So you’ve been frustrated about issues on your construction project, and you’re at the point where you want to pull the trigger and terminate the contract.
Before you do, you need to be sure that you’re in a solid position to terminate.
Failing to terminate a construction contract properly can drastically affect your entitlements and legal position, and can leave you exposed to a claim by the other party.
Basically, if you don’t get it right you can find yourself unexpectedly on the back foot.
Because each contract is unique, understanding your contract and the specific terms which entitle you to terminate is always going to be your starting point.
The benefit to terminating pursuant to the terms of the contract (as opposed to finding some alternative method outside the contract) is that the process is generally clearer and more straightforward.
In this article we’re going to work through the process used in a lot of common construction contracts (though, of course, you always need to check your own contract for the details!).
Process for Terminating a Construction Contract
Most standard contracts, including the Australian Standards building contracts, contain a formal process for the parties to follow if they want to terminate the contract.
The process exists to minimise doubt about whether a party had the right to terminate. The process does not, of course, remove the chance of argument entirely.
The more popular Australian Standards ordinarily contain a procedure where a Principal (or Head Contractor), in the event of a substantial breach, sends a notice to the Contractor (or Subcontractor) to “show cause”.
Most standard construction contracts also, helpfully, contain a non-exhaustive list of what may constitute a substantial breach.
Usually, the contract itself will set out what’s required in a show cause notice.
‘Show cause’ notice must be compliant
To trigger your right of termination, a show cause notice must be validly issued under the contract.
In some cases, the Courts have taken a pragmatic view in this area. A Court has not always required technically strict compliance with termination provisions but rather adopted a ‘common-sense’ business approach – that doesn’t necessarily require the detailed particulars.
But while some Courts have adopted this pragmatic approach, it has not been embraced universally. So, if you’re terminating a contract, your best (and safest) bet is to strictly follow the terms of your contract and ensure any notices are produced, and sent, in compliance with the requirements of the contract itself.
By and large, the Principal’s show cause notice must be sufficiently detailed so that the Contractor is able to understand the breach alleged against it. The notice must also typically call upon the Contractor to remedy its breach (if possible).
What if the Contractor doesn’t show cause?
After receiving a show cause notice the Contractor needs to respond to it in the form, time and manner prescribed.
Of course in many cases the notice to show cause comes after a number of other discussions, and is part of a larger dispute.
A Contractor might therefore think there is no merit in the show cause notice, or dispute the underlying facts. In that case, the Contractor’s response to the notice should:
- Identify the extent to which it believes the Principal has failed to meet the procedural requirements for issuing a show cause notice.
- Respond to the allegations of fact, particularly the extent to which the Contractor disagrees with the assertions of fact.
- Explain why the Contractor disagrees with those assertions of fact.
- Further ‘show cause’ as to why the Principal should not exercise any right of termination.
- To the extent that the Contractor has been called upon to remedy its breach and is prepared to take action in that regard, should state what it intends to do.
If the Contractor fails to respond or the response is inadequate, the Principal may usually, by written notice, either (subject of course to the terms of the contract itself):
- take out of the Contractor’s hands the whole or part of the work remaining and suspend payment; or
- terminate the contract.
Parties’ post-termination rights and obligations
So what happens if a Contractor’s response does not satisfy the Principal under the terms of the Contract, and the Principal has terminated the contract or taken the work out of the Contractor’s hands?
What comes next?
Principal’s rights
If works are taken out of the Contractor’s hands, the Principal can typically complete such work and may – if the contract allows for it – use materials, equipment and other things intended for work under the contract.
In doing this, the Principal may also, without payment of compensation to the Contractor, take possession of and use construction plant and design documents, and contract with consultants and Subcontractors.
Following take out, if the Contractor is indebted to the Principal, the Principal can often retain plant on or near the site, or other things it has taken until the debt is satisfied (and sometimes even sell the plant if the debt is not paid).
If the Principal decided to terminate, the Principal can recover loss suffered by them to put them in a position they would have been in had the breach of contract not been committed.
Contractor’s rights
A Contractor’s rights may look different depending on what the termination clause in the contract looks like.
A Contractor-favoured contract may include a clause entitling the Contractor to submit a progress claim if the contract is terminated.
A Principal-favoured contract may include a clause stating that the Contractor will not have any equitable claim if the contract is terminated.
Otherwise, the Contractor is often left waiting until the works are complete for any sense of what, if anything, it might be paid out of moneys owed or securities held.
Parties’ obligations generally
For most contracts, termination results in all parties being relieved of performing future obligations under the contract.
However, in some cases, certain clauses do continue to operate post-termination, such as:
- confidentiality obligations;
- provision of documentation;
- dispute resolution processes; or
- limitation of liability or an indemnity.
What If you Terminate Incorrectly?
What happens if you, as the Principal against the Head Contractor (or the Head Contractor against a Subcontractor) try to terminate but fail to follow the proper steps?
Perhaps you don’t issue a valid show cause notice, or perhaps the issue wasn’t properly a substantial breach, and you go ahead and issue a termination notice anyway.
Failing to terminate properly can kill off the key benefits you were seeking from terminating the contract in the first place.
How so?
Well, if you try to terminate but don’t do it right, it’s generally regarded as a “repudiation” of the contract.
The consequences of a wrongful repudiation are that the Contractor can:
- “affirm” the contract – that is, keep you bound to it; or
- terminate it themselves and claim their resultant loss (e.g. loss of anticipated profit on the project)
So in short, failing to follow the correct process under the contract can not only impact your claims against the Contractor, but also potentially leave you vulnerable to claims against you.
Conclusion
The above is a snapshot of the usual back and forth that might lead to terminating a construction contract.
Of course, the real world is generally a bit more complicated that this overview might suggest, and we would never recommend you terminate without getting advice about it first.
If you have any projects needing advice on termination – either from the viewpoint of the Principal or Contractor – then please don’t hesitate to get in touch.
