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Termination of Construction Contracts
From a legal perspective, choosing to terminate a construction contract can be an extremely risky course of action. Terminating parties often make basic mistakes which can lead to costly disputes. In this bulletin, we outline some of the key points that anyone considering terminating a construction contract should be aware of.
Almost all construction contracts contain provisions which permit termination for specified reasons. Most contracts (particularly standard form contracts) set out a detailed termination procedure, which generally entails the service of a “warning notice” identifying the breach and a further “termination notice” if the breach is not remedied.
Anyone wishing to terminate on contractual grounds must ensure they can prove that one of the reasons for termination set out in the contract has occurred. This is not always straightforward. For example, a “failure to proceed regularly and diligently” is a common ground for termination, but it is not easy to pinpoint exactly when this sort of failure has occurred. A party wishing to terminate on this ground will need to carry out a detailed assessment of the progress of the works to identify whether there really has been a breach.
Another important issue which often arises following termination of a contract on contractual grounds is whether the correct procedure has been followed. If the terminating party fails to comply fully with the termination procedure set out in the contract, this can result in the terminating party being in breach of contract himself and having to pay damages to the terminated party. If you choose to terminate a contract on contractual grounds, it is crucial to ensure you follow the procedure outlined in the contract to the letter. Remember to check what notices must be served, when they must be served, who they must be sent to and the required method of service.
Termination for Repudiatory Breach
The parties to a contract will usually have a common law right to terminate the contract which exists alongside contractual termination rights (although in some cases the contract will contain wording which excludes common law rights). A common law right of termination arises when a repudiatory breach of contract has been committed.
A repudiatory breach of contract is essentially a very serious breach which demonstrates that the party in breach clearly intends to abandon performance of the contract. An obvious example of this would be an employer preventing a contractor from entering the site. However, identifying a repudiatory breach of contract is not always straightforward. For example, a generally poor standard of workmanship might have serious consequences, but it is unlikely to be classed as a repudiatory breach. Occasional late payments could cause major cash-flow problems for the payee, but they will probably not amount to repudiatory breaches, particularly if past experience shows that payment is always made eventually.
A repudiatory breach does not automatically result in termination of the contract. The innocent party (i.e. the party who is not in breach) may choose to accept the repudiation (thereby bringing the contract to an end) or affirm the contract (allowing it to continue). Whether the contract is terminated or affirmed, the innocent party will be entitled to claim damages for the breach.
If the innocent party wishes to accept the repudiation and bring the contract to an end, the innocent party must do so quickly and avoid acting in a way which suggests they intend the contract to continue. It is very easy to accidentally affirm a contract by conduct. For example, if the innocent party allows the party in breach to continue working, this suggests the innocent party wishes the contract to continue. This is likely to result in the innocent party inadvertently losing its rights to accept the repudiatory breach and terminate the contract.
Repudiatory breach of contract is a very complex area of law. If you terminate a contract alleging repudiatory breach and it turns out that the guilty party’s breach was not actually repudiatory, you could be treated as being in repudiatory breach of contract yourself. This means it is often very difficult for parties who believe they may be the victim of a repudiatory breach to know how to proceed.
Innocent parties who consider they are a victim of a repudiatory breach but are unsure whether to terminate or affirm will need to clearly reserve their position whilst they decide what to do. However, the decision must be made quickly – it is possible to inadvertently affirm a contract simply by doing nothing for too long. In such cases it is essential to seek legal advice immediately.
Should You Terminate?
Notwithstanding that you might have a contractual and/or a common law right to terminate, termination of a contract should always be seen as a measure of last resort.
Before you begin to think seriously about terminating, you should ask yourself the following questions:
- Have you made the problem clear in writing?
- In cases of contractual termination, it is usually advisable to point out the breach in writing on at least one occasion before invoking the termination procedure. Suddenly terminating a contract out of the blue will almost inevitably result in a dispute.
- In addition, pointing the problem out at an early stage may result in it being resolved without the need for any further action.
- Have you got evidence?
- Evidence of the breach on which your decision to terminate is based is essential. The nature of the alleged breach will dictate what sort of evidence is required. It may even be necessary to seek independent advice on whether your evidence is sufficiently strong.
- What will the impact of termination be?
- Termination can have serious implications for the progress of the project. It is important to consider how that delay will be mitigated before you go ahead with the termination.
- It is worth bearing in mind that if the terminated party takes legal action, you may have to incur significant costs (and time) defending your position
- Do you have support from other members of the project team?
- A main contractor who terminates the employment of a key sub-contractor without the employer’s agreement may be looked upon unfavourably, particularly if that termination throws the whole project into delay. It is prudent to confirm that the other parties involved with the project support your position.
If the answer to any of these questions is in the negative, termination is unlikely to be the most appropriate course of action. Other ways of resolving the problem may need to be explored. However, even if you believe termination is the only way forward, it is always wise to confirm the position by taking legal advice.
This article contains information of general interest about current legal issues, but does not provide legal advice. It is prepared for the general information of our clients and other interested parties. This article should not be relied upon in any specific situation without appropriate legal advice. If you require legal advice on any of the issues raised in this article, please contact one of our specialist construction lawyers.