Lessons Learned: To Terminate or Not to Terminate?

The old saying that “hindsight is 20/20” rings true in construction, especially with respect to contractor termination. Looking back, the downward spiral towards contractor termination sometimes appears obvious and usually involves either defective performance, delayed performance, or both. Despite what may be seen by the terminating party as clear cut justification, terminations lead to some of the most difficult, and potentially costly, decisions facing a project owner or contractor. Even if the decision to terminate seems unavoidable, it is important to pause, carefully consider the options, and recognize that a misstep may further delay the project, drastically increase the cost, or unnecessarily expose the party exercising its right of termination to significant litigation and substantial damage claims.

Termination for cause is considered a draconian remedy and will be upheld by a court only upon good grounds and rock-solid evidence. A wrongful termination exposes the terminating party to breach of contract damages, including the terminated contractor’s lost profit on the entire contract. A defaulted contractor also may claim that the wrongful termination caused it to be de-barred from certain public bidding lists, suffer reduced bonding capacity limiting its ability to obtain work, or even put it out of business altogether. If the terminated contractor can prove these consequential damages, such evidence can lead to a substantial award.

This very scenario recently played out in favor of our client, Silvi Concrete, who was wrongfully terminated from the W Hotel Project in Center City Philadelphia. The project—a 52-story hotel skyscraper—required a 9-foot thick, concrete mat slab foundation. Due to a change in specifications, the original concrete supplier could not supply the concrete necessary to complete the mat slab foundation in a timely matter. As a result, less than a day before the pour was set to begin, the project’s concrete subcontractor, Thomas P. Carney, Inc., contracted with Silvi to supply not only the mat slab but all of the concrete necessary for the project. Silvi immediately mobilized, supplying 600 truckloads of concrete poured in a continuously for approximately 26 consecutive hours to complete the mat slab. Twelve days after the pour, Carney wrongfully terminated its agreement with Silvi without explanation or cause, but much with much belated rationalizations. After a long-fought litigation and a six-day trial, a jury returned a $1.2 million verdict for Silvi, which completely compensated Silvi for its outstanding contract balance and lost profit on the unperformed work.

Carney’s failure to fully evaluate its basis (or lack thereof) for termination proved costly for Carney and demonstrates the need for careful consideration prior to terminating a contractor for default. To assist owners, contractors, and subcontractors in deciding whether to terminate a construction contract, we suggest taking the following steps when exercising termination rights.

Step One: Begin with a Properly Drafted Termination Clause

All too often, owners and contractors learn of the inadequacies of contract termination clauses amid a termination. The proper time to assess the adequacy of contractual termination clauses is before contract execution. In assessing your termination clause, consider the following:

Does your termination clause clearly define the material breaches that may give rise to a termination for cause?
Does your termination clause contain provisions concerning reasonable notice and opportunity to cure?
Does your termination clause adequately specify each party’s post-termination rights and responsibilities?

Step Two: Consider Supplementing the Defaulting Contractor’s Forces

Termination for default almost always causes delays, cost overruns, and litigation. The risk of these potentially serious consequences can be reduced by exercising your right to supplement the work crew of the defaulting contractor or subcontractor. Thus, it is important to include a “right to supplement” clause in your contracts. If termination becomes necessary, your prior supplementation of forces will help demonstrate that you acted reasonably and explored less drastic remedies before terminating for cause.

Step Three: Follow the Contract Carefully

Because of the draconian nature of a default termination, courts closely scrutinize the terminating party’s exercise of its termination rights. If the terminating party fails to follow the contract provisions or terminates without cause, a court may find the termination wrongful and award the terminated contractor damages for the value of the work performed, lost profits and overhead on the unperformed work, demobilization costs, and other direct damages. Therefore, it is crucial to follow each contractually required step in the termination process:

Determine that adequate grounds for termination exists.
Document, document, document—sufficiently and contemporaneously record the contractor’s poor performance through correspondence, meeting minutes, schedules, daily reports, and photographs.
Carefully follow the notice provisions and other procedural requirements of the contract, including any required notice and opportunity to cure provisions.
Notify and/or consult the owner or the architect and obtain consent to the termination (if required by the contract).
After any notice and opportunity to cure period, confirm that the contract is terminated, even if the contract does not require another notice.

Step Four: Mitigate Damages and Document Any Completion or Corrective Work

In any ensuing litigation, the propriety of the termination will be scrutinized, but the damages following from the decision to terminate will also be closely examined. Following termination, you should take steps to minimize and properly document any additional costs or damages:

Protect the terminated contractor’s work until a replacement contractor is onsite.
Solicit bids from several qualified replacement contractors to make sure that a competitive price is obtained. A fixed price is better than time and material.
Detail the exact state of the defaulted contractor’s work at the time of termination by taking photographs, preparing as-built plans, and documenting any defective and incomplete work.
Require the replacement contractor to provide detailed applications for payment broken down by line item with appropriate backup documentation. If the work is procured on a time and material basis, obtain from the replacement contractor detailed backup documentation, including payroll records, invoices, and daily reports.

Though terminating a contractor for cause is a drastic measure, it is sometimes necessary to part ways before the project has reached completion. Given the risks associated with a termination for cause, it is imperative that owners, contractors, and subcontractors prepare themselves for this possibility. Contractors would be prudent to consult with legal counsel at each of these steps, from before termination is ever thought of, through to the desired outcome.