Conclusion of a Construction Contract
A Successfully Completed Contract,
A Gratified Owner, and a Contented Contractor
Arthur O'Leary, FAIA, MRIAI
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This is the second of three articles discussing the conclusion of a construction contract in three possible ways. Part One, in the last issue of Design Cost Data™, was based on the normal expectations of the owner and contractor: that the project would have been completed to the mutual satisfaction of the contracting parties.
This is Part Two, which considers the situation where the owner finds it necessary to eject the contractor and terminate the contract. It also covers the case where the owner finds it necessary to cancel the contract for convenience.
The third article, in the following issue of Design Cost Data, discusses the contractor's decision to discontinue the construction and terminate the contract.
The second and third options describe situations almost always fraught with controversy, recrimination, disillusionment, assertion of legal rights, attempted avoidance of responsibility, general dissatisfaction, and usually considerable legal turmoil and unexpected expense.
Each of these differing circumstances is analyzed from the viewpoint of an architect who would have designed the project, prepared the contract documents, and administered the contract. The multitude of legal implications must be left to the analysis of the construction bar.
All three contractual situations will be assumed to have been formed substantially from the standard AIA forms of agreement (Note 1).
Most owners and contractors enter into their construction agreements honorably and with optimism and high expectations. The owner is looking forward to seeing the happily anticipated project materialize and the contractor is pleased to further its business interests by embarking on a new, hopefully profitable, construction venture. The owner is extremely pleased to have found such a seemingly qualified contractor to build the project at an acceptable contract price and with an agreeable completion date. On the strength of the contract and the contractor's assurances, the owner begins making definite plans for vacating the old premises and moving into the new on the promised date. Some owners will have made significant financial commitments for receiving newly purchased materials, furniture, and equipment and newly hired personnel based on the anticipated completion date.
When the Bubble Bursts
As the contractor starts work on the site, both owner and contractor are brimming with optimism. Accordingly, it is with great disappointment and impending fear that the owner becomes increasingly aware of the contractor's apparent shortcomings. It seldom happens all at once. Conditions gradually deteriorate. It usually starts with small disappointments and minor violations of the contract. There will be days when no one is working on the job. There is always a plausible excuse. There will be lapses in workmanship and the appearance of inferior materials on the job. Construction equipment is mysteriously removed from the jobsite. The job superintendent is working sporadically, only part-time, or is replaced. When the contractor is questioned about any of these matters, there is a glib reply and a credible explanation, offering reassurance to the owner and often questioning the owner's lack of faith.
Gradually it becomes more difficult to communicate with the contractor. Telephone calls are not returned. Letters, emails, and faxes are not answered. Rumors are abroad that labor, subcontractors, and suppliers are not being paid. Invoices, statements, and demands from subcontractors and suppliers are beginning to show up in the owner's mail. The work is now starting to fall significantly behind the construction schedule.
On some projects it starts differently. The first clue of the contractor's financial slippage is seen in the monthly requisitions for payment. Most of the line items are slightly exaggerated, change orders are overpriced, and the contractor is becoming more persistent about prompt collection of the monthly payment, usually by messenger, and early, if possible. It is suggested that the retainage be reduced or released. The contractor is becoming more strident about money matters.
Increasingly, the owner grows more seriously concerned about the competence, reputability, honesty, and possibly the solvency of the contractor.
After an owner's confidence has been severely shaken by some of the illustrative symptoms, it would be extremely difficult to regain credible belief in the contractor. The owner's first reaction would be to promptly get rid of the contractor.
Regardless of the severity of the owner's upset state of mind about the contractor's real and supposed transgressions, there are specific grounds stipulated in the contract for the owner's terminating of the contract. The owner may terminate the contract only if the contractor does not diligently pursue the work, fails to pay construction bills, disregards building laws, or substantially breaches the contract. (Note 2)
It must be the owner's decision whether or not to take the momentous step of terminating the contract. It is not a decision to take lightly, as the contractor will undoubtedly resist such a move by all legally available means. Very few contractors would respond by simply leaving quietly upon receipt of the owner's termination notice. Moreover, the owner must then face the demanding task of finding and engaging a replacement contractor to finish the job. Few contractors would be enthusiastic about stepping into a situation teeming with dissatisfaction and possible legal repercussions. Fewer still would do the work on a fixed price contract or be willing to guarantee the work done by the displaced contractor.
The Architect's Approval
As a basic protection to the contractor, the AIA General Conditions does not allow the owner to make a unilateral determination of the contractor's default. The owner must obtain the architect's written certification that sufficient cause exists to justify the owner's proposed action.
The architect who executes such a certificate should make a positive independent determination that one or more of the causes specified in AIA Document A201-1997, Subparagraph 14.2.1, are in actual existence and can be proved by documentary, photographic, or other convincing evidence. In practically every case the basis of the certificate will be vigorously contested and will have to be proved to the satisfaction of an arbitrator or judge. It will be minutely dissected by the contractor's technical and legal advisors.
It will not be very impressive to arbitrators or judges if the architect's certificate is dated after the owner's termination notice to the contractor or if the certificate had not been appended to the notice.
Advance Notice of the Termination
The owner must give the contractor and the contractor's surety, if any, seven days' written notice prior to the date of termination.
Apparently the owner has the clear right to terminate if the grounds exist. However, if the contractor makes a successful effort to rehabilitate its position during the notice period, the owner could decide to set the termination aside. Economically, this is often the best solution to the problem for both parties, although the owner might have lost confidence in the contractor. The practicality of this outcome rests more heavily on the temperaments and personalities of the parties than on considerations of economics and legality.
Owner's Rights After Termination
After the contractor has been duly terminated, the owner is entitled to take over the site and all materials and equipment as well as all of the contractor's tools, construction machinery, and equipment. The owner may also accept assignment of any of the subcontracts it chooses to accept. (Note 3)
The owner may then undertake to finish the work by whatever reasonable means the owner deems expedient. This means, of course, that the owner must be very diligent not to waste funds nor incur any upgrading expense. Any project betterment costs must be strictly segregated, as they cannot be charged to the contractor. Competent record keeping is imperative, as all expenditures will undoubtedly be carefully scrutinized later by the contractor's accounting experts. All of these owner rights are subject to any prior rights of the surety, if any.
As a practical matter the owner has more to gain than lose by cooperating with the contractor's surety if there is one. The surety's interest will be to gain prompt economical completion of the contract. The surety will probably have more familiarity with the contractor's financial condition and sources of funds than the owner could possibly have. The surety will also have better rapport and communication and considerably more influence with the contractor than would the owner under the circumstances.
The surety, in furtherance of its own interests, will provide financial advice and assistance to the contractor. The surety is entitled to use its own judgment in deciding how to finish the work of the contract. It may use the same contractor, hire a new contractor and subcontractors, or continue with the existing subcontractors.
Balance of the Contract Sum
After termination and during the completion of the contract, the owner is not obligated to pay any further funds to the contractor. (Note 4)
If the cost of completion exceeds the unpaid balance of the contract sum, the excess will be charged to the contractor. In the usually unlikely event that the completion costs are less than the unpaid balance, the remaining funds are to be paid to the contractor. The architect is required to issue a certificate determining the final payment from or to the contractor. The obligation for payment pursuant to the architect's certificate survives the termination of the contract. (Note 5)
In most cases it would be extremely difficult if not impossible for the owner to finish the work for the funds remaining in the contract. Furthermore, the owner should realize that any cost overruns would be nearly impossible to collect from a bankrupt or impecunious contractor. If there is a surety bond, prospects might not be so bleak. However, both the owner's and the architect's actions will be strictly monitored by the surety in their efforts to keep the completion costs under control and limit their potential losses.
Considering the charged and contentious climate in which all these termination procedures will be taking place, the architect and owner must be exceptionally diligent in following the stipulated procedures and in their stewardship of the construction funds.
Suspension by the Owner for Convenience
Under the AIA construction agreements, the owner retains the right to stop the work of the contract at any time without stating any cause. It may be a temporary interruption or a permanent termination. This is a valuable right when it is needed and it comes with some cost. It is only fair and equitable that the contractor be paid for costs incurred. Should the owner require a temporary stoppage or termination, the contractor is entitled to be reimbursed for all extra costs actually incurred including profit on the increased costs. In the event work is resumed later, the contractor is entitled to be paid for remobilization expenses as well as for any intervening cost escalation. (Notes 6 and 7)
1. The general contract would have been formed from the following AIA standard form documents:
Standard Form of Agreement Between Owner and Contractor (where the basis of payment is a Stipulated Sum), AIA Document A101-1997,
Standard Form of Agreement Between Owner and Contractor (where the basis of payment is the Cost of the Work Plus a Fee with or without a Guaranteed Maximum Price), AIA Document A111-1997, and
General Conditions of the Contract for Construction, AIA Document A201- 1997.
The architect's services would have been contracted for by the owner using the standard AIA form:
Standard Form of Agreement Between Owner and Architect, AIA Document B141-1997.
2. AIA Document A201-1997, Subparagraph 14.2.1: The Owner may terminate the Contract if the Contractor:
1. persistently or repeatedly refuses or fails to supply enough properly skilled workers or proper materials;
2. fails to make payment to Subcontractors for materials or labor in accordance with the respective agreements between the Contractor and the Subcontractors;
3. persistently disregards laws, ordinances, or rules, regulations or orders of a public authority having jurisdiction; or
4. otherwise is guilty of substantial breach of a provision of the Contract Documents.
3. AIA Document A201-1997, Subparagraph 14.2.2.
4. AIA Document A201-1997, Subparagraph 14.2.3.
5. AIA Document A201-1997, Subparagraph 14.2.4.
6. AIA Document A201-1997, Paragraph 14.3.
7. For those interested in additional information about the closing out process based on AIA documentation, see "A Guide to Successful Construction - Effective Contract Administration," by Arthur F. O'Leary, Chapter 14, Closing Out the Job.
“A Guide to Successful Construction: Effective Contract Administration” by Arthur F. O’Leary, FAIA, MRIAI or “Construction Nightmare Jobs From Hell & How To Avoid Them” by Arthur F. O’Leary and James Acret are available from
bookworkz.com or call DCD at 800-533-5680.
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