The tricky question of termination

Laura Waterhouse, UK Construction and Engineering Group at international law firm Pinsent Masons, discusses how to terminate contracts.

One area which parties can often get into difficulties with is how to bring a construction and engineering contract to an end in a manner which is lawful.

This is a key issue for parties and most contracts include an express term setting out the parties right to terminate the contract. The standard forms of contracts contain such terms as a matter of course. The second and other common route to termination exists at common law. One party has the right to treat a contract as being at an end if the other party has breached his obligations under the contract (this type of breach is termed a repudiatory breach of contract). Importantly, not every breach gives rise to an entitlement to terminate the contract. The key question to consider is whether the breach of contract which the party is relying on as the reason to terminate goes to the root of the contract.

This is not a straightforward matter. The parties must tread a careful line when deciding whether a particular breach is a repudiatory breach which it can accept so as to terminate the contract (to effect the termination the breach must be accepted because it is this acceptance and not the breach which is the trigger for termination).

For example, a contractor may consider terminating a contract for an employer's failure to pay. There is no general right of termination available to the contractor for breach of non-payment. It is for this reason that there is a statutory right to issue a notice to suspend performance of the works for non-payment under the Housing Grants, Construction and Regeneration Act 1996. Therefore, the failure to properly pay sums due does not automatically constitute a repudiatory breach and the contractor must carefully consider whether in the circumstances the non-payment is a sufficiently fundamental breach so as to bring the contract to an end.

There are serious consequences if a party does not do so and terminates too hastily by accepting a breach which is later determined not to be sufficiently serious to qualify as a repudiatory breach. The risk is that premature and wrongful acceptance of a repudiatory breach may itself constitute a repudiatory breach. If the other party is alert enough it may then accept that breach and claim damages for the wrongful termination. This can be a costly mistake.

The question of when a party can terminate is a little more straightforward if there is an express contractual right of termination. The relevant contractual clause will often set out in some detail the circumstances in which the right to terminate arises. It can be relatively simple to determine if some of these circumstances have occurred, such as if one party has become insolvent or another specified event has occurred. However, other rights are more complicated and require closer consideration.

For example, the JCT Private with Quantities standard form of contract requires an employer not to act "unreasonably or vexatiously" when exercising its right to terminate the contract and the NEC 3rd Edition allows the parties to terminate where the contractor has "substantially" failed to comply with its obligations. There is some guidance which assists the parties in judging if these factors have been satisfied. For example, the recent case of Reinwood Limited v L.Brown & Sons (2007) B.L.R. 10 gives six principles to help assess whether a party has acted unreasonably or vexatiously. These include that by vexatious it is meant that the terminating party determined the contract with the ulterior motive or purpose of oppressing, harassing or annoying the other party and that the test of what is reasonable is to be determined by looking at how a reasonable contractor would have acted in all the circumstances.

Finally, when operating an express right to terminate, it is important to be clear what the consequences of termination are. The notice to terminate typically brings some but not all of the obligations under a contract to an end. Other obligations will survive the termination. It will be necessary to check each contract individually to establish which obligations survive. Examples of typical obligations that may survive include to demobilise and safely secure the site and works, to make certain termination payments or that a third party has a right to step-in to take over the contract. Knowing what terms survive allows a party to make an informed choice about whether it should terminate or not.

From the above, it should be apparent that when taking the step to terminate parties should tread carefully. The right to termination can be very effective and useful (whether exercised under an express term or at common law). However, due consideration must always be given to whether the right to terminate has arisen. Just as important is the question of whether it is commercially sensible, bearing in mind the obligations which will survive termination and arrangements on termination, to exercise that right.