During the course of construction, things can go wrong. Relationships can break down, trust can evaporate and, in a difficult economic climate, companies and individuals can go bankrupt. As a result, a parting of ways is often contemplated by one or both parties to a construction contract before the project can be substantially completed. In the legal world, this is known as termination.
Terminating a construction contract can present serious risks and have wide-reaching effects if done improperly. This is because termination of a contract without proper cause is itself a breach of contract. It is therefore important that both parties to the contract understand and appreciate the law on contract termination and the process it requires.
Common Contractual Bases for Termination
Typically, standard-form construction contracts set out the basis on which a party may terminate the contract, the most common of which are as follows:
- the party is adjudged bankrupt or makes a general assignment for the benefit of creditors;
- a receiver is appointed because the party is insolvent;
- the contractor neglects to prosecute the work properly or otherwise fails to comply with the requirements of the contract to a substantial degree;
- through no fault of the contractor, the work is suspended or delayed for a period of time as a result of a court order or something similar;
- the owner fails to pay the contractor when the amounts certified as having been completed are due;
- the owner violates the requirements of the contract to a substantial degree; and
- a “termination for convenience” clause is included in the contract, allowing one party to terminate the contract at any time with or without giving any reasons.
The Termination Process
If a terminable breach has occurred, the innocent party must then turn its mind to the process required to lawfully terminate the defaulting party. Generally speaking, an on-site “you’re fired!” won’t cut the mustard. Depending on the type of breach, steps must first be taken before a contract can be terminated with minimal consequences.
1 – Content of Notice in Writing
Termination requirements are often in “two-tier” form: a first notice setting out the default or breach and providing a period of time for the default or breach to be remedied followed by a second definitive notice of termination. In every case, the contract terms must be carefully considered and closely followed, both as to the content and timing of the notices. Generally speaking, notices should:
- identify the termination provision relied upon;
- sufficiently identify the breached contractual term(s) that has been breached and that forms the basis for the termination;
- describe the defaulting party’s particular act or omission that resulted in a breach of contract;
- give a reasonable period of time for the defaulting party to cure its breach; and
- list the actions the innocent party may take in the event that the defaulting party fails to correct its breach within the stipulated time period.
The Court in Doyle Construction Co. v. Carling O’Keefe Breweries of Canada Ltd. (1987), 23 C.L.R. 143, had the following to say about the notice requirement:
The grumblings of this contractor, recorded though they may be in site minutes, display no intention to claim until December 1983. Even then, no claim was actually advanced, but intent was indicated. But no details were given: an owner would be hard put to know exactly what it is to meet, and hence what it is to do. The purpose of the notice is to give the owner an opportunity of considering his position and perhaps taking corrective measures, and he is prejudiced by not being able to do it.
2 – Form of Notice in Writing
Most standard-form construction contracts require “notice in writing” to follow a specific form. For example, it may require that the notice be mailed or couriered to a specific address. Courts have also strictly applied these terms by requiring that the notices be in writing and sent to the address stipulated in the contract. In Graham Construction and Engineering (1985) Ltd. v. LaCaille Developments Inc., 2006 ABQB 898, the Court found that the contractual language requiring notice in writing of delays was a condition precedent to any claim by the contractor for delay damages.
3 – Correction of Default
As noted above, standard-form construction contracts usually require that the innocent party provide the defaulting party with written notice that the wrongdoer is in default of its obligations and to instruct the wrongdoer to correct the default within a stipulated period of time (usually 5 working days). This requirement is designed to provide the defaulting party an opportunity to correct its mistakes before being removed from the project.
Even if not spelled out in the contract, it would be prudent, in most circumstances, to provide notice of termination and to provide the defaulting party a chance to rectify its breach.
4 – Termination
In the event that the defaulting party fails to remedy the breach within the stipulated time period, a second notice of termination should be provided. This notice should include:
- a reference to the notice letter;
- a statement that the party has been terminated;
- the termination provision relied upon;
- the contract terms that have been breached;
- the defaulting party’s particular act or omission that resulted in a breach of the term(s) of the contract;
- the date the termination is effective;
- a statement similar to “this termination is made without prejudice to any legal rights or remedies which the innocent party has or may have, either at law, in contract or in equity.”
The defaulting party’s failure must be contemplated in the first notice of the termination. In other words, the innocent party cannot terminate for a “new” failure that occurred after the first notice. If a new failure arises, notice of that failure must first be given, followed by the notice of termination.
Common Law Grounds for Termination
In the absence of contractual termination provisions, parties do have a common law right to terminate in the event that the defaulting party repudiates the contract. Repudiation occurs by “words or conduct evincing an intention not to be bound by the contract” or “when one party indicates its intention not to fulfill any future obligations under the contract: Guarantee Co. of North America v. Gordon Capital Corp.,  3 S.C.R. 423 at paras. 40 and 47, citing in part S.M. Waddams, The Law of Contracts, 4th ed. (Canada Law Book, 1999) at para. 620.
Usually, parties don’t explicitly communicate their intention not to be bound by the contract. In those cases, the test for determining whether a repudiatory breach has occurred is objective. A court must consider whether the consequences of the breach, in the particular circumstances of the case, deprive the innocent party of “substantially the whole benefit” of the contract. Common considerations include:
- Terms going to the root of the contract – breaches of these fundamental terms are considered serious in nature. For example, an owner’s failure to pay or a contractor’s abandonment of the work may be considered repudiatory breaches.
- “Conditions”, “conditions precedent” and “time of the essence” terms – sometimes, the parties intend to raise “non-fundamental” terms to the level of being fundamental (or to the root of the contract). Breaches of these terms have been considered repudiatory in nature.
- Repeated breaches of non-fundamental terms – most terms in a contract are not fundamental but, rather, are warranties. A breach of a warranty does not always give the innocent party the right to terminate. Rather, the defaulting party may have liability in damages after the contract is completed. However, repeated breaches over long periods may show an inability to perform the contract so as to justify termination.
If the innocent party is certain that a repudiatory breach has occurred, it has an option to elect to either: (1) accept the breach and treat the contract as at an end, at which point it may immediately sue for damages; or (2) affirm the contract and continue to press for performance and bring the action only when the promised performance fails to materialize. The communication of this election must be prompt and clear. The innocent party may reserve its position but, if it does nothing for too long, it could be taken to have affirmed the contract. How much time the innocent party can spend considering its options will depend on the facts of the case.
While notice of acceptance of a repudiatory breach need not be in writing, it is prudent to give such notice in the form of a letter stating that the defaulting party has repudiated the contract and the repudiation is accepted.
Finally, it must be recalled that the parties can always agree at any point during the term of a contract to terminate it. In difficult economic circumstances, there may be valid business reasons for doing so.
The decision to terminate is an important one. We recommend that parties to construction contracts seek legal advice prior to terminating a contract or if they have been terminated.