Traditionally,
the owner of a construction project could not terminate the general
contractor, and the general contractor could not terminate a subcontractor,
without cause. A termination without cause was treated as a breach
of contract, sometimes subjecting the owner or general contractor
to damages beyond what they anticipated paying under the contract.
Many years ago, however, the federal government introduced the
concept of "termination for convenience," under which
the government could terminate a contract without cause so long
as it acted in good faith. In that circumstance, the contractor
was entitled to recover some lost profit but generally was not
entitled to recover the full measure of damages for breach of
contract.
More recently,
the concept of termination for convenience has gained acceptance
in private contracts. In fact, the concept of termination for
convenience is becoming relatively commonplace, as demonstrated
by the most recent version of the AIA form contracts. For example,
the AIA A201-1997 form of general conditions, which governs most
AIA form contracts and is probably the most common form of general
conditions used in private construction, now includes paragraph
14.4.1, which provides that:
The owner
may, at any time, terminate the contract for the owner's convenience
and without cause.
Section 14.4.2
of the A201 form provides that upon termination for convenience,
the contractor must cease operations as directed by the owner;
take any actions necessary (or that the owner may direct) for
the protection and preservation of the work; and, except for work
directed to be performed prior to the effective date of termination,
terminate all existing subcontracts and purchase orders and enter
into no further subcontracts and purchase orders.
Thus, many
owners (and general contractors) now have the option to terminate
their contractors for convenience. But whether a termination for
convenience makes sense depends on the circumstances. Many factors
come into play. An owner or general contractor considering termination
for convenience should consider at least some of the following
questions:
1. Does
termination make sense?
2. If so, to what extent does cause exist for a default termination?
3. Even if cause for a default termination arguably exists,
will it result in an unnecessary, protracted and expensive legal
battle over cause?
4. What are the costs of terminating for convenience as compared
with the costs of terminating for cause?
I. THE
TERMINATION DETERMINATION
Obviously,
the paramount consideration in deciding whether to terminate either
for convenience or for cause is the question of termination itself.
If a project has lost funding or otherwise is not going to move
forward, termination for convenience almost always makes sense
and in many cases cause for a default termination may not exist
at all. More commonly, however, the owner or general contractor
considers termination when the project, or some portion of it,
is going badly. For example, the project schedule may have slipped,
or the performance may be unsatisfactory.
Of course,
a project that has gone bad can be turned around, but it is often
the case that when serious problems begin to occur with regularity
on a project, they often persist throughout the life of the project.
On the other hand, terminating a project mid?course makes it difficult,
if not impossible, to maintain the schedule and to preserve the
original contract price. Such a termination can also result in
liens or other claims by subcontractors which the owner may need
to satisfy. Ultimately, the owner (or general contractor) must
decide whether it is better off toughing it out and completing
the project with the original contractor, albeit subject to delays
and performance deficiencies and/or other problems, or whether
the project is so far gone that it makes more sense to start afresh
midstream.
These are
not necessarily easy calls to make. They are essentially business
decisions, not legal decisions. For the purposes of this article,
we will assume that the owner (or general contractor) is dissatisfied
with the contractor's performance and has decided that termination
makes sense.
II. DOES
CAUSE EXIST?
Once the decision
to terminate is made, the owner (or general contractor) should
carefully consider whether cause exists. Not every contract will
define what constitutes cause. The AIA A201 general conditions
provide some guidance and a good example of what may qualify as
cause. Section 14.2 of the A201 spells out the standards for termination
for cause:
The owner
may terminate the contract if the contractor:
1. persistently or repeatedly refuses or fails to supply enough
properly skilled workers or proper materials;
2. fails to make payment to contractors for materials or labor
in accordance with the respective agreements between the contractor
and the subcontractors;
3. persistently disregards laws ordinances, or rules, regulations
or orders of a public authority having jurisdiction; or
4. otherwise is guilty of substantial breach of a provision of
the contract documents.
These are
fairly obvious categories. Failure to properly staff the job or
failure to use the proper materials should constitute cause under
any contract. Failure to make payments to subcontractors such
that the job is subjected to lien or bond claims likewise should
constitute cause, although that may be somewhat debatable if it
is not spelled out specifically in the contract. Disregard for
laws, ordinances or rules of public authorities should not be
controversial, although it is perhaps somewhat nebulous. Committing
a substantial breach of a provision of the contract documents
is not particularly defined but presumably includes such things
as substantial schedule slippage, failure to complete the work
in a workmanlike manner and similar blatant breaches of contract.
At least under
the AIA documents, the owner may not unilaterally declare cause
sufficient to terminate the contract. Rather, and presumably to
prevent abuse by the owner, prior to terminating for cause the
architect must certify that sufficient cause exists to justify
termination. Sometimes the architect is reluctant to certify that
sufficient cause exists to justify termination. Moreover, it is
not always a clear-cut call. If it is a clear-cut call, it is
probably advantageous to terminate for cause. For example, if
the project has slipped into delays from which the contractor
can make no reasonable recovery, and those delays significantly
impact the project, cause probably exists and the architect should
so certify.
There are
multiple advantages to terminating for cause. For example, under
the A201 general conditions, when an owner terminates for cause,
the owner may take possession of the site and of all materials,
equipment, tools and construction equipment and machinery owned
by the contractor necessary to complete the project. Moreover,
in a termination for cause the owner may assume the subcontracts
and force the subcontractors to perform. And finally, in a termination
for cause the owner need not pay the contractor anything more
until the work is finished and the owner may finish the work by
whatever reasonable method is expedient.
At the end
of the day, if the costs and damages caused by a proper termination
for cause exceed the unpaid balance on the original contract,
the contractor must pay the difference to the owner. In other
words, at least under the A201, in a termination for cause the
owner is entitled to back charge in the amounts by which completion
of the job exceeds the original contract amount. None of these
favorable remedies exist in a termination for convenience. At
the same time, owners (and general contractors) must recognize
that contractors (and their sureties) rarely accept a termination
for cause without a fight.
III. IS
THE FIGHT OVER CAUSE WORTH IT?
The question
of whether cause exists is largely factual in nature. Of course,
there may be legal disputes as to whether certain conduct can
constitute cause, but by and large the disputes revolve around
factual issues such as whether the project truly is irreparably
delayed, who is responsible for delays, whether work is genuinely
faulty, whether faults with the project relate to defective design
specifications and/or plans, and a whole host of similar issues.
Moreover,
there is generally a cure period (often seven days) during which
the contractor may take curative steps. This is another possible
point of dispute. First, given a contractor's history on the job,
the owner may be reluctant to allow the contractor to cure and
continue. Second, there may be very legitimate questions as to
whether the contractor can cure, or whether it has taken the necessary
steps to cure.
The problem
is that it is costly and consumes valuable management time to
fight these disputes over cause. Again, in some circumstances,
cause will be clear-cut, but more often than not it is not. In
the typical construction dispute, there are a myriad of small
and large issues that combine together from the perspective of
the owner (or the general contractor) to constitute cause. Each
of these individual issues provides fertile ground for dispute.
Imagine, for example, a delay dispute involving 50 separate items,
perhaps no one of which is substantial by itself, but which in
combination add up to substantial delay. Each of the 50 items
might be hotly disputed by the parties. Properly preparing for
such a dispute may, in effect, require a virtual trial within
a trial of each disputed item as part of the overall trial or
arbitration. This takes substantial lawyering time (translation:
cost) and substantial management time which may detract from the
completion of the project or subsequent projects.
Depending
on the costs, it may be cost prohibitive to fight over all of
those individual issues. The dispute also may raise risk factors
to unacceptable levels. For example, what if the owner prevails
on 50% of the issues - does that total add up to sufficient delay
or other problems to constitute cause? Do the potential upsides
outweigh the likely cost of the dispute, or is the risk of coming
up empty to great in light of the likely costs?
These are
fundamental issues to consider. The owner (or general contractor)
must carefully consider these costs in determining whether to
terminate for cause. Of course, these issues are largely non-existent
in a termination for convenience, and sometimes it will be more
cost effective for the owner (or general contractor) to cut its
losses by doing a termination for convenience.
IV. THE
COST OF TERMINATION FOR CONVENIENCE
Obviously,
there are advantages, but also some substantial costs to a termination
for cause. While a termination for convenience eliminates many
of the disputes and therefore many of the costs associated with
a termination for cause, termination for convenience carries its
own costs which need to be factored into the analysis. While other
contracts may differ from the A201 with respect to termination
for convenience, the A201 represents the most common set of general
conditions in private contracts and thus is a fair point for analysis.
First, under
the A201, when an owner (or general contractor) terminates for
convenience, it does not have the right to assume the subcontracts.
This means that unpaid subcontractors may have lien rights to
which the owner has little or no defense. In other words, the
owner may be required to pay subcontractors even though it may
not entirely be satisfied with their work (of course, there is
room for dispute in this arena, but the owner typically occupies
an unfavorable position when lien rights are asserted). Moreover,
the owner is in no position to force the subcontractors to complete
their work. More often than not this results in the subcontractor's
charging more for their part of the work, resulting in higher
project costs.
Second, under
the A201's version of a termination for convenience, the owner
is required to pay the contractor for work executed (obviously
subject to offsets for work that was not properly performed),
termination costs, and reasonable overhead and profit on the work
not completed. While the owner may have some offsets to apply
against the work yet to be completed, most often in a termination
for convenience the owner will end up paying the contractor something
on top of what must be paid for the work completed to date. Moreover,
to the extent offsets are disputed, termination for convenience
may result in the same sorts of disputes that arise under a termination
for cause. Generally, however, these disputes are more limited
in scope and less expensive to defend.
Third, unlike
terminations for cause, if the project costs more to complete
than the original contract amount, there is no right of back charge
against the contractor.
These costs
may lead one to legitimately question whether termination for
convenience under the A201 is any better for the owner than breaching
the contract was under the old rules that did not permit a termination
except for cause. Of course, the answer is at least partly in
the eyes of the beholder. Without question, there is convenience
in avoiding the costs and distractions of a dispute over cause.
And if the costs of the A201 termination for convenience seem
too high, the owner can always modify those terms to something
more palatable before signing the contract.
V. ULTIMATELY,
THIS IS A BUSINESS DECISION
Ultimately,
the decision to terminate for convenience as opposed to terminate
for cause is a business decision. Termination for convenience
in large part allows the owner to avoid getting mired in costly
and time-consuming disputes over issues of cause. Frequently,
the owner (or general contractor) will be miles ahead in an economic
sense by avoiding these disputes and their associated costs. On
the other hand, an owner (or general contractor) must guard against
developing a reputation as a pushover in disputes. When cause
is clear-cut, it usually makes good business sense to terminate
for cause. It is only when questions of cause are less obvious,
as they very often are, that an owner should consider termination
for convenience.
At the end
of the day, the owner (or general contractor) must do something
of a cost/benefit analysis comparing the upsides and downsides
of termination for cause against termination for convenience,
and make a business decision as to which course of action to pursue.
In either event, a careful review of the contract provisions is
required.
Kevin
Bridston is a partner in Holland & Hart LLP's Construction
and Real Estate Litigation Group.
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