Plaintiff v Defendant

Supreme Court of Victoria|2007-12-07|Before: BYRNE J

BUILDING CONTRACTS - valuation of work after termination without breach - method of valuation - significance of agreed price - work within contractual workscope valued by reference to contractual price - value of other work on cost plus basis - what work within contractual workscope - margin for overheads and profit.

1 On or about 4 April 2002[1] the defendant, McConnell Dowell Constructors (Aust) Pty Ltd ("MacDow") with others entered into a Head Contract with BHP Billiton Petroleum Pty Ltd ("BHPB") for the design and construction of certain facilities with respect to the Minerva Gas Field development near Port Campbell in the State of Victoria. The works included the horizontal drilling and installation of two cased crossings from the onshore plant to a point on the seabed some 1500 metres from the shore. These crossings were to be 10 inch diameter cased boreholes, one to carry a bundle of chemical injection lines and a control line from the shore ("the umbilical crossing"); the other to carry the gas product to the shore ("the flowline"). The work of designing, drilling and installing these crossing was sub-let by MacDow to the plaintiff AJ Lucas Drilling Pty Ltd ("Lucas Drilling").

2 On 28 November 2002 Lucas Drilling and MacDow executed a sub-contract dated 26 June 2002 for the performance of the work which was sub-let to Lucas Drilling. Under the sub-contract, Lucas Drilling was to receive for its work $5 million by progress payments payable upon the achievement of certain milestones.

3 On 10 September 2003 BHPB terminated the employment of MacDow under the Head Contract. As a consequence, the employment of Lucas Drilling under the sub-contract was terminated pursuant to clause 24.3 of the sub-contract. At that stage Lucas Drilling's work was largely, but not totally, complete.

4 Pursuant to clause 24.4 of the sub-contract Lucas Drilling was, thereupon, entitled to be paid for its work prior to termination as follows:

... [Lucas Drilling] shall be paid (after allowing for any previous payment):

the value of the Sub-Contract Works completed at the date of determination, such value to be calculated according to clause 14;
the value of work begun and executed but not completed at the date of such determination, such value to be calculated according to clause 14;

the value of any unfixed goods and materials delivered upon the Site for use in the Sub-Contract Works the property in which has passed to [MacDow] under the terms of the Head Contract.

the cost of materials or goods properly ordered for the Sub-Contract Works for which [Lucas Drilling] shall have paid of which it is legally bound to accept delivery. On such payment by MacDow, the property in the goods and materials so paid shall be transferred by [Lucas Drilling] to MacDow;
the reasonable cost of removal from the Site of its temporary buildings, plant, machinery, tools, goods and materials insofar as this has not already been included in payments made or the value of work or materials; and
loss of profit, if any, on the remaining parts of the Sub-Contract Works.

As at the date of termination MacDow had not made any payments to Lucas Drilling because, it was said, no milestone had been achieved.

5 In this proceeding, Lucas Drilling seeks to recover approximately $10 million which it says is its entitlement under clause 24.4.[2] The position of MacDow is that Lucas Drilling has an entitlement to payment under clause 24.4 but that this entitlement is $2,246,643.67 plus GST[3] and that sum has been paid on 12 October 2007.

6 The provisions of clause 24.4(a) and (b), which I have set out above, refer to clause 14, the provision in the sub-contract for the valuation of variations. The relevant provision, clause 14.5, is in these terms:

The value of all variations made or allowed shall be valued in accordance with the schedule for pricing of the variations, or, where there is none, then, unless otherwise agreed, such value shall be determined in accordance with the following rules:-

The schedule of rates or the bills of quantities as the case may be upon which the Sub-Contract Sum is based shall determine the valuation of extra work of similar character executed under similar conditions as work priced therein.
The said prices where extra work is not of a similar character or executed under similar conditions as aforesaid, shall be the basis of prices for the same so far as may be reasonable, failing which a fair valuation thereof shall be made by agreement between MacDow and [Lucas Drilling].

The prices in the said schedule of rates or bills of quantities shall determine the valuation of items omitted, provided that if omissions substantially vary the conditions under which any remaining items of work are carried out the prices for the remaining items shall be valued under sub-clause (b).

Where MacDow considers extra work cannot properly be measured and valued, [Lucas Drilling] shall be allowed daywork rates or the process prevailing when such work is carried out (unless otherwise provided in the Sub-Contract Documents):-

(i) at the rates, if any, inserted by [Lucas Drilling] for this purpose in the schedule of rates or the bills of quantities or in any other Sub-Contract Document; or

(ii) where no such rates have been inserted, at the actual prime cost to [Lucas Drilling] of his materials, transport and labour for the work concerned, plus the percentage stated in the Schedule, which percentage shall be deemed to compensate adequately [Lucas Drilling] in respect of all costs including costs of ordinary plant, tools, existing scaffolding and for supervision, overheads and profit.

Provided that as a condition precedent to payment in either case under this paragraph, vouchers specifying the time daily spent upon the work (and, if required by MacDow, the workmen's names) and any plant, equipment or materials employed shall be delivered for verification to MacDow not later than one working day following that in which work has been executed.

7 The parties agreed at the outset of the trial that I should determine all issues between them other than the quantification of the claim. As will appear, this apparently attractive approach presents its own difficulties in this case. They were agreed, however, that the questions for my determination might be formulated as follows:

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?

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?
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?

8 In the course of final submissions, counsel for Lucas Drilling told me that question 3 was no longer pressed since the cost of unfixed materials was included in their client's reckoning of the total costs of carrying out the Sub-Contract Works. The sum of $14,134.75 was therefore claimed under clause 24.4(a) rather than under clause 24.4(c). This claim was admitted by MacDow as to $3,318.75 for unfixed thinsulators, but denied as to $10,816 for HDPE piping. For reasons which will appear, I shall, nonetheless, address this question.

9 As the case was presented, the particular parts of clause 24.4 which are relevant are parts (a) and (b), dealing with the evaluation of work performed, and part (f), dealing with loss of profit on the parts of the work which remained unperformed at the time of termination.

10 The principal area of contest at trial was as to the claims under parts (a) and (b) of clause 24.4, for the valuation of work performed. Here, the area of controversy between the parties was to identify the work to be valued. On behalf of Lucas Drilling, it was put that I should value the work as it stood at the time of termination and that this should be undertaken on a cost-plus basis. I should not, therefore, concern myself with questions as to how the work came to be performed. It is sufficient that I be satisfied that the work was reasonably performed in the furtherance of the sub-contract, making such allowance as may be necessary for any defective or redone work.

11 These conditions, it was said, are conceded in the defence so that the only issue was whether the claimed costs were incurred, and reasonably so, in the performance of the Sub-Contract Works. Since this, too, was accepted by MacDow, the Lucas Drilling claim must inevitably succeed.

12 The position adopted by MacDow was altogether different. Counsel focussed on the fact that clause 24.4 required that the valuation be of the Sub-Contract Works completed. Sub-Contract Works is described in clause 3 of the schedule to the sub-contract as follows:

Design and construction of two horizontal directional drilled ("HDD") short zone crossings for the Minerva flowlines, chemical injection lines and umbilical control line. More fully described in appendix 'A' attached hereto.

What was said was that, under the terms of the sub-contract, Lucas Drilling undertook the responsibility and attendant risks of the design and methodology for the drilling of the crossings and the installation of the lines. These risks included risks associated with the geological conditions which might be encountered. Extra work which had become necessary as a consequence of difficulties encountered by Lucas Drilling in areas of its own risk should not be valued for the purposes of clause 24.4(a) or (b). MacDow, then, contended that the parties had in the sub-contract valued the whole of the Sub-Contract Works at $5 million. The task of valuing the work completed should be approached as if the works were to be valued by a contract administrator determining the contract value of the work performed, including any legitimate variations.

13 And so, the trial proceeded in two directions. The first, following the path preferred by Lucas Drilling, involved the identification of all costs incurred and the determination of the appropriate margin to be applied to them. Although evidence was led from the Lucas Drilling chief financial officer, Mark Anthony Summergreene, that the total costs incurred by Lucas Drilling on the project were $6,312,724, not including selling, general and administrative ("SG&A") costs or margin, the determination of the actual figure was left for later determination. My role is simply to determine that margin. The second, the path preferred by MacDow, involved the conventional process of adjusting the contract price by reference to variations to the Sub-Contract Works and to the extent of completion of those works. For this purpose, the parties prepared a Scott Schedule showing the various component parts of the work performed and their valuation of each on this basis. A copy of this schedule is attached to these reasons (Annexure A). For my present purposes, the issue as to these items is whether they should be included in the valuation; their quantification is for later determination.

14 I make mention in these introductory remarks of a particular difficulty which the trial threw up. Counsel for each of the parties told me at the outset that it was, in truth, a very simple case and, of course, that their client's case was simply irresistible. Notwithstanding these brave assertions, each side presented an extraordinarily complicated case. In a trial that occupied only 15 sitting days, over 2,600 documents were put in evidence. For the most part they received no further attention and, it seems that this was because most of them had little to do with the matters in issue. The matters in issue were obscure. The pleadings were voluminous, occupying some 270 pages including requests and particulars, most of which served to confuse rather than to identify these issues. Counsel did not appear to engage in communication so as to clear away peripheral matters, so that much of the evidence seemed to address matters which were in issue in the pleadings but not in fact. Add to this that counsel for one party focussed on the minutiae of the case while counsel for the other party spurned this, relying upon a more broad-brush approach. And to cap off all of this the trial was conducted electronically so that it was extraordinarily difficult for me to browse through the thousands of exhibits to see what, if anything, they contained. I have, therefore, to a greater extent than usual, been obliged to focus only on the documents and arguments referred to and presented in final submissions which were themselves fulsome. As a consequence, I apologise in advance to the parties if I have overlooked some nugget which may be lurking in the mass of material before the Court and which was not drawn to my attention.

15 The fundamental issue between the parties involves the construction of clause 24.4. According to counsel for Lucas Drilling, I am concerned only with part (a) of this clause, and not part (b). For reasons which will appear, I am not so sure.

16 The Lucas Drilling contention requires that I consider the structure of clauses 24.2 and 24.3. I will therefore set them out in full together with clause 24.4.

24.2 [Lucas Drilling] shall pay to MacDow the amount of any and all loss, damages, costs and expense caused to MacDow by reason of such determination. Until after completion of the Sub-Contract Works MacDow shall not be bound to make further payment to [Lucas Drilling] but upon such completion and within a reasonable time thereafter MacDow shall ascertain the amount of expense reasonably incurred in completing the Sub-Contract Works and the amount of loss, damages, costs and expense caused to MacDow by reason of the determination and if such amounts when added to the monies paid to [Lucas Drilling] before the date of determination exceed the total amount which would have been payable on due completion in accordance with the Sub-Contract the difference shall be a debt payable to MacDow by [Lucas Drilling]; and if the said amounts when added to the said monies do not exceed the said total amount then the money payable to [Lucas Drilling] shall be the lesser of:

(i) the said amounts when added to the said monies; and

(ii) the said total amount; or

(i) the value of any work actually and properly executed and not paid for at the date of such determination, such value to be calculated according to clause 14;

(ii) the value of any unfixed goods and materials which were taken over by MacDow on determination and used by MacDow and a fair payment for hire of such of [Lucas Drilling's] plant as were used by MacDow, in completing or having completed the Sub-Contract Works.

Notwithstanding anything else herein, no sums shall be payable to or credited to [Lucas Drilling] following determination under clause 24.1, until MacDow is in receipt from the Employer of a payment which includes such sums.

24.3 If for any reason MacDow's employment under the Head Contract is determined (whether by MacDow or the Employer and whether due to any default of MacDow or otherwise) then the employment of [Lucas Drilling] under this Sub-Contract shall thereupon also be determined automatically.

24.4 Unless the determination of the Head Contract was caused or contributed to by any default or breach of contract [Lucas Drilling] (in which event [Lucas Drilling] shall be liable to MacDow for damages on the same basis as if [Lucas Drilling] had wrongfully repudiated the Sub-Contract) or unless MacDow was entitled at time of determination of the Head Contract to exercise its right of determination under clause 24.1 (whether or not any act or default of the [Lucas Drilling] caused or contributed to the determination of the Head Contract, [Lucas Drilling] shall be paid (after allowing for any previous payment):

the value of the Sub-Contract Works completed at the date of determination, such value to be calculated according to clause 14;
the value of work begun and executed but not completed at the date of such determination, such value to be calculated according to clause 14;

the value of any unfixed goods and materials delivered upon the Site for use in the Sub-Contract Works the property in which has passed to the Employer under the terms of the Head Contract;

the cost of materials or goods properly ordered for the Sub-Contract Works for which [Lucas Drilling] shall have paid or of which it is legally bound to accept delivery. On such payment by MacDow, the property in the goods and materials so paid shall be transferred by [Lucas Drilling] to MacDow;
the reasonable cost of removal from the Site of its temporary buildings, plant, machinery, tools, goods and materials insofar as this has not already been included in payments made or the value of work or materials; and
loss of profit, if any, on the remaining parts of the Sub-Contract Works.

17 The argument presented on behalf of Lucas Drilling is that, under clause 24.4, the amount payable by MacDow to Lucas Drilling upon termination for Lucas Drilling's default is the lesser of two sums. The first of these sums is calculated by reference to Lucas Drilling's contractual entitlement; the second by reference to the value of the work performed. This second sum is similar to that to be calculated under clause 24.4(a). This shows that this calculation, too, is to be undertaken otherwise than by reference to Lucas Drilling's contractual entitlements. It was therefore sufficient that Lucas Drilling show that it carried out work reasonably in the furtherance of the sub-contract in order for it to be entitled to the value of that work. Value was to be determined upon a cost-plus basis.

18 Counsel for MacDow protested that this claim was not pleaded. There is much to be said for this. The claim as pleaded is for variations to a contract made on 26 June. The case as presented disavowed this claim. I will nevertheless entertain this new argument. It depends essentially upon an analysis of the contract documents so that I am not persuaded that MacDow suffers any prejudice.

19 In order to understand this Lucas Drilling submission, it is necessary to examine closely the terms of clause 24.2. Clause 24.1, which I have not set out, confers upon MacDow the right to terminate the sub-contract for any of a number of matters, which might broadly be characterised as defaults by Lucas Drilling. Clause 24.2 sets out the financial consequences of this.

20 The sub-contract makes no provision for termination by Lucas Drilling for default by MacDow. Presumably it may do so where this is permitted by law.

21 Clause 24.3 provides for termination of the sub-contract where it is the Head Contract which is determined and this for any reason, whether by default of MacDow or otherwise. Under clause 45 of the Head Contract, BHPB is entitled to terminate the contract for default by MacDow, for its own convenience or where the works are halted by force majeure. MacDow also is entitled to terminate the Head Contract for default by BHPB. There may be, too, other circumstances where the Head Contract might be brought to an end by operation of law or by order of a court. It would seem that, in any such case, the sub-contract is automatically terminated pursuant to clause 24.3.

22 Clause 24.4, then, provides for the financial consequences of termination of the sub-contract upon termination of the Head Contract, provided that Lucas Drilling is not itself in default. Counsel for Lucas Drilling emphasised that the evident intent of the drafting of clause 24.4, as opposed to that of clause 24.2, is to make more generous provision for the innocent sub-contractor.

23 Under clause 24.2, upon termination of the sub-contract for default by Lucas Drilling, no further payments are to be made to the sub-contractor until completion. Thereupon, an account is taken of the net cost to MacDow of completing the work. This requires the ascertainment of a number of components:

(a) the amount of expenses incurred by MacDow in completing the sub-contract work;

(b) the amount of loss, damages, costs and expense suffered by MacDow as a consequence of the termination;

(d) the total amount which would have been payable to Lucas Drilling had it completed the sub-contract work. This would presumably be the sub-contract sum within the meaning of clause 13.1.

These components are then inserted in the following formula to produce x, the first sum to which Lucas Drilling might be entitled:

If x is a positive figure, it is payable by Lucas Drilling to MacDow. If it is not a positive figure, it must be compared with another figure, y, which is the result of another calculation using different components.

(f) the value of unfixed goods and materials and plant hire used by MacDow for the completion of the work.

The obligation of MacDow under clause 24.2 is to pay to Lucas Drilling the lesser of the sums represented by x and y.

24 It will be immediately apparent that there is much similarity between the verbiage of clause 24.2(b)(i) and clause 24.4(a) and (b). In each case, it is necessary to value the work performed and there is in each case a direction to calculate this value "according to clause 14".

25 I turn then to clause 14. It is here that the contract becomes difficult to construe. As I have mentioned, clause 14 is concerned with variations. These are defined in fairly conventional terms which include extras, omissions and changes in the work. For the valuing of a variation it is necessary to refer to clause 14.5 which I have set out above.[4] At the outset, it is necessary to observe that the provision suffers from the apparent difficulty that it is a standard form provision which sits uneasily in the circumstances of this contract. This task becomes more difficult when the provision is here required to perform a function for which it was not designed. What clause 24.2(i)(a) and clause 24.4(a) and (b) require is that clause 14 be used to value, not an extra, omission or change, but all work performed.

26 Clause 14.5 first directs the valuer to apply "the schedule for the pricing of variations". There is in this contract no such schedule other than, perhaps, Appendix C which contains daily rates for standby and a metre rate for extra drilling. Second, the valuer is encouraged to agree the valuation. Third, if this be not achieved, the valuer is to apply any of four rules. Rules (a) and (b) require the valuer to apply or to have regard to the prices in the schedule of rates or the bill of quantities. But there is no such schedule or bill in this contract. It is also to be noted that the first two rules are to be used to value extra work and the third to value omitted work. No guidance is offered for a variation of different kind.[5] The valuer is then directed by rule (d)(i) to apply daywork rates or prices prevailing when the work is carried out. When these rates or prices are included in the schedule of rates or bill of quantities or otherwise in the contract, they are to be adopted. But there are none in this contract. Part (ii) of rule (d) then directs the valuer to value the variation at the actual prime costs rate to Lucas Drilling of its materials, labour and transport for the work concerned plus a stipulated all-inclusive margin of 7% for materials and 5% for services.

27 Each of the parties before me disavowed rule (d)(ii) as the appropriate guide for the valuation of the sub-contract work in this case. With some misgivings, I will respect the wish of the parties that this rule has no application.

28 I return, then, to clause 24.4. Given that clause 14 provides no basis for valuation, counsel for MacDow accepted that this did not mean that Lucas Drilling was denied any entitlement. I am to apply clause 24.4(a) or (b) as if there were inserted in each case at the end of the part the words "if applicable". This means that the Court is to ascertain the value of the work with no contractual guidance as to how to approach this task.

29 Lucas Drilling put its case under part (a), on the basis that the work to be valued is "the Sub-Contract Works completed at the date of determination". In fact, the sub-contract work was not fully completed on that date. In essence, the sub-contract work was to bore two holes and to insert the umbilical bundle in the one and the flowline pipe in the other. There were other ancillary activities to be performed as well as demobilisation and the provision of documentation. When the sub-contract was terminated on 16 September 2003 the bore holes were completed but the insertions and other work had not been achieved. In these circumstances, it may be more appropriate to treat the valuation as that under part (b). Notwithstanding the small verbal differences between the two parts, no party made anything of this.

30 Sub-clauses 24.4(a) and (b) require the determination of the value of the work completed. There are many ways at looking at value in this context. It is commonly approached on the basis of actual cost to the contractor plus a margin or margins for overheads and profit, since this represents its value to the contractor. Another approach is to receive evidence of what price the work would command in the marketplace. A third might be the value to the principal and this, too, might represent the cost to which it, the principal, might expect to pay to have it performed or the contribution of the work to the increase in the value of the principal's asset. Where the work is performed under a contract which itself values the work, this may also be brought to account. The correct approach must be to have regard to these and any other factors which are appropriate in the circumstances of the particular case and then to arrive at a fair and reasonable value. The circumstances will include the arrangements under which the work was performed and also the circumstances in which the valuation comes to be made.

31 These various approaches to valuation have their own potential shortcomings and difficulties and the authorities make it clear that there is no single path to be preferred. The Court must weigh up the suggested approaches and their applicability to the facts of the case before it and to the circumstances which give rise to the requirement that the valuation be made. It must make such adjustments to these approaches as seem appropriate, but always bearing in mind that the objective of the exercise is to arrive at a valuation which is fair to the parties.[6]

32 I have included in my description of the task which the Court must address, the circumstances which give rise to the requirement that the evaluation be made. This is not a case where the contract has been found to be illusory, where the contract is void for illegality or for some other reason, or where the contract is void ab initio.[7] The work has been performed under a valid and subsisting contract and the parties have made provision for the adjustment of their rights in an event which has been foreseen.[8] They have required that the work be valued upon termination in accordance with the terms of the contract with a direction that the contractual valuation methodology be adopted, if possible. The valuation, too, is to be undertaken in circumstances where the sub-contractor has lost the contract due to no fault of its own.

33 The evident intent of clause 24.4, is that, so far as is possible, the sub-contractor be not disadvantaged by this event any more than it should receive some bonus or some solatium for the disappointment it suffers. This is apparent from the structure of its six component parts. Parts (a) (b) and (c) speak of value, a concept which doubtless includes an allowance for profit and overheads for these are part of the contractual value of those items for the sub-contractor. Parts (d) and (e) speak of cost, not value. This is consistent with the intent which I have identified, for these items are not part of the work performed. The sub-contractor's profit on them should be picked up in part (f). Part (f) ensures that the sub-contractor receives its profit on the unperformed work. In contrast to Rule (d)(ii) in clause 14.5, this does not include on-site or off-site overheads. These costs however would have been included in a valuation based on the schedule of rates or priced bill.[9] The assumption appears to be that these have not been incurred in respect of unperformed work.

34 I was referred to a number of English authorities which were concerned with the valuation of variations under clause 52 of the ICE conditions (6th Ed). Sub-clause 52.1 provides for valuation by reference to the priced bill of quantities and, if that not be reasonable or applicable, by reference to a reasonable or proper rate. In this sense it has some resemblance to clause 14.5 of the sub-contract. Two things, however, must be emphasised. The English cases turn upon a different contractual regime and they are concerned to value variations, not the whole work. Furthermore, the determination of the reasonable rate is undertaken in respect of work which is outside the pre-variation scope of work and not covered by the contractual rates. In these circumstances, it is not surprising that the debate in that country focuses upon the competing interests of a cost-plus evaluation and one based upon commercial rates current in the marketplace.[10]

35 In the 11th edition of Hudson there is to be found a useful discussion of the task of arriving at a fair valuation for variations where, as here, the work is not covered by the agreed prices in the bill of quantities or a schedule of rates. The learned author there speaks of what he calls the "shopping list principle". Under this principle, work which is capable of being valued under the contract price is valued in accordance with that price: neither party may ignore the element of profitability or unprofitability in that price. Work which is not so capable is to be valued on a costs basis. But, even in such a case, the valuation, albeit on a costs basis, must have regard to this price in arriving at a fair valuation.[11] In the present case, it would be therefore necessary to identify what part of the sub-contract work falls within the agreed price and for which the price, subject to any necessary adjustment, remains applicable and what part is outside that price, for which a costs based evaluation is appropriate.

36 To the same effect is the opinion of Mason and Carter in their Restitution Law In Australia,[12] where they observe that there is some support for the view that where a contract is discharged without breach in circumstances not regulated by the legislation with respect to frustrated contracts, the contract price should be a ceiling on the claim.

37 Notwithstanding similarities, this task of valuing work under clause 24.4 is not to be equated with the task of a contract administrator who is evaluating the work for the purposes of a progress certificate.[13] The sub-contractor here may be entitled to payment of the value of the work performed notwithstanding that procedural requirements of the contract have not been satisfied. For example, it is not suggested here that Lucas Drilling would not be entitled to payment for work performed without a written approval, as is required under clause 14.4, or without the delivery of vouchers as is required under the proviso to clause 14.5.

38 I conclude, therefore, that in valuing the sub-contract work in this case, the Court must start from the agreed price, making such adjustments to it as are appropriate to accommodate changes to that work which have been required or agreed to be performed. These adjustments would, in the ordinary course, be made under the contractual provisions for variations but where, as here, they are not applicable, the adjustments must aim to ensure that the sub-contractor receives a proper remuneration for these changes. This will ordinarily be based on the reasonable cost of carrying them out provided that these costs themselves were reasonably and properly incurred. To this must be added a reasonable margin for overheads and profit, bearing in mind that the profit component is applied to work which has actually been performed so that it is not appropriate to load the profit with an allowance for risk or contingencies which might properly be included upon a costing undertaken upon work yet to be performed.[14] But in undertaking this task of valuing the changes, the valuer must bear in mind that the valuation is performed within a contractual framework, so that the adjustments to the price are not out of line with that contract price. The end result is to arrive at a figure which, within the contractual framework, fairly compensates the sub-contractor for performing the work which was performed prior to termination.

39 The next issue is that which requires me to consider what elements of the work performed by Lucas Drilling are to be valued and this, in turn, requires an analysis of the obligations of the parties under the sub-contract and, in particular what is comprehended in the contractual scope of work. The contract executed on 28 November 2002 is, as I have mentioned, dated 26 June 2002. This came about in the manner following.

40 The Minerva Gas Field project was under consideration for many years prior to 2002 and Lucas Drilling had had an involvement in the early planning. In or about early 2002 the Head Contract was put to tender to a number of contractors including MacDow. As part of the tender process, Lucas Drilling was requested by some of these tenderers to submit a price for the horizontal drilling and the installation of the lines. Its last quoted price to MacDow was contained in a letter dated 12 February 2002, but which was sent on 15 February 2002. The price was $6,042,286 excluding GST. In this letter Lucas proposed to perform the work with respect to the two crossings differently. It includes the following descriptions of these procedures:

Drilling 1 off 1550m x 16 inch (406mm) pilot hole.
Supply and Installation of NB 10 inch (NB 250mm) casing. (note: this will be left in situ). Approximately 1550m in length. Internally flush with external casing connectors.
Installation of a 140mm OD umbilical and 2 off glycol lines (32mm OD each) into the NB 10 inch casing. The Umbilical and glycol lines will be centralized with a bonded urethane or HDPE spacers every 5 meters. Approximately 1900m in length. (approx. 1550m in hole and 350m on seafloor).

Stringing, welding, x-ray, blasting and joint coating of the glycol lines will be by Lucas.

Drilling 1 off 1550 meter x 16 inch pilot hole. (second pilot hole).
Installation from land of 1900m off 10 inch (250mm) product pipe.
Stringing, welding, x-ray, blasting and joint coating of product pipe.
Coated product pipe is to free issue to Lucas.

I shall refer to this letter as the 15 February 2002 letter.

41 The methodology for drilling the umbilical line in borehole 1 was described by the Lucas Drilling witnesses as a drill and leave method. Broadly speaking, this involved mounting the 16 inch drill head on the 10 inch casing which then acted as a drill pipe, so that the casing moved forward down to the required depth and then horizontally under the seabed as the drill moved forward. This casing, in 9 metre lengths or thereabouts, would be attached to the length ahead by a screw thread so that, as each length moved into the ground, the next length would be attached to it. The progress of the casing would be achieved by pushing from the landward end and, of course, by the action of the cutting head which was driven by fluid pumped inside the casing under pressure from the start point on the land. This fluid, which mainly comprised water, would then be driven under pressure back along the borehole through the annulus which lay between the 16 inch borehole and the 10 inch casing, carrying with it the broken rock and other material generated by the drill. When the head arrived near the exit location it would make its way upward toward the seabed and, upon emerging, it would be removed by divers and the casing capped. The chemical injection and the control lines would then be inserted in the casing which would remain in place as a protection for and housing of these lines. These lines which comprised the umbilical bundle, would be pulled through the casing by tug from the seaward end of the borehole.

42 The methodology in the quotation for the drilling and installation of the flowline was different. Essentially, this methodology was to be that the 16 inch borehole should be drilled as with borehole 1, but with a 6⅜ inch drill pipe. When the exit point was reached the drill would be withdrawn, leaving the borehole unsupported except for an 18 inch surface casing which was inserted for the first few metres of soft surface material. Then, the 10 inch product pipe of some 1900m length provided by MacDow, which had previously been assembled and laid out in a string would be inserted at the on-shore end and pulled by tug into the borehole until it arrived at the exit point.

43 In due course MacDow won the contract and executed its Head Contract with BHPB on 4 April 2002. On 24 June of that year there occurred a telephone conversation between Mark Bumpstead, the MacDow operations manager, and Stephen Heaton Loneragan, the Manager, Directional Drilling, of Lucas Drilling and perhaps Hamish David Pryor.[15] The purpose of this discussion was to reduce the Lucas Drilling price. In order to achieve this MacDow proposed to take over certain aspects of the work. Notable among these items was the supply of the 10 inch umbilical casing, the welding of the product pipeline, site establishment and restoration.

44 On the same day, Mr Loneragan sent to Mr Bumpstead a four page fax setting out the matters discussed and some further thoughts on the HDD project and on the possibility of further reducing the price of $6,042,286 quoted by Lucas Drilling in its 15 February 2002 letter. This price was to be reduced, as discussed that day, by deleting items for which Lucas Drilling had allowed in its quote $906,000 plus 10%, a total of $1,007,000. Other price reduction proposals were made in this fax.

45 In response, Mr Bumpstead wrote to Lucas Drilling an important letter dated 26 June which I set out in full (omitting formal parts):

I am pleased to advise our intention to proceed to award of [sic] this subcontract to AJ Lucas Drilling subject to the following terms and conditions:

Price - Lump Sum A$5,000,000.
Scope of Work - Generally in accordance with the workscope outlined in Lucas letter dated 12 February 2002 (Ref. C:\tenders\2002\Minerva\Revised offer - McDowell 15 Feb 2002.doc) save and except that [MacDow] will undertake:

(a) Site establishment

(b) Supply of 10" casing pipe

(c) String, welding and joint coating of chemical injection lines and product pipeline

(d) Site restoration.

Agreements on sub-contract terms and conditions a draft of which will be forwarded to you for your review overnight tonight.
Approval of AJ Lucas Drilling Pty Ltd by our client BHPB as the HDD subcontractor.

The effect of this document shall be terminated in the event that approval of AJ Lucas Drilling Pty Ltd by BHPB is not forthcoming or the parties fail to conclude negotiations after a period of 14 days from the date of this letter.

We look forward to again working with Lucas and to the successful completion of the Minerva HDD crossings.

The letter referred to in paragraph numbered 2 is the 15 February 2002 letter.

46 After the date of this 26 June letter, and well beyond the 14 day period, negotiations on a number of topics continued. These topics concerned the detail of the work to be performed by Lucas Drilling and a miscellany of other matters which might loosely be called, commercial matters. A draft of the proposed sub-contract was prepared by MacDow and submitted to Lucas Drilling for its acceptance. It seems that this draft was with Lucas Drilling by 2 July and it went through a number of internal revisions before it was returned to MacDow. It is next mentioned in an exchange of faxes in late August and early September in which both parties were suggesting and agreeing changes. The correspondence shows that the terms of the sub-contract were not finally settled until the date of its final execution on 28 November 2002.

47 Commercial matters which were the subject of negotiation in this period included insurance, performance security, liquidated damages, the payment schedule, and perhaps the date of completion.

48 Of greater significance for the purposes of this litigation are the discussions which took place after 26 June with respect to the Lucas Drilling workscope. Mr Loneragan said that, when the letter of 26 June 2002 was received, Lucas Drilling intended and MacDow understood that the work would be carried out as quoted in February 2002, subject to the 26 June amendments. In particular, he said that the discussions, at least since February 2002, proceeded on the basis that the umbilical borehole would be cased by a 10 inch casing whose component parts would be joined by threading and that this would serve as a drill pipe. This was to be a drill and leave operation. This evidence was the subject of attack by counsel for MacDow but I am satisfied that Mr Loneragan's account of this is reliable and I accept it.

49 On behalf of Lucas Drilling, it was said that, in the five month period which separated the letter of 26 June and the execution of the sub-contract on 28 November, there were a number of changes made to the workscope. Leaving to one side for the moment the question whether they amounted to variations within the meaning of clause 14, it is common ground that changes were made. Despite the voluminous correspondence in evidence, it is difficult to fix the date of these changes. This task is rendered the more difficult by the contractual arrangements which existed between the principal parties, BHPB, MacDow and Lucas Drilling. As between BHPB and MacDow, the contract specification was expressed in functional terms. MacDow assumed responsibility for achieving crossings which met the stipulated performance standards; how it did this was for itself as designer of the crossings. Having in this way passed to MacDow responsibility for this design work, BHPB retained control over almost every aspect of it. Under the Head Contract, most aspects of the work had to be submitted to BHPB for approval before the work was undertaken. Lucas Drilling was also bound to a large extent by these Head Contract requirements. This meant that the five month period was characterised by extensive communications between the three parties in order to obtain the necessary approvals. Meantime, MacDow and Lucas Drilling were preparing to undertake the work. In this period, too, the design of the umbilical bundle was evolving and this had an impact on the umbilical casing.

50 Under the arrangements made in June 2002, MacDow assumed responsibility for the supply of this casing. Very soon after that date, two significant changes were made. First, MacDow proposed, and Lucas Drilling accepted, that the casing segments be joined by welding rather than by threading. Second, the diameter of this casing increased from 10 inches to 12 inches. This was to accommodate an enlarged umbilical bundle and pulling head. It is not altogether clear when these changes were made or which of them came first. Perhaps it is not important, for the final approvals to this were given some time later, well after Lucas Drilling and MacDow were readying themselves to carry out the work as changed. Moreover, the correspondence shows that the requirements for the umbilical casing were under constant review and changes were frequently foreshadowed and incorporated in the design before they were documented. If it were necessary for me to make a finding on this matter, I would accept the evidence of the MacDow engineering manager, Stephen Chien Tung Chai, that from some time after 30 July, all parties were working on the basis that the dimension would be 12 inches and that the drill and leave methodology was no longer applicable.

51 I accept the evidence of the Lucas Drilling engineers and that of Professor Rahman that the drill and leave methodology was not practicable using a 12 inch casing. The abandonment of this drilling methodology for the umbilical crossing was, therefore, a consequence of the dimensional change to the casing. This was formally communicated to BHPB on 2 September and again on 18 September 2002 and approved by it on 20 September. Lucas Drilling accepted that the drilling of this borehole would have to be undertaken in the same way as that for the flowline, that is, by pulling the casing from the seaward end into the previously drilled 16 inch borehole. This presented a difficulty which was not present for the flowline crossing: the external diameter of the 12 inch casing was very close to that of the borehole. BHPB doubted that such a casing could be pulled through a 16 inch borehole and withheld approval for the insertion. As at the date of the execution of the sub-contract this matter had not been resolved.

52 In this period, too, BHPB required that the diving work which was required at the seaward end of the boreholes be carried out in conformity with the requirements of the Commonwealth Petroleum (Submerged Lands) Act 1967. This required greater capacity and certifications than were possessed by the diving company selected by Lucas Drilling for the work. The end result was that Lucas Drilling was obliged to let the diving work to another company, Covus Corporation Pty Ltd, at greater cost.

53 These matters were all discussed and settled prior to 28 November 2002 when the sub-contract agreement was finally executed, although their impact on the project was said to continue thereafter.

54 Two fundamental submissions as to the construction of the sub-contract were put on behalf of MacDow. First, it was said that, notwithstanding its date, the sub-contract was entered into on 28 November 2002, the date on which it was executed. This meant that its terms as to the scope of work were to be found, not only in the formal instrument of sub-contract and the documents expressly incorporated in it, but also in the scope of work as it had been settled prior to that date. In short, the contractual scope of work was that which the parties on 28 November 2002 had then agreed to be performed. The second was that the specification of the work to be performed was expressed in functional or performance terms, so that it was for Lucas Drilling to achieve cased holes which met these standards. How it did this was, to a large extent, for it, as designer, to determine. And so, any changes in methodology to achieve this performance and any consequential costs were the responsibility of Lucas Drilling.

55 The normal starting point for the determination of an issue such as this, might be to look at the pleadings whose function, after all, is to identify these issues. As I have mentioned, the pleadings in the present case, however, on both sides, appear to obfuscate rather than illuminate them. It may be said in defence of the pleaders, that the documents were prepared for use in the larger litigation involving BHPB which has now settled. After attempting to read them, I was not surprised that very few of these pleaded issues were pressed at trial. Indeed, counsel for Lucas Drilling at one stage urged me to put the pleadings to one side and rely upon the matters raised at the trial and those in the agreed questions. Counsel for MacDow did not accept this approach, urging me to have regard to the matters pleaded. I shall, in the circumstances, struggle through the thickets as best I can.

56 In paragraph 17 of the Statement of Claim, Lucas Drilling alleges that the sub-contract was entered into on 26 June 2002 and that it is written and/or to be implied. I pass over the possibility that this is intended to be a true alternative: no one suggested that this is an implied contract and no implied terms were asserted. Nine documents are identified as being contractual including the formal sub-contract and the letter of 15 February 2002 as amended by the letter of 26 June 2002. This raises an immediate conceptual difficulty, because it is common ground that, on 26 June 2002, none of these documents, other than the incorporated Head Contract documents and the two letters, was in existence. Indeed, their terms had not been settled and agreed at that time. Furthermore, the analysis must confront the difficulties posed by the conditions which were inserted in the letter of 26 June. The terms and conditions of the sub-contract were not finally settled until 28 November 2002 and Lucas Drilling was not approved by BHPB as sub-contractor until 30 June 2002. The Lucas Drilling analysis of the contractual arrangements, however, lays the foundation for its contentions which follow - that the changes introduced after 26 June 2002 were variations to the scope of work and should be valued as such, if the task of valuation of the work is to be undertaken as MacDow contended.[16]

57 The formal response of MacDow is found in paragraph 17 of its defence, a plea which occupies some four pages. In essence, MacDow agrees that the parties entered into the sub-contract on 28 November 2002 and that the contract was partly written and partly to be implied as a matter of law and in order to give business efficacy to the contract. No implied terms, however, are alleged. Insofar as it is in writing, it is said to be contained in the formal sub-contract agreement executed by the parties in November.

58 That said, the defence in paragraph 17.2 sets out five matters which, it is said, were common ground between the contracting parties as at the date of execution. These matters included the increased size of the umbilical bundle and of the pulling head for the umbilical line, the enlargement of the diameter of the casing for the umbilical line and the requirement that this casing be welded. As a matter of fact, it is correct that these matters were understood by the parties at the time of the execution of the sub-contract to be part of the works to be performed. The fifth matter is that any extra costs incurred as a consequence of one only of these preceding four matters, namely, the enlargement of the diameter of the umbilical line casing, would be treated as a variation. This may be a controversial allegation inasmuch as the Lucas Drilling witnesses said that they pressed MacDow for a variation instruction for this change in dimension, but that it was not forthcoming, at least prior to the commencement of the drilling work. It is, however, fair to say that MacDow did not deny that this was a variation within the meaning of clause 14.

59 The interest, for present purposes, of the allegations in paragraph 17 of the Statement of Claim and paragraph 17.2 of the Defence is that the latter plea does not spell out the contractual significance of this common understanding. At trial, it appeared that MacDow contended that these matters became part of the contract in some way. This analysis, too, faces serious obstacles. The contract is said to be in writing and to be implied. The documents which record the common understandings are not pleaded to be contractual documents. Indeed, this is not surprising; they are, in important respects, inconsistent with the terms of the sub-contract agreement.

60 In my opinion, the proper legal analysis must start with the terms of the sub-contract itself. It is dated 26 June 2002. That is, in the circumstances, a matter of considerable significance. Furthermore, the description of the Sub-Contract Works in the contract includes the installation of 10 inch casing for the umbilical line, and that the casing is to be left in situ as was agreed on 26 June. These were two important respects in which the scope of works had moved on by 28 November. These are powerful indications that Lucas Drilling and MacDow were, in the sub-contract, documenting an agreement as to the scope of works as it stood following the 26 June letter.

61 A counter-indication is to be seen in the contractual obligation cast upon MacDow of welding the umbilical casing. This obligation arose after the 26 June letter. In the course of the contractual negotiations, Lucas Drilling requested and MacDow had agreed that MacDow's responsibility as to welding should be inserted in the scope of works in the draft contract, and this was done on or about 5 September 2002. Counsel for MacDow laid emphasis upon this as an indication that the contractual scope of work incorporated this and all other changes which were made in the five month negotiating period which followed the 26 June letter. Moreover, a comparison between the scope of work as it appears in the letters of 15 February 2002 and 26 June 2002 and with that in the contract discloses that other changes were introduced. The contract scope of work is expressed to be inclusive and part of a general obligation for the design and installation of the umbilical bundle and the flowline; it includes the preparation and submission of documentation required under the Head Contract; the diameter of the control line within the umbilical bundle is increased from 140mm to 146mm and that of the glycol lines from 32mm to 42mm. Some, but not all, of these post-26 June changes are matters of detail and it is apparent from an examination of the progressive drafts of the contract over the five month period that the parties were seeking to express in a more formal way the principal features of the Lucas Drilling scope of works as agreed on 26 June. The contrary intention, that they were seeking to formalise the scope of works as it stood at the date of contract, sits uneasily with the insertion in the sub-contract of the 26 June date and the superseded dimension of the umbilical casing. The position is to be contrasted with the commercial and other non-workscope matters introduced after 26 June. These show that the parties had not achieved an agreement on that date; they were negotiating and agreeing these terms progressively through this period.

62 Mr Loneragan spoke of telephone discussions with Mr Chai at which a zero point for the scope of work was established. He said that there were numerous changes being discussed which Lucas Drilling was requested to accommodate within its price. In the conversation, the two men fixed the workscope concerned by the price as being that specified in the MacDow letter of 26 June 2002. I am, however, not prepared to act upon this evidence. Mr Loneragan appeared to be uncertain when these conversations took place and as to what was in fact said. It was not put to Mr Chai when he gave evidence.

63 I am satisfied that the true legal position is that no binding contract was entered into on 26 June 2002. There remained on that date many matters to be settled. At that time, however, the parties were agreed upon the general scope of Lucas Drilling's work and the price to be paid for this. A binding contract was entered into on 28 November 2002 when the sub-contract was executed. The description of the workscope in the schedule and in Appendix A was intended generally to reflect the parties' understanding as to what was the work as at 26 June. To the extent that they have failed accurately to describe this 26 June work or that they included variations to it, they must abide their contract. To the extent that work extra or different to that in the contract was expected or required to be performed as at 28 November 2002, this is capable of being treated as a variation under clause 14.

64 The removal from the Lucas Drilling scope of work without price adjustment of the obligation to weld or otherwise join the sections of the umbilical casing is not inconsistent with this analysis. It did not involve extra work for Lucas Drilling. It may be that this reduction in its work was seen as being balanced by the increase in the drilling time which would be caused by the new requirement that the sections be welded on site rather than threaded together. It may be, too, that this was not seen as significant as it was expected that the drill and leave method would be abandoned following the foreshadowed increase in the diameter of the umbilical casing.

65 I conclude, therefore, that the Lucas Drilling scope of work was that described in clause 3 of the schedule to the sub-contract, including Appendix A. Any departure from this is capable of being a variation warranting extra payment beyond the agreed $5m.

66 It was next put on behalf of MacDow that the specification was a functional specification and that the method selected by Lucas Drilling to achieve the specified objective of the HDD drilling and associated work was a matter for itself. If Lucas Drilling found it necessary or convenient to change its methods this was not a change warranting a variation or extra payment under clause 14.

67 The Head Contract was in evidence. It is apparent that the part of the work which was sub-let to Lucas Drilling was in fact described in the specification in functional terms. Although the Lucas Drilling sub-contract incorporates much of the Head Contract specifications, the relationship between MacDow and Lucas Drilling with respect to the sub-contract work was fundamentally different. In its letter of 15 February 2002, Lucas Drilling, not only set out its price for performing the HDD and associated work, it also set out how it proposed to perform this work. This methodology was proffered with the stipulated price. In the four months which followed, this methodology was subjected to scrutiny by MacDow and changes were introduced with a view to reducing the price. I am satisfied that on 26 June 2002 the parties understood and accepted that the price offered by Lucas Drilling and which was provisionally accepted involved the performance of the work in accordance with a stipulated methodology which included the drill and leave insertion of a 10 inch casing for the umbilical crossing. If demonstration for this be required, it is to be found in the Technical Query Form from Mr Chai to BHPB of 3 July 2002 and his fax to Mr Loneragan of 11 July.

68 I turn now to the construe the sub-contract in order to determine whether the drill and leave methodology is part of the scope of works for the insertion of the umbilical line casing or whether the casing was to be pulled into the previously drilled 16 inch borehole. The workscope is said to include 19 activities which are listed with bullet points. For my purposes, the relevant activities are described as follows:

Preparation and submittal of all required documentation required by the Head Contract in relation to the HDD works inclusive of work methods statements, profile drawings, Environmental, Safety and Quality Management Plans
Mobilisation
Drilling 1 off 1500m x 16 inch (406mm) pilot hole
Installation of NB 10 inch (NB 250mm) casing (note this will be left in situ). Approximately 1550m in length
Installation of a 146mm OD umbilical and 2 off chemical injection lines (32mm or 40mm OD each) into the NB 10 inch casing. The umbilical and glycol lines will be centralised with a bonded urethane or HDPE spacers every 5 metres. Approximately 1900m in length (approximately 1550m in hole and 350m on seafloor)
Drilling 1 off 1550 metre x 16 inch pilot hole (second pilot hole)
Installation from land of 1900m off 10 inch (250mm) product pipe (approximately 1550m in hole and 350m on seafloor)

Provision of marine and diving spreads relevant to HDD works inclusive of:

― Recovery of drilling tooling

― Seaward grouting operations

― Hydrotesting support as required

― Tow-out operations for the product pipe, chemical injection and umbilical lines

― Placement of temporary anchoring system for the product line, chemical injection and the umbilical control line

...

Submarine transport of the chemical injection lines and umbilical "tail" across to the product pipe "tail" and subsequent stabilisation of the bundles on the seafloor. Stabilisation will be able to be removed by others at a later date.
Filling of both boreholes annuli with a bentonite or similar electrolyte. This may required placement of a grout plug in the borehole annulus and will be limited to one operation per borehole.

...

Services to be provided by [MacDow] are limited to:

Supply, welding and field joint coating of coated chemical injection lines (approximately 3900m)
Supply and installation of cathodic protection anodes for the flowline, chemical injection lines and umbilical casing
Supply, welding and field joint coating of coated product pipe (approximately 1900m)
Supply and delivery to site of one continuous umbilical control line (approximately 1900m)
Assembly of chemical injection line and umbilical bundle including attachment of PE spacers (specified by Lucas)
Supply, delivery and welding of coated 10 inch casing pipe to site (1550m approx)
Site preparation and access roadway
Site restoration
Supply and installation of HDPE or urethane spacers (specified by Lucas).

Counsel for Lucas Drilling relied upon the third and the fourth of these activities as indications of a drill and leave methodology. It was put that a pulled casing must inevitably be left in situ so that there was no point in mentioning this in the activity description if that was the intended methodology. The significance of the words in parenthesis in the fourth bullet point is that a drill pipe would normally be withdrawn after drilling for later re-use. The words in parenthesis make it clear that this is to be left in place. A further aspect of this is the in the drilling industry there is a distinction between casing pipe and drill pipe. The drill and leave method contemplated that a casing pipe serve the function of a drill pipe during the drilling operation. It was this casing which was then to be left in situ. Counsel contrasted the terminology in this bullet point with the absence of the parenthesis in the comparable activity for the drilling and casing of the flowline borehole. Reference is also made under the eighth bullet point to marine activities which Lucas Drilling is to perform. These include tow out operation for the product pipe and for the umbilical bundle; there is no mention of a tow out of the umbilical casing. They relied, too, on the fact that "left in situ" terminology dates from the early quotations where it was clearly understood that drill and leave was the methodology for the umbilical borehole. They argued that these words must be understood in the context, known to both parties, that, in this respect, the workscope harked back to 26 June 2002 when drill and leave was known to be the methodology.

69 Notwithstanding that the "left in situ" terminology is to be found in Lucas Drilling Construction Plan of 3 September 2002 which contemplated that drill and leave had no further role to play, I am persuaded, for the reasons advanced on its behalf, that the Lucas Drilling construction of the contractual scope of work is to be preferred.

70 I conclude, therefore, that, under the sub-contract, Lucas Drilling was obliged to drill a 16 inch borehole for the umbilical crossing using a 10 inch welded casing on a drill and leave basis. The changes to a 12 inch casing and to the drilling methodology which were already being implemented at the date of contract, are to be treated as variations. Lucas Drilling is therefore entitled to payment if it incurred extra cost in performing this work in a different way as a direct or indirect consequence of an instruction by MacDow.

71 In the Lucas Drilling Statement of Claim the suggested changes to the contractual workscope are set out under two headings:[17] the drilling works and the diving and associated marine works.[18] Lucas Drilling contended that the changes made in these two activities were outside the contractual workscope and that they had a far-reaching impact upon the whole of the Sub-Contract Works and the cost to Lucas Drilling of performing them. A significant suggested consequence was the wholesale abandonment of the methodology which had been pursued up to mid-March 2003 and the insertion into both boreholes, which were reamed to a 24 inch diameter, of a 16 inch HDPE casing. This interruption to the pre-existing methodology and the development and pursuit of the new methodology was referred to at trial as the re-engineering.

72 Before I turn to the detail, I make mention of a credit issue raised on behalf of MacDow. The facts underlying this are not controversial. When the changes to the diameter of the umbilical casing and to the drilling methodology were made prior to 28 November, Lucas Drilling made no protest about the cost or engineering implications. Indeed, it was only when the drilling was encountering difficulties that questions were raised internally at Lucas Drilling. There were in evidence a series of emails passing in March 2003 between the various Lucas Drilling personnel in effect exploring the possibility of bringing a substantial claim for extra cost and time extension arising out of the changes to the drilling and the marine activities. The tone of these emails was suggestive of a creative attempt to retrieve the parlous commercial position in which Lucas Drilling then found itself. And, later on 18 June 2003 Lucas Drilling presented to MacDow a document setting out 10 substantial claims. It was put, with some force, that these claims were a spurious attempt to extract money from BHPB through MacDow in an effort to recover losses incurred on what had turned out to be an ill-advised contract. It was then said that the Lucas Drilling claim before the Court should be treated as yet another attempt to pursue this objective.

73 I must acknowledge that these documents do not reflect well on the bone fides of the Lucas Drilling claims. Nevertheless, the fact that a litigant puts forward a spurious claim does not lead to the conclusion that all of its claims are spurious. Accepting as I do that, in important respects the June 2003 claims have been shown to be misconceived and that the March emails show a readiness in Lucas Drilling to drum up claims in which they have little confidence, I will look at the present claims with more than usual caution. This particularly applies to assertions made on its behalf that a particular change has had an engineering or financial consequence which was not foreseen at the time by persons in its employ who were very experienced in the industry or was not appreciated by them soon after the event.

74 That the internal dimension of the umbilical casing was enlarged during the design phase of the project is not in doubt. In the early days, December 2001, it was to be 7 inches. In the 15 February 2002 letter it was 10 inches, and this is how things stood on 26 June 2002. By 30 July Mr Chai was writing to Mr Loneragan foreshadowing an increase in diameter to 12 inches with a possible further increase to 14 inches. The increase to 12 inches led to the abandonment of the drill and leave methodology. This change in methodology was approved by BHPB on 20 September. Meantime, other options were considered because difficulties were recognised in pulling a casing with an external diameter larger than the 12 inch internal diameter through a hole which itself was only 16 inches. An option of using HDPE casing was rejected on the basis that it would need to have an external diameter of 355mm, which in the opinion of the Lucas Drilling Project Manager, Michael Brian Robertson, was too tight for insertion in the 16 inch borehole. At this time, too, BHPB required to be satisfied that the pull operation was feasible, given the load to be tugged, the strength of the umbilical terminal assembly and the clearance in the borehole. In the event, notwithstanding that these concerns of BHPB had not been finally resolved, Lucas Drilling mobilised on 6 January 2003 and on 22 January, having obtained approval from BHPB for the drilling, Lucas Drilling commenced drilling the borehole for the umbilical crossing using a standard 6⅝ inch drill pipe. The drilling was, of course, of a borehole of 16 inches, as was envisaged in the contractual workscope. The only change to this operation was in the methodology. But the enlarged steel casing was never pulled through this hole.

75 I pause at this stage to analyse the contractual position of the parties with respect to this work. For reasons which I have set out, I am satisfied that the changed methodology for the drilling of the umbilical crossing borehole was a consequence of the change in dimension of the casing. Since this methodology was part of the contractual workscope, this consequential change is also a variation. Any costs thrown away by this change in methodology and any extra costs incurred are chargeable to MacDow as part of the work to be valued.

76 It was also put on behalf of Lucas Drilling that, as a consequence of these changes, contractual risks which it had assumed under the sub-contract fell away because its assumption of those risks were part of the contractual package which included the drill and leave method for which it had agreed to receive $5 million. I am not persuaded that this is the case. Under the sub-contract it had agreed to design the crossings as well as to construct them. It accepted the changes in dimension which were required and the consequential changes in the methodology. It follows that, for an appropriately adjusted price, it was bound to implement these changes. If it had misgivings about the prospects of successfully implementing the methodology, it might have qualified its acceptance of the change or perhaps have declined to undertake the work. The fact remained that it did none of those things.

77 In his fax of 30 July in which he told Mr Loneragan of the possible increase in the diameter of the umbilical casing, Mr Chai enquired whether the casing could be pushed through the 16 borehole and what would be the effect of this on work method and cost. Mr Loneragan made no written response. He said, however, in his second witness statement, that he replied by telephone advising Mr Chai that the change would create considerable construction risks and therefore costs implications. Mr Chai said that he was aware that the enlargement of the casing increased the risk of it becoming stuck in the borehole, but he did not recall the conversation of which Mr Loneragan spoke. Mr Chai was not challenged on this. I accept the evidence of Mr Chai that he discussed the engineering implications of the dimensional change with Mr Loneragan in August, but that there was no discussion of the cost consequences.

78 At a meeting on 31 January 2003, Mr Robertson proposed that Lucas Drilling be paid an extra $1.7 million for the change. The response of the MacDow representatives at that meeting was to request documentary substantiation of these costs. By fax dated 4 February 2003, Mr Robertson explained the impact of the changes on the drilling and offshore works and estimated the extra-over costs at $1,802,890.88. To this he added a margin which was said to be 7% for materials and 5% for services in accordance with Rule (d)(ii) of clause 14.5,[19] making a total claim of $2,037,266.70. The matter was discussed further at a meeting on 6 February at which Mr Lukas and Mr Pryor represented Lucas Drilling. Mr Bumpstead's note of the meeting records that there was no issue with Lucas Drilling's contention that the dimensional change to the umbilical borehole casing was a variation, but that the principal cost concern at that time was with the extra cost of the marine work. This meeting was not the subject of evidence from any other witness. I accept the accuracy of the note.

79 On the same day, at a depth of 878.78m, the drilling of the borehole struck a fracture in the rock formation, which had the consequence that 100% of the drilling fluid was lost. This delayed progress until drilling was again resumed on 15 February, and on 11 March 2003 the drill had exited the ocean floor.

80 I pause again to observe that any extra costs involved in overcoming this loss of fluid and of returns or in the consequent extension of the drilling time of this borehole were not a consequence of the changes. They were part of the geological risk for which Lucas Drilling was always responsible.

81 I am mindful of the evidence of Mr Lukas and other Lucas Drilling witnesses that risks of delays and extra cost due to geological problems in the umbilical borehole were much greater without the support of the drill casing. This may be so; it is not a matter which I have to resolve. The fact remains that, by accepting the change in methodology, the design obligation of Lucas Drilling extended to the new work. Any risk extra to that inherent in the drill and leave methodology would have been valued. Lucas Drilling did not do so at the time; it was prepared to accept the change without proposing any adjustment of the contract price. I do not, however, infer from this that it agreed to vary the work without a price adjustment to cater for any extra expense and risk. The special feature of this case is, of course, that the geological factors are no longer mere risks. The drilling was completed and difficulties encountered were overcome. Moreover, the change in casing size did not lead to a change in the dimension of the borehole. In these circumstances, the task of the valuer is to determine whether any extra costs were incurred in the drilling due to geological or other causes for which Lucas Drilling had a general responsibility and to identify what part of those costs was extra to those which might have been incurred had the drilling been undertaken by the contractual drill and leave methodology. It is these extra costs which are to be assessed.

82 I turn now to the second heading of suggested change to the contractual workscope. This concerned the diving and associated marine work. It is necessary to underline that there are here two separate causes of extra cost. Lucas Drilling at trial did not distinguish between them, doubtless because of the way its primary case was presented. The first is the extra work which may have been the consequence of the changes to the umbilical borehole, drilling and casing. This did not affect the flowline crossing because this was always to be tugged from the seaward end. Second was the requirement of BHPB that the offshore work comply with the Commonwealth regulatory regime rather than the State regime. This second course requires an examination of these regimes to determine which was contractually applicable and, if the Commonwealth regime was not applicable, as to the contractual consequence for the parties before me of the BHPB insistence that, nonetheless, the Commonwealth regime be complied with.

83 As to the first cause, evidence was given of the extra marine and diving work which became necessary as a consequence of the changes to the dimensions of the casing and to the drilling methodology. Mr Robertson spoke of extra tugging and additional work in picking up the drill pipe from the ocean floor and capping. The fact is, however, that in January 2003, before the umbilical borehole was completed, Mr Bumpstead told MacDow that his company was not prepared to carry out the marine or diving work and, in fact, Lucas Drilling did not do this work. Such cost as it incurred was incurred in mobilising and paying standby charges to its marine sub-contractor. These costs will be included in the valuation only and if, and to the extent that, they have been shown to have been reasonably incurred over and above those which it would have incurred in the performance of the contractual workscope.

84 As to the second cause of extra cost, Mr Lukas and Mr Loneragan told me that they expected to perform the marine and diving work using light diving spread. This involved engaging a diving company, The Diving Company (NSW) Pty Ltd ("TDC"), which it had used on other projects. TDC was approached by Mr Loneragan to quote for the work in June or July 2002 and its quotation of 22 August was given on the basis that the umbilical casing would be tugged through borehole number 1. The price includes the supply of a dive support boat; it does not appear that TDC was also to provide the tug.

85 Under clause 21.1(a) of the Head Contract, prior approval was required by BHPB for major sub-contracts. These are defined in clause 1 in general terms including, "certain critical components or services of the Works". In Appendix 1 which sets out the Head Contract scope of works, there is reference to "significant work". This is, again, defined in very general terms. At a meeting on 8 October 2002 BHPB advised that it had determined that the diving was significant work and that the sub-contractor would have to be approved and that the diving work would have to comply with Commonwealth legislation. In order to obtain approval for TDC, material was submitted to BHPB in support of TDC as an appropriate sub-contractor and also detailing the way it proposed to carry out the offshore work. On 14 October 2002 Joe Cini of BHPB faxed a lengthy list of comments to MacDow and indicted that the documentation provided was not impressive and that approval of TDC was unlikely. On 22 October, BHPB formally advised MacDow that TDC was unacceptable. In its letter of rejection, BHPB set out a number of criticisms of TDC and its proposed procedures, including that its "equipment... proposed to date are inappropriate for the site conditions and legislative requirements". Although this decision was criticised by Lucas Drilling at trial, I am not required to determine its lawfulness and I do not do so. The decision meant, however, that Lucas Drilling had to find another diving sub-contractor and this it did.

86 An alternative sub-contractor, Covus, was approached, and, on 7 November 2002 provided a quotation for the offshore work. On 27 November a letter of intent was issued to Covus and on 12 December it was approved by BHPB as a major sub-contractor.

87 In the course of the November negotiations regarding the offshore sub-contract, Mr Chai, on 14 November, sent an email to Mr Cini asking for clarification as to the regulatory regime under which the Lucas Drilling offshore work sub-contract submission was being considered. The response dated 18 November 2002 made it clear that BHPB expected compliance with the Commonwealth regime. In particular, it made reference to the Petroleum (Submerged Lands) (Diving Safety) Regulations 2002 which were not yet in force. They were then expected to come into force in 2003.[20] This information was acted upon so that, thereafter, Lucas Drilling treated itself as obliged to comply with the Commonwealth regime.

88 The case of Lucas Drilling here is that the sub-contract which it entered into required compliance with the Victorian regime, so that the stance taken by BHPB represented a variation of its scope of work so that it is entitled to any extra costs incurred as a result. The response of MacDow to this is three-fold:

Compliance with the Commonwealth regime was required under the sub-contract.
In terms of the compliance obligations of Lucas Drilling or its sub-contractor, there was no difference between the Commonwealth regime and the Victorian regime.
It was not demonstrated that extra or different work was performed or extra cost incurred.

The matter is rather complicated by the fact that the TDC quotation of 22 August, which represents the starting point for this part of the claim, was based upon compliance with yet another regime, that prescribed by the Australian and New Zealand standard, ANZS-2299 (1999). It was pointed out, however, that this standard has no application where the diving work in question is governed by the Victorian Petroleum (Submerged Lands) Act 1982 ("the Victorian Act") or the Commonwealth Petroleum (Submerged Lands) Act 1967 ("the Commonwealth Act"). Accordingly, the TDC quotation was founded on error. The consequence of this is that the contest now became whether the Commonwealth regime contractually applied, as MacDow contended, or whether the State regime applied, as Lucas Drilling contended or whether the standard applied, as TDC supposed, and what were the relevant differences between these regimes.

89 It is common ground that the boreholes each exited through the ocean floor at about 1 kilometre or a little more from shore. The diving and associated activities concerned the area of exit while the tugging may have occurred some 1.5 kilometres or so further out to sea. The Victorian regime applied to an area offshore which is described in the legislation as "the adjacent area". Without venturing far into this complex legislation, the areas in which the marine activity which the Lucas Drilling sub-contractor was to undertake fall within the geographical limits of the adjacent area. There is a further requirement that these areas be the subject of an exploration permit under the Commonwealth Act on 14 February 2003 and a further provision that the areas remain part of the adjacent area only so long as that permit subsists.[21] It follows from this that the offshore activities were not governed by the Commonwealth Act. There seems no doubt that they were governed by the Victorian Act, so that the ANZ standard does not apply.

90 This, however, is not the end of things. Counsel for MacDow contended, nonetheless, that the requirements of the Head Contract relating to occupational health and safety in Appendix 11, clause 5.2 included a general requirement that MacDow and its sub-contractors comply with best industry practice. What precisely amounts to best industry practice cannot be determined in the abstract. What is to be valued in respect of each suggested extra or different activity is whether, notwithstanding that it was not required under the Victorian regime, it was required by best industry practice or, indeed, any other provision of the Head Contract which is incorporated into the Lucas Drilling sub-contract. If it is not, then its net cost should be included in the valuation. I speak of net cost because allowance must always be made for any cost of the activity which fell within the contractual workscope. I refer to other provisions of the Head Contract because it was suggested that some of the activities for which a claim is made were acquired under the Head Contract requirements for environmental impact assessment ("EIA") approval or environmental management plans.

91 Next, it was put on behalf of MacDow that, even if the Victorian regime applied and no Head Contract provisions required the suggested extra or varied activity, there was no difference between the relevant requirements of the Commonwealth regime and the Victorian regime, so that this debate is entirely without practical significance.

92 The applicable regulatory regime under the Victorian Act is that contained in a ministerial direction dated 21 March 1997 made pursuant to s. 101 of the Victorian Act. This direction is directed to a number of holders of licences or leases, including BHPB in respect of the Minerva site. It directs that they comply with the requirements set out in a document entitled Specific Requirements as to Offshore Petroleum Exploration and Production, dated 18 December 1995, as amended. The requirements in this document are relevantly no different from those in the equivalent instrument issued under the Commonwealth Act. Accordingly, assuming that the Victorian direction is effective, there is no substance in any claim which depends upon the Commonwealth regime being more onerous than the Victorian regime.

93 Lucas Drilling then contended that the ministerial direction was not binding upon it. Section 101 of the Victorian Act permits the direction to be given to the registered holder of a lease or licence, in this case BHPB. By s. 101(2) the direction may be expressed to be given to certain other persons described in parts (a) and (b) of that sub-section and, in such a case, it is deemed to apply to such other persons. The direction in this case is directed to the following class of persons other than the registered holder of the licence or lease - "each person, servant or agent [of the registered holder]... in accordance with s. 101(2)(a) and (b)". Sub-sections (2A) and (2B) then require the registered holder of the licence or lease to cause a copy of the direction to be given to those other persons or to cause it to be prominently displayed. Failure to comply with these sub-sections renders the registered holder liable to a penalty. The point taken by Lucas Drilling was that, since there was no evidence that the direction had been given to it or displayed as required by s. 101(2A) or (2B), Lucas Drilling was not bound by the direction.

94 This point, which was not raised in the pleadings, is without substance. The receipt of notice is not expressed in the statute to be a condition of an obligation to comply. It would be remarkable indeed, given the evident purpose and content of the directions, that Parliament would relieve a person of the obligation of compliance simply because of some failure on the part of the registered holder. I bear in mind the significance of these provisions in the present case is as to whether, under its sub-contract with MacDow, Lucas Drilling is obliged to comply with a ministerial direction. Given the requirements of the Head Contract that MacDow and, indirectly, Lucas Drilling, comply with all laws and with best practice, it could be hardly said that Lucas Drilling is not contractually so bound.

95 I turn now to the detail of the extra or different work which Lucas Drilling says was the consequence of BHPB's direction that it comply with the Commonwealth regime. They are set out under seven heads in paragraph 47 of the Statement of Claim.

(a) BHPB refused to approve TDC as the sub-contractor for the offshore work.

96 This cannot be a consequence of the BHPB direction. The reasons for its refusal to approve TDC are set out in the letter of 22 October, reasons which were not challenged. Moreover, it appeared from the evidence of TDC's director, Mark Dowd, that the TDC proposal was, in many important respects, superficial and inadequate. While it is true that reference is made in the letter of 22 October to the legislation, it does not appear that the approval would have been given for this critical work to be undertaken by TDC under the Victorian regime.

(b) On 6 November 2002, BHPB directed that there be a larger dive support vessel with a decompression chamber and a full complement of divers on standby at all times.

97 This appears to be a reference to an email from John Rickman of BHPB dated 4 November 2002 which was passed to Mr Robertson on 6 November. The email contains no such direction.

98 Such a recommendation is indeed made in Mr Rickman's email of that date. It was no more than a recommendation. It does not appear that it was acted upon.

(d) Mr Rickman in the 4 November email advised that Covus was the only diving sub-contractor which BHPB would approve within the available timeframe.

- Apparent lack of progress in appointing a diving subcontractor. We have all committed to achieving certain dates for commencing and completing the HDD activities. Appointing a diving subcontractor is becoming critical to meeting those dates. There is insufficient time for a subcontractor to develop procedures which comply with P(SL)A requirements and to have them approved by the Government. Therefore, the diving subcontractor must have a full set of diving procedures and documents already approved under the P(SL)A schedule. I can advise that we would approve Covus Corporation Pty Ltd (Contact: Peter Rash 08 9353 7933 or 0417 907 503) without further audit based on past experience. Other diving contractors may also be suitable, but we would need details of experience, safety systems, diving manuals, engineering capability, etc.

It is not clear what Lucas Drilling can make of this. It is apparent that, following rejection of TDC, the appointment of a new sub-contractor was urgent. There is no evidence that BHPB would refuse any sub-contractor but Covus. Indeed, according to Mr Robertson, Ian Bavin, BHPB's diving consultant, suggested that Lucas Drilling try two diving companies: Covus and Global Offshore.

(e) Lucas Drilling had no alternative but to engage Covus, which it did.

100 Again, it is not clear what this has to do with Lucas Drilling's claim. Following the rejection of TDC, Lucas Drilling sought quotations from Covus and from Global Offshore. At the same time, it was exploring the possibility that it might still use TDC together with another diving company, Allied. Its decision to engage Covus appears to have been reached independently of BHPB. Indeed, Mr Robertson in his witness statement in reply, said that "in the end, since Global had not fulfilled all the government documentation approvals, I felt Lucas had no alternative but to engage Covus".

(f) A larger dive boat had to be mobilised from Western Australia.

101 What is put here is that it was necessary to engage the large dive vessel, Bhagwan-K. This decision was made on 19 December 2002. There were in early December a number of vessels under consideration as being suitable for the proposed methodology of combining the tug and the dive support vessel. It seems that the larger vessel was required to accommodate the requirements of the Commonwealth regime. The difficulty here is that, subject to one matter, Lucas Drilling did not identify how it was that adherence to the BHPB requirements changed the offshore work which it had agreed in November 2002 to perform. The one matter which did receive attention was the requirement under the Commonwealth regime that there be a decompression chamber on board the dive support vessel when the divers were working at a depth of 20 m. This was, however, also a requirement under the ministerial direction made under the Victorian Act. As the case unfolded, however, it became apparent that the Lucas Drilling contention was rather different. Counsel on its behalf said that there should not have been a requirement for such a chamber under either regime because the work was to be done at a depth of less than 20 m. If this is correct, then the complaint is not that the extra cost was incurred in complying with the Commonwealth regime; it must be that BHPB and MacDow imposed a requirement that was outside either regime. It may be, in these circumstances, that the requirement was imposed to meet the industry best practice regime. But none of this warrants extra payment. A further possibility is that the larger vessel was required to cope with the greater pulling load envisaged for the increased diameter casing in the umbilical borehole but this was not explored in evidence or final submission.

(g) Lucas Drilling was required to perform additional works and to incur additional costs over and above those which would have been required under the Victorian regime.

102 This is the nub of this claim. In response to a request for particulars of the extra work, Lucas Drilling referred to Schedule G to its Statement of Claim. This schedule is not enlightening on the point. In response to a request for particulars of the extra costs, Lucas Drilling refers to Schedule B of its Statement of Claim. There is no Schedule B. It will be recalled that Lucas Drilling carried out no work involving the Bhagwan-K and that it had in January 2003 indicated to MacDow that it would withdraw from the offshore work. Notwithstanding this, the Bhagwan-K was on charter on 4 February and was mobilising from Western Australia to Portland. It remained on standby during the period of delay incurred in completing the umbilical borehole and on 27 February Mr Robertson agreed that both Covus and the Bhagwan-K would be demobilised until borehole 1 was complete. This borehole was encountering difficulties due to loss of returns in the bad geological environment and was not punched out until 11 March 2003 by which time Lucas Drilling was about to commence the re-engineering of the whole operation and work was suspended on 17 March for this purpose.

103 Absent any detail in the pleadings, I shall endeavour to identify what is said to be the extra work and costs involved with respect to the marine and diving work. In its claim of 18 June 2003 Lucas Drilling said that it had incurred to date $850,000 against a contract allowance of $400,000. In the Scott Schedule under Item 22, the amount claimed for additional marine work, not including margin, is $652,942.94. In each case no detail is provided other than a reference to the Fox report and the evidence of the Lucas Drilling Chief Financial Officer, Mark Anthony Summergreene. This report was primarily directed to quantum and was not, therefore, the subject of detailed examination. Mr Summergreene, however, says that in January 2007 the claim by Covus against Lucas Drilling arising out of this project which totalled $453,663.92 was settled for $300,000, inclusive of costs.

104 I next turn for assistance to the Scott Schedule itself. The items in the schedule are all of the items for which Lucas Drilling seeks payment and the costs claimed to have been expended for those items. There are only three items of marine work: Item 4, marine works related to umbilical borehole works (under original scope) $25,119.64; and Item 6, marine works related to product borehole works (under original scope) $3,782.50. These two items and the costs (but not the margins) have been agreed and paid. The third is Item 22 which is simply described as additional marine works and for which a cost of $652,942.94 is claimed.

105 What it is, precisely, that was involved in the marine work which might flow from the change in dimension? It is known that on 30 January 2003 Lucas Drilling intended to use three vessels for the work, for it was on that date that Mr Robertson sought approval for their use. The preliminary survey work and later guard activities were to be performed by Orca III out of Port Campbell. The dive support boat was to be the Bhagwan K out of Western Australia and the tugging of the casings was to be carried out by Adsteam's MT Keera. By that stage, no standby costs had been incurred.

106 On 4 February 2003, the day that the Bhagwan K went on charter, Mr Robertson advised that Lucas Drilling would not commit to engaging Covus until the extra payment issues had been resolved. Covus was informed of this and, by email of 8 February 2003, its project engineer confirmed that the Bhagwan K was demobilised and would be put on standby and that equipment would be stored at Portland at the expense of Lucas Drilling. The Orca III was put off hire as at that date. The Bhagwan K and its crew and other Covus personnel were demobilised on 6 March 2003.

107 Apart from these standby charges, Mr Robertson, in his witness statement, said that the extra costs involved were the consequence of the requirement that the marine work be carried out under the Commonwealth regime. I have concluded that this is not a basis for extra payment.

108 It remains, therefore, to identify what, if any, extra or different work was the consequence of the dimensional change to the umbilical casing and the consequent change in the drill methodology and that of placing the casing. According to the Lucas Drilling witnesses, these led to a need for more diving activities as well as heavier tugging. If any such action was carried out, it should be considered for present purposes. What the valuer must attempt is to value the extra-over cost in terms of the off-shore works incurred as a consequence of these changes. I emphasise, for the assistance of the valuer, that what is involved is an assessment of what marine costs, including standby, were actually incurred and to what extent these costs were greater than would have been the case had the smaller umbilical casing been placed using the drill and leave method. Then, it will be necessary to determine whether any, and if so what, part of those extra costs were incurred as a consequence of the change in the dimension of that casing and the consequent change in methodology.

109 Following the completion of the drilling of borehole 1 on 11 March 2003, this borehole was left unsupported, except for the initial surface casing, and the rig moved to borehole 2. On 7 March BHPB had approved commencement of drilling this borehole on condition that it not proceed beyond 850m without prior approval and, further, that drilling stop if fluid loses exceeded 10%. This condition was imposed due to concerns about the risk of damage to borehole 1, as well as environmental concerns. Drilling in borehole 2 commenced on 12 March but stopped on 17 March at 700m due to concerns about loss of fluids.

110 The period between 17 March 2003 and 1 June 2003, when Lucas Drilling remobilised, was occupied with its discussing alternative methods of constructing the crossings and with disputation between it and MacDow regarding its claims for extra payments for variations. The position which appeared to have been taken by BHPB was that the problems which Lucas Drilling was addressing were within its area of risk. The solution which Lucas Drilling proposed and which BHPB and MacDow accepted was that both boreholes would be reamed to 20 inch diameter and, in each, a 16 inch HDPE casing would be inserted. Within this casing would be inserted the umbilical bundle in borehole 1 and the flowline in borehole 2. In each borehole the insertion of the HDPE casing and of the umbilical bundle and the flowline, respectively, would be achieved by thrusting them from onshore. A consequence of this was to reduce, to a very large extent, the offshore work because the tugging of each of the umbilical bundle and the flowline would be undertaken to pull it to the full length of the tail only from the point of exit. It was apparent from the evidence of Mr Robertson that this new methodology was driven largely by the very substantial cost of the offshore work required under the previous methodology; a cost which Lucas Drilling had passed to MacDow when it declined to perform this part of its workscope and a cost which MacDow was threatening to back-charge to Lucas Drilling. It was also driven by the difficulty of drilling through the poor geological material which contained fissures which permitted the loss of drilling fluid and also by the apprehended difficulty of pulling the 12 inch umbilical casing, and even the 10 inch flowline, through the 16 inch boreholes.

111 The drilling of the enlarged 20 inch flowline borehole 2 was re-commenced on 12 June and completed on 5 July 2003. There were, however, difficulties encountered in inserting the HDPE liner. Accordingly, borehole 2 was, between 31 July and 2 August, reamed again, this time to 24 inches, and by 2 August its HDPE liner was in place. Meantime, the umbilical borehole 1 was reamed to 24 inches between 12 July and 19 July 2003, and by 28 July its HDPE liner was installed.

112 By this time there were serious difficulties between BHPB and MacDow and work was suspended by direction of BHPB between 12 and 27 August. Lucas Drilling recommenced work on 29 August and continued until 8 September when MacDow directed that work stop. Its contract with BHPB was terminated two days later.

113 No criticisms of the work of Lucas Drilling during this period of resumed work were made at the trial and its criticisms of MacDow and BHPB are of no present concern. The issue here is as to whether the work carried out by Lucas Drilling during this period of about three months, as well as its planning in the preceding months, is a variation to the contractual workscope and whether, as a consequence, Lucas Drilling is entitled to extra payment of its extra costs.

114 The response which I give is an unhesitating negative. The difficulties which the re-engineering sought to, and did in fact overcome, were all within the risk of Lucas Drilling. The escalation of cost of the offshore work was a consequence of either Lucas Drilling's obligation to comply with the Commonwealth regime, as it says, or as a consequence of its under-costing of this part of its contract work, which is more probable. The drilling difficulties caused by the bad rock which led to the loss of fluid are part of the geological risk which it assumed in its sub-contract. This risk remained with it, as I have found, even after the enlargement of the umbilical casing and the effect of this on the drilling methodology. The apprehended difficulties of pulling the casing in each instance through the 16 inch borehole were matters which its design should have addressed.

115 I conclude that no part of the re-engineering or the performance of the re-engineered work is to be valued, for it falls within the contractual workscope for which Lucas Drilling had agreed to be paid $5m.

Q.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?

116 As expressed, this question contains ambiguity. Pursuant to cl. 24.4(a) or (b), what is to be valued is the Sub-Contract Works completed or the value of the work begun and executed but not completed. The expression "Sub-Contract Works" is defined in the sub-contract to mean the scope of work described in the schedule and in Appendix A, including authorised variations to this. MacDow accepted that Items 1 - 7 and 23 and 24 in the Scott Schedule fell within this description. In fact, none of the work which was in issue in this case was a variation which had been authorised in terms of cl. 14.4. On a strict reading of the question, insofar as it concerns the remaining Items 8-22 and 25-27, the answer might be "none".

117 Looking at the question from another perspective, it is clear that the contractual instruction contained in cl. 24.4(a) or (b) is to value all of the completed work. On that basis the answer might be "all of them". This, of course, leaves unasked the question as to how these works are to be valued.

118 On the approach which I consider to be the correct one, the answer is a little more complicated. It is difficult to apply the items in the schedule in many cases to the contractual circumstances as I have found them.

119 I have concluded that the entitlement of Lucas Drilling for the work which was within the contractual workscope in terms of the sub-contract is for such part of the $5m contract price as reflects the percentage of that work which was completed. Lest there be any misunderstanding, the correct way to approach this part of the valuation is not to deduct from $5m the value of the incomplete work or the cost to complete the work within the contractual workscope; Lucas Drilling is entitled to the proportion of the agreed price of $5m as is reflected in its degree of completion of the work within that workscope.

120 I have found that the change to the dimension of the casing of the umbilical borehole is a change to the contractual workscope and that this had the consequence that the drill and leave method was abandoned in favour of a drill and pull through procedure, as was commenced in January 2003. Any cost of this incurred by Lucas Drilling extra to the proper cost of the pre-change work is to be valued. This cost is the actual cost (if any) incurred as a consequence of the change, including, if this be the case, the extra cost of a more powerful tug and any extra standby or other charges which may have been incurred as a consequence of this change in dimension and methodology. Again, lest there be any misunderstanding, I find that any extra costs incurred, by reason only of the BHPB requirement that the offshore work be carried out in compliance with the Commonwealth regime, are not to be valued, for they are within the contractual workscope. Likewise, the costs which have been referred to as the re-engineering costs are not to be included in this part of the valuation.

121 Applying these conclusions to the items in the Scott Schedule, I find that Items 8-22 and 25 are not to be valued except insofar as they might include work as a consequence of the changes which I have identified in the preceding paragraph as changes to be valued.

122 Items 1-7, 23 and 24 are agreed. Item 26 comprises $3,318.75 for thinsulators which have been included and accepted already under Item 24. The remaining component under Item 26 is the unfixed HDPE casing which I shall consider under question 3. The final item, Item 27, loss of profit, I shall deal with under question 4.

Q. 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?

123 No part of cl. 14.5 is applicable. All parts of this provision other than part d(ii) are inapplicable because the rates and prices upon which they depend are absent from the sub-contract. The parties were agreed that part (d)(ii) was inapplicable.

Q. 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?

124 The concept of fair valuation appears in cl. 14.5(b). This provision was not said by either party to be applicable.

125 If this question is directed to the concept of "the value of work" in cl. 24.4(a) or (b), it may be assumed that what is here intended is a value which is fair to both parties. This valuation is to be approached by allowing to Lucas Drilling that part of the agreed contract sum of $5m which reflects the degree of completion of the works within the contractual workscope and the extra-over value of work which it was required to carry out but which was outside this contractual workscope.

126 The value of the work outside this workscope is to be determined by assessing the actual cost to Lucas Drilling of performing that work less any actual saving by reason of its not having to do the work in the contractual workscope which it replaced. The value, then, represents this actual cost and actual saving in each case with a margin.

127 Q. 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?

128 I am required to determined here what margin should be added to the actual costs incurred or saved so as to represent the overheads and profit of Lucas Drilling. In the question three margins are proposed. In evidence, two other possibilities emerged.

129 Mr Summergreene spoke of the practice within Lucas Drilling of including 3.5% on direct costs for SG&A indirect costs, but not including interest. This margin, he said, is taken in at the level of management accounts to establish a true net profit margin. When a horizontal drilling job is priced a further margin of 31.5% is normally charged to the direct and indirect costs to allow for the risks of the project and, presumably, for overheads and profit. As a matter of mathematics, this means that the aggregate margin on direct costs is 35%.

130 Mr Summergreene disclosed that the actual margin for this project was 28.9%. He said that this appears from the tender budget. The document produced by him as the tender budget shows that a total cost of $3,558,498 was expected to be incurred. It does not appear that this included an SG&A margin. The tender price was $5m, so that the difference, representing overheads and profit, was budgeted to be $1,441,502, or 28.8%.

131 The next margin which emerged was that used at the time of the negotiations between Mr Loneragan and Mr Bumpstead in June 2002. Mr Loneragan made his calculations of price reduction on the basis of a 10% margin.

132 My task, then, is to determine what allowance for overheads and profit should be allowed for the work which is to be valued on a net cost-plus basis. I bear in mind that the work to be valued has been completed. This means that the risk component might be put to one side. This risk is a component of the suggested tender margin of 40.6%, the typical margin of 36.1% and the actual profit margin of 28.9%. The remaining suggested margins range from 7% and 5%, provided for in cl. 14.5(d)(ii), 10% used by Mr Loneragan in his negotiations and 17.5% being the industry margin. This last margin was that determined in the Fox report and is said to include SG&A indirect costs. Mr Fox was not called to give evidence in support of his report and it is not altogether clear whether his industry margin was that used in the industry for tendering or for some other purpose.

133 The adoption by the parties in this contract of margins for the valuation of variations is, to my mind, a very powerful consideration. Indeed, putting to one side the contractual instruction to value the work according to cl. 14, it is apparent that these margins are directed to the same items of overheads and profit which are apposite to the task of evaluation under cl. 24.4. Mr Loneragan's figure of 10% is in the same region and, again, was proposed in an analogous context. This was where work was to be removed from the contractual workscope. No party, however, suggested that I might adopt Mr Loneragan's figure. In the circumstances, I find that the appropriate margins are 7% and 5% for materials and services respectively.

134 For the assistance of the valuer, I add that the base cost figures to which these margins are to be applied are the actual cost to Lucas Drilling of the materials and the cost of labour including in the latter event, statutory additions for insurance, holidays, superannuation and the like. These same margins should also be applied to the deleted work for which credit is to be given so as to arrive at the extra-over cost of the varied work.

Q. 3. 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?

135 Counsel for Lucas Drilling said that these items in the Scott Schedule, Items 24 and 26, were not pursued because they were already included in the total cost calculation. Since this approach is not to be adopted, I would suppose that they should be brought back into account.

137 It was put on behalf of MacDow that the $10,816 cost of the unused HDPE casing should not be allowed because it was not part of any variation. I reject that submission. Clause 24.4(c) simply refers to unfixed materials brought on site - property which has passed to MacDow. It is clearly the case that these materials were brought on site for use in the project. That is sufficient.

138 The value of unfixed goods to be assessed under cl. 24.4(c) should also include the same 7% margin for overhead and profit.

At a glance

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Judgment (231 paragraphs)

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Legislation Cited (3)

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