HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS. PART 8: Suspension, Termination and Default Claims
Introduction
Construction is a
business fraught with risk. Disputes
over even the smallest of issues can quickly escalate, with crippling
consequences to the project and the parties.
The cost to resolve a construction dispute can cost as much as the
amount in dispute if a matter is not managed properly. Over the years, the construction industry has
developed various methods of contractually allocating the risk of project delay
and disruption. Some of these methods
include liquidated damages provisions, "no damages for delay"
clauses, mutual waivers of consequential damages, provisions that limit
liability, claims notice provisions, “waiver of damages clauses”, acceleration
clauses, “time is of the essence” clauses, change order clauses, and provisions
addressing responsibility for the adequacy of the construction plans and
specifications. Parties frequently
litigate the sufficiency of these risk-shifting efforts in conjunction with the
underlying merits of differing site conditions, change order, delay, disruption
and many other disputes.
The Most
Frequently-Encountered Construction Claims & Disputes
In Part 1 of our
series of how to manage construction disputes to minimize surety and
construction claims, we addressed the construction delay claims and the methods
typically used to analyze them.
We indicated there
that the most frequently encountered claims include:
1. Construction Delay
Claims
2. Disruption and Loss
of Labor Productivity Claims
3. Design and
Construction Defects Claims
4. Force Majeure Claims
5. Acceleration or
Compression of the Schedule Claims
6. Suspension,
Termination and Default Claims
7. Differing Site
Conditions Claims
8. Change Order and
Extra Work Claims
9. Cost Overrun Claims
10. Unacceptable
Workmanship or Substituted Material Claims
11. Non-payment Claims
(stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private
construction projects) and payment bond claims)
Part 8 of this
series discusses item 6 above: Suspension, Termination and Default Claims.
Suspension
and Termination Claims
Suspension
occurs on a construction project when an owner instructs a contractor to temporarily
stop work on all or a portion of the project. Termination occurs when an owner
instructs a contractor to permanently stop the performance of work and leave
the site. Construction contracts typically specify each party’s rights,
obligations, and remedies for suspension and termination. Therefore, it is
advisable for all parties to thoroughly review, understand, and follow the
contract provisions relative to suspension and termination. Suspension and
termination on construction projects often result in claims and disputes;
therefore, the decision to proceed with either option should not be taken
lightly.
Common Issues Encountered Relative to Suspension and
Termination Claims
Contracts/projects
may be suspended for a number of reasons. Contractors may submit
suspension-related claims if the duration of the suspension is long enough to
delay the project or impact progress. Therefore,
suspension-related claims often require a schedule delay analysis to evaluate
the impact to the project’s critical path. Other contractor claims may include,
but are not limited to, the following issues:
· Standby or idle
costs
· Demobilization/remobilization
costs
· Other actual costs
incurred due to the suspension
On
longer suspensions, there may be a provision for compensation to the contractor
for demobilizing from the site and later remobilizing to avoid the project
owner having to continuously pay for labor and equipment which is not being
used. In addition, if the owner’s actions do not allow the work to proceed but
the suspension clause has not been invoked, the contractor may claim for
constructive suspension. A suspension can also be implemented if there is a
dispute between the contractor and the owner, and a termination is being
considered. Additionally, some contracts contain provisions that terminate the
contract if the suspension lasts longer than the specified duration.
Construction
Contracts Termination
Construction and design contracts increasingly
contain provisions giving one or both parties the power to terminate the
contract. A termination is the decision to stop performance of the contract
before it is completed. Termination is a
right granted the owner or general contractor and does not have a parallel
right for the contractor or subcontractor to "terminate" a
contract. A contractor or subcontractor
can "abandon" a contract upon breach by the owner or general
contractor, but cannot "terminate" the contract. See M. T. Callahan, Termination of Construction and Design Contracts, Aspen Publishers,
2014.
There
are two “types” of terminations:
(1)
terminations for convenience, and
(2)
terminations for default.
Normally,
neither party to a contract may terminate a contract without becoming liable to
the other party for all resultant damages, including lost profits and any
consequential damages. Termination for
convenience allows the owner/general contractor to stop the work for just about
any reason without having to pay for anticipated profit or unperformed
work. Termination for default, in
contrast, allows the owner/general contractor to procure alternative
performance at the contractor/sureties/subcontractors' expense.
A. Termination for Convenience
A
termination for convenience clause affords the owner or general contractor the
flexibility to alter its course, and eliminate unnecessary expenditures without
repudiating its performance or materially breaching the contract. In absence of a termination for convenience clause,
the owner or general contractor would have the right to terminate the contract,
but could face the full consequence of breach of contract, including payment of
anticipated profits on unperformed work.
Termination
for convenience is so important to the federal government that even if the
federal contract does not expressly reserve the government's right to
terminate, courts will read that right into the contract by operation of law. See G. L. Christian & Associates v. U.
S., 312 F.2d 418 (Ct. Cl. 1963). Today,
termination for convenience clauses are also found in most commercial
construction contracts, which gives owners and/or general contractors rights
similar to those of the federal government.
There
are four primary issues to remember when negotiating a termination for
convenience clause.
·
First,
is the clause enforceable?
·
Second,
how do I invoke the clause?
·
Third,
if invoked, what are the parties' obligations under the clause, and
·
Four,
what compensation is the terminated party entitled to under the clause?
It is common for a
termination for convenience clause to provide that if the right to terminate is
exercised, the terminating party's liability is limited to the reasonable value
of any material or labor furnished to the project up to the point of
termination. An example of such a clause is set forth below:
The Contractor
may, at its option, at any time, terminate the whole or
part of this Agreement for the convenience of the Contractor.
Subcontractor agrees that upon any such termination, the Subcontractor’s
sole remedy, shall be payment of full value for all work properly
performed or materials delivered, plus reasonable profit thereon, less
all payments Subcontractor has previously received on account of
such work performed. Subcontractor agrees to waive all claims for damages,
including lost or anticipated profits, arising from or related to
any such termination by Contractor.
Another
termination for convenience clause in a subcontract may read as follows:
Upon three (3)
calendar day's written notice to Subcontractor, Contractor may terminate this
Subcontract in whole or in part for Contractor's convenience and/or at its
option. Subcontractor's remedy for such convenience or optional
termination is limited to the following: (1) payment pursuant to the
terms of this Subcontract for all Work properly performed prior to termination;
(2) partial payment for lump sum items of Work on the basis of the percent
complete of such items at the time of termination; and (3) Subcontractor's
reasonable close-out costs. In no event shall Subcontractor be entitled
to any compensation for loss of anticipated profits or unallocated overhead on
Work not performed. See Associated General Contractors of
Washington Subcontract Form (2009).
Under
this clause there is no obligation for the terminating party to compensate the
terminated party for any profit that may have been included in the contract
price. The subcontractor will lose the benefit of his bargain which is a
legally cognizable right.
Many
subcontractors may prefer not to run the risk of termination and potential loss
of their profits, but will agree to a termination for convenience clause in
order to get the job. That is a business decision that should be best made by
the subcontractor. However, termination for convenience clauses may contain hidden
risks involving much more than the potential of lost profits.
The
unseen dangers of the termination for convenience clause lie in the
subcontractor's obligations to suppliers and lower tier subcontractors once the
contract has been terminated. The subcontractor may have ordered expensive
equipment or materials that have been specifically designed for that particular
project that is unusable elsewhere. Furthermore, specially fabricated materials
may be on order at the time that the contract is terminated which cannot be
canceled. In other words, the party whose contract has been terminated may be
legally obligated to buy these items, but may have no one to whom the items can
be sold. These dangers should be recognized and dealt with accordingly.
To
prevent a terminated subcontractor from being left "holding the bag,"
there may be a couple of options which can be utilized. First, a provision may
be inserted in the contract that makes the terminating party responsible for
all cancellation charges and all consequential damages caused by the
termination. In this way, the terminating party is responsible for all
"non-cancelable" materials and equipment which were ordered in good
faith in anticipation of their use on the project.
Some
sample subcontract clauses are set forth below:
D. Termination
For Convenience.
Contractor has the right to terminate this Subcontract without cause and at
Contractor's convenience upon five (5) days’ notice. Upon termination of this
Subcontract for the Contractor’s convenience, Subcontractor will immediately
cease performance of all Work and remove all of its tools, equipment and
personnel from the Project site and Subcontractor will have no claim of any
kind whatsoever against Contractor for breach of this Subcontract and Contractor
will be liable only for the cost of the Subcontract Work
actually completed in accordance with the Contract Documents, including
reasonable overhead and profit on completed work by Subcontractor prior to
termination, less all sums previously paid to Subcontractor and less all
deductions made by Contractor pursuant to this Subcontract. In the event any termination by Contractor
under Sections 8(A), (B), or (C) of this Subcontract is found to be improper or
wrongful, then any such termination shall be deemed a termination for
convenience under this Section 8(D) and Subcontractor’s recovery shall be
limited to amounts due under this Section.
E. Suspension of the Subcontract Work
by Owner. Should the Owner suspend,
delay or interrupt the performance of the Prime Contract, or any part of which
affects the Subcontract Work, then the Contractor shall so notify the
Subcontractor in writing and Subcontractor shall immediately suspend, delay or
interrupt that portion of the Subcontract Work as ordered by Contractor. Any claim by Subcontractor for any damages
caused by said suspension of the Subcontract Work shall be subject to Section 5
of this Subcontract.
F. Termination by Owner. Should the Owner terminate the Prime Contract, or
any part of which includes the Subcontract Work, the Contractor shall notify
the Subcontractor and the Subcontractor shall immediately stop the Subcontract
Work and follow the Contractor’s instructions concerning termination
procedures. In the event that the Owner terminates the Prime Contract for the
convenience of the Owner, then Subcontractor’s claim for any damages resulting
from termination shall be subject to Section 5 of this Subcontract.
If
that cannot be done, a subcontractor should try to include its own termination
for convenience clause in any of its lower tier subcontracts or purchase orders
related to that project. This can be accomplished by using appropriate
"flow through" language in the subcontract or purchase order or by
using an independent termination for convenience clause. If an independent
clause is used, care should be taken to assure that there is no liability for
lost profits and any other consequential damages. By the contractor or
subcontractor using its own termination for convenience clause, the risk of termination
will be shared by all parties involved.
There
are additional limitations on an owner or general contractor's right to
terminate for convenience. An owner
and/or contractor cannot exercise a termination for convenience clause in bad
faith or when abusing its discretion. For example, a general contractor terminating
a subcontractor for convenience to convert the lucrative subcontract profits to
itself would likely be found to be an abuse of discretion or bad faith. Courts have found that where a contractor is
terminated was for reasons unrelated to the performance of the contract, it was
actually a pretext for breaching the contract and the contractor would be
entitled to its lost anticipated profits.
In the government contracting context, the government may have to
demonstrate some "changed circumstances" as a precondition to
terminating the contract for convenience, taking away the optional unfettered
discretion once thought to be the test for convenience terminations. The court and arbitrator may also apply a
heightened scrutiny when private Termination for convenience clauses are
employed to terminate a contractual relationship.
B. Termination for Default
Termination
for default is a draconian action and one of the most serious provisions in a
construction contract. It constitutes a
type of forfeiture; therefore, courts scrutinize terminations for defaults
carefully to ensure that the contractual provisions the parties agreed to as
part of their original bargain are followed to the letter. The impact of a termination for default is a
cessation of revenue by the contractor or subcontractor for the specific
project. The terminated contractor or
subcontractor may be accountable for re-procurement costs and other
damages. Generally, because default
terminations are forfeitures, Courts regard them with disfavor.
The
greatest risk of either the owner or the contractor in terminating a contract
is that the termination could be determined by a court or arbitration panel to
be wrongful. If the termination is
proved to be wrongful, then the party terminating the contract not only fails
to collect its additional funds spent to complete the project, but must also
pay the wrongfully terminated party its contract payments through the date of
termination and potentially the loss of profit on the work not performed.
GROUNDS
FOR TERMINATION BY AN OWNER
The
contractor has many obligations under a typical construction contract. Whether an event of default exists must, of
course, be determined with reference to the contract itself. Most construction contracts, however, define
at least the following acts or omissions by the contractor as events of default
which entitle the owner, at its option, to terminate:
Sub-Standard, Defective or Nonconforming Work
The
contractor is obligated to perform its work in a good and workmanlike manner. See, e.g., Tharpe v. G.E. Moore Company,
174 S.E.2d 397, 399 (SC 1970); Weck v. A:M Sunrise Construction Company,
184 N.E.2d 728, 734 (Ill. App. 1962). Moreover,
the contract will typically provide express warranties regarding the quality of
the work and the materials used. In AIA
Document A201, for example, the Contractor warrants the following:
…materials and
equipment furnished under the Contract will be of good quality and new unless
otherwise required or permitted by the Contract Documents, that the Work will be
free from defects not inherent in the quality required or permitted, and that
the Work will conform to the requirements of the Contract Documents. Work not conforming
to these requirements, including substitutions not properly approved and
authorized may be considered defective.
See
AIA document A201-1997, § 3.5.1
The
owner itself may have the authority to reject nonconforming or defective work,
or the contract may provide different or additional mechanisms by which such work
may be rejected. In AIA Document A201,
the architect has the authority to reject work that does not conform to the
contract documents. See AIA document
A201-1997, § 4.2.6. The performance of
work by the contractor which is rejected by the architect is a ground for
termination of the contract. The owner would have the burden of proving that
the defective work is of a material nature to the project and would justify
termination of the contract.
Other
omissions of the contractor that could result termination of the contract
include:
·
Failure to
Pay Subcontractors and Suppliers;
·
Failure to
Pursue Work Diligently;
·
Violation of
Laws, Ordinances, Etc.;
·
Certification
by Architect;
A
typical termination for default clause reads as follows:
Termination for
Default. If
Subcontractor refuses or fails to supply enough properly-skilled workers or
materials to maintain the schedule of Work, refuses or fails to make prompt
payment to lower-tier subcontractors or suppliers of labor, materials or
services, fails to correct, replace, or re-execute faulty or defective Work
done or materials furnished, disregards the law, ordinances, rules, regulations
or orders of any public authority having jurisdiction, fails to consistently
follow safety requirements, files for bankruptcy, or is guilty of a material
breach of this Subcontract, and fails to correct the default and maintain the
corrected condition within not less than three (3) working days of receipt of
written notice of the default, then Contractor, without prejudice to any rights
or remedies otherwise available to it, shall have the right to any or all of
the following remedies:
(1) Supply such
numbers of workers and quantity of materials, equipment, and other facilities
as Contractor deems necessary for the completion of Subcontractor's Work, or
any part thereof, which Subcontractor has failed to complete or perform after
the above notice, and to charge the cost thereof to Subcontractor who shall be
liable for the payment of same including reasonable overhead and profit.
(2) Contract with
one or more additional subcontractors to perform such part of Subcontractor's
Work as Contractor shall determine to provide prompt completion of the Project
and charge the cost thereof to Subcontractor.
(3) Withhold
payment of any monies due or to become due Subcontractor pending corrective
action to the extent required and to the satisfaction of Contractor.
(4) Terminate this
Subcontract, use any materials, implements, equipment, appliances, or tools
furnished or belonging to Subcontractor to complete Subcontractor's Work and
furnish those materials, equipment, and/or employ such workers as Contractor
deems necessary to maintain the orderly progress of the Work:
Subcontractor's equipment shall only be utilized when equivalent
equipment is not locally available to lease, will not be supplied by a
substitute subcontractor, and when procurement of substitute equipment will
delay completion of the Main Contract. All of the costs, including
reasonable overhead, profit and attorneys' fees, incurred by Contractor in
arranging to and performing Subcontractor's Work shall be charged to
Subcontractor and Contractor shall have the right to deduct such expenses from
monies due or to become due Subcontractor. Subcontractor shall be liable
for the payment of any expenses incurred by Contractor in excess of the unpaid
balance of the Subcontract Price.
In the event of any
emergency, Contractor may proceed as above without notice.
See
Associated General Contractors of Washington Subcontract Form (2009).
Generally,
a termination for default clause contains the following elements:
Definition
of Default.
The default provision contains certain grounds for a default termination.
Most common are the failure to meet the
completion date; failure to make progress; failure to make payment to subcontractors,
lower-tier subcontractors, and suppliers; failure to repair or replace faulty
or defective work; disregard of laws, ordinances, rules, or other regulations;
filing for bankruptcy; or otherwise materially breaching a term of the
contract/subcontract.
Notice
to the Contractor
When
the decision is made to terminate the contract because of default by the contractor,
the owner must review the contract carefully to determine what notice must first
be given to the contractor. Contract provisions which require notice to the
contractor and an opportunity to cure are common. Under AIA Document A201, for
example, the owner must give the contractor (and the surety, if any) seven (7)
days’ written notice before terminating the contract. See A201 §14.2.2. Depending on the type of default alleged, a
contract may provide specific opportunities for the contractor to cure the
default. In the case of defective or
non-conforming work, for example, AIA Document A201 provides that if the
contractor does not commence and continue the correction of the work within
seven (7) days of the receipt of written notice from the owner, then the Owner
may after such seven-day period give the Contractor a second written notice to
correct such deficiencies within a three-day period. If the Contractor within such three-day period
after receipt of such second notice fails to commence and continue to correct
any deficiencies, the Owner may, without prejudice to the other remedies the
Owner may have correct such deficiencies.
See A201 §2.4.1.
Thus,
in the contract language quoted above, as in many construction contracts, the
owner may not peremptorily terminate the contract by reason of an alleged
breach by the contractor. In many instances, the contract will allow the
contractor a reasonable opportunity to cure the alleged breach and protect its
interest under the contract once it receives notice of the owner’s alleged
basis for termination.
Cure
Notice. The second feature of a well-written termination
clause is a cure notice. Generally, the
contractor/subcontractor is given a period of time (3 to 5 working days) to
cure the default after being provided with written notice of the event giving
rise to the termination. A properly-crafted termination letter includes
the specific bases for the default, the specific cure demanded of the
contractor or subcontractor, and complies with the cure notice duration in the
contract to the letter.
Default
Remedies.
The third feature of the well-written
default provision is that the default remedies are set forth with
particularity. Among the default
remedies are augmentation of the contractor/subcontractor's work through
engagement of other workers or subcontractors, subcontractor's withholding of
money, and ultimately the termination and takeover of the contractor's work.
Although
not expressly stated in the standard default clause, closely-related concepts
of contractor anticipatory repudiation or abandonment provide additional
grounds for default termination. If a subcontractor or contractor leaves
the project without any intention of returning, that constitutes an
"abandonment," which allows the owner/general contractor to take over
the contractor's/subcontractor's work. To show that the contractor or
subcontractor has abandoned the project, you must demonstrate an affirmative,
unequivocal, and unconditional declaration of intent not to perform or some
other unequivocal, definite demonstration of intent not to return.
The
existence of a technical default by the contractor/subcontractor does not
necessarily mean that a default termination is proper. Wrongful
termination is itself a breach of contract. It relieves the
contractor/subcontractor's liability for preceding breaches and discharges the
surety of any obligation under its performance bond. The owner or general
contractor bears the burden of proof with respect to whether the termination
for default was justified regardless. A default termination is a drastic
remedy that should be imposed only for good grounds on solid evidence.
Notice
to the Surety
Where
the contractor has provided a performance bond for the project, the owner must
not forget to provide timely notice to the surety before terminating the
contract because of the contractor’s default. As a general matter, there is no
obligation to notify the surety before declaring a default and terminating the
contract. See, e.g., School District v.
Universal Surety Co., 135 N.W.2d 232, 237 (Neb. 1965). However,
a provision in the bond itself which requires notice to the surety will
ordinarily be enforced in any subsequent legal proceeding. Moreover, the
construction contract itself may require notice to the surety. See, e.g., AIA Document A201-1997, §14.2.2.
Once
the owner has complied with the notice provisions in the bond and has declared
a default by the contractor, the surety will generally have the option to
complete the project itself (directly or through agents) or pay the cost of
completion (up to the amount of the bond) to the owner. AIA Document A312 gives the surety the
following options:
1. to arrange for the contractor to complete the job, but only
if the owner consents;
2. to perform the contract itself, through agents or
independent contractors;
3. to obtain a bid for completion of the work by the contractor
acceptable to the owner, secured by bonds equivalent to those issued on the
original contract, and pay the owner the cost of so completing the work, up to
the amount of the bond;
4. to promptly determine the amount of its liability to the
owner, and pay the owner that amount; or
5. to deny liability and notify the owner in writing of the
reasons for doing so.
Termination is a tricky area of the law of
contracts. Contractors and subcontractors are well advised to involve experienced
legal counsel before undertaking a contract termination, as the facts and
circumstances of construction defaults vary widely and are oftentimes both
factually and legally complex. Given the potentially harsh results,
including the consequences of the default termination and the death sentence that
the default termination suggests, it is prudent to contact an experienced
construction lawyer at the first sign of trouble, and certainly before taking
the extreme action of terminating a construction contract.
In theory,
terminating for convenience avoids the hassle of documenting the contract
breaches, providing notice and cure periods, and arguing over definitional
ambiguities. It also purportedly gives the terminating party certainty in
regards to termination damages. However, this is not always the case, in
particular, where termination for convenience clauses have not been carefully
negotiated and drafted.
Traditionally,
without cause, an owner or contractor could not terminate another contractor
without breaching the parties' contract, thereby being exposed to litigation and
potential damages for anticipatory profits. The result was often disastrous for
the owner/contractor leading to significant budget overruns when the
terminating party had to pay anticipatory profit to the terminated contractor,
and then pay to retain another contractor to complete the terminated
contractor's work.
Solutions began
evolving
During World War I, the U.S. government
introduced the concept of termination for convenience as a way to allow it to
avoid such costs by giving it the right to terminate a contract that had become
“unnecessary” given recent developments in the war. Torncello v. The United
States, 231 Ct. Cl. 20, 20, 681 F2d 756, 759 (1982). Upon termination, the
contractor was entitled to recover some lost profit, but typically was not entitled
to the full measure of damages available under a traditional breach of contract
claim.
As the doctrine
continued into World War II, the government's basis to include these clauses was that
they were “only intended to handle changed conditions, relieving the government
of the risk of receiving obsolete or useless goods.” Torncello v. The United
States, 231 Ct. Cl. 20, 20, 681 F.2d 756, 763 (1982).
Post-war, the courts
continued to allow the government to terminate contracts for convenience, but
relied on the “risk allocation nature of the concept to allow termination for
convenience only when the expectation of the parties had been subjected to a
substantial change that made continuance of the contract clearly inadvisable.”
Id.
For example, if the
job became impossible, too difficult or too costly to perform if pushed through
to conclusion, the government could typically terminate the contract for
convenience. Nolan Brothers, Inc. v. The United States, 186 Ct. Cl. 602,
606, 405 F.2d 1250, 1253 (1969).
But, it was clear
that the government could not just terminate the parties' contract without any
reason whatsoever, despite what the untutored reading of the termination for
convenience clause suggested. Rather, some change from the parties' original
bargain was required.
In 1974, the courts
first allowed termination for convenience for a different reason than risk
allocation and allowed the government to terminate a contract as a matter of
strategy in order to save the government money. Torncello v. The United
States, 231 Ct. Cl. 20, 20, 681 F.2d 756, 767 (1982).
More good faith
glitches
The case was highly
criticized, however, on the grounds that the ability to terminate a contract
for no reason at all is nothing more than an illusory promise, and illusory
promises are void and unenforceable for want of consideration. Id.; see also
Restatement (Second) of Contracts § 77(a)(1981).
So, to avoid
consideration criticisms, the courts limited the termination for convenience
clause by incorporating a good faith element. Kalvar Corp. v. United States,
211 Ct. Cl. 192, 298-99, 543 F.2d 1298, 1301-02 (1976), cert. denied, 434 U.S.
830, 98 S. Ct. 112 (1977).
Still, courts
struggled with lack of consideration issues and what constituted good faith.
Within just four years,
the good faith limitation was interpreted to require the change of
circumstances historically contemplated. Torncello, 231 Ct. Cl. at 20, 681 F.2d
at 772. No doubt this frustrated the government, which had enjoyed much
latitude regarding their contracts over the previous several decades.
Unsurprisingly, the
Competition in Contracting Act (CICA) was enacted, requiring a lenient standard
in applying governmental termination for convenience clauses.
Application of CICA
eliminated the “changed circumstances” requirement from federal contracts and
relaxed the duty of good faith such that the government now has almost an
unfettered discretion to terminate a contract for its convenience, although at
least one state has continued to apply the changed circumstances test in the
governmental context. See RAM Engineering & Constr., Inc. v. Univ. of
Louisville, 127 S.W.3d 579, 587 (2003).
As the use of
termination for convenience clauses grew in federal contracts, the clauses
started gaining acceptance in private contracts. In 1987, the A201 introduced
the concept of termination for convenience, but limited it to suspension. AIA
Document A201-1987 § 14.3.
In 1997, termination
for convenience was added and thereafter retained in the 2007 revisions. AIA
Document A201-1997/2007 § 14.2.
Unlike federal
government contracts, in the private context, the law remains that any decision
by a party to terminate a contract must be made in good faith, as determined by
the reasonable expectations of the parties at the time the contract was
executed. Questar Builders, Inv. v. CB Flooring, LLC, 978 A.2d 651, 675-76, 410
Md. 241, 281-82 (2009).
Don't push the limits
– convenience clause may not cover you
The question then
becomes, what constitutes bad faith in terminating a contract and how far can
you push the limits of one of these clauses before rendering your contract
illusory?
In Questar Builders,
Inc. v. CB Flooring, LLC, Questar Builders (Questar) was hired as general
contractor to construct a luxury mid-rise apartment and townhome complex. 410
Md. 241, 245, 978 A.2d 651, 653 (Ct. App. 2009).
After receiving bids
from three flooring subcontractors, Questar selected CB Flooring, LLC (CB) to
install carpeting for the project at a total contract price of $1,120,000.00.
Id.
After entering into
the subcontract, however, the interior design firm working on the project
changed the carpets to be installed in certain portions of the project. Id. at
249, 978 A.2d 656.
Questar immediately
sought a price quote from one of the previous bidders, Creative Touch Interiors
(CTI), “assertively because it was trying to keep CB honest on any requested
change order.” Id. Shortly thereafter, CB submitted a change order requesting
an upward adjustment to the subcontract price for the carpet change. Id. at
250, 978 A.2d 656.
CB's change order
request exceeded the price quote provided by CTI. Id. Questar terminated the
contract with CB and issued the contract to CTI. Id. CB filed suit against
Questar for damages, including lost anticipatory profits. Id. at 251, 978 A.2d
at 657.
The trial judge
concluded that Questar improperly terminated the subcontract and awarded
expectation damages to CB, considering and rejecting Questar's contention that
“it enjoyed a right to terminate the subcontract for any reason based upon its
termination for convenience clause in the subcontract.” Id. at 251, 978 A.2d at
657.
Further, the trial
judge specifically found that Questar's assertion to be without merit, that its
“subjective loss of faith in CB's ability to perform satisfactorily satisfied
whatever implied limitations there might be on the exercise of the termination
for convenience clause.” Instead the judge held that something more objective
was required to satisfy the good faith limitation. Id.
On appeal, the Court
reviewed the history of the clause's development in the context of federal
procurement and found that the case law supporting such a “broad termination
right” was “too broad” in the private context. Id. at 270-71, 978 A.2d 669.
The Court declined
“to recognize for private parties the near carte-blanche power to terminate
that courts have given the federal government under convenience termination
clauses” on the basis that without special government legislation allowing it,
such contracts are illusory, and therefore unenforceable. Id.
Rather, the Court,
following the historical analysis of termination for convenience clauses, found
that “the right to terminate a contract for convenience is a risk allocating
tool.” Id. at 277, 978 S.2d 672.
To that end, the Court
held that a contractor may terminate a contract, in its discretion, only if it
first determines that continuing with the subcontract would subject it
potentially to a meaningful financial loss or some other difficulty in
completing the project successfully” (i.e., a change in circumstances). Id.
Moreover, the Court specifically found that as it relates to the above, a
contractor has an obligation to “act reasonably in ensuring that a subcontract
does not become inconvenient.” Id.
One of the only
courts to rule on termination for convenience clauses in the private context,
and the most recent decision, Questar, is from a terminating owners and
contractors perspective, because it suggests that despite including a
termination for convenience clause in your contract, you are still going to
have to show some element of cause to get around the duty of good faith.
Specifically, it
suggests that even if you have a change in circumstances or the project
requirements or scope, it may not be enough to justify termination. It further
suggests that termination for convenience clauses in the private context are
going to be carefully scrutinized with disfavor.
The
CBCA Issues an Interesting “T for D” Decision, Applying UCC Principles to Reach
a Common-Sense Result
A
termination for default (T for D) is “a drastic sanction which should be
imposed or sustained only for good grounds and on solid evidence.” A T for D
will impact future responsibility determinations and needs to be fought by
contractors who want to continue to work in the Government market. In DMW
Marine Group v. Department of Commerce, the Civilian Board of Contract
Appeals (CBCA) granted a contractor’s appeal, effectively reversing the
National Oceanic and Atmospheric Administration’s (NOAA) T for D based on the
contractor’s failure to provide a certification called for under the contract.
The Board’s decision reflects a common-sense understanding of the exchanges
between the parties—and a proper rejection of an overly aggressive use of the
“drastic sanction.”
The
contract at issue in DMW Marine required delivery of a crane to a NOAA
coastal mapping vessel. Throughout performance, the parties had a disagreement
about the certification requirements imposed by the contract, with the agency
asserting that a certain type of American Bureau of Shipping (ABS)
certification was required. When work on the crane was almost complete, DMW
Marine sent the CO a letter stating:
The
requirements for ABS [s]tate: contractor shall receive Government and ABS
approval of the crane system. It is our intent that upon installation ABS
will certify the onboard load test thereby approving the crane system.
Please issue concurrence with above, as we are not shipping this crane until it
is agreed upon.
The
CO accepted DMW Marine’s position regarding “the ABS requirements,” noting “it
appears that you and ABS have a good path forward that meets the requirements
of the contract and is acceptable to the Government.”
After
delivery of the crane, the CO asserted that the “onboard load test”
certification was inadequate, and that DMW Marine should have “inform[ed] [ABS]
prior to the commencement of construction in order to initiate the necessary
surveys in due time.” As going back in time wasn’t possible, and as the
Government wasn’t paying, the frustrated contractor made increasingly colorful
responses to the CO’s correspondence, e.g., “[j]ust ship the crane back
to us and we will refund your slow and late payments,” “if full payment[i]s not
made, ‘[w]e are ready to repossess the crane,’” “[w]e will pick up our crane
tomorrow.” Not amused, the CO terminated the contract for default, after paying
only 71% of the contract price for a “crane [that] continues to be installed
on” NOAA’s vessel.
The
CBCA’s problem with NOAA’s actions are obvious: the interpretation of the
inspection clause had been disputed between the parties, but when DMW Marine
made clear what it was going to do and asked for the CO’s concurrence before
shipment and installation of the crane, the CO unambiguously agreed. Then,
after obtaining the crane, the CO flip-flopped and asserted that a further
certification was required. The CBCA reached back to the basic commercial legal
principles taught to law school 1Ls, i.e., UCC § 2-607(2), to explain
that “[a]cceptance of goods by the buyer precludes rejection of the goods
accepted and if made with knowledge of a non-conformity cannot be revoked
because of it . . ..”
When
NOAA accepted delivery of the crane, it “knew well” that it was not
ABS-certified in the manner the agency later demanded. Given “all that had
transpired during the previous months,” the agency’s attempted rejection of the
crane was improper and, thus, “[t]erminating the contract for cause was not
justified.”
It
should be noted that, although DMW Marine is surely pleased to have the T for D
thrown out, it will likely not obtain the complete recovery it likely believes
is due. The CBCA ordered that the termination be converted to one for the
convenience of the Government. Under FAR 52.212-4(l), an agency that T
for Cs a contract must pay “a percentage of the contract price reflecting the
percentage of work performed prior to the notice of termination, plus
reasonable charges the Contractor can demonstrate . . . resulted from the
termination.” The parties can usually negotiate T for C settlements, but
agencies can resist full payments and, given the history of this case, may do
so here.
Subcontractor
Default Insurance
A
subcontractor default on a construction project is one of the greatest risks
faced by the general contractor in constructing a project. Generally, contractors protect themselves from
that risk by purchasing bonds, and now, also subcontractor default insurance. An example best contrasts the differences
between bonding and insurance.
1.
Contrast Between Bonding and Default Insurance.
Assume
on a high end condominium project the drywall contractor uses non-compliant
drywall screws to fasten the weather barrier to the studs. This error is not discovered by the general
contractor until the project is virtually complete.
When
confronted with the oversight, the subcontractor refuses to redo the faulty
work and walks off the job. In a second
scenario, the subcontractor may simply walk off the job and in a third scenario
the subcontractor may go out of business.
Now,
the general contractor is on the hook, not only for replacing all the wall
coverings, granite, tile, paint and other finishes, but also for the indirect
costs associated with the overall project delay.
If
the general contractor had bonded the subcontractor, the loss is capped at the
penal sum of the bond (the bond amount limits the recovery), and generally no
liquidated damages associated with project delay will be reimbursed by the
bond. Generally, the project will be delayed further while disputes between the
general contractor and the bonding company are being settled. If on the other hand,
the general contractor had purchased subcontractor default insurance, the
insurance companies are generally able to promptly mitigate the damages,
complete the project quickly, without the limitation of a penal sum, and with
coverage for indirect damages (liquidated damages).
2.
Default Insurance.
There
are three commercial products on the market for subcontractor default
insurance, Zurich's Subguard®, XL Insurance's ConstructAssure®, and a
product from Construction Risk Underwriters (CRU). Subcontractor default insurance, an
alternative to surety bonds, protects the general contractor from losses
arising from defaults by un-bonded subcontractors. The general contractor enrolls all
prequalified subcontractors for a specific project or policy term and is
indemnified (held harmless) by the insurance company for any direct or indirect
costs incurred if one of those subcontractors defaults on performance.
Subcontractor
default insurance operates under a high deductible, high co-pay model offered
at a significant discount to bonds. It protects the general contractor against
losses well above the penal sum of the bond and also rewards those general
contractors with the best risk management procedures.
The
premium for subcontractor default insurance includes an option to collect the
potential deductible and co-pay responsibilities in a loss fund. If the general
contractor does not incur any losses, and therefore does not withdraw against
the loss fund, that money is profit to the general contractor. Under a bond,
the premium money is paid to the bonding company never to be seen again, even
if the general contractor manages the job and subcontractors perfectly. Thus, subcontractor default insurance provides
a significant financial incentive that compensates general contractors for the
risk management work they are already doing day in and day out.
QUANTIFICATION
OF CONTRACTOR TERMINATION DAMAGES
Damages
Claims Formula No. 1 – The contract price less the amount that it would
cost the contractor to complete the work;
Damages
Claims Formula No. 2 – The profit on the entire contract (total contract
price less the contractor’s cost of completion) plus the cost of the work
actually performed; and,
Damages
Claims Formula No. 3 – For the work completed, that proportion or ratio of
the contract price as the cost of the work performed bears to the total cost at
completion, plus, the remaining profit on the uncompleted work.
Where
adequate proof can be made as to the contractor’s cost of completing the work
and where the entire job can be performed at a profit, the application of
formulas two and three may produce similar, if not identical, results. If the
contractor is unable to prove with reasonable certainty what it would cost to
complete the remaining work, the first formula is not applicable, whereas under
formulas two and three, she might recover for the work completed in compliance
with the contract.
Termination for Convenience/ Wrongful Termination of
Contract by Contractor
Only
the owner can terminate, or suspend, the Contract for convenience. The
contractor does not have this right. If a contractor wrongfully terminates the
contract and abandons the job, he will likely be sued for the difference
between the owner’s cost to complete and the earned value of the contract work
completed. He may be required to pay extra costs associated with the delay, the
hiring of a completion contractor(s), etc.
Contractor’s Damages
If
it is shown that the contractor terminated the contract for cause, he may be
entitled to claim to recover payments for work executed and earned, and for
proven compensable loss with respect to materials, equipment, tools, and construction
equipment and machinery, including reasonable overhead, profit and damages.
Typical
claims from contractors under termination for cause may include, but are not
limited to, the following, to the extent that the contract does not specify
otherwise:
·
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
·
Betterment
issues – 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
Suspension and
termination actions on complex construction projects are typically complicated
and expensive to resolve and often result in litigation or other forms of
dispute resolution. Owners and contractors are advised to maintain detailed
records and documents, such as costs reports, progress reports, invoices,
schedules, and other contemporaneous project documents, as this will facilitate
accurate and persuasive construction claims preparation.
Contractor’s Termination
Prior
to termination or abandonment, the contractor can elect to suspend the work if
a material breach has occurred such as untimely payments by the owner of valid
payment applications where proper notice has been given, and where the
contractor is not in breach. This is a much safer course of action than
termination, and it allows the owner a chance to cure. If the contractor must
terminate for cause, he must comply the terms of the contract and provide
proper formal written notice to the owner.
If
both the owner and contractor are in material breach of contract at the time of
termination, the above assessments and formula may change and the relative
nature and degree of the breaches become relevant. Termination and damages will
be examined in greater detail here in the future.
Analyzing Suspension and Termination Claims
Metropolitan
analyzes suspension and termination claims and disputes by reviewing the
factors which led to the event. This
typically involves reviewing contract documents, project correspondence, such
as e-mails, letters, meeting minutes, project schedules, periodic job reports,
and other relevant documentation, as well as interviewing key project
personnel. As contractor performance is
often viewed as a justification for suspension or termination, the actions of
the contractor and owner must be reviewed thoroughly for compliance with
contract requirements and industry norms for standard of care.
Often,
the amount of claimed damages is in dispute. Metropolitan‘s construction consultants
analyze the project data, within the realm of the specific contractual
obligations, to determine the appropriate damages, if any, due to either the
contractor or the owner.
Metropolitan’s
construction consultants can provide the following services relative to
suspension and termination claims:
· Claims preparation
or analysis
· Schedule analysis
· Damage
quantification
· Document review
· Expert analysis and
testimony
SAMPLE CLAUSES FOR DEFAULT, TERMINATION AND
REMEDIES
A. Default.
1. Notice to Cure. If the Subcontractor refuses or fails to
supply enough properly skilled workers, proper materials, or maintain the
Project schedule; or if it fails to make prompt payment to its workers, subcontractors
or suppliers; or if it disregards laws, ordinances, rules, regulations or
orders of any public authority having jurisdiction; or if it otherwise fails to
perform in accordance with the provisions of this Subcontract, the Subcontractor
shall be deemed in default of this Subcontract.
If
the Subcontractor fails within three (3) working days after written
notification to satisfactorily correct any such default, then Contractor,
without prejudice to any other rights or remedies, shall have the right to any
or all of the following remedies:
(a) the right to enjoin or restrain such
default and to demand and to have specific performance;
(b) the right to receive and recover
damages resulting therefrom;
(c) the right to withhold or to offset any
progress, final or other payments under this Subcontract or any other
subcontract between the parties now or hereafter in force; and/or
(d) without being deemed to have waived or
cured such breach or default, the right to perform any act and make any payment
for which Subcontractor is in default, in which event all expenses, costs,
losses, damages, and fees (including, without limitation, attorneys' fees)
suffered or incurred in so doing, plus fifteen percent (15%) of such costs and
expenses for overhead and administrative costs, shall immediately constitute
indebtedness due and owing from Subcontractor. In exercising this right,
Contractor shall be entitled to enter the Project site and take possession and
use any materials, tools, and equipment for such purpose.
In
the event of an emergency affecting the safety of persons or property,
Contractor may correct any such default without first giving three (3) working
day’s written notice to Subcontractor, but shall thereafter give prompt written
notice of such action to Subcontractor.
B. Termination. If the Subcontractor fails to satisfactorily
correct such default within the three working days after written notification
issued under Section 8A, then Contractor may, instead of or in addition to the
remedies set forth in Section 8A, issue a second notification to
Subcontractor. Such second notice shall
state that if Subcontractor fails to satisfactorily correct any default within
two (2) working days from the second written notification, the Subcontract may
be terminated.
In the event of such termination and
upon Contractor’s written request, the Subcontractor shall immediately remove
from the Project site all of its employees, equipment, tools, supplies and
materials without any disruption of the work in progress and at its own cost
and expense. Should Subcontractor fail
to do so, Contractor shall be entitled, but under no obligation, to remove and
store any equipment, tools, supplies and materials at Subcontractor’s cost and
expense.
Further, in the event of such
termination, Contractor shall be entitled to enter the Project site for the
purpose of completing the Subcontract Work and shall be permitted to take
possession of all materials, tools and equipment to finish the Subcontract Work
either by itself or through other contractors.
In the case of termination of this
Subcontract, Subcontractor shall not be entitled to receive any further payment
until the Subcontract Work shall be wholly finished, at which time, if the
unpaid balance of the amount to be paid under this Subcontract shall exceed the
expense incurred by Contractor, including an overhead fee of fifteen (15%)
percent of the cost incurred in finishing the Subcontract Work, such excess
shall be paid by Contractor to Subcontractor.
However, if such expense shall exceed such unpaid balance, the
Subcontractor shall immediately pay the difference to Contractor.
C. Insolvency or Bankruptcy. In the event Subcontractor voluntarily or
involuntarily becomes subject to bankruptcy proceedings, makes an assignment
for the benefit of creditors, becomes insolvent, or has a trustee, receiver or
liquidator appointed for any part or all of its assets, this Subcontract shall
terminate. Notwithstanding the foregoing,
if the Subcontractor, or Subcontractor’s trustee in bankruptcy, if any, gives
notice of its intent to assume the Subcontract and provides adequate assurance
of its ability to perform hereunder, this Subcontract shall not be terminated
but shall be subject to the provisions of Section 8A and 8B.
Contractor, while awaiting the decision of the Subcontractor or its
trustee to reject or to assume the Subcontract and to provide adequate
assurance of its ability to perform, may avail itself of such remedies under
this Section 8 as are reasonably necessary to comply with Contractor’s
obligations under the Prime Contract.
Metropolitan Engineering, Consulting & Forensics
(MECF)
Providing
Competent, Expert and Objective Investigative Engineering and Consulting
Services
P.O. Box
520
Tenafly,
NJ 07670-0520
Tel.:
(973) 897-8162
Fax:
(973) 810-0440
E-mail:
metroforensics@gmail.com
Web
pages: https://sites.google.com/site/metropolitanforensics/
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