You can’t have your contract and eat it: electing not to terminate

A party to a contract may be precluded from enforcing a contractual right if it has acted in a way that is clearly inconsistent with that right. This is known as the doctrine of election. Last Friday the New South Wales Court of Appeal applied the principles of election to a complex factual scenario in the decision of Donau Pty Ltd v ASC AWD Shipbuilder Pty Ltd [2019] NSWCA 185.

 

Let's get unequivocal: understanding the doctrine of election

The doctrine of election comes into play in situations where a party must choose between alternative remedies or inconsistent rights.

A common example of a situation where a party is faced with a choice between inconsistent rights is where that party's right to terminate the contract is enlivened – the party can either choose to exercise its right to terminate the contract or it can choose to affirm the contract and insist on performance of the contractual obligations.

Once the party has made its choice clear (either by express words or by its conduct), there is no going back – it must live with it. Thus a clear election to continue with the performance of the contract is generally regarded as final and irrevocable. However, subject to the operation of an estoppel, nothing prevents the party from subsequently terminating the contract if its right to terminate re-enlivens (for example, if the other party commits a later terminable breach).

There are two elements of an election to continue with performance:

  1. the party knows that its right to terminate the contract has enlivened; and
  2. the party makes it clear that it has chosen to insist on performance of the contract through its unequivocal words or conduct.
According to the courts in Australia, the "unequivocal" in this context means that the party's words or conduct is only consistent with the exercise of one right and inconsistent with the other. As one might expect, the party's subjective intention is irrelevant to the question of whether it has unequivocally elected to insist on the performance of the contract.

There is unlikely to be any controversy in a situation where the party with the right to terminate expressly insists that the other party performs its obligations under the contract or otherwise tells the other party that it wants to continue the contract. This constitutes a blatant election and the party will be precluded from subsequently terminating the contract (unless the right to terminate re-enlivens).

However, practically speaking, in most cases there will be no such express communication. Rather, the issue will turn on whether the party’s conduct is such that it is only consistent with continued performance of the contract and entirely inconsistent with its termination.

Ships in the night: overview of the dispute in Donau Pty Ltd v ASC AWD Shipbuilder Pty Ltd [2019] NSWCA 185

In essence, the proceedings concerned a contractual dispute between Donau Pty Ltd (Donau), formerly Forgacs Engineering Pty Ltd, and ASC AWD Shipbuilder Pty Ltd (ASC).

In 2009, ASC contracted Donau to construct various blocks of three "Hobart Class" air warfare destroyers (Original Contract). Once the blocks were constructed they were to be shipped to Adelaide to be assembled by ASC.

Under the Original Contract, Donau was to be paid its fees pursuant to a complicated performance-based formula. However, the project suffered from a number of design changes, defects and delays (many of which were outside of the control of either Donau or ASC). As a result, the Original Contract soon become unworkable and Donau and ASC executed a new contract, the Second Heads of Agreement (SHOA). The intention of the SHOA was to simplify the parties' contractual relationship and provide more certainty to their obligations, especially with respect to the mechanism for determining Donau's fee entitlements. Another important aspect of the SHOA is that it streamlined the work scope approval process when compared to the Original Contract.

Under the SHOA, ASC had a unilateral right to terminate if the parties had not re-baselined their performance metrics by 28 February 2013. It was common ground that the parties had not completed the re-baseline by that date. ASC then purported to terminate the SHOA on 7 June 2013.

The two threshold issues in dispute in the proceedings were whether the operative provisions of the SHOA (including the new fee payment mechanism) had come into effect (referred to as the Transition Date in the SHOA) and, if so, on which date did Transition Date fall. On these issues, Bell P and Basten JA held that the Transition Date occurred on 14 December 2012 and thus the SHOA came into effect on that date.

One of the key remaining issues was whether ASC's purported termination on 7 June 2013 was invalid because ASC had elected to affirm the SHOA.

The Court of Appeal shines a light through murky waters

Donau submitted that ASC had lost the right to terminate the SHOA because it had engaged in conduct that objectively demonstrated its intention to continue with the SHOA. In support of this, Donau pointed to the fact that ASC continued to follow the work scope approval process under the SHOA following the accrual of its right to terminate on 28 February 2013, rather than reverting to the work scope approval process under the Original Contract. Donau argued that this amounted to unequivocal conduct that could only be consistent with a decision to continue to follow the SHOA.

Bell P, with whom Basten JA and Emmett AJA agreed on this issue, found that ASC's conduct was equivocal. This is because ASC had long departed from the work scope approval process under the Original Contract and had been following the work scope approval process under the SHOA informally for some weeks before the SHOA actually took effect. Affirming the reasoning of Ball J at first instance on this issue, Bell P held that the fact that ASC continued to follow the SHOA's work scope approval process after 28 February 2013 was equally consistent with a decision to continue following this informal process as it was to affirm the SHOA.

Furthermore, Bell P considered that the following factors prevented ASC's conduct from the necessary unequivocal status to sustain a claim of election:

  1. the parties continued to attempt to re-baseline the performance metrics after 28 February 2013;
  2. the parties had a long history of operating outside of the precise terms of their contractual arrangements; and
  3. it was an implied term of the SHOA that ASC had a reasonable time after that date to exercise its right to terminate, but it was unknown to the parties at the time when that time would expire.
However, as explained in our recent article, the Court of Appeal ultimately held that ASC's purported termination of the SHOA was invalid because it was not exercised within a reasonable time.

Take home tips

Insofar as possible, if you have a right to terminate a contract, you should expressly communicate your intentions to the other party as soon as possible after the right to terminate enlivens.

If you are unsure of whether to terminate the contract or persevere with it and you want to buy time to consider your options, you should consider entering into a standstill agreement with the other party to preserve your right to terminate while you try to resolve the situation.

McCabe Curwood acted for Donau throughout the dispute with ASC, including at first instance before the Supreme Court and before the Court of Appeal.

Contributors

Chiara Rawlins Principal
Luke Dominish Associate
Guy Lewis Lawyer