Courts provide guidance on when 'innocent' parties may terminate a contract
A party may terminate a contract under a contractual right, or if the other party:
- breaches a condition (or an 'essential term'); or
- commits a sufficiently serious breach of an 'intermediate term'.
Although these principles are simple to state, they can lead to considerable uncertainty in practice, both in characterising a term (as a condition, intermediate term or warranty); and, in the case of an intermediate term, evaluating the severity of the breach.
The great risk faced by a party terminating a contract is that if a court ultimately determines there was no right to terminate, then the act of termination will usually itself be a repudiation of the contract. One method for reducing this risk is to serve a notice on the other party requiring performance of the relevant obligation. The advantage of this method was illustrated by a decision of the NSW Court of Appeal in Cromarty Resources Pty Ltd v Thalanga Copper Mines Pty Ltd 1.
In Cromarty, a party consistently paid royalties later than the time required by the contract. Although the judge at first instance considered the payment obligation to be an essential term, the NSW Court of Appeal disagreed and held that it was an intermediate term. The issue for the court, therefore, was whether the breaches were sufficiently serious to enable the 'innocent' party to terminate. The court held that they were, largely because of the breaching party's failure to comply with a notice requiring payment of the outstanding amounts within a reasonable time. The court explained that serving a notice did not convert the payment obligation into an essential term, but that the failure to comply with the notice:
conveyed to the reasonable person in [the innocent party's] position that [the party in breach] did not intend to perform its existing contractual obligations with respect to the payment of royalties and that it was only prepared to pay royalties on a basis that was not the subject of any agreement between the parties and which was substantially inconsistent with its existing obligations.2
The failure to comply with the notice was therefore repudiatory conduct that entitled the innocent party to terminate. The court also noted that a further advantage of serving such a notice is that it may prevent a party from obtaining equitable relief preventing termination of an agreement.
Parties will often include termination provisions in their agreements, to avoid the uncertainty as to whether there is a right at law to terminate. These provisions can, however, generate their own uncertainty. For example, in Australia City Properties Management Pty Ltd v The Owners – Strata Plan No 651113 there was a dispute as to:
- whether certain breaches of the agreement (including breaches of an implied term) constituted 'gross misconduct'; and
- whether provisions concerning post-termination rights applied both to termination under the contract and termination for fundamental breach.
The court held that some of the breaches did constitute gross misconduct and that the owners corporation was therefore entitled to terminate the agreement. Of particular interest, however, was the court's finding that:
- the conduct of the party in breach was repudiatory (which, in the absence of a termination clause, would have entitled the other party to terminate the contract); but
- the scope of the contractual right to terminate was so broad (and most likely covered any conduct that was repudiatory) that it constituted an exclusive code for terminating the contract.
In relation to this second point, it is not clear whether the court was referred to the judgment of the Full Court of the Federal Court in Neptune Hospitality Pty Ltd v Ozmen Entertainment Pty Ltd4, discussed in the 2020 Contract Law Update.5 In that case, the court noted the presumption (which can be ousted by clear language) that common law termination rights continue to exist when there are also contractual rights of termination. It is possible that the NSW Court of Appeal would have decided in any case that the language in this agreement was clear enough to oust that presumption.
As a practical matter, these difficulties can be avoided if the agreement expressly states whether contractual rights to terminate are intended to operate concurrently with, or to the exclusion of, common law termination rights.
Another common issue that can be avoided by appropriate drafting is whether an 'innocent' party is entitled to a refund of instalment payments when a contract is terminated. In Scott Fury trading as Fury Custom Boats v Nasso6 the Western Australian Court of Appeal considered this issue in the context of an agreement to build a boat for a fixed price. The court concluded that the purchaser was entitled to a refund of his instalments because (among other reasons) they could not be characterised as payments for work progressively completed and the purchaser did not receive a substantial part of the benefit expected under the contract.
Cromarty Resources Pty Ltd v Thalanga Copper Mines Pty Ltd [2021] NSWCA 284
Termination of agreement following late payment of royalties
In this case, the Supreme Court considered the calculation of a royalty under an asset Sale agreement (the agreement), where the royalty was to be calculated as a percentage of 'net sales realisation' amount. It then considered whether a breach of the time stipulated for making a payment justified termination and non-payment of the royalty amount.
The court held that a royalty, calculated as a percentage of the 'net sales realisation' amount, should be based on the 'net sales realisation', which does not include a deduction of the expenses necessary to realise the sales. In finding this, the court had regard to the definitions in the agreement.
The court further held that, although the obligation to pay royalties should not be considered an essential term, such as would justify termination of the agreement, termination was permitted following failure to comply with a notice.
This case demonstrates the manner in which a contract may be terminated for breach of a non-essential term
Facts
The respondent, Thalanga Copper Mines Pty Ltd, agreed to sell interests in certain mining exploration permits and mining leases in central Queensland (the tenements) to Kagara Copper Pty Ltd in May 2006 (the agreement).
Clause 13.1 of the agreement stipulated that Kagara Copper was to pay a 4% royalty to Thalagna within '15 Business Days after the end of the month of actual sales'.
On 24 March 2015 the appellant, Cromarty Resources Pty Ltd, a wholly owned subsidiary of the second appellant, Red River Resources Ltd, acquired these interests from Kagara Copper under a deed of covenant, assignment and release. Under this deed, Cromarty assumed all of the obligations Kagara had been subject to under the agreement.
Cromarty began producing ore from the tenements in mid-2017. Cromarty paid royalties to Thalanga in the manner stipulated by the agreement for all sales up until 30 June 2018. However, Cromarty then ceased making regular payments. In late October 2018 Cromarty proposed that, going forward, the payments be made in relation to 'quarterly' rather than 'monthly' sales.
There was minimal negotiation in relation to the payment date, and Thalanga's solicitors gave notice demanding payment by 13 December 2018. On 28 December 2018 Thalanga's solicitors gave written notice of intention to terminate the agreement. Cromarty's solicitors accepted that the agreement had been terminated in a letter dated 8 January 2019.
The key issues on appeal were:
1. The timing of payment and the calculation of net sales realisation
- whether the amount that was royalty was due 15 business days after the end of a month during which an 'actual sale' had occurred, or at the end of three months, when the actual sales price was known; and
- whether the 'net sales realisation' amount, to which the 4% royalty rate was applied, was to be determined after deducting sales realisation expenses, including insurance and sea freight.
2. Termination
- whether Clause 13.1 was an essential term; and whether Thalanga was entitled to terminate the asset sale agreement on 28 December 2018.
3. The quantum of the judgment sum, which the primary judge found was the equivalent of:
- the sum of the unpaid royalties for actual sales that had occurred before 28 December 2018; and
- the net value of royalty payments made in relation to sales after the termination date, which Thalanga would have received for the asset sale agreement had it not been terminated as a result of Cromarty's wrongful conduct.
Judgment
The timing of payment and calculation of the net sales realisation, due for 'actual sales'
Cromarty argued that the 'actual sale' could only be determined at the end of three months, after the actual sales price was known. The court dismissed this argument. It had regard to the 'ordinary language' in the agreement – in particular, clause 13.1(a), which provided that the royalty is to be paid 'within 15 Business Days' after the end of the month 'actual sales'.
Termination
The court found that the payment of the royalty amount was not an essential term, such as to justify Thalanga's termination for breach. Rather, the court construed it as an 'intermediate' term with 'greater flexibility'.
However, while the ongoing non-payment was not enough to repudiate the contract, Thalanga's provision of notices to complete 'operate[d] as evidence that [Thalanga] consider[ed] that a reasonable time for performance ha[d] elapsed'. Consequently, Cromarty's continuing non-payment, and lack of response to Thalanga's demand to pay by 13 December 2018, 'evinc[ed] an unwillingness or an inability to render substantial performance of the contract', justifying Thalanga's termination.
The quantum of the judgment sum
The court agreed that the judgment sum should include the sum of unpaid royalties made for actual sales up until the time the agreement was terminated, in addition to the value of royalty payments related to sales made after the termination date.
Australia City Properties Management Pty Ltd v The Owners – Strata Plan No 65111 [2021] NSWCA 162
Termination – what constitutes gross misconduct – repudiation of the contract – implied terms – construction of unusual terms
In this case, the NSW Court of Appeal considered a caretaker agreement; and whether there was an implied term that the caretaker not use its position to obtain an unauthorised benefit, whether breach of that term constituted gross misconduct, and whether the agreement had been validly terminated.
The court also considered the requirements under the agreement following termination, and whether failure to follow that procedure amounted to a repudiation of the contract by the owners corporation, which then entitled the caretaker to loss of bargain damages.
The court considered the duration of the agreement under the relevant statutory regime, and whether variations to the original agreement created a new agreement.
The court held that an implied term in the agreement had been breached in circumstances involving deliberate deception, which amounted to gross misconduct. The contract had been validly terminated by the owners corporation. A failure to follow the process after termination did not amount to repudiation. Variations to the contract in this particular case had the effect of creating a new and different contract (for the purposes of the relevant statutory regime). The court must give effect to the language of the contract, particularly where this does not have an arbitrary or capricious result.
This case illustrates the difficulties in construing termination clauses where there are multiple breaches of differing seriousness
Facts
In 2001 Australia City Properties Management Pty Ltd (ACPM) entered into an agreement with the Owners of Strata Plan No 65111 (the OC) to provide caretaking services for an apartment building in the CBD. Under the agreement, ACPM also owned the caretaker's lot in the apartment building (Lot 179).
Under clause 9.3 of the agreement, the OC could terminate the agreement for gross misconduct or gross negligence by ACPM. Clause 10 provided that if the OC terminated under clause 9, it must grant ACPM the right to sell its interest in the agreement and Lot 179. Clause 18.2 prohibited directors and shareholders of ACPM from nominating themselves for election to the strata committee of the OC.
In 2010 and 2015 the parties entered into deeds of variation that extended the term of the agreement to 2041.
Under the relevant statutory regime, new caretaker agreements were limited to a term of 10 years.
On 17 August 2019 the OC terminated the agreement under 9.3 because, it claimed:
- ACPM had not paid for electricity used on Lot 179, thereby breaching an implied term in the agreement that it would not use its position to obtain an unauthorised benefit from the OC. This breach was compounded because ACPM had lied to the OC about who paid for the electricity (the Electricity breach);
- ACPM had failed to properly inform the Strata Committee that there were problems with the fire alarm system (the Fire Safety breach); and
- ACPM had offered its directors for election as office bearers of the executive committee (the clause 18.2 issue).
Following termination, the OC took possession of Lot 179 and nominated itself purchaser of Lot 179 (and did not purchase rights in the caretaker agreement).
ACPM claimed the OC's termination was invalid, and, that in any case, the OC had repudiated the agreement by failing to follow the process set out in clause 10, which applied regardless of the seriousness of ACPM's breach.
ACPM sought compensation and loss of bargain damages, calculated on the basis that the agreement expired in 2041 because the statutory regime did not apply to an existing agreement.
The primary judge held that:
- the agreement was validly terminated by the OC under clause 9.3 because both the electricity breach and fire safety breach amounted to gross misconduct;
- ACPM had also breached clause 18.2 but this did not constitute gross misconduct;
- the OC had breached the provisions of clause 10 but this did not amount to repudiation; and
- the 2010 and 2015 deeds of variation caused a new agreement to come into existence and therefore, under the relevant legislation, the term of the agreement was up to 2025.
The OC was ordered to deliver up possession of Lot 179 to ACPM and pay compensation to it for being out of possession; however, ACPM was not entitled to loss of bargain damages.
Both parties appealed the primary judgment.
Judgment
The NSW Court of Appeal allowed ACPM's appeal and dismissed the OC's cross-appeal.
The electricity breach
On proper construction of the agreement, ACPM had no right of reimbursement for electricity expenses incurred regarding Lot 179. The court cited BP Refinery (Westernport) Pty Ltd v Shire of Hastings (1977) 180 CLR 266 in considering the requirements for an implied term, and held the prohibition against taking an unauthorised benefit was reasonable and equitable, was necessary to give business efficacy to the agreement, was so obvious it goes without saying, was capable of clear expression and did not contradict any express terms in the contract.
What constitutes gross misconduct is a question of fact considered in the context of the contractual obligations of the caretaker. The court referred to the right of an employer at common law to summarily terminate a contract of employment, as discussed in Willis Australia Group Services Pty Ltd v Mitchell-Innes [2015] NSWCA 381. The misuse of electricity, and the deliberate deception, demonstrated such a flagrant disregard for the essential conditions under which ACPM was engaged that it constituted gross misconduct.
The fire safety breach
ACPM's failure to warn the OC promptly that the fire control panel was playing up and needed to be replaced was a breach of the agreement but did not amount to gross misconduct.
Citing Gooley v Westpac Banking Corporation (1995) 129 ALR 628, the court observed that for conduct to constitute gross negligence in the context of termination provisions, it would have to amount to an act or omission that demonstrated an inability to exercise the judgment necessary to carry out important functions conferred on the caretaker. Referring to Rankin v Marine Power International Pty Ltd [2001] VSC 150, the court said gross misconduct amounted to more than ill-advised conduct or an omission to act as a result of an error of judgment.
The clause 18.2 issue
The court considered clause 18.2 in the context of the agreement as a whole, and observed its purpose was to ensure that instruction as to and supervision of the caretaker’s activities be conducted by persons independent of ACPM. The court noted this purpose is undermined if persons associated with ACPM are able to sit on the Strata Committee and that, in those circumstances, a breach of clause 18.2 could not be described as inconsequential.
ACPM's breach of 18.2 amounted to gross misconduct enlivening a right to termination under clause 9.3.
Repudiation by OC
The OC had validly terminated the agreement under clause 9.3, and although the it had failed to comply with its obligations under clause 10, this did not constitute a repudiation of the contract. It had not been established that the OC was not willing to comply with the terms of clause 10 once the correct interpretation of that clause was established.
Damages and repudiation by ACPM
Even if the contract were validly terminated, ACPM sought damages for the failure of OC to comply with clause 10 following termination.
OC argued that clause 10 did not apply where ACPM had repudiated the contract and OC had accepted that repudiation. The court disagreed, and held that the regime in clause 10 still applied in those circumstances.
ACPM was therefore owed compensation for loss of possession of Lot 179 and loss of profits. The quantum of profits depended in part on the application of legislation limiting the duration of caretaker agreements. The court held that the legislation did apply, because of the deeds of variation entered into after the legislation, so the effective expiry date of the agreement was 2025.
Scott Fury trading as Fury Custom Boats v Nasso [2021] WASCA 171
Contractual interpretation – whether a contract is divisible – whether there had been a total failure of consideration under the contract
In this case, the Western Australian Court of Appeal considered whether a contract between Mr Nasso (the purchaser) and Mr Fury (the seller) for the construction of a custom fishing boat should be characterised as:
- a divisible contract, where a right to payment was owed on fulfillment of certain milestones in the construction of a custom boat; or
- an entire contract, where a right to retain payment was contingent on the supply of a completed custom boat
The court upheld the trial judge's finding that the contract should be characterised as an 'entire contract' for the supply of a custom boat. Mr Fury's failure to provide a completed boat for the price agreed between the parties entitled Mr Nasso to a refund of all instalment payments made under the contract.
This case demonstrates that a construction contract will not necessarily be considered divisible by simply stipulating that payment is owed on specific dates. Accordingly, parties looking to structure a contract on a divisible basis should make this intention clear and consistent.
Facts
Mr Nasso entered into a contract on 6 September 2014 with Mr Fury, a boat maker, for the construction of a custom dual console fishing boat for $275,400. Before entering into the written contract, it was agreed that Mr Fury would pay for an architect to prepare the boat's designs. It was also agreed that Mr Fury would retain the rights in those designs for future use in other projects.
Mr Fury commenced construction of the boat in November 2014 and provided periodic updates on progress to Mr Nasso. By April 2015 Mr Nasso had paid $115,400 to Mr Fury, being the deposit and first instalment payment stipulated under the contract. By this stage, Mr Nasso had expressed concerns to Mr Fury that it appeared the boat was not being built to agreed specifications. Despite this, Mr Fury continued to depart from agreed specifications and completed construction of the custom boat in early 2016.
Mr Fury then demanded that Mr Nasso pay an additional $45,000 for the boat as constructed for additional costs accrued for improvements outside of specified designs. Mr Nasso refused to pay the additional sum and commenced proceedings in the Supreme Court of Western Australia to recover $115,400 in instalment payments. At first instance, the trial judge found that there had been been a total failure of consideration, entitling Mr Nasso to recover all money paid under the contract, including the deposit payment.
Judgment
Mr Fury appealed the decision on the grounds that the trial judge erred in finding that:
- Mr Fury's right to retain the instalment payments were conditional upon delivering the completed boat at the agreed price (the first ground);
- there had been a total failure of consideration (the second ground); and
- in light of the second ground, Mr Nasso was entitled to recover the deposit payment (the third ground)
Justice Morrison (with whom Justices Vaughan and Buss agreed) found that Mr Fury had failed on all three points and the appeal should be dismissed.
Regarding the first ground of appeal, Justice Morrison considered the terms of contract did not support Mr Fury's interpretation that the contract was severable and therefore entitled him to payment for work progressively done. His Honour noted that the payment schedule, although broken down into stages, should be interpreted in the context of the contract to be a reflection of the timing of payments, rather than a perceived value of the construction that may have occurred during each relevant period. His Honour also referenced the fact that the contract stipulated the ourchaser had no right to possession of the boat until the entire purchase price was paid as evidence that the entire contract was for the purchase of a completed custom boat.
Regarding the second ground of appeal, his Honour rejected Mr Fury's argument that Mr Nasso had retained any substantive benefit under the contract. Mr Fury argued that Mr Nasso had retained a benefit via the opportunity to 'workshop' the custom design that could otherwise be used in the construction of a boat in the future. The court found that, on no reasonable view, could it be said that the opportunity to participate in the design represented a substantial benefit contemplated under the contract.
On the third ground of appeal, Mr Fury contested that a reference to a 'non-refundable' deposit referred to in the 'formation' terms of the contract should be interpreted as non-refundable in all circumstances. His Honour found that the reference to the deposit being non-refundable, in context, only applied where the purchaser withdrew from the contract within the 21-day 'cooling-off' period stipulated in the formation terms. His Honour was aided in drawing this conclusion by the fact that other references to the deposit in the contract were not expressed as a 'non-refundable' deposit.