A Guide to Termination Agreements for Construction Contracts

What is a Termination Agreement in Construction Contracts?

A construction contract termination agreement, also referred to as a termination of contract agreement, is a legal document utilized in the construction industry to provide a means by which executives of two involved entities (a property owner and construction company) can formally resolve the problems that have arisen between them.
The main purpose of a construction contract termination agreement is to legally document the cancellation of a contract that has previously been entered into by both parties. It is vital that construction contract termination agreements are clear as to the purpose for their execution , whether that purpose be to cancel a contract without assigning responsibility, or to assign responsibility for legal problems to the entity that created them.
Core Elements of a Construction Contract Termination Agreement
The core components of a construction contract termination agreement include:

• objective
• parties
• background
• cancellation date
• payments
• warranty work
• insurance
• indemnification
• dispute resolution
• costs
• additional provisions

After a well-stated and balanced construction contract termination agreement has been signed, both parties will benefit, since a previously damaged working relationship can now show signs of improvement.

Reasons for Termination in Construction Contracts

Construction contracts can be terminated for a number of different reasons. Of course, most contracts provide that any party can terminate a contract if it is in its best interest to do so. However, there are certain circumstances that are more common than others. First and foremost, a contract can be terminated because one party, usually the owner, is not fulfilling its obligations under the contract.
It is not uncommon for an owner to want to terminate a contract when the project is behind schedule. Owners tend to get busy with other projects and believe that they must terminate a contract and hire a new contractor willing to push the project through to completion. If possible, owners should do everything in their power to keep the original contractor. While this may not be in the owners best interest in the near term, it can minimize further expense down the road.
Non-compliance with state codes or federal regulations is another reason for contract termination. Depending on the situation, a contractor may be able to avoid termination for this reason by fixing the code violations. However, if a contractor refuses to remedy code violations, termination of the contract might be appropriate under the facts.
Financial problems are another common reason for termination of a construction contract. If a contractor is facing insolvency, it might be terminated. Additionally, a contract may be terminated if a contractor knows that it will not have enough funds to complete a project if it proceeds under the terms of the contract. A general contractor that does not have enough funds to pay subcontractors may be forced to terminate a contract because of the necessary termination of subcontracts.

Essential Clauses in Termination Agreements

Some of the key clauses in a construction contract termination agreement include the procedure to be followed upon termination, how disputes will be resolved in the event that they arise, the amounts to be paid and issued to the Contractor on termination, and the property rights of both parties. This post looks at these clauses in more detail.
Termination procedure
Contract termination agreements should explicitly provide how a contract may be terminated. For instance, many contracts allow the client to terminate the contract for convenience. This means that the client can terminate the contract without any reason given. If this clause is not included in a contract, it is unlikely that the construction contract can be terminated on the basis of convenience, as the English courts will not imply any right in the absence of a provision being inserted in the contract.
Even where a termination for convenience clause is included in a contract, an express procedure should be outlined in the contract for the termination to be effective. A court will not imply a term into the contract to set out how the termination is to be performed. For example, in Osmanoğlu v Dignam, it was held that a contract could not be terminated with immediate effect if the contract did not specifically state that termination could occur immediately effect. Rather, a reasonable timeframe should be provided in order for the contract to be terminated. Caution should therefore be taken when creating termination provisions in construction contracts so that they are specific as to the circumstances of termination and any other procedural requirements.
Dispute resolution
A standard clause for the resolution of disputes in a construction contract may require any disputes arising from the contract to be referred to adjudication. Hereagain, the contract should set out the terms of the adjudication process, unless both the client and contractor agree otherwise. If an adjudicator wishes to proceed without either party’s consent, the clause should set out whether or not a response should be issued to the claim within a specified period of time. Otherwise, caution should again be exercised when creating provisions concerning the resolution of disputes in a construction contract.
If a contractual dispute arises following a termination, the process for resolving the dispute should be clearly set out in the contract so that the parties are under no doubt as to how the dispute should be resolved. For instance, it should be made clear whether the dispute should be referred to adjudication or arbitration, or whether an expert determination would be the appropriate procedure to be followed.
Payments to and from the contractor
Any amounts that are to be paid to or from the contractor upon termination should be explicitly stated or referred to in the termination provisions of a contract. Any such amounts will usually refer to the sums that must be paid by the client to the contractor for work completed prior to termination. Such sums are described in s111 of the Housing, Grants, Construction and Regeneration Act 1996 (the Act). Under the Act, construction contracts are meant to give full effect to the statutory payment provisions when a contract is terminated.
Some construction contracts do not require evaluation procedures for termination or the calculation of the sums to be paid to the contractor to be followed in accordance with the Act. For instance, in Carillion Construction Ltd v Devonport Royal Dockyard Ltd 2004 ESTL 23, it was stated in the construction contract that no evaluation procedures were to be followed following termination. As such, it was concluded that the sums to be paid to the contractor that were brought in question by the termination of the contract could not be evaluated in accordance with the Act.
Property rights
The termination of a construction contract may leave properties such as work-in-progress, plant, equipment, materials and intellectual property. The treatment of these properties upon termination should therefore be considered in a termination clause. Generally, construction contracts state that all such property rights must be returned to the client upon termination. However, any property rights that are not owned by the client should be returned to the contractor upon termination.
Where a construction contract lapses in accordance with its terms, this is viewed as a termination by negotiation. It should be noted that a court would not require the parties to follow any formal procedure for termination in the same way that a contract for termination would permit.
The above clauses that may be included in a construction contract termination agreement under English law are not a complete list. Indeed, there may be other clauses that may be included as the circumstances require. However, each termination clause must always be clear and unambiguous so that claims can be dealt with appropriately.

Legal Effect of Termination in Construction Contracts

The legal implications of terminating a construction contract require careful analysis. A termination agreement must be based on the contractual framework and align with the provisions of a governing statute, such as the Construction Lien Act. Further, it should reflect the intention of the parties, who are best-placed to negotiate an accommodation that is fair and reasonable under the specific circumstances. Otherwise, there is a risk that a termination agreement will be deemed unenforceable and set aside by the Courts.
It is important for the cancelling party to keep in mind that entering into a termination agreement with the other party does not prohibit or prevent the cancelling party from claiming damages for breach of contract against the terminating party, if the grounds for termination are not valid.
Moreover, contracting parties must consider the position of third party beneficiaries at the time of contract termination. The inclusion of third party beneficiaries in a contractual framework may result in their having a vested and accrued right to performance of the work and the possible obligation to pay for such performance. Even where non-performance of contractual obligations is clear, the intention of the parties becomes significant upon cancellation. In situations where the parties mutually agree to end their contractual relationship, it may reasonably be inferred that the right of third parties to performance of the work also ceases to exist. While this point is likely to be settled if the contract contains a termination provision for convenience, a judicial determination may be required in other circumstances.

Basic Steps for Drafting a Termination Clause

A comprehensive and legally sound construction contract termination agreement requires careful drafting and input from legal experts. The following is a step-by-step process to follow in creating a termination agreement that protects the client’s rights and can be enforced in court.

• – Include Signature and Date Lines. Get the date and signature lines on the agreement before you move on to the next steps. It is much easier to change dates and add parties signatures before you have a completed agreement.
• – Identify Parties and Project. Put in as much information as possible about the parties and the address of the project. Leave no doubt about who is a party to the agreement.
• – Recitation of Action Being Taken. Describe the work being done, i.e. a Cleanup Agreement or a Repose and Withdrawal Agreement, and why it is being done, i.e. remedial actions to address mold or contaminants on the property, etc.
• – Waivers , Releases and Disclaimers. Require all parties to waive or release any claims against any other parties. Include time period limitations for addressing claims that are not discovered until after the agreement is signed.
• – Payment Terms. Stipulate the amount to be paid, when (and if necessary how) payment will be made to all parties to the agreement, and who is responsible for making the payments.
• – Exculpatory Clauses. Include exculpatory clauses in the agreement, i.e. who bears the risk of failure to comply with permits, regulations or other governmental requirements.
• – Insurance Requirements. Require the Contractors to include the client on the Contractor’s insurance policies as an additional insured. Specify that the client has the right to obtain insurance from any other source if the contractor fails to provide the necessary insurance.
• – Engunderline Parties’ Representation. All parties to the agreement should include language that the parties agree that no one is acting under duress and the parties are entering into the agreement voluntarily.

Implications For Project Parties

The parties that are affected when a construction contract is terminated are the contractor, subcontractor, suppliers, and others, such as the bonding company. Obviously the primary party affected will be the contractor who will be obligated to pay its subcontractor and suppliers but may also have to respond to claims made by the owner and the bonding company. The terms of the various contracts will determine the rights and obligations of each party. For instance, with respect to the subcontractors and suppliers, if the contract between the contractor and owner requires the contractor to pay its subcontractors and suppliers, the general rule is that the owner must pay. A well stated rule for both owners and contractors is that an owner is not an insurer. However, many contractor/owner contracts are quite specific as to the obligations of each party with respect to payment obligation to subcontractors and suppliers.
The cost of defending a lawsuit, arbitration or mediation proceeding is generally better borne by the owner. However, the same principle may apply here. The outcome of each dispute would have a serious financial impact on the contractor, subcontractors, suppliers and the surety and, therefore, means should be found to avoid litigation. Each case is different so there cannot be a catchall rule for all cases. The outcome of the Termination will impact on every legal dispute that comes before the court. When dealing with proper plaintiffs and defendants, as opposed to a lawsuit or claim brought in bad faith, ignoring the outcome of the termination will only result in delaying a decision and increasing the cost of ultimately resolving the issue.

Case Examples of Contract Termination

The following examples demonstrate some of the factors and considerations that we’ve discussed above, but in a real-world context. These examples first address contract termination for convenience by the defense department and then by a prime contractor. The lessons learned here apply equally to prime and subcontractor relationships across a broad range of industries.
The U.S. Department of Defense (DOD) issued a contract to build a facility on Fort Benning in Georgia. After spending more than two years on the project, with more than $100 million of costs incurred, DOD terminated the contract for convenience based on both DOD and the contractor’s mutual failure to agree on the design of the facility. The contractor subsequently submitted a settlement proposal seeking compensation for the amounts it had spent on the project. With regard to indirect costs, the contractor relied on its accounting system for determining its G&A and insurance costs, which assumed that home office expenses could be allocated to its work on the project. DOD disputed the contractor’s entitlement to those indirect costs because it could not show that there was a contractual requirement to retain an office in the region or that it was somehow better suited to build a defense industry facility than other commercial builders. Citing to the Federal Acquisition Regulation and the Defense Contract Audit Agency’s Contract Audit Manual, the Armed Services Board of Contract Appeals (Board) rejected the contractor’s G&A and insurance claims and limited it to direct costs only. By way of background, this case involved a dispute between a prime contractor and sub contractor to a defense construction contract. The contract allowed the prime contractor to undertake work on an "as-required" basis , meaning that the prime contractor could unilaterally direct the sub to perform work at no fixed location when required and at a specified unit price. When the prime contractor asked the sub to perform such work, it deferred payment while the sub began to perform, stating that it was taking cash positive control of the sub’s performance. During the period of performance, the sub incurred both direct and indirect costs, and expected to be paid at the rate provided in the contract. The prime contractor, on the other hand, did not pay for the additional work based on its assertion that it was owed warranty remedy costs from a previous project. In other words, the prime contractor argued that it owed nothing because it was in effect exercising a right of set-off. Exercising discretion, the Government ordered the prime contractor to terminate the contract for convenience based on the continued delay in performance and the Government’s need to contract with a more qualified company. Both the prime and the sub questioned the termination for convenience, claiming that their performance was complete and satisfactory and there was no basis for terminating the contract. The AGBCA noted "that a termination for convenience is not made contingent on fault, breach, or defenses raised in response to a suit brought by a contractor for breach of contract." 561 BCA 1723, 2004. It further noted that "a termination for convenience is discretionary and is not dependent on a contractor’s fault." In the end, the ACGBA granted the sub’s request for settlement costs and denied the prime’s claim for a credit. The lesson here is that the Government can terminate contracts for convenience and exercise its rights of set-off to its advantage.