Defence contractual dispute — the power of mediation

This case study shows how effective mediation can be in dealing with large-scale and complex issues.

About the case study

The case study concerns a contractual dispute between the Ministry of Defence and BAE Systems regarding warranty and remedial claims for the Royal New Zealand Navy Protector fleet, including the HMNZS Canterbury.

It demonstrates:

  1. that mediation can be successfully used for complex and technical contractual disputes involving large sums of money
  2. the benefits of clear and robust alternative dispute resolution contract clauses
  3. how effectively using mediation can achieve a win-win outcome, save money and time as well as preserve business relationships.

The issues that arose in Project Protector

Project Protector was a $500 million project to acquire seven new ships for the Royal New Zealand Navy (RNZN). The new fleet was intended to meet some obvious gaps in the NZ military, civil surveillance and sealift capabilities. The seven ships included two offshore patrol vessels, four inshore patrol vessels and one large multi-role vessel (MRV).

To meet this need, in 2002 the Ministry of Defence (‘the Ministry’) issued an invitation for interested parties to register for the contract. In May 2004, a fixed price contract was accepted from Tenex Defence Systems and signed off in July that year. After three years, the MRV, HMNZS Canterbury, was delivered and accepted by the Ministry and commissioned into the RNZN.

Unfortunately, it was not long before issues arose. In July 2007, just two months after its arrival, one of the rigid hull inflatables (RHIBs) with which HMNZS Canterbury was equipped was lost at sea. Soon after, tragically, a crew member was drowned during a manoeuvre to deploy a RHIB. These events cast some serious doubt regarding safety and systems on HMNZS Canterbury, particularly in relation to the RHIBs.

Later that year, the Minister of Defence, Phil Goff announced an independent review into the ship’s acquisition and introduction. The review was to identify and clarify any issues relevant to the operation of HMNZS Canterbury, its design, performance and whether it was capable of performing the functions for which it had been purchased. The review would also provide advice on any remedial action or alterations that could be made to improve the safety and efficiency of the ship.

The report on the review was known as the Coles Report, after the team leader, John Coles. The review found the HMNZS Canterbury was intrinsically safe, but modifications would be required to enable the ship to meet military functions. Further, it noted that:

“Acquisition has been constrained, however, by the initial choice of ship design: it has been managed to get the ship into service as soon as possible and has been characterised by shortcomings in project management and collective wishful thinking. It is unlikely to meet all the requirements of the contract.” - Coles Report

Choosing mediation over lengthy litigation

The Coles Report made the need for remedial work and enhancement very clear. The original company, Tenix Defence Systems, had by now been taken over by BAE Systems. This is a large global company that provides defence and aerospace systems and employs a significant workforce in over 40 countries. Not surprisingly, the company declined the New Zealand Defence Force (NZDF) offer to remedy the perceived specification failings of the HMNZS Canterbury. A dispute was therefore difficult to avert, but the Ministry choose an alternative approach to litigation to resolving this matter that ended up having a range of benefits.

The dispute arose over warranty claims. The Ministry engaged a consultant to manage the dispute and attempts to negotiate were initiated. However, negotiations quickly failed and the dispute resolution provisions in the contract, which specified mediation and arbitration were invoked. The conditions of the contract were robust and well considered. The overriding intention was to keep any dispute from becoming a lengthy, expensive and unbecoming court case.

With this in mind, the Ministry, NZDF and Crown Law began planning for the mediation with meticulous care. A highly skilled and committed team was established with the support of well-qualified Naval architects, and spent almost a year preparing for the mediation. The team members brought a range of experience, as well as negotiation, mediation and legal skills. The hope was to avoid confrontation through litigation and ultimately make cost savings.

The process of mediation always involves trade-offs and the outcome of the two week mediation demonstrated this. The mediation resulted in the Crown being paid $90 million in compensation, which was close to what the mediation team had hoped for. This provided funding to make the required modifications, which had been estimated by the Coles Report at $20 million. Furthermore, it became possible for all involved to move on within just a couple of weeks of settlement being reached, and the process of remedy could begin.

“We saved a lot of time and money. We did put a lot of effort into it but much less than if we had gone to Court. As well as that, things like this take up so much energy from the management team. What happens is they tend to focus on the dispute and it undermines all other projects that require attention”. Des Ashton – Deputy Secretary of Defence

Mediation delivers a win-win

The outcome of this mediation process was positive for the Ministry. It also allowed BAE Systems to move on and provided avenues for BAE to undertake further New Zealand contracts, so it was essentially positive for all concerned. BAE Systems was well prepared to engage in the mediation and the Ministry also took the time to prepare well. Over the two week mediation process both parties made trade- offs and concessions, but both parties felt that a successful outcome had been achieved, the ubiquitous – “win-win”.

Robust contract makes all the difference

Mediation in this case had multiple advantages for the government. The issues with the protector fleet compromised the ability of the RNZN to operate with optimum effectiveness and were a distraction. However, the contracts that had been put in place to commission the HMNZS Canterbury stood up to resolving this major dispute. The well-prepared team was able to use the dispute resolution provisions in the contract to reach an equitable agreement. The government also gained long term assurance that the contracts in use for acquiring military capability were robust, and capable of withstanding scrutiny and challenge.

Alternative dispute resolution in the form of mediation provided the government and NZDF with an effective and ground-breaking outcome in what had been a lengthy and complex dispute. There was a commitment to negotiate and resolve the issues with expedience and, while the cost savings were important, safety for the entire fleet was of equal importance.

This outcome has led the way for the Ministry of Defence to use mediation as their ‘go to’ approach for resolving disputes. It also demonstrates more generally the value and effectiveness of using alternative or innovative approaches to resolve disputes, including for complex and high value disputes.

Project Protector update

The remediation of the Protector ships is essentially complete. A small amount of minor work was to be completed by the RNZN in a timeframe consistent with operational tasking and planned maintenance periods. Funding was made available to the RNZN to complete this work. The Remediation Project was formally closed in November 2016.

The remediation improved seakeeping, landing craft operations and mission systems operational effectiveness. The project was completed within the budget approved by Government.