Common issues with termination of construction contracts
One noticeable consequence of the COVID-19 pandemic has been an increase in the number of disputes relating to the termination of construction contracts.
In May 2020 the Construction Leadership Council published ‘Best Practice Guidance’ for dealing with contractual issues caused by COVID-19. The guidance aimed to encourage collaborative behaviour, warning that without fair and reasonable administration of contracts, COVID-19 could have a significant and detrimental effect on the construction industry.
One suggestion was that “The parties should consider agreeing to waive any relevant termination triggers in the contract”, for example, if it is necessarily to temporarily suspend the works due to COVID-19.
In some cases we have indeed seen commendable examples of collaboration. However, we have also seen a significant rise in disputes, as parties seek to escape from contracts in light of new and unforeseen commercial pressures.
Ways to terminate
There are a number of ways in which a contract may be prematurely brought to an end. The most common are:
If the parties are able to agree commercial terms, then the contract can be terminated by mutual consent. This enables both parties to avoid the cost and uncertainty of a legal dispute, providing the agreed terms are carefully documented.
Consultant appointments usually include a right for one or both parties to terminate at will, without giving a reason (also known as termination for convenience). In contrast, termination rights under building contracts are usually much more limited, reflecting the greater investment required by contractors when taking on projects.
Insolvency almost invariably gives rise to a contractual right to immediately terminate, although it is important to check the specific definition of insolvency in the relevant contract. For example, it may be necessary to wait until a formal winding-up order has been made.
If the contractor has completely abandoned the site, this is also likely to provide a relatively straightforward basis for termination (e.g. JCT clause 18.104.22.168), although it may be necessary to give a warning notice first, and allow the contractor a period of time rectify the default.
Failure to pay may entitle the contractor to terminate, although the contractor also be careful to strictly follow the contractual notice requirements before suspending or terminating, to avoid inadvertently breaching the contract themselves.
In recent months, the contractual right to terminate following a defined period of suspension has attracted attention as, for example, either party might be entitled to terminate if the works are suspended for two months due to a force majeure event. This could arguably include COVID-19, although the Government’s revised guidance for construction sites states that work may continue, if done safely.
Other contractual grounds for termination can be more controversial. Clause 22.214.171.124 of the JCT Design and Build Contract 2016 and JCT Standard Building Contract 2016 states that the Employer can terminate if:
(a) the Employer gives notice that the Contractor is failing to proceed “regularly and diligently” with the works; and
(b) the default is continued for 14 days from receipt of that notice.
The leading case is West Faulkner Associations v London Borough of Newham (1994) 71 BLR 1, in which the Court of Appeal held that:
“Taken together, the obligation upon the contractor is essentially to proceed continuously, industriously and efficiently with appropriate physical resources so as to progress the works steadily towards completion substantially in accordance with the contractual requirements as to time, sequence and quality of works…”
Keating on Construction Contracts (10th Ed) suggests at para. 20-085 that:
“This construction is very wide and would appear to have the consequence that almost any failure by the Contractor to comply with a major contractual requirement would amount to a failure to proceed regularly and diligently, thereby putting the Contractor at risk of a determination notice under Cl.126.96.36.199.”
Nevertheless, the question of whether a contractor is failing to proceed regularly and diligently with the works is a subjective issue to be decided by a court or adjudicator, and there is usually a considerable element of risk when relying on this ground. It is insufficient that the contractor is simply running late, as liquidated damages provide a remedy for delay. An unjustified contractual termination might be itself deemed a repudiatory breach by the employer.
There is a similarly subjective right to terminate under the JCT sub-contracts: following 10 days’ notice of default, the contractor may terminate if the sub-contractor “without reasonable cause fails to proceed with the Main Contract Works so that the reasonable progress of the Sub-Contract Works is seriously affected”
Time-permitting, an employer might be able to obtain some comfort in advance by seeking a declaration from an adjudicator prior to termination, although this would still risk a conflicting final determination by a court or arbitrator.
In addition to express contractual rights, every party has a common law right to terminate a contract on grounds of the most serious breach. A breach that gives rise to this right is known as a repudiatory breach. This includes:
(c) breach of a ‘condition’ i.e. a fundamental term whose every breach will trigger the right to terminate; or, more commonly
(d) breach of an ‘intermediate terms’ i.e. a term whose breach is only repudiatory if it deprives the aggrieved party of substantially all the benefit that was intended under the contract.
For example, a complete refusal to perform the contract by one party is likely to be a repudiatory breach. In contrast, mere delay by the contractor is unlikely to amount to a repudiation unless time has been made of the essence. Even failure to attend site for several days may be insufficient to evidence an intention by the contractor to repudiate his contractual obligations if, for example, he has retained some plant and equipment on site.
A repudiatory breach gives rise to a claim for damages, like any breach of contract. The innocent party can choose to whether treat the contract as discharged or affirm the contract and insist on performance.
While you need not accept the repudiation immediately, if you delay there is a risk that you will eventually be deemed to have affirmed the contract by your inaction and waived your right to terminate. You may therefore wish to protect your position by expressly reserving your rights. There is also a risk that the offending party will rectify its breach and thereby end any continuing right to accept the former repudiation.
Contracts may also be ended by illegality, mistake or frustration, although these are relatively rare in a construction context.
Assess whether the right to terminate is likely to have arisen – serving an unjustified notice of termination could itself be a repudiatory breach of contract, allowing the other party to sue for damages. A termination notice cannot be revoked once given. It is notoriously difficult to predict which party’s interpretation of the facts will be favoured by a court or adjudicator, whose ultimate judgment may turn on a clinical analysis of ill-tempered correspondence, hastily written in the heat of the moment. Therefore, before seizing an apparent opportunity to terminate a contract, you should consider your options and strategy carefully.
If relying on a contractual termination right, carefully check the notice provisions. For example, a JCT Standard Building Contract 2016 provides that:
- termination notices should be delivered by hand or sent by Recorded Signed for or Special Delivery Post; and
- notice of default should be given by the Architect/Contract Administrator whereas the subsequent notice of termination should be given by the Employer.
On or before termination, employers should:
- ensure that the appropriate insurance policies are in place, as the contractor’s insurance obligations are likely to end on termination of the building contract;
- secure the site as quickly as possible to prevent unpaid subcontractors and creditors removing plant, equipment and materials until title in the goods has been established;
- ensure the site is safe: when the employer regains control of the site from the contractor, the employer will owe a duty to lawful visitors to see that the site is safe for the purposes of their visit;
- the employer should also ensure that the works are adequately protected against damage following the removal of scaffolding, temporary roofing etc; and
- undertake an immediate audit of on-site plant, equipment and materials and a valuation of work done at the date of termination.