how to perform the works, if they are taken over, will not be evidence of a failure to exercise good faith.

At first instance, the primary judgment[2] provided useful clarity on the issue of treatment of security for performance following either the termination of contract or where the works are taken out of the hands of the contractor prior to completion. The Court first determined that despite the taking out having ended the contractor’s obligations to perform the works, there existed no contractual right entitling it to the return of security. This position was affirmed in the appeal.

Background

In April 2017, Galileo Miranda Nominee (Galileo) engaged Duffy Kennedy Pty Ltd (DK) under a design and construct contract for two luxury, residential tower buildings in Miranda, NSW. Following the issue of a payment schedule by DK in February 2019, dispute arose between the parties surrounding the consequence of Galileo’s failure to pay interest accrued (amounting to $177).

DK contended that under section 72(2) of the Building and Construction Industry Security of Payment Act 1999 (NSW) (Act) the unpaid interest was a “scheduled amount” due and payable and consequently, that Galileo’s failure to make payment entitled it to suspend the works. Galileo’s position was instead that the definition of “scheduled amount” did not include interest accrued following the due date for payment and that DK was in breach by wrongly suspending the works once the principal portion of the progress payment had been made. The Court at first instance accepted Galileo’s position.

On 29 March 2019, a notice to show cause as to why it should not terminate the contract or take works out of the hands of DK was issued by Galileo to DK, which provided its response on 12 April 2019. Galileo assessed the response as insufficient, and on 29 April 2019 issued a notice taking the work out of the hands of DK. DK argued that Galileo’s actions amounted to repudiatory conduct and elected to terminate the contract in response, seeking the return of its security for performance.

Key issues

Having resolved at trial the question of whether DK was in breach of the contract by wrongly suspending the works without reasonable cause, the remaining issues in focus upon appeal concerned a close scrutiny of Galileo’s conduct when issuing both the show cause and take out notices. The appeal examined whether a failure to demonstrate strict compliance with the process and manner set out in the terms of the contract would invalidate the effect of each notice.

1. Whether show cause notice was validly issued

DK argued that the validity of the show cause notice was at issue for two principal reasons. Firstly, the terms of the contract provided that it was the express role of the Superintendent, as the Principal’s Representative, to give proper consideration to the grounds for the notice. Secondly, the terms required the notice to be issued by the Principal’s Representative. In this case, the show cause notice was drafted by Galileo’s lawyers and issued on Galileo’s letterhead. DK submitted that due to Galileo’s involvement in the preparation and sending of the notice, it was not “issued” by the Principal’s Representative as required by the meaning of the terms. DK contended further that this was evidence to the point that the Principal’s Representative did not properly exercise its discretion, as required, to independently assess the grounds to issue the notice, and had merely signed the notice at the request of its Principal, Galileo.

The Court upheld the view of the primary judge that the involvement of Galileo in the drafting of the notice, on its own letterhead, was immaterial to the question of whether the Principal’s Representative had in fact properly exercised its discretion, and did not invalidate the notice. Further, the Court of Appeal held that the Principal’s Representative did not need to exercise its judgement entirely independently of the Principal and that on the evidence put forth, DK had failed to establish that the Principal’s Representative had not adequately satisfied itself of the grounds for issuing the notice as required by the terms.

2. Whether take out notice was validly issued

DK challenged the validity of the take out notice on the basis that the Principal’s Representative had failed to give proper and good faith consideration to their response to the show cause notice, and that as a result Galileo was not entitled to terminate the contract or take over the works. This challenge was made on the basis that the Principal’s Representative was required under the contract to act independently, reasonably and in good faith in determining that the show cause response was unsatisfactory and that it failed to do so predominantly by blindly following the direction of its Principal.

DK relied upon the evidence that there was “… no written communication or record in respect of any review of the response to the show cause notice.”[3] In addition, DK relied upon an email sent the day before its response to show cause was due to Galileo. The email contained a direction by Galileo to the Principal’s Representative to “consider the next available course of action”[4] once the works had been taken out of DK’s hands.

Both challenges were unsuccessful. The Court was not satisfied, on the balance of evidence, that there was a lack of consideration or that either Galileo or the Principal’s Representative had prejudged its response to show cause notice simply by making plans in advance.

Key takeaways

When considering whether to exercise a right to take works out of a contractor’s hands (or to terminate the contract) Principals should endeavour to carefully ensure they do so in strict observance of the terms of the contract. A wrongfully exercised right may invalidate its effect, potentially giving rise to a right of the contractor to accept a wrongful repudiation, regain its security and claim compensation.

Evidence demonstrating the performance of an appropriate and good faith consideration of a contractor’s response to a notice will be examined by the Court when examining Principal’s conduct in properly exercising its right to take out work. Principals would be well placed by implementing an internal procedure for documenting its consideration and determination of decisions in these instances.

However, prudent consideration and planning for what will be required to perform the works after taking over the works will not, in and of itself, be regarded as evidence of predetermination or failure to exercise good faith when considering a response to a show cause notice.

Authors: Kyle Siebel & Benjamin Mann

[1] Duffy Kennedy Pty Ltd v Galileo Miranda Nominee Pty Ltd [2020] NSWCA 25
[2] Galileo Miranda Nominee Pty Ltd v Duffy Kennedy Pty Ltd[2019] NSWSC 1157
[3] [2020] NSWCA 25 at [156].
[4] [2020] NSWCA 25 at [159].

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Kyle Siebel

Published by Kyle Siebel, Benjamin Mann

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