In the current financial climate, it is not surprising to find many property developers considering the commercial viability of their prospective and ongoing projects. Funding issues, falls in investment value and difficulties in finding potential tenants may all lead developers to consider cancelling or mothballing projects to which they have already committed. What many developers may not expect however, is that, once they have engaged a contractor to carry out their planned project, walking away may not be as easy as simply carrying out a financial appraisal of their potential investment and then deciding not to proceed.
The developer's right to terminate a building contract
Many straightforward development projects in Scotland are carried out under building contracts based one of the JCT/SBCC standard forms. These forms are familiar to most developers, who are used to operating their provisions on a day to day basis in a more buoyant market, and it may therefore come as a surprise to these developers - who may never have had to consider the issue before - to discover that these standard form contracts only permit termination in certain limited circumstances (insolvency or on the occurrence of specified breaches). The Employer under a JCT/SBCC contract has no right to terminate "at will" (although some other standard form contracts, such as the NEC forms, do provide for this). While JCT/SBCC contracts set out a contractual mechanism and provide for an accounting process to establish monies due in the case of termination on the basis of one of the specified grounds, no mention is made of the possibility of termination for any other reason (e.g. simply because the developerr has decided not to proceed with the project) and the issue is left to be dealt with at common law.
Consequences of termination due to the project being cancelled
Termination of a JCT/SBCC contract purely on the basis that the project has been cancelled will amount to repudiation of the contract by the developer. In these situations a contractor has two options: either ignore the purported termination and insist on performance by the developer, or accept the repudiation and sue for damages. In practical terms, ignoring an employer's repudiation may not be an option that is open to the contractor, as he will almost always need the developer's ongoing co-operation in relation to issues such as access to the site, issuing of instructions and the contractor will obviously also want to be paid for any work done. Performance of the contractor's obligations will therefore become impossible if the developer has ceased to co-operate, and so the only real remedy for the contractor is likely to be a claim for damages.
Damages in this situation will be assessed in accordance with the usual rules of recovery, meaning that the contractor will be able to recover loss which naturally flows from the developer's breach of contract and which may reasonably be supposed to have been in the parties' contemplation at the time of entering into the contract. Case law has established that in the construction industry, it is foreseeable that delay in payment to the contractor may result in him being short of working capital and incurring finance charges, and so losses in this category may form part of a contractor's claim. Contractors are also likely to claim for overheads, loss of profit, increased expenditure on labour and materials through loss of productivity and managerial time (in addition to the value of work carried out to date), all of which may add up to a hefty sum.
How can developers protect themselves and preserve their options in the current market?
Given the prevailing financial circumstances, developers may wish to consider preserving their right to cancel projects after the building contract has been entered into. There are various ways in which a developer could protect its position, and thought should be given to the most appropriate in the circumstances (including the nature and value of the project and the developer's long term objectives). The most straightforward solution would be, simply to amend the standard form contract to provide that the developer may terminate at will. However for this to be palatable to contractors, the developer would also need to spell out the consequences of termination in these circumstances, which are likely to include financial recompense for the contractor.
Some projects, particularly larger projects with longer programmes, may lend themselves to more sophisticated solutions. One option would be for the developer to split the project into separate phases, to be dealt with under separate building contracts. Even if the project cannot be split geographically (e.g. where separate blocks are to be constructed), it may be possible to provide for the project to be carried out in discrete phases, for example demolition works; site preparation works; shell and core works and fit-out works. The developer could then enter into the building contracts a phase at a time, letting each contract as he became certain of his funding and commitment to proceeding.
Assuming that it is intended that one contractor carry out the whole project despite the separation into phases, the contractor could be asked to commit, in the event of the developer instructing the future phases by an agreed date, to an agreed programme for the whole development, to agreed prices for future contracts (or at least elements of them such as the percentage for overhead and profits), and to rolling over the contract terms agreed for the first phase for the subsequent contracts. The more "phases" – i.e. separate building contacts – the developer is able to split the project into, the less risk there is for the developer in entering into a building contract which does not provide for termination at will. If, despite taking these steps, the developer still found himself needing to terminate the contract, the damages which the contractor could claim would relate only to the loss of a much smaller contract rather than the whole project.
Consider all available options
Neither of these solutions is free from drawbacks: the option of simply amending the contract may not be looked on favourably by contractors, and unless they are in a strong bargaining position, developers may find themselves forced to commit to consequences of termination which are little better for them than common law would have provided for. Splitting the project into phases may reduce contractor interest in the project if potential contractors feel that the prospect of future work is by no means guaranteed and they may look to price the works to take account of this perceived risk. In addition, the process of obtaining collateral warranty packages for third parties such as funders, future purchasers, and tenants will be more time consuming and costly where the project have been split (particularly on a basis other than geographically), as these parties are likely to look for packages to cover each separate phase of the project.
However, while the market continues to prove challenging, developers would be well advised to consider all options prior to committing to carry out a project under a JCT / SBCC contract, and to be conscious that, if the contract is left unamended, termination other than on a ground provided for under the contract is likely to result in a large claim for damages from the contractor.