Any owner or general contractor who has a few projects under his or her belt has likely had this thought: “My contractor (or subcontractor) is not performing the way I expected; should I replace him?” The other side of the termination coin is: “This project is not going the way I expected; should I get out?”
While there may be an emotional high that immediately comes from terminating a contractor or subcontractor (or leaving a project, in mid-stream), there are many factors to be weighed, before making that decision.
Project Delay. Replacing a contractor or subcontractor that has already begun performance always results in delays to the project. Assessing the work in place, interviewing replacement contractors, and negotiating the terms of the new relationship can easily consume weeks, if not months of project time.
Warranty Obligations. Another consideration is that of warranty. Industry standard places a one-year “general warranty” on new construction. In short, this warranty obligation requires the contractor parties to repair and/or replace defective work, for one year, following project completion. When a contractor or subcontractor relationship is terminated part-way through the project, the general warranty picture is blurred. What work did the first Subcontractor complete? The second Subcontractor? What about the work that was partially completed by each of the two?
Wrongful Termination/Abandonment? Even if termination is the right decision, financially, there still remains the legal issue: Is the termination proper? If you are the owner or GC looking to terminate your contractor/subcontractor, there needs to be proper basis for the termination.
Generally, there are two sources of termination rights: common law and contract. Under common law, if the party to-be-terminated is in “material breach” of its contract, then the non-breaching party may terminate the relationship. Obviously, whether a breach is “material” or not can be difficult to determine. Also, the common law approach leaves open the question as to what, if any, remedies the non-breaching party is entitled to recover from the terminated contractor.
The second and more common basis for contractor termination is contractual – what does the contract or subcontract state, as to termination? (The owner’s right to terminate for convenience is a separate topic, for another article.)
Additional Costs Associated with Contractor Substitution. In the many projects I am familiar with in which a general contractor or subcontractor was replaced part-way through a project, the cost to complete that contractor’s scope of work with a replacement contractor has always been greater than the contract or subcontract balance. Even with the customary 10% retention withheld, the likelihood of a GC or owner completing the scope of work for the original contract/subcontract price is extremely low. Although many contracts and subcontracts include a provision that states that, in the event a contractor or subcontractor is terminated for cause, the owner or GC can complete the work with a replacement then charge the terminated contractor the excess cost, the reality is that such reimbursement rarely takes place, at least not without great expense.
Termination – Get it in Writing. Once the parties have reached agreement, as to the terms of the termination, it is important that the parties execute (sign) an agreement that addresses all of the key provisions. If properly drafted and executed, the termination agreement becomes “the contract” between the parties. All rights and obligations are determined by the new document, rather than the original construction contract.
The termination agreement terms should include:
- The amount and timing of final payment (if any) to the terminated Contractor or Subcontractor.
- Whether terminated Contractor/Subcontractor has any further obligations. These may include on-site work (such as protection of the work in place); delivery of materials and equipment; delivery of accounting information, plans, permits, or other documentation; warranty obligations; assignment of subcontracts and purchase orders to Owner or Lender; and cooperation with Owner in the transition process.
- Mutual release of any claims. Once the parties agree, as to what payment, if any, Owner is to make to Contractor (or Contractor to Subcontractor), the parties typically release each other from any claims, known or unknown. In effect, Owner accepts all work in place, as well as materials and equipment furnished by Contractor, and Contractor waives any right to further payment. Owners often exclude latent conditions and third-party claims for bodily injury or property damage from the release.
- Risk of loss or damage to the Project, as of the date of termination.
- Miscellaneous terms (indemnification, attorney’s fees provision, litigation/arbitration of disputes, etc.)
In the case of a terminated subcontractor, it is typically advisable (if not required, by contract or statute), that the general contractor notify the owner prior to subcontractor termination, regardless of what the cause of the termination is. Owners are often parties to a termination agreement between the prime contractor and a subcontractor, as some of the terms affect the owner.
Lastly, if you are contemplating the termination of a contractual agreement, you should seek legal counsel prior to “pulling the pin.”
Article by Patrick McNamara, Esq. Mr. McNamara is Of Counsel with Porter Law Group, Inc. His practice includes advising contractors and owners, as to contract, dispute resolution, and insurance matters. For more information, please email him at: firstname.lastname@example.org or call (916) 381-7868.