There are two basic steps to terminating a construction contract. The first is to make sure that you have a right to terminate the contract. The second is to follow the right process. This article provides an introduction to this complex area of law.
The right to terminate a construction contract
The right to terminate arises from two sources:
- at common law (outside the contract); and
- under the terms of the contract
Depending on the circumstances, there may be concurrent rights to terminate both at common law and under the contract.
When can you terminate a construction contract?
The most common reasons for parties terminating construction contracts are:
- Repudiation – the other party demonstrates that it is unable or unwilling to continue to perform the contract;
- Serious breach(es) – although falling short of a repudiation, the other party breaches the contract in a way that triggers an express right to terminate under the contract, or alternatively, a right to terminate at common law (outside of the contract);
- Termination for convenience – where you have an express right to terminate the contract, even though the other party has not repudiated or breached the contract; and
- Agreement – both parties agree to treat the contract as being terminated
Although insolvency events were traditionally treated included in contracts as events that would automatically allow you to terminate a contract, this scenario has become more complicated when the Corporations Act was amended in 2018.
Each of these scenarios is explained in more detail below.
Termination for repudiation
A repudiation occurs where one party shows to the other party by its conduct that it is either no longer able to substantially perform its obligations under the contract, or that is unwilling to do so.
The test for repudiation is whether the party has shown that either:
- it no longer intends to be bound by the contract; or
- it intends to fulfil the contract only in a way that is substantially inconsistent with the party’s obligations
Repudiation is more than just a breach of contract. It is conduct which evidences a clear intention by one of the parties to no longer perform its obligations under the contract.
If the other party repudiates the contract, you have two options. You can either:
- accept the repudiation and elect to terminate the contract; or
- affirm the contract and insist that the other party continue to perform
You can read more about repudiation and how you terminate for repudiation here.
Termination for breach of contract
If the other party breaches your contract, this will sometimes entitle you to terminate. However, not all breaches of contract will entitle you to terminate.
A right to terminate for breach of contract can arise under the contract or at common law (outside the contract) or both.
Termination for breach under the contract
Whether you can terminate for breach under the contract will depend on whether the contract gives you an express right to terminate for the breach concerned.
Most construction contracts will contain a clause that lists the types of breaches that will allow a party to terminate. These are usually described as ‘substantial breaches’ and are set out in a ‘default’ clause.
In the case of contractors, a substantial breach will usually encompass failures to provide security or evidence of insurance, failure to proceed with the works regularly and diligently, wrongful suspension of the works, failure to comply with a direction of the Superintendent and failure to use the materials or standards of workmanship required by the contract.
In the case of principals, a substantial breach will typically include failure to provide security or evidence of insurance, failure to give the contractor access to or possession of the site and failure to make a payment due under the contract.
Where a substantial breach occurs, the contract will typically explain the process that must be followed in order to terminate it. If you are the party seeking to terminate, it is critical that you comply strictly with that process otherwise your termination may not be effective and you can end up repudiating the contract yourself.
Termination for breach at common law
Whether you can terminate for breach at common law will depend on the seriousness of the breach. There are two circumstances that give rise to a common law right of termination:
- breach of an essential term of the contract; and
- a sufficiently serious breach of a non-essential term of the contract, also described as a material breach of an intermediate term of the contract
A term is essential if a party would not have entered into the contract unless assured of strict or substantial performance of the obligation. A right to payment or performance of an obligation within a particular time (which is expressed to be of the essence), are essential terms, breach of which will entitle a party to terminate at common law.
A sufficiently serious breach of an intermediate term will arise if the breach is so serious it goes to the root of the contract or deprives the other party of substantially the whole benefit of the contract. Whether a breach of an intermediate term gives rise to a common law right to terminate will depend on the particular circumstances.
There can be circumstances where a breach is so serious that it gives you an express right to terminate under the contract and a separate right at common law (outside the contract).
However, not all breaches justify termination, so you need to be careful and consider the seriousness of the effects that flow from the breach.
You can read more about termination for breach and how you do it here.
Termination for convenience
Termination for convenience clauses allow one party to a contract to terminate that contract without there being a default or breach of the contract by the other party.
These clauses give the principal (in a head contract) or contractor (in a subcontract) the right to terminate the contract at any time in its absolute discretion. There is no requirement to justify the reason or reasons for termination. The principal or contractor may simply terminate the contract, provided notice is given in accordance with the clause.
If you’re terminating for convenience, you must also follow the requirements of the contract. This often simply requires a written notice to be provided specifying the date on which the termination will take effect. Sometimes the notice takes immediate effect, but often 7 days’ notice is required.
You can learn more about termination for convenience in an upcoming blog.
Construction contracts will typically include an express right to terminate where an insolvency event occurs. An insolvency event is a defined term and will often include where either party is insolvent, is subject to a scheme of arrangement with its creditors, has a receiver or manager appointed or enters into voluntary administration.
These types of clauses give an automatic right of termination on the happening of a specified event of insolvency. They are commonly referred to as ‘ipso facto’ clauses (“by the fact itself”).
However, as a result of legislative reforms which took effect from 1 July 2018, referred to as the ‘Ipso Facto’ reforms, a party is prevented from enforcing its contractual right to terminate in the event the other party becomes subject to certain insolvency events.
There are some exemptions to the application of the insolvency reforms and the legislation does not have retrospective effect. You can learn more about termination and insolvency in an upcoming blog.
What if you get it wrong?
Termination is a complex area of law and the consequences of not getting it right are serious. If you terminate a contract without a valid basis for doing so, you may find that you have yourself repudiated the contract. This will entitle the other party to terminate and claim damages for wrongful termination. It is important to exercise any right to terminate carefully and seek legal advice before doing so.