American Bar Association
Forum on the Construction Industry
__________________________________________________________________
SHIPWRECKED: Dealing With Construction Contract Defaults
in the Real World
(“Cross
the Sea: Navigating the Distressed
Construction Project”)
Deborah S. Butera
Adorno & Yoss, LLC
October 25 & 26, 2007
Hyatt Regency Newport Hotel & Spa –
__________________________________________________________________
© 2007 American Bar Association
I. SKIMMING
THE SURFACE: INTRODUCTION
Serious
legal consequences attend a declaration of default and subsequent
termination. If the disputes lead to
litigation or arbitration, a reviewing court or arbitrator will examine the
events leading to the termination to determine whether the termination was
justified. The terminating party runs
the risk that its actions will be second-guessed to the point that the
termination is deemed wrongful. The
terminating party also risks significant cost overruns and may have problems
with the replacement contractor. The
parties may undergo financial pressure, upheaval, or even bankruptcy. The terminated party may lose its reputation,
its bonding capacity, and possibly its financial viability. Default termination significantly increases
the likelihood of litigation or other dispute resolution procedures, which,
whether initiated during the project’s performance or after the project’s
completion, will require substantial commitments in time and money.
In
addition to the consequences to the parties, default may have various
consequences to the project. Costs are
likely to increase dramatically. The
schedule may be delayed or acceleration required. Scopes of work must be completed. Patent or latent defects may exist.
This paper will examine the
concept of a material default and the types of events that may lead to a
default. It will review approaches that
can be utilized to avoid a termination for default. It will also examine the standard industry
contract terms concerning default and termination, required notices, and
post-termination issues.
II. THE
SINKING SHIP: IS THERE REALLY A DEFAULT?
Whether
a party breached a contract is generally a question of law for the court, which
will determine as a matter of law what the contract requires.[1] When the terms of a contract are unambiguous
and the facts concerning breach or performance are undisputed or conclusively
established, the trial court decides whether the facts show performance or
breach.[2] Not every performance failure or occurrence
of a default event will rise to a level warranting termination. A distinction exists between a breach of contract
and a material breach. Material breach
by one party may excuse the other party from any obligation to perform and
generally presents a question of fact.[3]
The Second Restatement of Contracts provides the following considerations to determine whether a failure to render or to offer performance is material:
(a) the extent to which the injured party will be deprived of the benefit it reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the part of that benefit of which it will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer forfeitures;
(d) the likelihood that the party failing to perform or to offer to perform will cure its failure, taking account of all of the circumstances including any reasonable assurances; and
(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.[4]
A. Default
Events
Events that may rise to the
level of a material breach vary. A
discussion of some commonly occurring issues follows:
1.
Failure to Perform
Work must be performed
timely and in a workmanlike manner.[5] Failure to perform may include a party’s
failure to complete a scope of work, untimely performance, defective execution
of a scope of work, failure to complete punch list work, or failure to honor
warranty obligations. An owner or
general contractor’s failure to provide site access also constitutes a failure
to perform.
In the
materials and
equipment furnished under the contract will be of good quality and new unless
otherwise required or permitted by the Contract Documents, that the Work will
be free from defects not inherent in the quality required or permitted, and
that the Work will conform to the requirements of the Contract Documents. Work not conforming to these requirements,
including substitutions not properly approved and authorized, may be considered
defective.[6]
The
The
contractor’s untimely completion of work may also constitute a default
event. In that regard, the
2.
Failure to Pay
Generally, the performance of work on a construction project triggers a corresponding obligation to pay.[9] An owner, general contractor, or upper-tier subcontractor’s failure to pay amounts justly due is a breach of contract. If the contract includes a “time is of the essence” provision, the failure to make timely payments may be deemed a material breach.[10] One of the reasons for progress payments is to provide the funds necessary for continued performance. A contractor or subcontractor who is unreasonably denied payment is justified in suspending performance until paid.[11] Professor Corbin, in his treatise on contracts, recognizes the particular circumstances attendant to a building contract:
There is a special factor to be considered in the case of a building contract, or any other contract the financing of which requires a progressive expenditure in the course of performance. In these cases, one reason for providing for installment payments as construction proceeds is to supply the funds necessary for the agreed performance; and failure to pay one or more installments is more likely to cause inconvenience and difficulty to the building contractor. Therefore, a failure to make one of the progress payments, even though the contract is not divisible into pairs of separate equivalents and the installment unpaid is only a small part of the whole consideration, is more likely to justify suspension of performance by the builder, or even total renunciation of further duty.[12]
The United States District Court for the Eastern District of North Carolina has stated this point thusly:
The subcontractor cannot and should not be expected to finance the project until such time that the prime contractor or the government decides to pay the amount due. If the subcontractor is ordered to perform the work or even required to do so, then the obligation in the absence of an express contract provision falls upon the parties so ordering the work to be done to pay a reasonable amount for that work within a reasonable time. To hold otherwise would cast the burden upon the subcontractor which in many cases would be impossible to carry as a subcontractor is usually smaller in size than the prime contractors.[13]
What is deemed a “reasonable time” in which payment must be made? Absent a specific contractual provision pertaining to when payment must be made, the parties are entitled to state their opinions of what constitutes a reasonable time. A reviewing court or arbitrator may consider the number of days between requisitions and payments for prior pay applications in determining what is reasonable.[14]
The impulse of an unpaid contractor or subcontractor may be to walk off the job. However, not every failure to pay may be sufficient to justify project abandonment. Absent specific contract provisions, the question under the common law will become whether or not the nonpayment constitutes a material breach. The contractor who guesses wrong may find itself liable for breach of contract if it leaves the job and the inevitable delay and disruption results. Delay in making payment when the amount of work performed or disputed or is being negotiated is not, standing alone, a breach of contract.[15] Rather, a breach may occur when a contractor unilaterally leaves the job site without completing its contractual duties.[16] In such instances, completion costs may be assessed against the party that breached the contract.[17] In essence, if the parties are engaged in a legitimate dispute about the amount due, the quality of the work performed, or another equally legitimate reason for delaying payment, project abandonment is a risky course of action.
Contractors and
subcontractors are not lacking in remedies for non-payment. Under
(1) the payment must be past due (or the work stopped) for a period of thirty (30) consecutive days;
(2) the cause of the work stoppage or non-payment must not be the fault of the contractor, a subcontractor, sub-subcontractor, or any of their agents or employees;
(3) the lack of payment must result from either the architect’s failure to issue a certificate for payment without reason, or because the owner has failed to make payment even though a certificate of payment has been issued and thirty (30) days have passed; and
(4) If the above conditions are met, the contractor must give a written notice of its content to terminate the contract in seven days. If the owner cures within that time period, the conditions for termination are not satisfied.[18]
Failure
to pay subcontractors and suppliers may be cause for termination of the
contract.[19] The owner of a private project may be exposed
to liens if the owner or its contractor fails to pay subcontractors.[20] The
[W]arrants that upon submittal of an Application for Payment all Work
for which Certificates of Payments have been previously issued and payments
received from the Owner shall, to the best of the Contractor’s knowledge,
information and belief, be free and clear of liens, claims, security interests
or encumbrances in favor of the Contractor, Subcontractors, material suppliers,
or other persons or entities making a claim by reason of having provided labor,
materials and equipment relating to the Work.[21]
The contract may provide for
a dispute resolution process upon notice of a claim. Under the anticipated 2007 revisions to the
3. Failure to Administer the Construction
Contract
The architect’s duties under
the
Failure to administer the
construction contract may also include the owner’s or owner’s representative’s
failure to respond to requests for information (“RFIs”). Failure to process RFIs may cause project
delay. The owner or upper-tier contractors
may fall short of their contract administration duties by failing to process
change orders in a timely manner.[24] Failure to process change orders may cause
delay or, alternatively, a contractor or subcontractor may be placed in the
position of having paid for labor and materials to perform the changed work
without receiving timely compensation.
4. Providing
Defective Plans or Specifications
Nearly all construction
contracts specify that the project must be built in accordance with the plans
and specifications. The owner impliedly
warrants the adequacy of the plans and specifications.[25] Accordingly, a contractor is not responsible
for the consequences of defects in the plans and specifications, and the owner
is responsible for the contractor’s increased costs resulting from defective
plans and specifications.[26] The owner warrants that the plans and
specifications are accurate and that the plans and specifications, if followed,
will be adequate to accomplish the purpose of the project.[27] However, the owner will not be responsible
for latent or obvious defects or for defects that a reasonable pre-bid
inspection would have disclosed.[28]
The owner’s responsibility for defective specifications
will depend upon whether it provided a performance specification or a design
specification.[29] “Performance specifications set forth an
objective or standard to be achieved, and the contractor is expected to
exercise ingenuity in achieving that objective or standard of performance,
selecting the means and assuming a corresponding responsibility for that
selection.”[30]
Conversely, design specifications “describe in precise detail the materials to
be employed and the manner in which the work is to be performed. The contractor has no discretion to deviate
from the specifications, but is required to follow them as one would a road
map.”[31] Design specifications set forth precise
measurements, tolerances, materials, tests, and inspection requirements.[32] A contractor will not be liable if it
complied with a design specification.[33]
5. Violation of Laws
It is incumbent upon the parties to a construction
project to accomplish their duties without violating the law. Legal violations that may impact a
construction project include a public entity’s disregard of the public
procurement laws, OHSA violations, the employment of illegal aliens, or
violations of environmental laws. The
project may be shut down or fines or criminal penalties imposed as a
consequence of unlawful activities.[34] The
6. Failure to Provide an
The construction contract
may include a provision requiring notice to the defaulting party and an
opportunity to cure. These duties apply to
the owner, contractors, and subcontractors.
The requirement to provide notice of default and an opportunity to cure
allows the defaulting party to repair its defective work, to reduce the
damages, and to avoid further performance defects.[36] It also promotes the informal settlement of
disputes. The party alleged to be in
default will have the opportunity to consider whether the claimed defect is
within the scope of its contractual obligations, to determine potential
liability, and to take responsive action if deemed necessary.
Even when the parties have
not included a cure provision in their contract, courts have imposed a duty to
provide notice and an opportunity to cure before the contract may be terminated
for faulty performance.[37] Failure to provide notice of defects and an
opportunity to cure may be deemed a material breach of the contract.[38]
As is the case with any
other contract provision, a party may waive the cure provision.[39] A party may demonstrate waiver by showing
actual knowledge or a course of conduct that would result in a waiver. For example, a subcontractor may waive a
notice to cure provision by stating it has no intention of completing its
contractual obligations or taking actions to that effect.[40]
The
B. Waiver
of Default
A
party may waive its right to terminate for default if the party becomes aware
of events that rise to the level of a material default yet fails to take
action. “Waiver refers to the
‘abdication of rights under a contract.’”[44] For example, waiver may occur by implication
if a performance date passes and the contractor has not been terminated for
default.[45] The elements of such a waiver are the owner’s
failure to terminate within a reasonable time after the default under
circumstances indicating forbearance, reliance by the contractor on the failure
to terminate, and continued performance by the contractor with the owner’s
knowledge and implied or express consent.[46]
Termination
rights may be retained by expressly indicating as much to the other party. Preservation of termination rights places a
heavier burden on the party seeking to prove that the right to terminated has
been waived.[47] Once a performance issue or deadline has been
waived, new performance criteria must be set, either unilaterally or
bilaterally. Notice and a reasonable
opportunity to meet the new criteria must be provided.[48]
C. Documenting
the Default
Since termination greatly
increases the likelihood of ensuing litigation or other dispute resolution
proceedings, the events giving rise to the default should be well
documented. Documentation of defective
work may consist of correspondence, photographs, or videotapes depending upon
the circumstances. Schedule-based
defaults may be documented by progress reports, as-planned schedules, and the
contractor or subcontractor’s payment applications. Key witnesses should be identified,
interviewed, and encouraged to memorialize their observations to aid later
recall.
II.
CAN THIS SHIP STAY AFLOAT? ALTERNATIVES TO TERMINATION FOR DEFAULT
Even if just cause exists for default termination,
termination for default is inherently risky and should be undertaken only as a
last resort. Options to avoid
termination for default should be carefully considered. An owner or upper-tier contractor should be careful to
preserve and not to waive its rights if termination alternatives are
undertaken. Written notification of the
party’s intent to preserve and not waive its right to terminate for default is
recommended.
A. Termination for
Convenience
If available by contract, a termination for convenience may
be utilized to avoid default termination.
A termination for convenience provision grants an owner or upper-tier
contractor a broad right to terminate a contractor or subcontractor’s
performance without cause after a contract award. Termination for convenience provisions
generally limit the terminated party’s damages to costs plus profit on
completed work and the costs of preparing the termination proposal. The terminated party may not recover breach
of contract damages, anticipated profits, or other damages. However, if a termination for convenience is
found to be improper, damages may be available to the terminated party.
1. Contract
Provisions
The federal government’s right to
terminate for convenience is set forth in the Federal Acquisition Regulations
System (“FAR”). Various alternate
prescribed clauses are included in the FAR, depending upon the dollar value and
nature of the contract. For example, the
provision governing termination for convenience for a fixed-price contract over
$100,000 in value states:
(a) The Government may terminate performance of work under this contract in whole or, from time to time, in part if the Contracting Officer determines that a termination is in the Government's interest. The Contracting Officer shall terminate by delivering to the Contractor a Notice of Termination specifying the extent of termination and the effective date.[49]
The contractor is required to stop work upon receipt of a notice of termination. The contractor must place no further subcontracts and terminate all existing subcontracts. All right, title, and interest in the terminated subcontracts must be assigned to the federal government. The contractor must settle outstanding liabilities if approved by the contracting officer; complete performance of work not terminated; and take other actions as directed by the contracting officer.[50]
The
The owner may, at any time, terminate the contract for the owner's convenience and without cause.[51]
Section 14.4.2 of the AIA A201 provides that upon termination for convenience, the contractor must cease operations as directed by the owner; take any actions necessary or that the owner may direct for the protection and preservation of the work; and, except for work directed to be performed prior to the effective date of termination, terminate all existing subcontracts and purchase orders and enter into no further subcontracts and purchase orders. Under the AIA A201, when an owner or general contractor terminates for convenience, it does not have the right to assume the subcontracts. The owner will be unable to force the subcontractors to complete their work. The subcontractors may increase their prices to complete the work, dramatically increasing the project’s cost.
2. Bad Faith
Termination for Convenience
The right to terminate for convenience is not
absolute. Termination for an improper
motive or with the intent to injure may constitute a bad faith termination for
convenience. A bad faith termination for
convenience may result in breach of contract damages.
Bad faith termination for
convenience has been equated with evidence of “some specific intent to injure
the plaintiff.”[52] Courts will examine whether the termination
was motivated by malice and have found bad faith when there was evidence of a
“conspiracy to get rid of [the] plaintiff.”
When termination is motivated by animus toward the terminated party, bad
faith may be found.[53] In contrast, a termination for convenience
simply for the purpose of saving money would not equate to a specific intent to
injure the plaintiff and would not provide a basis for a finding of bad faith.[54] Absent proof of bad motive, an intentional
discretionary decision that happens to result in economic disadvantage may be
of no legal significance.[55]
In APJ Associates, Inc. v. North American Philips
Corporation,[56]
the terminated party alleged that it was told not to worry about a contract’s
termination for convenience provision because no one had ever been terminated
as long as sales targets were met. The
plaintiff claimed it was assured that, while the written contract came from the
home office and was not negotiable, an oral agreement to the effect that the
plaintiff would not be terminated for convenience was the actual agreement.[57] The court rejected these contentions based
upon the contract’s merger provision, as the termination for convenience
provision was plain on its face and therefore excluded any consideration of
parol evidence.[58]
B. Correct and Back Charge
The owner or upper-tier contractor may have the option to
correct and back charge the under-performing party in lieu of termination. If this option is undertaken, adequate notice
must be provided. Contractual provisions
requiring notification of backcharges will be enforced.[59] Without proper notification, a court or
arbitrator may find the back charge claim is barred.[60] If litigation ensues, the reasonableness and
perhaps even the necessity of the back charge may be called into question. The scope of work should either be put out to
bid or, if this is not feasible, the pricing should be reviewed in light of
R.S. Means[61]
data or other standards to insure reasonableness.
C. Deductive
Change Order
A deductive change order may be issued to delete items from
the non-performing contractor or subcontractor’s scope of work. Contract terms and courses of dealing
relating to change orders should be observed.
Clients should be counseled to obtain an executed copy of the deductive
change order from the lower-tier contractor to remove any question that the
work was de-scoped and the contract amount reduced.
D. Renegotiate
the Contract
It may be possible for the parties to renegotiate the
contract to alleviate the default. Scope
of work items may be added or removed, means and methods may be specified, or
contract terms and conditions revised.
E. Default and
Allow Completion
It often happens that once a party is placed on notice of
default, but prior to any termination, it will suddenly find the resources necessary
to perform its obligations. The owner
will pay the contractor, or the contractor will complete its scope of work in a
satisfactory manner. Faced with a loss
on the project, the negative repercussions of a default termination, and the
involvement or possible release of a surety, the party may renew its commitment
to the project. As set forth in the
companion paper, the surety may elect to provide financial assistance to a
defaulted contractor under certain circumstances to assist its completion of the
project.[62]
F. Withhold Payment
Frequently, an owner or upper-tier contractor may
withhold payment when the work is alleged to be defective or untimely. Lien or bond claims are likely to result.[63]
G. Schedule-Based
Remedies
In lieu
of default termination, the schedule may be re-worked. In some circumstances, project milestones may
be adjusted without impact upon the date of substantial completion. Alternatively, the date of substantial
completion may be revised if all parties agree to do so.
H. Change of
Personnel
Sometimes the personnel placed on a project are not well
suited to the job. Personality conflicts
may arise that disrupt the work.
Individual skill sets may differ from what is necessary for the
satisfactory completion of the work. A
distressed project may be salvaged with a personnel change.
I. Work
Force Supplementation
An underperforming party’s work
force may be supplemented to avoid default termination. This may be particularly useful if required
permits cannot be transferred or other obstacles to default termination
exist. Notice and an opportunity to cure
should be provided, or an agreement to the supplementation obtained beforehand,
to avoid arguments about whether the resulting back charges were necessary.
J. Remedies
to Force Payment
A mechanics or
materialman’s lien is a security interest on the owner’s property in favor of
unpaid parties on a nonpublic project.
Claimants should be aware that, in most states, the lien laws are strictly
construed against the lien claimant. As
a result, the requirements of the state’s lien law should be followed exactly.[65]
2. Public Project Remedies
A lien on public property is unenforceable.[67] Payment bonds are required by the Miller Act[68] for any federal construction contract; they are also required for public projects by state statutes (“Little Miller Acts”).[69] Thus, the payment bond provides laborers and materialmen with a remedy on public projects that they would not otherwise have.[70] Private project common law payment bonds are also issued. The law is liberally construed in favor of the bond claimant under the Miller Act[71] and under the law of various jurisdictions.[72]
The Miller Act limits bond claims to only those parties having direct contractual relations with either the bonded contractor or with a subcontractor of the bonded contractor.[73] State bond law rights may differ.[74]
A Miller Act payment bond covers items or materials considered indispensable to the prosecution of the work. Materials considered indispensable to the prosecution of the work include water delivered to operate steam dredges,[75] lumber for concrete forms,[76] freight for materials used in the construction of the work,[77] rented earth moving equipment,[78] food supplied to labor crews,[79] transportation charges,[80] labor,[81] contributions to an employee welfare fund,[82] and architectural services for superintending the work.[83]
Items not covered as labor or material under the Miller Act payment bond include bank loans,[84] boarding houses operated by contractors for profit where workers stay,[85] insurance premiums for workers’ compensation,[86] and transportation charges for capital investment equipment.[87]
a. Notice
Requirements
Notice of the bond claim is a condition precedent under the Miller Act payment bond if the claimant is not in privity of contract with the bonded contractor.[88] Notice must be given to the bonded contractor.[89] The failure to provide proper notice is a fatal flaw to the action.[90] Notice must be given within 90 days of last furnishing labor and materials.[91] Where a materials supplier furnishes materials under open account, the 90 days will begin to run from the date of the last materials furnished to the project.[92] Remedying defective work or performing punch-list work may not extend the notice deadline.[93] Oral notice will not meet the statutory requirements.[94] Notice must be served by any means that provides written, third-party verification of delivery to the contractor at any place the contractor maintains an office, conducts business, or at the contractor’s residence.
b. Suit Requirements
A lawsuit must be filed to perfect the Miller Act
payment bond claim. Exclusive
jurisdiction lies in the federal court in the district where the contract was
to be performed.[95] Suit must be brought in the name of the
From the subcontractor’s perspective, it is worth
observing that a pay-if-paid clause in the underlying contract may not relieve
the surety of its obligation.[102] It would defeat the
purpose of a payment bond to suggest that non-payment by an owner absolves a
surety of its payment obligations.[103]
Generally, the surety’s
liability is co-equal to that of its bonded principal.[104] The surety may take the position that a
payment bond claim is barred by a provision making final payment to the
subcontractor conditioned upon “final payment by owner to contractor under the
Contract.”[105] A surety advanced this argument in a case in
which the payment bond at issue contained the following language:
(2) The above-named
Principal and Surety hereby jointly and severally agree with the Obligee that
every claimant as herein defined, who has not been paid in full before the
expiration of a period of ninety (90) days after the date which the last of
such claimant’s work or labor was done or performed, or materials were
furnished by such claimant, may sue on this bond for the use of such claimant,
prosecute that suit to final judgment for such sum or sums as may be justly due
claimant, and have execution thereon.[106]
The
court rejected the surety’s argument:
The bond is absolute on its
face. Accordingly, the obligation which
it secures is also absolute . . . . The
only limitation imposed is upon claimants who did not have a direct contract
with the principal. In that case, the
contract provides for payment within ninety (90) days of notice.[107]
“[T]he very purpose of securing a surety bond contract is
to ensure that claimants who perform are paid for their work in the event
that the principal does not pay. To
suggest that nonpayment by the owner absolves the surety of its obligation is
nonsensical, for it defeats the very purpose of a payment bond.”[108]
In Brown and Kerr, Inc. v.
[The subcontractor] is suing under
the bond and not the subcontract. The
two are separate agreements.
The court also held that the payment
bond did not contemplate that payment of a subcontractor should await the
determination of an extended legal dispute between upper-stream parties
concerning work completely unrelated to the work of the subcontractor:
We do not believe the bond
contemplates that payment of subcontractors should await the determination of
an extended legal dispute between the owner and general contractor concerning
his work which is completely unrelated to [the subcontractor], particularly
since the underlying purpose of the bond is to assure the payment of
subcontractors and when, as here, [the subcontractor] has completed performance
under the subcontract.[113]
State statutes may provide a basis for a mandamus proceeding to require a public entity to make payments. The plaintiffs in a mandamus action must have a clear legal right to payment.[114] Generally, mandamus will not lie to compel the payment of an unliquidated, unascertained, or doubtful claim against a public entity.[115] In addition, mandamus generally will not lie if another specific legal remedy exists. However, when the public entity’s real property is totally exempt from levy and sale, and the entity is authorized to pledge all or part of its revenues to secure the payment of bonds, a suit upon the contract and the judgment rendered would not afford the plaintiff an adequate remedy for the enforcement of its claim.[116] A court may find that an adequate remedy at law does not exist when a court action would cause a lengthy delay that would result in serious economic harm.[117]
IV. HITTING
BOTTOM: TERMINATION FOR DEFAULT
A default termination is a
drastic sanction which should be imposed only for good grounds and on solid
evidence.[118] After due consideration of the alternatives
to avoid a termination for default, it may nevertheless become evident that
termination for default is unavoidable.
This section of the paper will review the
A. Contract
Provisions
A review of the contract
that governs the parties’ relationship is imperative before the decision to
terminate is made. The provisions of the
contract must be followed exactly to avoid a finding of wrongful
termination. The surety must be notified
in accordance with the provisions of the bond, the contract, and any applicable
statutory provisions.
1. Termination by the Contractor
Article
14.1.1 of the
1. Issuance of an order of a court or other public authority having jurisdiction which requires all work to be stopped;
2. An act of government, such as a declaration of national emergency which requires all work to be stopped;
3. Because the architect has not issued a certificate for payment and has not notified the contractor of the reason for withholding certification, or because the owner has not made payment on a certificate for payment within the time stated in the contract documents; or
4. The Owner has failed to furnish to the Contractor promptly, upon the Contractor’s request, reasonable evidence of the owner’s ability to fulfill its financial obligations.[119]
In addition, the contractor may terminate the construction contract upon repeated suspensions, delays or terminations of the work by the owner.[120] Finally, the contractor may terminate if the work is stopped for sixty consecutive days through no fault of the contractor or its agents and employees and due to the owner’s failure to fulfill its obligations respecting progress of the work.[121] The contractor must provide a seven-day written notice to the owner and the architect prior to terminating the contract.[122]
2. Termination
by the Owner
Section
14.2 of the
The owner may terminate the contract if the contractor:
1. persistently or repeatedly refuses or fails to supply enough properly skilled workers or proper materials;
2. fails to make payment to contractors for materials or labor in accordance with the respective agreements between the contractor and the subcontractors;
3. persistently disregards laws, ordinances, or rules, regulations or orders of a public authority having jurisdiction; or
4. otherwise is guilty of a substantial breach of a provision of the contract documents.
Under
the
B. Remedies Upon Termination for Default
Various remedies are available to the owner or contractor
upon termination for default. Under the
1. Damages Upon Termination for Cause
Upon termination for cause, the law will attempt to place the parties in the position they would have held had the terminated party fulfilled its contractual obligations. The owner or general contractor that terminates a general contractor or subcontractor, as the case may be, will be entitled to recover any completion costs that exceed the unpaid balance of the contract price.[126] The terminating party must act reasonably and mitigate its losses and cannot recover the full cost of completion under the contract price if the project may be completed at a lower cost.[127] If the contract can be completed within the unpaid contract funds, then the terminating owner or general contractor incurs no damages and must pay any balance remaining to the terminated party.[128]
Along with general damages, courts have allowed a wide range of consequential damages to owners when a contractor defaults. Such consequential damages may include damages for the loss of the full use and enjoyment of the structure[129] or profits lost from the use of a commercial building.[130] More liberal consequential damages have been awarded in cases involving homeowners.[131]
2. Damages Upon Wrongful Termination
In the event of a wrongful termination, the terminated
party may prevail on a damages claim. A contractor that has been wrongfully prevented from
completion of its contract is entitled to an amount that would place the
contractor in a position equivalent to that which the contractor would have
occupied had the contract been performed fully.[132] The contractor may also recover damages
sustained by reason of the owner’s breach, including the profits the contractor
would have earned had it been permitted to perform.[133]
The owner or general contractor who
wrongfully terminates its contractor or subcontractor, as the case may be,
risks being unable to recover the costs to complete the work. The terminating party may be responsible for
contract payments through the date of termination and may be potentially liable
for lost profits on the work that has not yet been performed.
Lost profits claims for uncompleted
work are in most cases subject to attack as being overly speculative or not
within the contemplation of the parties.[134] However, some states have a relaxed standard
of review for such claims.
For example,
(a) if the fact of damage
is proven with certainty, the extent or the amount thereof may be left to
reasonable inference; (b) where a defendant’s wrong has caused the difficulty
of proving damage, he cannot complain of the resulting uncertainty; (c) mere
difficulty in ascertaining the amount of damage is not fatal; (d) mathematical
precision in fixing the exact amount is not required; (e) it is sufficient if
the best evidence of the damage which is available is produced; and (f) the
plaintiff is entitled to recover the value of his contract as measured by the
value of his profits.[136]
The terminated party might also try to claim an entitlement to profits on other jobs it could not bid because of its diminished bonding capacity. At least one court has allowed claims for lost potential profits on jobs a contractor could not bid as a result of diminished bonding capacity.[137] However, that court recognized that the award was “to some degree speculative.”[138]
C. Notice to the Surety
Timely notice to the surety is required if a terminating party (the owner or the contractor oblige) expects to call on the surety’s performance bond to fulfill the terminated party’s obligations. While some courts have held that, absent specific notice requirements in the performance bond, there is no requirement that the surety be notified prior to declaring a default and terminating the contractor,[139] the better practice is to notify the surety promptly. Moreover, the construction contract itself may require that notice be provided to the surety.[140]
Beneficiaries of the bond will be bound by the terms of
the bond.[141] If the bond includes particular notice
requirements, they will be enforced. If
proper notice is not provided within the time and in the form required by the
terms of the bond, the terms of the construction contract, or the terms of any
relevant statute, the surety may be relieved of its obligations under the bond.[142] The claimant’s notice obligations continue
beyond project completion if bond coverage is sought for subsequently
discovered defects. An owner who repairs
construction defects prior to notifying the surety may be unable to recover
under the bond.[143] The notice provisions of the
V.
CONCLUSION
The distressed construction project
presents many challenges and considerations for the parties and their counsel. The decision to terminate for default should
be viewed as a last resort, and alternatives to avoid termination for default
should be considered. Careful analysis
will be required to identify whether a breach rises to a level that warrants
termination for default. Parties who
choose to terminate for default should follow the relevant contract terms to
minimize the risk of finding a wrongful termination.
[1] Meck v. Bishop Peterson & Sharp, P.C.,
919 S.W.2d 805, 808 (Tex. Ct. App. 1996).
[2]
[3] See, e.g., Mustang Pipeline Co. v. Drive Pipeline Co.,
134 S.W.3d 195, 196 (Tex 2004).
[5] See,
e.g., Tharpe v. G.E. Moore Co., 174 S.E.2d 397, 399 (S.C. 1970).
[6]
[7]
[8]
[9] A
pay-if-paid provision would create an exception to this rule in jurisdictions
where such provisions constitute a valid condition precedent to payment
obligations. “A
contractor is not liable and bound to pay a subcontractor until satisfaction of
all conditions imposed by the subcontract.”
Associated Mechanical Corp., Inc. v. Martin K. Eby Constr. Co., Inc.,
67 F. Supp. 2d 1375, 1378 (M.D. Ga. 1999), aff’d, 271 F.3d 1309 (11th Cir. 2001).
[10]
[11]
[13] F.E. Robinson Co. of N.C., Inc. v.
Alpha-Continental, 273 F. Supp. 758, 775-76 (E.D.N.C. 1967).
[14] Manganaro Corp. v. HITT Contracting, Inc.,
193 F. Supp. 2d 88, 96 (D. D.C. 2002).
[15] In re Fordson Eng’g Corp., 25 B.R. 506,
510 (Bankr. D.
[16]
[17]
[18]
[19]
[20]
Remedies for non-payment are discussed in greater detail in Part II.J., infra.
[21]
[22]
[23]
[24] See,
e.g., Manganaro Corp. v. HITT Contr., Inc., 143 F. Supp. 2d 88, 96 (D. D.C.
2002) (contractor’s failure to pay outstanding change order invoices was
unreasonable and justified subcontractor’s performance suspension).
[25]
[26]
[27] The Spearin
case also held that the owner’s responsibility is not overcome by site
investigation clauses.
[28] ABB Joint Venture v.
[29] Rhone Poulenc Rorer Pharm. v. Newman Glass
Works, Inc., 112 F.3d 695, 701 (3d Cir. 1997) (McKee, J., dissenting).
[30] Blake Constr. Co. v.
[31]
[32] Aircraft Gear Corp. v. Kanran Aerospace
Corp., 856 F. Supp. 446, 452 (N.D.
[33] Rhone Poulenc Rorer Pharm., Inc., 112
F.3d at 702 (McKee, J., dissenting).
[34] For
example, the Immigration Reform & Control Act of 1986 makes it unlawful to
knowingly hire individuals who are not legally authorized to work in the
[35]
[36] Pollard
v. Saxe & Yolles Dev. Co., 525 P.2d 88, 92 (1974); Sturdy Concrete
Corp. v. Nab Constr. Corp., 411 N.Y.S.2d 637, 644 (1978).
[37]
[38] Carter
v. Krueger, 916 S.W.2d 932, 936 (Tenn. Ct. App. 1996) (contractor entitled
to damages, including net profits, as a result of owner’s failure to provide
notice of default and an opportunity to cure).
[39]
Wolff
& Munier, Inc. v. Whiting-Turner Contracting
[40]
[41]
[42]
[43] Enterprise
Capital, Inc. v. San-Gra Corp., 284 F. Supp. 2d 166, 176 (D.
[44] Dangfeng
Shen Ho v.
[45]
[46] Abcon
Assoc., Inc. v.
[47]
[48]
[49] 48
C.F.R. § 52.249-2(b).
[50] 48
C.F.R. § 52.249-2(b).
[51]
[52] Kalvar Corp. Inc. v.
[53]
[54] Capital Safety, Inc. v.
[55]
[56] 317 F.3d 610 (6th Cir. 2003).
[57]
[58]
[59] Mirra
Co., Inc. v. Semass Corp., 2002 WL 31012226, at *2 (
[60] See,
e.g., Sturdy Concrete Corp. v. Nab Constr. Corp., 452 N.Y.S.2d 252, 253
(N.Y. App. Div. 1982); Hotel 57 LLC v. Harvard Maintenance, Inc., 816
N.Y.S.2d 420, 420 (N.Y. App. Div. 2006).
[61] R.S.
Means provides construction cost information to owners, developers, architects,
engineers, contractors, subcontractors, and others in the construction
industry.
[62] George
J. Bachrach, The Surety Performance Bond
Lifeboat: Bailing Out and/or Salvaging Someone Else’s Wreck, Part IV.A.6.
[63]
Payment bond claims and lien claims are discussed in Part
[64] Part
II.A.2., supra, includes a discussion
of factors to be considered in assessing whether delays in payment are
sufficient to justify project abandonment.
[65] For an
excellent survey of state lien and bond law requirements, see Robert F. Cushman & Stephen D.
Butler, Fifty State Construction Lien and
Bond Law (2000) or Lawrence Lerner & Theodore M. Baum, Performance Bond Manual (2006).
[66] Compare
[67] See,
e.g., DeKalb County v. J & A
Pipeline Co., Inc., 437 S.E.2d 327, 333 (
[68] 40
U.S.C. §§ 3131-3134.
[69] See,
e.g.,
[70]
[71]
[72] See, e.g., Sunderland v. Vertex Assoc., Inc., 199
[73] 40 U.S.C. § 3133(b); MacEvoy Co. v. United States, 322 U.S. 102, 110 (1944); see United States ex rel. Water Works Supply Corp. v. George Hyman Constr. Co., et al., 131 F.3d 28, 35 (1st Cir. 1997) (material supplier furnishing materials under open account need not have a “formal contract”); Home Indem. Co. v. Battey Machinery Co., 136 S.E.2d 193, 195 (Ga. 1964) (all persons supplying labor or material are covered, even a supplier to a third-tier subcontractor); see also Tom Barrow Co. v. St. Paul Fire & Marine Ins. Co., 421 S.E.2d 85, 87 (Ga. 1992) (supplier of second-tier subcontractor may assert bond claim).
[74] For a
survey of state bond law requirements, see
Cushman & Butler or Lerner & Baum, supra note 65.
[75] Sadler and Co. v. W.H. French Dredging and
Wrecking Co., 52 F.2d 235, 238 (D.
[76] Turover v. Thompkins Co., 72 F.2d 383,
384 (D.C. Cir. 1934).
[77]
[78] Carter-Schneider-Nelson, Inc. v.
[79] Equitable Cas.
[80] Standard Acc. Inc. Co. v. Powell, 302
[81] American Sur. Co. v. Barrow Agee
Laboratories, Inc., 76 F.2d 67, 68 (5th Cir. 1935).
[82] Sherman v. Carter, 353
[83]
[84]
[85]
[86]
[87]
[88] 40
U.S.C. § 3133(b)(2).
[89] 40
U.S.C. § 3133(b)(2).
[90] General Elec. Co. v. I.H. Lewis Constr. Co.,
375 F.2d 194, 197 (2d Cir. 1977).
[91] 40
U.S.C. 3133(b)(2).
[92]
[93] Southern Steel Co. v. United Pac. Inc. Co.,
935 F.2d 1201, 1205 (11th Cir. 1991).
[94]
[95] 40
U.S.C. § 3133(b)(3)(B).
[96] 40
U.S.C. § 3133(b)(3)(A).
[97] 40 U.S.C.
§ 3133(b)(4).
[98]
[99] United States ex rel. Portland Constr. Co.
v. Weiss Pollution Control Corp., 532 F.2d 1009, 1012 (5th Cir.
1976).
[100]
[101] F.D. Rich Co. v.
[102] U.S. ex rel. T.M.S. Mechanical Contractors,
Inc. v. Millers Mutual Fire Ins. Co. of Texas, 942 F.2d 946, 949 n.6 (5th
Cir. 1991).
[103] Moore Brothers Co. v. Brown & Root, Inc., 207 F.3d 717, 723 (4th Cir. 2000).
[104] But see United States ex rel. Walton Tech., Inc. v. Weststar Eng’g., Inc.,
290 F.3d 1199, 1205 (9th Cir. 2002) (“The liability of a surety and
its principal on a Miller Act payment bond is coextensive with the contractual
liability of the principal only to the extent that it is consistent with the
rights and obligations created under the
Miller Act.”).
[105] Aesco Steel, Inc. v. J.A. Jones Constr. Co., 621 F. Supp. 1576, 1578 (
[106]
[107]
[108]
[109] 940 F. Supp. 1245 (N.D.
[110]
[111]
[112]
[113]
[114] Housing Authority of The City of Carrollton
v. Ayers, 88 S.E.2d 368, 369 (
[115]
[116] Id. at 370 (architect’s petition for
mandamus appropriate on written contract providing for compensation calculated
according to fixed mathematical formulas; where housing authority executed
certificates of final acceptance of projects, petition clearly stated a
liquidated claim).
[117] State of
[118] Sipco
Servs. & Marine, Inc. v. United States, 41 Fed. Cl. 196, 220
(Fed. Cl. 1998).
[119]
[120]
[121]
[122]
[123]
[124]
[125]
[126] 6
Philip L. Bruner and Patrick J. O’Connor, Jr., Bruner & O’Connor
Construction Law §
[127] Louise
Caroline Nursing Home, Inc. v. Dix Const. Corp., 285
N.E.2d 904, 907-08 (1972).
[128]
[129] Raven’s
Cove Townhomes, Inc. v. Knuppe Dev. Co., 114
[130] Smart
v. U.S. Fidelity & Guaranty Co., 513 S.W.2d 291, 296 (Tex. Ct. App.
1974) (awarding $10,000 for loss of veterinary medicine practice resulting from
delayed building construction).
[131] See,
e.g., Whitener v.
[132] Dankowski v.
[133]
[134] See, e.g., Nohcra Communications, Inc. v. AM
Communications, Inc., 909 F.2d 1007, 1011
(7th Cir. 1990) (applying
[135] M&R Contractors & Builders, Inc. v. Michael, 138 A.2d 350, 354 (
[136] 138
A.2d at 355.
[137] See, e.g., Tempo,
Inc. v. Rapid Elec. Sales & Serv., Inc.,
347 N.W.2d 728, 733 (Mich. Ct. App. 1984).
[138]
[139] See,
e.g., School Dist. No. 65R of Lincoln County v. Universal Surety Co., 135
N.W.2d 232, 237 (
[140]
[141]
[142] Enterprise
Capital, Inc. v. San-Gra Corp., 284 F. Supp. 2d 166, 178 (D. Mass. 2003)
(owner’s failure to provide seven-day default notice to contractor as required
by
[143] Insurance
Co. of North Am. v.
[144] See Bachrach,
supra note 62, at Part III.B.2.