Terminating a Subcontractor or Sub-tier Contractor—Not so Fast—Read Your Contract!

Every few months I receive a call from a general contractor or subcontractor who has just terminated a subcontractor or sub-tier contractor for non-performance and is “checking in with me to see if there are any liability issues.”  After the termination has taken place, if the termination is wrongful, there are serious legal consequences.  Calling your lawyer after the fact will not cure missteps in the termination process.  Termination for non-performance is a common term in most contract documents.  As courts interpret contracts, however, the right to earn revenue from a contract is a substantial interest, and courts generally “abhor” forfeitures (termination) of that right.  In other words, the courts will strictly determine whether the terminating party to a contract has complied with the termination process to the letter.  A recent example from Connecticut is instructive in this regard. [1]

The general contractor on a large hospital project in Connecticut terminated its electrical subcontractor, hired others to finish the electrical subcontractor’s work, and then sued the electrical subcontractor for $26 million.  The electrical subcontractor countersued the general contractor for $3.6 million of work that it had completed at the time of the termination which had not been paid for.  The subcontractor claimed that due to the many changes that had occurred on the project, it stopped work because the changes altered the contract to the point that it was no longer the same contract.  The subcontractor walked off the project and the general contractor then terminated the subcontractor and re-procured the work from other subcontractors.

The court first analyzed whether in fact the changes made during the course of the project were so radical and “cardinal” in extent that they amounted to repudiation of the contract, and, thus, justified the subcontractor’s halting performance.  The court found that the changes, irrespective of the dollar amount at issue, did not change the basic character of the project, and, therefore, the subcontractor was not justified in abandoning the project.

The court then looked at the contract between the general contractor and subcontractor and found it to be a lopsided bargain, which the court described as “hardly a bargain at all.”  Nevertheless, because the bargain had been struck between two commercially-sophisticated entities, the court was not about to rebalance the bargaining power between these commercial entities, and so the subcontractor had to live with the application of the contract terms.  Thus, irrespective of the changes, the court found that the subcontractor’s temporary or permanent abandonment of the work amounted to a material breach of contract.

The general contractor’s behavior was then considered and the court found that the general contractor’s subcontract required a certain notice and cure opportunity (48 hours) which the general contractor did not comply with.  Accordingly, the court found that the general contractor also materially breached the contract.

Now we have both parties in material breach, the subcontractor for its abandonment of the project and the general contractor for failing to follow the termination provisions of its subcontract.  The court held that the subcontractor was not obligated to compensate the general contractor for the re-procurement costs that the general contractor incurred as a result of the subcontractor’s walking off the project.  The subcontractor, however, was not entitled to its $3.6 million that it was seeking in payments that it was due from work performed prior to the termination.  The court held that the subcontractor had been overpaid, and therefore, was not entitled to the compensation it was seeking, and instead owed the general contractor $3.8 million in overpayments.

Comment:  The subcontractor in this case was saved from the worst consequences of its wrongs (the walking off the job) by the general contractor’s own missteps (wrongdoing) for it failed to follow the termination provisions of the subcontract.  The lesson to be learned here is when terminating a subcontract, or a sub-tier subcontract, for non-performance, the termination provisions—that is the provision of the contract that provide an opportunity for the subcontractor or sub-tier subcontractor to cure the default—must be complied with.  The failure to so comply will expose the terminating contractor to significant liability.  In this case, the subcontract contained a clause that converted a wrongful termination for cause to a termination for convenience.  That clause permitted the general contractor to then recover the overpayments.  But for that conversion from termination for cause to termination for convenience, the court may have ruled differently.

[1] Semac Electric Company v. Skanska USA Building, Inc., 2017 WL 4508507 (CT. Super. Ct. Aug. 23, 2017) (unpublished opinion).
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