This paper considers termination of contract by the Employer under the 1999 FIDIC Red and Yellow Standard Forms of Contract, (the termination provisions of both forms of contract are identical) which are used on international construction and engineering projects.
Dr C.S.Suryawanshi, Former Chief Engineer & Joint Secretary (P.W.D) Senior Consultant Mumbai.
This fact of life has parallels in the law when parties seek to terminate commercial relations, particularly in the case of construction contracts, where the stakes are often high and the reputation and egos of the protagonists is paramount especially in construction dominated economies.
Contracts are binding commercial agreements which are not easily set aside or varied. At common law, a party may only terminate a contract if the other party has breached an essential term or repudiated the contract.
Not every term of a contract is an 'essential' term. Contracts contain a number of terms, some being more important and fundamental to the transaction than others. For example, a construction contact may specify that as built drawings must be of a certain size and contain certain information. If a contractor produces drawings of a different size then it will be in breach of contract but that breach is unlikely to be so fundamental to the transaction that the principal would have a right to terminate. However, the failure by a contractor to design and construct a plant to meet certain performance characteristics may be essential to the transaction and may give rights to the principal to terminate if those performance requirements are not met.
Because of the difficulties in determining if a term is an essential term, most contracts will specify the procedure when a party is in default and whether the innocent party has the right to terminate because of that default. Generally, these clauses deal with the non-performance of a party such as, delay, a failure to pay, a failure to comply with directions and do not deal with external events which may make the contract more difficult or in some cases impossible to perform.
Importance of Right to Terminate
Any astute party negotiating a contract should always consider a definitive "get out" strategy that will cover a variety of situations that may arise during a contract period, including those based on convenience or default on the part of the other contracting party. The decision to terminate should be well considered as, in essence, the party being served with a notice to terminate is being deprived of a lawful bargain.
Contractual Provisions (Right to Terminate)
The right to terminate is both important and practical as it helps to ensure the contract is performed as agreed. It also helps to form the basis upon which parties may re-negotiate with each other if their contractual relationship encounters difficulties.
The decision to terminate, either by the contractor or employer, should not be taken in circumstances where there is a minor breach or no breach at all (convenience). The decision to terminate should only be exercised in the event of a major breach or an incident occurring which is the fault of neither party e.g. events constituting force majeure.
In the present climate where the construction industry in the developing countries is facing an unprecedented rise in the costs of construction materials, the issue of termination is sometimes foremost on the minds of the contracting parties, especially contractors who have not properly estimated the costs during a project lifecycle.
Our recent experience suggests that notwithstanding contractual agreement on the price of materials, contractors sometimes threaten termination based on some other pretext and given the current scarcity of available contractors with capacity to resource projects, they are mostly successful.
Typical Contractual Grounds to Terminate
Termination clauses are a common feature in standard construction contracts such as FIDIC. It is usual for parties to set out the events upon which one or both the parties may terminate the contractual relationship between them. Some of the typical reasons include:
- when one party breaches certain terms of the contract (e.g. workmanship);
- when one party repeatedly fails to perform its obligations;
- when a specific event occurs, e.g. when a party becomes insolvent or has a receiver or administrator appointed over its assets;
- when one of the parties exercise its discretionary right to terminate for its own convenience;
- when a prolonged suspension or force majeure type event occurs.
Termination by Employer
It is important to appreciate that coupled with the right to terminate is the essential issue of the enforcement of the right to terminate. This goes to the heart of the current dilemma facing practitioners in the construction industry.
The question here boils down to the following: does a party follow what the contracting parties intended and agreed as reflected in contractual terms (often based on a hybrid of FIDIC standard conditions) or do they ignore what they agreed and resort to mandatory provisions in the Civil Code on construction contracts?
The answer is both can be considered correct depending on the wording of the contract.
Termination of a contract is a serious step to take. Its consequences, both practical and legal, should be considered before notice is given to the Contractor. There will be significant financial consequences for the Employer if the Contractor objects to termination and the Dispute Adjudication Board (DAB) or Arbitrator later decides that the Employer was not entitled to terminate.
A party's right to terminate under the contract must be distinguished from its right to terminate at law. The grounds on which a party may terminate the contract at law depend on the governing law of the contract, and are often very narrow. In contrast, contractual termination provisions often provide greater or different remedies than are available under the governing law. The right to terminate under a contract does not necessarily exclude the right to terminate at law. However, the right to terminate at law may be excluded where an express right to terminate has been negotiated giving the same grounds for termination as at law.
Termination Under the FIDIC Contract
Clause 15 sets out the circumstances that may lead to a termination of the Contract by the Employer as a result of a default by the Contractor, and describes the procedures that must be followed and the financial arrangements that will apply. It also provides for an Employer's termination for convenience (where there has been no default by the Contractor). This is one of the main differences between termination by Employer and termination by the Contractor: a terminating Contractor is not entitled to terminate for convenience.
However, there are also other sub-clauses which give the Employer the right to terminate in certain circumstances:
- Sub-clause 9.4(b): failure to pass tests on completion.
- Sub-clause 11.4(c): failure to remedy defects.
- Sub-clause 19.6: optional termi- nation payment and release (force majeure or exceptional events).
- Sub-clause 19.7: release from performance under the law.
Grounds for termination
The grounds on which an Employer can terminate for cause are set out at sub-clause 15.2.
Termination by Employer
The Employer shall be entitled to terminate the Contract if the Contractor:
"(a) fails to comply with Sub-clause 4.2 [Performance Security] or with a notice under Sub clause 15.1 [Notice to Correct]."
If sub-clause 4.2 applies, the Employer is entitled to terminate the Contract if the Contractor:
- Fails to provide the Performance Security within the required time.
- Fails to ensure it is valid and enforceable for the period required.
- Fails to extend its validity as required.
"(b) abandons the Works or otherwise plainly demonstrates the intention not to continue performance of his obligations under the Contract."
This is a general ground entitling the Employer to terminate for cause; it does not relate to a specific failure of the Contractor under the Contract. It is of limited application, available only in circumstances where the Contractor has abandoned the Works or otherwise plainly demonstrates an intention not to continue performance under the Contract.
While it should be obvious whether a Contractor has abandoned the Works, it is less clear what conduct might constitute an intention not to continue performance. Some commentators have suggested that the words "or otherwise" contemplate an intention on the part of the Contractor not to continue performance of his obligations as a whole under the Contract. They suggest that circumstances where the Contractor refuses to carry out a particular obligation might not be caught by the clause unless that obligation went to the root of the Contract. This concept is similar to the common law right of one party to terminate by accepting the repudiation of the other, where that repudiation amounts to demonstrating an intention to no longer be bound by the Contract.
(c) without reasonable excuse fails:
(i) to proceed with the Works in accordance with Clause 8 [Commencement, Delays and Suspension], or
(ii) to comply with a notice issued under Sub-clause 7.5 [Rejection] or Sub-Clause 7.6 [Remedial Work], within 28 days after receiving it".
The reference to "proceed with the Works" in paragraph (c)(i) is found only in sub-clause 8.1, however, a number of the obligations in clause 8, for example, to proceed in accordance with the programme (sub-clause 8.3) and to adopt measures to expedite progress (sub clause 8.6), could be construed to relate to the Contractor's obligation to proceed with the Works.
In relation to paragraph (c)(ii), sub-clauses 7.5 and 7.6 empower the Engineer to instruct the Contractor to take remedial actions or carry out urgent work required for the safety of the Works. The Employer is entitled to terminate the Contract if the Contractor fails to comply with a notice under either of these sub-clauses. It should be borne in mind that the Engineer must give reasons for any rejection under sub-clause 7.5, and an Engineer's instruction under sub-clause 7.6 may be subject to a "reasonableness" requirement.
"(d) subcontracts the whole of the Works or assigns the Contract without the required agreement".
Although it does not expressly say so, this provision relates to the prohibitions in subclauses 1.7 and 4.4 against the Contractor assigning or sub-contracting the whole or any part of the Contract without the prior agreement of the Employer.
"(e) becomes bankrupt or insolvent, goes into liquidation, has a receiving or administration order made against him, compounds with his creditors, or carries on business under a receiver, trustee or manager for the benefit of his creditors, or if any act is done or event occurs which (under applicable Laws) has a similar effect to any of these acts or events".
Paragraph (e) places the Contractor's finances under the spotlight. The Contractor's insolvency amounts to an event of default entitling the Employer to terminate the Contract; which is something we may see more frequently in the current economic climate. The operation of this paragraph (e) will depend on the governing law and other applicable laws. If the Contractor is in breach of this sub-paragraph, the Employer is entitled to give notice to terminate immediately, rather than having to wait 14 days (as set out under Procedure for termination).
"(f) gives or offers to give (directly or indirectly) to any person any bribe, gift, gratuity, commission or other thing of value, as an inducement or reward:
(i) for doing or forbearing to do any action in relation to the Contract, or
(ii) for showing or forbearing to show favour or disfavour to any person in relation to the Contract,
or if any of the Contractor's Personnel, agents or Subcontractors gives or offers to give (directly or indirectly) to any person any such inducement or reward as is described in this sub-paragraph (f). However, lawful inducements and rewards to Contractor's Personnel shall not entitle termination."
Paragraph (f) addresses bribery and corruption. It prohibits the giving of bribes, gifts, gratuities or commission by the Contractor's Personnel, agents or sub-contractors, to any person for doing or allowing any action in relation to the Contract, or to gain favour.
The Employer may also terminate the Contract if the actions of sub-contractors, over which the Contractor has no control, amount to bribery and so on under this sub-paragraph.
Importantly, "lawful inducements and rewards" to the Contractor's Personnel (that is, the Contractor's Representative and all personnel whom the Contractor uses on Site, and who may include the staff, labour and other employees of the Contractor and of each Subcontractor and any other personnel assisting the Contractor in the execution of the Works) are excluded. However, there is no such qualification in relation to persons who do not fall under the definition of "Contractor's Personnel". It is also not clear which laws should be applied when considering whether an inducement or reward is "lawful".
As above, if the Contractor is in breach of these sub-paragraphs, the Employer is entitled to give notice to terminate immediately, rather than having to wait 14 days (see Procedure for termination).
Procedure for Termination
The remainder of sub-clause 15.2 sets out the procedure to be followed in the event of an Employer's termination for cause (it does not separately number the remaining subparagraphs):
"In any of these events or circumstances, the Employer may, upon giving 14 days' notice to the Contractor, terminate the Contract and expel the Contractor from the Site. However, in the case of sub-paragraph (e) or (f), the Employer may by notice terminate the Contract immediately."
The requirement to give 14 days' notice gives the Contractor a final opportunity to comply with the relevant obligation or discuss the issue with the Employer. It is unclear whether the notice has automatic effect; that is whether the Contract is terminated automatically 14 days after a valid notice has been given under sub-clause 15.2 or whether the Employer must give a further notice of termination. To be on the safe side, it may be advisable for the Employer to give the Contractor notice that the Contract has been terminated on the expiry of the 14-day period.
This sub-paragraph does not mention whether the Employer's right to terminate is lost after giving the required 14 days' notice if the Contractor resolves the event or circumstance giving rise to the notice. This is a potential area of uncertainty that the parties might want to clarify before concluding the Contract.
"The Employer's election to terminate the Contract shall not prejudice any other rights of the Employer, under the Contract or otherwise."
Importantly, the Employer's rights and remedies under the Contract and at law are preserved on termination. So, for example, the Employer's right to complete the Works itself following termination is maintained.
"The Contractor shall then leave the Site and deliver any required Goods, all Contractor's Documents, and other design documents made by or for him, to the Engineer. However, the Contractor shall use his best efforts to comply immediately with any reasonable instructions included in the notice (i) for the assignment of any subcontract, and (ii) for the protection of life or property or for the safety of the Works."
Following termination, the Contractor must leave the Site (which includes the places to which Plant and Materials are to be delivered) and deliver any Goods (which includes Plant, Materials, Temporary Works and Contractor's Equipment, including Subcon- tractor's equipment) required to the Engineer. This provision may be difficult for the Contractor to implement in practice, particularly if he wants to use his equipment on any another job.
This sub-paragraph also contemplates the termination notice including instructions concerning safety and the assignment of sub-contracts. It is suggested that the notice also includes any other instructions concerning the Contractor's departure from the Site, such as a list of the Goods the Employer requires and a valuation of the Works as at termination in accordance with sub-clause 15.3. Employers should be careful not to provide these instructions too early, for example, in circumstances where the Contract may not be terminated at the expiry of the 14-day notice period. This is because these instructions could be considered to be an election to terminate under the Contract, or may amount to repudiatory or material breach of contract at law.
"After termination, the Employer may complete the Works and/or arrange for any other entities to do so. The Employer and these entities may then use any Goods, Contractor's Documents and other design documents made by or on behalf of the Contractor." This sub-paragraph empowers the Employer to complete the Works itself, using the Contractor's Equipment, Plant and Temporary Works, Contractor's Documents and other design documents. The Employer can then claim the costs of completing the Works from the Contractor under sub-cause 15.4(c).
"The Employer shall then give notice that the Contractor's Equipment and Temporary Works will be released to the Contractor at or near the Site. The Contractor shall promptly arrange their removal, at the risk and cost of the Contractor. However, if by this time the Contractor has failed to make a payment due to the Employer, these items may be sold by the Employer in order to recover this payment. Any balance of the proceeds shall then be paid to the Contractor."
This sub-paragraph permits the Employer to sell the Contractor's Equipment and Temporary Works to discharge the Contractor's debts. This may be legally and practically difficult to implement as it depends on whether the Contractor actually owns that equipment.
Consequences of Termination
The consequences of termination by the Employer under sub-clause 15.2 are set out in sub-clauses 15.3 (Valuation at Date of Termination) and sub-clause 15.4 (Payment after termination), as follows:
- "As soon as practicable after the notice of termination has taken effect", the Engineer is required to determine "the value of the Works, Goods and Contractor's Documents, and any other sums due to the Contractor for work executed in accordance with the Contract" (sub-clause 15.3).
- The Employer "may withhold further payments to the Contractor until the costs of design, execution, completion and remedying of any defects, damages for delay in completion (if any), and all other costs included by the Employer have been established" (sub-clause 15.4(b)).
- The Employer "may recover from the Contractor any losses and damages incurred by the Employer and any extra costs of completing the Works, after allowing for any sum due to the Contractor under Sub-Clause 15.3 [Valuation at Date of Termination].
Employer's Termination for Convenience (Without Cause)
Sub-clause 15.5 gives the Employer the right to terminate the Contract at any time for convenience, that is, without any default on the part of the Contractor or other justification, as follows:
"15.5 Employer's Entitlement to Termination
The Employer shall be entitled to terminate the Contract, at any time for the Employer's convenience, by giving notice of such termination to the Contractor. The termination shall take effect 28 days after the later of the dates on which the Contractor receives this notice or the Employer returns the Performance Security. The Employer shall not terminate the Contract under this Sub-clause in order to execute the Works himself or to arrange for the Works to be executed by another contractor.
After this termination, the Contractor shall proceed in accordance with Sub-clause 16.3 [Cessation of Work and Removal of Contractor's Equipment] and shall be paid in accordance with Sub-clause 19.6 [Optional Termination, Payment and Release]."
Sub-Clause 19.6 provides:
"19.6 Optional Termination, Payment and Release
If the execution of substantially all the Works in progress is prevented for a continuous period of 84 days by reason of Force Majeure of which notice has been given under Sub-Clause 19.2 [Notice of Force Majeure], or for multiple periods which total more than 140 days due to the same notified Force Majeure, then either Party may give to the other Party a notice of termination of the Contract. In this event, the termination shall take effect 7 days after the notice is given, and the Contractor shall proceed in accordance with Sub-Clause 16.3 [Cessation of Work and Removal of Contractor's Equipment].
Upon such termination, the Engineer shall determine the value of the work done and issue a Payment Certificate which shall include:
- [payment for work prior to termination];
- [payment for Plant and Materials];
- [other reasonable costs]... incurred by the Contractor in the expectation of completing the Works;
- the Cost of removal of Temporary Works and Contractor's Equipment from the Site and the return of these items to the Contractor's works...; and
- the Cost of repatriation of the Contractor's staff and labour..."
A termination for convenience clause is generally intended to cover circumstances where the project is no longer required or must be abandoned for some reason; for example, if the Employer is no longer able to fund the project. The idea is to restore the Contractor to the financial position it would have been in had the project never commenced (therefore there is no allowance for profit). It follows that the Employer is not entitled to terminate the Contract in order to complete the Works himself or by engaging a new (and potentially cheaper) Contractor.
Sub-clause 15.5 is obviously of great benefit to the Employer. Whether the Contractor accepts its inclusion in the Contract really depends on the relative bargaining power of the parties. The Contractor may seek to include an allowance for profit; but this really goes against the overall intention of the clause. In any event, if the Contract is terminated because the Employer has run out of money then at a practical level the Contractor may find it difficult to get its costs back, let alone any profit on top of that.
If the volume of case law is anything to go by, termination for convenience clauses are invoked by Employers relatively regularly in the United States. However, the same cannot be said for England and Wales, & India where termination for convenience clauses are either not always included in construction contracts, or fault-based termination is preferred (as it is generally more financially advantageous). The English courts have confirmed the validity of these clauses (although not specifically in relation to the FIDIC Contracts) in Hadley Design Associates v The Lord Mayor and Citizens of the City of Westminster  EWHC 1617 (TCC).
Although there is no case law on this point, some commentators suggest that Employers may terminate the Contract under sub-clause 15.5 where they themselves are in breach, as a pre-emptive step to prevent the Contractor making a claim for breach of contract. This is not what FIDIC intended.
Given the current global economic climate, it is likely that we will see this clause invoked more frequently as Employer's find it increasingly difficult to fund projects. However, it should be noted that the application of sub-clause 15.5 may be restricted by the governing law of the Contract; this should be checked by the Employer before invoking this clause.
Procedure of Termination for Convenience
The notice of termination must comply with the formalities set out in sub-clause 1.3, and must be copied to the Engineer.
Termination takes effect 28 days after the Contractor receives the notice, or after the Employer has returned the Performance Security, whichever is later. Following termination, the Contractor must proceed in accordance with sub-clause 16.3 (Cessation of Work and Removal of Contractor's Equipment). This means the Contractor must stop all further work, deliver up Contractor's Documents, Plant and Materials and remove all Goods from the Site.
Consequences of Termination for Convenience
There is no provision to compensate the Contractor for the loss of profit that he would otherwise have made had he completed the Works. However, the Contractor is entitled to recover the value of work done and any other Cost or liability that he has reasonably incurred in expectation of completing the Works, together with the cost of clearing the Site and repatriating staff.
Practical Considerations Upon Termination
In the midst of complying and focusing on the procedural and legal requirements of termination parties often overlook important issues and subsisting rights which ideally should be factored as part of the termination process and can sometimes actually facilitate the process of termination.
These issues include:
- demobilisation from the site;
- removal of unwanted materials and debris;
- facilitating unencumbered site access to other contractors;
- securing the perimeter of the site;
- ensuring the proper storage of materials and equipment (particularly hazardous materials);
- the compilation, production and handover of the employer's proprietary material, agreeing copyright issues in material, relocation of staff and labour;
- handover of labour accommodation and the site office and its facilities;
- Negotiating the return of contractual forms of security such as advanced payment bonds.
Rights of termination are important as a practical means to apply pressure on the other party to perform but the exercise of such rights must be approached with extreme caution. The interaction of common law principles under FIDIC based contract conditions and their interplay with the Civil Code is not straightforward by any means.
Coping with termination does not necessarily need to be a time consuming and costly affair, but failing a commercial settlement, careful attention needs to be paid as to how the procedural requirements country laws and contractual rights fit together to best suit the interests of the party seeking to terminate, both prior to and following termination.
Although times may have changed so that performance of a contract is less profitable or indeed uneconomic, that in itself is unlikely to allow a party to terminate. A party who does not terminate a contract correctly or terminates a contract unlawfully will itself be in breach of contract and liable for damages. Accordingly, any termination must be carefully considered and professional advice obtained.
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