By A. J. Manion, ajmanion@kkbevansville.com

Contractors start projects with optimism.  When negotiating or contracting, the parties rarely start thinking their project will be suspended or even canceled.  Prudent contractors, however, know proper planning requires setting aside resources anticipating a stream of revenues.  The interruption or loss of the anticipated revenues can be devastating, thus contractors are wise to contemplate and plan for either potential outcome.  Terminations not only separate a contractor from an intended stream of revenue to cover home office overhead but prevent the contractor from realizing anticipated profit.  Suspensions, by contrast, are an insidious creeping loss as contractors maintain the status quo or other state of readiness through an interruption of an unknown duration.  Either predicament is unenviable.

In the traditional language of risk management, the risk of owner suspension or termination is a risk the contractor has chosen to retain.  The risk, therefore, should be managed.  No different from other risks, contractors should analyze the likelihood of adverse consequences and then manage through established principles.

Due diligence

As in any undertaking, construction projects can fail because an owner does not have the wherewithal to complete the project.  Before agreeing to perform the work, contractors, therefore, should investigate the owner’s potential to see the project through to completion.  For those project owners who only occasionally engage in construction projects, challenges can result from a lack of sophistication.  For example, does the owner really know what it wants?  Has the site been selected?  Does the owner understand the construction timetable.  What is the owner’s business?  What is the owner’s history for building?  Keep in mind as well that an owner building a new facility may project diminished needs in its segment.  Even when working with professional developers, contractors should still exercise prudence.  For example, what are the owner’s assumptions about financing and returns?  What is the nature of the project?  An owner may abruptly decide a more aggressive design or ambitious venture is too risky in a down market.  Finally, whether working for an occasional owner or a seasoned developer, always verify an owner’s ability to pay.  There are many ways to assess an owner’s ability to pay, including running credit reports and obtaining verification from financing sources, but any such efforts are always most effective when accompanied by candid conversation.

The “law” of the project

Assuming the parties collectively deem the project worth the risk, they will form an agreement to proceed.  The necessity of a written agreement cannot be understated.  A contractor anticipating a project sets aside resources and avoids otherwise interfering opportunities.  Credit may not be extended per se, but expenses climb on an hourly basis and even a termination at this early stage may result in damages to the contractor.  In the event of this “pre-project” termination, the contractor wants to recover whatever damages it has incurred.  A written agreement provides the only real path for this and helps ensure all parties are in agreement at the outset as to how damages should be determined.  As the saying goes, oral agreements are not worth the paper on which they are written.  The written agreement provides tangible proof of a plan to proceed.

Owner’s suspension/termination for convenience

Where reserved in the contract, the owner can suspend the contractor’s operations or terminate the contract entirely for any reason or for no reason at all.  Where the right to terminate for convenience is reserved, the contractor’s remedies are prescribed.  In contrast to a termination for default, termination for convenience is not the “fault” of the contractor thus the contractor should not suffer damage when the project is suspended or terminated for the owner’s convenience.  Contractors signing any owner’s “convenience” provision, therefore, should review closely to ensure the owner has not limited liability for contractor’s actual damages.  Specifically, the contractor’s actual damages would typically include (a) all labor, supervision and equipment dedicated to the project at the time of the termination, (b) all material purchased for the project even where stored off-site (or, if available, supplier re-stocking costs), (c) all subcontractor termination costs and (d) lost anticipated profit and contribution to overhead.

If the right to terminate for convenience is not reserved but the owner elects to suspend or cancel without cause, the contractor will be entitled to recover all direct and consequential damages resulting from the suspension or termination.

Owner’s termination for cause

In all contracts, whether express or implied, the owner has the right to terminate in the event of the contractor’s default.  Default is breach and where one party breaches, the other does not need to endure the breach.  Where a right to terminate for default exists, the contractor will have a right to recover the value of all work and material in-place (subject to set-off) but the contractor will not be able to recover its lost profit or contribution to overhead.

Contractor’s risk transfer

A portion of a suspended or terminated contractor’s damages will arise from its subcontractors or suppliers.  So as to not expose itself to inequitable results, contractors must be sure arrangements with subcontractors and suppliers provide for the same ability to suspend or terminate at the owner’s convenience on at least the same terms as the owner’s.

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In conclusion, a project suspension or termination can be very costly to a contractor.  A prudent contractor will endeavor first to avoid the suspension or termination by contracting only with owners it investigates and determines are likely to complete the project.  When the project proceeds, however, relationships must be defined by written contract and establish the manner of payout in the event of a termination for convenience.