3.3.10 Termination Scenarios

• Jurisdiction: Arizona

A few simple scenarios illustrate the principles discussed in this chapter. Following the description of the key factors on which a decision must be made, there is a recommendation whether the contract should be terminated, and whether alternative action might resolve the problem without making it necessary to terminate the contract. However, these termination scenarios are not a substitute for obtaining legal advice and using sound judgment before taking any action that may affect rights or liabilities.

Scenario No. 1: “Delayed but performing.” General contractor is three weeks behind schedule on a project with a 180-day contract time, but it has completed 90% of the project. It has about two weeks of work to complete before it will achieve substantial completion. The contractor and its subcontractors have fully staffed the project, and they are attempting to accelerate their work to make up some of the delay. The contract with the owner also contains a liquidated damage provision of $1,500 per day for every day that the contractor is late in achieving substantial completion.

Recommendation: This situation does not justify a default termination. In fact, the owner might be liable for wrongful termination if it attempted to prevent the contractor from completing its work. The owner has an adequate remedy for the delay in its liquidated damage clause. The owner may be justified in requested assurances from the contractor that it is doing everything necessary to recover the lost time, or it may order the contractor to supply additional manpower to make up time on the project.

Scenario No. 2: “Subcontractor in trouble.” A subcontractor responsible for critical path work has not supplied sufficient labor to maintain the schedule despite repeated demands by the general contractor for supplementation. The general contractor has received calls from suppliers and lien notices indicating the subcontractor is not paying for its materials. An updated survey of the project shows that the subcontractor is over-billed, and it may not have sufficient funds left in its contract to complete its work.

Recommendation: After complying with any notice provisions in the subcontract, the general contractor may be justified in terminating the subcontract for default. If the subcontractor is bonded, the notice of termination (and any show cause notices that precede the notice of termination) must also be sent to the subcontractor’s surety.

Scenario No. 3: “Budget over-run.” Midway through the construction of a highway project, an unanticipated cost increase in a key material threatens to exceed the funds appropriated for the work. The highway department can only cover the material cost increase if it reduces the quantity of roadway paved on the project from the amount originally planned.

Recommendation: Given this material change in circumstances, the highway department may be justified to negotiate either a mutual termination of the contract, or cause a partial termination for convenience. The prime contractor and its subcontractor and its subcontractors will be compensated for the value of their work completed and reasonable termination expenses as provided in the contract term or standard specifications dealing with terminations for convenience of the owner.

Scenario No. 4: “Contest of wills.” Work is proceeding on the project but the contractor and project architect are embroiled in an ongoing dispute. The contractor has stated on several occasions that it intends to file large claims for additional compensation due for extra work allegedly due to defects in the architect’s plans and specifications for the project. The architect believes the contractor made an error in estimating the costs of the project, and is attempting to avoid a loss by submitting change orders for work that is properly within its contract scope. The architect has countered the contractor’s threats by stating that the contractor is incompetent, and it will never receive another contract with the owner.

Recommendation: This scenario illustrates the type of dispute-riddled project that could result in major litigation if an attempt is made to terminate the contract for default. Nor may the contractor unilaterally terminate the contract without the risk of being found in breach. Both parties should consult legal counsel and make certain they have good cause for taking action against the other before proceeding. Mediation or some other alternative dispute resolution procedure may provide a means to resolve the disputes on this project without making it necessary to invoke contract termination clauses.

Scenario No. 5: “No pay, slow pay”. Work is proceeding on schedule on the project and the contractor has completed about 60% of its work. The owner has refused to honor change order requests submitted by the contractor for differing site conditions encountered during the excavation of the project, even though the architect has certified that the change orders are justified. The owner is also running 30-45 days late on paying progress payment applications on the project, and it has taken arbitrary deductions from those pay applications for reasons that the contractor does not accept. The financial impact on the contractor’s cash flow has begun to affect other projects, and it is clear to the contractor that it will incur a loss if it is forced to complete the contract for the original price.

Recommendation: While the contractor may be justified to terminate its performance on this contract due to the owner’s default, it should not take that action without establishing further justification for doing so. The owner’s failure to pay for extra work, and its back-charges, may not be a material breach if it has a bona fide dispute with the contractor over those claims. The contractor should request reasonable assurances of the owner’s ability to resume timely progress payments on the project, and attempt to resolve disputes over its claims and disputed back-charges before claiming the owner is in breach. The contractor should also advise the owner of the potential consequential damages caused by non-payment or slow payment on this project. If the owner fails or refuses to honor its contractual obligations, and the contractor can honestly say the owner’s breach is material, then a default termination may be justified. Even so, the contractor should attempt to complete the project and then assert its contract or lien claims against the owner rather than abandoning the project. If nothing else, the contractor may be forced by the owner to litigate the issue of whether its termination was justified.

Scenario No. 7: “A day late and a dollar short.” The contractor has all but abandoned the project, sending skeleton crews that are not sufficient to keep the work on schedule. The owner learns that suppliers for the project have placed the contractor on C.O.D. terms because it has exceeded its credit limits and failed to pay timely for prior purchases. The contractor’s responses to repeated demands for additional labor and a recovery schedule have been evasive at best. The architect’s representative also reported that a key subcontractor pulled off the job for nonpayment, and the replacement subcontractor has not been maintaining the quality standards or schedule required by the project. The contractor posted a performance and payment bond at the start of the project.

Recommendation: If the contractor does not respond suitably to written notice of deficiencies and demand for cure, the owner may terminate the contract for cause according to its terms. Notice of the termination should be delivered to both the contractor and its surety, and the owner should demand prompt action by the surety to complete the project. The owner must cooperate with the surety in allowing a reasonable opportunity for its investigation and proposal of an appropriate method to complete the project.

Scenario No. 8: “Let’s part friends.” The contractor has mobilized its forces and commenced grading and excavation work. The owner has had difficulty getting permits issued and commencement of the building construction has been delayed significantly. The contractor is incurring additional costs due to the delay, and it has another project to start that will also be impacted by the delay.

Recommendation: This scenario may prove to be suitable for a mutual termination of the contract by negotiation with the owner. Ordinarily the owner is responsible for obtaining permits or other authorizations needed for the contractor to commence its work. If the contractor can spare the owner unnecessary expense by terminating the contract before either party has incurred significant expense from the mobilization, that may yield a good result for all concerned.

Appendix 1 Notice of Excusable Delay

[Name of Contracting Officer]

[Agency Name and Address]

Re: [Contract Name and Number]

Dear _________________:

[Alternative paragraph 1: Event causing delays in completion]

We are writing to advise you that, on [date delay event occurred] we encountered circumstances causing a delay in the completion of this project which were not reasonably foreseeable to [name of contractor or subcontractor] or subject to our control. Specifically, the performance of our work, and that of our subcontractors on this project, was hindered and delayed by [describe nature of delay event]. We presently estimate that this delay will justify a [number of days] time extension on this project. We also anticipate that we will incur additional costs of approximately $ ___________, due to this delay. We will prepare and submit an itemized change order request for this delay event under separate cover.

[Alternative paragraph 2: Damage to completed work]

We are writing to advise you that, on [date delay event occurred] we encountered circumstances causing damage to completed work, and a delay in the completion of this project, which were not reasonably...