The Dotted Line: Recession fears spur uptick in terminations for convenience

This feature is a part of “The Dotted Line” series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.

With talk of a pending recession growing louder by the day, owners have increasingly been pulling the plug on projects, attorneys say. While the uptick hasn’t been severe – yet – it has been noticeable by many.

“Right now, the termination trend is being driven by cost increases and volatility,” said Jade Davis, a construction attorney at law firm Shumaker, Loop & Kendrick.

Jade Davis

Courtesy of Shumaker, Loop & Kendrick.

 

“A lot of people thought stabilizing material costs would help with price volatility, but supply chain issues have continued,” Davis said. 

Higher interest rates, as the Federal Reserve has waged war against historically high inflation, have compounded the issue.

“The quick increase in interest rates has resulted in several owners putting their projects on hold,” said David González, general counsel at South Florida-based contractor ANF Group. While he says he hasn’t experienced stoppages among his firm’s clients, he has seen it happening elsewhere.

When owners pull the plug on projects, they typically do so via a termination for convenience clause, which is built into most construction contract templates, including those available from the American Institute of Architects. Termination for convenience clauses are overarching language that typically let owners, and in some cases contractors, walk for any reason they see fit.

Josh Spitalnik is an attorney at Spitalnik & Spitalnik.

Josh Spitalnik

Courtesy of Spitalnik & Spitalnik

 

“The case law provides that under termination for convenience, the contract can be terminated for any reason, or no reason at all,” said attorney Josh Spitalnik, owner of the Spitalnik & Spitalnik law firm in Roslyn, New York.

Shoring up projects

Attorneys say contractors should carefully navigate their contracts and take steps to prepare for unilateral terminations, should they become more prevalent.

Carol Sigmond, partner at Greenspoon Marder.

Carol Sigmond

Permission granted by Courtesy of Greenspoon Marder

 

“I suspect that as the labor shortages continue, construction material prices increase and bank lending tightens, more jobs will be stopped mid-stream,” said Carol Sigmond, a partner at New York City-based Greenspoon Marder. “Contractors should take the long view have a strategy in place to work with owners to shut the jobs down in a safe and lawful manner, while also trying to obtain fair compensation for work performed.”

Doing so starts with knowing what’s in your contract. For example, while most contract templates include termination for convenience clauses, they also give contractors the ability to recoup “lost profits,” the gains the contractor would have had if it worked the job to completion.

But owners’ attorneys will often try to strike those terms upfront.

“As the attorney for a GC or sub, I always try to make sure they get lost profits on uncompleted work,” Spitalnik said. But, “it’s often difficult, especially when there’s an experienced construction attorney on the other side.”

What contractors can reasonably expect to recover, however, are costs that have already been incurred, as well as “demobilization” expenses they take on to stop work in midstream.

“You should have provisions that you’re paid for work performed, reasonable costs to demobilize and the cost of material and equipment already purchased for the job,” Spitalik said.

Who’s left holding the bag?

In the current supply chain environment, however, where many contractors have been ordering materials months in advance to ensure they have supplies when needed, that can introduce additional risk.

“Downstream contracts can be greatly impacted because many contractors and subs buy out the materials and cannot return them,” said Brad Shefrin, a partner in the Denver office of Hall Booth Smith.

For that reason, contractors should make sure they stay on top of invoicing and getting change orders approved before work gets done.

“The way to best protect yourself is to ensure the owner is up to date with all payments and consistently process change orders,” Spitalik said. “You do not want to be in a situation where you have done extra work, then the contract is terminated for convenience, and no one wants to pay.”

The cost to owners

As a GC, it’s also a good idea to put some language regarding termination fees into your contract, to make terminating for convenience less palatable for owners.
 
“For owners, a termination for convenience almost always comes during difficult financial times,” said Cleveland, Ohio-based Tucker Ellis partner Seth Wamelink. “Owners often underestimate what their termination for convenience costs will be.”
 
One way to make it less of an attractive option for owners who are already stressed about making their project pencil out is to ensure there are termination fees in a contract, as well as the lost profits component for contractors.
 
“That may disincentivize the owners from terminating in the first place,” said David Fine, a partner at Worcester, Massachusetts-based law firm Mirick O’Connell.

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