A contract default happens when one party identified in the contract fails to perform one or more outlined duties. When contract default happens in the construction industry, it usually stems from a contractor failing to perform certain actions, which in turn impacts the progress or outcome of the construction project, sometimes leading to construction project termination.
While some defaults are avoidable, others are challenging to foresee. In this article, we will discuss the common causes of construction termination and defaults, the parties impacted by such occurrences, how to prevent and manage terminations and defaults with contracts, and some essential points to keep in mind.
Common Causes of Construction Termination and Default
Numerous factors lead to the termination of construction projects, including:
1. Delays in Construction
Several factors may cause construction project delays, such as miscalculating inherent risks and uncertainties, change in client interest, insufficient or inadequate initial project definition and force majeure, such as a pandemic. Other common factors include project complexity, inadequate planning, design variation, improper project schedule and management, improper post-execution phase management and inaccurate engineering estimates. While some of these factors are excusable, others may entitle the non-breaching party to sue.
In each of these instances, the liable party or parties depend on the facts of each case. Similarly, the remedies available depend on the nature of the breach. For example, a non-breaching party may be entitled to terminate the contract and sue for damages in the case of a material breach. However, if the breach is immaterial, or not a “total breach,” the non-breaching party may be entitled to damages but not termination.
The standard American Institute for Architects (AIA) A201-2017 may provide greater leniency to contractors facing uncontrollable delays, making contract termination based on such delays unlawful. This is significant, as the AIA A201–2017, General Conditions of the Contract for Construction, is considered a keystone document, providing the terms and conditions under which the owner, contractor and architect will work together during the building construction process.
2. Higher Unexpected Costs
Budget overrun or cost increase is any unexpected cost that causes the budget estimate to arise considerably beyond what the parties planned and agreed upon. Various factors may cause such a challenge, including the following:
- Labor shortages: Over 40% of the current United States construction workforce is expected to retire over the next decade. As labor demand increases, project cost is also affected. Such a shortage could be general or relate to a specialization of workers with needed expertise in certain areas.
- Poor cost estimation: Construction estimators play a crucial role in the success of projects. They offer contractors and developers a degree of certainty regarding the cost of the materials and labor, which usually reflects in construction contracts. It’s essential to conduct proper estimates to avoid challenges such as delays or cancellation of the project.
- Improper material management: Contractors and construction workers sometimes misuse the materials available for the project. This misuse may require the injection of further capital. Such occurrences may lead to project delays, shortage of funds and a lack of trust between the parties, forcing parties to terminate the construction.
3. Failure to Provide Promised Materials or Structures
There are instances where suppliers fail to provide the materials needed for the construction project as agreed. This failure may result from several reasons, such as shortages, sudden price increments and inclement weather. As a result, it is essential to implement measures to mitigate such challenges.
For example, contractors can leverage network relationships to ensure a constant supply of quality materials from trusted persons. Another common approach is diversifying the supply chain to protect yourself against disruptions. This strategy allows you to benefit from different suppliers and reduces delays and non-performances. Again, it helps you avoid common dispute triggers where contractors end up securing inferior supplies to enable them to complete the project as scheduled.
4. Performance Issues
Underperformance is an industry-wide issue. According to 69% of property owners, poor contractor performance is the most significant cause of project underperformance. Additionally, over 50% of construction professionals and engineers report one or more underperforming projects.
Performance management is crucial in construction. It enables contractors to create an environment where employees and subcontractors perform optimally. The result is that contractors can complete projects on time and within budget without compromising quality. Ultimately, it helps contractors avoid multiple lawsuits and claims.
Who Can Be Impacted by Construction Termination and Default?
Construction termination and defaults affect multiple parties, such as the property owner, contractors and subcontractors. Each player may have different interests and claims depending on the project’s outcome.
- Owners: Owners invest vast sums of money in construction, especially when the project is for commercial purposes. When the owner contracts with contractors, they expect the tasks to be completed according to plans and specifications. As such, delays or defaults on the contractor’s part may encourage owners to terminate the contract and seek the services of another professional.
- Contractors: Contractors have the expertise and qualification to execute construction projects of varying kinds. To perform optimally, they rely on subcontractors or independent contractors and suppliers to handle certain aspects of the project. If any party defaults, the contractor may terminate the agreement subject to the terms of the contract.
- Subcontractors: Subcontractors play a crucial role in construction. Contractors often have their own contracts with subcontractors, hiring the subcontractors to complete certain pieces of the work. Generally, when subcontractors perform their obligations under the contract, contractors may not be entitled to terminate the agreement.
Preventing Construction Terminations or Default
Contracts are efficient means of preventing construction terminations. Especially in major construction projects, contracts provide the details of the rights and responsibilities of each party, which serve as a helpful reference point in case disputes arise. Creating a contract may clarify matters and allow the project to move forward as planned.
In addition to outlining each party’s options and duties, contracts can assist with risk management associated with each project. For example, they can help parties plan for potential areas for dispute by outlining solutions before they are even needed. One might find provisions regarding economic price adjustments and material escalation clauses, for instance.
What to Know About Terminating a Contractor’s Contract
As a general rule, a material breach — also called a substantial or fundamental breach — may entitle the non-breaching party to terminate the contract, file a lawsuit against the breaching party and claim damages. But what qualifies as a fundamental breach?
Fundamental breaches occur when one party fails to perform a significant portion of the contract. In other words, the breach goes to the root of the contract. For example, when the contractor is aware that time is of the essence yet fails to perform in a reasonable timeframe, that delay may be fundamental. Some breaches may be excusable, such as when an event makes it practically impossible for the parties to perform their obligations.
The contract may also contain provisions concerning the termination procedures and requirements. Such terms may apply to both the owner and contractor. For example, the agreement may require that termination is valid when a notice of termination is given for a specified period and in a specified manner. Generally, the recipient of the notice of default for a construction contract would offer the defaulting party the opportunity to remedy the situation.
Again, the contract may contain a “termination of convenience” clause that enables a party to terminate the agreement without establishing default. However, a termination purported to be in accordance with such a clause may be invalid if exercised in bad faith. A “termination of convenience” clause differs from a “termination for cause” clause in that the latter allows the non-breaching party to sue based on a default on the part of the other party.
Contact a Construction Termination and Default Attorney at Calabrese Law Associates
Construction terminations and defaults are not always straightforward from a legal perspective. Construction termination may affect parties differently, making it essential to set out each party’s rights, liabilities and obligations in contractual terms. Beyond contracts, common law rules apply in assessing the legal positions of each party — that is, to determine whether a construction termination or default is lawful.
Calabrese Law Associates is a trusted law firm specializing in construction and real estate law. We partner with clients facing legal challenges or needing legal advisory services in Massachusetts. Contact us today to learn more.
This publication and its contents are not to be construed as legal advice nor a recommendation to you as to how to proceed. Please consult with a local licensed attorney directly before taking any action that could have legal consequences. This publication and its content do not create an attorney-client relationship and are being provided for general informational purposes only.
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