THE END IS NEAR…but don’t fret! Here’s three ways to terminate your contract without FEAR!

Termination should be a last resort and can backfire if done wrong. When it comes time to pull the trigger, do you know how to make it count?

Termination is one of the more complex and misunderstood areas of law. Whilst there are many ways to terminate a contract, most methods fall within three broad categories:

1. Termination pursuant to an unconditional contractual right (i.e. termination for convenience);
2. Termination pursuant to a conditional contractual right (i.e. notice to show cause, default etc.); and
3. Termination at common law.

The requirements and effect of each type of termination differ significantly and each have a different commercial outcome.

Often, these three areas are confused which can unfortunately lead to disaster. WHY? Because a wrongful termination is a serious breach of contract and aside from being invalid, allows the other party to recover damages for any losses it suffers which flow from the wrongful termination. Similarly, some types of termination do not allow you to recover damages!

When you factor in the value of unreturned security (i.e. retention, bank guarantees etc.), unpaid variations, loss of profit, missed set offs and demobilisation costs – a wrongful termination can be a costly exercise!

In this article, I provide a brief overview of the types of termination and the things you need to consider before parting ways.

1.    Termination for convenience

Modern construction contracts often contain what is known as a termination for convenience clause which entitles one party to unilaterally terminate a contract without cause. In other words, they allow one side to end the agreement at any time and for any reason.

Here’s an example of the operative part of a typical termination for convenience clause:

“10.  Termination for convenience

The Principal may at any time and for any reason terminate the Contract for its convenience (including where there has been no default or insolvency of the Contractor) by 5 business days notice to the Contractor.”

The main advantage of terminating for convenience is that, if the clause is properly drafted, it can be done for ANY REASON. There has been some challenges in the past as to whether the exercise of a termination for convenience clause requires that it is exercised in good faith: Kellogg Brown & Root Pty Limited v Australian Aerospace Ltd [2007] VSC 200. However, that argument has only been successful on a handful of occasions.

The disadvantage of terminating for convenience is that it makes it difficult to recover damages. Terminating for convenience is exactly that – for CONVENIENCE. Not breach, not delay, not even a breach of the work health and safety legislation. This means that if used incorrectly, you essentially give the other side a ‘get out of jail free card’.

Say for example you’re a principal who terminates a builder half-way through a project for repeated work health and safety breaches – one of which resulted in a fatality. The new builder who comes on board charges an additional 25% over and above the remaining contract price to finish the work and to factor in the risk of the work carried out by the previous builder.

If you terminated for convenience in this scenario, you would lose the right to recover from the builder the additional 25% to complete the works. If on the other hand, you terminated pursuant to a contractual right or at common law, then you would be able to recover that amount from the builder.

2.    Termination pursuant to a contractual right

Construction contracts often contain clauses which allow a party to terminate for a specific reason. These reasons can be individually identified (such as a failure to obtain finance by a certain date) or may be identified within in a general category of reasons such a ‘substantial breach’.

For example, clause 39.2 of the Australian Standard 4000 contract allows the principal to terminate after providing a notice to show cause for the following reasons:

Ordinarily, terminating at common law is a difficult task and requires specific circumstances before one party becomes entitled to terminate. The purpose of these types of clauses is to lower the bar for what would ordinarily be required for termination (discussed below).

Put simply, these clauses merely identify the conditions or events that need to take place before one party is entitled to terminate. Ordinarily, those events would not entitle a party to terminate. Using the above example, a failure to provide evidence of insurance would not be enough to allow a party to terminate at common law, however, it is possible using the above clause.

The price for having an easier right to terminate, however, is that it is necessary to STRICTLY comply with the preconditions in the contract. This includes allowing the entire show cause period to complete. 

For example, in Eriksson v Whalley [1971] 1 NSWLR 397, the contract required show cause notices to be sent by registered post, however, the superintendent hand delivered the notice to the builder’s foreman. Ultimately, it was held that this notice was invalid for several reasons – one of which was that the notice requirements had not been complied with.

As a general rule of thumb, the more power a clause provides, the more strictly it should be complied with.

3.    Termination at common law (repudiation)

Whilst terminating pursuant to a contractual power is ideal, sometimes the above options do not exist (either because there is no contractual right to terminate or because an immediate termination is required) – leaving termination at common law as the only way to bring a contract to an end.

Fortunately, the right to terminate for repudiation at common law exists separate and independent from the contractual termination regime: Mazelow Pty Ltd v Herberton Shire Council [2003] 1 Qd R 174.

Whilst, working out whether a party is entitled to terminate at common law can be a difficult task – you will almost always be entitled to terminate if you can answer “yes” to the following questions:

Has there been a breach of an essential term? An essential term is basically a term that is so fundamental to the purpose of the contract that either party would not have entered into the contract unless they knew the other party’s “strict or substantial performance” of the term: Tramways Advertising Pty Ltd v Luna Park (N.S.W.) Ltd (1938) 38 S.R. (N.S.W.) 632.

A breach of an essential term, howsoever slight, gives rise to a right to terminate: Re Ronim Pty Ltd [1999] 2 Qd R 172.

Accordingly, if there has been a breach of a material term, you are entitled to terminate at common law.

Has there been a sufficiently serious breach of an intermediate term? Whilst a minor breach of an essential term usually provides an immediate right to terminate, conversely, a serious breach of a non-essential term can also provide a right to terminate.

A non-essential term (also referred to as “intermediate” terms) is a term of the contract that is not immediately essential but can become an essential term if the breach of that term goes “to the root of the contract” or “substantially deprives the innocent party of the bene?t of the contract”: Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007) 233 CLR 115 at [51]–[55].

In Koompahtoo it was found that a failure by a developer (Sanpine) in a joint venture to maintain books of account and financial records of the joint venture amounted to a sufficiently serious breach of a non-essential term that entitled the Land Council to terminate. Whilst such a breach would ordinarily not entitle one party to terminate, the circumstances changed significantly when the development failed and went into liquidation.

At that time, the developer’s failure to be able to explain how the borrowed funds, which had been secured against the development site had been used by the joint venture “went to the root of the contract” and deprived the Land Council of “a substantial part of the bene?t for which it contracted”.

Has the other party evinced an intention that it is no longer willing to be bound by the contract, or to fulfil the contract only in a manner substantially inconsistent with that party's obligations? This is mouthful of a question, but basically asks whether the other side had repudiated the contract.

Repudiation is used legally in two ways. First, it is used to describe any type of breach which entitles the other party to terminate (including the above two scenarios). Second, it is a catch all term for conduct which “evinces an unwillingness or an inability to render substantial performance of the contract.”

This second use of the term is designed to capture scenarios where there has been no breach of an essential term, no serious breach of a non-essential term – but one party has lost the benefit of the contract because of one party’s conduct to comply with the contract.

Some good examples of repudiation include:

• Multiple minor breaches of a contract: Multiple breaches of a contract may when looked at together in the context of the contract amount to repudiation of a contract: Hudson Crushed Metals Pty Ltd v Henry [1985] 1 Qd R 202. These breaches can include repeated breaches of the same term (such as a failure to pay by the due date) or multiple breaches of different types of terms.
• Maintaining an incorrect interpretation of a contract: Only agreeing to carry out the contract in accordance with an incorrect view is grounds for termination: DTR Nominees Pty Ltd v Mona Homes Pty Ltd (1978) 138 CLR 423. A classic example is where there is a dispute as to how work should be carried out in light of ambiguous contract documents. In this case, the safer option for the contractor is to do the work and claim a variation.
• Wrongful termination: As set out at the start of this article, attempting to terminate itself is an act of repudiation: Ogle v Comboyuro Investments Pty Ltd (1976) 136 CLR 444.

As a final thought, a termination may be justified on any grounds available at the time, even if they are not specified in the termination notice: Shepherd v Felt and Textiles of Australia Ltd (1931) 45 CLR 359, 377-8. This means that a well drafted termination for convenience clause can act as a ‘safety net’ when an attempt to terminate at common law goes wrong.

Conclusion

The construction industry is often relationship first, contract second. Unfortunately, relationships can only handle so much and when it’s time to part ways – there is nothing worse than getting it wrong and adding insult to injury. 

Whilst not discussed in this article, the better option is almost always to NEGOTIATE and terminate any contract by agreement or cutting a deal. The reality is that few people ever win from a dispute (except lawyers). Even if you seamlessly terminate your contract, win an adjudication and win the subsequent court proceedings – you’re still likely to be out of pocket for legal expenses. Further, even if there are any gains from terminating a contract, they almost always end up being less than the amount you would make from a future project.

In any event, if you have to fight then you might as well do it right. And remember as Ray Kroc said in the 2016 movie ‘the Founder’, “Contracts are like hearts, they’re made to be broken”. When they are, be sure to make sure that you’re not the one who will be suffering the heartache.

aaIf you found this article helpful, please like, share and leave your comments below about whether you’ve encountered any of the above issues on your projects. I am currently preparing one article per week on all aspects of construction law and common issues that I see in my practice. If you would like a specific topic addressed in the future, please send me an email to [email protected].

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*All my articles are drafted with references to case law and legislation. This is not to bore you with the intricacies of the law, but to allow you to rely on my material when resolving your own disputes – should it not be feasible to instruct a solicitor such as myself.

As a disclaimer, the content does not constitute legal advice and should not be relied upon as such. Appropriate legal advice should be obtained in actual situations. Feel free to contact me at [email protected] should you require any assistance in resolving a legal dispute.