How to terminate a building contract

Construction work is complicated and difficult work and the successful completion of a construction project on time, within budget and without defects would be quite exceptional for all but the simplest of projects.

It is not unusual for issues to arise at some point in construction program. Sometimes the issues are able to be resolved and the work progresses, other times the issues are insurmountable for one of the parties: the principle contractor, the sub-contractor or the owner. In these situations, it is not unusual for one party to obtain legal advice in relation to terminating the contract.

Terminating a building contract is a serious step and should be considered carefully based upon legal advice. If a building contract is not terminated validly there may be costly consequences. In many cases, in addition to the legal issues, there are important commercial factors which also need to be considered when weighing up whether terminating the contract is the best course to take.

A construction lawyer can advise on the right to terminate, the process of termination, and the commercial implications of terminating the contract. Often the termination of the contract results in a legal dispute, and it is preferable if the lawyer involved in terminating the contract has the experience and resources to act in any associated legal proceedings.

Following are some of the steps which need to be considered. If you are thinking about terminating a building contract, please consider the steps below as an introduction, and not as a substitute for legal advice.

Step 1 – Is termination of the contract absolutely necessary?

Termination of the building contract is not reversible. It will bring the whole of the commercial relationship to an end. Each party signing up to the contract did so for a commercial gain. If the contract is terminated not only will that gain have been lost but it may not be able to be replaced or may be replaced at significant further expense.

If you are a homeowner, you will need to find a new builder. Generally, builders do not like taking over work from another builder as this exposes the new builder to risk. This will usually result in a higher construction price. There may be delays before a new builder can resume the work, this could result in additional financing costs and interest. There may also be difficulty obtaining certificates for the work performed. The pervious builder’s sub-contractors may not work with the new builder and they will not usually be willing to provide certificates for work partly completed.

If you are a contractor, or a sub-contractor, you will be losing a source of income. If the contract is terminated early in the construction program you will need to find new work to maintain cash flow. If you have more than contract with the other party, terminating one contract may impact upon the other contracts. Usually terminating the contract will have a damaging effect on business relationships.

A construction lawyer can advise of the specific consequences arising from termination of the contract and provide strategies for minimising the risk of the consequences arising.

Step 2 – Understand the process to terminate

All standard form building contracts set out the process under which the contract may be terminated. Sometimes there are special conditions in the contract which, although they may not appear to relate to termination, have an impact upon one of the parties rights to terminate. It is important to obtain legal advice based upon the contract documents.

Many contracts prescribe a dispute resolution process which requires that the parties attend a meeting. Alternatively, the terminating party will usually be required to provide a “show cause” notice setting out the offending conduct or omission and giving the defaulting party an opportunity to remedy the issue.

If notice is required it is very important that the notice is prepared and provided to the defaulting party strictly in accordance with the terms of the contract. For example, the contract may provide that notice is to be served at a specific address, or on a specific person, that service occurs within a specific time, or that certain information must be provided.

Most contracts provide that the defaulting party has a period of time to respond to a notice by giving reasons as to why the contract should not be terminated or to remedy the issue.

For a homeowner wishing to terminate a principle builder, or a principle builder wishing to terminate a sub-contractor, the two main issues which usually give rise to termination of the contract are defects and delay. In such circumstances it is not unusual for the notice to be supported by a report from a building consultant.

For a principle builder or sub-contractor wishing to terminate for non-payment, usually the first step is to suspend the work and request evidence of capacity to pay. Where the work is suspended for an extended period of time usually one of the parties instigates the termination process outlined above.

Step 3 – Consider the grounds for termination

There are three main grounds for terminating the contract:

  1. Termination for substantial breach of the contract.
  2. Termination for repudiation of the contract.
  3. Termination rights arising from a specific clause in the contract.

Termination for a substantial breach of the contract requires and detailed review of the contract, assessment of the offending conduct or omission and clear identification of the clause in the contract which has been breached.

To terminate a contract for substantial breach the clause of the contract which has been breached must be either an “essential” term of the contract. An essential term is also called a “fundamental” term.

The question of whether a term in a contract an essential term may be difficult to answer as it depends upon the mutual intention of the parties when they entered into the contract and as expressed in the contract documents. An example of an essential term is the term that time is of the essence.

Termination for repudiation of the contract may be available where the defaulting party demonstrates unwillingness or inability to perform the obligations under the contract. This may occur expressly, or it may be implied, but it must be a serious breach of the contract.

An express repudiation of the contract may arise if the homeowner advises the principle builder that it does not have sufficient funding to make a payment claim. An implied termination may arise when the principle builder has failed to attend the site for an extended period despite persistent requests from the homeowner to progress with the work.

Termination based upon a specific cause of the contract is based upon a particular event arising. For example, the contract may provide that if the homeowner is unable to obtain finance within a specified time frame the builder has a right to terminate. Most contracts provide that if one of the parties becomes bankrupt, or enters into administration, the other party has a right to terminate.

Step 4 – Is termination by agreement feasible?

It is somewhat rare, but sometimes the parties to the contract acknowledge that the least risky and the most cost effective means of ending the contact may be for both parties to reach an agreement on how the contract is to be terminated.

Where a contract is terminated by agreement, the parties may agree upon such matters as:

  • Any outstanding amount owed to the builder.
  • Compensation for the cost to rectify defects.
  • Compensation for the loss associated with delay.
  • Novation of fencing, scaffolding, materials and sub-contracts to the new builder.
  • The provision of the certificates required by the certifier or council for the issue of an occupation certificate.

Another reason parties may reach an agreement to terminate is to remove the risk associated with wrongful termination. Wrongfully terminating the contract gives rise to a claim against the terminating party.

For example, if the builder wrongfully terminates, the homeowner may claim the cost associated with finding a new builder, the additional amount it will cost the new builder to complete the work, plus financing, interest and loss of rent for delay.

If the homeowner wrongfully terminates, the builder may claim for loss of profit, the value of any intellectual property rights held by the builder, and may make a claim under the law of “quantum meruit” for the value of the work performed.

Alternatively, the motivation to terminate by agreement may arise if the commercial benefits of terminating the contract outweigh the legal risk that they will need to pay compensation for wrongful termination.

Terminating a building contract is a complicated and risky process and it is best to obtain advice from a construction lawyer as early in the process as possible. If you require assistance in relation to a building contract please do not hesitate to contact Williamson Lawyers to arrange a meeting.

The information provided in this article is general information only and should not be relied upon as legal advice or be used as a substitute for obtaining legal advice. The specific circumstances relating to you impact upon your legal rights and obligations and personal legal advice based upon your circumstances should be obtained. This area of law changes frequently and the law may have changed after the time this article was prepared, up-to-date legal advice should be obtained. Please do not hesitate to contact Williamson Lawyers if we may be of assistance.

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