By Kaitlyn M. Linsner, Associate, Chicago
Parties do not typically enter a construction contract planning for failure, but as industry participants know, there are obstacles during project execution which may challenge the contracting parties’ relationships. Many of these obstacles can be resolved through the dispute procedures outlined in the contract, however; there are times when an owner or contractor may be so dissatisfied with a downstream party’s performance that terminating the contract for default appears to be the best option.
Since termination of the contract is one of the most serious actions that can be taken on a construction project, making the decision to do so requires careful consideration. This article provides tips to consider when declaring a downstream party in default, terminating the construction contract, and a brief overview on the consequences for getting it wrong.
Read the Contract
The contract governs the parties’ obligations and should be closely examined before proceeding down the path of terminating a contract for default. The contract will outline the grounds upon which a downstream party may be terminated and the steps to achieve lawful termination. Familiarity with the entire contract is critical, particularly the provisions relating to both termination and the dispute underlying the default.
- Determine Grounds
The first step in determining if a party is entitled to terminate the contract for default is to establish if the downstream party is in default. Whether an event of default exists must be determined by referencing the contract itself. Common examples of events of default in construction contracts include: 1) substandard, defective or nonconforming work; 2) failure to pursue work diligently; 3) failure of a contractor to pay subcontractors or suppliers; 4) violation of laws, ordinances or regulations; and 5) other substantial breaches of contract.
- Follow Notice Provisions
If grounds for defaulting the downstream party exist, the contract’s notice provisions should be reviewed and followed. These provisions will explain how to give proper and timely notice for default and, in some cases, whether you need to provide an opportunity to cure. For example, under AIA A201, the owner must give the contractor, and the contractor’s surety, seven days’ notice before terminating the contract for cause. See AIA Document A201-2017 at § 14.2.2. A subcontract may require giving the sub notice of default, with direction and opportunity to cure, within a specific period. Only if the sub fails to cure the default can its employment be terminated, and in some instances, the subcontract may also require issuing a separate written notice of the decision to terminate.
Keep in mind that the notice of default will be an important piece of information should litigation commence after termination. The notice should therefore be as complete and objective as possible.
- Termination
The right to terminate will only arise if the defaulting party does not adequately act or respond to the notice of default in the manner required by the contract. Be sure to exercise care and ensure compliance with all of the contractual requirements in electing to terminate the contract.
Monitor Progress and Enforce the Schedule
A downstream party likely has an obligation to work under the contract diligently and to meet completion milestones. Many construction contracts also include a “time is of the essence” clause to reinforce that the owner, for example, expects the job will be completed by the deadlines in the contract. If a downstream party is not meeting these deadlines, the delays are significant, and time is of the essence, this may generally justify termination of the contract.
If dealing with untimely performance, monitoring progress and enforcing the schedule is important to avoid potential prejudice and waiver arguments. For example, if an owner seeks to default a contractor for failing to complete a project on time, courts may look to whether the owner waived the right to enforce the completion date by allowing and encouraging the contractor to continue with the work after the date has passed. See Banks Bldg. Co., LLC v. Malanga Family Real Estate Holding, LLC, 926 A.2d 1 (2007). More specifically, an owner may waive its right to enforce a substantial completion date or the “time of the essence” provision if they allow the date to pass without setting a new deadline and continue to issue change orders and construction change directives requiring the contractor to perform additional work. See RDP Royal Palm Hotel, L.P. ex rel. PADC Hospitality Corp. I v. Clark Const. Group, Inc., 168 Fed. Appx. 348 (11th Cir. 2006).
Keep Good Records
A helpful acronym to keep in mind when declaring a downstream party in default and terminating the contract is F.A.T. – keep records that are Factual, Accurate and Timely. Regardless of the default alleged, good documentation will prove helpful due to the risk of litigation and substantive disputes following termination. Setting forth F.A.T. records can help prove the elements of default and prevent evidentiary issues down the road. Keep Factual records by avoiding personal attacks and sticking to the facts. Keep Accurate records by not inflating the facts. Stick to what is supported by project data. Finally, keep Timely documents that can be relied upon. Contemporaneous documents are more reliable evidence than recreated facts at a later date based on faded memories.
Self-Reflection
Self-reflection of one’s actions under the construction contract is also advised. Before declaring a downstream party in default, it is important to make sure you are not in default. The most common examples of an owner or contractor defaulting include nonpayment or concurrent delays. In the event of a concurrent delay, performing a forensic schedule analysis and closely examining the cases of concurrency may be necessary to properly allocate responsibilities for delays and to specify the proper entitlements.
Bond Claim Considerations
In making a claim against a performance bond, reviewing the bond is crucial. Failing to comply with applicable notice requirements, for example, may prove fatal to a bond claim because failure to follow a performance bond’s notice requirements can constitute a material breach of the bond, thereby rendering it null and void. See Int’l Fid. Ins. Co. v. Americaribe-Moriarty JV, 906 F.3d 1329 (11th Cir. 2018). There are certain conditions precedent that must be met to invoke surety performance. Under the commonly used AIA A312-2010 bond form, for example, the owner must:
- not be in default under the construction contract;
- provide written notice to the contractor and surety of owner’s intent to declare a default. The notice must indicate whether the owner is requesting a meeting among the owner, contractor and surety to discuss the contractor’s performance. If the owner does not request a meeting, the surety may do so;
- attend the meeting between parties, if requested;
- if agreed to by the parties, provide contractor a reasonable opportunity to perform;
- declare the contractor in default and terminate the contract; and
- pledge to pay to the surety the remaining contract balance.
Another important step in pursuing a performance bond claim is to provide the surety all relevant documents including pay apps and correspondence between the parties.
Potential Consequences
Generally speaking, one of the biggest risks in terminating the contract of a downstream party is that the termination could be deemed wrongful by a court or arbitration panel. If this happens, the party terminating the contract could end up paying twice and facing other substantial damages such as consequential and punitive (unless waived), attorneys’ fees (if provided for in contract) and bond claim costs (if bond claim and surety performs). A common example of wrongful termination is terminating a contract after failing to follow procedural requirements such as issuing proper notice and affording the requisite opportunity to cure the defective work.
When exploring the option of default and termination, there are legal, factual, economic and practical considerations to be assessed as a part of that decision. These tips, along with a full understanding of legal principles and the critical facts of each case, can assist in navigating the often times complicated default and termination process in the construction industry.