The termination of a construction contract is one of the most powerful remedies an employer has against a contractor, especially when the contractor is in default.[1] There are numerous different situations in which the employer or, less frequently, the contractor, might have to resort to contract termination. Most commonly, a party resorts to termination due to the other party’s failure to fulfil its obligations under the contract, or if the other party has committed a fundamental breach of contract, so serious as to undermine the fundamental objectives of the innocent party. The law on termination varies depending on the applicable law and jurisdiction.[2] There are also notable differences between civil and common law legal systems. It is universally accepted, however, that if one party did not have the right to terminate the contract, and/or failed to comply with the procedural requirements, termination would be considered wrongful, entitling the other party to damages.
Contractual Termination
Construction contracts commonly provide for provisions relating to termination, entitling either party to terminate the contract, and the consequences flowing from termination.[3] Typically, there are two types of termination clauses, “termination for convenience“, and clauses that allow for termination where there has been a default on the part of one of the parties, “termination for default“. The termination rights, in case of termination for default, may be exercised only upon a breach of an obligation and where the requirements stipulated under the contract are satisfied. In well-drafted construction contracts, the innocent party would also normally have to allow for a certain “grace period” following a preliminary notice, during which the breaching party is given an opportunity to rectify the breach of contract.[4] Common contractual grounds giving the employer the right to terminate include, inter alia:
- A contractor’s suspension without valid reason/abandonment of the works;
- A contractor’s failure to proceed with the works regularly and diligently/with due diligence;
- A refusal to comply with an instruction requiring the Contractor to remove works/goods not in accordance with the contract/failure to remedy defects;
- Subcontracting without prior approval of the employer;
- A failure to provide security required by contract, such as a performance bond.
Termination for convenience clauses, on the other hand, typically allow a party (usually the employer) to terminate the contract at will (for whichever reason or for a specified reason not involving performance by the other party). This may happen, for instance, if the contract has become economically unviable or due to changes in prices and materials.[5]
Both termination for default and termination for convenience are similar in their application, but their results and consequences might vary. In case of termination for convenience, clauses typically make provision for the adjustment of the parties’ respective rights and obligations upon termination, such as, for instance, that the employer is required to compensate the contractor for wasted costs or amounts which have become due for payment up to the termination.
Alternatively, and in parallel, the common law also provides for termination for a breach of contract (i.e., so-called repudiatory breach), which entitles the employer to terminate a contract even in the absence of termination provisions in the contract and subject to certain conditions, as explained below.
Termination for Breach at Common Law
The common law provides for the right to terminate a contract if certain conditions are met, even in the absence of explicit contractual provisions in a contract. There are two situations in which the employer may terminate the contract under the common law, both of which are known as “repudiatory breach”:
- If a party makes it clear that it has no intention of performing the contract (renunciation of the contract by one party, i.e., a party, by words or conduct, unequivocally conveys to the other party that it does not mean to perform the contract further);
- If a party has committed such a serious breach of contract that it will be treated as having no intention of performing its obligations; the focus is on the consequences of the breach, and it has to be such that it deprives the non-breaching party of substantially the whole benefit of the contract.
Frequently cited examples of serious breaches include, for instance, the employer’s failure to give possession of the site and preventing the contractor from performing the works. In such a case, the non-breaching party has two options: to either terminate the contract or to affirm the contract, in which case it loses the right to terminate. If the party facing a repudiatory breach decides to terminate the contract, it should be careful and make sure, first, that the breach is repudiatory (i.e., that the other party demonstrated a clear intention not to be bound by the terms of the contract). Second, the party should also act quickly, to avoid any affirmation of the contract, as in such a case it might lose the right to terminate for repudiatory breach.
Normally, unless explicitly provided in the contract, the common law right to terminate continues to exist in parallel with the contractual right and it is open to a party to terminate on the basis of its contractual right or, in the alternative, at common law, as held in Stocznia Gdynia SA v Gearbulk Holdings [2009] EWCA Civ 75.
Consequences of Termination of Construction Contracts
The consequences of contract termination may also be different in case of termination at common law and contractual termination. If a contract is terminated under the common law, the contract comes to an end and both parties are released from further performance of their obligations. This might not always be the case in the event of contractual termination, as contractual termination provisions typically terminate the contractor’s right and obligation to carry out the works but do not entirely release the parties from further performance of their obligations.[6] Certain clauses survive contract termination and the parties maintain the rights which had accrued prior to contract termination, which means that the parties would still be liable for their breaches prior to termination. This may be the case for, by way of example, liquidated damages or dispute resolution/arbitration clauses (see Does an Arbitration Clause Survive the Termination of a Contract?). Certain contracts even explicitly prescribe that certain obligations are to continue post-termination, including limitations on liability and indemnities.
A party deciding to terminate a contract should accordingly be careful, as in most legal systems a wrongful termination would be regarded as a repudiation itself, entitling the other party to damages. If the employer wrongly terminates the contract, it can be liable for the contractor’s lost profits and damages. Proving such losses, however, is not easy in practice as the contractor has to demonstrate the contract would have been profitable and how much profit it would have earned on the remaining balance of the work.
If the contractor was, however, in default, it can become liable for the employer’s extra cost of completing the work with another subcontractor (the cost over and above what it would have incurred if the original contractor had completed the project in accordance with its contractual obligations).[7]
The Bottom Line: Be Careful When Deciding Whether to Terminate Construction Contracts
It is important for all parties to be well aware of their rights, risks and duties from the outset. The consequences of wrongful termination can be significant and should be taken seriously. Employers are therefore always advised to verify carefully the contractual and legal entitlement to terminate the contract, especially any notice and procedural requirements. Termination of construction contracts should also be a last resort remedy, and the risk and consequences should always be carefully evaluated against any other alternatives.
[1] S. Brekoulakis, D. V. Thomas QC, “GAR Guide to Construction Arbitration” (GAR, October 2021), pp. 74-75.
[2] International Bar Association, Issues arising on termination of a construction contract, construction Law International.
[3] J. Bailey, “Construction Law” (Informa Law from Routledge, Second Edn, 2016), para. 9.64.
[4] Termination of Construction Contracts, Squire Patton Boggs, 2017.
[5] J. Bailey, “Construction Law” (Informa Law from Routledge, Second Edn, 2016), para. 9.74.
[6] J. Bailey, “Construction Law” (Informa Law from Routledge, Second Edn, 2016), paras. 9.110, 9.128.
[7] S. Brekoulakis, D. V. Thomas QC, “GAR Guide to Construction Arbitration” (GAR, October 2021), p. 75.
