The construction industry has no shortage of challenges, from unforeseen delays to unexpected costs, creating an environment where terminating a contract may become unavoidable. Navigating these difficulties requires careful consideration of legal issues and financial implications, making the decision to terminate a construction contract a complex and often challenging endeavour.
This article outlines when a party might be able to terminate a contract; how to do so, and some of the risks that might arise.
Please note - this article does not cover all the ways a contract may be ended and contains general information only. You must have regard to the specific terms of your contract and the particular circumstances of your case – and we recommend that you obtain legal advice before seeking to terminate.
The right to terminate a contract may arise by any of the following ways:
The contract may include a term that automatically terminates the contract should a specified event occur. These terms usually relate to date and/or time sensitive obligations where a party’s failure to perform by a specified time will result in automatic termination.
The contract may contain a list of specified events that will create a right of termination. An example of this is where a party is unable to obtain a particular permit or government approval before construction is due to commence. The difference from an automatic termination is that a breach of this nature is usually not instantaneous when it occurs, rather there would commonly be a requirement to effect termination by provision of a written notice to the other party.
Perhaps the most common contractual right of termination is by default - where one party commits a serious or substantial breach. For example, a failure to make payment on time, or the failure to proceed diligently with the works may constitute a substantial default, which may entitle termination.
The defaulting party is usually issued with a ‘show cause’ notice requiring either the breach to be rectified within a specified time, or requiring the defaulting party to justify why the contract should not be terminated.
Be careful – the ‘show cause’ notice must comply with any contractual requirements, otherwise it might not be effective.
The right to terminate will arise when the defaulting party fails to sufficiently act on or respond to the ‘show cause’ notice as required by the contract.
A termination for convenience clause allows a party to terminate the contract for any reason, even where the other party has done nothing wrong. This clause is usually in the contract to benefit the principal or head contractor and should allow for some compensation to be paid to the terminated party for work done; costs of demobilisation and – possibly (albeit rarely) loss of profits.
To be effective, a termination for convenience clause must be clear and unambiguous.
A contract may be terminated by agreement between the parties. The parties may agree that each party should be released before performing the agreed obligations. For example, the parties may agree that they no longer wish to do business together. It is also possible for one party to release the other party, even if the other party has not satisfied their obligations under the contract.
Essential terms are those key important conditions – such as timely performance or payment.
A breach of an essential term of a contract does not automatically terminate the contract. Instead, the breach creates a right to terminate.
If that right is created, the affected party must promptly elect whether to terminate or keep the contract on foot and preserve the claim for damages.
We recommend obtaining legal advice on whether a contractual term is essential because if not, it may be deemed a non-essential term or an ‘intermediate’ term which requires a more severe breach to create a right to terminate.
If the breached term is not essential to the contract, it is possible to still terminate if there is a sufficiently serious breach of a non-essential or ‘intermediate’ term.
Whether a term is a non-essential term will depend on the nature of the contract, the nature of the breach and the consequences that may affect the concerned party.
There may be a right of termination where the other party has repudiated the contract by demonstrating an intention to no longer be bound by the terms of the contract.
The other party may communicate repudiation by providing express notice of their intentions, or by implied conduct through their actions, such as by descoping the works.
Examples of repudiatory behaviour include where a party:
The affected party must promptly elect whether to accept the repudiation or insist that the contract be performed. If the affected party accepts the repudiation, this will create a right of immediate termination.
Frustration occurs when an unforeseen event renders performance of a contract impossible or radically different from what was originally contemplated by the parties. No party is considered at fault.
If the contract contains express terms which indicate how the risk of an event will be allocated between the parties, frustration will not apply. The contract may include a “termination by frustration” clause which sets out the parties’ obligations where a contract is discharged due to frustration. A force majeure clause in the contract may exclude the operation of the doctrine of frustration.
If a contract is found to be frustrated, it is automatically terminated and all future obligations of the parties to the contract are discharged. Under common law, neither party can make a claim against the other for loss arising from frustration. For example, there may be no entitlement to claim demobilisation costs or loss of profits on remaining works which have been discharged (unless allowed for by the contract or by legislation).
Please note that the standard to prove frustration is very high, and there is a risk of inadvertently repudiating the contract. On that basis, we recommend that legal advice is sought before asserting frustration.
There may be legislation which could provide a right to terminate the contract and specify certain conditions which, if breached, may create a right to terminate.
The Australian Consumer Law contained in the Competition and Consumer Act 2010 (Cth) includes consumer guarantees in relation to a contract between a supplier and consumer. Where breaches by the supplier of those guarantees arise, as the consumer, there may be rights to certain remedies including termination.
Navigating the challenges of the construction industry is no easy feat. There may come a time where continuing with the contract may no longer be viable, and termination is the only option. It is important to know what your rights are, and what compensation you may be entitled to.
If you wrongfully terminate a contract, you could find yourself in breach of the contract or repudiating the contract, and as a result be liable for a claim for damages. It is therefore important to carefully follow the procedures for termination if they are set out in your contract.
There are also common law principles and statutory provisions which may apply.
If you are unsure about whether you are lawfully terminating your contract, we suggest that you seek legal advice to understand what your risks and options are.
Disclaimer: Professional advice should be obtained before applying this information to particular circumstances. The information should not be used or relied upon for advice or as the basis of formulating decisions.