Clayton Utz Insights
02 August 2012
By Philip Dawson, Victor Lau and Vanja Bulut.
If you're going to get a third party to rectify defects, you'll need to consider four key issues.
Construction contracts often provide the owner, the contract administrator, or both of them, with the power to require the contractor to rectify defects. Frequently the construction contract ties this power to defects liability period requirements. When an owner decides to arrange for a third party (who is not the contractor or a party contracted to the contractor) to rectify the defects, and those defects actually exist, there is an issue as to whether the owner is entitled to recover the costs of rectification as damages.
In Australia, although the position is not settled, the more favoured approach suggests that the owner is not entitled to recover any of its costs paid to third parties, if it departed from its contractual obligations and failed to notify the contractor of the defects and give it the opportunity to rectify the defects. When the court has allowed the owner to recover damages against the contractor, its approach has been to limit the quantum of the owner's recovery by reference to the cost (if any) to the contractor of rectifying the defect (thereby effectively enforcing the owner's duty to mitigate its loss).
Another approach, which appears to be less followed in Australia, is that taken by the English Court of Appeal in Pearce & High Ltd v Baxter (1999) BLR 101, which recognised that the owner will have the common law right to damages where there is a breach of contract by the contractor resulting in defects, unless such a right is expressly, or by strong implication from the express words used, excluded from the contract.
However, as illustrated by the recent English Court of Appeal decision in Woodlands Oak Limited v Conwell  EWCA Civ 254, an owner's failure to mitigate loss may result in a failure to recover any damages. Although UK authorities do not legally bind future decisions in Australia, the principle of mitigation of loss is applicable, and the decision in Woodlands Oak should serve as a caution.
In the Pearce case, the building owners, Mr and Mrs Baxter, did not follow the contract procedures on notifying the builder of the defects. Although the Court of Appeal held that the owners were entitled to damages, it also held that under the duty to mitigate the loss the owners cannot recover more than the amount which it would have cost the contractor himself to remedy the defects. Accordingly, the contractor was not liable for the full cost of repairs.
Recently, in the Woodlands Oak case, the English Court of Appeal stated, in respect of an oral agreement for various building works which did not include a defects liability provision, that if the owner fails to give the contractor an opportunity to rectify defective work, then that may amount to a failure to mitigate its loss.
In the Woodlands Oak case, it was found that the defects could have been put right by the contractor's subcontractors at no cost to the contractor and, more importantly, at no cost to the owners. The Court of Appeal noted (without elaborating) that while there may be circumstances in which it would be entirely reasonable not to give the contractor the opportunity to fix the defects, that was not the case in this instance.
While the Court of Appeal did not provide guidance as to when it would be reasonable not to provide the contractor an opportunity to fix the defects, it seems that this is a question of fact and degree. Such a finding may be assisted by evidence showing the contractor's performance fell well short of that expected by any reasonable standards, or evidence showing the contractor was not capable of constructing the works in accordance with the contract.
Position in Australia
Although the English Court of Appeal decision of Pearce was cited with approval in the NSW Supreme Court in SAS v Carver  NSWSC 1097, it does not appear that any other Australian decision has adopted this approach.
The more favoured approach by Australian courts appears to place a greater burden on the owner to stick to the contractual bargain and to follow the procedures prescribed under the contract in notifying defects once they have been identified, and subsequently allowing the contractor to rectify the defects.
In Turner Corporation Ltd (Receiver and Manager Appointed) v Austotel Pty Ltd (1994) 13 BCL 378, the NSW Supreme Court found, contrary to Pearce, that the owner/principal cannot recover the costs for the third party that it had engaged to rectify defects during the defects liability period, even though the contract did not expressly surrender the common law right to damages.
In Turner, the court found that the owner, through its architect, did not strictly follow the procedural steps and notice provisions in the contract relating to defects. It did not accept the owner's argument that strict compliance was not required, nor that the owner had a "wider common law right" beyond the contract to engage others and then to claim the costs incurred as damages for breach of contract.
The court found that the construction contract outlined all the rights, liabilities and obligations of the parties. Provided the owner issued the notices required under the contract, it was entitled:
- to have the defects rectified by others at the contractor's costs; or
- to have the defective works removed from the contract with an appropriate monetary adjustments; or
- to terminate its contract with the contractor and have the works rectified by others at the contractor's cost.
The court held that there was not a separate basis for claiming damages for defects (without compliance with the relevant notices).
The Turner decision was recently followed by the NSW Supreme Court in Bitannia Pty Ltd v Parkline Constructions Pty Ltd (2010) 26 BCL 335. In that case, the owner took possession of the property prior to the contractor finalising all the alleged defective works, and engaged a third party to rectify the defects. The owner claimed against the contractor for costs incurred as a result of the contractor's alleged breach of contract.
The court, in denying the owner's claim, found that the owner repudiated the contract when it asked the contractor to leave the site and not to come back onto the site, as such denying the contractor the opportunity to fix the defects as required under the contract.
The decision in Bittania affirms the importance placed by the Australian courts on ensuring that the obligations of the parties, as contained in the contract, are complied with.
Although the UK position, recently highlighted by the decision in Woodlands Oak, allows for common law rights to damages for defective work unless such rights are expressly excluded in the contract, the courts in Australia have mostly taken a different view which focuses on ensuring that parties are kept to their end of the bargain.
There are a number of practical steps that owners who are parties to construction contracts should consider when faced with defects:
- ensure that the contract provisions on defects are followed. There are often provisions which require the owners to notify the contractors of the defects and to provide the contractor with the opportunity to fix the defects. There is a risk that no damages will be recovered if the contract provisions are not followed. As to whether the contractor was afforded the opportunity to fix the defects, this may be a question of fact and degree and its answer may include a court inquiring whether the contractor was afforded a reasonable time to fix the defects, or whether access was afforded to the contractor to fix the defects;
- ensure that the notices or instructions clearly and unambiguously describe the offending work that is to be rectified or removed, and include all particulars required under the relevant contract provisions to avoid unnecessary dispute as to whether the required notices or instructions had been issued;
- before engaging a third party to fix the defects, always consider whether a defect exist by taking into consideration whether the work is merely incomplete, or consider when the contractor is required to fix its defects. Be aware that merely because there is (at some point in time) work that is not being done in accordance with the contract, it does not necessarily mean that there is an existing breach by the contractor. Under some contracts, a breach may arise in respect of a failure to carry out works in a proper and workmanlike manner, as distinct from an obligation to "complete" the works in accordance with the contract; and
- always consider inviting the contractor to fix the defects, if necessary, specifying a reasonable period for rectification consistent with the contract requirements. A failure to do so may lead to an allegation that the owner has failed to mitigate its loss, resulting in a risk that owners may not be able to recover the full, or any, amount from the contractor. This is because a contractor can often rectify the defects at either no cost to itself through its subcontract arrangements, or at less cost than having it done by a third party.
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