It is extremely important for an owner to incorporate specific termination provisions in order to protect it from non-performing or under-performing contractors. Without these provisions, an owner may find itself on the defensive and at greater risk when the contractor claims that the termination was wrongful. And, if the owner cannot prove that the termination was proper, it may find itself having to pay the contractor lost profits in addition to sums claimed to be owed for work performed.
Most construction projects have a baseline schedule which shows the duration of each trade contractor’s work and, among other items, the substantial completion date. In some situations, there are milestone dates for specific tasks to be performed by a trade contractor. One of the most detrimental termination clauses that owners put in their contracts provides that the contractor shall be in default of the contract, in the event that the contractor does not achieve a milestone date or the substantial completion date set forth in the schedule. However, this event of default may not be enough for the owner to mitigate its losses if the contractor is not performing at a pace which the owner believes would allow the contractor to achieve its performance dates.
Many owners terminate contracts for cause at various points during the project claiming that based on their experience, the contractor will not be able to achieve a performance date based on the owner’s personnel’s review of the status of the contractor’s work and the duration of time left for the work to be performed. Unbeknownst to many owners in the construction industry, there is a rule of law which requires the owner to engage an independent expert to determine whether a contractor will be able to complete its work based on the status of the work and the duration of time left to complete the work. However, if the owner incorporates and uses other types of events of default based on the contractor’s performance or lack thereof, such rule of law will not result in the determination that the termination was wrongful if the owner does not engage the independent expert.
There are various provisions that an owner may incorporate in its construction contracts which would give the owner latitude in declaring an event of default which would not require an independent analysis. For example, an owner should incorporate provisions which result in events of default such as the contractor’s (i) failure to supply labor or materials in sufficient quantities for sufficient durations as required by the owner; (ii) interference or delay to other trade contractor’s work or to the progress of the construction; (iii) failure to make payment to the contractor’s subcontractors in accordance with the subcontracts; (iv) failure to promptly and timely prosecute work, and (v) failure to add additional manpower at the direction of the owner in order to progress the work at a faster pace. These types of provisions permit the owner more latitude in determining that the contractor is not progressing the work at an acceptable pace. Without these provisions, the owner will have to prove that the contractor would not have been able to complete its work at a time when there is time left to perform the work and it would be up to a judge or jury whether the contractor could have finished the work had the contractor been given the opportunity to do so. The problem is that by the time the substantial completion date occurs, the contractor may be so far behind in its work that the owner will have to incur more costs to complete the work than it would have had if it had the means to terminate the contract earlier on during construction. Essentially, the provisions discussed above, among others, will allow the owner to cut its losses and bring in another contractor before the owner pays the original contractor higher sums which it will have to recoup from the original contractor after the work is completed by others.
The moral of the story is that an owner must incorporate provisions in its contracts which give it the latitude to terminate a contract early on during the construction process when it believes that the contractor is not going to be able to complete its work by the completion date. Without this latitude, the owner will have to engage in a battle of the experts to prove that the contractor would not have had the ability to complete its work by the substantial completion date and lose the leverage it needs to mitigate its losses. To mitigate this type of exposure, owners should have their contracts prepared or otherwise carefully reviewed by specialized construction counsel.
Andrew Richards is a co-managing partner – Long Island office, chairman of construction practice group, at Kaufman Dolowich & Voluck, LLP, Woodbury, N.Y.