By Aman Kahlon
Most construction contracts contain termination provisions of some kind. These provisions usually fall within two categories: (1) termination for default and (2) termination for convenience. A termination for default clause will describe the events of default or breach that give rise to the non-defaulting party’s right to terminate the contract. The clause will also set forth each party’s rights and remedies upon termination. The defaulting party will likely have limited rights to recover compensatory damages, and the non-defaulting party may have substantial rights of recovery against the defaulting party, especially if the cost to complete the terminated work exceeds the remaining contract balance in the terminated agreement.
A termination for convenience clause will define the parties’ rights to terminate absent an event of default and set forth the rights and remedies of each party upon such termination. These clauses typically permit a non-defaulting party the right to recover demobilization costs and some associated markup, but they may limit the recovery of consequential or incidental damages like lost profits. It is unusual for a downstream party to have any right of termination for convenience, but downstream parties often negotiate for some limited right of termination for default to cover, for example, instances of sustained nonpayment for completed work.
One of the more difficult decisions construction owners, contractors, and subcontractors have to make is when to terminate a contract for default. Obviously, considerations for making the termination decision will vary depending on where a party falls in the project hierarchy. When a project gets sideways and tensions are high, parties often instinctively turn to their termination provisions as a way out of a soured relationship. However, a “trigger-happy” approach to terminating a party for default can have severe consequences including prolonged and expensive litigation. Caution and clear, objective thinking are advisable when making the decision to terminate a contract. Let’s look at some questions you should consider before making that decision.
TERMINATION RISKS
You should read through each of the termination provisions in your contract to determine exposure to damages for things like lost profits, impact damages, and claims for reputational harm. An objective assessment of your potential liability upon termination will help you make an informed decision. Note, if you are terminating for default and it is later determined that the termination should be treated as one for convenience, your counterparty may be able to recover damages under the separate termination or convenience clause of your contract. That possibility should be factored into your liability assessment.
Additionally, termination can and, often does, result in some kind of legal dispute. You should consider the risk and expense of dealing with liens, indemnity demands, costs of completion, or claims resulting from the termination decision. Before you decide to terminate a party, consider how the legal dispute will play out. Does the terminated party have strong defenses (i.e., the ability to rebut allegations of default)? Do you have sufficient documentation to support the termination? Are you ready and able to handle any resulting litigation?
You should also consider how termination may impact other requirements in the contract. For example, termination may affect warranty rights on completed work or rights against a surety on a payment and performance bond.
TERMINATION ALTERNATIVES
If there is a dispute over a certain portion of the work, one option in lieu of termination may be to enter into a deductive change order on the troublesome scope of work. Note a deductive change may create challenging material and coordination issues on remaining work and may have impacts on warranty rights and obligations that need to be considered.
Additionally, if there is some external issue disrupting the project, an upstream party could elect to suspend the project instead of pursuing termination. This may give the parties time to sort through the external impacts. Under such circumstances, there may be change disputes relating to the costs of the suspension, but, depending on the circumstances, such limited disputes may be favored over the consequences of termination.
PLAN POST-TERMINATION
If you are an upstream party, you need to map out a strategy for completing the project after a termination for default. Make sure you have a replacement contractor or subcontractor lined up to complete the work or at least some sense of the cost of completion. Consider whether termination will create licensing or permitting issues (e.g., your replacement contractor is not licensed to perform work where the project is located, or permits are issued in the original contractor’s name and will need to revised and resubmitted). Understand that if you intend to pursue the terminated party for the costs to complete, you likely have a duty to mitigate your damages. Spending recklessly will limit your ability to recover in any resulting litigation. If you need materials, equipment, designs, etc. from the terminated party, have a plan for getting possession of those items and a plan on how to proceed if the terminated party refuses to cooperate.
If you are a downstream party, consider what your options will be against the upstream party if you decide to terminate. Can you pursue litigation or place a lien on the property? Is there a bond, parent guarantee, or other security for you to claim against if the upstream party is insolvent? What is your exposure if costs for the upstream party to complete exceed the remaining contract balance? What responsibility do you have to protect material and turn over equipment for the project upon termination?
CLOSING THOUGHT
There is substantial uncertainty and risk inherent in the decision to terminate, which is why you should proceed cautiously. Consulting an outside attorney may be useful in evaluating this risk and may save you expense in the long-term or, at least, give you some comfort on your potential exposure.
About the author:
Aman Kahlon is a partner in the Construction Practice Group at Bradley Arant Boult Cummings (www.bradley.com) in Birmingham, Alabama. He represents owners, general contractors, and subcontractors in construction and government contracts matters. His litigation experience covers a wide variety of disputes, including substantial experience in power and energy matters. He also advises clients on delay, interference, defective design, and negligence claims. He can be reached at akahlon@bradley.com.
Modern Contractor Solutions, September 2020
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