It’s Not Me, It’s You: Owner Considerations in Terminating a Contractor For Cause

August 16, 2018 Publications

By:  Bill Toliopoulos

Though many construction contracts allow for termination of a prime contractor for cause, owners are reluctant to exercise such a draconian option even when it is abundantly clear that a dysfunctional project relationship cannot be salvaged.  The decision to terminate a prime contractor is often gut-wrenching and fraught with complicated considerations that are often more nuanced than most owners initially recognize.  Careful planning, a bit of self-evaluation, and a clear action plan can soften the blow.

Establish Relationship Rules from the Beginning

While termination for cause provisions in public contracts focus on a contractor’s timeliness in completing work, private contract agreements such as those promulgated by the American Institute of Architect (“AIA”) and the Engineers Joint Construction Document Committee (“EJCDC”) provide more detailed scenarios and exhibit a heavy focus on the contractor’s provision of sufficient manpower to complete the work. Notably, many contracts, including those promulgated by ConsensusDocs employ a more generic (and arguably precarious) standard for triggering an owner’s right terminate a contractor.

The AIA A201 General Conditions §14.2, provides four distinct scenarios for a disappointed owner to terminate a contractor for cause: 1) repeatedly refusing or failing to supply enough properly skilled workers or proper materials; 2) failing to make payment to subcontractors for materials or labor in accordance with the respective agreements between the contractor and the subcontractors; 3) repeatedly disregarding laws, ordinances, rules, regulations or orders of a public authority having jurisdiction; and 4)  otherwise substantially breaching a provision of the contract documents.

Similar to the AIA, the EJCDC provides for-cause termination in the event of contractor’s: 1) persistent failure to perform the work in accordance with the contract documents (including, but not limited to, failure to supply sufficient skilled workers or suitable materials or equipment or failure to adhere to the schedule); 2) disregard of laws or regulations of any public body having jurisdiction; 3) repeated disregard of the authority of the project engineer; or 4) a substantial violation of the contract documents.

In contrast to the AIA and EJCDC, some construction contracts, including ConsenusDocs, provide a different approach, simply allowing an owner to terminate a contractor for cause if the contractor “fails to commence and satisfactorily continue correction” of any default set forth in an owner’s notice to cure. While generic contract language similar to the ConsensusDocs example above provides owners wide latitude to invoke their right to terminate for cause, sometimes these types of nebulous provisions give rise to additional disputes.

Typically, owners choose to terminate contractors when at least two of their three key needs are not being satisfied: schedule, cost and/or quality.  Although many owners can endure various shortcomings of their prime contractor during a construction project, the likelihood that an owner will begin to look elsewhere significantly increases when the number and/or amount of unsatisfactory conditions and disappointments continue unabated.      Though termination may be the last thing on an owner’s mind during the contract drafting phase, in order to ensure that appropriate safeguards are in place, care should be taken to draft agreements that provide a clear set of circumstances that give rise to the “nuclear option” of termination for cause.

The Grass Is Greener…Right?

While the decision to terminate a contractor is never taken lightly, owners should weigh the comparative advantages and disadvantages of ending a dysfunctional project relationship.  Termination for cause effectively ends one or both parties’ contractual obligations prior to the completion of the project.  Therefore, careful consideration should be given to potential consequences.

Below are some of the potential advantages of a termination for cause that should be considered:

  • A termination for cause may allow the owner to establish a “hard re-set” on schedule and cost with a replacement contractor;
  • A termination for cause may permit the owner to spend project capital on construction costs, rather than attorneys’ fees, consultant costs or questionable change order requests by the original contractor;
  • A termination for cause may allow the owner to re-assess and perhaps maneuver around pitfalls and complications that original contractor could not overcome; and
  • A termination for cause may put the owner in a position to select a new contractor with a particular sub-set of expertise to push the project to completion (i.e. complex scheduling of a historic mixed use re-development).

There are disadvantages to a termination for a cause that must also be considered.  Though the timeliness of project completion is often threatened, additional costs incurred, and the owner is exposed to damages in the termination context – there are also a number of practical drawbacks that an owner should evaluate.

First, although an owner may yearn for a fresh “re-set” of a construction project through the introduction of a new contractor, replacement contractors are often (and sometimes justifiably) leery – believing that a complicated project and/or owner may be more trouble than a projected fee is worth.  As an initial consideration, owners that are “back on the market” should understand that a replacement contractor will likely not agree to a stipulated sum contract or even a conservative GMAX contract to complete a project.  A follow-on contractor may charge a premium to deal with the proverbial soap opera of disgruntled subcontractors, incomplete work and disappointed expectations that the original contractor left behind.  More likely than not, replacement contractors will require a cost-plus contract arrangement with either no guaranteed maximum price or a GMAX loaded with contingencies and allowances to protect them from a myriad of risks.

Second, it is likely that lien and bond claims will be asserted by subcontractors following an original prime contractor’s termination.  Owners should also be prepared for possible turnover because the replacement contractor may prefer to terminate subcontractors with which they have no previous relationship in favor of their own preferred tradesmen.

Third, owners should be prepared with conservative expectations regarding project recovery.  A project’s schedule and costs may never fully recover to match the original pro forma that an owner had keenly and optimistically prepared.  Depending on the overall project duration and an owner’s reluctance to change direction through termination, it is likely that the inefficiencies of stopping and re-starting work will have an adverse effect on a construction schedule.  As a corollary, work quality may be incomplete/compromised and various warranties would likely be voided or unavailable despite design specifications or intentions.

Fourth, to the extent defective conditions are discovered at any time during a replacement contractor’s work on a project, an owner will likely have limited or no recourse against liable trades simply because these subcontractors are no longer on the project or do not feel the same sense of loyalty they felt with a terminated contractor.

The grass in not always greener on the other side.  Before firing of a termination letter, an owner must carefully assess the potential consequences of such action.

Take a Look in the Mirror

When considering whether to terminate a contractor for cause, an owner must also make sure to take a long hard look in the mirror.  Prior to pulling the termination trigger, an owner should confirm that it has fulfilled its own contractual obligations, abided by the contract dispute resolution procedure, and timely and fairly considered the contractor’s claims.

Taking Control of Your Destiny: Practical Strategic Considerations

Once the decision to terminate a contractor has been made, owners should develop a concise strategy to minimize internal and external disruptions as well as re-initiate project momentum.  Though every project is different, some key action items to help get the project back on track include:

  • Review of the contract documents to ensure that termination is being executed in accordance with agreed-upon procedures. For example, AIA contracts typically require the project architect or Initial Decision Maker to verify and sign off on the basis for termination;
  • Providing written notice to all relevant insurers (i.e. Builder’s Risk, CGL, professional liability) and obtain updated certificates of insurance from subcontractors with corrected additional insureds;
  • Analyzing loan documents and operating agreements to ensure proper notices and approvals are obtained;
  • Providing notice to title company and providing clear direction on how payment applications and payments are to be handled going forward;
  • Notifying all sureties and obtaining written acknowledgment of contractor termination in advance;
  • Providing written notice of contractor termination to each subcontractor/supplier and informing same of any new arrangements (multi-prime versus new general contractor);
  • Arrange for 3rd party professional video and/or photographic record of all site conditions immediately prior to termination (within 24 hours);
  • Arranging for gate and door locks to be changed immediately;
  • Arranging for 24-hour security personnel to guard site (for at least 30 days);
  • Notifying municipal authorities of contractor change (i.e. permit revisions);
  • Identifying what on-site equipment is owned vs. leased and keeping track of who is responsible; and
  • Taking title to key owned equipment on site to reduce de-mobilization and re-mobilization time and costs.

Developing and implementing an action plan will help keep the transition interruptions to a minimum and steer the project back on course.

It’s OK to Keep Score:  Documentation is Key

Diligent documentation is critically important to owner’s claim preservation and also to the project’s successful completion.  A prudent owner should make an effort to:

  • Confirm that project records communicated to the contractor contain a concise list of reasons for termination and are based on the procedural and substantive guidelines in the construction contract;
  • Perform an audit of all proposed and executed change orders between owner and contractor as well as those between contractor and subcontractors to ensure scope, cost and schedule coincide;
  • Prepare and execute assignment, assumption and/or consent agreement between owner, new prime contractor and each subcontractor clearly establishing the transition and the parties’ respective rights and responsibilities;
  • To the extent subcontractors refuse to continue to work on the project and are not contractually obligated to do so, ensure that each such subcontractor documents their reasons for refusing and the costs associated with any change in tradespeople; and
  • Diligently track unanticipated project costs/delays and document the reasons for each, such as:
    • Price escalation
    • Remobilization costs
    • Unrealized/unused tax credits
    • New/additional insurance and bond premiums.

Conclusion

Though terminating a contractor for cause is a drastic measure, it is sometimes necessary for an owner and contractor to part ways before the project has reached completion.  Given the risks associated with a termination for cause, it is imperative that an owner proactively prepare itself for this possibility at the contract drafting stage, fully and thoughtfully evaluate the potential consequences before pulling the trigger, and develop and implement a plan to make the process as painless as possible and steer the project back on course.

© Laurie & Brennan, LLP 2018

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