The recent decision of the Supreme Court of New South Wales in Donau Pty Limited v ASC AWD Shipbuilder Pty Limited [2018] NSWSC 1273 considered, amongst other things, whether a contract was validly terminated.

ASC AWD Shipbuilder Pty Ltd agreed to build the Commonwealth three air warfare destroyer ships. ASC entered into a subcontract with Donau Pty Limited, formerly known as Forgacs Engineering Pty Ltd, for the construction of certain parts of the hull on each ship. Due to a large number of design changes the subcontract ceased to operate effectively.

Consequently, ASC and Forgacs negotiated a “contract refresh” which culminated in a Second Heads of Agreement (2HA). Relevantly, Clause 4.1(a) of the 2HA provided that if the parties had not agreed to certain elements related to the works (the Baseline True Up) by 28 February 2013, ASC may terminate the 2HA on written notice. While the Baseline True Up was not agreed by 28 February 2013, the parties continued to negotiate. No agreement was ultimately reached and in June 2013, ASC served a notice purporting to terminate the 2HA.

Forgacs disputed ASC’s purported termination on two grounds. First, Forgacs contended that by complying with the procedures of the 2HA and exercising its rights to personnel integration and steel storage under the 2HA, ASC made an election that was consistent with an affirmation of the 2HA, such that the right to terminate no longer existed. Secondly, Forgacs submitted that the right to terminate was subject to an implied limitation that it be exercised within a reasonable time, and ACS failed to do so.In finding that the 2HA was validly terminated, Ball J held that:

•   a party is able to act in a way which is compliant with the contract whilst also reserving its position as to an inconsistent contractual right (such as the right to terminate) without an unequivocal election being made;
•   there was an implied term that the contractual right to terminate must be exercised within a reasonable time period; and
•   what constitutes a reasonable time for the performance of such a right is a question of fact dependent on the context in which the right arises and the circumstances of each case.

Of note, Ball J considered it significant that:

•   after 28 February 2013, both parties proceeded on the same basis as they had prior to the relevant date while the Baseline True Up negotiations continued;
•   ASC did not insist on compliance with the procedures set out in the 2HA; and
•   Forgacs was not prejudiced by the delay.

This decision serves as a reminder that parties should be mindful of their conduct when exercising a contractual right to terminate. If an election to affirm the contract is made or the termination right is not exercised within a reasonable time period, parties may find that their purported termination is ultimately invalid.

The full decision can be found here.