ACLN - Issue #42 19

1----------------Defects-------------------1

Defective Work

- Philip Davenport, Lecturer, School of Building,University of NSW.

SynopsisWhen the Contractor supplies defective work, the

rights and liabilities of the Principal, the Superintendentand the Contractor depend not only on the terms of thecontract. Common law doctrines such as waiver, estoppel,mitigation, de minimis and unjust enrichment materiallyaffect, and sometimes extinguish, those rights. Thesedoctrines are never referred to in the contract. This paperredresses that gap and discusses economic waste andeconomic breach.

1. Introduction'Defective work' is any work, materials orworkmanship

which is not strictly in accordance with the requirements ofthe specification and drawings - whether it is inferior to orbetter than the contract requires. 'Defective work' isnecessarily something provided by the Contractor to thePrincipal outside the terms of the construction contract. Ifwork is within the terms of the contract, it is not defectivework. 'Defective work' includes defects in drawingsprovided by the Contractor.

Most construction contracts involving major workhave provision for a Superintendent (sometimes called'the Architect' or 'the Project Manager') to administer thecontract on behalfofthe Principal. For this reason, the roleof the Superintendent receives particular attention in thispaper. What the Superintendent does when a defect isapparent, whether noticed by the Superintendent or not,can drastically affect the Principal's rights against theContractor.

Whenever defective work is discovered, the Principal(or the Superintendent on behalf of the Principal) mustelect between:

1. directing that the defective work be removed;2. not directing that the defective work be removed.

The Contractor must elect between:(a) removing the defective work;(b) not removing the defective work.

The election must be made promptly. Otherwise,despite what the contract states, the right to elect may belost. Of course, the Principal and the Contractor canalways agree to vary their contractual rights and that may

resolve the problem. If the Principal directs that defectivework be removed, then despite what the contract states, theContractor always has the capacity to refuse or fail tocomply with the direction. Doing so may result in theContractor being liable to the Principal for damages forbreach ofcontract, but the damages may be much less thanit would have cost the Contractor to remedy the defect.Breach of contract may be the more efficient option(subject to the significant risk of thereby repudiating thecontract). This is sometimes called an 'economic breach'.

If the Contractor refuses to rectify the defect, thePrincipal is not always entitled as damages to the cost ofrectifying the defect. Sometimes it may not be necessaryand reasonable to rectify the defect. It would be economicwaste to do so. Then the Principal's right to damages islimited to such diminution in the value of-the Works as thePrincipal can show arises as a consequence of the defect.

Because 'defective work' can be superior to thespecified work, the Principal can be liable to pay extra ifthe Principal or the Superintendent allows defective workto remain. This is explained later, together with anexplanation of the duty of the Superintendent when theSuperintendent becomes aware of defective work.

Mostforms ofconstructioncontract in Australiaprovidethat upon discovery of a defect, the Superintendent candirect the Contractor to rectify the defect. Only AS2124-1986 and contracts which have copied it, specificallyprovide for acceptance by the Principal of the defectivework, or a variation to overcome the defect, in bothinstances with an adjustment of the contract price (seeclauses 30.3 and 30.4 of AS2124-1986).

No construction contracts deal with the common lawrights which exist independently of the contract and cannegate rights under the contract. These rights include theapplication ofthe doctrines ofwaiver, estoppel, mitigation,de minimis and unjust enrichment. The parties to thecontract and the Superintendent must not only be aware ofthe provisions of the contract but must also be aware ofthese doctrines. Many disputes arise simply because oneparty or both are relying solely on rights or remedies speltout in the contract. It is often only when the dispute getsto court orarbitration that it is discovered that the contractualright is extinguished or varied by some common lawdoctrine.

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2. Duties of the SuperintendentThe Superintendent is engaged by the Principal to look

after the interests ofthe Principal, not to assist the Contractor.The Superintendent does not owe a duty to the Contractorto discover defective work. But the Superintendent doesowe a duty to the Principal to discover defective work - thatis what the Superintendent is engaged to do.

If the Superintendent fails to inspect work or inspectsbut fails to detect defective work, then the Superintendentmay be in breach of the Superintendent's terms ofengagement. Sometimes the Superintendent could also beguilty of common law negligence. The Superintendentcannot be in breach of the construction contract. TheSuperintendentis not aparty to that contract. The Contractorcannot sue the Superintendent simply because theSuperintendent fails to make a inspection. But if theSuperintendent does make an inspection and fails to detecta defect, or detecting a defect, fails to do anything about it,then the Contractor may have rights against theSuperintendent. These are discussed under3. Implicationsofconcurrent tort liability.

As well as the Superintendent's potential liabilitydirectly to the Contractor, there is the Principal's potentialliability to the Contractor for the acts or omissions of theSuperintendent. Cases where a Contractor has succeededin a claim against the Superintendent are not common. Butcases where the Contractor has avoided liability to thePrincipal on account of acts or omissions of theSuperintendent are countless. When the Superintendent isan employee of the Principal, the Employees' Liability Act1991 (NSW) requires the Principal to indemnify theSuperintendent.

Under the construction contract, the Superintendentdoes not have any authority to permit the Contractor to door leave defective work. Only the Principal can make thatdecision. However, sometimes the Principal has given theSuperintendent the additional authority to make thatdecision for the Principal. Only then can the Superintendentallow defective work. Otherwise, the Superintendent islimited to notifying the Contractor that the Principal electsto accept the material or work notwithstanding that it is notin accordance with the Contract.

In contracts which lack an express power for thePrincipal to accept defective work (with a consequentadjustment of the contract price), the Superintendent mustbe very careful to reject the defective work in all but triflinginstances, unless the Principal and the Contractor arrive atsome agreement. Otherwise, in the absence of a direction,the Principal may be taken to have waived the right tocomplain about the defect or to have voluntarily acceptedthe defective work, thereby rendering the Principal liableto pay for it on the basis ofthe doctrine ofunjust enrichment.Only AS2124-1986 in clause 30.4, and contracts whichhave copied this provision, have this express power.

In an attempt to overcome the gap which exists in mostcontracts, the Superintendent sometimes attempts to ordera 'variation' accepting defective work. A variation cannotbe directed retrospectively. The Superintendent's'variation' powercannotvalidly be used to accept defective

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work. The purported variation is usually a waiver. Themisuse of the 'variation' power can lead to all manner ofproblems. In particular, it can lead to the Principal beingliable to pay the Contractor the whole contract pricewithout deduction for the defect, or being liable to pay theContractoronthebasis ofthe Contractor's costs ofexecutingthe defective work rather than the lesser amount which thedefective work is worth to the Principal. In that event, thePrincipal's only remedy, if any, would be against theSuperintendent.

Under the construction contract, the Superintendentdoes not have any authority to negotiate an agreementbetween the Principal and the Contractor to overcome adefect. Only the Principal can make the decision to agreewith the Contractor that for a certain reduction in thecontract price, the Principal will permit defective work toremain. Again, sometimes, the Principal may have giventhe Superintendent the additional authority to make thatdecision for the Principal. Only then can the Superintendentvalidly make an agreement between the Principal and theContractor concerning what is to be done about the defect.

When the Superintendent does have the delegatedauthority to negotiate an agreementconcerning the defectivework, that is usually the best solution. However, such anagreement is a legally binding agreement between thePrincipal and the Contractor. The Superintendent must becareful to consider all possible implications. This iscovered in more detail under 5. Agreement to overcomedefect.

3. Implications of concurrent tort liabilityIn the present context, the Superintendent can be liable

to the Contractor:(a) Under the law of tort, for negligently breaching

a duty ofcare owed by the Superintendent to theContractor. (A duty of care could arise if theSuperintendent gave the Contractor advice);

(b) Under section 5 of the Law Reform(Miscellaneous Provisions) Act 1946 (NSW)for a contribution to damages which theContractor must pay the Principal; or

(c) Under statute for misleading or deceptiveconduct in the course of trade or commerce(s.52 of the Trade Practices Act 1974 (Cth) ors.42 of the Fair Trading Act 1987 (NSW)).

So far as concerns the Superintendent's functions ofadministering the construction contract, liability under (c)may be little more than a theoretical possibility. In theSuperintendent's relationship to the Contractor, the elementof 'trade and commerce' seems to be absent. In so far asthe Superintendent is an agent of the Principal, themisleading conduct could be imputed to the Principalthereby rendering the Principal liable for the breach of s.52or s.42.

Liability under (a) is easily avoided. Don't give theContractor advice. Don't use construction contracts whichrequire the Superintendent to approve work or drawings.Don't make the Contractor's rights dependant upon the

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opinion of the Superintendent.Liability under (a) is liability directly to the Contractor

for the Contractor's own loss or expense. It is liability forbreach of a duty of care in tort owed by the Superintendentto the Contractor. Liabilityunder (b) is liability to reimburseto the Contractor amounts which the Contractor must paythe Principal. It is liability for breach of a duty of care intort owed by the Superintendent to the Principal - not theContractor. Liability under (b) cannot arise where theSuperintendent is an employee of the Principal and itcannot arise unless the Contractor has a liability in tort(usually an act of negligence) to the Principal.

Liability under (b) is a very real risk when theSuperintendent is a consultant engaged by the Principal.Section 5 of the Law Reform (Miscellaneous Provisions)Act 1946 (NSW) provides that if two or more personscommit separate torts (usually acts ofnegligence) that giverise to the same damage, each can seek an order from thecourt that the other must contribute a portion of thecompensation. The portionwill depend upon the respectiveblameworthiness ofthe persons involved. The contributioncan be as much as 100% (as in Pantalone v Alaouie 18NSWLR [1989] 119).

An example of liability under (b) would be where theContractor negligently produces a drawing with a defect init and the Superintendentnegligently approves the drawingwithout detecting the defect. Both may be in breach of aseparate duty of care owed separately to the Principal. Ifthe Principal were to sue the Contractor or theSuperintendent, either the Superintendentor the Contractorcould seek a contribution from the other under section 5 ofthe Law Reform (Miscellaneous Provisions) Act 1946(NSW).

For present purposes, it will be taken as settled that aliability in tort can exist side by side with a liability incontract. There are some cases, exemplified by the EnglishCourt of Appeal decision in Barclays Bank v FaircloughBuilding Society [1994] 3 W.L.R. 1057, where there willbe no concurrent liability in tort and contract.

The basic common law rule is that no one has to assistanother person unless there is some duty recognised bylaw, e.g. a parent to a child, a consultant to a client, anemployer to anemployee. However, ifsomeone voluntarilyassists another, then the volunteer has a duty to do sowithout negligence. No one is obliged to be a rescuer, buthaving assumed the role, arescuermust not act negligently.

The Superintendent must distinguish:(1) instances where the Superintendent is required

by the Principal to give the Contractor advice;and

(2) instances where the Superintendentis voluntarilygiving the Contractor advice.

Instances where the Superintendent is required by thePrincipal to give the Contractor advice are usually found inthe construction contract when the Superintendent isrequired to approve of work or drawings or to givecertificates which are binding on the Contractor. Bycarefully drafting the contract, these instances can be

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avoided.The fact that the Superintendent is required by the

Principal to give the Contractor advice does not mean thatthe Superintendent is authorised to give incorrect ormisleading advice. The Superintendent is not relieved ofliability for giving misleading advice simply because theSuperintendent is bound by contract to give advice.

The Superintendent should never voluntarily give theContractor advice. The Principal has not engaged theSuperintendent to assist the Contractor. Ifasked a questionby the Contractor, the Superintendent might say to theContractor, "I think the answer may be to do X, but I couldbe wrong. I have not considered all the implications andyou must not rely on me. Get your own advice". For moreabundant.caution, the Superintendent should confirm inwriting to the Contractor that the Contractor must getindependent advice and not rely upon anything said by theSuperintendent.

The Superintendent can also mislead the Contractor bysilence. Forexample, ifon an inspection the Superintendentsees defective work and does not say anything, theContractor might be·misled into believing the Principalwaives any rights with respect to the defect. Acting on thatassumption, the Contractor may cover over the defectivework. Assume that subsequently the Superintendentdirectsthat the defective workbe uncovered andremoved. Assumethat the Contractor refuses to do so and is sued by thePrincipal. Even though the Contractor is responsible forthe defective work,· the conduct of the Superintendentcould give the Contractor three separate avenues foravoiding or reducing liability.

The first, a complete answer, is estoppel. This isdiscussed under 4. Estoppel. Estoppel could prevent thePrincipal from taking any action against the Contractor inrespect of the defect. The second is a reduction in theContractor's liability by virtue of s.l0 of the Law Reform(Miscellaneous Provisions Act) 1965 (NSW) (the' 1965Act'). The third is a contribution from the Superintendentby virtue of s.5 of the Law Reform (MiscellaneousProvisions Act) 1946 (NSW) (the' 1946 Acf).

The Law Reform (Miscellaneous Provisions Act) 1965NSW s.10 provides:

"Where any person suffers damage as the"result partlyofhis own fault and partly ofthe fault ofanother personor persons, a claim in respect of that damage shall notbe defeatedby reason ofthe fault ofthe person sufferingthe damage, but the damages recoverable in respectthereof shall be reduced to such extent as the courtthinks just andequitable having regard to the claimant'sshare in the responsibility for the damage ..."

The term 'fault' is defined in s.9 of the 1965 Act tomean negligence or other act or omission which gives riseto a liability in tort. It does not apply where the liability issolelyfor breachofcontract. However, for presentpurposes,it will be assumed that there is a concurrent liability in tortand contract. Then the reduction under s.10 applies.

The third possibility is provided by the Law Reform(Miscellaneous Provisions) Act 1946. Under that Act, the

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Contractor may seek to be indemnified, in whole or in part,by claiming that, although the Contractor was negligent inperforming the defective work, the Superintendent wasalso negligent in not detecting the defect and directing itsrectification before the work was covered over.

The argument would be that both the Superintendentand the Contractor owed a separate duty of care in tort tothe Principal and they breached their respective duties ofcare. Assume that a court finds the Contractor and theSuperintendentequally blameworthy, then the courtwouldorder that each pay half the damages incurred by thePrincipal. This would not apply where the Superintendentis an employee of the Principal (see Employees LiabilityAct 1991 (NSW)). Where the Superintendentis anemployeeofthe Principal, the reduction in damages referred to in the1965 Act would apply in lieu of the contribution under the1946 Act. It is one or the other - a contribution to damageson account ofconcurrent negligence by the Contractor andthe Superintendent (the 1946Act) or areduction in damageson account of the Principal's contributory negligence (the1965 Act).

Just as the Superintendent has no duty to assist theContractor, so too the Contractor has no duty to assist theSuperintendent. The prudent Superintendent will discusswith the Contractor the options for dealing with defectivework. However, the Contractor has no obligation to assistthe Superintendentor to suggest a solution. The Contractoris quite entitled to say, "Tell me what you want me to doabout the defective work." The Works are the Principal'sWorks. It is up to the Principal, not the Contractor, todecide what the Principal wants done about a defect.However, the Contractor does not necessarily have to waitfor an instruction. Pending an instruction from theSuperintendent, the Contractor may be able to rectifydefective work and thereby eliminate or minimise theContractor's liability for the breach of contract.

4. EstoppelEstoppel is a legal doctrine. Sometimes the law

prevents (estops) a person from relying upon a legal right.For example, if by words or conduct, an owner knowinglyallows a builder to carry out defective work, it may beunfair that the owner should be able to take action againstthe builder as a consequence of the breach. The owner isthen said to be estopped from enforcing the contractualobligation.

Take the case where a contract requires the builder tobuild a brick fence. Assume that in error the builder startsbuilding a paling fence. When the fence is half finished,the owner does an inspection. The breach is apparent. Theowner has the opportunity to tell the builder to rectify thebreach. If the owner says nothing, the owner wouldprobably be estopped from claiming that the builder hasbreached the contract by building a paling fence. Thebuilder is in breach of contract. But if the owner isestopped from relying upon the breach, the builder doesnot have to pay damages and the owner will have to pay thecontract price, perhaps without any deduction for the factthat a paling fence costs less to build than a brick fence (see

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9. Electing to accept defective work, example 2).The Superintendent is the Principal's agent. So far as

concerns the Contractor's rights, an inspection by theSuperintendent has the same effect as an inspection by theowner personally. Hence, whenever the Superintendentbecomes aware of a defect, the Superintendent must actquick!y. The Superintendentmustnotpermitthe Contractorto continue the breach. Otherwise, the Superintendentmay cause the Principal to forfeit the right to take actionagainst the Contractor.

This obligation to act promptly is reflected in clause30.5 of AS2124-1986, where it is provided that as soon aspracticable after the Superintendent becomes aware of adefect, the Superintendent must give a direction underclause 30.2 (remove defective work) or clause 30.3(variation to overcome defect) or a notice under clause30.4 (Principal accepts the defective work).

To avoid the possibility that the Principal will becaughtby the doctrine ofestoppel, the Superintendentmayhave to order that work orportion ofthe work be suspendedpending the making of a decision on rectification.

There is an easy way for the Superintendent to avoidthe possibility that the Contractor might allege that theSuperintendent delayed in giving a direction. Immediatelyon discovering defective work, the Superintendent shouldgive the Contractor a direction to remove it but theSuperintendent can add, "I am prepared to consider otheroptions, evenwithdrawing this instruction, ifthe Contractoroffers a satisfactory alternative by (date)".

5. Agreement to overcome defectThe Principal or, with the authority ofthe Principal, the

Superintendent on the Principal's behalf can negotiatewith the Contractor in an endeavour to make an agreementto overcome the problem caused by the existence of thedefective work.

The agreement may be as simple as that the Principalwill accept the defective work in place of the specifiedwork and the contract price will be reduced by an agreedamount. However, the agreement could be much moreinvolved. The Principal may agree to accept the defectivework in return for a warranty by the Contractor that thedefective work will last 20 years. The warranty may gofurther. The Contractor may agree that ifat any time in thenext 20 years, the item ceases to function properly, theContractor will replace it at no cost to the Principal.

Normally any actionby the Principal to recoverdamagesfor defective work must be commenced within 6 yearsafter the defective work is done (Limitation Act 1969(NSW)). However a warranty for a certain number ofyears can effectively extend thatperiod. Then the Principalhas 6 years to sue running from when the warranty isbreached.

The agreement may include provision of a bankguarantee as security for performance of the defectivework for a specified period. It may include provisions thatif the defective work causes the Contractor to be delayedin the performance of any other work or necessitates avariation to any other work, the Contractor will not be

=$400~.

=$375

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entitled to an extension of time or to any additionalremuneration on account of the delay or the variation. Thepossibilities are endless.

If the Principal voluntarily accepts defective workwithout any warranties, the Principal accepts the risks thatgo with the defective work. The Principal, or theSuperintendent on the Principal's behalf, must make surethat all implications have beenconsidered. Having'accepteddefective work, it will be very difficult to mount a claimbased on the fact that the work is more defective thananticipated or causes problems which were not anticipatedat the time of acceptance.

Sometimes the Contractor will give assurances that thedefective work will perform to a certain standard. If, inreliance on these assurances, the Principal accepts thedefective work, the Principal may have a claim against theContractor under section 52 of the Trade Practices Act formisleading and deceptive conduct should the assurancesprove wrong.

6. Rectification orderIf the Superintendent decides to order rectification of

a defect, the Superintendent must give a specific direction.A direction to "rectify work" is ambiguous. It could meandemolish and remove the defective work and replace itwith the work required by the contract. It could mean leavethe defective work there but patch it up. It could meanovercome the effect of the defect.

The Superintendent must be careful to leave noambiguity. The Superintendent must use words such as'remove that material from the site' or 'demolish thatwork' and 'then construct the work in accordance with therequirements of the contract' .

At the risk of liability for damages, the Contractoralways has the capacity to breach the contract. TheContractor can always refuse to remove defective work. Inthat event, it is up to the Principal to decide what action thePrincipal wants to take, for example taking work out of thehands ofthe Contractor, terminating the contract, or lettingthe defect remain and merely claiming damages. Theoption ofterminating the whole contract will not always beavailable.

7. Trifling defectThe law does not have regard to trifles. In law, a matter

which is 'de minimis' (trifling) will be ignored - treated asnot existing.

Sometimes a defect will be a mere trifle,inconsequential, ofno real detriment to the Principal. Butthe cost of rectifying it may be out of all proportion to thedetriment caused. For example a polished wood floor mayhave a slightblemish. To rectify the blemishmay necessitatesanding back and repolishing the floor. Nevertheless someover-zealous Superintendent may order the Contractor todo just that. The sensible Contractor will refuse to complywith the direction. The Principal cannot recover damagesfor a trifle.

The risk for the Principal and the Superintendent is thatthe Contractor may comply with the instruction and sue for

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the cost as a variation. The court or arbitrator may applythe de minimis rule - thereby ignoring the defect - and rulethat the direction to sand back andre-polishwas a variation.The court or arbitrator might find that the blemish was amere trifle which should be ignored. Then, ignoring it, thecourt or arbitrator would see the direction to sand back andrepolish as extra work ordered by the Superintendent.

8. Progress paymentsDefective work has no value under the contract. It is

not work under the contract. Therefore, on discovery of adefect, the Superintendent must never include in progressvaluations any amount for the defective work. In addition,the Superintendent should estimate the cost of rectifyingthe defect, e.g.· removing the defective work, and shoulddeduct that amount from the progress valuation. The truevalue of work done must reflect the cost of removingdefective work.

Assume that the contract requires the Contractor tobuild a fence 10m long and that the contract rates are $100per m. Assume that after the Contractor has built 5m theContractor requests a progress payment of $500. Assumethat the Superintendent inspects the fence and finds that thefirst metre is out of alignment. The Superintendent mustdecide whether the defect is such that this metre of fencewill have to be demolished. If the defective metre offencewill have to be demolished, the Superintendent mustestimate the cost of demolition. Assume it is $25. Theprogress valuation would then be:

4m@ $100Less estimated cost of demolitionProgress value

If the fence can be realigned at a cost of $25 withoutdemolishing any portion, then the valuation would be:

5m@ $100 = $500Less estimated cost of remedial work ~Progress value = $475

The Superintendent must not make the mistake of notmaking the. deduction because, in the opinion of theSuperintendent, the Principal holds sufficient security and·retention to cover the cost of rectification. Security andretention are to cover defects or defaults which have not yetbeen discovered, and other risks.

9. Electing to accept defective workMost forms of construction contracts ignore the

possibility of the Principal electing to accept defectivework. This is a shortcomingbecause, inpractice, acceptanceof defective work is quite common. In no form ofconstruction contract is there power for the Superintendentto accept defective work by way of a variation order.However, to overcome the shortcoming, the Superintendentfrequently purports to use a variation order to acceptdefective work. It is a mistake to do so.

Underclause 30.4 ofAS2124-1986 the Superintendentcan notify the Contractor that the Principal elects to acceptdefective work. The Superintendent would first need the

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authority of the Principal. That authority does not existmerely by reason ofthe fact that the Superintendenthas thepower to give the notice under clause 30.4 (see 2. Duties ofSuperintendent).

Voluntary acceptance of defective work entails quitedifferent consequences to involuntary acceptance ofdefective work. The Principal does not have to voluntarilyaccept any defective work but sometimes the Principal hasno choice but to accept defective work. That is involuntaryacceptance. Sometimes it is impossible to rectify thedefect or it would be economic waste to do so.

Voluntary acceptance of defective work does not givethe Principal a right to damages. The act of voluntarilyaccepting the defective work is usually a waiver of thebreach..A waiver of the breach extinguishes the breach. Itis no longer regarded as a breach. The Superintendent hasno power to order a variation retrospectively. For thosereasons, AS2124-1986 includes clause 30.4 to protect theinterests of the Principal. If the voluntary acceptance isunder clause 30.4, then under AS2124-1986 "the resultingincrease or decrease in the value to the Principal of theWorks and any other loss suffered by the Principal shall bevalued under clause 40.2". Clause 40.2 is the clausedealing with valuation of price adjustments generally.

Following are three examples of the implications ofaccepting or rejecting defective work.

Example 1A contractor builds a fence but out of alignment. The

Principal must elect between accepting the work-albeitthat it is defective-or rejecting the work. If the Principalelects to accept the fence then the Principalhas waived thebreach and has no right to damages. Unless the contractcontains clause 30.4 of AS2124-1986 or an equivalentprovision, the Principal must pay the full contract price.Under clause 30.4, the price payable by the Principal isadjusted to reflect the difference in value, if any, to thePrincipal of a fence which is out of alignment compared toa fence which is in aligned as required by the contract.

Ifthe Principal elects to reject the fence, the Contractoris then put to an election. The Contractor must electbetween rectifying the defect or not. Perhaps the defect issuch that it would not be necessary and reasonable for thePrincipal to rectify the defect if the Contractor fails to doso. In that event, the damages for which the Contractorwould be liable are the diminution in value of the fence asa consequence of it being out of alignment. Dependingupon the particular circumstances, this amount may benominal or considerably less than the cost ofrectifying thedefect. It may be more economic for the Contractor torefuse to rectify the defect.

If it is not necessary and reasonable for the Principal torectify the defect yet the Principal incurs the expense ofdoing so, the Principal would not be entitled to recover thatcost. This is because the law requires the Principal to takereasonable measures to mitigate (minimise) the Principal'sdamages.

On the other hand, if it is necessary and reasonable torectify the defect and the Contractor refuses to do so, the

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Principal can recover the cost of rectification as damages.

Example 2A Contractor builds a paling fence in lieu of a brick

fence as specified in the contract. The paling fence costs$1,000 to build compared with a cost of $3,000 to build abrick fence. The Principal must elect between acceptingthe paling fence or rejecting it. If the Principal elects toaccept the paling fence the Principal must pay a reasonableprice for the work - $1,000. Except where the election isunder clause 30.4 of AS2124-1986 or equivalent, thepayment does not increase the contract price - it is apayment outside the contract. If the construction contractcontains the usual variation clause, the Principal can varythe contract and omit the brick fence. That variation mayreduce the contract price by $3,000.

The Superintendent must never 'accept' the palingfence by a variation order. How can the Superintendentdirect the Contractor to build something that is alreadythere? Moreover, the contract provisions for variationscan result in anomalies. For example, the Contractor maybecome entitled to an extension of time for the additionalwork (a paling fence) and to prolongation costs. Mostcontracts do not include provision for reduction of thecontract period to reflect the omission of the brick fence.

Except in those contracts that contain clauses 30.3 and30.4 of AS2124-1986 or an equivalent, the Contractordoes not have to permit the Principal the right to elect toaccept the defective work. The Contractor can say, "Noyou cannot have the paling fence unless you pay me $2,000for it."

Example 3Taking the precedingexample, assume that the situation

was reversed, the Contractor builds a brick fence ($3,000)instead of a paling fence ($1,000). If the Principal electsto accept the brick fence, then, except where the electionis under clause 30.4 of AS2124-1986 or equivalent, thePrincipal must pay $3,000 for the fence.

Where the election is under clause 30.4 of AS2124-1986, there is an entirely different measure of the amountpayable by the Principal for the fence. The amount payableis the increased value, if any, to the Principal of the brickfence over a paling fence. If the Principal has alreadycontracted to sell the premises, or if the Principal has nointention of ever selling the premises, there may be noincreased value to the Principal. In that event, underAS2124-1986, the Contractor would receive the samecontract price even though it cost the Contractor threetimes more to build the brick fence.

If the Superintendent made the error of purporting todirect a variation 'accepting' the brick fence in lieu of thepaling fence, the Principal would have to pay $3,000 forthe brick fence - with a credit of$1,000 for the paling fencewhich is omitted from the work under the contract.

What should the Superintendent do? In contractswithout the equivalent ofclauses 30.3 and 30.4 ofAS2124-1986, the answer is for the Superintendent to tell theContractor as soon as the defect is discovered:

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"The Principal does not accept the brick fence. It is notwork under the contract. You must remove it and buildthe fence specified in the contract. However, thePrincipal is prepared to accept it on the followingconditions (e.g. price, warranties, no extension oftime,etc.). You may accept this offer by notice in writingdelivered to me by 5pm on (date)."

The Superintendent would need the prior authority ofthe Principal to make this offer on behalf of the Principal.

When the Principal elects not to accept the brick fence,the Contractor is in trouble. The Contractor has no rightunder the contract to payment of extra for the brick fence.It is not work ordered by the Principal. In rare cases, suchas where the Superintendent stood by, knowing that theContractor was building a brick fence instead of a palingfence, and said nothing, the Contractor may have a remedyin restitution based on the doctrine of unjust enrichment.The mere fact that the Principal is enriched by the error ofthe Contractor is not unjust. For unjust enrichment, theremust be some conduct on the part ofthe Principal which thelaw classifies as unjust. The Contractor's view, or even theview of a reasonable person of what is unjust, is irrelevant(see 10. Valuing involuntarily accepted defective work).

Assume the Contractor does not remove the brickfence as directed. Assume that it is not necessary orreasonable for the Principal to demolish the brick fence.Assume that there is an increase in value to the Principalof the Works ($3,000 - $1,000). Under AS2124-1986 orany other form of contract, the Contractor would not beliable for damages and the Principal could keep theadditional benefit without being unjustly enriched.

Now consider how different the situation would be ifthe Superintendent tried to regularise the situation byissuing a variation order. Now the Principal would have topay an extra $2,000 ($3,000 - $1,000) as the price of thevariation, and perhaps grant an extension of time. TheSuperintendent should never use a 'variation' in suchcircumstances.

Of course, the Principal and the Contractor may agreethat the Principal will accept the defective work. They mayagree upon a price at which the Principal will accept thedefective work. But sometimes, particularly ifthe Principalis in a hurry to occupy premises or the rectification woulddelay other contractors to the Principal, the Principal willwant to be able to accept defective work whether or not theContractor wants to hand it over. Then clause 30.4 ofAS2124-1986 can be most useful. Generally speaking,unless agreement is reached between the Principal and theContractor on the adjustments to be made to price,warranties, etc., the Principal is better advised not tovoluntarily accept defective work.

10. Valuing involuntarily accepted defectivework

If the Principal involuntarily accepts defective work,then it is aquestionofquantifying the Principal's entitlementto damages for breach ofcontract. That entitlement can beeither:

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(1) estimated or actual cost of rectification; or(2) diminution in value.

Involuntary acceptance may occurwhere the Contractorrefuses to rectify a defect when directed to do so, or wherethe Principalleams of the defect when it is too late to orderrectification.

The courts have developed some tests to determinewhether the Principa1.should be entitled to rectificationcosts and when the Principal should be confined todiminution in value (see Belgrove v Eldridge (1954) 90CLR 613). Rectification costs can sometimes exceed byfar the diminution in value. For example, the Contractormay install pvc pipes where steel pipes were specified.The cost of excavating and replacing the pipes may be outofall proportion to the loss, ifany, suffered by the Principalby reason of the breach. The usual test in Australia iswhether rectification is 'necessary' and 'reasonable'(Belgrove vEldridge (1954) 90 CLR 613). Ifrectificationis unnecessary and unreasonable, the Principal may beconfined to such diminution in value of the Works as thePrincipal can prove.

Even where the. substitution is deliberate, generallyspeaking, the· Principal is confined to recovering the losssuffered by the Principal rather than the saving made by theContractor. The importance is in the word "recovering".If the Principal has not paid the Contractor, the Principalcannot be compelled to pay the contractor for work whichthe Principal did not order. The Principal is not bound topay for the defective work. But having paid for it, thePrincipal is confined to one of two remedies, rectificationcosts or diminution in value. For this reason, it is mostimportant that the Superintendent carefully inspects workbefore including a value in a certificate.

There are three· exceptions to the statement that thePrincipal cannot be compelled to pay the Contractor forwork which the Principal did not order. The first is wherethe Principal is estopped from denying that the Principalordered the work. See 4. Estoppel. The second is wherethe Contractor has a right to payment outside the contract.Sometimes a Contractor has a right to 'restitution' basedon the doctrine of 'unjust enrichment'. The third is wherethe works are substantially complete.

The term 'restitution' is a legal term. By way of'restitution', a court or arbitrator may award a contractora 'quantum meruit'. That is, a reasonable price for workdone. Examples of where a contractor might recover aquantum meruit are:

1. Where on the express or implied instructions of thePrincipal or the Superintendent, the Contractorperforms additional work outside the contract(Update Constructions Pty Ltd v Rozelle ChildCentre Ltd (1991) 20 NSWLR 251);

2. In an emergency, the Contractor performs workwhich is outside the contract but benefits thePrincipal by preserving property of the Principalfrom damage (agency ofnecessity - Goff & Jones,The Law ofRestitution, 4th ed. Sweet & Maxwell,London, 1993);

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3. The contract is terminated by frustration but workcontinues (Codelfa Construction Pty. Ltd. v StateRail Authority (1982) 149 CLR 337);

4. The Principal voluntarily accepts defective work(free acceptance - Goff & Jones, above p.166);

5. The Principal repudiates the contract and theContractor elects to treat the contract as at an end(Renard Constructions (ME) Pty Ltd vMinisterforPublic Works (1992) 26 NSWLR 234).

In each of these instances, the Principal could be saidto be unjustly enriched if the Principal failed to pay for thevalue of work received. The right to restitution is a rightwhich exists outside the contract. Ifthe contract covers thesituation, either by providing that the Contractor is entitledto be paid or that the Contractor is not entitled to be paid,then there is no unjust enrichment. Enrichment pursuantto a contract is not unjust enrichment. The doctrine ofunjust enrichment does not override the law of contract. Itfills a gap not covered by a contract.

The doctrine of 'substantial completion' works asfollows. If the Works are substantially complete and thePrincipal has the use of them, then even though there aredefects, the Principal must pay the contract price less anamount which equals the damage suffered by the Principalby reason of the defects. The damage suffered by thePrincipal will be the cost of rectifying the defects or, if itis not necessary and reasonable to rectify the defects, thediminution in value of the Works as a consequence of thedefects.

11. Variations to overcome a defeetWhen the Superintendent detects that the Contractor is

performing defective work, it may be more expeditious tolet the Contractor finish than to order that the Contractorremove the defective work and start again.

Take the case where the Contractor is building a highrise building. The Contractor may have built a concrete liftshaftwhen the Superintendentdiscovers that the dimensionsof the shaft are smaller than specified but only by a fewcentimetres which are nevertheless enough to require avariation in the dimensions ofthe lift. The cost ofrectifyingthe lift shaft may be out of all proportion to the cost ofvarying the dimensions of the lift, say $10,000.

Under AS2124-1986, the Superintendent would givethe Contractor three separate directions, which can becombined in the one document. They are:

(1) a notice under clause 30.4 that the Principalelects to accept the lift shaft already constructed,notwithstanding that it is not in accordance withthe Contract;

(2) a variation under clause 30.3 omitting thespecified lift shaft which is now replaced by the'defective' lift shaft;

(3) a variation under clause 30.3 changing thespecified dimensions for the lift so that it fits thelift shaft accepted by the Principal.

Under AS2124-1986, there are three separate sources

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of power to order a variation. They are sections:[1] 30.3 - a variation to overcome a defect;[2] 40.1, para 2 - a variation for the convenience of

the Principal;[3] 40.1, para 6 - a variation for the convenience of

the Contractor.

Under AS2124-1986, the Principal would not have topay the Contractor anything for the variation. Clause 30.3of AS2124-1986· provides that a variation under clause30.3 "shall be valued under clause 40.2 and-

(a) if the variation causes an increase or decrease inthe value to the Principal of the Works, regardshall also be had to the increase or decrease; and

(b) ifthe variationresults in the Contractor incurringmore or less cost than would reasonably havebeen incurred had the Contractor been given adirection under Clause 30.2, regard shall also behad to the difference."

However, under forms of construction contract in usein Australia, except those that have copied AS2124-1986,only the second type of variation is provided. Theconsequence is that ifthe Superintendent orders avariationto the lift dimensions, the Contractor will be entitled underthe contract to the additional cost of the variation ($10,000in the example) and an extension of time.

The Principal might argue that the cost of the variation($10,000) is damages flowing from the defective work.The problem with that argument is that $10,000 is notpayable by the Principal on account of the Contractor'sbreach. The breach has not caused the Principal to be liableto pay $10,000. The Principal is liable to pay because thePrincipalwas naive enoughto promise withoutqualificationto pay the Contractor for variations ordered by theSuperintendent. The Principal did not limit the Principal'srisk by imposing the qualification that the variation mustnotbe onenecessitatedby defective workby the Contractor.

Standard forms which fail to provide for thiscontingency come in for trenchant criticism in Hudson'sBuilding Contracts 11th ed., Sweet & Maxwell, London1995 p.881. AS2124-1986 covers the problem in clause30.3.

12. ConclusionThe best summary is the following instruction to the

Superintendent:1. If you discover defective work act promptly.

Don't rely on the Contractor. The Contractor isnot bound to come up with any proposals andmay recover delay costs from the Principal ifyou delay in giving a direction.

2. You don't have to tell the Contractor how toremedy the defect but your direction must bespecific. Don't say "rectify". Say exactly whatmust be demolished or what repair work mustbe done.

3. Don't accept defective work unless you havethe Principal's authority.

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4. Ifyou accept defective work, do so under either:(a) acollateral agreementbetween the Principal

and the Contractor; or(b) ifthe conditions are AS2124-1986, a notice

under clause 30.4.

Otherwise, voluntary acceptance may act as awaiver· by the Principal of rights against theContractor or may result in the Principal beingliable to pay the Contractor the cost ofexecutingdefective work.

5. Never include the value of defective work inany progress or final valuation. Once defectivework is voluntarily accepted, it ceases to bedefective work and it has a value.

6. Never use a variation order to accept defectivework.

7. Frequently, if you accept defective work, youmust order a variation omitting the specifiedwork which is replaced by the defective work.Sometimes subsequentwork must also be variedto take account of the defective work. UnderAS2124-1986, that variation should be underclause 30.3.

8. Under AS2124-1986, accepted defective workand variations consequent on a defect are valueddifferently to normal variations. The valuationunderclause 30.3 and 30.4must take into accountthe value to the Principal rather than the cost tothe Contractor.

9. Under other forms of contract, the ordering of avariation to overcome a defect may be costly forthe Principal. The variation should not beordered without exploring all the implicationsand alternatives.

10.Under other forms of contract, acceptingdefective work otherwise than under a collateralcontract is fraught with risk for the Principal. 0

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