HOW TO MANAGE CONSTRUCTION DISPUTES TO MINIMIZE SURETY AND CONSTRUCTION CLAIMS. PART 8: SUSPENSION, TERMINATION AND DEFAULT CLAIMS

Introduction

Construction is a business fraught with risk. Disputes over even the smallest of issues can quickly escalate, with crippling consequences to the project and the parties. The cost to resolve a construction dispute can cost as much as the amount in dispute if a matter is not managed properly. Over the years, the construction industry has developed various methods of contractually allocating the risk of project delay and disruption. Some of these methods include liquidated damages provisions, "no damages for delay" clauses, mutual waivers of consequential damages, provisions that limit liability, claims notice provisions, “waiver of damages clauses”, acceleration clauses, “time is of the essence” clauses, change order clauses, and provisions addressing responsibility for the adequacy of the construction plans and specifications. Parties frequently litigate the sufficiency of these risk-shifting efforts in conjunction with the underlying merits of differing site conditions, change order, delay, disruption and many other disputes. We use our renowned "Lessons Learned" methodology to perform loss control and risk management services.

The Most Frequently-Encountered Construction Claims & Disputes

In Part 1 of our series of how to manage construction disputes to minimize surety and construction claims, we addressed the construction delay claims and the methods typically used to analyze them.

We indicated there that the most frequently encountered claims include:

1. Construction Delay Claims

2. Disruption and Loss of Labor Productivity Claims

3. Design and Construction Defects Claims

4. Force Majeure Claims

5. Acceleration or Compression of the Schedule Claims

6. Suspension, Termination and Default Claims

7. Differing Site Conditions Claims

8. Change Order and Extra Work Claims

9. Cost Overrun Claims

10. Unacceptable Workmanship or Substituted Material Claims

11. Non-payment Claims (stop notice (or Notice to Withhold) claims, mechanics’ lien (only for private construction projects) and payment bond claims)

Part 8 of this series discusses item 6 above: Suspension, Termination and Default Claims.

Suspension and Termination Claims

Suspension occurs on a construction project when an owner instructs a contractor to temporarily stop work on all or a portion of the project. Termination occurs when an owner instructs a contractor to permanently stop the performance of work and leave the site. Construction contracts typically specify each party’s rights, obligations, and remedies for suspension and termination. Therefore, it is advisable for all parties to thoroughly review, understand, and follow the contract provisions relative to suspension and termination. Suspension and termination on construction projects often result in claims and disputes; therefore, the decision to proceed with either option should not be taken lightly.

Common Issues Encountered Relative to Suspension and Termination Claims

Contracts/projects may be suspended for a number of reasons. Contractors may submit suspension-related claims if the duration of the suspension is long enough to delay the project or impact progress. Therefore, suspension-related claims often require a schedule delay analysis to evaluate the impact to the project’s critical path. Other contractor claims may include, but are not limited to, the following issues:

· Standby or idle costs

· Demobilization/remobilization costs

· Other actual costs incurred due to the suspension

On longer suspensions, there may be a provision for compensation to the contractor for demobilizing from the site and later remobilizing to avoid the project owner having to continuously pay for labor and equipment which is not being used. In addition, if the owner’s actions do not allow the work to proceed but the suspension clause has not been invoked, the contractor may claim for constructive suspension. A suspension can also be implemented if there is a dispute between the contractor and the owner, and a termination is being considered. Additionally, some contracts contain provisions that terminate the contract if the suspension lasts longer than the specified duration.

Construction Contracts Termination

Construction and design contracts increasingly contain provisions giving one or both parties the power to terminate the contract. A termination is the decision to stop performance of the contract before it is completed. Termination is a right granted the owner or general contractor and does not have a parallel right for the contractor or subcontractor to "terminate" a contract. A contractor or subcontractor can "abandon" a contract upon breach by the owner or general contractor, but cannot "terminate" the contract. See M. T. Callahan, Termination of Construction and Design Contracts, Aspen Publishers, 2014.

There are two “types” of terminations:

(1) terminations for convenience, and

(2) terminations for default.

Normally, neither party to a contract may terminate a contract without becoming liable to the other party for all resultant damages, including lost profits and any consequential damages. Termination for convenience allows the owner/general contractor to stop the work for just about any reason without having to pay for anticipated profit or unperformed work. Termination for default, in contrast, allows the owner/general contractor to procure alternative performance at the contractor/sureties/subcontractors' expense.

A. Termination for Convenience

A termination for convenience clause affords the owner or general contractor the flexibility to alter its course, and eliminate unnecessary expenditures without repudiating its performance or materially breaching the contract. In absence of a termination for convenience clause, the owner or general contractor would have the right to terminate the contract, but could face the full consequence of breach of contract, including payment of anticipated profits on unperformed work.

Termination for convenience is so important to the federal government that even if the federal contract does not expressly reserve the government's right to terminate, courts will read that right into the contract by operation of law. See G. L. Christian & Associates v. U. S., 312 F.2d 418 (Ct. Cl. 1963). Today, termination for convenience clauses are also found in most commercial construction contracts, which gives owners and/or general contractors rights similar to those of the federal government.

There are four primary issues to remember when negotiating a termination for convenience clause.

· First, is the clause enforceable?

· Second, how do I invoke the clause?

· Third, if invoked, what are the parties' obligations under the clause, and

· Four, what compensation is the terminated party entitled to under the clause?

It is common for a termination for convenience clause to provide that if the right to terminate is exercised, the terminating party's liability is limited to the reasonable value of any material or labor furnished to the project up to the point of termination. An example of such a clause is set forth below:

The Contractor may, at its option, at any time, terminate the whole or part of this Agreement for the convenience of the Contractor. Subcontractor agrees that upon any such termination, the Subcontractor’s sole remedy, shall be payment of full value for all work properly performed or materials delivered, plus reasonable profit thereon, less all payments Subcontractor has previously received on account of such work performed. Subcontractor agrees to waive all claims for damages, including lost or anticipated profits, arising from or related to any such termination by Contractor.

Another termination for convenience clause in a subcontract may read as follows:

Upon three (3) calendar day's written notice to Subcontractor, Contractor may terminate this Subcontract in whole or in part for Contractor's convenience and/or at its option. Subcontractor's remedy for such convenience or optional termination is limited to the following: (1) payment pursuant to the terms of this Subcontract for all Work properly performed prior to termination; (2) partial payment for lump sum items of Work on the basis of the percent complete of such items at the time of termination; and (3) Subcontractor's reasonable close-out costs. In no event shall Subcontractor be entitled to any compensation for loss of anticipated profits or unallocated overhead on Work not performed. See Associated General Contractors of Washington Subcontract Form (2009).

Under this clause there is no obligation for the terminating party to compensate the terminated party for any profit that may have been included in the contract price. The subcontractor will lose the benefit of his bargain which is a legally cognizable right.

Many subcontractors may prefer not to run the risk of termination and potential loss of their profits, but will agree to a termination for convenience clause in order to get the job. That is a business decision that should be best made by the subcontractor. However, termination for convenience clauses may contain hidden risks involving much more than the potential of lost profits.

The unseen dangers of the termination for convenience clause lie in the subcontractor's obligations to suppliers and lower tier subcontractors once the contract has been terminated. The subcontractor may have ordered expensive equipment or materials that have been specifically designed for that particular project that is unusable elsewhere. Furthermore, specially fabricated materials may be on order at the time that the contract is terminated which cannot be canceled. In other words, the party whose contract has been terminated may be legally obligated to buy these items, but may have no one to whom the items can be sold. These dangers should be recognized and dealt with accordingly.

To prevent a terminated subcontractor from being left "holding the bag," there may be a couple of options which can be utilized. First, a provision may be inserted in the contract that makes the terminating party responsible for all cancellation charges and all consequential damages caused by the termination. In this way, the terminating party is responsible for all "non-cancelable" materials and equipment which were ordered in good faith in anticipation of their use on the project.

Some sample subcontract clauses are set forth below:

D. Termination For Convenience. Contractor has the right to terminate this Subcontract without cause and at Contractor's convenience upon five (5) days’ notice. Upon termination of this Subcontract for the Contractor’s convenience, Subcontractor will immediately cease performance of all Work and remove all of its tools, equipment and personnel from the Project site and Subcontractor will have no claim of any kind whatsoever against Contractor for breach of this Subcontract and Contractor will be liable only for the cost of the Subcontract Work actually completed in accordance with the Contract Documents, including reasonable overhead and profit on completed work by Subcontractor prior to termination, less all sums previously paid to Subcontractor and less all deductions made by Contractor pursuant to this Subcontract. In the event any termination by Contractor under Sections 8(A), (B), or (C) of this Subcontract is found to be improper or wrongful, then any such termination shall be deemed a termination for convenience under this Section 8(D) and Subcontractor’s recovery shall be limited to amounts due under this Section.

E. Suspension of the Subcontract Work by Owner. Should the Owner suspend, delay or interrupt the performance of the Prime Contract, or any part of which affects the Subcontract Work, then the Contractor shall so notify the Subcontractor in writing and Subcontractor shall immediately suspend, delay or interrupt that portion of the Subcontract Work as ordered by Contractor. Any claim by Subcontractor for any damages caused by said suspension of the Subcontract Work shall be subject to Section 5 of this Subcontract.

F. Termination by Owner. Should the Owner terminate the Prime Contract, or any part of which includes the Subcontract Work, the Contractor shall notify the Subcontractor and the Subcontractor shall immediately stop the Subcontract Work and follow the Contractor’s instructions concerning termination procedures. In the event that the Owner terminates the Prime Contract for the convenience of the Owner, then Subcontractor’s claim for any damages resulting from termination shall be subject to Section 5 of this Subcontract.

If that cannot be done, a subcontractor should try to include its own termination for convenience clause in any of its lower tier subcontracts or purchase orders related to that project. This can be accomplished by using appropriate "flow through" language in the subcontract or purchase order or by using an independent termination for convenience clause. If an independent clause is used, care should be taken to assure that there is no liability for lost profits and any other consequential damages. By the contractor or subcontractor using its own termination for convenience clause, the risk of termination will be shared by all parties involved.

There are additional limitations on an owner or general contractor's right to terminate for convenience. An owner and/or contractor cannot exercise a termination for convenience clause in bad faith or when abusing its discretion. For example, a general contractor terminating a subcontractor for convenience to convert the lucrative subcontract profits to itself would likely be found to be an abuse of discretion or bad faith. Courts have found that where a contractor is terminated was for reasons unrelated to the performance of the contract, it was actually a pretext for breaching the contract and the contractor would be entitled to its lost anticipated profits. In the government contracting context, the government may have to demonstrate some "changed circumstances" as a precondition to terminating the contract for convenience, taking away the optional unfettered discretion once thought to be the test for convenience terminations. The court and arbitrator may also apply a heightened scrutiny when private Termination for convenience clauses are employed to terminate a contractual relationship.

B. Termination for Default

Termination for default is a draconian action and one of the most serious provisions in a construction contract. It constitutes a type of forfeiture; therefore, courts scrutinize terminations for defaults carefully to ensure that the contractual provisions the parties agreed to as part of their original bargain are followed to the letter. The impact of a termination for default is a cessation of revenue by the contractor or subcontractor for the specific project. The terminated contractor or subcontractor may be accountable for re-procurement costs and other damages. Generally, because default terminations are forfeitures, Courts regard them with disfavor.

The greatest risk of either the owner or the contractor in terminating a contract is that the termination could be determined by a court or arbitration panel to be wrongful. If the termination is proved to be wrongful, then the party terminating the contract not only fails to collect its additional funds spent to complete the project, but must also pay the wrongfully terminated party its contract payments through the date of termination and potentially the loss of profit on the work not performed.

GROUNDS FOR TERMINATION BY AN OWNER

The contractor has many obligations under a typical construction contract. Whether an event of default exists must, of course, be determined with reference to the contract itself. Most construction contracts, however, define at least the following acts or omissions by the contractor as events of default which entitle the owner, at its option, to terminate:

Sub-Standard, Defective or Nonconforming Work

The contractor is obligated to perform its work in a good and workmanlike manner. See, e.g., Tharpe v. G.E. Moore Company, 174 S.E.2d 397, 399 (SC 1970); Weck v. A:M Sunrise Construction Company, 184 N.E.2d 728, 734 (Ill. App. 1962). Moreover, the contract will typically provide express warranties regarding the quality of the work and the materials used. In AIA Document A201, for example, the Contractor warrants the following:

…materials and equipment furnished under the Contract will be of good quality and new unless otherwise required or permitted by the Contract Documents, that the Work will be free from defects not inherent in the quality required or permitted, and that the Work will conform to the requirements of the Contract Documents. Work not conforming to these requirements, including substitutions not properly approved and authorized may be considered defective.

See AIA document A201-1997, § 3.5.1

The owner itself may have the authority to reject nonconforming or defective work, or the contract may provide different or additional mechanisms by which such work may be rejected. In AIA Document A201, the architect has the authority to reject work that does not conform to the contract documents. See AIA document A201-1997, § 4.2.6. The performance of work by the contractor which is rejected by the architect is a ground for termination of the contract. The owner would have the burden of proving that the defective work is of a material nature to the project and would justify termination of the contract.

Other omissions of the contractor that could result termination of the contract include:

· Failure to Pay Subcontractors and Suppliers;

· Failure to Pursue Work Diligently;

· Violation of Laws, Ordinances, Etc.;

· Certification by Architect;

A typical termination for default clause reads as follows:

Termination for Default. If Subcontractor refuses or fails to supply enough properly-skilled workers or materials to maintain the schedule of Work, refuses or fails to make prompt payment to lower-tier subcontractors or suppliers of labor, materials or services, fails to correct, replace, or re-execute faulty or defective Work done or materials furnished, disregards the law, ordinances, rules, regulations or orders of any public authority having jurisdiction, fails to consistently follow safety requirements, files for bankruptcy, or is guilty of a material breach of this Subcontract, and fails to correct the default and maintain the corrected condition within not less than three (3) working days of receipt of written notice of the default, then Contractor, without prejudice to any rights or remedies otherwise available to it, shall have the right to any or all of the following remedies:

(1) Supply such numbers of workers and quantity of materials, equipment, and other facilities as Contractor deems necessary for the completion of Subcontractor's Work, or any part thereof, which Subcontractor has failed to complete or perform after the above notice, and to charge the cost thereof to Subcontractor who shall be liable for the payment of same including reasonable overhead and profit.

(2) Contract with one or more additional subcontractors to perform such part of Subcontractor's Work as Contractor shall determine to provide prompt completion of the Project and charge the cost thereof to Subcontractor.

(3) Withhold payment of any monies due or to become due Subcontractor pending corrective action to the extent required and to the satisfaction of Contractor.

(4) Terminate this Subcontract, use any materials, implements, equipment, appliances, or tools furnished or belonging to Subcontractor to complete Subcontractor's Work and furnish those materials, equipment, and/or employ such workers as Contractor deems necessary to maintain the orderly progress of the Work: Subcontractor's equipment shall only be utilized when equivalent equipment is not locally available to lease, will not be supplied by a substitute subcontractor, and when procurement of substitute equipment will delay completion of the Main Contract. All of the costs, including reasonable overhead, profit and attorneys' fees, incurred by Contractor in arranging to and performing Subcontractor's Work shall be charged to Subcontractor and Contractor shall have the right to deduct such expenses from monies due or to become due Subcontractor. Subcontractor shall be liable for the payment of any expenses incurred by Contractor in excess of the unpaid balance of the Subcontract Price.

In the event of any emergency, Contractor may proceed as above without notice.

See Associated General Contractors of Washington Subcontract Form (2009).

Generally, a termination for default clause contains the following elements:

Definition of Default. The default provision contains certain grounds for a default termination. Most common are the failure to meet the completion date; failure to make progress; failure to make payment to subcontractors, lower-tier subcontractors, and suppliers; failure to repair or replace faulty or defective work; disregard of laws, ordinances, rules, or other regulations; filing for bankruptcy; or otherwise materially breaching a term of the contract/subcontract.

Notice to the Contractor

When the decision is made to terminate the contract because of default by the contractor, the owner must review the contract carefully to determine what notice must first be given to the contractor. Contract provisions which require notice to the contractor and an opportunity to cure are common. Under AIA Document A201, for example, the owner must give the contractor (and the surety, if any) seven (7) days’ written notice before terminating the contract. See A201 §14.2.2. Depending on the type of default alleged, a contract may provide specific opportunities for the contractor to cure the default. In the case of defective or non-conforming work, for example, AIA Document A201 provides that if the contractor does not commence and continue the correction of the work within seven (7) days of the receipt of written notice from the owner, then the Owner may after such seven-day period give the Contractor a second written notice to correct such deficiencies within a three-day period. If the Contractor within such three-day period after receipt of such second notice fails to commence and continue to correct any deficiencies, the Owner may, without prejudice to the other remedies the Owner may have correct such deficiencies. See A201 §2.4.1.

Thus, in the contract language quoted above, as in many construction contracts, the owner may not peremptorily terminate the contract by reason of an alleged breach by the contractor. In many instances, the contract will allow the contractor a reasonable opportunity to cure the alleged breach and protect its interest under the contract once it receives notice of the owner’s alleged basis for termination.

Cure Notice. The second feature of a well-written termination clause is a cure notice. Generally, the contractor/subcontractor is given a period of time (3 to 5 working days) to cure the default after being provided with written notice of the event giving rise to the termination. A properly-crafted termination letter includes the specific bases for the default, the specific cure demanded of the contractor or subcontractor, and complies with the cure notice duration in the contract to the letter.

Default Remedies. The third feature of the well-written default provision is that the default remedies are set forth with particularity. Among the default remedies are augmentation of the contractor/subcontractor's work through engagement of other workers or subcontractors, subcontractor's withholding of money, and ultimately the termination and takeover of the contractor's work.

Although not expressly stated in the standard default clause, closely-related concepts of contractor anticipatory repudiation or abandonment provide additional grounds for default termination. If a subcontractor or contractor leaves the project without any intention of returning, that constitutes an "abandonment," which allows the owner/general contractor to take over the contractor's/subcontractor's work. To show that the contractor or subcontractor has abandoned the project, you must demonstrate an affirmative, unequivocal, and unconditional declaration of intent not to perform or some other unequivocal, definite demonstration of intent not to return.

The existence of a technical default by the contractor/subcontractor does not necessarily mean that a default termination is proper. Wrongful termination is itself a breach of contract. It relieves the contractor/subcontractor's liability for preceding breaches and discharges the surety of any obligation under its performance bond. The owner or general contractor bears the burden of proof with respect to whether the termination for default was justified regardless. A default termination is a drastic remedy that should be imposed only for good grounds on solid evidence.

Notice to the Surety

Where the contractor has provided a performance bond for the project, the owner must not forget to provide timely notice to the surety before terminating the contract because of the contractor’s default. As a general matter, there is no obligation to notify the surety before declaring a default and terminating the contract. See, e.g., School District v. Universal Surety Co., 135 N.W.2d 232, 237 (Neb. 1965). However, a provision in the bond itself which requires notice to the surety will ordinarily be enforced in any subsequent legal proceeding. Moreover, the construction contract itself may require notice to the surety. See, e.g., AIA Document A201-1997, §14.2.2.

Once the owner has complied with the notice provisions in the bond and has declared a default by the contractor, the surety will generally have the option to complete the project itself (directly or through agents) or pay the cost of completion (up to the amount of the bond) to the owner. AIA Document A312 gives the surety the following options:

1. to arrange for the contractor to complete the job, but only if the owner consents;

2. to perform the contract itself, through agents or independent contractors;

3. to obtain a bid for completion of the work by the contractor acceptable to the owner, secured by bonds equivalent to those issued on the original contract, and pay the owner the cost of so completing the work, up to the amount of the bond;

4. to promptly determine the amount of its liability to the owner, and pay the owner that amount; or

5. to deny liability and notify the owner in writing of the reasons for doing so.

Termination is a tricky area of the law of contracts. Contractors and subcontractors are well advised to involve experienced legal counsel before undertaking a contract termination, as the facts and circumstances of construction defaults vary widely and are oftentimes both factually and legally complex. Given the potentially harsh results, including the consequences of the default termination and the death sentence that the default termination suggests, it is prudent to contact an experienced construction lawyer at the first sign of trouble, and certainly before taking the extreme action of terminating a construction contract.

In theory, terminating for convenience avoids the hassle of documenting the contract breaches, providing notice and cure periods, and arguing over definitional ambiguities. It also purportedly gives the terminating party certainty in regards to termination damages. However, this is not always the case, in particular, where termination for convenience clauses have not been carefully negotiated and drafted.

Traditionally, without cause, an owner or contractor could not terminate another contractor without breaching the parties' contract, thereby being exposed to litigation and potential damages for anticipatory profits. The result was often disastrous for the owner/contractor leading to significant budget overruns when the terminating party had to pay anticipatory profit to the terminated contractor, and then pay to retain another contractor to complete the terminated contractor's work.

Solutions began evolving

During World War I, the U.S. government introduced the concept of termination for convenience as a way to allow it to avoid such costs by giving it the right to terminate a contract that had become “unnecessary” given recent developments in the war. Torncello v. The United States, 231 Ct. Cl. 20, 20, 681 F2d 756, 759 (1982). Upon termination, the contractor was entitled to recover some lost profit, but typically was not entitled to the full measure of damages available under a traditional breach of contract claim.

As the doctrine continued into World War II, the government's basis to include these clauses was that they were “only intended to handle changed conditions, relieving the government of the risk of receiving obsolete or useless goods.” Torncello v. The United States, 231 Ct. Cl. 20, 20, 681 F.2d 756, 763 (1982).

Post-war, the courts continued to allow the government to terminate contracts for convenience, but relied on the “risk allocation nature of the concept to allow termination for convenience only when the expectation of the parties had been subjected to a substantial change that made continuance of the contract clearly inadvisable.” Id.

For example, if the job became impossible, too difficult or too costly to perform if pushed through to conclusion, the government could typically terminate the contract for convenience. Nolan Brothers, Inc. v. The United States, 186 Ct. Cl. 602, 606, 405 F.2d 1250, 1253 (1969).

But, it was clear that the government could not just terminate the parties' contract without any reason whatsoever, despite what the untutored reading of the termination for convenience clause suggested. Rather, some change from the parties' original bargain was required.

In 1974, the courts first allowed termination for convenience for a different reason than risk allocation and allowed the government to terminate a contract as a matter of strategy in order to save the government money. Torncello v. The United States, 231 Ct. Cl. 20, 20, 681 F.2d 756, 767 (1982).

More good faith glitches

The case was highly criticized, however, on the grounds that the ability to terminate a contract for no reason at all is nothing more than an illusory promise, and illusory promises are void and unenforceable for want of consideration. Id.; see also Restatement (Second) of Contracts § 77(a)(1981).

So, to avoid consideration criticisms, the courts limited the termination for convenience clause by incorporating a good faith element. Kalvar Corp. v. United States, 211 Ct. Cl. 192, 298-99, 543 F.2d 1298, 1301-02 (1976), cert. denied, 434 U.S. 830, 98 S. Ct. 112 (1977).

Still, courts struggled with lack of consideration issues and what constituted good faith.

Within just four years, the good faith limitation was interpreted to require the change of circumstances historically contemplated. Torncello, 231 Ct. Cl. at 20, 681 F.2d at 772. No doubt this frustrated the government, which had enjoyed much latitude regarding their contracts over the previous several decades.

Unsurprisingly, the Competition in Contracting Act (CICA) was enacted, requiring a lenient standard in applying governmental termination for convenience clauses.

Application of CICA eliminated the “changed circumstances” requirement from federal contracts and relaxed the duty of good faith such that the government now has almost an unfettered discretion to terminate a contract for its convenience, although at least one state has continued to apply the changed circumstances test in the governmental context. See RAM Engineering & Constr., Inc. v. Univ. of Louisville, 127 S.W.3d 579, 587 (2003).

As the use of termination for convenience clauses grew in federal contracts, the clauses started gaining acceptance in private contracts. In 1987, the A201 introduced the concept of termination for convenience, but limited it to suspension. AIA Document A201-1987 § 14.3.

In 1997, termination for convenience was added and thereafter retained in the 2007 revisions. AIA Document A201-1997/2007 § 14.2.

Unlike federal government contracts, in the private context, the law remains that any decision by a party to terminate a contract must be made in good faith, as determined by the reasonable expectations of the parties at the time the contract was executed. Questar Builders, Inv. v. CB Flooring, LLC, 978 A.2d 651, 675-76, 410 Md. 241, 281-82 (2009).

Don't push the limits – convenience clause may not cover you

The question then becomes, what constitutes bad faith in terminating a contract and how far can you push the limits of one of these clauses before rendering your contract illusory?

In Questar Builders, Inc. v. CB Flooring, LLC, Questar Builders (Questar) was hired as general contractor to construct a luxury mid-rise apartment and townhome complex. 410 Md. 241, 245, 978 A.2d 651, 653 (Ct. App. 2009).

After receiving bids from three flooring subcontractors, Questar selected CB Flooring, LLC (CB) to install carpeting for the project at a total contract price of $1,120,000.00. Id.

After entering into the subcontract, however, the interior design firm working on the project changed the carpets to be installed in certain portions of the project. Id. at 249, 978 A.2d 656.

Questar immediately sought a price quote from one of the previous bidders, Creative Touch Interiors (CTI), “assertively because it was trying to keep CB honest on any requested change order.” Id. Shortly thereafter, CB submitted a change order requesting an upward adjustment to the subcontract price for the carpet change. Id. at 250, 978 A.2d 656.

CB's change order request exceeded the price quote provided by CTI. Id. Questar terminated the contract with CB and issued the contract to CTI. Id. CB filed suit against Questar for damages, including lost anticipatory profits. Id. at 251, 978 A.2d at 657.

The trial judge concluded that Questar improperly terminated the subcontract and awarded expectation damages to CB, considering and rejecting Questar's contention that “it enjoyed a right to terminate the subcontract for any reason based upon its termination for convenience clause in the subcontract.” Id. at 251, 978 A.2d at 657.

Further, the trial judge specifically found that Questar's assertion to be without merit, that its “subjective loss of faith in CB's ability to perform satisfactorily satisfied whatever implied limitations there might be on the exercise of the termination for convenience clause.” Instead the judge held that something more objective was required to satisfy the good faith limitation. Id.

On appeal, the Court reviewed the history of the clause's development in the context of federal procurement and found that the case law supporting such a “broad termination right” was “too broad” in the private context. Id. at 270-71, 978 A.2d 669.

The Court declined “to recognize for private parties the near carte-blanche power to terminate that courts have given the federal government under convenience termination clauses” on the basis that without special government legislation allowing it, such contracts are illusory, and therefore unenforceable. Id.

Rather, the Court, following the historical analysis of termination for convenience clauses, found that “the right to terminate a contract for convenience is a risk allocating tool.” Id. at 277, 978 S.2d 672.

To that end, the Court held that a contractor may terminate a contract, in its discretion, only if it first determines that continuing with the subcontract would subject it potentially to a meaningful financial loss or some other difficulty in completing the project successfully” (i.e., a change in circumstances). Id. Moreover, the Court specifically found that as it relates to the above, a contractor has an obligation to “act reasonably in ensuring that a subcontract does not become inconvenient.” Id.

One of the only courts to rule on termination for convenience clauses in the private context, and the most recent decision, Questar, is from a terminating owners and contractors perspective, because it suggests that despite including a termination for convenience clause in your contract, you are still going to have to show some element of cause to get around the duty of good faith.

Specifically, it suggests that even if you have a change in circumstances or the project requirements or scope, it may not be enough to justify termination. It further suggests that termination for convenience clauses in the private context are going to be carefully scrutinized with disfavor.

The CBCA Issues an Interesting “T for D” Decision, Applying UCC Principles to Reach a Common-Sense Result

A termination for default (T for D) is “a drastic sanction which should be imposed or sustained only for good grounds and on solid evidence.” A T for D will impact future responsibility determinations and needs to be fought by contractors who want to continue to work in the Government market. In DMW Marine Group v. Department of Commerce, the Civilian Board of Contract Appeals (CBCA) granted a contractor’s appeal, effectively reversing the National Oceanic and Atmospheric Administration’s (NOAA) T for D based on the contractor’s failure to provide a certification called for under the contract. The Board’s decision reflects a common-sense understanding of the exchanges between the parties—and a proper rejection of an overly aggressive use of the “drastic sanction.”

The contract at issue in DMW Marine required delivery of a crane to a NOAA coastal mapping vessel. Throughout performance, the parties had a disagreement about the certification requirements imposed by the contract, with the agency asserting that a certain type of American Bureau of Shipping (ABS) certification was required. When work on the crane was almost complete, DMW Marine sent the CO a letter stating:

The requirements for ABS [s]tate: contractor shall receive Government and ABS approval of the crane system. It is our intent that upon installation ABS will certify the onboard load test thereby approving the crane system. Please issue concurrence with above, as we are not shipping this crane until it is agreed upon.

The CO accepted DMW Marine’s position regarding “the ABS requirements,” noting “it appears that you and ABS have a good path forward that meets the requirements of the contract and is acceptable to the Government.”

After delivery of the crane, the CO asserted that the “onboard load test” certification was inadequate, and that DMW Marine should have “inform[ed] [ABS] prior to the commencement of construction in order to initiate the necessary surveys in due time.” As going back in time wasn’t possible, and as the Government wasn’t paying, the frustrated contractor made increasingly colorful responses to the CO’s correspondence, e.g., “[j]ust ship the crane back to us and we will refund your slow and late payments,” “if full payment[i]s not made, ‘[w]e are ready to repossess the crane,’” “[w]e will pick up our crane tomorrow.” Not amused, the CO terminated the contract for default, after paying only 71% of the contract price for a “crane [that] continues to be installed on” NOAA’s vessel.

The CBCA’s problem with NOAA’s actions are obvious: the interpretation of the inspection clause had been disputed between the parties, but when DMW Marine made clear what it was going to do and asked for the CO’s concurrence before shipment and installation of the crane, the CO unambiguously agreed. Then, after obtaining the crane, the CO flip-flopped and asserted that a further certification was required. The CBCA reached back to the basic commercial legal principles taught to law school 1Ls, i.e., UCC § 2-607(2), to explain that “[a]cceptance of goods by the buyer precludes rejection of the goods accepted and if made with knowledge of a non-conformity cannot be revoked because of it . . ..”

When NOAA accepted delivery of the crane, it “knew well” that it was not ABS-certified in the manner the agency later demanded. Given “all that had transpired during the previous months,” the agency’s attempted rejection of the crane was improper and, thus, “[t]erminating the contract for cause was not justified.”

It should be noted that, although DMW Marine is surely pleased to have the T for D thrown out, it will likely not obtain the complete recovery it likely believes is due. The CBCA ordered that the termination be converted to one for the convenience of the Government. Under FAR 52.212-4(l), an agency that T for Cs a contract must pay “a percentage of the contract price reflecting the percentage of work performed prior to the notice of termination, plus reasonable charges the Contractor can demonstrate . . . resulted from the termination.” The parties can usually negotiate T for C settlements, but agencies can resist full payments and, given the history of this case, may do so here.

Subcontractor Default Insurance

A subcontractor default on a construction project is one of the greatest risks faced by the general contractor in constructing a project. Generally, contractors protect themselves from that risk by purchasing bonds, and now, also subcontractor default insurance. An example best contrasts the differences between bonding and insurance.

1. Contrast Between Bonding and Default Insurance.

Assume on a high end condominium project the drywall contractor uses non-compliant drywall screws to fasten the weather barrier to the studs. This error is not discovered by the general contractor until the project is virtually complete.

When confronted with the oversight, the subcontractor refuses to redo the faulty work and walks off the job. In a second scenario, the subcontractor may simply walk off the job and in a third scenario the subcontractor may go out of business.

Now, the general contractor is on the hook, not only for replacing all the wall coverings, granite, tile, paint and other finishes, but also for the indirect costs associated with the overall project delay.

If the general contractor had bonded the subcontractor, the loss is capped at the penal sum of the bond (the bond amount limits the recovery), and generally no liquidated damages associated with project delay will be reimbursed by the bond. Generally, the project will be delayed further while disputes between the general contractor and the bonding company are being settled. If on the other hand, the general contractor had purchased subcontractor default insurance, the insurance companies are generally able to promptly mitigate the damages, complete the project quickly, without the limitation of a penal sum, and with coverage for indirect damages (liquidated damages).

2. Default Insurance.

There are three commercial products on the market for subcontractor default insurance, Zurich's Subguard®, XL Insurance's ConstructAssure®, and a product from Construction Risk Underwriters (CRU). Subcontractor default insurance, an alternative to surety bonds, protects the general contractor from losses arising from defaults by un-bonded subcontractors. The general contractor enrolls all prequalified subcontractors for a specific project or policy term and is indemnified (held harmless) by the insurance company for any direct or indirect costs incurred if one of those subcontractors defaults on performance.

Subcontractor default insurance operates under a high deductible, high co-pay model offered at a significant discount to bonds. It protects the general contractor against losses well above the penal sum of the bond and also rewards those general contractors with the best risk management procedures.

The premium for subcontractor default insurance includes an option to collect the potential deductible and co-pay responsibilities in a loss fund. If the general contractor does not incur any losses, and therefore does not withdraw against the loss fund, that money is profit to the general contractor. Under a bond, the premium money is paid to the bonding company never to be seen again, even if the general contractor manages the job and subcontractors perfectly. Thus, subcontractor default insurance provides a significant financial incentive that compensates general contractors for the risk management work they are already doing day in and day out.

QUANTIFICATION OF CONTRACTOR TERMINATION DAMAGES

Damages Claims Formula No. 1 – The contract price less the amount that it would cost the contractor to complete the work;

Damages Claims Formula No. 2 – The profit on the entire contract (total contract price less the contractor’s cost of completion) plus the cost of the work actually performed; and,

Damages Claims Formula No. 3 – For the work completed, that proportion or ratio of the contract price as the cost of the work performed bears to the total cost at completion, plus, the remaining profit on the uncompleted work.

Where adequate proof can be made as to the contractor’s cost of completing the work and where the entire job can be performed at a profit, the application of formulas two and three may produce similar, if not identical, results. If the contractor is unable to prove with reasonable certainty what it would cost to complete the remaining work, the first formula is not applicable, whereas under formulas two and three, she might recover for the work completed in compliance with the contract.

Termination for Convenience/ Wrongful Termination of Contract by Contractor

Only the owner can terminate, or suspend, the Contract for convenience. The contractor does not have this right. If a contractor wrongfully terminates the contract and abandons the job, he will likely be sued for the difference between the owner’s cost to complete and the earned value of the contract work completed. He may be required to pay extra costs associated with the delay, the hiring of a completion contractor(s), etc.

Contractor’s Damages

If it is shown that the contractor terminated the contract for cause, he may be entitled to claim to recover payments for work executed and earned, and for proven compensable loss with respect to materials, equipment, tools, and construction equipment and machinery, including reasonable overhead, profit and damages.

Typical claims from contractors under termination for cause may include, but are not limited to, the following, to the extent that the contract does not specify otherwise:

· Costs to bid the project

· Mobilization and demobilization costs

· Anticipated profit on the project

· Costs for work performed but not paid

· Home office overhead costs

· Winding-down costs

· Damages for loss of good will/loss of future business due to potential negative publicity following termination

· Betterment issues – changes or upgrades included in the owner’s cost-to-complete damage model that are above and beyond the contractor’s original scope of work

Suspension and termination actions on complex construction projects are typically complicated and expensive to resolve and often result in litigation or other forms of dispute resolution. Owners and contractors are advised to maintain detailed records and documents, such as costs reports, progress reports, invoices, schedules, and other contemporaneous project documents, as this will facilitate accurate and persuasive construction claims preparation.

Contractor’s Termination

Prior to termination or abandonment, the contractor can elect to suspend the work if a material breach has occurred such as untimely payments by the owner of valid payment applications where proper notice has been given, and where the contractor is not in breach. This is a much safer course of action than termination, and it allows the owner a chance to cure. If the contractor must terminate for cause, he must comply the terms of the contract and provide proper formal written notice to the owner.

If both the owner and contractor are in material breach of contract at the time of termination, the above assessments and formula may change and the relative nature and degree of the breaches become relevant. Termination and damages will be examined in greater detail here in the future.

Analyzing Suspension and Termination Claims

Metropolitan analyzes suspension and termination claims and disputes by reviewing the factors which led to the event. This typically involves reviewing contract documents, project correspondence, such as e-mails, letters, meeting minutes, project schedules, periodic job reports, and other relevant documentation, as well as interviewing key project personnel. As contractor performance is often viewed as a justification for suspension or termination, the actions of the contractor and owner must be reviewed thoroughly for compliance with contract requirements and industry norms for standard of care.

Often, the amount of claimed damages is in dispute. Metropolitan‘s construction consultants analyze the project data, within the realm of the specific contractual obligations, to determine the appropriate damages, if any, due to either the contractor or the owner.

Metropolitan’s construction consultants can provide the following services relative to suspension and termination claims:

· Claims preparation or analysis

· Schedule analysis

· Damage quantification

· Document review

· Expert analysis and testimony

SAMPLE CLAUSES FOR DEFAULT, TERMINATION AND REMEDIES

A. Default.

1. Notice to Cure. If the Subcontractor refuses or fails to supply enough properly skilled workers, proper materials, or maintain the Project schedule; or if it fails to make prompt payment to its workers, subcontractors or suppliers; or if it disregards laws, ordinances, rules, regulations or orders of any public authority having jurisdiction; or if it otherwise fails to perform in accordance with the provisions of this Subcontract, the Subcontractor shall be deemed in default of this Subcontract.

If the Subcontractor fails within three (3) working days after written notification to satisfactorily correct any such default, then Contractor, without prejudice to any other rights or remedies, shall have the right to any or all of the following remedies:

(a) the right to enjoin or restrain such default and to demand and to have specific performance;

(b) the right to receive and recover damages resulting therefrom;

(c) the right to withhold or to offset any progress, final or other payments under this Subcontract or any other subcontract between the parties now or hereafter in force; and/or

(d) without being deemed to have waived or cured such breach or default, the right to perform any act and make any payment for which Subcontractor is in default, in which event all expenses, costs, losses, damages, and fees (including, without limitation, attorneys' fees) suffered or incurred in so doing, plus fifteen percent (15%) of such costs and expenses for overhead and administrative costs, shall immediately constitute indebtedness due and owing from Subcontractor. In exercising this right, Contractor shall be entitled to enter the Project site and take possession and use any materials, tools, and equipment for such purpose.

In the event of an emergency affecting the safety of persons or property, Contractor may correct any such default without first giving three (3) working day’s written notice to Subcontractor, but shall thereafter give prompt written notice of such action to Subcontractor.

B. Termination. If the Subcontractor fails to satisfactorily correct such default within the three working days after written notification issued under Section 8A, then Contractor may, instead of or in addition to the remedies set forth in Section 8A, issue a second notification to Subcontractor. Such second notice shall state that if Subcontractor fails to satisfactorily correct any default within two (2) working days from the second written notification, the Subcontract may be terminated.

In the event of such termination and upon Contractor’s written request, the Subcontractor shall immediately remove from the Project site all of its employees, equipment, tools, supplies and materials without any disruption of the work in progress and at its own cost and expense. Should Subcontractor fail to do so, Contractor shall be entitled, but under no obligation, to remove and store any equipment, tools, supplies and materials at Subcontractor’s cost and expense.

Further, in the event of such termination, Contractor shall be entitled to enter the Project site for the purpose of completing the Subcontract Work and shall be permitted to take possession of all materials, tools and equipment to finish the Subcontract Work either by itself or through other contractors.

In the case of termination of this Subcontract, Subcontractor shall not be entitled to receive any further payment until the Subcontract Work shall be wholly finished, at which time, if the unpaid balance of the amount to be paid under this Subcontract shall exceed the expense incurred by Contractor, including an overhead fee of fifteen (15%) percent of the cost incurred in finishing the Subcontract Work, such excess shall be paid by Contractor to Subcontractor. However, if such expense shall exceed such unpaid balance, the Subcontractor shall immediately pay the difference to Contractor.

C. Insolvency or Bankruptcy. In the event Subcontractor voluntarily or involuntarily becomes subject to bankruptcy proceedings, makes an assignment for the benefit of creditors, becomes insolvent, or has a trustee, receiver or liquidator appointed for any part or all of its assets, this Subcontract shall terminate. Notwithstanding the foregoing, if the Subcontractor, or Subcontractor’s trustee in bankruptcy, if any, gives notice of its intent to assume the Subcontract and provides adequate assurance of its ability to perform hereunder, this Subcontract shall not be terminated but shall be subject to the provisions of Section 8A and 8B.

Contractor, while awaiting the decision of the Subcontractor or its trustee to reject or to assume the Subcontract and to provide adequate assurance of its ability to perform, may avail itself of such remedies under this Section 8 as are reasonably necessary to comply with Contractor’s obligations under the Prime Contract.

METROPOLITAN ENGINEERING, CONSULTING & FORENSICS (MECF)

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