Over the past few months, an increasing number of owners have decided to halt, cancel or postpone their construction projects. Concerns about health and safety, decreased demand and changed financial circumstances have all prompted owners to sit down and reassess their portfolios. Financial instability of contractors as a result of the prolonged COVID-19 pandemic may also result in conditions that could justify termination for cause. But before taking such drastic action, owners should consider the contractual risks of suspending or terminating work on a project.
Here are some of the pitfalls owners face when stopping work on a project:
Rubber Stamp From the Architect for Termination for Cause
AIA Document A201 – 2017, General Conditions of the Contract for Construction (the A201) permits the owner to terminate for cause for certain specified reasons. One condition to terminate for cause under the A201 is certification by the architect that sufficient cause exists to terminate. Many courts hold that the certification cannot be a rubber stamp and instead must reflect the architect’s independent investigation of the grounds for termination. See, e.g., Ingrassia Const. Co., Inc. v. Vernon Tp. Bd. of Educ., 784 A.2d 73 (N.J. App. Div. 2001).
Insufficient Notice for Termination for Cause
Under the A201, a seven-day notice must be given to both the contractor and the surety prior to termination for cause. The notice should specify the grounds for termination of the work. Owners should also check the terms of the performance bond for additional notice provisions. In particular, the AIA form performance bond (AIA Document A312 – 2010) requires notice that the owner is considering declaring the contractor in default and, if requested, a meeting among the owner, contractor and surety. Failure to follow the notice provisions may be deemed a failure to meet a condition precedent, effectively releasing the surety from its performance obligations. See, e.g., Seaboard Sur. Co. v. Town of Greenfield, ex rel. Greenfield Middle School Bldg. Committee, 370 F.3d 215 (1st Cir. 2004); 120 Greenwich Development Associates, LLC v. Reliance Ins. Co., 2004 WL 1277998 (S.D. N.Y. 2004).
Repeated Suspensions, Delays or Interruptions
The A201 allows the owner to suspend, delay or otherwise interrupt work, in whole or in part, for the convenience of the owner. However, the A201 also provides that a contractor can terminate the contract if (1) the work is stopped for a period of 30 consecutive days by an act of the government; (2) the owner suspends work for more than 100 percent of the days scheduled for completion or 120 days in a 365-day period, whichever is less; or (3) the work is stopped for a period of 60 consecutive days for any reason that is not the fault of the contractor or its subcontractors, including if the work is stopped due to the owner’s failure to perform obligations under the contract. These contract rights act as limitations on the owner’s right to suspend work for convenience and expressly enable the contractor to recover reasonable overhead and profit on work that was not performed prior to the termination.
Bad Faith and Wrongful Termination
Where the owner attempts to terminate for cause, but fails to adhere to the contract requirements for doing so, the contractor may be able to recover damages against the owner for wrongful termination. See, e.g., Franklin Pavkov Const. Co. v. Ultra Roof, Inc., 51 F. Supp. 2d 204 (N.D. N.Y. 1999); Denny Const., Inc. v. City and County of Denver ex rel. Bd. of Water Com’rs, 199 P.3d 742 (Colo. 2009). Even where the owner has a right to terminate the contract for convenience, it is still susceptible to challenge on the grounds that the termination was made in bad faith or an abuse of discretion. See, e.g., Krygoski Const. Co., Inc. v. U.S., 94 F.3d 1537 (Fed. Cir. 1996). A written termination notice that articulates a good faith reason for ending the contract stands a better chance of resisting such challenges.
Although the prime contract may allow termination for convenience, a contractor’s downstream subcontracts may not. In the absence of a flow-down provision that allows the contractor a similar right to terminate for convenience, owners could be on the hook for termination fees or other costs attributable to termination of subcontracts and purchase agreements, such as material restocking fees or demobilization costs. These costs would be in addition to payment for any work completed prior to termination of the contract.
The decision to terminate or suspend work on a project is rarely an easy one. Owners need to consider not only the economic and financial circumstances of their projects, but also health and safety in these trying times. Good legal counsel can help owners navigate the contractual risks associated with terminating or suspending a project. As always, the cardinal rule is to read your contract and pay special attention to the conditions and consequences of suspending or terminating work. Failure to appreciate these details can make an already difficult decision even more costly later down the road.
This article summarizes content from Bruner & O'Connor on Construction Law. For more information on this topic, or for additional citations, see § 5.263–70.