Breaking Up is Hard to Do: Termination Rights of Owners and Contractors

By Siraj Ahmed of Kasem, Ko & Ahmed

Rights to Terminate

Generally, an owner or contractor can properly terminate a contract in one of two scenarios. First, if a contract term provides a right of termination, then termination pursuant to this term is proper. Second, termination is proper where the other party commits a material breach of contract.

Pursuant to Contract Terms

Owners may terminate where the contract language provides a right of termination. For example, the contract may permit the owner to terminate if a contractor repeatedly fails to supply workers or materials. Some contracts contain a "termination for convenience" clause, which permit the owner to terminate solely for owner's convenience. If an owner exercises this right, the contractor is generally able to recover costs for work performed to the date of termination. Contracts typically do not provide contractors with the right to terminate for convenience. As such, a contractor must ensure that its subcontracts contain similar clauses. Thus, if the owner terminates the prime contract, the contractor will be able to terminate its subcontracts.

Like owners, contractors also reserve the right to terminate where the contract language provides a right of termination. For example, the contract may permit the contractor to terminate if a public authority requires that work be stopped. Another example where the contract permits the contractor to terminate is where the owner fails to remit payment within the specified time period.

Material Breach

Owners and contractors may also terminate where the other party commits a material breach. For a breach to qualify as material, the breach must concern an essential condition or element of the contract. Whether a breach is material depends on the specific facts of each case.

In regards to owners, a Massachusetts court has held that a contractor's failure to provide four reinforcing rods instead of two in the concrete posts of a building constituted a material breach. However, a contractor's failure to inform owner of a substitute material where the contract permits the substitution may not be material. A delay may also constitute a material breach to the owner where "time is of the essence" to the contract. Put another way, if timely performance is material to the contract, then a delay in contractor's performance will constitute a material breach.

In regards to contractors, a frequently encountered problem is that of nonpayment by owner. A contractor may not terminate unless nonpayment by owner constitutes a material breach. A Massachusetts court has held that a contractor was entitled to terminate because the owner materially breached the contract by failing to remit payment for 90% of the contract price. Before terminating for nonpayment, however, a contractor must be certain that the nonpayment was both substantial and unjustified. Otherwise, the contractor may be liable for damages to the owner.

Conclusion

Owners and contractors must carefully weigh the risks and benefits of terminating a contract. Even where termination is justified, the terminating party may be held liable for damages if the proper legal notice requirements are not met. Thus, an improper termination may constitute a breach of contract. Further, a terminated party may claim damages under several legal theories, such as "unjust enrichment" or "quantum meruit." In sum, while termination may be justified in certain situations, owners and contractors must tread carefully to avoid incurring liability.

This article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and you are urged to consult a lawyer concerning your own situation and any specific legal questions that you may have.

Copyright C 2008 Kasem, Ko & Ahmed, All rights reserved.