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Breaking up is hard to do... Termination issues in construction contracts

This article is designed to give a brief overview of terminating a construction contract using the contractual provisions of the contract or at common law. It supplements a more detailed lecture, which can be delivered in house upon request, by Catherine Piercy and Brenna Conroy.

Contractual Right to Terminate

The majority of standard form building contracts contain express termination clauses that provide the Employer and Contractor, or "Either Party" with the right to terminate the contract in specified circumstances.

A contractual right to terminate is often the preferred method of bringing a contract to an end because sometimes it does not require a breach of contract to be proved at all and, even where it does, the right to terminate can be exercised even if the breach is not of a repudiatory nature required for a common law determination. The contractual provisions also provide certainty as to the procedure to be followed by an innocent party and are often drafted to allow for a period of grace during which the party in default can remedy its breach and may, therefore, avoid disruption to the project or a breakdown of commercial relations.

Notice Requirements

Terminating pursuant to a contractual right often requires a notice or notices to be served. It is of paramount importance to pay close attention to the notice requirements of the contract. The form, content, timing and mode of service of the notices is normally set out in the contract and, as far as possible, should be followed to the letter. 

In respect of the content of the notice, it is advisable to refer specifically to the clauses of the contract as well as their content when drafting notices, as although a purposive interpretation will be given to notices, a reasonable recipient of the notice must be left in no doubt as to its meaning (see Reinwood Ltd v L Brown & Sons Ltd [2008] UKHL 12).

Time limits will be interpreted strictly and are likely to be a condition precedent to valid termination. Therefore, it is important to consider: whether time is calculated on the basis of business days and/or clear days; how the contract deals with public holidays; and how the “deeming” provisions for dates of service operate under the contract.

Contrastingly mode of service is not likely to be critical to validity of the Notice, provided an equally efficacious mode of service is adopted and the notice actually reaches the recipient, see Sun Alliance and London Assurance Co Ltd v Hayman [1975] 1 All ER 248 CA.

Care must be taken to ensure that the notice is given and received by the correct person; the recipient must be correctly identified and served at the right address. As a general rule, default notices are given by the Architect/CA (there are legitimate reasons for this, see Sutcliffe v Thackrah [1974] A.C. 727 at 737) and termination notices are generally given by the Employer.

There are also a number of other general principles to bear in mind when considering issuing default/termination notices:

  • Don’t delay! Affirmation can apply even to contractual rights to terminate and even where there is a “no waiver” clause: Tele2 v the Post Office [2008] EWHC 158 (QB).
  • Where the contract requires service of a Default Notice prior to a Termination Notice, there must be a “sensible connection” between the two Notices both in content and time: Architectural Installation Services Ltd v James Gibbons Windows Ltd 46 B.L.R. 91.
  • Under the JCT standard terms, once the first default notice has been served, the Architect/CA has no right to serve a further default notice if the default is repeated, but it is entitled to terminate the contract: Robin Ellis Ltd v Vinexsa International Ltd [2003] BLR 372.

Contractual Rights - Contractor

Examples of the types of circumstances which may be expressly provided in the contract as giving the Contractor a contractual right to terminate are:

  • non-payment;
  • interference with or obstruction of the issue of any certificate;
  • an assignment of the construction contract by the Employer without consent;
  • a failure by the Employer to comply with CDM regulation requirements; and
  • if the works are suspended for a continuous specified length of time caused by Architect’s/CA’s instructions or any act of prevention by Employer.

The Contractor may also have a right to suspend works as implied by statute: see s.112 of the Housing Grants, Construction and Regeneration Act 1996 as amended.

Contractual Rights - Employer

The common express clauses giving the employer the right to terminate are:

  • suspension without cause/abandonment of the works;
  • failure to proceed regularly and diligently/with due diligence (see West Faulkner Associates v London Borough of Newham 71 BLR 1 at p14 and Sabic UK Petrochemicals Limited v Punj Lloyd Limited [2013] EWHC 2916 (TCC);
  • refusal to comply with an instruction requiring to remove works/goods not in accordance with the contract/failure to remedy defects;
  • sub-contracting or assigning without consent;
  • failing to comply with the CDM requirements; and
  • failure to provide security required by contract, e.g. performance bond.

Note that the JCT suite of contracts provide that notice of termination of a Contractor’s employment shall not be given "unreasonably" or "vexatiously". In John Jarvis Ltd v Rockdale Housing Association Ltd (1986) 10 ConLR 51, the Court held that “When used in a legal context, the adverb 'vexatiously' connotes an ulterior motive to oppress, harass or annoy… 'Unreasonably'… is a general term which can include anything which can be objectively judged to be unreasonable”. However, a Notice is unlikely to qualify as unreasonable simply because it turns out to stem from a mistaken decision. 

Termination by Either Party

The standard form contracts also contain clauses which deal with events that give either party the right to terminate. For example:

  • “At will” clauses (see TSG Building Services Plc v South Anglia Housing Limited [2013] EWHC 1151 (TCC))
  • force majeure;
  • loss or damage to the works caused by specified perils (save where caused by the Contractor);
  • civil commotion/terrorism;
  • act of Government directly effecting the execution of the works; and
  • insolvency (of the other contracting party)

Common Law Right to Terminate

If there are no express termination provisions in a contract, your client is left with no other option but to look to the common law and determine whether or not there has been a repudiatory breach of contract. If this is established, it would entitle your client to elect to put an end to all remaining primary obligations of both parties under the contract.

However, the right to treat a contract as repudiated at common law is also applicable to contracts which contain express termination provisions (see Stocznia Gdynia SA v Gearbulk Holdings [2009] EWCA Civ 75). It is important to give careful consideration to the common law right as it may in fact give your client a better option than terminating under the contract.

Whether to terminate under the contract or at common law is dependent upon a number of factors:

  • The type of breach that has occurred: for example, it may become necessary if the breach being alleged is that the other side have wrongfully exercised their contractual right to terminate. In such circumstances, the contract would not provide a remedy for that breach so your client would need to look at the common law.
  • A consideration of the level of damages that may be awarded: termination at common law can be more attractive because the damages awarded are more considerable under the common law. If a party establishes a repudiatory breach of contract, it is usually entitled to "loss of bargain" damages, which is compensation for the loss of profit due to the contract not being performed in future. Damages as a result of termination under a contract will usually be limited to loss suffered up to the date of termination unless the contract expressly provides otherwise.
  • Whether the common law right is expressly (or impliedly) excluded by the terms of the contract: look out for clauses that provide that the contract may only be terminated by exercising a contractual right (however, an attempt to exclude or limit liability for breaches of contract, or attempts to restrict the available remedies, may be caught by the Unfair Contract Terms Act 1977 or the Unfair Terms in Consumer Contracts Regulations 1999).

What is a Repudiatory Breach?

A repudiatory breach occurs when a party commits a breach of contract that is sufficiently serious that it entitles the innocent party to treat the contract as terminated with immediate effect and to sue for damages for breach of contract.

In the construction context, the following constitutes a repudiatory breach of contract justifying termination at common law: (a) a breach of condition (as opposed to warranty); (b) a refusal to perform; and (c) a sufficiently serious breach of an intermediate/innominate term.

A breach of an intermediate or innominate term (i.e. neither a condition nor a warranty) only justifies termination if the breach is sufficiently serious. It must "go to the root of the contract", "frustrate the commercial purpose" of the contract or "deprive the party not in default of substantially the whole benefit” of the contract: Hong Kong Fir Shipping Co. Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26. In every case, the court will look at the nature and consequences of the breach to decide whether termination is justified.

Ordinarily, certain extreme types of breach will amount to a clear repudiation of a construction contract. Examples include an absolute refusal to carry out work (without lawful excuse), abandonment of the site or removal of plant by the contractor or a failure by an employer to give access to the site.

Other breaches may not be clear-cut. In circumstances where there has been, for example, delay by the contractor, a failure to pay instalments by the employer or a wrongful suspension of works by the contractor, whether or not the breach amounts to a repudiation is dependent on the facts of the case, applying the test set out above in Hong Kong Fir.

For example, delay on the part of the contractor (where time is not of the essence) does not amount to a repudiation unless it is such as to show that it will not, or cannot, carry out the contract or that the delay is such as to deprive the innocent party of substantially the whole benefit of the contract. See for example Hill v London Borough of Camden (1980) 18 B.L.R. 31, CA: a breach under a JCT Contract for failing to proceed “regularly and diligently” did not amount to a repudiatory breach of contract. However, where time is of the essence either by virtue of the terms of the contract, or as a result of a notice making it of the essence, and the contractor fails to complete to time, the employer is entitled to treat the contract as at an end and to dismiss the contractor from the site: Rickards v Oppenheim [1950] 1 K.B. 616 at 628, CA.

In respect of a contractor who has suspended works, it is important to remember that in the absence of an express term, there is no general right to suspend work if payment is wrongly withheld (although as discussed above s112 of the Housing Grants, Construction and Regeneration Act 1996 as amended gives a contractor a statutory right to suspend performance of its obligations in the absence of payment in certain circumstances). In Mayhaven Healthcare Limited v (1) David Bothma (2) Teresa Bothma (t/a DAB Builders) [2009] EWHC 2634 (TCC), the Court had to consider whether, if a Contractor under a construction contract breaches that contract by wrongfully suspending the works, such conduct amount to a repudiatory breach of contract. Mr Justice Ramsey explained at [26]:

"...As Lord Wilberforce said in Woodar v Wimpey a party who bonafide relies on an express provision of the contract, in the present case to suspend performance, is not by that fact alone to be treated as having repudiated his contractual obligations if he turns out to be mistaken in his rights. Rather, that is one factor. The suspension must be viewed in the light of all the facts and circumstances of the case.”

Again, this reaffirms the position that in all but the clearest of cases (i.e. extreme types of breach discussed above), the answer as to whether there has been a repudiatory breach is fact specific, applying the test in Hong Kong Fir, which explains why terminating under the common law is inherently more risky than terminating under the contract.

Election

It is important to remember that termination is not automatic; the innocent party may elect either: (a) to accept the breach and treat the contract as discharged; or (b) to affirm the contract and urge the party in breach to perform. The danger for your client when making this decision is that they must take care not to jeopardise the right of election by either taking too long to respond or losing the right of election by inconsistent conduct, for example by operating the termination provisions of a contract, which would appear to be an affirmation of the contract (although see discussion below). If your client affirms the contract and then seeks to treat it as repudiated, it puts itself at risk of being in repudiatory breach.

In order to minimise the risk of losing the right of election, your client should take care to reserve its position. In Stocznia Gdanska SA v Latvian Shipping Co [2002] 2 Lloyd‘s Rep. 436, CA, the Court held that if an innocent party maintains the contract in being for the moment, whilst reserving the right to treat it as repudiated if the other contracting party persists in its repudiation, then the innocent party is deemed to not have exercised its right of election.

Relationship Between Contract and Common Law

Can an employer can hedge its position and rely on the contract and common law? The immediate answer would appear to be no: operation of a contractual determination provision, prima facie would appear to operate as an affirmation of the contract, which is inconsistent with accepting the event in question as a repudiatory breach: Fercometal v Mediterranean Shipping [1989] A.C. 788 at 805, HL.

However, in circumstances where a termination clause is expressed to be “without prejudice to any other legal or equitable right or remedy”, the exercise of the contractual right of termination may not be an affirmation of repudiatory conduct such that there would appear to be no difficulty in that party subsequently relying on the same events as a ground of a repudiatory breach.

In the absence of such a clause, the position seems unclear. It has been held that a party may, prima facie, rely both on its contractual and common law rights, without thereby affirming the contract. See: Stocznia Gdynia SA v Gearbulk Holdings Ltd [2009] EWCA Civ 75, Dalkia Utilities Services Plc v Celtech International Ltd [2006] 1 Lloyd‘s Rep. 599, Shell Egypt West Manzala GMBH v Dana Gas Egypt Ltd [2010] EWHC 465 (Comm). However, each of these cases is fact specific and careful consideration should be given to the principles applied in each of these authorities.

Practical Tips

When considering terminating either at common law or under the terms of the contract, it is crucial to pay consideration to the following:

  • Do the necessary circumstances arise – for contractual termination and repudiation?
  • Is the timing right – has there been an affirmation of the contract?
  • In choosing the contractual procedure, have you:
    • served the right notices;
    • by the right person;
    • to the right person;
    • using the right form of service;
    • within the required time period?
  • Have you got evidence, for example from other members of the project team, a delay analysis, a defects report, meeting notes, correspondence, etc.?

Preparation is key:

  • Where appropriate (and it nearly always will be), notify the Employer/Contractor of the issue in writing.  This may be your “default notice”, but be careful not to affirm!
  • Give the employer/contractor the necessary time to rectify any default or, at the very least, respond to the complaint.
  • Then issue the termination notice – but be consistent with your reasons. 

Think about the consequences of termination for your client and the project

  • Have you got a strategy, e.g. an alternative contractor lined up?
  • What will happen to subcontractors – novation/new appointments
  • Have you got all the necessary collateral warranties?
  • Who has the project insurance?
  • Can the contractor recover payment through adjudication without terminating, i.e. can he afford to continue pending payment?