Termination of construction contracts – the nuclear option

Termination is a very serious step, so this article will look at the termination of construction contracts: when the right arises and how to go about it when it does, the need to ensure that it is done properly and the consequences of getting it wrong. It will also look briefly at the effect of the Corporate Insolvency and Governance Act 2020 (‘CIGA’) when it comes to termination for insolvency. It links up with the recent article on suspension. Although this article is aimed specifically at construction contracts, which includes professional consultancy appointments, to a large extent it is relevant to any contract.

Common law termination

While many contracts, and most construction contracts, will contain express provisions governing termination to a greater or lesser degree (see below), where there are no such provisions then the only right that a party will have to terminate the contract will be at common law. This is obviously more than somewhat restrictive.

The main way that such a right will arise is when a party has committed a breach, or the threat of a breach, so serious that it goes to the root of the contract. This is known as a ‘repudiatory breach’ and is when a party ‘evinces an intention no longer to be bound’ by the contract and its terms. Examples would be a contractor just walking off site and refusing to continue with no right to do so; or an employer unjustifiably and categorically refusing to make any further payments.

If it does arise, then the innocent party is faced with a choice: either accept the breach by notifying the other party, which then means the contract is terminated and the innocent party is entitled to claim damages caused by the breach; or it can decide to affirm the contract in which case the contract is not terminated and carries on, but it can still claim damages. It must however act quickly if it wants to terminate otherwise a delay will have the effect of affirming the contract and the right to terminate for that breach is lost.

A party wishing to terminate for repudiatory breach must ensure that the breach has occurred and is actually repudiatory before taking action. Wrongly claiming that a breach is repudiatory and notifying the other party that the contract is terminated will itself then amount to a repudiatory breach, the effect of which is that the other party can then choose whether to terminate or affirm the contract, and can seek damages.

Although common law termination is the only option available to where a contract contains no express termination provisions, unless expressly excluded in a contract, it will remain an option in appropriate circumstances in addition and in parallel to any express provisions.

Express contract termination provisions

Most standard form construction contracts, whether building/engineering contracts or professional consultancy appointments will contain express provisions for termination, a benefit of which is that both parties know what circumstances will trigger that right and what the consequences are, which will often be different depending on what event has triggered it.

Both JCT and NEC4 standard forms contain comprehensive provisions that deal with both the events that trigger the right to terminate and the consequences of terminating.

In the JCT Standard Building Contract Without Quantities 2024 (JCT SBC/XQ 2024) separate trigger events are provided for termination by the employer and the contractor, as are how to effect termination (i.e. the notice requirements) and the consequences (including what happens to payment) if the contract is terminated. These provisions are in the main relatively straightforward and easy to operate.

NEC4 is more complicated and has a table setting out the relevant provisions for the two parties divided into three: ‘reasons’ (i.e. the trigger event) of which there are 22(!), ‘procedure’ (i.e. how to effect termination – 4 no.) and ‘amount due’ (i.e. how payment is to be dealt with – 4 no.). These are then set out in detail in three separate sections but mean in practice that one will probably keep having to refer back to the table, which is not exactly ‘user friendly’, since particularly in the case of reasons although many (12 of the 22) apply to both employer (in the contract ‘client’) and contractor, several apply only to either employer (8) or contractor (2).

Standard form construction consultancy appointments (e.g. RIBA, ACE and similar) likewise contain express termination provisions although these are generally not so comprehensive as JCT or NEC4. What they will commonly have, which JCT and NEC4 do not, is a right for the employer to terminate at will and without cause subject to written notice which may or may not require a minimum period. Termination without cause will likely mean that the employer will be liable to pay not only for any services provided up to the date of termination but unpaid, but also for loss of profit on the balance of services that will not now be provided.

Bespoke contracts or terms and conditions may contain provisions that are less comprehensive; in many cases they will contain provide expressly for termination only by the party proposing them and omit any provisions for the other party to terminate. For the party on the receiving end this needs to be avoided if at all possible and amendments made to provide them with their own express termination rights.

Insolvency and CIGA

In construction contracts containing express termination provisions, insolvency of either party is usually one of the events stated as triggering a right to terminate. This is certainly the case with JCT and NEC4 contracts. The right is immediate, subject to notice of termination being given. Common law does not allow a contract to be terminated for insolvency, so it has to be provided for expressly.

If terminated for insolvency, the consequences will depend on whether the insolvent party is the employer or the contractor (of whatever tier). Typically (e.g. under JCT) if the contractor is insolvent, the employer terminates the contract, can employ others to continue the work and is then not obliged to pay any more money until the project has been completed and any defects made good. At this point an account is taken of the costs incurred by the employer following the insolvency which will be set against any sums that the contractor was entitled to but which were unpaid at the date of termination to establish what is owed to whom. If the contractor terminates because of the employer’s insolvency, then its obligation to carry out and complete the work ceases.

The right to terminate for insolvency has been complicated somewhat by the coming into effect of CIGA, which was a way for the Government to give businesses some relief during COVID, but which remains in place today. There is not scope in this article to set out all the relevant provisions and ramifications of CIGA on termination for insolvency – this would require a separate article in itself. The latest JCT suite of contracts (2024 Edition) has amended the definitions of insolvency to take this into account. For the purpose of this article the provisions of CIGA need to be borne in mind if seeking to terminate for insolvency.

Procedure for termination

What is required to terminate where a right to do so has properly arisen will vary from contract to contract. The important point to remember is to check very carefully what is required in the contract and follow it precisely.

Taking JCT SBC/XQ 2024 as an example, first establish the ground for termination (e.g. the contractor wholly suspending carrying out the works without reasonable cause); it is then for the architect/contract administrator (NB not the employer) to issue a written notice to the contractor specifying the default. In this case the contractor then has 14 days from receipt of the notice to cure the default and get back to work. If at the end of that 14 days period the contractor has not complied, then the employer (NB not the architect/contract administrator) can within 21 days following the expiry of the 14 day initial notice period issue a further written notice to the contractor terminating the contractor’s employment under the contract.

For the contractor under that contract, if the employer for instance interferes with or obstructs the issue of a payment certificate, then the same two-stage notice procedure applies with the same notice periods, the only difference being that it is the contractor that issues both notices.

Note any provisions as to the required method of service of the notices and follow them.

Getting it wrong

As with exercising any right to suspend the contract, it is very important to ensure before exercising any right to terminate the contract or a professional appointment, that the right to do so has actually occurred. In the case of termination for failure to pay a sum properly due in full by the final date for payment, check that the sum is in fact contractually due; that the sum has actually been finalised and certified by a valid payment and/or payless notice, or that the amount sought has been validly applied for and has become the amount payable because of a failure by the employer to issue a valid payment and/or pay less notice. Then carefully follow the contract provisions for termination to the letter (see example above).

If an attempt to terminate is made wrongly (e.g. the right to terminate has not actually arisen, the wrong person has issued the notice, it has been wrongly served, the correct notice periods have not been observed) then this will mean that the attempted termination is invalid and will amount to a repudiatory breach of contract, the consequences of which were explored at the beginning of the article and are serious.

Alternatives to termination

Termination is very much a nuclear option, and it may very well be that it is the correct course, but it is worth first considering whether there are any other options before pushing that button.

• For an employer, suspension where there would be an entitlement to do so, e.g. If the issue is one of failure to pay in full by the final date for payment
• Adjudication if the issue can be crystallised into a dispute
• Mediation
• Re-negotiation and amendment of the contract
• A negotiated settlement
• Activation of a performance bond or parent company guarantee.

Other aspects to consider

If an employer decides to terminate a contract, then consider what else this will or may involve. If there is a funder providing finance for the project, what are the employer’s obligations under its finance agreement regarding termination of the contracts and professional appointments? What about sub-contracts? Will they be assigned? Will they have to be novated to a replacement contractor? Will they refuse because they are owed large sums of money that the employer has already paid the contractor, but which has not been passed on? What about securing the site, obtaining relevant documents.

For a contractor, will they need to give a period of notice before actually terminating because of step-in rights under any collateral warranties they may have given?

Conclusion

Termination is a very serious, but also a very important, right and remedy to have. If it is to be used, the party seeking to invoke it must make sure that they have the right to terminate and that they follow all the required procedures to the letter to ensure that the termination is valid. The consequences of any mistake will be severe. Also, the results of a termination should be very carefully considered from both a practical and commercial standpoint.