A J Lucas Drilling Pty Ltd v McConnell Dowell Constructors

2 On 29 August 2008, Byrne J gave judgment for the plaintiff, A.J. Lucas Drilling Pty Ltd ("Lucas") in the sum of $1,900,194.45. In addition to giving judgment for that amount, his Honour ordered the defendant, McConnell Dowell Constructors (Aust) Pty Ltd ("McDow") to pay Lucas' costs of the proceeding.[1]

3 On 18 December 2009, this Court (constituted by Redlich JA, Dodds-Streeton JA and Beach AJA) dismissed Lucas' appeal and allowed McDow's cross-appeal. As a result of allowing McDow's cross-appeal, the order made by Byrne J on 29 August 2008 was varied by substituting for the sum $1,900,194.45, the sum of $472,440.29.

4 Upon the pronouncement of the Court's orders in relation to the appeal and the cross-appeal, counsel for McDow indicated that there had been an offer of compromise made on 4 September 2007 ("the offer of compromise"), and that as a result of the offer of compromise, McDow would seek to have the order for costs made by Byrne J varied.

5 Neither side was prepared to argue the question of costs on 18 December 2009. Both sides wished to file written submissions and supporting material before being given the opportunity to advance oral argument on the question of costs. Upon the parties' being advised of the then imminent resignation of Dodds-Streeton JA from this Court, both sides consented to the issues of costs which were then outstanding being determined by a Court constituted by the remaining members of the Court as presently constituted.

6 Subsequently, written submissions and supporting material were filed by the parties and the matter came on for hearing today.

7 Before dealing with the offer of compromise and the arguments, it is necessary to say something about the form of the written submissions filed in relation to costs. On 18 December 2009, we gave leave to the parties to file outlines of submissions limited to three pages each. In breach of both the letter and spirit of what we said, the parties filed material as follows:

(a) McDow's original submissions on costs (three pages, together with three pages of attachments);

(b) Lucas' original submissions (five pages, together with 110 pages of attachments);

(c) McDow's reply submissions (three pages, together with seven pages of attachments);

(d) Lucas' rejoinder submissions (three pages, together with five pages of attachments).

8 We had anticipated that in an appeal occupying 19 volumes of appeal book printed on both sides of the page, 750 words would have been more than adequate for each party to outline its submissions on costs. That is the maximum amount of words each party would have had if there had been compliance with r 27.03 as to margins, legibility and double spacing. Instead, the parties chose to deliver documents containing thousands of words of submission. Resort was had to single spacing and reducing font size in order to achieve this end. In addition there were extensive footnotes in even smaller font, the footnotes often containing the most critical assertions of fact.

9 It is conduct of this kind that has caused some overseas jurisdictions to impose word limits, rather than page limits, on parties' submissions. No leave was given to the parties to do anything other than file one three page outline of submissions prepared in accordance with the rules. It would be different if the provision of the extra material (by way of additional documents, single spacing and reducing print size) had been of assistance to the Court. However, this was not the case - and in any event, there was no warrant for the parties disregarding the terms of the leave given to them on 18 December.

10 The offer of compromise was in the following terms:

McConnell Dowell Constructors (Aust) Pty Ltd offers to compromise the claims made against it by the Plaintiff and its counterclaims against the Plaintiff in these proceedings ("the claims") on the basis that:

1. McConnell Dowell Constructors (Aust) Pty Ltd pay to the Plaintiff the sum of $4,000,000 (four million dollars) (exclusive of Goods and Services Tax) within 30 days of acceptance of this offer in full and final settlement of the claims.
2. This offer of compromise is exclusive of any Goods and Services Tax. To the extent that any supply made upon or in connection with acceptance of this offer is a taxable supply, the GST-exclusive consideration otherwise to be paid or provided for that taxable supply is increased by the amount of any GST payable in respect of that taxable supply and that amount must be paid at the same time and in the same manner as the GST-exclusive consideration is otherwise to be paid or provided. A party's right to payment under this clause is subject to a valid tax invoice being delivered to the recipient of the taxable supply.
3. This offer of compromise is served in accordance with Order 26.02 of the Supreme Court (General Civil Procedure) Rules 2005 and is open to be accepted by the Plaintiff for a period of fourteen days after service.

11 The judgment sum below was calculated as follows:

Interest on $3,672,925.00 from 23 September 2003 to 12 October 2007 at penalty interest rate applicable from time to time

Interest on $1,426,281.33 from 13 October 2007 to 8 August 2008 at penalty interest rate applicable from time to time

Interest on $25,000 from 23 September 2003 to 29 August 2008 at penalty interest rate applicable from time to time

12 The sum of $1,900,194.45 was varied on appeal to $472,440.29 because, in our judgment, interest was only payable from 5 February 2007, rather than from 23 September 2003 as allowed by the trial judge.

13 McDow submits that the trial judge ordered it to pay the amount of $3,697,925 exclusive of GST. The dismissal of Lucas' appeal means that there was no alteration to this figure. McDow then submits that interest at the rate prescribed under s 2(1) of the Penalty Interest Rates Act 1983 for the 212 days from 5 February 2007 until the service of the offer of compromise produces the figure of $257,740.31. When $3,697,925 is added to $257,740.31, the figure of $3,955,665.31 is produced. McDow submits that this figure, being less than $4 million, means that the plaintiff obtained a judgment that was not more favourable than the terms of the offer of compromise. McDow then relies upon Rule 26.08(3) of the Supreme Court (General Civil Procedure) Rules 2005. Rule 26.08(3) provides:

Where an offer of compromise is made by a defendant and not accepted by the plaintiff, and the plaintiff obtains a judgment on the claim to which the offer relates not more favourable to the plaintiff than the terms of the offer, then unless the Court otherwise orders -

(a) the plaintiff shall be entitled to an order against the defendant for the plaintiff's costs in respect of the claim up to and including the day the offer was served taxed on a party and party basis; and

(b) the defendant shall be entitled to an order against the plaintiff for the defendant's costs in respect of the claim thereafter taxed on a party and party basis.[2]

14 As a result of the operation of r 26.08(3), McDow seeks to have the costs order made on 29 August 2008 varied as follows:

(a) McDow pay Lucas' costs of the claim and counterclaim up to and including 5 September 2007, to be taxed on a party and party basis;

(b) Lucas pay McDow's costs after 5 September 2007, to be taxed on a party and party basis.

15 However, in addition to relying upon r 26.08(3), McDow seeks to have its costs subsequent to 7 December 2007 paid on a solicitor/client (or indemnity) basis. The foundation for this submission is Lucas' conduct of the trial following 7 December 2007. McDow categorises Lucas' conduct of the trial from that time as being "in obdurate disregard of the trial judge's reasons [earlier delivered]".

16 Lucas submits that the trial judge's order that McDow pay Lucas' costs of the proceeding should be upheld. Alternatively, Lucas contends that the costs order below should be varied so that McDow pay Lucas' costs of Lucas' claims up to and including 5 September 2007 and the cost of McDow's counterclaim, to be taxed on a party and party basis; and the parties bear their own costs of Lucas' claims after 5 September 2007.

17 Lucas first seeks to resist McDow's application for costs from 5 September 2007 on the ground that the judgment as varied by this Court is still more favourable than what was offered in the offer of compromise. Lucas contends that when one adds the amount of $3,672,925 (as assessed by the trial judge), the amount for interest to the time of the offer of compromise ($257,740.31[3]) and the amount allowed by his Honour for GST ($367,292.50), one arrives at a total of $4,322,957.81. Lucas then submits that the offer of compromise was $4 million plus an indemnity for the GST amount referred to in paragraph 2 of the offer of compromise, if payable. Lucas asserts that as no such GST amount was payable, the offer was $4 million, which is less than the amount of judgment as varied by this Court.

18 Lucas submits that no GST amount of the kind referred to in paragraph 2 of the offer of compromise was payable for the following reasons:

The indemnity for GST in paragraph 2 of the Offer relates to "any supply made upon or in connection with acceptance of this offer [that] is a taxable supply". This would appear to have been intended to capture so-called "discontinuance supplies" as referred to by the Australian Taxation Office (ATO) in GST Ruling GSTR 2001/4 (GST Ruling), at paragraphs 50 to 55. While that is a "supply" for GST purposes, the ATO confirms that "[w]here the only supply (other than a 'discontinuance' supply) in relation to a court order or out-of-court settlement is an earlier supply and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that [earlier] supply" (at paragraph 101). Here the earlier supply to which the Offer relates is the supply of services by Lucas to McDow pursuant to the Contract and for which it was entitled to payment pursuant to clause 24.4. It follows that any discontinuance supply constituted by offer and acceptance of the Offer would not meet the description of a "taxable supply" because there is no consideration for that supply as required by section 9-5(a) of the A New Tax System (Goods and Services Tax) Act 1999. Clearly, the indemnity for GST in paragraph 2 does not, on its terms, apply to the GST in respect of the "earlier supply" because it does not meet the description of a "supply made upon or in connection with acceptance of this offer". Rather, the earlier supply clearly preceded the Offer and was made in connection with the obligations assumed by Lucas pursuant to the Contract.

The correctness of this analysis was the subject of dispute before us.

19 Lucas resists McDow's application for a variation of the costs order below on other grounds which concern the existence of McDow's counterclaim, the changing and evolving issues at and about the time of offer of compromise and alleged uncertainties in relation to the offer of compromise and the Court's discretion in any event to "otherwise order".

20 Central to the resolution of the costs issues before us is the question of whether Lucas obtained a judgment not more favourable to it than the terms of the offer of compromise. However, before we turn to this issue, it is necessary to analyse paragraph 2 of the offer of compromise in relation to any underlying liability for GST.

Paragraph 2 of the offer of compromise and GST

21 As is explained by the Australian Taxation Office in its Goods and Services Tax Ruling GSTR 2001/4 - Goods and Services Tax: GST consequences of court orders and out-of-court settlements (12 November 2008), there are two possible supplies that might relate to a settlement brought about by the sub-contract and any settlement that might have been achieved by the acceptance of the offer of compromise. First, there is what the GST ruling describes as an "earlier supply". An example of an earlier supply is given in paragraph 47 of the GST Ruling as follows:

47. Widget Company supplies toys to a retailer. A dispute between the parties over payment for the toys is subsequently resolved through an out-of-court settlement, with the retailer paying all monies owed. The supply of the toys, that is the subject of the dispute, is an earlier supply because it occurred before the dispute arose.

22 Secondly, there might be what the ruling refers to as a "discontinuance supply". In the present case, the discontinuance supply would be a release by Lucas Drilling of McDow from further obligations in relation to the dispute between them.

23 In order for GST to be payable on a supply, the supply must be made for consideration. That is, there must be a nexus between the supply and the consideration. So far as earlier supplies are concerned, paragraph 101 of the GST Ruling provides:

101. Where the only supply (other than a 'discontinuance' supply[4]) in relation to a court order or out-of-court settlement is an earlier supply and a sufficient nexus exists between the payment made under that order or settlement and the earlier supply, the payment will be consideration for that supply.

24 So far as discontinuance supplies are concerned, paragraph 109 of the GST Ruling provides:

109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

25 In our view, the language of paragraph 2 of the offer of compromise is suggestive of an indemnity in respect of a discontinuance supply which, if the offer of compromise had been accepted, would have come into existence upon the acceptance of the offer of compromise. However, McDow contends that by using the words "in connection with" in paragraph 2 of the offer of compromise, the offer of compromise was also an offer to indemnify in respect of GST payable on the earlier supply. Against this, it is to be noted that nowhere in paragraph 2 of the offer of compromise is there any express reference to a GST liability in relation to the earlier supply.

26 In our view, there are good grounds for considering that the offer to indemnify was only an offer in respect of a GST liability (if any) on the discontinuance supply. Further, there are good grounds for thinking that because Lucas' case was not "so lacking in substance" that there would not have been any GST liability in respect of the discontinuance supply. Whilst McDow's submission that the words "in connection with" are words of wide import which can extend to both prior and subsequent events is correct so far as it goes, it is at least curious that McDow did not offer an indemnity in terms for the earlier supply - if that is what McDow intended should be covered by the offer of compromise. Having read paragraph 2 of the offer of compromise, we are left with the impression that McDow was attempting to have a bit each way. That is, McDow offered an indemnity that might be capable of being construed so as to cover any GST liability for the earlier supply - but which was also capable of being held to have a more limited effect (an indemnity for a discontinuance supply which did not attract GST).

27 In any event, there was a real lack of clarity about what was being offered in clause 2 of the offer of compromise. Scope existed for McDow to contend that if there was a GST liability, then it was in respect of the earlier supply and the indemnity given by paragraph 2 was only in respect of a discontinuance supply, in respect of which there was no GST liability.

The judgment and the offer: which is more favourable?

28 In our judgment on the appeal, we set out clauses 3, 13, 14 and 24 of the sub-contract between the parties. GST was provided for in clause 15 of the sub-contract. Clause 15 provided:

15. Goods and service tax and value added tax

15.1 Any reference to the Sub-Contract Sum or any part thereof shall be regarded as such sum exclusive of any goods and services tax, value added tax or tax of a similar nature (hereinafter called the "Taxes").

15.2 MacDow shall pay or reimburse to the Sub-Contractor any Taxes chargeable on the supply by the Sub-Contractor to MacDow of any goods and services under this Sub-Contract and the Sub-Contractor's Progress Statement and Final Statement shall set out any Taxes payable.

29 The trials below on liability, quantum and loss of profits and costs respectively[5] proceeded on the basis that GST was payable on whatever principal sum was assessed as the value of the work done. The only issue concerning GST in the trials below was in relation to interest. No interest was ordered to be paid on the GST determined by the trial judge because Lucas had not actually paid any such tax.[6]

30 Having regard to the terms of the sub-contract and the way in which the trials were conducted below, it is perhaps surprising that McDow did not merely make an offer of compromise of $4,400,000. One asks what would have been the effect of the offer of compromise if Lucas had accepted it. The possibility of a dispute between the parties is obvious. No doubt, McDow would have contended that it was obliged to pay $4 million plus the further sum referred to in paragraph 2 of the offer of compromise if Lucas could establish that it had a liability in respect of such a sum. On the other hand, one might have expected Lucas to require $4,400,000 to be paid pursuant to the terms of the offer of compromise without any further discussion. That is the position which appears to have pertained to the running of the trials (that is, GST of 10% was simply to be added to whatever the value was of the sub-contract works).

31 No doubt, McDow framed the offer of compromise in the hope that if it was accepted, then McDow might only have to pay $4 million. The uncertainty of whether McDow might have to pay $4 million or $4,400,000 (or perhaps even some other amount) means that it is not possible to say whether the judgment (as varied by this Court and taking into account interest only up to the date of the offer of compromise) of $4,324,173.56[7] or $4,322,957.81[8] is not more favourable to the plaintiff than the offer of $4 million with a potential for the payment of a further sum of $400,000.

32 In Duncan & Weller v Mendelson,[9] Kaye J[10] said[11] an offer of compromise ought not leave an offeree in any reasonable doubt about the consequences of its acceptance. Further, the terms of an offer of compromise should be reasonably certain.[12] In the present case, the terms of paragraph 2 of the offer of compromise are not reasonably certain. In our view, they could only have left Lucas in (at best for McDow) some doubt about the consequences of the acceptance of the offer.

33 It is not necessary for us to definitively rule on the validity or otherwise of the offer of compromise. It is sufficient to say, for the reasons we have already given, that it is not possible to say that the judgment to which Lucas is now entitled is not more favourable than the offer of compromise. It follows that r 26.08(3) has no application in this case.

34 Even if the offer of compromise was certain so as to enliven r 26.08, Lucas submits that the court should exercise its discretion not to alter the order for costs made in its favour by the trial judge. It submits that it could not make a proper assessment of the offer when it was made because there was specific uncertainty as to McDow's defences and the facts that it intended to contest.

35 At the time of the offer of compromise, the proceeding between McDow and BHP Billiton, which was to be heard at the same time as the Lucas proceedings, was settled. Until then, McDow had alleged that the subcontract with Lucas had been terminated because of breach by Lucas, and McDow had sought damages from Lucas and an indemnity against any liability it had in the BHP Billiton proceeding.

36 As a result of the settlement of the BHP proceeding and a further amendment of the statement of claim, McDow advised that it would be necessary to amend its defence and its counterclaim, possibly including further or different claims in response. On 19 September 2007 senior counsel for McDow informed the trial judge that its pleading had been 'really re-caste' and though the draft was in an advanced state it was not in a state to be delivered. At that time he foreshadowed that there was also a counterclaim although it was not subsequently pursued. Despite demand by Lucas that McDow provide its amended defence and counterclaim, they were not served on Lucas until some days after the time for acceptance of the offer of compromise had expired.

37 There were substantial amendments made to the pleadings, which it does not appear that Lucas could have anticipated, which significantly changed McDow's position and the claims being prosecuted. It was not until after receipt of the amended pleadings that Lucas was able to ascertain that McDow formally accepted that the Lucas subcontract had been terminated for 'no fault' and the only issue was an assessment of the work performed by Lucas.

38 Correspondence passing between the parties in the week before the expiration of the time in which the offer could be accepted, disclosed considerable uncertainty by both parties as to the position of the other on liability and quantum, and in particular the content of the Fox report, which Lucas had served on 7 September.

39 Prior to its settlement with BHP Billiton, McDow had claimed from BHP Billiton the amount of $12m that it considered was due to Lucas. This amount had been calculated in an expert's report. It was not in dispute that Lucas was aware of the content of the report. We accept the likelihood that Lucas had intended to rely upon McDow's claim against BHP as part of its assessment of its loss.

40 The parties appeared before the trial judge during this period to discuss the content of the Fox report. If any expert report in reply by McDow was to be relied upon, it would not be provided until well after the time for acceptance of the offer had expired. Numerous issues regarding the Fox report were explored by the parties during this time. McDow expressly rejected an invitation by Lucas that there be discussions between the parties experts on any of these issues. In the end McDow did not rely upon any expert as to quantum. We consider there to be some force in the contention by Lucas, that it was not until after the period of time for acceptance of the offer had expired that Lucas was able to understand the extent to which McDow agreed with the assessment in the Fox report.

41 In our judgment delivered 18 December 2009, we observed[13]:

Before the trial judge, each side presented 'an extraordinarily complicated case'.[14] The evidence was voluminous, although much of it was not referred to. The pleadings were, his Honour observed, also voluminous and confusing and did not identify the issues. His Honour noted that there was little co-operative identification or refinement of the real issues. The approach adopted by one party 'focussed on the minutiae' while the approach of the other party was 'more broad-brush'.[15]

The parties, agreed, however, on the following questions for determination at trial:

1. As to clause 24.4(a), what elements of work or items (as claimed by Lucas in the Scott Schedule) are included in the "Sub-Contract Works" for which Lucas is entitled to be paid?

2.1 What is the proper interpretation of clause 14.5; alternatively, which part of it is applicable, in determining the basis upon or approach to valuing the works?

2.2 If "fair valuation" is the appropriate basis for valuing the works, what is the basis upon which that value is to be calculated?

2.3 If "fair valuation" is cost plus margin, is the appropriate margin:

(a) tender margin;

(b) industry margin;

(c) the margin specified by the parties in item 10 of the Schedule to the subcontract, being 7% on materials and 5% on services?

1. As to clause 24.4(c), what is the value of any unfixed goods and materials delivered upon the site for use in the subcontract works, the property in which has passed to the BHPB under the terms of the Head Contract?
2. As to clause 24.4(f), what is the loss of profit on the remaining parts of the subcontract works?

5.1 On what basis is interest payable?

5.2 From what date does interest run?

5.3 What rate of interest?[16]

42 Despite the 'shifting landscape' acknowledged by McDow (indeed, Senior Counsel for McDow conceded, on this issue, that this case was a rather unusual set of circumstances), McDow contended that if Lucas' ability to assess the offer was in any way impaired, it could have sought further time to consider the offer or made a realistic offer of its own. Whether or not either course was open, the offer came at a time of great disruption to these most complex proceedings and prior to the issues in the case being adequately identified. McDow must bear its measure of responsibility for that state of affairs which rendered it unfair to expect that Lucas could then properly evaluate the offer.

43 The policy behind Rule 26.08 (3) is discussed in Maitland Hospital v Fisher[17] which was cited, with approval, by Hayne, JA in his dissenting judgment Grbavac v Hart.[18] The policy is well recognised and need not be restated. We are conscious of the duty of courts to give effect to the purposes of the rule, so that save for exceptions in particular cases, there should be no departure from the prima facie entitlement of the defendant offeror to its party party costs from the time of the offer, where the plaintiff fails to obtain a judgment more favourable than the offer.

44 It follows that even if we had determined that r 26.08(3) had application in this case, for the reasons given above, we would have determined that the discretion to depart from the ordinary consequences of the rule is warranted in the present circumstances. In our view there was such a level of uncertainty both as to the issues that were in dispute and the evidence which either party intended to adduce in relation to those issues that we would on that ground 'otherwise order' had it been necessary to do so.

45 For the reasons we have given McDow's application to vary the costs order below so as to provide for the payment of costs to it after 5 September 2007 must be refused.

46 On 18 December 2009, this Court ordered Lucas to pay McDow's costs of the appeal and the cross-appeal. We propose to vary those orders so that they relate only to the costs of the appeal and the cross-appeal up to and including 18 December 2009. In view of the conclusion we have reached in relation to McDow's application to vary the trial judge's order for costs, we are of the view that Lucas should have the costs of the appeal and cross-appeal after 18 December 2009.

[1] Save that Lucas was not entitled to:

(a) the costs of and incidental to the preparation of the first Court Book for use at the hearing commencing on 30 June 2008; or

(b) the costs of the first half day of the hearing on 30 June 2008.

[2] As to the effect of interest in relation to determining the consequences as to costs referred to in r 26.08(3), see r 26.08(5).

[3] In fact, Lucas contends this interest figure is $258,956.06. However, nothing turns on this dispute between the parties for reasons which will become apparent below.

[4] Discussion of discontinuance supplies commences at paragraph 50.

[5] A J Lucas Drilling Pty Ltd v McConnell Dowell Constructors (Australia) Pty Ltd [2009] VSCA 310, [19].

[6] See the quantum judgment below [2008] VSC 275, [67].

[7] If one uses Lucas' figure for interest of $258,956.06.

[8] If one uses McDow's figure for interest of $257,740.31.

[9] [1989] VicRp 36; [1989] VR 386.

[10] With whom Southwell and Hampel JJ agreed.

[11] At [1989] VR 401.

[12] See further John Goss Projects Pty Ltd v Thiess Watkins White Constructions Limited [1995] 2 QdR 591, 595 and Gove v Black & Ors [2006] WASC 298, [58].

[13] At [2009] VSCA 310, [25]-[26].

[14] [2007] VSC 500, [14].

[17] (No 2) (1992) 27 NSWLR 721, 724.