Termination of a construction contract is tricky and fraught with risk. Whether the termination is for cause or for convenience, the contract must be followed to the letter for a termination to be valid. Virtually every well-written construction contract contains a variety of termination provisions. Such provisions are infrequently exercised because the result is often catastrophic for the project, as well as everyone involved. Because contract terminations usually result from unexpected circumstances, the use of termination provisions typically signals the onset of increasing disputes.
The distinctions between termination for cause and termination for convenience are significant. When a contract is terminated for cause, the owner typically is entitled to stop paying the contractor and to seize the contractor’s materials and equipment for use during contract completion. Additionally, the terminated contractor may become liable for the costs of contract completion above the original contract amount. A termination for default creates seismic impacts on the contractor’s ability to obtain future work, and may negatively affect the contractor’s bonding capacity and credit rating.
In stark contrast to termination for cause, termination for convenience is intended to allow both parties to a contract to walk away reasonably satisfied. Although the agreed contract language governs in any particular case, the contractor typically is entitled to receive payment for work completed, including reasonable profit. In addition, the contractor may recover the reasonable expenses of termination such as demobilization costs and penalties for breaking other contracts, such as lease or supply agreements. From the perspective of the owner, a termination for convenience can be beneficial because the contractor typically is not entitled to anticipatory profits or consequential damages resulting from cancelled work.
Importantly, where a termination for cause is unjustified and deemed wrongful, most contracts will convert the termination to one of convenience. In the absence of a contractual provision allowing for such a conversion, courts generally recognize the doctrine of “constructive termination for convenience,” which judges apply to prevent owner abuse of default terminations. The conversion of a default termination to one for convenience exposes the owner to significant additional costs, and often involves expensive litigation. Proper termination for cause reduces the owner’s exposure to such costs, whereas improper termination for cause provides opportunities for a contractor to recoup otherwise lost expenses. Below are a few examples of termination situations to consider. Although discussed in the context of the owner-contractor relationship, they apply equally to the contractor-subcontractor relationship.
Pretext.
An owner cannot terminate for default as a pretext to other considerations. In one example, a federal government agency terminated a navy cap supply contract for default after a Senate committee investigating textile procurement implied the contract should be terminated. The agency proceeded to mechanically terminate for default at the suggestion of the Senate committee, a factor which had no relation to the contractor’s performance under the contract. The court converted the default termination to one for convenience and allowed the contractor to recover damages.
Another example of pretext involved termination of a contract to develop a stealth plane for the Navy. The contractor was terminated for default after the program’s funding was cancelled by the Secretary of Defense. Although the Navy terminated because the contractor was behind schedule and over budget, the trial court determined the Navy had a broader objective of abandoning the program altogether, and converted the termination to one for convenience. The appeals court reversed, finding the Navy’s concerns regarding the contractor’s schedule and budget performance to be fundamental elements of the contract. Thus, pretext appears to be limited to situations where the basis for termination is wholly unrelated to the performance of the contract.
Waiver and Delay.
An owner can waive its right to terminate for default by unreasonably delaying termination of the contract. However, courts tend to be lenient, allowing owners a reasonable time to evaluate the circumstances surrounding a default to determine whether termination is in the owner’s best interest. A simple delay in termination is not enough to establish waiver. Instead, an owner must allow or encourage a contractor to continue performance beyond the substantial and/or final completion dates without any comment or reservation of rights. To avoid the risk of waiver, owners must be diligent in their communications and reservations of rights in the event of a material breach by a contractor.
Revocation of the Right to Complete.
In an unreported case, an owner suspended a construction contract pending an investigation into the contractor’s claim of differing subsurface conditions. The owner reserved all rights of termination, thereby avoiding a waiver argument. At the same time, the owner also determined the contractor would not be allowed to complete the work and directed the contractor to demobilize regardless of the outcome of the investigation. A year later, after determining the contractor’s differing conditions claim lacked merit, the owner terminated the contract for default. The owner’s revocation of the contractor’s right to complete the work and direction to demobilize was found to constitute termination for convenience.
As shown by the examples above, contract termination involves complex factual scenarios which ultimately may be interpreted by a court or arbitrator. A clear and thorough understanding of a contract’s termination provisions prior to commencing performance yields great benefits when litigating after contract termination. Owners seeking to terminate must follow the contract to the letter, including use of the proper terminology, allowance for any stipulated notice and cure periods, and timely initiation of claims with bond sureties. Contractors threatened with the risk of default termination should carefully document all facts, circumstances and correspondence surrounding contract performance, and inventory the status of completed work, in order to challenge the termination. While avoiding termination is usually the best course of action, all parties are best served by careful documentation and informed decision-making when termination becomes inevitable.
