Reservation of Rights

It is a familiar phrase: ‘All of our rights are reserved’. It has an authoritative ring which can provide a welcome sense of security and comfort, especially for nervous lawyers who hope the words may be endowed with magical properties.

When things are not going to plan, parties often adopt a wait and see approach in an attempt to keep options open. The trouble is that people don’t like making big decisions. Reservation of rights is not a complete solution to this problem.

In a highly complex and fast-moving project environment, the failure to make decisions can become a source of risk in itself. To be fair, many project teams are stretched thin. Where there’s an overwhelming amount of information to be considered, the decision-making process may start to get into Gordian knot territory. Nevertheless, there are times when decisions need to be fed into the contract machine to keep it chugging along.

In circumstances where there is a breach and the innocent party has a choice between exercising a right or continuing the contract, a decision is required. The right to terminate the contract for breach is an obvious example. Similar issues may arise, for example, if the contract grants a right to suspend performance for breach or where the Principal has a right to step-in for breach. These rights may be lost by:

• an election to affirm the contract; or
• failing to exercise the right within a reasonable time.

If there is a genuine reason to fear the loss of rights, then a well-considered reservation can be effective to protect against a claim that a communication (or conduct) amounts to waiver of rights or gives rise to estoppel. However, repeated and indiscriminate use of reservation wording runs the risk of being ineffective at reserving any rights at all. In circumstances where an election is required, the reservation does not avoid the need for a decision and it may give a party the false impression that a decision can be delayed for an indefinite period.

The key message is to be decisive, specific and consistent.

The starting point is to have a clear understanding of what rights are intended to be reserved and why they are being reserved. Is an election required? What problem is the reservation intended to address? Will a generic statement of reservation be adequate to solve that problem?

For example, if there has been a serious breach of contract that might justify termination of the contract, the innocent party will probably need time to investigate the issues and to obtain advice before a final decision can be made. A bespoke reservation may be required in that case.

Another scenario where a bespoke reservation may be appropriate is when the parties are discussing a cure plan while carrying out investigations to understand the root cause of a performance problem. It might not be clear which party is in breach if there is a mix of poor design, defective equipment, poor operation or some other combination of reasons. Even if the innocent party understands some aspects of the problem, they will need the flexibility to be able to raise new arguments in the future. Gathering the information may take months, meanwhile day to day project administration needs to continue and a cure plan needs to be finalised.

In these complex situations, it is necessary to consider the life span of the reservation. If termination rights are involved, even the most skilfully drafted reservation will not necessarily buy much time for the innocent party.

A party faced with a choice between termination and an alternative (for example, continuing the contract and making a damages claim) is not required to make an immediate decision. However, the right to terminate for breach of contract has a relatively short shelf life compared to some other remedies, such as a claim for damages. The decisions in Donau v ASC AWD Shipbuilder Pty Ltd [2019] NSWCA 185 (Donau) and Armada Balnaves Pte Ltd v Woodside Energy Julimar Pty Ltd [No. 2] [2020] WASC (Armada) highlight that the right to terminate must be exercised within a reasonable time.

In the Armada case, there were delays and performance problems. The innocent party was waiting for information about whether a floating production, storage, and offloading (FPSO) facility would satisfy its required performance tests. When that information became known, a decision to terminate was made. Even though this work took a long time the court found that the activity during this period was not dilatory or unreasonable.

In the Donau case, the parties agreed to use reasonable endeavours to agree a Baseline True Up by 14 December 2012. ASC had a right to terminate the contract if agreement wasn’t reached by 28 February 2013. Agreement wasn’t reached although the parties were in commercial negotiations. After 3 months and 1 week after the trigger date, ASC purported to terminate. The court found it was too late.

Donau demonstrates that on major projects a conservative approach is needed when a party is assessing the sunset date for the right to elect to terminate. Australian courts are not sympathetic to parties who sit on their rights.

The question of what time for exercise of the right to terminate is reasonable will be determined by what is fair to both parties at the time of exercise of the right. When fairness is considered, it will be relevant whether the time that has elapsed (or any other circumstances) caused the other party to be lulled into a false sense of security because they understood there was acquiescence.

 

Be Decisive

As outlined above, the reasonable time to exercise a right of termination may be a surprisingly short period from the breach of contract or trigger event.

Rather than allowing the matter to drift, identifying a calendar date for the decision may be a helpful discipline for the project team. The use of a decision tree may be helpful to work through the steps that are going to be needed to make a decision. This will focus attention on the nature and extent of information the ultimate decision maker will need to make the critical decision.

The decision tree may help the project team to realise that reliable information on which to base a termination decision is not going to arrive within a reasonable time frame or at all. For example, depending on the nature of the breach, an expert report may be required and this may take months to obtain. This may require a reconsideration of the strategy.

Be Specific

For a reservation to be effective it needs to be clear what rights are being reserved. The cliche that ‘all rights are reserved’ or the statement that certain conduct is ‘without prejudice to the client’s rights’ may lack the necessary detail and result in no rights being reserved at all.

Where the reservation is very broad this may raise questions about the motivation behind the reservation. The reservation may not be effective if the court concludes that a general reservation was worded simply to attempt to ensure that all options (including better arguments not yet thought of by the legal team) could be kept open: Equitix ESI CHP (Wrexham) Limited v Bestor Generacion UK Limited [2018] EWHC 177 (TCC).

The court will be concerned about the possibility that a broad reservation is part of a strategy to have a bet both ways or to ambush the other party: was it or should it have been clear to all concerned that a reservation on a specific issue was being made?

A reservation regarding the jurisdiction of an adjudicator was challenged in LJH Paving Limited v Meeres Civil Engineering Limited [2019] EWHC 2601 (TCC). In that case, Meeres put forward a long letter disputing the jurisdiction of an adjudicator and, after the adjudication, then raised an argument that there was a jurisdictional defence which prevented enforcement of the adjudicator’s decision. The question was whether Meeres had reserved the right to raise this specific argument.

The letter from Meeres clearly argued that there was no jurisdiction because of what Meeres claimed were contractual non-compliance issues. However, the court focused on whether Meeres had properly objected to jurisdiction (or effectively reserved its right to do so) on the specific grounds that no dispute had crystallised due to insufficient substantiation. The Court considered the reservation in the letter which cast a wide net to capture arguments that had not yet been raised. The letter stated that Meeres reserved ‘its rights to maintain its position on further issues which may have arisen and are not addressed herein’. The Judge found these words of reservation were ‘so vague as to be ineffective’.

Be consistent

The innocent party is entitled to keep the question of termination open, provided they do not affirm the contract and do not cause prejudice to the other party.

Affirmation can arise where a party says one thing but does another. Where the project is still in construction phase, this creates practical problems. It is easy to get into the situation where legal letters say one thing but the project personnel are doing another.

There is a risk that ongoing performance of the contract by the innocent party over an extended period may be found to have affirmed the contract. The risk is that while a party is waiting for information to make a decision, day to day performance activities continue and as these accumulate the breach becomes a distant memory. Acts of performance may be found to amount to conduct which affirms the contract. Conduct which is found to be an act of affirmation has legal consequences, even if the innocent party claims the act is without prejudice.

Checklist

• The time for a decision cannot be extended on an indefinite basis simply by stating that rights are reserved.
• Consider what rights are being reserved and whether election between rights is necessary.
• Consider the potential life span of the reservation, adopting a conservative approach.
• As an internal project management discipline, identify a calendar date for decision and prepare a decision tree.
• Take active steps to ensure there is evidence that a timely decision has been made.
• General reservations should not be treated as boilerplate drafting.
• Serve the reservation notice in accordance with the contract notification process.

Disclaimer: This publication is intended to provide a summary and general overview of matters of interest. The content is not comprehensive and does not constitute legal advice. Liability limited by a scheme approved under Professional Standards Legislation