What You Should Know About Terminating a Contract
A termination is the cancellation of a contract. Accordingly, the concept of termination represents the end of a contract in both general and specific terms. That said, termination can actually progress through several stages, beginning with what can only be deemed as the "literal" termination of a contract and ending with a process that can be characterized as a complete and total destruction of all aspects of the contract, leaving nothing behind for either party.
Although the precise language employed in a contract will help dictate the course of any termination, there are certain general aspects to how a termination process should unfold. These include:
Notice – The first step in any termination is presenting notice to the other party or parties involved. Without notice , you will not have the right to terminate the contract, or at least won’t be able to successfully do so.
Cure Time – After presenting notice of termination to the other party, federal contracting officers must provide a specified amount of time for the contractor to address the issue or "cure" the terms of the contract. While the amount of time is typically 10 days for contractors operating under a fixed-price contract, the time allotted may vary on a case-by-case basis depending on the circumstances.
Termination Letter – Once the cure time has passed without resolution, the authorized official in charge of the contract is responsible for drafting and submitting the termination letter.
Termination by Agreement
Mutual agreement is a less common but still very effective way to terminate a construction contract. In many cases, it can be a wise solution because even though the parties want to end the relationship officially, they will still have to work together for a time after the termination (to finish the work, transfer payment, transfer retainage, settle change orders or address warranty issues).
Generally, if you’ve included requirements such as mediation and arbitration into your contract, you’ll be forced into those proceedings prior to terminating the contract. Some of those proceedings may end in a mutual termination or if one party is found in breach, then the contract terminates.
Outside of these settings, however, this is a straightforward process: just have both parties agree to the termination in writing. In most cases the contract should outline how any outstanding issues, including making final payments or settling a counter claim, are to be resolved. You can decide on various terms, such as extending the contract period, allowing for the contractor to retain a percentage of the contract amount or providing for a set-off to cover damages or uncompleted work.
While termination by mutual agreement is very straightforward, the contract must allow for it and the parties should have addressed terminations without cause, terminations without fault and obligations post-termination (e.g., close-out activities and passing along warranties and manufacturer’s guarantees).
Termination for Cause
A method of terminating a contract allowed in many complex construction contracts is termination for cause. In order to terminate for cause, the party seeking to terminate must have just reason to do so. Termination for cause may occur when a party materially breaches the agreement, fails to pay on time, fails to follow safety rules, follows inferior or defective work, or is guilty of other misconduct. It must be noted that the termination must be based upon conditions prescribed in the contract. A party cannot terminate for any reason it chooses or for reasons that are not enumerated in the contract.
The breach must be so significant or material that it affects the entire contract performance. Termination is not permitted when it only affects a portion of the contract. Though it is true that the courts generally allow an aggrieved party to terminate a contract for cause that has not been fulfilled, the aggrieved party should only terminate the contract after providing the breaching party a reasonable amount of time to rectify the breach.
There are some contracts that allow termination for cause if there is a lack of cooperation with the terms of the contract, and the non-performing party has failed to ensure that the contract will be complied with on a non-temporary basis. A contract may also include a clause that requires termination of a contract for other failures as well as if the contract is abandoned. In addition, termination for cause may occur if the contractor defaults and continues to make mistakes even after the errors have been repeatedly pointed out.
In order to legally terminate a contract for cause, some contracts require that a notice be provided. Both the completion of the notice and the amount of time required from the moment the notice is provided to the contract termination is determined by the contract itself. The notice may be offered by certified mail or letter and notice is completed when it is delivered in person.
Many contracts allow an aggrieved party to continue with the project when a contract is terminated for cause. Therefore, there is often little recourse for the contractor that has had the contract terminated. Termination for cause usually allows the contractor to regain the claimed damages via a trial and/or arbitration. Usually the contractor will attempt to recover the monetary amount it lost due to the contract termination by seeking additional compensation. Courts often rule in favor of the party that terminated for cause.
Termination for Convenience
Another option to consider at the outset and during the administration of the contract is the right to terminate the contract for convenience. A termination for convenience clause can provide the parties with much more leeway and flexibility than a termination "for cause." Rather than having to allow time to cure any defects, deficiencies or failure to perform and give the contractor a chance to fix them, if a termination for convenience clause is present, the contracting party can exercise its right to terminate without cause at any time, subject to any terms and conditions contained in the resulting termination for convenience document.
Under a typical termination for convenience clause, event though a party actually may have (in parallel) a right to terminate for cause, the terminating party, rather than terminating for cause, can instead elect to terminate the contract for convenience and thereby limit any potential liability and resultant consequential damages. In other words, if the owner has a right to terminate for cause for the contractor’s failure to faithfully perform the work, and the contractor is entitled to delay damages as a result of the termination for convenience, then the owner’s exposure can be limited significantly.
Termination for convenience clauses typically state that the contract can be terminated anytime for any convenience whatsoever, without cause. Such clauses usually place the onus on the contractor to submit a termination schedule and/or mitigate its damages. One key term worth having in a termination for convenience clause is that in the event a contractor receives a wrongful termination for convenience (in violation of the express terms of the contract) , the contractor’s recourse should be limited to the amount of the contract price, in addition to its reasonable costs (including home office overhead). For example, a general contractor who has been terminated for convenience by an owner, and who subsequently develops into breach of contract (a claim against the owner), operates under a completely different paradigm. A claims engineer is typically assigned to examine and support the contractor’s claim against the defaulting owner. The contractor who is terminated for convenience should only be entitled to the remainder due under the contract and/or its reasonable costs to terminate its work, and not entitled to consequential damages arising from the wrongful termination for convenience. This provision will help to minimize the contractor’s recoverable damages from a termination for convenience to its actual, direct damages that it incurs (including demobilization costs) to mitigate those damages (including termination damages and/or site cleanup costs).
Under the Federal Acquisition Regulation ("FAR"), typically a reimbursement contractor on a fixed-price contract is compensated at a standard hourly rate, pursuant to its schedule of rates, but it is not relieved from its obligations under the contract. To the contrary, it must complete any unfinished work and rectify any defects of its work and subcontractor work. Most termination for convenience provisions place a duty on the contracting parties to effect an equitable settlement. If mutual agreement cannot be reached, the parties must submit the matter to the appropriate contract administrator or board of contract appeals.
Legal and Financial Consequences
In most termination cases, you have to strictly follow the contractual requirements for termination. If you fail to fulfilled these contractual termination requirements, there is going to be potentially a lot of expensive litigation that follows. For this reason you should always look at the contract first before terminating it with a construction contract.
The terms and conditions of the termination clause are legally binding and as such, courts take them seriously. When issues arise with a termination clause, the courts typically look at the circumstances under which it was written and how it was negotiated. This means, they aren’t likely to look at each section of the agreement or provision in isolation off one another. The court will likely examine whether the contract was fairly negotiated. Then they will consider how the termination clause was written and whether there are any other conflicts between any other provisions in the contract and the termination clause. In determining whether the contract termination clause was in good faith, several factors may be considered . These include whether there was a mutual intention behind the termination clause, whether there was coercion by one party, whether there was undue influence, if independent advice was given before signing, how the contract related to industry practices, if there was an unconscionable bargain, and the like.
In the unfortunate event, where the termination provision is found to be not well drafted, the court will make a decision with regard to the true meaning of the context of the contract instead of applying the actual text. Apart from being required to draft termination clauses properly, the grounds for termination have to be valid as well. You have to give proper notice and follow any other contractual requirements for termination as well. Sometimes disputes will arise over what constitutes ‘serious breach’ or ‘material breach’. For example, does not maintaining a safe workplace constitute a material breach under the contract? Sometimes parties unjustifiably terminate agreements and then end up having to pay heavy damages. It is important therefore that you consider all options before terminating the contract. Seek legal advice about any potential outcomes and damages from a breach of a construction contract in order to evaluate the costs associated with the termination.