Construction can be a very frustrating process for all involved when things don’t go according to plan. Deviations from delivery schedules and variations to plans and specifications during the build can ultimately lead to delays and blown out budgets. However, there are only limited circumstances which will give a party to a building contract a right to terminate.
Whether or not you can ‘get out of’ your building contract will largely depend on the building contract itself. A party’s right to termination can arise through both the common law and through clauses contained in the building contract. In most instances, the contract will also reflect a party’s common law right to termination.
What is ‘Termination’?
Termination of a contract is the process of ending or cancelling a contract before the parties have fully performed their obligations. Once a contract has been terminated, all remaining performance obligations created by the contract cease to exist.
Common Law Grounds for Termination
Under common law, there are three grounds which give rise to termination:
1. Termination by Agreement.
A contract can be terminated by agreement either expressly or by implication. Although parties can expressly terminate an agreement verbally, it is recommended to do so in writing. Any implied agreement to terminate must be clear, through the parties’ conduct, indicating that there is an intention that neither party requires the other to perform their obligations under the contract.
2. Termination for Breach of Contract
The first step is to identify the clause of the contract which has been breached and determine whether that clause is an ‘essential’ term or ‘non-essential’ term. Essential terms are sometimes described as ‘conditions’ and are the fundamental terms of the contract. In comparison, a non-essential term is described as a warranty and are sometimes known as an ‘intermediate’ term.
Where a party has breached an essential term of the contract, the innocent party will be entitled to terminate the contract. Essential terms in building and construction contracts commonly relate to payment and time stipulations.
A ‘sufficiently serious’ breach of a non-essential term may also give an innocent party a right to terminate. Commonly cited case law describes a sufficiently serious breach to be a breach ‘going to the root of the contract’, ‘an obligation of basic importance’ and a breach that ‘substantially deprives the innocent party of the benefit of the contract’.
3. Termination for Repudiation of Contract.
An act of repudiation will occur where one party, either expressly or through its actions, demonstrates an intention that they are either unwilling or unable to perform their obligations under the contract. Termination will only occur if the repudiation relates to either a fundamental or sufficiently serious obligation. The innocent party must accept that repudiation and must be ready and willing to perform the contract before the contract can be terminated.
An innocent party terminating a contract for either breach or repudiation may be entitled to claim damages. The law relating to damages is complex and outside the scope of this article.
Contractual Right of Termination
A building and construction contract can allow for automatic termination in some situations as well as generate a right to terminate based on either specific events or defaults.
Building contracts, like any other type of contract, can contain clauses which result in automatic termination when a specified event occurs. Automatic termination clauses are more commonly formed as a pre-condition with a time stipulation. For example, if Party A does not obtain clear title of the subject land by X date, the building contract will automatically terminate.
Specific Events Creating a Right to Termination
Most contracts contain a list of specific events that will give rise to a right of termination. Common examples in building and construction contracts include:
- Failure to obtain municipal or government approval by a specified date;
- Failure to obtain necessary finance by a specified date; and
- Acts of insolvency, for example, where one party becomes bankrupt, or the company is wound up, or a liquidator is appointed.
Here, a party that has acquired the right of termination must typically provide formal written notice to the other party with their intention to terminate.
Termination After Default
Building and construction contracts will contain a termination clause setting out the specific breaches of contract that will give rise to a right of termination. These breaches are sometimes referred to as an event of default. Termination clauses generally reflect the common law approach, and only the fundamental and sufficiently serious breaches will give rise to a right to terminate.
Common examples in building and construction contracts include:
- Failure to make payment on time;
- Failure to complete building works;
- Failure to supply the requisite quality materials; or
- Failure to supply materials by a stipulated date.
Termination of a contract after default is not automatic. Where there has been an event of default, the building contract will generally include a ‘notice clause’. A formal written notice will need to be provided to the defaulting party providing details of the breach. The defaulting party will then have an opportunity to rectify the breach within a specified time frame. If the defaulting party fails to rectify or remedy the breach, the innocent party provides a further written notice confirming that the contract has been terminated.
A contract that gives a party a right to termination after an event of default will also specify the remedies available to the innocent party.
A notice clause must be strictly followed to ensure effective termination. If there is any deviation from the steps required in the notice clause, the innocent party may be considered to have repudiated the contract, potentially giving the defaulting party a right to termination.
There are specific and limited circumstances which can result in a party terminating a building and construction contract. In some circumstances, a contract may be terminated under both the common law and under a contractual clause. In this circumstance, it can be a matter of strategy as to which approach should be taken.
Some points to keep in mind are as follows:
- A party can terminate a contract under common law either by agreement, after a fundamental or sufficiently serious breach of the contract or where there has been a repudiation of the contract.
- Contractual termination can arise automatically, as a result of a specific event, or after an event of default.
- It is essential a party strictly complies with a notice clause in a building contract to ensure effective termination.
There can be major consequences to terminating a contract, and it’s important to first seek legal advice. If you have any questions, get in touch with our specialist building and construction lawyers on 1300 544 755.