Australia: Adjudicator's deficient reasoning amounts to failure to exercise jurisdiction under Security of Payment Act

In brief - Supreme Court of NSW overturns adjudication determination in State Water v Civil Team

The recent Supreme Court of NSW decision in State Water Corporation v Civil Team Engineering Pty Ltd [2013] NSWSC 1879 is an important reminder that a court will not uphold an adjudication determination if the reasoning process is so deficient that it amounts to a failure on the part of the adjudicator to exercise the jurisdiction given to him under the Building and Construction Industry Security of Payment Act 1999 (NSW) (SOP Act).

Water supplier enters contract with engineering company to construct fishway

On or about March 2010, State Water Corporation entered into a contract with Civil Team Engineering Pty Ltd pursuant to which Civil Team agreed to construct a fishway (ie. a structure facilitating the migration of fish on or around barriers such as dams or weirs). Throughout the course of the contract, Civil Team suffered extensive delays to the works due to flooding.

State Water rejects payment claim from Civil Team

On or about 18 February 2013, Civil Team served a payment claim under Section 13 of the SOP Act for costs, expenses and losses suffered as a result of delays due to flooding preventing access to, or performance of works on the site.

On or about 20 February 2013, State Water responded to Civil Team's payment claim by sending a letter proposing to pay $4,528.42 (inclusive of GST) to Civil Team. This letter consisted of only three sentences, assessed a number of issues raised and noted that "Issues Nos 117 & 118 are still being assessed".

On 22 February 2013, State Water sent a letter to Civil Team explaining that it rejected Civil Team's payment claim as it was based on the premise that a flood is a latent condition, which was specifically excluded under clause 12.1 of the contract.

First adjudication awards small payment to Civil Team

Civil Team lodged an adjudication application.

State Water lodged an adjudication response which set out a number of submissions for non-payment that directly or indirectly related to the proper construction of clause 12 of the contract.

During the adjudication process, the adjudicator, relevantly, made requests for further submissions regarding the interpretation of clause 12 of the contract, which Civil Team and State Water duly provided.

On 8 April 2013, the adjudicator issued an adjudication determination, awarding an amount of $4,528.42 to Civil Team, rather than the amount it sought of $5,028,436.65 ("the first adjudication determination").

Civil Team awarded payment for shortfall in insurance cover

On 18 June 2013, Civil Team served a payment claim on State Water for an amount of $6,333,553.76 (inclusive of GST).

Relevantly, as a variation to the contract, State Water instructed Civil Team to obtain a policy of insurance for the works. Civil Team included in the claimed amount a claim for $443,552.40 (inclusive of GST) for costs or loss as a result of damage caused by flooding incurred above and beyond what was covered in the insurance policy (ie. not the actual cost of obtaining the policy itself, but rather the shortfall in indemnity provided by the insurer).

On 1 July 2013, State Water responded with a payment schedule. Relevantly, in respect of Civil Team's claim for $443,552.40, State Water certified an amount of $Nil.

On 17 July 2013, Civil Team served an adjudication application on State Water.

The adjudicator issued an adjudication determination awarding Civil Team the amount of $443,552.20 (inclusive of GST) ("the second adjudication determination").

State Water and Civil Team file claims against one another in Supreme Court of NSW

State Water filed a claim against Civil Team in the Supreme Court of NSW in relation to the second adjudication determination. State Water contended that:

• There was an issue estoppel (i.e. where an issue has been decided in earlier proceedings, a party cannot raise it in later proceedings);
• There was a denial of natural justice by the adjudicator; and / or
• The adjudicator did not act in good faith.

State Water sought either a declaration that the second adjudication determination was void and further (or in the alternative), an order in the nature of certiorari pursuant to Section 69 of the Supreme Court Act 1970 (NSW) quashing the said purported adjudication determination.

Civil Team (unusually) filed a cross claim against State Water, contending that the first adjudication determination was void and should be quashed on the basis that the adjudicator committed jurisdictional error and failed to afford Civil Team natural justice.

Court rules that first adjudication determination should stand

Civil Team attempted to argue that the adjudicator took into account submissions that were not "duly made", being submissions made by State Water in its adjudication response as to the proper construction of clause 12.

The court held that even though it was not raised as a reason in the payment schedule, the adjudicator was entitled to consider it as it related to the proper construction of the contract, being an express matter that the adjudicator is to take into account.

Further, the adjudicator was entitled to consider the submissions as he had requested submissions on clause 12.

The court ultimately held that the first adjudication determination should stand.

State Water challenges second adjudication determination

State Water challenged the second adjudication determination on the basis that:

• The adjudicator's construction of clause 12 was inconsistent with the construction given in the first adjudication determination. Thus, there was an issue estoppel.
• There was a denial of natural justice as the adjudicator reached the determination on the basis of three conclusions in breach of procedural fairness.
• The adjudicator did not act in good faith in exercising the powers conferred on him by the SOP Act, that is, the adjudication determination was devoid of the reasoning process required by the SOP Act.

No issue estoppel as adjudicator reached determination independently of clause 12

The first adjudication determination held that flooding was excluded from the definition of latent conditions and hence, did not allocate the risks associated with flooding upon State Water. However, the second adjudication determination held the exact opposite.

The court referred to the principle in Blair v Curran [1939] HCA 23; (1939) 62 CLR 464 that an issue estoppel will only arise from a previously decided issue of fact or law if that decided issue was a necessary component of the reasoning process leading to the conclusion reached.

The court reviewed the adjudicator's reasoning process and held that the ultimate conclusion was reached purely on the basis of the adjudicator's understanding of the effect of the insurance variation under clause 40, independent of the meaning of clause 12. The meaning of clause 12 was not germane to the adjudicator's reasoning. Thus, there was no issue estoppel.

Was there a breach of natural justice by the adjudicator?

State Water argued that there was a denial of natural justice on the basis that, in reaching three of his conclusions, the adjudicator did not identify the "understandings" upon which he relied in reaching his conclusions, the conclusion was not advanced by either party and/or the adjudicator did not notify State Water of his proposed conclusion.

In determining whether there was a breach of natural justice by the adjudicator:

• the court must first determine whether "the matter about which the adjudicator did not provide an opportunity to be heard was a point upon which the adjudicator based his or her decision and was significant to the actual determination": John Holland Pty Ltd v TAC Pacific Pty Ltd [2009] QSC 205; [2010] 1 Qd R 302 per Applegarth J at [40]; and
• "[t]he reasons under challenge must be read as a whole. They must be considered fairly. It is erroneous to adopt a narrow approach, combing through the words of a decision-maker with a fine appellate tooth-comb, against the prospect that a verbal slip will be found warranting the inference of an error of law": Maxstra NSW Pty Ltd v Blacklabel Services Pty Ltd [2013] NSWSC 406 per Rothman J at [77].

Applying the above principles, the court held that there was no denial of natural justice as:

• The "understandings" upon which the adjudicator relied in reaching his conclusions were clearly mentioned in Civil Team's payment claim and adjudication application.
• It was open for the adjudicator to make the inference on the basis of the content of the adjudication application and regardless, this was not part of the reasoning process that led to his ultimate conclusion. It was not germane to the adjudicator's reasoning.
• The adjudicator's conclusion, when read in context of the balance of the determination and the facts given to the adjudicator, was an inference that was capable of being appropriately drawn on the material made available to the adjudicator.

Adjudicator did not act in good faith

State Water successfully challenged the second adjudication determination on the basis that the adjudicator did not act in good faith in exercising the powers conferred on him by the SOP Act. That is, the adjudication determination was devoid of the reasoning process required by the SOP Act.

In determining what constituted sufficient reasoning, the court examined the following principles:

• that the determination should give intellectual justification for the decision that was made and should involve a process of consideration or reasoning: Bauen Constructions v Westwood Interiors [2010] NSWSC 1359 per McDougall J at [40]; and
• a decision based on illogical reasoning is treated as a failure to exercise jurisdiction: Chase Oyster Bar Pty Ltd v Hamo Industries Pty Ltd [2010] NSWCA 190; (2010) 78 NSWLR 393 per McDougall J at [177].

In this case, there was no logical explanation as to why or how the variation operated to require State Water to pay the shortfall in insurance coverage. State Water was required to pay for the procurement of insurance, not shortfalls in indemnity.

Applying these principles, the court held that the adjudicator's reasoning process was so deficient that the adjudicator did not act in good faith and failed to exercise the jurisdiction given to him under the SOP Act.

The court ultimately declared the second adjudication determination void.