In BAE Systems Australia Ltd v Cubic Defence New Zealand Ltd [2011] FCA 1434, the Federal Court was required to consider whether a purported 'termination for convenience' of only part of a Subcontract was valid. The Court also considered whether or not certain implied terms could be excluded by the use of an 'entire agreement' clause.
Background
The respondent, a defence contractor, entered into a contract (the Prime Contract) with the Department of Defence for the supply, operation, support and maintenance of certain information and simulation systems for a training program. It subsequently entered into a contract with the applicant (the Subcontract) for the provision of supplies and support services in relation to the program.
Both contracts provided for works relating to the program to be divided into two phases: an acquisition phase, which had already been completed, and an 'operate and support/manage' (OSM) phase, which was ongoing.
The respondent and the Commonwealth entered into discussions with a view to separating the two phases so that the OSM elements under the Prime Contract could be made the subject of an Australian Standard for Defence Contracting (ASDENFCON) template.The applicant and the respondent began concurrent negotiations about a new flow-down version of the Subcontract to reflect the changes. However, there was disagreement between the parties and the negotiations subsequently broke down.
In late October 2011, the respondent notified the applicant that the Commonwealth had "terminated for convenience that portion of the Prime Contract...that includes all Operations Support and Maintenance (O/S&M) requirements" and purporting to terminate for convenience "all of the corresponding O/S&M requirements" in the Subcontract. in doing so, the respondent relied on clause 12.3.1 in the Subcontract which provided that it may "terminate the contract or reduce the scope of the contract by notifying the Subcontractor in writing" in certain circumstances, including where it had "received a corresponding notice to that effect from the Commonwealth."
When asked by the applicant to provide evidence of a corresponding notice by the Commonwealth, the respondent provided the applicant with a copy of a contract change proposal deed (Deed), executed by the respondent and the Commonwealth. The deed stated that its purpose was to "reduce the scope" of the Prime Contract and to reflect the parties' intentions that the OSM requirements be deleted from it and "form the basis of a separate performance based ASDENFCON contract".
The applicant issued proceedings in the Federal Court claiming a declaration that the respondent's notice purporting to terminate the Subcontract for convenience was unlawful and invalid and that the respondent was therefore in breach of the Subcontract.
The applicant's case relied on two arguments, one based on an alleged breach of express terms in the Subcontract and one based on a breach of certain implied terms. Under the former, it was argued that the respondent was only entitled to rely on clause 12.3.1 to terminate the Subcontract for convenience where it had received a corresponding notice to the same effect from the Commonwealth but that it had not received such a notice. Instead, the applicant claimed that the deed and the new ASDENFCON contract should be characterised as either a "reduction in the scope of the contract" or "a varied form of the contract".
The applicant further claimed that certain terms were implied into the Subcontract, which had been breached by the respondent. These included implied terms that neither party would by its own motion prevent the performance of the Subcontract, that neither party would do anything to destroy the efficacy of the bargain and that each party would do all things to enable the other to have the benefit of the Subcontract.
Judgment
With respect to the applicant's first argument, the court considered the construction of the termination for convenience clause in the Subcontract. it found that the clause entitled the respondent to either terminate for its convenience or, alternatively, reduce the scope of the Subcontract but that this power "was conditional on the respondent receiving a corresponding notice to that effect from the Commonwealth" (at [40]). The question for The Court was whether the deed between the respondent and the Commonwealth could be characterised as being a corresponding notice of termination.
The Court reviewed the deed and the correspondence between the respondent and the Commonwealth giving rise to it in light of the requirements of the clause. It was held that while the clause referred to "notifying the Subcontractor in writing", no specific form for that notification was required and, as a result, "a corresponding notice from the Commonwealth may be constituted by a deed to which the recipient of the notice is a party" (at [39]).
In characterising the deed, the Court considered both the written provisions of the deed and the substance of what was effected by it. Importantly, Besanko J noted that:
Turning to the substance of what was effected by the Deed, the Court considered whether or not it could be characterised as a termination, variation or reduction in scope of the Prime Contract. the Applicant had submitted that, while couched in terms of Clause 12.3.1, the substance of the deed was in fact to simply vary the terms of the Prime Contract which meant that it could not be relied upon by the respondent.
The Court referred to previous authorities in Morris v Baron & Co [1918] AC 1 and Tallerman & Co Pty Ltd v Nathan's Merchandise (Victoria) Pty Ltd (1957) 98 CLR 93 regarding the distinction between Variation and Rescission. Applying the reasoning from these authorities, The Court held that the Deed had effected a reduction in scope of the Prime Contract rather than a variation of its terms as any new obligations between the parties were now dealt with in a "new free-standing contract". This was so even though minimal substantive obligations remained under the Subcontract as "a reduction to nil is nevertheless a reduction in the scope of the contract" (at [51]).
As a result, despite not receiving a formal notice from the Commonwealth and there being no "termination for convenience", the respondent's actions in issuing the notice to the applicant were held to be consistent with clause 12.3.1 as the Clause also covered reductions in scope.
In relation to the applicant's implied terms argument, the Court noted that the Subcontract contained an 'entire agreement' clause, which provided that the Subcontract document was "an exclusive statement of the parties' contractual obligations". referring to the High Court decision of Hart v Macdonald (1910) 10 CLR 417, which had held that an entire agreement clause did not preclude the implication of a term unless there were express words to that end, the Court found that the relevant clause did not go far enough to exclude the implied terms.
Ultimately, the Court held that the respondent had not breached the implied terms pleaded by the applicant because: (1) there was no evidence that the respondent had any option other than to enter into the Deed and the new ASDENFCON contract with the Commonwealth, (2) the failed negotiations meant that the benefit of the new ASDENFCON terms could not be passed on to the applicant by simply varying the terms of the Subcontract and (3) any terms of the Subcontract, including implied terms, were qualified by the rights and obligations under the 'termination for convenience' clause.
Implications
The decision is of interest for government contractors who look to replicate or insert "back-to-back" provisions in their Subcontracts because it provides a good example of how Courts will interpret such provisions. interestingly, the Court appears to have taken a practical approach to the requirement for corresponding notices under flowdown 'termination for convenience' clauses. It appears that the requirement of corresponding notification in writing will not necessarily require a formal notice unless there are express words stating this. Furthermore, it appears that even though notification provided to a Subcontractor is expressed incorrectly, for example as a termination when it is in fact simply a reduction in scope, this will not be invalid provided that the substance of what was intended in the notice is covered by the relevant clause.
The case is also relevant in that it reaffirms the position that 'entire agreement' clauses will not preclude the implication of terms unless those terms are explicitly excluded. Contracting parties should be mindful of this fact and should ensure that if they wish to exclude implied terms such as the obligation not to undermine the efficacy of the contract or the duty of cooperation then they should do so expressly in the contract.
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