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Prepare for Tomorrow by Reviewing Your Contract Today – Termination Clauses

March 26, 2020

Overview

In response to COVID-19, owners, contractors, and subcontractors should be evaluating their existing contracts, including clauses related to force majeure, claims for increase in Contract Sum and/or Contract Time, delays, extensions of time, emergencies and notice. Such evaluation allows proactive, collaborative dialogue to occur between owners, contractors, and subcontractors in an effort to mitigate the effects of COVID-19 on a project’s labor, materials, schedule, and/or completion.

Even with the parties’ best efforts, invoking termination and/or termination for convenience clauses may become necessary to mitigate protracted work, labor, and/or material delays. Private construction contracts typically provide that an owner, contractor, or a subcontractor can terminate a contract if certain conditions are met.

For example, Article 14 § 14.1 of The American Institute of Architects’ (“AIA”) A201-2017 allows a contractor to terminate a contract with the owner if work is stopped for a period of 30 consecutive days through no act or fault of the contractor or its subcontractors, for certain reasons including: 1) issuance of an order of a court or other public authority having jurisdiction that requires all work to be stopped, or 2) an act of government, such as a declaration of national emergency that requires all work to be stopped.[1] The contractor may terminate the contract and recover payment for work executed, including reasonable overhead and profit on work not executed, and costs incurred by reason of such termination after providing seven (7) days written notice to the owner and architect.

Similarly, Article 14 § 14.4 of the AIA A201-2017 allows an owner to terminate a contract for convenience and without cause upon the contractor’s receipt of written notice of such termination. The contractor would need to cease operations as directed, take action necessary for the protection and preservation of the work, and terminate all existing subcontracts and purchase orders. If a contract is terminated for the owner’s convenience, the owner shall pay the contractor for work properly executed, costs incurred by reason of the termination (including costs attributable to the termination of any subcontract), and a termination fee.

The termination provisions of the “Prime Contract” are usually referenced and/or integrated with subcontract specific termination clauses included in contracts between the contractor and its subcontractors.

It is important for owners and contractors to understand distinctions on the legal consequences that flow depending on whether a termination is “for cause” or “for convenience”.  In a termination for cause scenario, the party declaring the termination may have to prove that the “cause” was justified. If the cause for termination was not justified, the party declaring the termination may very well be responsible for consequential damages that flow from the unjustified termination. 

In a termination for convenience scenario, the party declaring the termination is relieved of the obligation of proving cause, and relieved of the exposure to consequential damages if the termination was not justified.  However, the party making the declaration waives all contract defenses to payment. In other words, if an owner decides to terminate a contractor for convenience, the owner cannot offset costs for alleged defective work against the sums otherwise due to wind up the contract. We have seen several instances where owners or contractors believe they can terminate for convenience and attempt to back charge for allegedly defective work they correct, only for the owners or contractors to discover that opportunity is waived.

The Oregon Court of Appeals held that “at least in the absence of an opportunity to correct allegedly defective work that, where a party has terminated a contract for convenience, that party may not then counterclaim for the cost of curing any alleged default.”[2] Washington courts have not addressed this issue. Nevertheless, any owner or contractor contemplating a termination for convenience should consider whether there is any defective and/or deficient work that needs to be addressed prior to termination.

Public construction contracts also usually include provisions addressing terminations for convenience. For example, Federal Acquisition Regulation (“FAR”) 52.249-2 provides that the government may terminate performance of work under a contract if the contracting officer determines that a termination is in the government’s interest. Upon receipt of such notice, the contractor must stop work, place no further subcontracts or orders, terminate all subcontracts, assign all right, title and interest to the government (as directed by the contracting officer), and complete performance of the work not terminated, amongst other items. Contractors should promptly request adjustment of costs and time to protect their entitlement to such additional costs and/or time.

It is vital that an owner, contractor, or subcontractor review and understand these provisions to ensure compliance, payment, recoupment of costs, and to avoid being caught flat-footed should such drastic action be necessary.  Rights will differ greatly from contract to contract so a thorough analysis of the specific contract in question is required.

To learn more, view helpful videos, or read additional articles about COVID-19, please visit Schwabe's COVID-19 resource page.

[1] A contractor may also terminate the contract if, through no act or fault of the contractor or its subcontractors, work is repeatedly suspended, delayed, or interrupted more than one hundred percent (100%) of the total number of days scheduled for completion or 120 days in any 365-day period, whichever is less.

[2] Shelter Prod., Inc. v. Steelwood Const., Inc., 257 Or. App. 382, 402, 307 P.3d 449, 461 (2013).

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