Most well-drafted construction contracts expressly recognize an owner’s right to terminate a prime contract upon the default of the contractor. Typically, this right is memorialized in a “termination for default” clause in the prime contract. Most subcontracts contain a parallel clause allowing the contractor to terminate the subcontract upon the subcontractor’s default. Terminations for default should not be invoked lightly. A default termination can be a death sentence — the construction industry equivalent of capital punishment.
Circumstances that constitute a default should be enumerated in typical construction contracts. A typical subcontract may provide that the subcontractor shall be deemed in default if the subcontractor: (a) fails to prosecute the work with promptness and diligence, (b) fails to prosecute the work in a workmanlike, skillful, cooperative, safe and careful manner, (c) fails to supply sufficient, adequate or competent supervision, (d) fails to furnish a sufficient number of properly skilled workmen, (e) fails to supply sufficient materials and equipment of the proper quality and quantity, (f) fails to promptly correct defective or deficient work, (g) fails to promptly pay its sub-subcontractors or suppliers or otherwise fails to faithfully discharge its financial obligations on the project, (h) fails to maintain the project schedule or otherwise materially delays the work of the contractor or other subcontractors, or (i) fails to submit any required progress, procurement and man-hour completion schedules.
Given the harsh consequences of a default termination, contracts typically provide the downstream party with an opportunity to cure a default before the upstream party is allowed to exercise its right to terminate the contract. The extreme act of termination should not be the upstream party’s only option in dealing with a downstream party’s default. Accordingly, contracts typically provide some alternatives. A subcontract may give a contractor several different options if the subcontractor fails or refuses to cure a default within the specified time period. Options might include: (a) supplementing the subcontractor’s workforce, (b) having a second subcontractor take over a portion of the subcontractor’s work, (c) making direct payments to the subcontractor’s material and equipment suppliers, subcontractors, and laborers, or (d) accelerating the subcontractor’s work.
When faced with a threat of termination, or a situation in which termination becomes inevitable, because the downstream party refuses to perform or otherwise cure a default, an owner, contractor or subcontractor should immediately seek the advice of an experienced construction lawyer familiar with construction contracts and termination issues. Decisions must be made quickly and competently to protect each stakeholder’s position. In conjunction with seeking legal advice, the following list of action items will help the defaulting contractor or subcontractor formulate a plan.
1. Document the factual accuracy of any threat of termination or formal notice of termination. Refute, in writing, any inaccurate statements and support your position with relevant documents contradicting the inaccurate statements.
2. Evaluate the legal adequacy of any threat or formal notice of termination. Does the notice comply with the contract? Does the contract provide a right of termination for the alleged breaches of contract set out in the notice? Was the default a material breach of the contract? Does the notice follow contractual procedures concerning timing of the notice, timeframe for a response and right to cure the alleged default?
3. Invoke your right to cure, if the contract allows a cure period. If the termination notice articulates legitimate complaints, then respond within the contractual cure period with a detailed plan of action to cure the default. If the contract does not provide a cure period, submit your detailed curative plan of action as quickly as possible.
4. Implement your curative plan. If the complaints are legitimate, consider taking immediate action to cure the default to avert a default termination.
5. Demonstrate good faith. Showing your commitment to cure the default may go a long way. Agreeing to work overtime, work weekends, add shifts, or expedite materials and equipment may convince the non-defaulting party that you are serious about meeting your contractual obligations and finishing the project. The cost of these efforts may pale in comparison to the costs incurred if terminated.
6. Preserve the evidence. If termination is threatened, carefully and meticulously document the status of your work. Document the as-built status and conditions of the work, as well as any obstacles to performing your work, by marking-up the plans, taking photographs and taking videos.
7. Gather and protect project records. Most contractors and subcontractors have standard procedures in place and project-specific documentation systems to provide, elicit, record and track project data, so that it can be used during the course of the job and efficiently retrieved. Review project records to make sure that you have gathered and organized specific types of project documentation. These records will be important in defending or prosecuting claims that flow from the termination. Gather and preserve any paper documents from jobsite trailers, which may become critically important evidence in resolving claims. Note that after termination, the terminating party may request project records to assist in the completion of your work, such as copies of subcontracts, purchase orders and related outstanding invoices, particularly if the provisions of your contract assign downstream agreements to the upstream party in the event of a termination.
8. Anticipate the possible loss of key project staff. Following a default termination, you may lose one or more valuable members of your project staff. Ask your construction lawyer how best to memorialize the knowledge of your project staff of the issues likely to arise in a later dispute over the termination. Discuss whether to take sworn declarations or affidavits from project staff, while the facts are fresh in their minds, to lock in their testimony.
9. Reassure and cooperate with your performance bond surety. If you are the principal on a performance bond for the project, it’s likely that your surety will be notified of any threats of termination. The surety has discretion to settle claims against the bond and then pursue recovery from you under the general indemnity agreement. Assure your surety of a proper response to the threatened termination.
10. Anticipate potential claims from downstream subcontractors and suppliers. When a contract is terminated, downstream subcontracts and supply agreements will be impacted. Document the status of your subcontractors’ and suppliers’ work in anticipation of potential termination claims. A default termination may impact your ability to pay your downstream subcontractors and suppliers. Make sure that your subcontractors and suppliers have all of the information they need to protect any lien rights they may have and any rights they may have against any payment bond posted by an upstream party. If your contract provides that your downstream agreements will be assigned to the upstream party in the event of a termination, then work with your subcontractors and suppliers to assure a smooth transition so that any damages resulting from the termination are mitigated for all parties.
The facts and circumstances of construction contract defaults vary widely and are oftentimes both factually and legally complex. Given the harsh consequences of a default termination and the death sentence it suggests, contact an experienced construction lawyer at the first sign of trouble.
