There are not many actions a contracting party can take that involve more risk than the decision to terminate a contract for default. Termination clauses are common in construction and design contracts. Such provisions allow parties to establish how they will end their contractual relationship if things don’t go as planned.
There are many situations in which termination is relatively straightforward, such as when the performing party – a contractor, subcontractor, supplier or designer – abandons a project or refuses to perform. However, there are other situations when the grounds for termination are less clear-cut.
More complicated situations require careful consideration and a degree of objectivity that may be difficult to achieve under the circumstances. This is particularly true when emotions are running high, and money, pride and reputation are on the line.
Termination of a contractor and use of a replacement contractor typically (though not always) costs money and delays project completion. In addition, if the terminating party doesn’t have sufficient grounds to terminate, that party may be exposed to lost profits and other damages due to wrongful termination. For those reasons, terminating a contract is not advisable without a high degree of confidence that termination is justified.
Conversely, a party’s decision not to terminate may result in delayed completion or additional defective work, or both, along with a host of other potential problems.
Parties considering termination, at a minimum, should:
1. Get accurate information about the cost to complete with the original contractor, the time for completion and any risks of completing with the original contractor.
2. Assuming a difference in completion time between the original contractor and the replacement contractor, determine how much this delay may cost in terms of additional expenses and other damages, including liquidated damages.
3. Determine whether there is sufficient documentation to support termination, including notices to the original contractor (and, if appropriate, the contractor’s surety) of specific defaults with an opportunity to cure those defaults (if the contractor has a right to cure).
4. List the reasons for termination and decide whether they are material breaches substantial enough to defeat a claim for wrongful termination – litigation over these issues should be anticipated and the costs of litigation should be factored into the decision to terminate.
5. Compare the advantages and disadvantages of replacing the original contractor with the advantages and disadvantages of keeping the original contractor. If the results of this analysis are inconclusive, evaluate whether there are any viable alternatives to termination.
6. If you decide to terminate, adhere strictly to the requirements of the contract for either a partial or a full termination. Legal counsel should draft or review any future correspondence with the terminated contractor.
7. Send notice and itemize all delays and damages to the terminated contractor as soon as possible and update the itemization periodically throughout the remainder of the project. These updates should be promptly provided to the terminated contractor.
8. If you retain a replacement contractor, carefully monitor the work and request detailed documentation of any delays, defective work and other problems. The replacement contractor should document the degree of completion by the terminated contractor, including all defects discovered in the terminated contractor’s work. Accounting categories for tracking corrective work should be created, as should categories for work performed outside the scope of the terminated contractor’s work. Careful implementation of prudent accounting practices and tracking of costs will significantly improve the odds of recovering damages in litigation.
9. Preserve all documents (paper and electronic) related to the project, and issue litigation hold notices to everyone working on the project.
10. Consider other alternatives. More often than not, there are several less risky options than termination, all of which involve continued use of the original contractor. Examples include supplementing the original contractor’s workforce to avoid delay, partial termination if permitted by the contract, contracting with others to correct defective work and attempting to persuade the defaulting contractor to perform. In addition, combining the threat of termination with one or more of these actions may be just the motivation a defaulting contractor needs to step up and perform.
Depending on the circumstances, several other considerations may be in play. However, the key point is that termination decisions should be made after a healthy dose of due diligence and evaluation – not on a knee-jerk emotional response to a difficult situation.
Sean Gay is an attorney in the Stoel Rives LLP construction and design practice group. Contact him at [email protected]. A version of this column originally appeared in Daily Journal of Commerce (Oregon), sister publication to The Daily Record.