Construction projects are complex and risky endeavors. One of the major risks that entities must manage is the risk of default by one or more parties to the project — whether its failing to make timely progress on the project, failing to make payments, or simply failing to meet performance and quality standards.
When a default occurs, termination is a common remedy; however, to do it right, it’s important for all construction entities to understand the legal requirements and procedures for terminating a contract for default as well as the potential consequences.
This article discusses ways to mitigate the risk of default to avoid contract termination. It also covers practical tips when terminating for default from a legal and pragmatic perspective and concludes with a discussion on how and why you should involve the surety during the termination for default process.
Mitigating Defaults
Terminating a contract is a drastic step for an owner or GC to take when dealing with a GC or subcontractor’s performance issues. Although it’s a powerful option, it also leads to the expenditure of the owner or contractor’s time and resources and can impact future business relationships.
As such, here are some steps parties can take to mitigate the risk of default and potential termination.
Thoroughly Review & Understand the Contract Terms
Before the project begins, parties should carefully review the contract and all of its terms including payment schedule, performance standards, and default provisions. This helps ensure that the project is properly financed and the parties are aware of the risks and obligations involved.
Monitor the Project’s Progress
Parties should closely monitor the project’s progress to ensure that all parties are meeting their obligations and the project is on schedule. This can be done through regular site visits, progress reports, and schedule updates.
Address Issues as Soon as They Arise
If a party identifies any issues with the project or any party’s performance, then they should be addressed as soon as possible. This could involve communicating with the party in default, discussing the issue with the project manager (PM) or other stakeholders, or consulting with legal counsel.
When communicating with the party in default, attempt to leverage contract language to avoid continued deteriorating performance, such as citing to notice periods and/or providing forewarnings of potential termination. This reminder of the contract language may assist in resolving the performance issues.
Stay Abreast of Industry Trends & Legal Developments
Parties should stay informed on industry trends and legal developments that may impact the project. This can include changes in construction laws and regulations, new technologies, and best practices in project management.
Have a Contingency Plan
Default by a party may lead to termination or dispute, and thus, the contractor should have a well-thought-out and well-structured contingency plan that includes how to complete the work, how to secure funding, and how to proceed with legal actions, if necessary.
Keep Clear & Accurate Records
Parties should maintain clear and accurate records of all financial transactions, invoices, receipts, contracts, progress reports, and other documentation relating to the project.
For example, during contract negotiations, parties may have multiple versions of a subcontract with various “strikethroughs” or changes — be sure the parties agree on one full, complete, and final version of the contract and ensure that it is executed by each party. This can help demonstrate that the parties have fulfilled their obligations and can be used as evidence in the event of a dispute.
Tools for Terminating for Default
Notwithstanding the preceding mitigation tips, sometimes there is nothing a party can do to avoid another party from defaulting on its contractual obligations. In this situation, the upstream party, whether it’s the owner or GC, may be left with no choice but to terminate the contract.
The following is a breakdown of steps to take and things to keep in mind when terminating a lower stream contractor for default.
The Contract Obligations
From a legal perspective, follow the terms of the contract regarding notice and the opportunity to cure. Generally, in order for a termination for default to be valid, the nonbreaching party must have provided the breaching party with a written notice of default that specifies the nature of the default and provides a reasonable opportunity to cure it. This is also called a notice to cure or cure notice, which gives the defaulting party a chance to rectify the issue and continue performing its obligations.
Additionally, the nonbreaching party should also provide the breaching party with a notice of termination, stating that the contract will be terminated if the default is not cured within a certain period of time. The specific timeframe and requirements to cure varies by jurisdiction and the terms of each specific contract, but it’s important to strictly adhere to the procedure laid out in the contract as well as the law of the jurisdiction.
Consequences for Wrongful Termination
The consequences for a wrongful termination include potentially being liable to the lower stream party for its lost profits, expenses and costs associated with the contract, lost business opportunities or reputational harm, and attorney fees and costs.
As a note, however, contracts may specifically limit damages that may arise out of the contract at issue, such as not allowing consequential damages including lost business opportunities and reputational harm.