Want to Terminate your Construction Contract? Take Care… It Could Backfire

Construction Litigation

So you’ve hit that point where you’re sick to death of dealing with the other party’s games, and you’re ready to pull the termination trigger.

Before you do, you need to be absolutely sure that you’re in a solid position to terminate the contract.

Failing to terminate a construction contract properly can drastically affect your entitlements and your legal position, and can actually leave you vulnerable to a claim by the other party.

The Usual Principles of Terminating Contracts

Below we deal with terminating contracts using the formula in the Australian Standard. However, while following that process might be normal, your common law rights of termination still exist and it’s important to understand how they work.

What does this mean? It means that a construction contract can be terminated even without strictly following the process it might have laid out in its terms.

The only exception here is if the contract clearly and expressly excludes your common law rights of termination, which is not usually the case.

The basic common law rights of termination are fairly straightforward:

  1. There must be a breach of a fundamental term of the contract;
  2. You must clearly terminate the contract following that breach.

As you’d expect though, despite this deceptively simple statement, most people follow the process in the Contract. This is because termination under the process in the contract is normally clearer and less contentious than relying on the common law position.

Because each contract is unique, fully understanding your contract and how it interacts (if at all) with your ordinary rights of termination is an essential starting point.

Termination under Australian Standards contracts

The majority of standard contracts, including the Australian Standards building contracts, contain a formal process for the parties to follow which can trigger a right to terminate.

The process exists to minimise doubt and dispute about whether or not a party had a right to terminate. The process does not, of course, remove the chance of argument entirely.

The more popular Australian Standards contracts ordinarily contain a procedure where a principal or head contractor, in the event of a major breach, sends a notice to the contractor or sub-contract to “show cause”.

Usually the contract itself will set out what’s required in a show cause notice. However, by and large, the notice will need to clearly state what the problem is and call upon the other party to either fix it or say how they are going to fix it in a specified period of time.

 ‘Show cause’ notice must comply

In order to trigger the right of termination, a show cause notice must be validly issued under the contract.

However, the Courts have taken a pragmatic view of in this area, not always requiring technically strict compliance with the provisions but rather adopting a common sense business approach having regard to the context.

What if you Don’t ‘show cause’

Having received a show cause notice the contractor needs to respond to it to the principal’s reasonable satisfaction. Depending on the context, that might include a plan for rectification, a plan to get back onto the timetable, and details about how and when that’s going to be achieved.

If the contractor fails to respond or the response is inadequate, the Principal may, by written notice, either: take out of the Contractor’s hands the whole or part of the work remaining and suspend payment; or terminating the contract.

What if the Principal is at Fault?

The standards operate similarly if it’s the Principal in substantial breach.

The main difference (at least, in some of the AS contracts) is that the Contractor must first suspend the works before it’s entitled to terminate.

Determining whether a party in substantial breach has ‘shown cause’

As we’ve mentioned, once a show cause notice is issued the party allegedly at fault has to respond to the notice.

Once you receive that response, your obligation is to give proper and honest consideration to whether the other party has, in fact, shown cause in response to the notice issued.

That said, Courts have upheld decisions to terminate even where that decision was unreasonable or purely self-interested by the innocent party.

This formal procedure is replicated in other variants of the AS4000 suite of contracts such as the AS 4901-1998 Subcontract conditions and the AS 4902-2000 General conditions of contract for design and construct. Similar procedures are also found in other standard form building contracts.

What If you Terminate Incorrectly?

What happens if you try to terminate but stuff it up in some way?

Perhaps you don’t issue a valid show cause notice, or perhaps the issue wasn’t considered a substantial breach?  And then, despite that, you go ahead and issue a termination notice.

The main benefits to terminating a contract when the other party is at fault are:

  1. Obviously, getting another party in to do the work properly (or getting yourself out of a contract that has become unprofitable);
  2. The ability to claim damages against the other party.

Failing to terminate properly can kill off both of these benefits.

How’s that? Well, if you try to terminate but don’t do it right, it’s generally regarded as a “wrongful repudiation”. That is, you’ve indicated that you don’t intend to be bound by the contract anymore.

In response to that, the other party can “affirm” the contract – that is, keep you bound to it – or they can terminate it themselves.

If they decide to terminate, it’s actually THEM who get to claim damages and not you.

This can put contractors in a tough situation. Say, for example, a Principal continually delays giving instructions or appears to be farming out work inside your scope to other contractors. Have they repudiated or not? Should you terminate or not?

Making the wrong decision can leave you not only unable to claim your losses back, but vulnerable to claims being made against you.

Damages for wrongful termination

So everything’s gone wrong – you tried to terminate and didn’t get it right, then the other party accepted your repudiation and terminated the contract themselves.

What can they claim against you?

A principal might, for example, try to claim the costs of getting a new contractor on the job (including tendering costs), the additional costs of that contractor coming up to speed, and potentially losses resulting from the project delay (for example, interest on finance).

A contractor might be able to claim not only for work done, but also for profits that they will no longer achieve on the job having been wrongly terminated. They might claim for staff costs and remobilisation costs, for equipment leases that had to be broken early, or many other categories.

In each case, all parties have a duty to take reasonable steps to mitigate (that is, minimise) their losses.

It’s also important to check whether your contract has provisions that affect your ability to claim for certain types of loss.

Practical Advice on Terminating a Construction Contract

Sometimes, of course, you have to terminate despite the risks.

If you’re in that situation here are our practical tips and questions to ask along the way:

  1. Know your contract – what does it say about termination, about losses, and about the situation that you are faced with?
  2. Why do you want to terminate the contract? What is it that has caused you to think that termination is the best option?
  3. Are there legal grounds to terminate either under the contract or at common law (you might need advice on this)?
  4. What process does your contract set out for termination, if any?
  5. What are your risks if something goes wrong and the other party claims you have wrongfully terminated?
  6. Are there other realistic options to termination that have lower risks or exposure which can give you a palatable outcome?

As always, we’re here to help you – if you’re faced with a termination problem, don’t hesitate to get in touch to work through the issues.

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