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Can a Contractor be Terminated Due to Delay Caused by an Epidemic?

On Behalf of | Apr 2, 2020 | Firm News

Written by Adam Cook

If the COVID-19 Pandemic makes it impossible – or even illegal – for a contractor to maintain the necessary workforce on a project, the resulting delay in progress is almost certainly outside the contractor’s control. But can the project owner terminate the contract in this situation? The answer lies in the language of the parties’ contract. And even when the language is as clear as possible, the final answer, like so many other times in the legal world, is “it depends.”

Most contracts for construction give two possible scenarios for the owner’s unilateral termination of the contract. One is a termination “for default.” If the contractor, due to some fault of its own, cannot progress the work, the owner can terminate the contract. It is a severe measure. Following such a termination, the contractor receives no further reimbursement of any kind for work it has performed, and the owner can even demand that the contractor pay for completion of the project. However, because a contractor is generally not at fault for an unforeseen and uncontrollable problem like a pandemic and shutdown, the owner cannot terminate for default in this situation. Doing so would be a breach of contract.

Of course, every situation has its nuances. Perhaps the contractor had known about the pandemic earlier in the project, and had nevertheless promised the owner that it could finish the job on time and under budget. In that situation, the delay experienced by the contractor may not be excusable, and the owner may be able to terminate the contractor for default. We are back again at “it depends.”

The second type of termination is “for convenience.” Many contracts state that an owner can terminate a contract unilaterally and without even giving a reason why. The only requirement is that the owner give the contractor sufficient written notification of the impending termination, so that the contractor can demobilize from the project. Once demobilization is complete, the contractor sends the owner a cost bill summarizing work performed as of the date of termination and asking for reimbursement for termination-related costs such as the demobilization. As long as the cost bill is reasonable, the owner usually has to pay it. The one thing the contractor generally cannot ask for is reimbursement of profit for work that it expected to do in the future but did not get a chance to do.

Can an owner terminate a contract for its own convenience because of the COVID-19 Pandemic? The answer is yes, and that scenario is playing-out all over the country right now. It is important to remember that an owner does not have to explain why it is terminating the contract for convenience. A contractor may argue that it is helpless against the effects of the COVID-19 epidemic, but that does not weigh on the owner’s right to terminate.

But there is one last wrinkle to consider. A termination for convenience provision is an agreement creating the option to end the contract and at the same time limiting the liability of the owner. Some jurisdictions hold that an owner cannot terminate a contract just to take advantage of that limitation of liability. For example, an owner cannot terminate for convenience only because doing so would allow it to avoid paying money otherwise due to the contractor. This is called a “bad faith termination.”

The line being drawn here is extremely fine, and the Alaska Supreme Court has never clearly explained whether the line is there at all. In City of Dillingham v. CH2M Hill Northwest, Inc. the Alaska Supreme Court considered a contractor who experienced severe cost overruns due to design problems. The owner pointed to a provision of the contract limiting liability to $50,000. The Alaska Supreme Court stated that a contractual limitation of liability is not effective if the party taking advantage has acted “fraudulently or in bad faith.” See 873 P.2d 1271, 1272 (Alaska 1994).  In another case, Pierce v. Catalina Yachts, Inc., the Alaska Supreme Court suggested that the enforceability of such provisions was fact-sensitive. See 2 P.3d 618 (Alaska 2000). The answer lies in whether the parties were equally sophisticated, transacted at arms-length, and did not actively seek to harm each other.

“Bad faith termination” usually comes into play when the owner enjoys a substantial advantage in sophistication and resources over the relatively small contractor. Such an owner may use its position to make unreasonable demands of the contractor and then threaten to terminate “for convenience” if the demands are not met. In a pandemic situation, an owner may use the threat of termination simply to intimidate a contractor in the midst of a bad economic environment. In the middle of the COVID-19 Coronavirus Pandemic, no contractor wants to lose any work, if possible. But such intimidation by an owner is bad faith. If the intimidation concludes with a termination – even a termination for convenience – then the owner may still be liable for essentially using the contract as a tool to act like a bully. Like everything else in the law, the specific facts of the situation determine what is and isn’t permitted.