The recent decision in Interserve Construction Ltd v Hitachi Zosen Inova AG, has confirmed the importance of understanding and complying with the contractual process when it comes to terminating a construction contract.

The decision

The case arose out of the construction of an energy from waste plant in Hartlebury. In July 2015, the main EPC contractor sought to terminate its sub-contract with its subcontractor, by issuing a letter and making arrangements to immediately remove them from site.

The sub-contractor had numerous grounds to justify immediate termination, however, in relation to some of them (including those relied on by the EPC contractor) the contract stated that the EPC contractor:

"…may (at its absolute discretion) notify the Contractor of the default and if the Contractor fails to commence and diligently pursue the rectification of the default within a period of seven (7) Days… terminate the employment of the Contractor under the Contract."

The subcontractor relied on this to argue that the contract had not been terminated correctly, as the EPC contractor had not issued a notice and allowed a seven day period for rectification of the default.

The EPC contractor tried to rely on reference to its “absolute discretion” under the clause, arguing it was exercising this discretion in not allowing the seven days for rectification. The court did not agree and held that the notice and 7 day period for rectification was not optional and instead was a condition precedent – meaning it had to be complied with prior to the EPC contractor having the right to terminate.

The decision meant that whilst a termination event may have occurred, and it may have been in the EPC Contractor’s absolute discretion to terminate; the exercise of that discretion had been expressly limited by the terms of the contract - meaning the necessary notice had to be given.

Practical points

The case serves as a useful reminder, both when entering into contracts and when seeking to bring them to an end, that both parties need to be clear firstly at what point the right to terminate arises, i.e. what are the events which give rise to the right, but also what must be done in order to exercise the right i.e. what process is to be followed.

Therefore, when entering contracts make sure to:

1. read the termination clauses carefully to establish if there are notice requirements and whether they are a condition precedent – look out for words such as “shall”, “subject to” or “condition precedent”;

2. check for bespoke amendments to the timeframes for serving any necessary notices – the standard form may be amended to require/allow the notices to be given as early as possible;

then when it comes to serving any notices:

3. make sure you comply with the form the contract requires – this usually means the notice needs to be in writing, needs to describe the event/circumstance relied on and make reference to the relevant contract provisions; and

4. finally, make sure you serve the notices in the correct way – the contract may require it be served on a particular office or person and by a specific method e.g. recorded delivery.

The risk is that if the process set out under the contract for termination is not followed, a party could be at risk of a claim for wrongful termination.