3 Ways a Construction Contract Can Be Terminated

By US Legal Forms Team
7 min read
Table of contents

Contracts are agreements between parties that allow them to collaborate together and are legally-binding documents. At times, one party or multiple parties involved in the contract will need to terminate it. 

This needs to be carefully done and usually with the help of an attorney to avoid any penalties associated with exiting a contract.

In this article, we will explore construction contracts, common reasons for terminating a construction contract, and proper ways to exit a construction contract.

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What is a Construction Contract?

A construction contract is a legally binding agreement between a contractor who will be providing work and an owner who is requesting the work. Typically, construction contracts are highly-detailed documents that include specifics about a project – how much time it is expected to take, cost and payment terms, what work is expected to be completed, and how disputes should be handled. 

When it comes to the construction industry, things can get a little complicated and confusing because there are so many moving parts to be aware of. Depending on the type of construction project, the delivery, schedule, budget, and other parties involved, there are different construction contracts that may be used.

Having an understanding of which contract should be used will set up the involved parties for success and will make the termination process a bit smoother should that need arise.

Here are 8 common types of construction contracts:

1. Cost-Plus Contract: This is a type of agreement where contractors are paid for all of their construction-related expenses, including materials, overhead costs, and profit. Contractors like this type of agreement because they assume little financial risk. On the other hand, owners may need to be cautious about cost-plus contracts because they can get pricey, they require saving and tracking receipts, and they sometimes limit owners to how much they can spend on certain aspects of the project.

2. Design-Build Contract: This agreement addresses design and construction costs at the same time (versus a project waiting to start until all designs have been finalized). With a design-build contract, an owner will save time since the process is streamlined into one contract and work can start while designs are still being created, but the final cost of the project may be higher than originally anticipated since costs will be estimated based on an unfinished proposal.

3. Guaranteed Maximum Price Contract: Owners like this type of agreement because it puts a cap on how much a contractor will be paid, which makes it easier to budget for the overall cost of the project. Entering into this type of contract can be a lengthy process, since details must be carefully scrutinized by both parties before the contract can be signed. Although it’s low risk for the owner, a guaranteed maximum price contract could result in a loss of profits for the contractor, as materials and labor might exceed the estimated amount.

4. Incentive Construction Contracts: As the name suggests, this type of contract provides a contractor with an agreed-upon payment if the project is delivered by a specific date. This gives the contractor an incentive to stay on schedule, which owners like and which often leads to a more communicative and collaborative relationship. However, the terms of this type of contract must be carefully considered and negotiated, as there is often plenty of room for disputes.

5. Integrated Project Delivery Contract: This is a multi-party agreement between the designers, the contractor, and the owner (and sometimes more parties, if needed). The IPD uses a shared-risk model, guaranteed costs, and assumptions of liability across the board. It spreads risk and rewards and is ideal for people who love to collaborate, and it fosters a sense of accountability and relies on all parties remaining committed to the terms of the agreement.

6. Lump-Sum Contract: Consider this a sort of prefabrication model when it comes to construction contracts. Typically used for straightforward projects that are easy to plan, a lump-sum contract is where a contractor agrees to deliver a project for a preset price. Usually, owners are less involved in this type of working relationship and contractors have more flexibility around choosing materials. This would not be a good option for a complicated project that requires a lot of details.

7. Time and Materials Contract: Another simple and straightforward construction agreement, a T&M Contract is where an owner pays an agreed upon price based on time spent, required materials, and profit rate. This helps owners budget appropriately and helps mitigate the risk of fluctuating prices for contractors.

8. Unit Price Contract: In this type of agreement, the owner will pay the contractor per unit used, which may be defined as labor, materials, supplies, overhead, and/or profit. This is a beneficial agreement for projects that have repetitive aspects to them, but won’t usually work for a project that uses a bunch of different materials or complicated tasks.

Why a construction contract may be terminated 

At times, certain circumstances make it necessary to back out of a construction contract. Many people may not know how to end a contract, or may wonder if canceling a contract before work starts is possible, or if terminating an independent contractor without notice would result in penalties. 

Because there are often consequences associated with contractual termination, careful consideration should be given to the decision to terminate. There are many reasons why an owner or contractor may terminate the contract, and some of those reasons include:

  • Breach of contract: This is one of the most common reasons most construction contracts end. If one party fails to fulfill their contractual obligations, the other party usually has a right to terminate without consequences. A breach of contract may be referred to as a material breach or repudiatory breach. A breach can occur when a project goes past deadline, when poor quality materials are used, when an owner does not pay a contractor, when a court orders a work stoppage, when the project fails to meet the proposed specifications, when the contractor fails to pay their subcontractors, and so on. When there’s a breach of contract, there may still be notice requirements expected from the terminating party.
  • Non-performance: Similar to a breach of contract,  non-performance refers to a contractor consistently failing to meet project deadlines or quality standards. In such a case, the owner may give the contractor a specified period of time to cure the default, or may seek a replacement contractor to finish the job. The owner may need to review the agreement to see if the project has performance bond coverage, which may influence the dispute resolution process. If repudiation occurs, courts may recognize that as a violation of contract law.
  • Insolvency: In certain circumstances, the contractor may become financially insolvent or bankrupt during the project. Depending on the provisions outlined in the agreement, and if the parties agree, the contract may terminate automatically. The owner may seek liquidated damages, which may be enforceable by law in accordance with the clauses of the contract.
  • Safety concerns: If the construction site becomes unsafe or if there are significant safety violations, an owner, contractor, or subcontractor may claim a breach of contract and may seek remedies in accordance with the law. 
  • Force majeure: Force majeure refers to unforeseen circumstances that make it impossible to continue a project. This could include natural disasters, government actions or “acts of god”. Force majeure is typically a provision in a contract that frees both parties from obligation if an unforeseeable event occurs and prevents one or both parties from performing  the responsibilities laid out in the agreement. Contract law says that force majeure must be something that is out of the parties’ control versus an economic hardship or unexpected difficulty. In other words, a flood, storm, fire, or war would be recognized as a force majeure event, but working during a recession would not. 
  • Owner’s convenience: A termination for convenience clause in a contract states that if the owner decides to cancel the project for reasons unrelated to contractor performance, the contract may be terminated. There does not need to be a breach of contract for this to happen. However, advanced notice is typically required. In the construction industry, sometimes a termination for convenience provision is between contractor and  subcontractors and will allow the contractor to replace subcontractors with cheaper labor, even if a subcontractor works regularly.
  • Quality issues: An owner may seek remedies or the termination of a contract if the contractor does not perform as expected or if the work does not meet the agreed-upon quality standards or specifications. This would be considered a failure to meet the project specifications and would give the owner the right to termination.
  • Mutual agreement: Sometimes both parties agree to terminate the contract due to changes in project scope, unforeseen circumstances, bad faith, or other reasons, and the termination can go into immediate effect.  
  • Legal reasons: A contract may end if there are legal issues or disputes that cannot otherwise be resolved through negotiation or mediation. 
  • Failure to obtain permits or approvals: A contractor failing to obtain required permits or approvals that are needed to proceed with a project gives an owner the right to terminate the contract and claim damages. 

Breaches of contract can get complicated or messy because the innocent party may end up suing the other party for failure to perform or meet obligations. Common law when it comes to contracts states that both parties need to act in accordance with the clauses laid out in their contract, and when that does not happen, lawsuits can become timely and costly.

How to terminate construction contracts

Anyone who wants to terminate a contract should not solely rely on their knowledge of common law and should seek guidance from legal counsel. Whether the terminating party is the contractor or the owner, they must do their due diligence and take careful consideration prior to proceeding with a termination.

Here are the steps to take to terminate a contract:

1. Review contract and grounds: A contract must be carefully reviewed and all termination clauses and provisions must be checked to make sure there is valid reason to terminate and so wrongful termination does not occur.

2. Notify the other party: One party must provide the other party with written notice of clear intention to terminate which details reasons for termination.

3. Consult legal counsel: As previously mentioned, it is always recommended to seek legal advice for compliance with common law and to follow procedural requirements.

4. Assess financial implications: Determine termination fees and outstanding payments and provide payment when needed.

5. Secure site and assets: The construction site must be protected and secured and the project assets must be protected as well.

6. Finalize settlement: Negotiate and settle any financial matters.

7. Execute termination agreement: Yes, you need a contract to end your contract. At this point, you should formalize the termination terms and conditions in writing.

8. Close out contract: Officially put an end to the original contract, complete any administrative tasks, and update your records. 

How US Legal Forms can help you with construction contracts

US Legal Forms is an online library of more than 85,000 state-specific legal documents. USLF can help you kick off your construction project by providing ready-to-use construction contract templates
Start with a basic construction contract or get more specific. You can search by the state you’re operating in or the type of contractor you are or are hiring.

Whichever route you choose, USLF provides access to legal resources, support documents, completion services, and even notary services to help you plan and execute your contracts from start to finish. 

Visit US Legal Forms to check out our construction contract templates today

The information contained in this article is provided for informational purposes only. It should not be construed as any financial, legal, accounting, or tax advice on any subject matter and should not be relied upon for those purposes. You should not act or refrain from acting on the basis of any content included in this article without seeking legal or other professional advice. The contents of this article contain general information and may not reflect current legal developments or address your situation. We disclaim all liability for actions you take or fail to take based on any content on this article. The operation of this website does not create an attorney-client relationship between you and airSlate Legal Forms, Inc. or airSlate, Inc.

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