Poor contract drafting – a critical and expensive lesson
Posted on September 02, 2012
The Supreme Court of South Australia has provided a critical reminder to the construction industry regarding the importance of obtaining competent legal advice prior to entering into a construction contract.
The decision relates to the case of Alstom Ltd v Yokogawa Australia Pty Limited & Anor (no. 7). This case resulted in disaster for Alstom, the head contractor.
Background
In March 2002, the owners of Port Augusta’s Playford Power Station entered into a turnkey contract for the power station’s refurbishment. The coal fired, steam turbine power station was built in the 1950s and required significant manual input in its operation. The refurbishment was to allow operation by remote control with limited onsite personnel. The head contract price, $148.5 million, contained provisions for clear time, performance and reliability requirements. To the extent that Alstom failed to achieve any of these requirements, liquidated damages and performance guarantee payments could be levied by the owner.
The Defendants, Yokogawa Australia Pty Limited and Downer EDI Engineering Pty Limited, formed a joint venture known as YDRML to tender for the electrical control and instrumentation work associated with the project.
After a number of pre-contract arrangements between YDRML and Alstom, under which a certain amount of preliminary work was conducted (up to $3 million), the parties entered into a formal contract for just over $33.8 million.
It transpired that Alstom was unable to perform some of its obligations under the head contract due to a number of issues. This resulted in legal proceedings between Alstom and the owners. Those proceedings were settled on the basis that Alstom pay the owners $20.5 million. This amount comprised just over $13.6 million, previously withheld from Alstom on account of a claim for liquidated damages, and an additional $6.86 million on account of damages.
Alstom, naturally aggrieved by having to pay the owners a large sum of money, then commenced proceedings against YDRML in which it sought to recover the $20.5 million paid to the owner - and more - on the basis that YDRML was largely responsible for Alstom’s failure to meet its obligations under the head contract. YDRML counterclaimed for approximately $9 million.
Alstom’s claims failed in their entirety and judgement was given in favour of YDRML with damages to be assessed. The result was a complete disaster for Alstom.
A Drafting Disaster
The subcontract was deceptively simple in form. It covered a mere 40 pages described as “special conditions of contract”. It sought to incorporate the whole of the head contract into the subcontract. Unfortunately for Alstom the clumsiness of the superimposing technique created a drafting disaster.
The superimposition of terms resulted in numerous ambiguities, inconsistencies, gaps and in some cases, grammatical nonsense. As the litigation showed, it provided fertile ground for dispute as to the contract’s real meaning and effect. The parties were even unable to agree on the complete text of the subcontract.
It was a contract between three large multinational corporations for almost $34 million. Breaches of it had ramifications for the performance of another contract worth $148.5 million. As Justice Bleby said, “it is almost inconceivable that such parties would allow themselves, without competent legal advice, to enter into a contract for a project of the size and complexity of this one where the contract was so poorly drafted and so obviously defective. It stands as an appalling indictment against those responsible for its drafting.” He went on to say “these features, but particularly the contract, have resulted in protracted litigation at an additional cost which must now equal or exceed the amounts in dispute, to say nothing of the ongoing cost of executive time in preparing for and managing the litigation.”
Justice Bleby concluded that none of Alstom’s claims would succeed. Instead, he found entirely in favour of YDRML and stated in the post script to his judgment “one might be permitted a moments reflection on why it happened this way. I considered that there are a number of contributing reasons. First was an appalling drafted contract. At least one of the parties to the head contract obtained and acted on competent commercial legal advice in the preparation of that contract. It was comprehensive and its terms appear to have been tolerably clear. Not so the subcontract, as witnessed by these reasons. If the parties had spent a tiny fraction of the costs of this litigation on competent legal advice in the drafting of this contract, this case might never have arisen.”
He concluded by saying, “if some lessons for the future have been learned through the experience of this case, then some good may have come out of it. Otherwise, I regret that this has been a damaging experience for some and a frustrating experience for all.”
Lessons Learned from Alstom
- Seek competent legal advice before entering into a contract.
- Be wary of contracts seeking to superimpose or ‘piggy-back’ upon a head contract.
- Clearly define the scope of the works to be completed under the contract and whether it is to be completed on a ‘turnkey’ or ‘design-and-construct’ basis.
- Never underestimate the simplicity of a contract in commercial construction.
- Construction disputes can best be avoided by insuring at the outset that your contract or subcontract text is clear as to the parties’ obligations.