Termination Claims in Nutshell

Termination occurs when the employer instructs a contractor to permanently stop the performance of work and leave the site. Construction contracts specify each party’s rights, obligations, and remedies for termination. Termination on construction projects often results in claims and disputes; therefore, the decision to proceed with this option should not be taken lightly.

There are two general types of termination typically addressed in construction contracts: termination for convenience and termination for cause (sometimes referred to as termination for default). In a termination for convenience, the owner may terminate the contract for whatever reason it wishes, such as economic/business reasons, or as the most expeditious way of eliminating a non-performing contractor with minimum risk of a legal dispute. Contractor’s remedies for termination for convenience vary from contract to contract, but may include a reasonable cost of work performed prior to termination, including profit, anticipated profits on uncompleted work, justifiable and reasonable termination costs including project wind-down costs and other costs as may be mutually agreed.

Termination for cause may occur when the owner believes the contractor has not performed according to its contractual obligations and thus has materially breached the agreement. Breach of a contract may terminate the obligations of the contract. Either one party or both parties have failed to perform an obligation as envisaged under the contract. A breach may usually occur when a party refuses to perform the contract, does something that the contract prohibits, or prevents the other party from performing its obligations. However, not all breaches end up in contract close-out.

A material breach is controversial that goes to the heart of the contract. The injured party can seek damages; that is, a monetary compensation enough to cover economic losses resulting from the breach of contract. For example, a contractor uses materials that are not in compliance with the specification. A material breach is any failure to perform that permits the other party to the contract to either compel performance, or collect damages because of the breach. If the contractor in the above example had been instructed to use copper pipes, and instead used iron pipes which would not last as long as the copper pipes would have, the employer can recover the cost of actually correcting the breach - taking out the iron pipes and replacing them with copper pipes. A contractor’s refusal to start work is clearly a material breach whereas a contractor’s installation of wrong ironmongery would be a non material breach.

Various circumstances can worsen to a degree that a disgruntled contractor has no option but to abandon the contract and walk off the site. Whether due to non payment, inadequate design drawings, too many instructions that cause the works technically different than envisaged in the original contract, excessive employer intervention, lack of cooperation from the engineer, or otherwise, the circumstances can be simply beyond the control of the contractor so that the decision to abandon the contract becomes inevitable. An analysis of when a contractor may justifiably abandon the contract begins with the fact of materiality. A breach is considered material if it substantially deviates the purpose of the contract and is serious enough to justify the other party in abandoning the contract.

A material breach releases the non breaching party from all obligations further owed to the breaching party under the contract whereas a non material breach will entitle the non breaching party to recover damages but will not releases him or her from further obligations. However, there is no litmus test that can readily distinguish the material breach from the non material breach. An immaterial breach of contract is therefore a trivial breach of contract and does not vitiate the contract. For example, a contractor for a HVAC system under which the maintenance is periodically taken place does not make inspections on a regular basis. This act is a technical breach of the contract but is immaterial as long as the ultimate objective of continuity of uninterrupted operation has been ensured.

Breach of contract is an actionable wrong. Non-compliance with the terms and conditions agreed upon entitles the party violating the same to resort to remedies available. Remedies for breach of contract may be embodied within the letters of the contract itself or in the absence of specific provisions in cases of breach; the applicable laws will supply the remedies. Common remedies for breach of contract more often includes demand for specific performance or rescission of the contract or claim for damages. It bears stressing that good faith must be exercised at all times. Full compliance with the terms and conditions laid down and specified in the contract must be observed. Breach of contract will definitely expose the erring party to liabilities, penalties and of course to such tremendous amount of inconvenience.

Some of the more commonly cited reasons for terminating a contract for cause include failure to pay labor, subcontractors, vendors, or material suppliers, failure to meet the project schedule or diligently perform the work, defective or deficient performance, failure to follow applicable laws or regulations and failure to consistently follow safety requirements.  

Since some construction contracts provide for excusable delays, such as force majeure, the decisions to terminate for cause must also consider events which are excusable under the contract and prevent the contractor from performing as required. Termination-for-cause contract clauses vary from contract to contract, but some may require the owner to provide proper notice to the contractor of its alleged breach or failure to perform and provide a reasonable period for the contractor to cure, or start to cure, the alleged breach.

Typical claims from owners under termination for cause include, but are not limited to, the following, to the extent that they are not waived by contract the extended project duration and overhead costs (e.g., replacing one contractor with another almost invariably results in overall project delays), loss of profits or deferred production, liquidated damages or actual damages for delay and cost to complete the project if the final project costs exceed the value of the terminated contract less amounts paid to the terminated contractor.

Typical claims from contractors under termination for cause may include costs to bid the project, mobilization and demobilization costs, anticipated profit on the project, costs for work performed but not paid, home office overhead costs, winding-down costs, damages for loss of good will/loss of future business due to potential negative publicity following termination and betterment issues such as changes or upgrades included in the owner’s cost-to-complete damage model that are above and beyond the contractor’s original scope of work.