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Contracts and Claims
Timely articles covering the most
pressing issues facing construction firms in the Midwest
Divorce, Construction-Style
How and Why an Owner May Terminate a Contract
A construction contract is much like a
marriage. You and an owner exchange legal vows to build something
worthwhile, and the process can seem as exciting as it does
uncertain. Then again, unlike a marriage, parties to a construction
contract usually intend to part long before their respective deaths.
But what happens if an owner wants to end your blessed union before
you’ve even completed the job? Such a circumstance surely gives new
meaning to the phrase the honeymoon's over. And the resulting
litigation can be just as lengthy and expensive as the most
tumultuous Hollywood breakup. Fortunately, under the law, owners may
break a construction contract for only two reasons with cause or for
convenience. Let’s take a closer look at these two important
concepts.
Termination with Cause
Perhaps the most obvious reason an owner may back out of a contract
is if he or she is drastically dissatisfied with the project. This
is called termination with cause. And the typical circumstances an
owner may resort to this measure are spelled out in the American
Institute of Architects ( AIA) A201-1997 Form of General Conditions
(considered by many the standard for construction contracts) . They
include:
* Incompetence. Owners may understandably cry foul if a contractor
fails to provide the materials and skilled labor force the contract
specifies, causes significant progress delays, or displays poor
workmanship. Such criticisms may particularly hold weight if job
failures continue after the owner brings them to your attention.
* Illegal activities. Another rather obvious cause for termination
is a contractor who fails to follow building codes, ordinances or
regulations, or who otherwise disregards federal, state or local
laws. Often, these violations arise from ignorance. So, if you're
building in an unfamiliar location, be sure to identify its
authorities and regulations before you start work. And, even in
everyday territory, stay apprised of code and law changes.
* Subcontractor neglect. Sometimes general contractors neglect
payment agreements with subcontractors. For example, a financially
strapped general contractor may divert cash from one job to a more
troubled one instead of paying the first job s subcontractors.
Often, this leads to those subcontractors filing liens on the
project, creating legal and financial troubles for everyone. Owners
may attempt to steer clear of this problem by requiring general
contractors to acquire payment bonds before a job's inception.
To judge whether cause for termination really exists, owner
inquiries frequently begin with the professional responsible for
drafting the project's specifications the architect. Typically, an
owner asks an architect to certify that cause exists and to state
the specific reasons behind it. He or she will generally comply when
circumstances are clear. But if substantial doubt clouds whether
termination with cause would hold up in court, many architects will
hesitate to enter into an undoubtedly lengthy litigation.
The Consequences of Cause
If able to establish termination with cause, an owner secures great
power and leverage. Although you and your sureties may put up a
fight, a successful case against you may grant the owner the right
to:
* Backcharge you for the amount that the final completed contract
cost exceeds the original contract assuming the revised job incurs
the same number and type of change orders you would have faced had
you finished the project (this amount can be difficult and quite
contentious to determine) ,
* Take control of your subcontractor agreements and require these
companies to complete their contracts under the original terms doing
so may remove their lien rights on work they started with you,
* Seize on-site materials, equipment and tools to complete the
contract, this generally leads to a more acrimonious dispute because
of the obvious hardship it places on you, and
* Complete the contract as expeditiously as possible (leading to the
backcharges mentioned above) and stop any remaining payments due to
you until the project is finished.
As you can see, termination with cause usually hits construction
companies quite hard. Recognizing this, most states require a grace
period (seven days, generally) for you and an owner to resolve the
dispute. It further complicates the owner's decision and may allow
you both enough time to cool off and reach a solution.
Termination for Convenience
Historically, termination with cause was the only reason an owner
could break a construction contract. But all that changed around the
middle of last century when the federal government began adding
termination for convenience clauses to its contracts. Under these,
Uncle Sam could terminate without cause as long as it did so in good
faith. The construction company involved could still recover some
lost profit, though not nearly the amount they would have for breach
of contract. Eventually, termination for convenience became accepted
in private contracts as well. Indeed, the AIA's A201 contract
provides that the owner may, at any time, terminate the contract for
the owner’s convenience and without cause. In this instance, you
must cease operations and follow the owner's requests to protect and
preserve the work completed to date. Furthermore, you need to
terminate existing subcontracts and purchase orders except those
directed to be performed before the effective termination date. And,
naturally, you may not initiate any new subcontracts or purchase
orders.
So why do owners terminate for convenience? Most often, they do so
because a project has lost funding and cannot proceed as expected.
Sometimes, weather delays or other slowdowns drag a job so far off
schedule that its owner just gives up. Of course, if he or she can
convincingly blame you for the delay, you may find yourself fighting
termination with cause. But, if not, the owner may throw in the
towel to cut his or her losses.
The Price of Convenience
Unsurprisingly, termination for convenience doesn’t grant owners the
substantial rights and control of termination with cause. For
starters, owners may not take control of your subcontracts. Thus,
they risk falling into lien battles with unpaid subcontractors,
which they’re often unlikely to win. Also, owners may not backcharge
you for the amount that the final completed contract cost exceeds
the original contract. And they must pay you for labor completed
though they can offset this amount by deducting for improper work,
termination costs and reasonable overhead on the project s remaining
phases. Now, like most contractors, you probably bristle at the
thought of an owner deducting dollars for improper work and
reasonable overhead. And, sure enough, these issues often turn a
termination-for-convenience situation into a termination-with-cause
dispute, bringing along the latter s legal lambasting. Nevertheless,
many owners terminate for convenience anyway, because these cases
narrower scopes and diminished value tend to curtail their duration
and expense.
Fantasy vs. Reality
In the best of all possible worlds, spouses would respect each
other's best interests when getting divorced. And, similarly, owners
would do the same when terminating a contract with a construction
company that's been working hard to finish a job. Sadly, here in the
real world, neither circumstance usually occurs. That’s why you need
to know your options should an owner suddenly pull the rug out from
under one of your projects.
An effective, supportable cost segregation analysis requires
engineering and valuation skills; a knowledge of construction
methods, materials, and costs; and a knowledge of income tax
regulations, court cases, revenue rulings, and procedures. For more
information on how a cost segregation analysis might help you please
call Jim Tortorella, CPA at Councilor, Buchanan & Mitchell, CPA
Bethesda, MD 301-986-0600
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