It is only reasonable that a contracting party should have the right to terminate a contract when extreme conditions exist because it goes both ways. One side promises to pay; the other side promises to perform. If there is no payment or no performance, then the law allows the party not in default to say, “It’s over.” All of this is fine in theory, but how do you know when a default termination is proper?
There appears to be a recent increase in terminations for default (T for D). Whether because of the pandemic or other economic factors, construction defaults are becoming more common. Even where the owner has some protection from delays through liquidated damages, many owners appear to be willing to invoke the termination clause rather than wait for the contractor to finish.
Making sense of the T for D clause
T for D clauses are fairly typical in construction contracts, although the wording can be wildly different. The T for D clause does not create any new rights but seeks to better define or limit the circumstances where a termination is appropriate. In a good number of contracts, the clause only defines the owner’s power; it says nothing about the contractor’s right to terminate.
Two widely used examples come from contracts developed by the American Institute of Architects (AIA) and the federal government. You should compare your contracts with the clauses in these examples.
Under the format developed by the AIA, a T for D can arise if the contractor 1) “repeatedly refuses or fails” to man the job or to support the work with materials, 2) fails to pay its subcontractors, 3) “repeatedly disregards” laws affecting the project or 4) otherwise substantially breaches the contract. Except for the one provision about major breach of contract, a contractor will not be subject to termination unless there is a pattern of misconduct. Implied in that idea is the need for the owner to give some advance warnings or notices of the contractor’s failings.
The next step of the AIA contract is for the owner to get a certification of default from the person designated in the contract as the decision-maker. The owner must then give the contractor notice that it intends to terminate the contract in seven days. The clause does not say “cure notice,” although courts often interpret it to mean the contractor gets seven days to cure the default. One week is an extremely short time for a contractor to remedy most kinds of defaults. This notice is essentially saying there will be no more “one more time” for forgiveness.
Federal government contracts substantially differ from AIA contracts in three respects. First, a T for D can be for portions of the work and need not be for the entire contract. Second, a T for D can be issued for a contractor’s anticipated default (the contractor hasn’t defaulted yet, but it is highly likely that it will). The “repeatedly” language of AIA is missing. Third, if the T for D is found later to be improper, it will be converted to a termination for convenience.
Wrongful use of a T for D
Under the AIA, a wrongful T for D is a breach of contract by the owner, allowing the contractor all damages arising from the breach of contract.
The owner should perform some investigation before issuing a T for D. For the government, the Code of Federal Regulations, Subpart 49.4, requires following a multistep process to justify a T for D. It is in the contractor’s interest to make certain it has written communications in its job file of the reasons why it has been prevented from meeting the contract’s terms.
In other words, you should immediately respond in writing to any criticisms by the owner about delays, crew size, safety violations or other items on the contract’s definition of defaults. There is a saying among experienced contractors for this situation: stay three letters ahead.
Many contractors hesitate to involve themselves in “papering the record,” but most contracts require this kind of effort. I know of contractors who would rather be wrong about the information they send to owners about delays, interferences, extras, etc., rather than not having sent anything at all about the problems they encountered.
If you get a cure notice with a short time frame, you probably will not have enough time to cure the problem. If so, at least submit a plan of action within the cure notice time that describes your defenses to the claims of deficiencies. An owner should know that replacing the contractor will cause even more delays and costs.
Do you have a right to terminate?
Unless there is a clause giving you a contractual right to cancel, your right to terminate will be set by general contract law principles. Chiefly, courts support a contractor’s abandonment of a job where there is nonpayment. There are, however, clauses that state that the contractor can declare the contract terminated if there is a work stoppage beyond a certain number of days’ duration. If your contract does not say that, you may want to add such a provision.