Americans view their contractual freedom—their ability to form contracts without government interference—as practically sacrosanct. When signing a contract, both parties expect the other to meet their commitments. When a party terminates a contract, however, they are announcing the agreement is impossible or so unworkable that they cannot, and should not, keep their end of the bargain. Regardless of who terminates a contact, the risks and potential expense are great for owners, developers and trades alike.
Difficult jobs are not rare, so when does a project go from being difficult to being unworkable or impossible? A proper contract termination usually arises in situations where there is a “total” or “material” breach of the agreement. Job needs, terms, and contract requirements measure performance and often define the circumstances when termination is available. However, the right to terminate does not normally arise because of a simple delay or other relatively minor contract breach. Instead, termination typically occurs when the breach relates to something so essential to the overall performance and goals of the agreement that the contract itself is rendered almost meaningless. These are terminations “for cause,” and often involve courts determining whether the breach is sufficient to justify termination.
Difficult jobs are not rare, so when does a project go from being difficult to being unworkable or impossible?
Termination can also occur when a contract gives one party the right to terminate or has terms identifying when termination is proper. These “for convenience” clauses are often introduced by owners or developers to allow them “flexibility” so they can avoid the need to formalize a termination “for cause.” Note that these clauses can be abused because they often provide no limit or requirement to establish a reason for termination.
The consequences of termination are serious whether “for cause” or “for convenience.” Delays and added costs for completion, ramp-up, and financing flow naturally. In addition, increased overhead, legal expenses, and additional surety risk can make termination dire for the terminated party. The risks of an improper termination are also significant: a court or arbitrator that finds a contract was wrongfully terminated can then award the improperly terminated party the contract value, lost profits, and other legal fees and costs.
So, how do you approach the need to terminate a contract? First, pause. Emotions might be high, but a court will simply look to the language of the contract and both parties’ performance. Read and understand terms in the contract that might prevent termination or provide an alternative to ending the agreement. Consider whether the work can be supplemented by others or addressed through an arbitration process during the project. Next, provide the non-performing party a specific and detailed demand, with clear timelines for performance and consequences for failure. If nothing improves and termination of the contract is the last recourse, advise them again of the specific failings, document the job conditions or performance issues justifying termination, and comply with all notice and contractual obligations to officially terminate the agreement. Remember, it is still necessary to comply with the contract’s terms even if the other party seems to have walked away from the agreement. Finally, weigh notice to surety or performance bonds; these can help offset costs brought about by termination.
But what if you are on the other end of the scenario and are being, or have been, terminated? The steps are somewhat similar. Start with a review of the contract terms. See if the terminating party complied with every required step. If they did not, demand they do so. Be willing to meet the contract’s terms, even if the other party refuses to let that happen. Be sure to document compliance with the contract, both before and after termination. Any effort to contest termination will require you to show that the work was meeting—at least substantially—the terms of the agreement and there was a willingness to continue. Finally, consider whether to involve your surety. They may have tools and resources that can help smooth over or heal contract termination processes.
Termination of a contract is a serious undertaking and should not be exercised lightly. Know your options and remedies whether terminating a contract or being terminated. And, when all is said and done, take a look back at what circumstances led to the termination and how to avoid them in the future.