According to the Code of Obligations, an owner may terminate a construction contract in case of delay. Article 366(1) of the code provides that in the event of a contractor's late commencement or failure to abide by the agreed project schedules, or if the works are delayed (through no fault of the owner) to the point that timely performance is no longer possible, the owner may withdraw from the contract immediately without waiting for the contractual completion dates.
In a landmark judgment (BGE 141 III 106) on March 30 2015, the Federal Supreme Court however imposed certain limitations on the owner's right to terminate for delay. In particular, the court ruled that in cases in which the construction contract provides for several distinguishable scopes of work, rather than one inseparable scope, the owner's right to terminate the entire contract for a delay relating to only part of the works is limited. In essence, without contrary language in the contract, the owner which intends to terminate the contract must establish that the delay to part of the works also jeopardises the timely performance of the other separate works. The owner's interest in terminating the entire contract must also be worthier of protection than the contractor's interest in keeping the contract in place for the works that are on time.
The case before the Supreme Court involved a Swiss main contractor which had hired an Italian subcontractor to deliver the façade of a new office building in Bern. The subcontractor's scope of work included a wooden façade and a façade consisting of slats and lamella. The subcontract provided for certain milestones, including
- commencement of work by August 2 2006;
- completion of the wooden facade and 50% of the lamella facade by October 31 2006; and
- completion of all works by February 28 2007.
The parties agreed to extend the time for commencement, but not the other milestones. On October 26 2006 the Swiss contractor wrote to the Italian subcontractor, noting that the works were delayed and granting a time limit of November 10 2006 to remedy the delays. The subcontractor did not respond. On November 13 2006 the main contractor terminated the subcontract and called the subcontractor's performance bond. Protracted court proceedings followed, which ended in the Supreme Court judgment.
A contract between a main contractor and a subcontractor is characterised as a construction contract under Swiss law, with the main contractor being the owner for the purposes of such a contract. The subcontractor in the case before the Supreme Court argued that the requirements of Article 366(1) of the code were not met and that the contractor's termination was unlawful.
It notably argued – but ultimately failed to establish – that by extending the commencement date the parties had implicitly extended the completion dates. The subcontractor also argued that the contractor's 10-day grace period to remedy delays was insufficient, and was in fact a sham, as demonstrated by the fact that the main contractor had already negotiated with a replacement subcontractor during the grace period. The court found that the subcontractor had waived its right to challenge the duration of the grace period, as it had failed to object immediately. According to the court, 10 days was not excessively short, given that when the subcontractor finally objected to the termination, it had asked for only a 15-day extension to complete all works. As to the main contractor's parallel negotiations with a potential substitute contractor, the court did not find it to be objectionable.
The subcontractor further contended that the main contractor could not rely on Article 366 since it was partially responsible for the delay to the works. However, the court found that it was not established that the main contractor had any effect on the subcontractor's failure to reach partial completion in a timely manner.
The subcontractor also took the view that the contract could not be terminated during the first 10 weeks of delay as the parties had agreed on a contractual penalty (which is admissible under Swiss law) of Sfr50,000 per week for a maximum 10-week duration. However, the court ruled that irrespective of the penalty, the owner was entitled to terminate the contract due to delay. Moreover, the contract was governed by the SIA 180 Norms, a standard form contract frequently used in domestic Swiss contracts, which provided that the payment of a penalty did not exempt the party at fault from performing its contractual obligations.
According to the court, the October 31 2006 milestone was a contractually binding partial delivery date. In principle, the subcontractor's failure to meet the date entitled the main contractor to terminate the subcontract. However, the court examined whether the main contractor was entitled to withdraw from the entire contract, or should have left the contract in place for the scope of work that was not delayed.
The court developed a four-step test to establish whether an owner or, in this case, a main contractor, has the right to terminate the contract in case of partial delay.
The first step, was to verify whether the contract itself provided for a remedy for delay to part of the works. In the case at hand, the contract was silent on this issue. However, the mere fact that all the works were included in a single contract did not, in the court's view, indicate any intention of the parties to treat the works as a whole for the purposes of delay.
As a second step, the court analysed whether, as a matter of fact, the works to be delivered were separable. If works can be performed only as a whole, a partial termination is, logically, impossible. The court found that in this case, the works under the contract could be broken into several portions. It noted that different parts of the works could have been performed by different subcontractors. In addition, the works could be priced separately. This was also confirmed by an expert, who was able to break down the lump sum for which the contract provided, and attribute partial sums to different parts of the works.
The court then turned to the third step, which consisted of looking into the reasons for the delay to determine whether past delays foreshadowed delays to the works as a whole. In this case, the subcontractor's delays related to works in which it had no experience, and it therefore depended on its own (sub)subcontractor. The court found that it could not conclude that the subcontractor would also incur delays with respect to other works which fell within its area of specialisation, for which it did not resort to (sub)subcontractors, and which remained on schedule.
Finally, as the fourth step, the court weighed the parties' respective interests. It found that the subcontractor's interest in keeping the contract in place for works that were on schedule was higher than the contractor's interest in terminating the entire contract. The court reasoned that construction works are usually tailor made. The terminated contractor could not simply sell the works on the market. Therefore, termination of the contract as a whole should be a last resort.
The judgment provides valuable guidelines for owners, main contractors and subcontractors in the event of delays to part of the works under a contract or subcontract. The Supreme Court guidelines are case specific, but certain lessons can be learned.
First, Article 366 is not mandatory law. Parties can determine the consequence of partial delays in their contract. Contractors with distinct scopes of work may want to enter into separate contracts for each individual scope or, in the event of a single contract, suggest that in the event of delays to part of the works, only that part can be terminated. Owners, on the other hand, might prefer a provision entitling them to terminate the entire contract for delays to a part of the works, even if other parts are not yet late.
Second, owners should avoid setting unreasonably short time limits for contractors to remedy delays before termination, and contractors should object immediately to grace periods that are unreasonably short (although certain authorities take the position that a contractor does not have to object to a manifestly unreasonable time limit to make an owner's termination unjustified).
Finally, failing agreement to the contrary, owners can terminate the contract and simultaneously claim payment of penalties.
For further information on this topic please contact Matthias Scherer or Samuel Moss at Lalive by telephone (+41 22 319 87 00) or email ([email protected] or [email protected]). The Lalive website can be accessed at www.lalive.ch.
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