Andrew Richard, Kaufman Dolowich VoluckAn owner’s decision to terminate a contractor’s contract can be a risky proposition which, if not executed properly, could result in protracted and expensive litigation and ultimately in the owner paying substantial damages to the terminated contractor. In many cases, it is clear that the contractor has failed to fulfill its obligations under the contract (i.e. fails to perform any work, goes bankrupt, etc.) and, thus, termination for cause is warranted. When a construction contract is terminated for cause, the owner generally is entitled to stop paying the contractor and to seize the contractor’s materials and equipment. The contractor also becomes liable for the additional costs incurred by the owner in a having another contractor complete the contract work.
However, in some cases whether or not the contractor has defaulted is not clear cut. In other cases, an owner may be unable to secure or maintain the financing needed to complete its project and wants to stop work thereon. When these situations arise, the owner is at risk of having a court, after years of expensive litigation, ultimately determine that its termination of the contractor for cause was wrongful. In such cases, the contractor could be entitled to significant damages from the owner, including, but not limited to, the profits it would have earned on the project if it had completed all of the work under the contact. The owner also would have to bear all of the costs of having another contractor complete the terminated contractor’s work.
In order to protect against itself such findings, and the costs associated therewith, there are several critical provisions that owners should insist be included in every construction contract that they enter into. First, an owner always should insist that construction contracts contain a “termination for convenience” clause which allows the owner to terminate the contract for any reason regardless of whether the contractor is in default of its obligations under the agreement. A termination for convenience allows both the owner and contractor to walk away reasonably satisfied. In most cases of termination for convenience, the contractor is entitled to receive payment for the work it completed up until the date of termination. The owner also benefits because, unlike in cases in which a termination for cause is deemed wrongful, the contractor cannot claim anticipatory profits on work not completed prior to the termination or consequential damages resulting from its termination.
To ensure that it enjoys the full benefits of a “termination for convenience” clause, an owner should ensure that its contract also contains a provision which provides that, in the event that an owner’s termination of a contractor for cause is determined to be wrongful, such termination will be converted to and treated as a termination for convenience. While a determination that an owner’s termination of its contractor was for convenience rather than for cause would result in increased costs to the owner, the cost increase would be significantly less than what the owner would incur if the termination was deemed wrongful.
Furthermore, owners should always insist that contracts contain provisions whereby the contractor agrees to waive consequential damages, incidental damages and lost profits.
A termination for convenience clause, however, is not necessarily a free pass for owners who do not act in good faith towards their contractors. In every contract, there is an implied covenant of good faith and fair dealing. Thus, in situations where am owner exercises a termination for convenience clause in bad faith, the contractor may be able to successfully argue that, notwithstanding the termination for convenience clause in the contract, the termination by the owner was still wrongful.
For this reason, it would be prudent for an owner to discuss its intent to terminate its contractor, and the grounds upon which it intends to terminate, with its attorneys prior to serving the notice of termination.
Andrew Richards, Esq., is a partner at Kaufman Dolowich Voluck, Woodbury, N.Y.
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