When a Contractual Right to Terminate May be Lost

22 MAY 2020

 

Background

The decision of the NSW Court of Appeal in Donau Pty Limited v ASC AWD Shipbuilder Pty Limited [2019] considered the circumstances in which a party, which has a right to terminate a contract, might lose that right.

In particular, the Court considered when the right might be lost due to an election to affirm or due to a failure to exercise the right within a reasonable time.

Key Takeaways

Where the time to exercise a right to terminate is not specified in the contract, ‘the law implies that it is to be performed within a reasonable time’.

A reasonable time will be ascertained as at the date of the contract, with reference to circumstances present at the date the right first accrues.

The Court is more likely to find that a reasonable time means a short time in circumstances where:

  • the parties are commercial and sophisticated;
  • a party is on notice of a future right in advance of it crystallising, such that it has time to consider the implications of exercising that right;
  • the right is not subject to further investigation or receipt of additional information;
  • it is not ‘apparent’ that a party has reserved its ability to exercise the right in the future.

Facts

Donau Pty Limited (Donau) and ASC AWD Shipbuilder Pty Limited (ASC) entered into a subcontract in 2009 (the Original Contract) in relation to the procurement of air warfare destroyers for the Commonwealth Government. 

In 2012, after the Original Contract became increasingly unworkable due to a series of formal and informal variations, the parties entered into a ‘Second Heads of Agreement (2HA).

The 2HA sought to re-baseline the performance metrics of the project, in light of the Original Contract’s frustrations, and restructure the mechanism used to calculate fees. These provisions were only to come into effect on the Transition Date.

The Transition Date was said to be the earlier of:

  • 14 December 2012; being the date the parties were to complete the Baseline True Up; and
  • 28 February 2013; being the date the parties were to agree to the Baseline True Up.

ASC was granted a unilateral contractual right to terminate if the Baseline True Up was not agreed by 28 February 2013.

The parties failed to comply with the provisions above and ASC terminated the contract on 7 June 2013 (3 months and 1 week after it became entitled to do so).

At issue was whether ASC had lost its contractual right to terminate on the basis that:

  • it had elected to affirm the contract by its conduct; and
  • it had not exercised its right to terminate within a reasonable time.

Decision

As to election, the Court found that ASC did not lose its right to terminate by continuing negotiation up to 28 February 2013, nor in the short period after.

However, as to the termination by ASC, the Court found that there was an implied term that the right must be exercised within a reasonable time. ASC had failed to exercise the right within a reasonable time, such that the termination was not valid.

A key factor in this decision was that ASC could have reserved its right to terminate, but did not do so.

Further, ASC was not waiting on more information pending exercising its right and notice that the provisions may not be agreed was to be received when the dates above failed to be met.

What Does This Mean for You?

The judgement confirms the difficulties in proving that a party has lost the right to terminate a contract due to an election to affirm it.

In particular, it will not suffice that the party’s conduct is consistent with the contract remaining on foot. There must instead be unequivocal conduct that is only consistent with affirming the contract and inconsistent with terminating it.

The judgement also provides guidance on the well-established rule that in the absence of any express provision governing when the right to terminate must be exercised, the right must be exercised within a reasonable time.

If you would like advice or assistance in relation to the above or any other Commercial matters, please contact our accredited business law specialists and Partners Justin Thornton on jthornton@marsdens.net.au and Rahul Lachman on rlachman@marsdens.net.au or otherwise by calling them on (02) 4626 5077.

The contents of this publication are for reference purposes only. This publication does not constitute legal advice and should not be relied upon as legal advice. Specific legal advice should always be sought separately before taking any action based on this publication.

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