Terminating a construction contract is risky and has wide-reaching consequences for all who are involved. Sometimes relationships or communication breaks down between the parties of a construction contract. One party may feel that the other is not performing according to the terms of the contract. Disagreements can arise due to cost, time, or quality of the build. Consequently, the parties may wish to bring the contract to an end. However, terminating a construction contract is not an entitlement. This article explores factors to consider before terminating a construction contract.
Terminating a Construction Contract
The termination of a contract refers to ending a contract before parties perform all of their obligations. A construction contract can end through:
- express provisions of the contract;
- rules of common law; or
If you wish to bring the contract to an end, you must have a good reason. You must also understand your reasons to determine whether or not you can lawfully terminate the contract.
Express Contractual Provisions
The contract may set out express terms allowing a party to terminate it. Such terms are limited and specific, so you should read them carefully. These may include:
- automatic termination, or termination due to a specific event or circumstance;
- default or breach of contract; or
- other rights of termination.
1. Automatic Termination, or Termination Due To a Specified Event or Circumstance
A contract can set out express provisions that automatically bring it to an end due to:
- a specific event; or
- when parties do not meet pre-conditions.
The wording must be clear that the termination is to be automatic. The contract should also set out the process for termination in such an event so it can properly occur. For example, the contract will be terminated if:
- a sunset clause is included;
- a party fails to obtain finance or planning approval; or
- one party becomes insolvent.
2. Default or Breach of Contract
A party will be in default or breach of a contract when they fail to comply or perform with a provision. The contract will typically set out those defaults or breaches that provide a party with a right of termination. The contract will also outline the process to follow if the right to termination for default arises. Further, it will usually require the non-defaulting party to give the defaulting party:
- notice; and
- a time frame to rectify or remedy the default (if it is capable of being remedied).
3. Other Rights of Termination
Some construction contracts contain an express right for one or both parties to terminate at their discretion. It is more common in contracts with higher risk profiles and usually included in favour of the principal (or the party engaging the builder in a construction contract). The contract may also provide that the parties may terminate upon a written agreement between the parties. However, these provisions are less common in construction contracts.
Common Law Grounds for Terminating
If you do not have an express entitlement to terminate, you may be able to terminate under common law (unless the contract expressly excludes your right to terminate at common law right).
The common law recognises specific reasons that allow parties to bring a contract to an end. These are:
- breach of an essential term;
- breach of an intermediate term; and
- unlawful repudiation.
1. Breach of an Essential Term
A breach of an essential term gives rise to the right to terminate the contract. An essential term usually deals with the payment or timely performance of works or services. The term must satisfy the test of essentiality. This means that a term must be so important that the other party would not have entered into the contract unless they were assured of the strict or substantial performance of such term, to satisfy the test of essentiality.
A breach of an essential term gives rise to a right to terminate and to sue for damages. While the breach of other terms of the contract (such as warranties or non-essential terms), do not give rise to a right to terminate they may give rise to the right to damages if one party does not comply with them.
2. Breach of an Intermediate Term
A sufficiently serious breach of a term that is non-essential and not a warranty may give rise to the right to terminate, depending on the circumstance. Whether or not it gives rise to the right to terminate depends on the:
- nature of the contract and seriousness of the breach; and
- impact on the innocent party.
If the breach of the non-essential term deprives the innocent party of a substantial portion of the benefit of the contract, they may have an entitlement to terminate and sue for damages.
3. Unlawful Repudiation
If a party evidently shows that they do not want to continue to be bound by the contract without any right to do so, the innocent party may terminate the agreement for the other party’s unlawful repudiation and sue for damages.
Statutory Right to Terminate
Legislation may set out a right to terminate a contract. For example, a contract may exist between a consumer and supplier, governed by the Competition and Consumer Act 2010 (Cth). In line with the Act, if a supplier breaches specific consumer guarantees, the consumer may have an entitlement to terminate the contract, among other remedies. The most relevant consumer guarantees concern the:
- quality of the product or service;
- fitness of the product or service; and
- description of the product or service under the contract.
Process to Follow
Your contract determines whether there is a specific process in the termination clause and other provisions that you must follow. Other provisions may include the process for resolving a dispute and providing notice. If there is a process, ensure you follow it correctly to minimise the risk of wrongfully terminating (or repudiating) the contract.
It is important to understand whether you have ongoing obligations to the other party once the contract comes to an end. Upon termination, contracts typically, but not always, release parties from future obligations. Therefore, you must check that the contract does not state that obligations will continue and survive termination of the contract. You may, however, continue to be responsible for liabilities accrued before termination.
When lawfully terminating a construction contract for breach, the innocent party will usually be able to recover the additional costs involved in having someone else complete the contract. In some cases, they can even recover loss of profits from the defaulting party. However, the contract may limit the amount you can recover by stating a specific amount.
Terminating a construction contract is not an easy or obvious process. It is complicated by various legal and commercial factors that may add time and expense to the project. The law sets out specific and limited reasons for ending a contract. Therefore, before terminating your construction contract, it is essential to understand your obligations and, if necessary, follow any processes that your contract outlines.
If you have any questions or need assistance terminating a construction contract, get in touch with LegalVision’s construction lawyers on 1300 544 755 or fill out the form on this page.
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