• Introduction
• All recent publications
• Construction publications
• Construction services

Focus: Construction – November 2007

NSW Court of Appeal decision will impact on indemnity clauses

In brief: A recent NSW Court of Appeal decision will have a considerable impact on the drafting of indemnity and exclusion clauses in Australian contracts. Partner Leighton O'Brien (view CV) and Senior Associate Morgan Clewley review the case.

• The facts
• Historical approach to interpretation
• The High Court of Australia and Canada Steamship SS
• Canada Steamship SS and the House of Lords
• Current approach
• Application of Andar and Ankar
• Implications

The facts

In 1964, AW Baulderstone Holdings Pty Ltd (Baulderstone) contracted with the South Australian Government to carry out building works at the Royal Adelaide Hospital. Baulderstone had subcontracted certain work, involving the application of asbestos insulation, to BI (Contracting) Pty Ltd (BIC). One of Baulderstone's employees, Mr Stutley, who was working at the Royal Adelaide Hospital, developed mesothelioma as a consequence of inhaling asbestos and brought proceedings against his employer. The proceedings were settled by Baulderstone paying $500,000 to Mr Stutley. Baulderstone, by way of cross-claim, commenced proceedings against BIC and other related corporate entities for contribution.

The subcontract entered into between Baulderstone and BIC contained the following Clause 6:

The Subcontractor shall take out and maintain workmen's compensation insurance and public risk insurance policies in respect of the subcontract works and shall pay all premiums thereon and all fees required by any public or local government authority in respect of the subcontract works and shall indemnify the builder against all liability relating to the subcontract works. (Emphasis added).

In deciding the appeal by BIC, the NSW Court of Appeal confirmed that the third principle in Canada Steamship Lines Ltd v The King [1952] would not be followed and that the courts would instead apply the 'strict construction approach' adopted in Andar Transport Pty v Brambles Ltd [2004]. At the same time, it also confirmed that the 'natural and ordinary meaning' test applied in Darlington Futures Ltd v Delco Australia Pty Ltd [1986] was no longer good law as far as indemnities were concerned.

BIC used the third principle in Canada Steamship SS to contend that, by construing Clause 6 strictly, it was not required to indemnify Baulderstone in respect of its liability to Mr Stutley. BIC submitted that the words 'and shall indemnify the builder against all liability relating to the subcontract works', should be construed as meaning that BIC was required to indemnify Baulderstone only for all liability in relation to BIC's carrying out the sub-contract works and not in relation to Baulderstone's negligence. BIC's submission was that the indemnity related only to a 'non-negligent liability' and that the words 'all liability' in the context of Clause 6 did not extend to BIC's liability in respect of Baulderstone's negligence.

Historical approach to interpretation

The third principle in Canada Steamship SS is that when construing an indemnity or exclusion clause, the court must initially consider whether the words used are broad enough to include negligence. If they are, the court must then consider whether some other cause of action may be covered by that clause. If this is also the case then negligence will not be covered by the clause.

In Canada Steamship SS, Lord Morton stated that the construction of indemnity provisions should be subject to the following three rules:

If the clause contains language which expressly exempts the person in whose favour it is made [the indemnified] from the consequences of the negligence of his own servants, effect must be given to that provision... If there is no express reference to negligence, the Court must consider whether the words used are wide enough, in their ordinary meaning, to cover negligence on the part of the servants of the [indemnified]. If a doubt arises at this point, it must be resolved against the [indemnified]... If the words used are wide enough for the above purpose, the Court must then consider whether 'the head of damage may be based on some ground other than that of negligence'...The 'other ground' must not be so fanciful or remote that the [indemnified] cannot be supposed to have desired protection against it; but subject to this qualification,...the existence of a possible head of damage other than that of negligence is fatal to the [indemnified] even if the words used are prima facie wide enough to cover negligence on the part of his servants.

In Darlington, the Australian High Court rejected the approach of strictly construing an exclusion clause. It was noted in Darlington that the meaning of an exclusion clause had to be:

...determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract and, where appropriate, construing the clause contra proferentem in case of ambiguity.

The decision in Darlington was then followed in Glebe Island Terminals Pty Limited v Continental Seagram Pty Limited [1993] where the Darlington decision was applied in relation to the interpretation of indemnity clauses.

The principle that an indemnity clause should be construed strictly in favour of the party providing the indemnity was used in Andar, where the court held that the principles stated in Ankar Proprietary Limited v National Westminster Finance (Australia) Limited [1987], in relation to contracts of guarantee, and later referred to in Chan v Cresdon Pty Ltd [1989], were also relevant to the construction of indemnity clauses. In Ankar, the view was taken that:

...the liability of the surety is strictissimi juris and that ambiguous contractual provisions should be construed in favour of the surety...a doubt as to the status of a provision in a guarantee should therefore be resolved in favour of the surety....

In Andar it was decided that the principles referred to in Ankar were also relevant to the construction of indemnity clauses, and that to the extent that there was ambiguity in an indemnity clause:

...[those] principles of construction...require the provisions [of the indemnity clause] to be construed in favour [of the party providing the indemnity].

The High Court of Australia and Canada Steamship SS

The principles in Canada Steamship SS have been applied and referred to in a number of Australian cases.

In Davis v The Commissioner for Main Roads [1968], the Commissioner for Main Roads relied upon an indemnity clause in its contract with a contractor. In this case it was found that the indemnity clause was unambiguous and operated according to its terms. Justice Menzies noted:

It was argued for [Davis]...that [the indemnity clause] should not be understood as conferring an indemnity upon the Commissioner against liability for the negligence of itself, its servants and agents, and reference was made by way of analogy to the decision of the Privy Council in Canada Steamship Lines Ltd v R....There it was decided, in accordance with well-established principles, that an exemption clause which did not limit liability for negligence in clear terms should be construed as relating to a liability not based on negligence. Here it appears to me plain from its language that [the indemnity clause] does not cover the Commissioner against liability for negligence of itself, its servants and agents. Default of this sort for which the Commissioner is liable seems to me the very subject matter of [the indemnity clause]...Accordingly, the only purpose, or at least the principal purpose, for taking such an indemnity, would be to protect the Commissioner against liability for its own fault...the indemnity should be allowed to operate in accordance with its terms which throw upon the Contractor the whole risk of carrying out the contract.

The third principle in Canada Steamship SS has been rejected by the Court of Appeal on a number of occasions. Firstly, in Schenker & Co (Aust) Pty Ltd v Maplas Equipment and Services Pty Ltd and Anor [1990], it was considered that the approach taken in Canada Steamship SS was inconsistent with the principles adopted in earlier Australian cases up to, and including, Darlington. Secondly, in Valkonen and Anor v Jennings Construction Ltd and Ors [1995], the Supreme Court of South Australia agreed with the decision in Schenker and stated:

The first and second limb of the Canada Steamship Lines tests provide acceptable working rules but the third imposes an artificial and inflexible rule of interpretation that is as likely as is not to frustrate the intention of the parties.

The third principle of Canada Steamship SS was also found not to be good law in relation to construction of indemnity and exclusion clauses in the Victorian Court of Appeal's decision in Andar.

Canada Steamship SS and the House of Lords

The NSW Court of Appeal referred to the House of Lords' decision in HIH Casualty and General Insurance Ltd and Ors v Chase Manhattan Bank and Ors [2003] in which the third principle from the Canada Steamship SS guidelines was applied. The facts of the HIH Casualty case related to a clause contained in an insurance policy which excluded liability 'for any information provided by any other parties'. The argument in HIH Casualty that the clause should be construed to exclude negligence was rejected.

The NSW Court of Appeal in BI (Contracting) held that the Australian High Court did not endorse the third principle in Canada Steamship SS as referred to in Andar and Ankar, and that if it had been intended to be applied it would have made an express reference to both the case and the principle. The NSW Court of Appeal considered that the third principle in Canada Steamship SS will no longer be followed as it is very specific and, rather than construing the clause strictly, relies upon the court to look for ambiguity in the construction of a clause as its first approach. 

Current approach

The NSW Court of Appeal therefore considered in the case of BI (Contracting) that the courts, 'must apply the approach adopted by the High Court in Andar'. The approach adopted by the courts in Andar and to be used in the interpretation of indemnity clauses will be, first, to construe the clause strictly in the context of the contract as a whole and then, to the extent that there remains any ambiguity, to construe the indemnity in favour of the party providing the indemnity.

Application of Andar and Ankar

The NSW Court of Appeal noted that BIC was required, under Clause 6, to take out and maintain public risk insurance, which would typically cover any liability that may be caused as a consequence of negligence. The Court of Appeal therefore considered that it was most likely that both BIC and Baulderstone had contemplated that the broad wording of the indemnity contained in Clause 6 was to cover Baulderstone's negligence. This would still have effect even where the negligence was also as a result of Baulderstone's actions. The NSW Court of Appeal concluded that the indemnity clause operated so that Baulderstone was indemnified for all liabilities including its negligence.

Implications

Indemnity clauses will be construed strictly in the context of the contract as a whole. In the event that an indemnity clause is drafted broadly, it will still cover negligence. To the extent that an indemnity clause contains any ambiguity, the clause will be construed in favour of the party providing the indemnity.

For further information, please contact:

• Leighton O'BrienPartner, Sydney
  Ph: +61 2 9230 4205
  Leighton.Obrien@aar.com.au
• John BaartzPartner, Brisbane
  Ph: +61 7 3334 3254
  John.Baartz@aar.com.au
• Nick Rudge Partner, Melbourne
  Ph: +61 3 9613 8544
  Nick.Rudge@aar.com.au
• Stephen McComishPartner, Perth
  Ph: +61 8 9488 3767
  Stephen.McComish@aar.com.au

Bookmark with What are these?