Do You Really Want to Terminate?

Termination of a Construction Contractor – California

I am often asked what the building owner’s options are when faced with a material breach of a ERNEST C. BROWN
construction contract and the Project is brought to a standstill. Smith Currie & Hancock, LLP
ecbrown@smithcurrie.com
I have been asked the same question by our general contractor clients where there is a subcon-
tractor in material default and the project schedule and budget is in jeopardy.

Often, this is accompanied by a contractor (or subcontractor) who is asking for more money to
complete the construction project. Of course, at times there are legitimate reasons for a contrac-
tor to stop work, ask for payment of claims or otherwise halt the work. For the purposes of this
paper, we will assume there are no legitimate reasons for the work stoppage.

The owner may be stuck with the possibility of paying a good deal more than the original con-
tract, or risking that the contractor will simply walk away. If he walks away, you will need to find
another contractor who may well charge you a remaining amount that will exceed your original
budget. And with many private contracts, and most subcontracts, there may not be a perfor-
mance or payment bond, leaving the owner (or general contractor) holding the bag for increased
project completion costs and a lawsuit to try to recover those costs from the owner.

A termination for fault almost always guarantees a protracted lawsuit. The owner wants their
money, and the contract will fight for their reputation and costs incurred to date.

As such, this is an outline of the typical problems and solutions that we consider in these situa-
tions – often called the most traumatic type of event on a project.

Let’s face it, contract terminations are significant legal events. If you wish to go down that path,
you need expert legal counsel. Anyone reading this should consider it to be background material
regarding contract disputes and termination issues and not specific legal guidance for your case.

1 | CONSTRUCTION I n sight from Hindsight: Issue 1

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If you are considering termination of a constructor or subcontractor, I
think hiring a lawyer would be a good first step. These are a few of the
major issues to consider before going forward:
1. Please, carefully review your contract. Most standard construction
contracts are quite specific about grounds for termination. If your
contract is vague on this point, it may create downstream issues
if it does not have any of the traditional boilerplate language that
defines the typical relationship between an owner and contractor,
then the termination will likely be governed by prevailing case law
and specialized statutes.
2. Consider which type of termination you might wish to follow. A
typical termination for default provision allows you to take over the
materials and equipment, restart the project, then sue the original
contractor for the increased costs to complete.
However, a termination for convenience clause would generally
provide the contractor all their costs to date, as well as reasonable
profit and overhead on accomplished work. Some termination for
convenience clauses also provide for payment of future profits on
work that is being taken from the contractor. So, know what type of
clause you have and how to trigger the correct one!
In the Federal arena, and in many private contracts, the failure to
prove the termination was for default renders the termination one
for convenience, opening the gates to a substantial contractor cost-
reimbursement claim.
3. See if the contractor is currently licensed. In one large airport
project that I advised, the contractor for a major element of the
project was not currently licensed due to a loss of their qualifying
person that they did not replace within the statutory period. The
lack of a license is an automatic ground for termination for default
in most states. In fact, it can be a criminal offense for an owner
(or general contractor) to continue employing an unlicensed
subcontractor on the project.
4. Next, see if there is a performance or payment (labor and
materials) bond on their work. If so, those provisions need to be
strictly followed or you will exonerate the surety.
5. Does the contract comply with the contractor’s license board
requirements. There are general requirements for large infrastructure
2 | CONSTRUCTION I n sight from Hindsight: Issue 1
projects to small jobs, such as the license number of the contractor
(see item 2., above). But if it is a smaller residential remodel project
(which in San Francisco could be a multi-million dollar effort), there
are numerous provisions required in a home remodel project (for
some of these provisions, applicable in California, see
http://www.dca.ca.gov/publications/legal_guides/k-10.shtml).
6. In some cases, a contractor might give you a proposal, which
both parties signed, but did not follow through with a formal
contract. This is extremely bad practice… which the contractor’s
license board would almost certainly respond with a disciplinary
investigation and fines, or worse.
7. In most instances, we then look to the construction contract for
your remedies in the event of material default. Often, the contract
has a formal termination clause, or 24 or 48 hour cure clause. In
some cases, the owner’s legal rights are a bit more vague than a
traditional contract.
8. Whether you terminate or not at this point in the job, you need to
first determine and then fully document that the contractor is in
material breach (or whatever the standard for triggering the default
provisions of the contract).
As such, I also strongly suggested that you photograph, video and
otherwise document the status of the physical condition of the
property, the status of payments and materials on site, and the
overall condition of the property.
It would be ideal that such photography be accomplished on the
day that you actually send out the notice of default, as it would
document the status upon termination.
9. Also, you should provide your insurance agent notice of the
situation, so they can be sure you have appropriate insurance in
place to protect your property (covering builder’s risk, rain damage,
vandalism, etc.).
10. You may also are exposed at the moment to large mechanics liens
being filed by material suppliers and subcontractors, as well as
builder themselves (for a general background on mechanics liens
and stop notice problems, see ConstructionLawyers.com and click
on Construction Law 101.
11. As such, this is a time for renewed diligence in asking for mechanic’s
lien release along the way (forms are available at the AGC of
California Website) that should be signed by material men and
subcontractors prior to your paying the general contractor. You
should get lien releases from the general contractor as well.
12. In many instances, it will help to issue a 24 or 48 hour notice
(or whatever the time period specified in the contract) to the
contractor detailing the numerous defaults on the contract to date
and directing them to return to the site and complete the contract
for the original price.
13. After that time has passed, you may wish to send them a
termination for default letter and essentially kick them off the site.
14. Before you do that, I suggest you get another quote for the
completion of the project, so you can decide if it is prudent or even
possible to get another replacement contractor. You might not get
anyone to complete a complex project where the contractor has
specialized equipment or is a certified installer for the equipment
company. In any cases, it may also void the warrantees of partially
installed equipment.
15. Before you terminate, you might wish to consider the chances
of recovery in a civil suit, as well as the cost and time involved
in pursuing the contractor. It might not be a viable option if the
contractor (or subcontractor) is so extended that they declare
bankruptcy or are simply insolvent. Remember, any payment made
to a contractor in a precarious financial situation within a specified
period prior to the filing of bankruptcy is subject to re-evaluation
by a Federal Bankruptcy Court as a preference item, meaning it
could be reassigned as an assets of the contractor and paid out in
the order that the Court determines the secured and unsecured
creditors have superior rights.
16. In some cases, such as outright abandonment, I have suggested
the owner pursue a state contractor’s license board complaint,
which might result in discipline and perhaps restitution for the
abandonment of a contract, as well as violations of the contractor’s
license laws regarding contracts, down payments and completion
of work. However, you can never threaten to do so, as it would
be technically extortion to threaten a business with going to a
regulatory agency to seek fines or punishment.
3 | CONSTRUCTION I n sight from Hindsight: Issue 1
17. If you are not at the point of termination, the owner may need to
realize that they will be paying a good deal more than the original
budget. However, there are steps that can be taken to try to
limit your losses of the contractor simply taking your money and
applying it to other jobs.
A. It might make sense to sign a formal contract amendment that
places substantially more controls on the contractor’s opera-
tions and finances. Such a modification can pin the contractor
down to a specific schedule and payments to complete. How-
ever, it is important that modification be drafted carefully, so you
don’t give up all the rights (fixed price & firm schedule) that you
thought you had secured in the original contract.
B. In some cases, the modification will upgrade the contract, such
as adding a Dispute Review Board (DRB), an independent ar-
bitrator, provide for mediation, or simply amend the existing
contract to say that the parties agree to be bound by the terms
of a standard industry contract, if their initial contract is too in-
formal. Examples of such reference contracts are the AIA Short
Form Contract or the AGC – California Short Form Owner –
Contractor Agreement.
C. Next, consider putting into place these types of protections for
contractors that appear to be on the financial rocks or function-
ally insolvent, including 1) do not pay the contractor anything
more until a final budget can be worked out, 2) only pay him
for his actual labor and not advance any money for materials or
subcontractors, 3) pay the materials and subcontracts direct and
be sure they are delivered to the house, 4) get conditional and
unconditional mechanics lien releases from all material men, sub-
contractors and the general contractor for all work performed
to date, 5) only pay the general contractor with joint checks
(filled out with the general’s name and the specific subcontrac-
tor or material men as well) for previously incurred material
men and subcontractor costs and 6) be sure the project is suffi-
ciently along so that it will not sustain water, storm or vandalism
damage while the project is at a standstill.
18. As a termination approaches, I strongly recommend getting your
architect or engineer involved in the process. Their concurrence
is often required in many AIA and similar contracts preferred by
 design professionals. The Architect may also be able to perform
some triage on the plans and specifications and reduce the scope
of the project so it is within your budget, whether completed by
your current contractor or not.
19. It may be prudent for the owner to retain another general
contractor as a consultant and potentially a replacement contractor.
Such a firm can act as a consultant with regard to whether the
extras being sought are legitimate or not. Construction Projects are
fraught with cost increases, as they involve tearing into unknown
conditions. But there is no reason you should accept shoddy work
or claims of extras without a legitimate basis for those claims (a
good contract format provides specific notice and guidelines for
claims, including unforeseen conditions.)
20. Know your applicable local law. Our law firm has attorneys
admitted in 26 states and the District of Columbia and is extremely
familiar with state, local and federal construction projects. These
laws are not uniform in the United States, especially with regard
to mechanics liens, stop notices and forms of releases. You need
knowledgeable and experienced legal assistance to guide you
through a termination event.
The ABA Forum Committee on the Construction Industry also has
numerous articles and resources regarding construction contracts,
performance, breaches and contract terminations, as does our edu-
cational website, www.ConstructionLawyers.com.
© 2012 Navigant Consulting, Inc. All rights reserved. Navigant Consulting is not a certified public accounting firm and does not provide audit, attest, or public accounting services. Navigant is a consulting firm
that does not practice architecture or engineering on design or construction projects in the United States.
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4 | CONSTRUCTION I n sight from Hindsight: Issue 1
21. As John F Kennedy said, “Do not negotiate from fear, but never
fear to negotiate.” There is nothing wrong with sitting down with
a defaulting general contractor or subcontractor and having a
frank discussion of their situation. If they have to go, a negotiated
termination (with the concurrence of the surety, if any), is far more
preferable than long years of litigation where the contractor is
defending themselves against a termination for default that has
serious implications for their bonding, their reputation, their ability
to bid public work, and therefore their livelihood.
As such, I have often said there must be 50 ways to terminate a con-
tractor (or subcontractor). Of these, a negotiated termination is the
most preferable way to end a relationship.
Such a negotiated termination agreement must be comprehensive and
legally binding. It will require a detailed settlement agreement with at-
tachments, the required documentation from materialism and suppli-
ers, including lien releases and assignment of the subcontracts, as well
as contain appropriate enforcement language. Otherwise, it is not of
much value and is likely to lead to other problems, perhaps even more
severe.
Finally, every termination is unique. So, treat them with care and dignity.
NOTE:The reader should not rely upon this general survey
of issues as legal advice and you should retain an attorney
and advise them of the full range of facts of your situation.
At that time, you can decide whether to terminate, or not.