I’ve recently been asked to address the question of a contractor’s right to terminate a contract in the AIA A201-2007 as well as two customized sets of general conditions that were being negotiated by clients for new, ground-up, vertical construction projects. Each contract I was given to review dealt with this issue in different ways.
The first contract had no termination clause whatsoever for either the owner or the contractor. In that situation, one must assume the termination rights and procedures are implied within the contract and controlled by common law. The second contract was modified by someone who had used it for a previous project and contained a highly detailed and well thought-out termination provision that contained multiple sections providing for severally scenarios and specific time-frames whereby the contractor could invoke its right to terminate the contract. However, the contract was silent as to the amounts owed to the contractor from the owner upon such a termination. The third contract had a detailed termination provision for the owner but nothing for the contractor.
These contracts bring to mind the question of contract termination rights for a contractor. In my representation of both contractors and owners, I have to look at this issue from both perspectives. In general, I view the right to terminate a contract as a mutual right provided to protect both parties in the event of the other’s material breach or default. However, in my opinion, it’s far more important to provide a detailed termination clause for owners than for contractors. Part of the reason for this opinion stems from surety defenses and owner protections on jobs where a performance bond is in place. A more detailed discussion of those concerns will be reserved for a later post.
For a contractor, the most important owner obligation in a contract is to provide payment for work performed. A failure by an owner to meet this basic obligation should provide the contractor with a right to terminate the project. If the owner has failed to pay for core-contract work, as opposed to changes or disputed extra work items and scope, the contractor may have a problem with an undercapitalized or otherwise financially distressed owner. In that instance, the contractor needs to consider suspension or termination. Another essential obligation owed to the contractor by an owner is not to interfere with or otherwise impede the contractor’s progress in performing its work. Suspending work, interfering with means and methods, dictating pace, or impeding progress will erode the contractor’s profits and burden the project such that it may interfere with the contractor’s ability to perform other work and other jobs. A times, these defaults can be overcome with change orders providing additional payment for lost productivity and owner interference claims.
So, getting back to the basic question of a contractor’s termination rights in a contract — what clause is most efficient and effective to adequately protect a contractor’s interests? A simple clause that provides the contractor the right to terminate the contract in the event of an owner default is really all that is needed. Simple language giving the contractor the right to terminate upon an uncured owner default is effective and efficient. In the clause, a provision for notice to cure and intent to terminate is essential to avoid an abandonment or wrongful termination by an owner. The contract will, or should, address owner obligations to pay for work, to allow access to the jobsite, not to delay the contractor’s progress, not to interfere with the contractor’s means and methods, and to pay for extra work or claims as they arise. If the termination clause is written simply, but clearly, and references these obligation contained elsewhere in the contract, a breach of these clauses by an owner can give rise to termination by the contractor.
Specifying continuing payment obligations or severity of the default is not necessary in my opinion, from a practical standpoint. In the event the contractor is contemplating termination, the likelihood of a negotiated settlement for profit on unperformed work, additional compensation for interference or extra work, and other claims is low. One presumes those discussion would have occurred prior to the issuance of a notice to cure by the contractor and that those discussions failed to resolve the issues. In a situation where a contractor needs to terminate the contract, the contractor is generally facing two equally unattractive options, walking away from a job and the associated losses or engaging in a post-termination claims process to try and recover the damages incurred that led to the decision to terminate.
The goal of the termination clause is to allow a contractor a way out of a contract when it finds itself dealing with an owner that fails to honor its contractual obligations. The clause should protect the contractor’s rights and put it in a position to cut the contractual bonds while leaving it in a healthy enough position to make the choice of walking away or bringing a claim. This final decision is a practical one that must take into account both the contractor’s financial health as well as the likelihood of recovery from the owner during or after the claims process depending on the owner’s own financial health and other considerations.
In drafting contract documents, keep these considerations in mind and provide a right to terminate, if needed. The issue should not be ignored based upon hope that it won’t be needed, nor should it be overly complicated. Remember, a termination provision is a provision and right or last resort. In both its drafting and invocation, it should be treated as such.