Consequences of recourse to security and termination provisions for contracts

So you’ve decided to terminate?  

Put yourself in this position.

You are a contractor carrying out labour intensive works on a remote site in the north-west.  The works are 80% complete:

• It has been an unhappy contract:
• The works are running three months late and the principal is unfairly blaming you for the delay;
• The principal keeps directing you to carry out works outside your scope but refuses to issue a variation order in the form required by the contract;
• The principal is unfairly imposing backcharges on all of your progress claims;

You now find that the principal is again late in providing free issue materials and cannot or will not tell you when the next lot will arrive;

You have all but run out of work for your workers on site.  Under the terms of the “bespoke” contract, you are entitled to an extension of time but no delay damages.

You ask yourself the question – should I terminate and leave site?  To answer this we will need to consider the following.

1. Do I have a good entitlement to terminate, either:
   • Under the contract; or
   • At common law.
2. What is the procedure for this?
3. What are the consequences?
   • Is there any limitation on my rights?
   • What if I am wrong?
   • Will the bank guarantees be pulled?

Termination under the Contract

Most contracts will make provision for termination for serious (or not so serious) breach of either of the parties:

• Such breach may not necessarily be sufficient to amount to a repudiation of the contract.  Some contracts class any breach of contract as sufficient.  If not a repudiation, the innocent party’s remedies will be limited to that expressly provided in the contract;
• In the normal course we would claim that the default is both a breach the contract classes as sufficient to allow termination and a repudiation;
• Most standard form construction contracts provide for:
  • a default notice/notice to show cause to allow the guilty party to explain away their default and as to why the contract should not be terminated;
  • notice of termination to follow; and
  • a list of the remedies then available.

Under an Australian Standard contract the contractor would normally become entitled to terminate for any substantial breach of contract by:

• Giving seven days notice to show cause; and if cause was not shown within that time;
• The Contractor could then suspend the works;
• And if the breach was not made good within 28 days, the Contractor would be entitled to terminate.

Termination for convenience

Termination for convenience clauses are present in most bespoke contracts.  Essentially, these clauses state that the principal may terminate on notice for any reason and at any time.

They usually provide for payment only for work done and demobilisation costs.  The contractor will lose the profit on the work taken away from him.

The only potential limit on a termination for convenience clause is by reason of an implied obligation of good faith being incorporated into the contract.  This may have the effect of preventing the principal relying on it in circumstances of bad faith, such as for the reason of imposing improper pressure on a contractor.

Other Bespoke Termination Clauses

The typical bespoke contract will limit the circumstances in which the contractor will become entitled to terminate and extend out the show cause procedure.  For example:

• Major Builder(1) Termination Provisions:
  • Only applies for “failing to make a payment due”;
  • Requires 21 days to show cause;
  • Contractor may then suspend but Principal has 60 days to make good. Only at the end of that 60 days can the Contractor terminate;
  • Contractor may claim common law damages but will not be entitled to quantum meruit even if the Principal repudiates.
• Industrial Engineer Termination Provisions:
  • No provisions allowing the Contractor to terminate.
• Major Builder(2) Termination Provisions:
  • No provisions allowing the Contractor to terminate;
  • However, if there was a repudiation by the Principal:

(a) No quantum meruit is available;

(b) And if it is found by a court that any termination by the Principal was wrongful,  the contractor will not be entitled to anything more that payment for work then done and reasonable demobilisation costs.

• Iron Ore Company Termination Provisions:
  • Only applies to failure to issue a certificate or make a payment then due (there being no bona fide dispute);
  • Requires 30 days notice of the default and then may suspend or terminate;
  • Contractor claim limited to the value of work completed plus cost of materials ordered and which cannot be returned.

• Oil & Gas Company Termination Provisions:
  • Only applies if payment is 40 days late;
  • Requires 15 business days notice to remedy before contractor may suspend;
  • If still not remedied within 20 business days may then terminate;
  • Remedy limited to the value of the work then completed, materials ordered and demobilisation costs.

The common theme in all of these is that:

• The circumstances in which the contractor may terminate are limited;
• The time that must elapse before the contractor may walk away is lengthy;
• The remedies on termination will be restricted, typically to include the following:
  • Payment for work then done and materials ordered (and perhaps demobilization costs), but no loss of profit on the balance;
  • The Contractor “will not be entitled to claim on a quantum meruit basis, which election the Contractor irrevocably makes”;
  • “then notwithstanding any other provision of the Subcontract, the Subcontract will be deemed to have been terminated by the Contractor for convenience under [the general conditions]”  – ie payment for work done, materials ordered and demobilisation.

If we apply such bespoke terms to our example, none of the clauses providing for termination apply to the breach of contract in question.

Even if they did apply, you would be left waiting for anywhere from 21 to 40 days before you could do anything about it. 

I expect that most parties will follow the set procedure for termination in the contract if possible in that (at least in AS contracts) it tends to provide more certainty to the person terminating that they are on good grounds.

Acceptance of a repudiation 

The alternative to termination under the contract is termination at common law, namely by acceptance of a repudiation.

In general, the law in this regard is that if a party, by words or conduct, shows an intention no longer to be bound by the contract, the other party may accept the repudiation and terminate the contract. The test of repudiation has been variously described as:

• “an unwillingness or inability to render substantial performance of the contract”;1 or
• “an intention no longer to be bound by the contract or to fulfil it only in a manner substantially inconsistent with the party’s obligations”;2 or
• Where the breach or breaches are “such as to deprive the injured party of a substantial part of the benefit to which he is entitled under the contract.”

A repudiation will not by itself terminate the contract.  The innocent party must then elect to accept the repudiation and terminate.  They may instead elect to insist on performance.  In doing so they may lose the right to terminate.  See for example the following:

• A builder was building an apartment block for a developer under a modified AS2124 contract;
• The developer was unhappy about the finish to the concrete on the completed slabs and gave notice in writing that it would not make any further payments until it was made good;
• The builder’s response was to invoke the dispute resolution provisions of the contract to have an Expert make a binding determination on the matter.  The Expert found that the defects were minor and could be adequately remedied closer to practical completion;
• The builder then notified the owner that it intended to continue with the works;
• Subsequently, the builder gave notice to the owner that it was treating the owner’s notice as a repudiation and terminating the contract;
• The Court held that the builder had elected to affirm the contract by invoking the dispute provisions of the contract then again by notifying the owner that it intended to continue with the works.

When such termination occurs, the contract is ended by the termination but only as concerns future performance.  It remains alive for the awarding of damages for the breach which constitutes the repudiation.

The consequence is that the innocent party may:

• (If a contractor) recover payment for all work done and loss of profit on the balance or alternatively, claim for all work done on a quantum meruit;
• (If a principal), recover the extra over costs of completing the contractor’s work.

On the other hand, the guilty party is still entitled to any rights that have accrued up until the date of termination which will include any rights of payment that have by then accrued.

What is sufficient to amount to a repudiation

• A good example of the application of these tests is found in the recent case of Sabic UK Petrochemicals Ltd v PunjLloyd Ltd [2013] EWHC 2916 (TCC):
• Sabic contracted SCL to design and construct a polyethylene plant for $135m;
• The contract relevantly provided that if SCL failed to proceed with the works with due diligence, Sabic may, after first giving warning, terminate the contract;
• Works did not proceed as planned and two significant variations to the works were entered into allowing further time to complete in exchange for further monies.  By the last variation on 2 July 2008, SCL committed to reach a significant Milestone by 5 December 2008;
• In early October Sabic gave notice that SCL was not proceeding with the works with due diligence, threatening to terminate if things did not improve as per the contract provision.  In November Sabic terminated the contract;
• A dispute arose with claims and cross claims made against the other.

The Court found that the contractor had failed to proceed with due diligence and as a result Sabic was entitled to terminate as provided under the contract.  This was because:

• On 2 July 2008 SCL committed to reaching a Milestone by 5 December 2008 in accordance with an agreed programme.  By 2 October 2008 it was already two months behind the programme;
• This had arisen because:
  • SCL failed to procure key subcontractors on time;
  • Failed to take any steps to remedy any slippages to the programme;
  • Rather than increase resources on site, it adopted a number of cost cutting measures which had the affect of reducing manpower on site.  It was more intent on reducing costs than maximizing resources on site;
•  This, according to the Judge amounted to a failure to proceed with due diligence.

Having made the finding, the Court did not have to consider the alternative argument of Sabic that the conduct of Sabic amounted to a repudiation.  The Judge nevertheless made a finding that there had been no repudiation:

• The Judge stated the relevant principles in particular “A renunciation of a contract occurs when one party by words or conduct evinces an intention not to perform, or expressly declares that he or she will be unable to perform...”;
• Found that there were aspects of SCL’s conduct which amounted to deliberate decisions not to comply with all of its contractual obligations, of which the decision to instruct its subcontractors to demobilize was perhaps the most obvious example;
• However viewed overall it cannot be said there was an absolute refusal by SCL to perform its side of the contract.  At all material times it protested its intention to being the Project to completion and, although failure to exercise due diligence was persistent and serious, mere delay – even when substantial – in not necessarily to be equated with a renunciation of the defaulting party’s side of the contract… In my judgement, SCL’s conduct came close to the line of being repudiatory, but did not cross it”.

In those circumstances (putting aside the contractual termination provisions), the principal’s remedies would be limited to damages for the breach such as LD’s for late completion.

If we apply that reasoning to our example, we have to make a call as to whether the conduct of the principal, viewed in its totality, amounts to conduct showing an intention not to render substantial performance or an unwillingness to perform its obligations.

The factors that would be considered are:

• Failure to follow contractual procedure for directing variations;
• Improper backcharging;
• Late issue of free issue materials.

Neither of the first two breaches would be sufficient by themselves, but may be relevant in painting an overall picture of refusing to perform the contract in accordance with its terms and bolstering the relevance of the third breach.

Applying the reasoning in the Sabic case, I would not have thought mere delay in delivery of free issue materials would be sufficient.  No doubt the principal intends to provide them as soon as practicable.

However, the fact that the contract only allows an extension of time for delay caused by the principal with no delay costs:

• may allow the third breach to be considered so serious as to deprive the contractor of a substantial part of the benefit of the contract for which it contracted and therefore a repudiation;
• In other words it undermines the heart of the bargain;
• It is interesting that a provision in a bespoke contract included by the principal with the obvious intention of benefiting the principal may allow the contractor to terminate in circumstances when otherwise it might be doubtful.

If the contractor is successful in demonstrating a repudiation and terminates, it will have the option of claiming payment for all work done and loss of profit for the balance of the works.  In the alternative, it may claim payment on a quantum meriut basis.  The clauses in the bespoke contracts would not in my opinion, impose any limitation on the contractor in such claims.  Even the bespoke contract term restricting Quantum Meruit claims would not be effective.  Such claim arises because the principal in repudiating the contract is then treated as not being able to rely on its terms.  It follows that any restriction under such contract could not be enforced by it.

The big consideration will be the practical consequences:

• The contractor will certainly like the opportunity to recover on a quantum meruit; but
• The bank guarantees will almost certainly be pulled.  You will have to see what may be done to injunct the principal from doing so;
• The principal will also lodge a counterclaim against you for the extra over costs of completion and any further delay costs it incurs.

Bear in mind that a contract may also be terminated by agreement.  It may be part of your strategy to issue a notice to show cause with a view to negotiating a deal under which the contract comes to an end and the consequences are agreed.