Executive Summary

• A recent NSW Court of Appeal case, MP Water Pty Ltd in its capacity as Trustee for the MP Water Trust v Veolia Australia Pty Ltd [2022] NSWCA 127, concerned the proper construction of a ‘step-in’ clause of a long term O&M contract for a water treatment facility near Lithgow, NSW.
• At first instance, the Supreme Court of NSW in MP Water Pty Ltd v Veolia Water Australia Pty Ltd (No 3) [2021] NSWSC 1023, construed the principal’s rights under the step-in clause narrowly, finding that the principal could not exercise its step-in rights by merely directing the service provider to continue operating the facility (albeit at the ultimate instruction of the principal) and to cure the default giving rise to the step in right. The consequence being that the principal, to exercise a step in right, would have to itself take operational management and control of the facility without the ongoing assistance of the service provider.
• The Court of Appeal overturned the Supreme Court’s decision and found that the step-in clause should not be interpreted narrowly and that the principal could exercise its step-in rights by simply directing the service provider to continue operating the facility (albeit at the ultimate instruction of the principal) and to cure the default giving rise to the step-in right.
• The Court of Appeal’s decision represents a victory for principals considering exercising a step-in right in an O&M contract, especially in circumstances where the principal is not itself in a position to operate the asset or facility once ‘stepped-in’ and must rely on the service provider’s ongoing operational support and provision of the O&M services.

Background

In November 2017, MP Water, as Project Co, and Veolia, as Services Provider, entered into the Services Provider Agreement (SPA) for Veolia to perform certain ‘Services’, namely to operate and maintain a water treatment facility located in NSW (Facility). The Facility is located adjacent to two coal mines and treats the water generated at the mines for the use at a nearby power station.

In May 2021, there was an outage at the Facility which MP Water contended was a ‘Major Services Failure’ under the SPA, prompting MP Water to issue Veolia with a ‘step-in notice’ under clause 44(a) of the SPA.  Clause 44(a) of the SPA relevantly provided:

(a) If at any time during the Operations Phase:

(1) a Services Provider Default Termination Event occurs;

(2) a Services Provider Default occurs and the Services Provider has failed to diligently pursue the relevant Services Provider Default Notice; or

(3) it is necessary for Project Co to take immediate action to discharge its statutory duties or powers, or comply with its obligations under applicable Laws and Approvals,

(4) a “Project Co Default Termination Event” occurs under and as defined in the WTSC;

(5) a “Project Co Default” occurs under and as defined in the WTSC and Project Co has failed to diligently pursue the relevant “Project Co Default Notice” under and as defined in the WTSC; or

(6) it is necessary for the Customer to take immediate action to discharge its statutory duties or powers, or comply with its obligations under applicable Laws and Approvals

Project Co (in the case of paragraphs (1) to (3)) or the Customer (in the case of paragraphs (4) to (6) and in accordance with clause 44 of the WTSC) may elect, and if it so elects the Services Provider will assist Project Co or the Customer wherever and however possible to ensure that Project Co or the Customer is able, to:

(7) temporarily take or assume total or partial possession, management and control of the Facility (or any part of the Facility) and the provision of the Services (or any of them);

(8) take such other steps as are necessary or desirable to continue the provision of the Services as required by this Contract or to minimise the risk to the Environment, to other members of the general public or of material damage to the Facility, as applicable; and

(9) do anything which the Services Provider is entitled to do under an O&M Project Contract or with respect to the Project,

(each a Step-in Right).

By way of MP Water’s step-in notice, and in purported exercise of its step-in rights, MP Water directed Veolia to operate the Facility and provide the Services under the SPA so as to remedy the Major Services Failure. The relevant text of MP Water’s step-in notice was as follows:

This is a Step-in Notice under clause 44.1(a) and (b) of the SPA. Pursuant to clause 44(c) of the SPA, Project Co hereby notifies the Services Provider of its intention to exercise Step-in Rights for the sole purpose of remedying the Services Provider Default described in the Services Provider Default Notice.

The extent of the Step-in Right being exercised will be limited to the matters below.

With immediate effect, pursuant to clause 44.1 of the SPA, Project Co elects and the Services Provider, must assist Project Co wherever and however possible to ensure Project Co is able to exercise its Step-in Rights to:

(a) to commence treatment of Mine Water by providing the Services as set out in clause 19.1 of the SPA, and including treatment of Mine Water at the Facility delivered to the Services Provider pursuant to clause 20.1 (which includes all Mine Water currently in the Mine Water Buffer Pond, and Mine Water which has been placed or directed into that pond by the Services Provider) and specifically to accept and treat at the Facility:

(i) Mine Water at the rate of between 19ML per Day and 25ML per Day from the Mine Water Transfer Pipeline,

blended with

(ii) Mine Water at the rate of 1ML per Day from the Mine Water Buffer Pond or such greater amount that can be safely and effectively treated at the Facility so as to reduce the level in the Mine Water Buffer Pond to less than 80ML,

(b) take such other steps as are necessary or desirable to continue the provision of the Services as required by the SPA or to minimise the risk to the Environment, to other members of the general public or of material damage to the Facility, as applicable,

(the Step-in Direction).

Project Co will Step-in only to the limited extent and duration described above. Except to the extent and direction of that Step-in, the Services Provider’s obligations under the SPA are not and will not be suspended.

Project Co’s Representative will attend site for the purposes of the Step-in on Friday, 14 May 2021 at 9am and requires the Services Provider to make itself available for the purpose of implementing the Step-in Direction described above.

Once the Step-in Direction has been given [and], in Project Co’s opinion, the necessary steps to commence Mine Water Treatment as described in the Step-in Direction has occurred, Project Co will, by written notice to the Services Provider cease to exercise its Step-in Rights pursuant to clause 44(f) of the SPA (Project Co Step-out), unless Project Co gives a further notice. Upon the occurrence of the Project Co Step-out and, pursuant to clause 44(i)(1), the Services Provider must immediately recommence performance of those Services Provider’s obligations suspended pursuant to clause 44(d) of the SPA.

In essence, MP Water was exercising its step-in right by directing Veolia to cure the Major Services Failure by recommencing water treatment at the Facility but otherwise Veolia was to continue its provision of the Services and operational management of the Facility.

Veolia disputed validity of the step-in notice and the entitlement of MP Water to step-in to direct Veolia to perform the Services.

In April 2021, MP Water successfully obtained an interim injunction in the Supreme Court of NSW requiring Veolia to comply with the step-in notice and perform the Services as directed by MP Water: see MP Water Pty Ltd v Veolia Water Australia Pty Ltd [2021] NSWSC 582.

Decision of the Supreme Court of NSW

At first instance Justice Williams of the Supreme Court of NSW, construing clause 44 narrowly, held that the Step-in Notice was invalid and MP Water was not entitled under clause 44 of the SPA to step-in and direct Veolia as to how Veolia was to operate the Facility and perform the Services.

Justice Williams construed clause 44(a) of the SPA such that the requirement of Veolia to “assist” MP Water was limited to Veolia enabling MP Water to take possession, management and control of the Facility and the Services, i.e. where MP Water was to physically ‘step-in’ and take over operation control of the Facility and perform the Services itself. Relevantly, at paragraph 380 of her judgment, Justice Williams found:

…sub-clause 44(a)(7) does not require Veolia to assist MP Water to take total or partial management of some or all of the Services (by issuing directions or instructions or instructions to Veolia) whilst Veolia remains in possession and control of the whole Facility and performs the Services under MP Water’s instructions.

The consequence of this construction of clause 44(a) was that MP Water, to exercise a step in right, would have to itself take over the possession, management and control of the Facility from Veolia, in circumstances where MP Water did not have the personnel or expertise to undertake such a task.

Decision of the NSW Court of Appeal

MP Water appealed Justice Williams’ decision on clause 44(a) of the SPA to the NSW Court of Appeal. The NSW Court of Appeal unanimously found in favour of MP Water on all points of appeal. Most relevantly, the Court of Appeal found that MP Water’s step-in notice, and exercise of its step-in right, was valid. At paragraph 90 to 93 of the judgment, the Court of Appeal held:

The focus of the dispute in the present case is paragraph (7), pursuant to which MP Water may take or assume total, or partial, “possession, management and control” of the Facility and provision of the Services, or any part thereof. The composite phrase “possession, management and control” accommodates a broad range of action that MP Water may elect to take in response to the occurrence of one of the circumstances in paragraphs (1) to (3). MP Water may, for example, take or assume total possession, management and control of the Facility and provision of the Services; it may take or assume total possession, management and control of any part of the Facility and provision of any part of the Services; or it may take partial possession, management and control in either respect.

I agree with MP Water that, as a matter of language, the taking or assumption of total or partial possession, management and control of all or any part of the Facility and provision of all or any part of the Services accommodates MP Water giving a direction to Veolia. One can readily envisage a need for directions, for example where, by reason of MP Water’s election, Veolia remains in partial control of the whole Facility and provision of the Services, or in total or partial control of part of the Facility and part of the Services…

As a matter of language, the paragraph would also accommodate MP Water giving Veolia a direction as to the operation of part of the Facility, or the provision of some or all of the Services, of which MP Water takes or assumes possession, management and control pursuant to subclause 44(a). Such a direction would be an incident of MP Water’s taking or assumption of control of the Facility or part thereof, and/or provision of the Services or part thereof, in response to the occurrence of the circumstances in one of paragraphs (1) to (3)….

If MP Water “so elects” to take action pursuant to paragraph (7), Veolia “will assist wherever and however possible to ensure that [MP Water] is able to” take the action the subject of its election. Consistently with Veolia’s correlative function, the terms in which its obligation to assist is formulated are capable of expanding or contracting to meet the extent of such “possession management and control” that MP Water elects to take (total or partial; as to the whole or any part of the Facility and/or any part of the Services). The ultimate end of that assistance, however, is to ensure that MP Water is able to achieve its elected level of control over the Facility and the Services.

In reaching its decision, the Court of Appeal considered remedial purpose and the commerciality of the clause 44.

Key takeaways

• Parties should take care when drafting step-in clauses to ensure that the scope of the step in rights are clear and, if desired, that a step-in allows for the principal to give directions to a service provider without itself taking operational control of the asset or facility.
• Before exercising a step-in right, or responding to a purported exercise of a step-in right, parties should give careful consideration to the specific terms of their contractual step in regime and seek prompt legal advice where appropriate.

As the outcome of these proceedings turned on the specific language of the SPA, care should be taken in generalising the outcome of these proceedings to step-in clauses that have different drafting.

MP Water Pty Ltd was represented by Gilbert + Tobin.