When can I terminate a construction contract?

by DLA Piper
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Court cases about NZS:3910 contracts are rare. Termination cases on NZS:3910 contracts are rarer still. In March this year the Court of Appeal released an important judgment about termination rights under a NZS:3910 contract in Custom Street Hotel Limited v Plus Construction NZ Limited (Custom Street). In this update we take a brief look at Custom Street and the key lessons for sector participants. While Custom Street concerns NZS 3910:2003, the default clauses in question are the same as those used in the updated NZS 3910:2013.

What happened in this case?

The case was about a project in Customs Street East, Auckland (contract value $14.5 million). The construction contract was signed on 1 November 2013. However, as noted by the Court of Appeal, 'problems overwhelmed the project' and there appeared to have been delays by the principal in obtaining the relevant consents required under the contract.

In July 2014, the contractor stopped work and launched adjudication proceedings against the principal. The adjudicator found fault on both sides. The consents were incomplete but this was not fatal to the project. Time was 'at large' and the contractor was entitled to a reasonable time to complete the works.

The last consent was obtained in November 2014 and the parties attempted to make a fresh start. On 27 January 2015 the contractor complained about outstanding invoices and issued default notices for outstanding fees against the principal. The principal's payment defaults were required to be remedied within 10 working days (by 10 February 2015).

Subsequently, the Engineer to the contract suspended works on site because of alleged health and safety breaches by the contractor.

The principal did not pay the contractor's payment default notices within the 10 working days and the contractor issued a notice of termination. The principal paid the outstanding amounts shortly after receiving the notice of termination and then challenged the validity of the contractor's termination notice. The Principal issued its own notice of default alleging that the contractor had "abandoned the contract" and "persistently, flagrantly or wilfully neglected to carry out its obligations under the contract".

Once its own default notice had expired, the principal then purported to terminate the contract and sought to call on the performance bond (which required the engineer to certify a breach of the contract). The contractor sought an interim injunction to stop payment of the performance bond but the parties settled that issue by agreeing to a process where the amount certified by the engineer would be paid into an escrow account and the dispute ultimately resolved by arbitration.

The engineer certified that $24 million was payable by the contractor to the principal (being the estimated cost to the principal of engaging a new contractor to do the work). The amount of the bond ($3.6 million) was paid into escrow and the case was referred to arbitration.

The arbitrator found in favour of the contractor. The matter was appealed by the principal on questions of law to the High Court and then the Court of Appeal. The contractor was successful in both courts.

What did the Court of Appeal say? 

The first question for the Court of Appeal was whether the contractor was entitled to issue a notice of termination. The principal alleged that the contractor was itself in default at the relevant time so the notice should be invalid.

The Court of Appeal agreed with the arbitrator and the High Court that the contractor's notice of termination was valid.

The contractor's termination notice would only have been invalid if, at the relevant time:

  • the contractor was refusing to perform the contract or was in breach of an essential term or some other serious breach had occurred; and
  • allowing the termination would mean that the contractor would benefit from its own wrongdoing.

Applying these factors to this case, at the relevant time, time for performance of the contract was 'at large' so the contractor was entitled to a reasonable time to complete the works. The contractor appeared to be ready and willing to complete the works. Accordingly, the contractor's notice of termination was valid. The principal's notice of default and related documents were issued after the termination by the contractor so could not change the position.

The second question for the Court of Appeal was about the process followed by the contractor. A literal interpretation of the termination provisions of NZS:3910 required the engineer to suspend the works at the request of the contractor before termination by the contractor could occur.

However, the Court of Appeal said that, outside the contract, the contractor had a statutory right to terminate (under the Contractual Remedies Act 1979 - which has now been re-enacted as part of the Contract and Commercial Law Act 2017). That was enough for the Court to find in favour of the contractor. However, the Court also said that despite the literal words of NZS:3910, the contractor should be entitled to terminate, despite a suspension by the engineer not having occurred. The Court read clause 14.3.3 as giving a right to terminate as soon as the right to obtain a suspension was triggered.

Finally, the Court was asked to rule on the proper interpretation of NZS:3910 on whether it entitled the principal to claim the $24 million from the contractor. This issue arose because the engineer to the contract relied on clause 14.2.4 of NZS:3910 when certifying the $24 million claim. This clause applies where the principal terminates the contract and, in summary, allows the principal to claim from the contractor any excess of the actual costs to complete using an alternate contractor and what would have been paid to the contractor if the contract had been validly performed.

In this case, the engineer to the contract was attempting to rely on this clause even though the contract works had not been completed - simply by estimating the cost to complete. The Court of Appeal confirmed this was not the right approach and that clause 14.2.4 would have only applied once the contract works had actually been completed by an alternative contractor (assuming there had been a valid termination by the principal).

What are the key lessons from the case? 

 We see the key lessons from the case as follows:

  • Termination of a construction contract by either party is a very serious step and parties should always proceed with caution, even where performance issues have been alleged to have occurred.
  • Payment defaults by the principal will almost inevitably be easier to establish than any performance issues by the contractor. Principals need to carefully consider whether they have a legal basis for withholding payment in any particular circumstances.
  • Both parties need to be aware that a party has a general right at law to cancel a construction contract based on the Contract and Commercial Law Act 2017, for serious breaches. This goes beyond the rights set out in NZS:3910.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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