BADGE CONSTRUCTIONS PTY LTD v PENBURY COAST P/L No. SCGRG-98-819 Judgment No. S6 [1999] SASC 6

The builder has a heavy burden to discharge. The relevant principles are noted in s38(5) of the Commercial Arbitration Act, 1986. I am satisfied that the determination of the question of law concerned would substantially affect the rights of the parties. I turn to the terms of s38(5)(b). The builder must demonstrate either that the arbitrator has made a manifest error of law or that the determination of the question may add substantially to the certainty of the commercial law. Again, the builder has a heavy burden to discharge. A manifest error of law will exist only if the error is evident or obvious, rather than arguable. While a judge is entitled to the benefit of adversarial argument when determining whether a manifest error of law exists, the epithet "manifest" denotes an error of law which is more than arguable: Promenade Investments Pty Ltd v State of New South Wales (1992) 26 NSWLR 203 at 225-227; Leighton Contractors Pty Ltd v South Australian Superannuation Fund Investment Trust [1994] SASC 5197; (1994) 63 SASR 444. With these principles in mind I turn to consider whether leave to appeal should be granted.

In his reasons on the issue of costs, the arbitrator noted the general rule that costs follow the event. He then noted that in order to depart from that rule he had to exercise his discretion judicially and that exceptional circumstances were required. He held that exceptional circumstances existed. Noting that the owner had been successful in its counter-claim and having successfully defended four of the five heads of claim by the builder, he held that a significant part of the costs which the parties had incurred, before and during the hearing, could be traced to the owner's counter-claim and the owner's successful defence of most of the builder's claims.

He then referred to observations made in the Interim Award to the effect that the respective claims of each of the parties were genuine and the parties had employed competent advisers. In his view, there was nothing in the conduct of the parties that indicated any unreasonable or vexatious behaviour. He, therefore, concluded that, having regard to the conduct of the owner and the success of the its counter-claim, a full costs order "would impose an unjust determination on the owner". Thus, notwithstanding that the builder had prevailed and had secured a balance judgment in his favour, the arbitrator ordered that each party should bear its own costs.

It is well settled that, in particular circumstances, it may be reasonable to require a litigant who has succeeded only upon a portion of his claim to bear the expense of litigating the other portion or portions, or that circumstances may dictate that a successful party who has failed on certain issues may not only be deprived of the costs in those issues but may be ordered as well to pay the other party's costs of them: see Hughes v Western Australian Cricket Association Inc (1986) ATPR 40-748 at 48136. But for the reasons which follow, I am satisfied that was not a case which justified that approach and that the arbitrator has made a manifest error of law and has wrongly applied the relevant principles.

The reasoning of the arbitrator is unobjectionable up to and including the proposition that exceptional circumstances are required to justify a departure from the usual order that costs follow the event. However, it is apparent from the reasons of the arbitrator that he has misunderstood or at least incorrectly applied the well settled principles relating to awards of costs where there is both a successful claim and a successful counter-claim.

The principles are well established. They are set out in a number of texts. Shortly stated, the rule is that, where there are cost claims, the successful party is the party who secures a judgment for the balance. In his reasons, the arbitrator referred to both Hudson's Building and Engineering Contracts (10th edition) and to Berry et al_, Legal Costs - South Australia_ (Butterworths). In the latter work the principles are set out in these terms:

"Where there is both a claim and a counter-claim the order for costs should be framed so as to give a just result: Chell Engineering Ltd v Unit Tool and Engineering Co Ltd [1950] 1 All ER 378; Childs v Blacker [1954] 2 All ER 243. In the ordinary course if both the claim and the counter-claim succeed the plaintiff and the defendant are each entitled to the costs incurred on their claim and counter-claim respectively: Provincial Bill Posting Co v Low Moor Iron Co [1909] 2 KB 344. In taxing such costs the claim is treated as if it stood alone and the costs are awarded for maintaining it. As to the counter-claim the only amounts awarded are for the increased costs occasioned by it: Medway Oil and Storage Co Ltd v Continental Contractors Ltd [1929] AC 88; Smith v Madden [1946] HCA 19; (1946) 73 CLR 129; Millican v Tucker [1981] 1 All ER at 1083. Where neither party is wholly successful the court in its discretion may order one party to have a percentage of its costs only: Foti v Banque Nationale de Paris (1989) 149 LSJS 401. Where the counter-claim is really in the nature of a defence or set-off, the court may give the defendant the costs, or where the plaintiff obtains a balance judgment, the court may give the plaintiff costs on the scale appropriate to the amount of balance judgment." Lowe v Holme (1883) 10 QBD 286; Childs v Blacker [1954] 2 All ER 243; Hanak v Green [1958] 2 QB 9.

The arbitrator referred to the last sentence in the passage just quoted but, quite curiously, in his reasons for deciding to depart from the general rule. Had he considered the whole passage, he might not have fallen into error.

The overriding principle is that the order for costs is fair and just in all the circumstances. The arbitrator has a broad discretion to ensure such a result. Thus, it will be appropriate when considering what award should be made as to costs to have regard to the conduct of the parties. So, a party may not be entitled to costs if he has advanced an inflated claim or counter-claim with the apparent purpose of frightening the other party by the fear of the costs of proceedings to drop the claim or accept less than the claim: Archital Luxfer Ltd v Henry Boot Construction Ltd [1981] 1 Lloyds Rep. 642.

The reasoning underlying the principles so far as they apply to cases arising out of building contracts are expressed in these terms in Hudson:

"It should be remembered that in building and engineering cases the issue between the parties is almost invariably financial, and that the machinery of the sealed offer is available to protect the position on costs. Though there may be many issues, in legal pleading terms, of claim, set-off, and counterclaim, the parties' eyes will always have been fixed on the final balance owing one way or another. Whoever secures or avoids paying that balance in effect has won. Only in the case of wildly exaggerated claims, or separate and costly issues on which the successful party has failed and which it was wholly unreasonable for him to raise, can there be, it is submitted, any justification for departing from the rule that the party ultimately successful on a final balance of claim and counterclaim should be paid his costs. There are cases in other situations where separate orders for costs on claim and counterclaim are appropriate, but counterclaims on building and engineering contracts arise out of the same transaction and are equitable set-offs, and the basic commercial realities, in the vast majority of cases argue very strongly, it is submitted, for a single award of costs in favour of the party ultimately successful on balance, unless the balance is so small as to justify the view that a party responsible for initiating the litigation and obtaining such a balance can be regarded as having been effectively unsuccessful."

In this context it is relevant to note that in cases under a building contract, where both the claim and the cross-claim arise under the building contract, the cross-claim constitutes an equitable set-off: Hanak v Green [1958] 2 QB 9 at 25-26 and at 29. That principle will usually have important consequences in respect of costs since, if the cross-claim exceeds the amount of the claim, the claim will be treated as having failed: Hanak v Green (supra) and see also the discussion in Hudson (11th edition) para 8.118.

Given the particular issues which arise when determining costs where both the claim and counter-claim arise out of a building contract and both claim and counter-claim are successful, it might be putting the principle too high to assert that exceptional circumstances are required to justify a departure from the general principles noted above. It is not necessary to decide that issue here. But it can at least be said that there must be good cause for departing from the general principles.

In this case there was a claim and cross-claim or counter-claim. The builder claimed certain items as variations. The building owner cross-claimed for an entirely separate item, namely, the failure of the builder to construct a cross-over, which failure was in breach of the building contract. Since both the claim and the cross-claim arose out of the same building contract, the cross-claim constituted a set-off. In the result, the award substantially favoured the builder. It justified a single costs order in favour of the builder or at least that an order that each party have its costs. If the arbitrator applied settled principles, he would have ordered the building owner to pay the builder's costs on the balance recovered by the builder. The arbitrator should not have made any other order unless there was good reason to depart from that general principle.

The arbitrator held that there were two exceptional circumstances which justified a departure from the general rule. But his reasons suggests that the arbitrator was not entirely sure what the general rule was. Even if he understood the general rule, the circumstances were not exceptional and did not give any good cause for departing from that rule. In other words, a balance judgment in favour of the builder was in no sense an exceptional circumstance.

The first of the circumstances said to be exceptional was that the building owner had been completely successful on its cross-claim and that it had successfully defended all but one of the builder's claims. The arbitrator continued:

"I have not attempted to count issues, and I have made no attempt to allocate time in the Hearing to the particular issues raised by the parties. I have not attempted to make a detailed assessment of the time which the Builder took to argue the Underfloor Fill Claim, or the time which the Owner took to pursue the Cross-over Claim. My general impression is that a significant part of the costs which the parties incurred, both before and during the Hearing, could be traced to the Owner's Counterclaim, and to the Owner's successful defence of a number of the Builder's Claims, and I give that matter judicial weight in reaching my decision. Legal support for that decision can be found in Butterworths in the following terms: 'Where the counterclaim is really in the nature of a defence or set-off, the Court may give the defendant the costs, or where the plaintiff obtains a balance judgement, the Court may give the plaintiff costs on a scale appropriate to the amount of the balance judgement.' (Butterworths Principles and Practice of Costs at p.1062)."

Pausing here, this reference, which was in truth to "Legal Costs - South Australia", ought to have alerted the arbitrator to the general rule. The whole of the relevant passage has already been quoted above. Certainly there is nothing in that passage which justifies the arbitrator's decision that there are exceptional circumstances. There is a further flaw in the arbitrator's reasons. He was not in a position to know or even have a general impression of the extent to which the costs incurred by the parties before the hearing would have been incurred in respect of separate issues. The only facts on which he would have had any proper understanding were those associated with the conduct of the hearing. In this respect, as I will note in a moment, the arbitrator concluded the parties had conducted themselves properly and the claims were genuine.

The second circumstance on which the arbitrator relied was the conduct of the parties. Referring to the terms of his interim award, the arbitrator remarked that there was nothing in the conduct of the parties either before or during the hearing "that indicated unreasonable or vexatious behaviour" to use the arbitrator's words. In addition, again to quote the arbitrator, "both parties have engaged competent legal advisers and counsel experienced in building disputes, and their respective submissions confirm that the issues separating the parties were genuine, rather than contrived". These were not facts which pointed to circumstances justifying departure from the general rules. Quite the contrary. Instead, they were facts which justified adhering to the general rule rather than departing from it. The reasons of the arbitrator, therefore, disclose no good reason for departing from the general rule.

A perusal of the arbitrators' reasons show that he identified what were in fact several factors pointing to the conclusion that the general rule should be followed. Those factors are:

(1) both parties succeeded on their claim and cross-claim albeit that the builder failed on four of its five claims determined by the arbitrator;

(2) the issues raised by each of the parties were properly raised and pursued;

(4) the parties had engaged competent legal advisers and counsel and that the respective claims were genuine; and

(5) the hearing of the claim and cross-claim proceeded very expeditiously before the arbitrator and had occupied one day only.

The expeditious hearing was obviously made possible by the preparation of the parties and the commendable co-operation which had existed between counsel, who had identified in clear terms the issues to be decided by the arbitrator and had agreed a considerable number of facts including the quantum of most, if not all, of the claims. Plainly the preparation before the hearing enabled all issues to be heard in one day.

Everything about the conduct of this arbitration pointed to the conclusion that the arbitrator ought to have applied the general rule which applies where the counter-claim is merely in the nature of a defence or set-off. The builder had had a substantial award made in his favour. This was, therefore, a case which was appropriate for the arbitrator to award costs on basis which was appropriate to the amount of the judgment in favour of the builder after deducting the counter-claim of the building owner.

For these reasons I am satisfied that the arbitrator has made a manifest error of law and leave to appeal should be granted. I am further satisfied that the appeal should be allowed and the matter remitted to the arbitrator for a determination of the builder's costs according to law.