Breaking up is hard to do. Especially on a construction project. It is extremely important to know when a contract can be terminated, how a contract must be terminated, and the remedies and penalties for wrongful termination.
Term/Finite Scope of Work.
The first question when determining whether a contract can be terminated is whether the contract has a finite term or scope of work. For instance, if a general contractor and a subcontractor enter into a contract with a specific schedule to perform a specific scope of work, the parties have agreed that the subcontractor has the right to perform that entire scope of work, unless there is a proper termination. Accordingly, neither party can terminate the contract unless they have a right to do so provided by the contract. The general contractor cannot simply fire the subcontractor. The subcontractor cannot simply walk off the job.
There are numerous agreements, however, where there is no such term or finite scope of work. For instance, many time and materials contracts are open-ended, informal agreements. This is especially true for change order work. A general contractor will often throw bodies at a problem to get the job done as quickly as possible.
If there is a finite term and/or scope of work, the contract can only be terminated if the contract provides permission. This permission typically comes in two forms: (1) termination for default, and (2) termination for convenience.
Termination for Default.
The most common reason for termination is default. Most contracts define “default” very carefully, including several contingencies such as failure to perform work, failure to properly staff the project, failure to maintain the schedule, failure to abide by any terms in the contract, violation of a law/regulation/ordinance, safety violations, failure to pay lower-tier subcontractors and suppliers, and insolvency.
The contract usually requires a party to provide formal notice (usually there are very specific methods for providing notice) and the opportunity to cure. The cure period is often quite short – three days or so. Certain defaults are curable within this time period, such as failure to provide payment or failure to adequately staff the project. More often, the default is not curable. For instance, if a subcontractor is weeks behind schedule, the opportunity to cure is usually for show. Even so, failure to provide the requisite notice and opportunity to cure can be catastrophic, resulting in a determination of wrongful termination.
Termination for Convenience.
Termination for convenience provisions are amongst the most unfair provisions in construction contracts. The following is an example of one such provision in a subcontract:
The Contractor may at any time terminate this Agreement for the convenience of the Contractor for any reason and without any default on the part of Subcontractor. In the event of such termination for convenience, provided the Subcontractor is not in default, the Subcontractor shall receive as its entire and sole compensation the reasonable cost of performing the Work to the date of termination.
This provision entitles the owner or general contractor to terminate the contract at any time for any reason. It does not take a great deal of imagination to understand the devastating consequences of such a decision. Especially on larger projects, contractors must clear schedules and dedicate their workforce for a considerable amount of time. The unexpected termination of a project can create a gaping hole in a schedule. Long lead times and intensive bidding processes make that hole hard to fill. Lost profits and layoffs often follow.
It is a large risk to agree to include this provision in a contract. Most owners and general contractors are reasonable and will agree to strike this provision. If they hesitate, propose to convert the provision from unilateral (only they have the right to terminate) to bilateral (both parties have the right to terminate). What is good for the goose is good for the gander. If they can terminate you at any time for any reason, you should be able to walk off the job at any time for any reason. If the owner/GC objects, it usually sounds like this: “But that would be extremely disruptive and expensive.” Yes, it would. Which is why neither party should be permitted to yank the rug out from under the other. If they are simply unwilling to either strike this provision or make it work to the benefit of both parties, you have to think long and hard about whether this is a company with whom you want to do business.
Even so, the right to terminate for convenience is not without limits. There is protection in the form of the inherent duty of good faith and fair dealing. Colorado law holds that every party to a contract has an unwritten, inherent duty to act in good faith and deal fairly with the other party or parties to the contract. Any party who violates this inherent duty breaches the contract. This comes up most often where one party has a considerable amount of discretion over the other. That is the case with a termination for convenience provision. One party has the ultimate discretion to terminate the contract. Colorado law holds that the more discretion a party has, the higher the duty. There are some scenarios where this duty would supersede the language of the contract. For example, relief might be available where an owner enters into a contract with a contractor, uses its estimates to obtain insurance approval, then terminates the contractor to go with someone cheaper and pocketing the additional insurance proceeds. Arguably, that would be bad faith and in contravention to the reasonable expectation of the parties.
But it is an uphill battle to escape this provision. A contractor’s best course of action is to eliminate it from the contract.
Change Order Disputes.
Change order disputes present a potentially costly scenario to contractors. The contract often requires the subcontractor to proceed with the work in the event of a dispute to keep the project moving forward. For instance, one such provision reads as follows:
Under no circumstances shall Subcontractor not perform changes or alterations to the Work which the Owner, Architect, Engineer, Contractor or Owner’s Representative may require. Should Contractor and Subcontractor not agree on the amount of increase or decrease to the Agreement, then Subcontractor shall proceed with the change or alteration, under a written directive from Contractor so as to not delay the progress of the Work, and pursue the dispute as provided by the dispute resolution provisions of the contract.
Many subcontractors are unaware of this requirement. If, for instance, the general contractor demands that the subcontractor perform work outside the original scope at great cost while offering a tepid argument as to why the work does not warrant a change order or only agreed to provide little additional payment, the subcontractor will often refuse to perform the work. This is especially true when it is clearly extra work that will require substantial cost. In that situation, if the above provision exists, the general contractor can properly terminate the contract, hire a replacement contractor, and pass on the extra cost to the subcontractor (usually by withholding amounts due and owing). Often the subcontractor makes it even easier by walking off the job. Subcontractors must be aware of this provision and its ramification both when negotiating contracts and making onsite decisions. More on this provision here.
Damages for Wrongful Termination.
The damages for wrongful termination can be devastating. This is why owners and contractors should proceed with great caution before taking such a drastic action.
From the perspective of the wrongfully terminated contractor, the damages are usually in the form of the lost profits the contractor expected to receive on the project. For example, if the total project cost was intended to be $1,000,000, the owner wrongfully terminated the contract with 60% of the scope of work remaining, and the contractor’s profit margin was 20%, the damages would be $120,000. Not only does the owner have to pay another contractor to complete the work (including overhead and profit), they also have to pay the wrongfully terminated contractor its expected profit as well. A bad decision can explode a budget.
From the perspective of the owner who has a contractor walk off the project, the damages are usually in the form of the increased project costs. Adjusting that same example, instead of being wrongfully terminated with 60% of the project remaining, the contractor walked off because of a dispute about a change order. If the owner’s replacement contractor completed the remaining work for a cost of $800,000, the damages would be $200,000. And this is conservative. Replacement contractors typically ratchet up their prices. They know the owner is in a bind. They know someone else is going to be paying the surcharge. And they are often leery about taking over someone else’s work. A contractor walking off a project better be certain they have the right to do so.
Finally, there is a potential for consequential damages. More on that here.