Owners and contractors should consider the recent Washington Supreme Court decision Conway Construction Co. v. City of Puyallup, which emphasizes the importance of carefully drafting, and following, a construction contract’s termination provisions.
An overview of termination provisions
Termination provisions dictate the terminating party’s rights, remedies and liabilities. Most standard construction contracts allow a party to terminate for cause (default) or convenience. Parties may elect to add a clause converting an otherwise improper termination for cause into one of convenience.
An owner may terminate for cause when a contractor fails to perform its contractual obligations. These provisions generally require the owner to provide formal written notice to the defaulting party and a reasonable opportunity to cure the defective performance. Additionally, these provisions often entitle the owner to recover damages incurred to correct the defective work.
In contrast, termination for convenience is generally permissible without providing an opportunity to cure. However, standard termination for convenience generally requires the owner to pay the contractor for all work performed up to the termination date. Further, owners are not entitled to damages – even if it is later determined that the contractor’s work was defective.
Conversion provisions may mitigate the risks of defective termination. These clauses characterize an improper termination for cause as one for convenience.
The basis for termination matters
In Conway, the city contracted with Conway Construction Co. to build the nation’s first major roadway with pervious concrete. The parties’ construction contract contained the three aforementioned termination provisions: (i) termination for cause; (ii) termination for convenience; and (iii) conversion.
The city subsequently lost confidence in Conway’s work, and, without providing an opportunity to cure, issued Conway a notice of termination for default and withheld payments. Post-termination, the city found significant defects in Conway’s work, and sought an “offset” for the money expended to issue corrections.
Conway sued the city, asserting improper termination for default. The Washington Supreme Court agreed the termination was improper, noting the parties’ contract specified that (a) Conway needed to show that it was not neglecting or refusing to cure defective work, and (b) the city needed to be reasonably satisfied with those efforts.
The evidence demonstrated Conway did not neglect or refuse to correct the defects (e.g., it took steps to remedy the conditions, reached out to the city to determine whether those efforts were sufficient, and repeatedly requested a meeting). The evidence also demonstrated that the city did not act reasonably in deciding whether it was unsatisfied with Conway’s curative efforts. The court noted “‘the right to terminate exists only when the latter party’s dissatisfaction is based upon reasonable grounds.’” In this case, the court held that “loss of confidence … is not grounds for default termination.” Accordingly, the city’s termination was converted to one of convenience.
Next, the court examined whether the city was entitled to an offset for defective work discovered after termination. Considering this issue (one of first impression in Washington), the court found persuasive Shelter Products, Inc. v. Steelwood Construction, Inc., in which “the Oregon Court of Appeals held that the terminating party was not entitled to offset allegedly defective work after it terminated the contract for convenience without giving the other party the contractually required notice of the defects and an opportunity to fix them.” In Shelter, the terminating party could not pursue “‘two inconsistent paths simultaneously: both terminating the agreement for convenience and seeking damages … as if it had terminated for cause and given (the non-terminating party) an opportunity to cure.’”
Informed by Shelter and the parties’ contract, the Conway court affirmed that the city could not claim an offset for the subsequently discovered defective work.
Drafting agreements post-Conway
Conway emphasizes that termination provisions are subject to strict construction and therefore strict adherence. Failure to abide by their terms will severely restrict the terminating party’s ability to seek damages for defective work. The following tips may reduce the risk of claims and preserve the right to damages, in light of the Conway decision:
- Know the contract terms. It is critically important to remain mindful of the contract’s termination provisions. For instance, most standard form construction agreements contain both termination for cause and termination for convenience clauses, but not conversion clauses. The owner or contractor should carefully consider whether a conversion clause will mitigate its liability should it fail to properly terminate for cause – understanding that, once converted, recovery of damages under the termination for cause clause is less certain, if not foreclosed.
- Consider adding specific language to preserve termination for cause remedies. Post-Conway, owners and contractors may wish to consider adding specific contractual language to preserve the right of offset even when the contract is terminated for convenience. In doing so, parties should consider the Shelter reference in Conway, in which the court held that a contractual provision entitling a party to terminate “without cause and without prejudice to any other right or remedy” was not specific enough to preserve the right to setoff.
- Always follow the contract. Careful, clear language delineating the precise steps needed to terminate a contract for cause will help prevent disputes regarding the basis of termination. The terminating party should verify the steps needed to properly terminate the contract prior to taking any action.
Originally published as an Op-Ed by the Oregon Daily Journal of Commerce on Aug. 19, 2021.