A failure to validly terminate a construction contract may radically alter the contractual and legal standing between the parties and may have disastrous commercial consequences.
Prior to making any decision to terminate a contract, ensure that all reasonable alternatives have been exhausted and that you are confident in your contractual position.
Termination under Australian Standards contracts
The Australian Standards (AS) building contracts set out a formal process to be followed by both Principal and Contractor with respect to terminating a contract.
The standard form contracts are designed to help remove doubt as to whether the termination process utilised by a party is valid. Therefore a party that has realistically interpreted and followed the procedure outlined in these contracts will minimise their exposure to any claims of wrongful termination.
The popular AS 4000-1997 General conditions of contract contains the procedure whereby a ‘substantial breach’ by the Contractor grants the Principal the right to issue a written notice to ‘show cause’.
‘Show cause’ notice must be valid
In determining whether a notice to ‘show cause’ is valid the courts generally adopt a non-technical construction “in accordance with business common sense and fairly in its context”.1
Consequences of Contractor failing to ‘show cause’
If the Contractor in substantial breach fails to show cause within the required timeframe the Principal may, by written notice, either:
- take out of the Contractor’s hands the whole or part of the work remaining and suspend payment; or
- terminate the contract.
Consequences of Principal failing to ‘show cause’
This ‘show cause’ procedure similarly operates should it be the Principal in substantial breach.
However, in that case the Contractor must first suspend the works before it becomes entitled to terminate.
Determining whether a party in substantial breach has ‘shown cause’
The issuer of the written notice to ‘show cause’ must give proper and honest consideration to whether the party in breach, in response to that notice, has actually shown cause.
However, the issuing party is not in breach by making a decision which is unreasonable and/or only serves its own interests.2
This formal procedure is replicated in other variants of the AS4000 suite of contracts such as the AS 4901-1998 Subcontract conditions and the AS 4902-2000 General conditions of contract for design and construct. Similar procedures are also found in other standard form building contracts.
Termination under common law
With respect to construction contracts, it has been held that the formal process of termination in an AS contract is not an exclusive means and does not extinguish common law rights with respect to termination.3
The mere existence of a specific contractual right to terminate does not exclude a common law right to terminate.4 Common law rights are generally to be excluded only if the contract contains an explicit intention of doing so.5
What this means for the construction industry is that there is the potential for a party to a standard form construction contract to successfully terminate at common law despite not having followed the termination process expressly contained in the contract.
Although useful to keep in mind, it remains that most parties that correctly terminate a construction contract will do so via the formal contractual process.
Terminating a construction contract under common law is generally much more contentious. Courts are generally unwilling to infer by a party an intention to end a contractual relationship except in very clear circumstances.6 As such, care must be taken to ensure that the actions of the other party that give rise to a decision to terminate are clear.
It is important to remember that every contract is unique. Some contracts may have been altered to expressly exclude common law entitlements. Therefore it is crucial that each party to a project carefully reads their contract before taking any steps to terminate in accordance with the common law. Check for any express rights relating to termination, understand the formal process that may be involved, and determine whether there is anything in the contract suggesting that common law rights have been extinguished.
Consequences of wrongful termination
A party to a construction contract might fail to observe the contractual procedure outlined, or elect to terminate at common law when the grounds for termination are not present. In those circumstances, they may themselves be found to have repudiated the contract, allowing the other party to accept that repudiation and recover damages.
Consider a situation where the Principal has continually delayed access to the construction site and recently engaged an alternative Contractor to carry out a large part of the work.7 The original Contractor is placed in the unenviable position of deciding whether or not to terminate the contract citing repudiatory conduct by the Principal.
The Contractor will need to determine if the Principal’s conduct constitutes valid grounds for termination for repudiation. That is, can it infer that the Principal does not intend to be bound by the contract?8 If the Contractor’s inference is held to be unreasonably formed, then the Contractor, rather than the Principal, may be the one held to have repudiated the contract due to wrongful termination and may be liable to the Principal for damages.
Damages claimed for wrongful termination
Be aware of potential damages claims wrongfully terminating a construction contract.
If a Contractor wrongfully terminates, the Principal may accept that act as a repudiation of the construction contract and seek to recover damages. Such damages may comprise the cost of sourcing a new contractor (for example, tendering costs) plus any increase in price for the new contractor. Depending on the nature of the project and the terms of the Contract, it could get much worse. For example, if the project is bank-financed and is intended to be income producing, the Contractor could also be exposed to a massive claim for (among other things) lost profits and increased costs of borrowing.
For a Principal who repudiates a contract (or a head contractor who repudiates a subcontract) the consequences can also severe but for different reasons. This is because the Contractor (or subcontractor, as the case may be), may be able to make a claim based on ‘quantum meruit’ as an alternative to a contractual damages claim.9 The ‘quantum meruit’ claim (that is, the reasonable value of the work performed, including profit margin) could far exceed damages by reference to the contract, especially if the fixed contract price was poorly estimated.
Note also that your entitlements to damages may be limited by the terms of your construction contract (e.g. existence of enforceable limitation or exclusion of liability clauses).
Before attempting to terminate any construction contract, seek advice to help you:
- Assess the reasons for wanting to terminate the contract.
- Assess whether such reasons are grounds for termination under the construction contract and/ or common law.
- Understand the procedural steps required before formally terminating the construction contract.
- Assess your potential exposure to damages in the event of wrongful termination.
- Most importantly, analyse and exhaust all possible alternatives to termination, given the very serious consequences of termination.