Termination clauses – a necessity in construction

Many construction contracts contain provisions which permit the parties to terminate their relations under certain circumstances. These provisions are widely referred to as “termination clauses” within the industry.

Termination clauses can generally be broken into two distinct categories: clauses allowing termination for cause and clauses allowing termination for convenience. Termination for convenience clauses allow a party to terminate for any reason. Termination for cause clauses typically allow a party to terminate only if the other party materially breaches the contract.

Many construction contracts allow the owner to terminate the contract at its convenience. Ostensibly, this allows the public or private owner to cap its costs and shut down a potentially expensive construction project without being liable for all of the contractor’s anticipated profits.

Termination for convenience clauses generally permit the contractor to recover the costs of its performance prior to the termination, plus a reasonable profit for work completed. Because the contractor cannot recover all profits he earned by completing the contract work, the owner is insulated against large lost-profit and business devastation damage claims.

Termination for cause is limited to only those situations in which the other party to the contract materially breaches one or more of its obligations. Most contracts require written notice of a default before termination. The intent is to give the breaching party an opportunity to cure its default and continue contract performance.

Termination for cause provisions usually require a “material breach.” A material breach is a failed or improper performance that is so serious that it defeats a central purpose of the contract or makes continuation of the contract useless or impractical.

For example, a contractor may commit a material breach by its failing to properly man the project for a sustained period of time or by failing to commence construction. An owner may commit a material breached by failing to make payment.

Whether a breach is material enough to justify termination is determined on a case-by-case basis. Many times, breaches by contractors such as the failure to prosecute work to the satisfaction of the owner have been found to be not sufficiently material to justify termination.

Likewise, an owner’s failure to make payment may not always justify termination such as when an offset for other claims or damages exists. Consequently, establishing materiality prior to exercising the right to terminate is critical to avoid liability for wrongful termination.

Whether or not a breach is material is almost always subject to interpretation and a common subject of construction litigation.

Termination for cause should be viewed as a mechanism of last resort. What may seem material today may later be judged as less than material when a party’s actions are examined under the harsh light of a courtroom.

The consequences of wrongful termination are severe. Wrongful termination is itself a material breach and will relieve the other party from its remaining contractual obligations.

It may also make the terminating party liable for claims for delays, lost profits and catastrophic business loss damages. Some owner-drafted contracts attempt to avoid this result by treating a wrongful termination for cause as a termination for convenience.

Experience suggests that termination should be used carefully because it leaves the terminated party with no alternative but litigation. At times it is necessary if a party is unable or completely unwilling to perform, but it is a remedy of last resort. Use it cautiously.

Arnold Wagner is an attorney with Meuleman & Miller LLP. He may be contacted at [email protected].