Terminating a subcontractor for inadequate performance is a difficult decision. The process can be long, expensive and risky from a legal perspective. There are several potential consequences to consider when deciding whether to terminate a sub or not. If however, termination is the only option, contractors should be sure they minimize as much risk as possible.
Things to Consider Before Terminating a Subcontractor
Before going through with the termination, prudent contractors should consider all of the risks and issues involved. What may seem like a simple solution, could potentially make a bad situation worse. Before pulling the trigger, contractors should conduct a thorough evaluation of all of the risks and costs associated with the termination
Practical Considerations
One of the most important things to consider is whether there are legal grounds for termination. For the answer, one only needs to look to the termination clause in their contract. Whether it is a termination for cause or termination for convenience, there are typically limits and procedures that must be followed. For example, if terminating for cause, was the sub provided notice and opportunity to cure? Any failure to comply with the provisions in the termination clause could potentially lead to a wrongful termination claim.
For a Deep Dive on Termination
- Termination for Cause | When Can Construction Contracts Be Terminated for Cause?
- Termination for Convenience | Can Your Customer Terminate You Without Good Reason?
Other practical issues to consider is what effect the termination will have on your schedule. The time it takes to assess the existing work, find a replacement and negotiate any contract terms can take weeks. If the delay is significant, requests for additional costs and time extensions will escalate quickly.
Replacement Costs
If you’ve read any of our posts on termination, a recurring theme is that termination is a costly process. The cost of replacing a contractor or sub is often always more expensive than the remaining balance of the terminated contractor’s work. This is true even with the standard 10% retention withheld. You may be asking yourself, “Isn’t there something in the contract that should cover the loss?” For example, in the AIA General Conditions, the termination for cause provision states:
If the unpaid balance of the Contract Sum exceeds the cost of finishing the work and any other damages incurred by the Owner… the Contractor shall pay the difference to the Owner.”
The answer is yes. If the cost of completing the scope of work of the terminated contractor exceeds the remaining balance of the original contract, the contractor may be required to pay the difference. Sure. But the likelihood of this actually happening is slim to none. At least not without incurring more expenses. Filing a lawsuit for breach of contract, handing off the debt to a collections agency or even pursuing the money yourself is a lengthy, expensive process.
Alternatives to Termination
Given all the potential risks involved in termination, never forget that there are still useful alternatives for dealing with non-performing subs. The easiest of which would be to talk it out with the sub. There may be other factors affecting their ability to perform such as interference by other trades or material and labor shortages. Other potential solutions include partial termination, a reduction in their scope of work or simply supplementing their workforce. Creativity and communication is key to resolving the problem, instead of resorting to termination.
Termination Agreement
If termination is absolutely necessary, the contractor should attempt to reach an agreement on the terms and conditions with the subcontractor. This agreement will basically be a second contract between the parties, detailing the remaining rights and obligations of each party. Executing a termination agreement is the best way to close out the contract properly.
Payments
First and foremost, the agreement should hash out how final payment will be made to the terminated subcontractor; if there is any. It should state the remaining balance of the money owed and when the payment will be disbursed.
Obligations
The termination agreement should also outline any remaining obligations of each party. This is going to be the majority of the termination agreement. These can include any on-site work, like preserving the work, demobilizing the crew, and delivering the existing materials and equipment. A terminated contractor should also hand over any accounting information, permits, drawings and specs, and any other relevant documents. Also, the contractor should execute an assignment of any existing subcontracts or pending purchase orders related to the project.
Mutual Release of Claims
This section of the termination agreement will state that the owner/GC accepts all the work in place, along with the materials and equipment already furnished. Be sure to include some language that excludes any third party claims or latent defects. Conversely, the contractor will be releasing any claim to any future payments under the original contract.
Document the Entire Process
Documentation important in all aspects of the construction industry. Once a subcontractor is terminated, it is essential to document the entire process. There should be an evaluation of the work in its current status, to provide insight into how much completion of the work will cost. GCs should create a file that includes this evaluation, photos of the work, and any daily reports or relevant correspondence. Additionally, if a dispute or claim arises, the terminating party will have all the evidence they need, ready to go.
Additional Resources:
- How a Termination Clause Works in a Construction Contract
- Wrongful Termination | When is Termination Considered Wrongful?
- Deductive Change Order vs. Partial Termination for Convenience | When the Scope of Work is Reduced
- Understanding the General Conditions in a Construction Contract
