Departments — September/October 2006

Navigating the Minefield: The Legalities of Terminating Subs

Contractors should use every reasonable means to avoid a termination, but communication, documentation and legal advice help avoid trouble later on

Salvatore N. Fornaciari, Esq. ATTORNEY AT LAW Salvatore N. Fornaciari of Fornaciari & Associates LLC, Southington, Conn., handles business and construction disputes, from investigations to appeals, as well as mediation and arbitration. Website: www.snflaw.com

One of the most difficult decisions a general contractor faces is whether to terminate a subcontractor. In a typical scenario, the sub is falling significantly behind schedule on critical path work. The GC may then be facing substantial costs in liquidated damages for late completion if the sub continues. On the other hand, if the GC terminates the sub, high costs are almost unavoidable: Litigation frequently follows the termination, and completion subcontractors-like attorneys-will not be cheap.

When faced with this lose-lose situation, the GC should first consider alternatives to termination. If termination is unavoidable, however, the GC must know how to navigate through the legal minefield.

Alternatives to Termination

The GC should use all reasonable means to avoid termination, keeping in mind how a judge, jury or arbitrator might later view these actions. A first step is for the GC and the sub to communicate effectively with each other.

Typically, real communication between them breaks down and a letter-writing campaign ensues. The lack of communication is a breeding ground for disputes. The parties should have a face-to-face discussion to identify the problem. For example, perhaps the sub lacks administrative personnel to handle the notorious paperwork on public projects or maybe it has major equipment problems.

Once the problem is identified, the GC should consider the following options to assist the sub:

• Helping with administrative burdens.
• Reducing the scope of work.
• Supplementing work force or equipment.

Contract Terms

As with anything else in life, it pays to be proactive. The general contractor should be certain it has the proper contract rights, including the right to complete the work and withhold payments due to the sub pending completion. If the amount to finish the work exceeds payments due the sub for its completed work, the terms should state that the sub is liable for the difference.

Another important subject is the general contractor's ability to be paid for all attorneys' fees and costs relating to the termination. Also, the general contractor should have the option to mediate and/or arbitrate any dispute.
Furthermore, the GC should ensure that any "Application for Payment" forms submitted to the owner after the sub's termination are consistent with its contract rights. For example, the American Institute of Architects application form states, in relevant part, that "all amounts have been paid by the Contractor for Work for which previous Certificate for Payment were issued and payments received from the Owner...."

Documentation

All projects should be well documented to ensure there is proper evidence for any potential litigation. Most important, the general contractor should always document the condition of the project as it progresses and not wait until termination is imminent. A series of pictures showing the progress, or the lack of progress, can be a powerful tool.

Before termination, the GC should take the following actions:

• Write detailed notes about any conversations with the sub.
• Write detailed letters or notes concerning any opportunities to cure.
• Attach to those letters any information that might be relevant, such as sketches indicating a reduced scope of work.
• Always follow the notice provisions in strict compliance with the contract.

Mitigation of Damages

In addition to demonstrating that termination was proper, the general contractor must also show its resulting damages in any litigation. Damages, however, are limited under the contract principle of mitigation of damages. This means that nonbreaching parties cannot simply sit idly by while damages accumulate. Instead, they must take all reasonable steps to minimize damages.

Although that principle sounds simple in theory, mitigation of damages is often a contentious point in termination cases. The problem is that the cost to complete the remaining work is typically extremely high when compared to the amount of work remaining under the original contract. For example, the general contractor may have terminated the steel sub when 50% of the work was completed on its $500,000 subcontract. Yet the cheapest completion sub costs $400,000, instead of $250,000.

Construction industry leaders understand that completion subs are very costly because of the risks of completing someone else's work, the limited availability of subs and the general contractor's diminished bargaining power. Nevertheless, a lay jury or a judge may have difficulty understanding the reasons for the high cost of completion.

The contractor should take the following steps to avoid that danger:

• Take detailed notes about all efforts used to obtain completion subs.
• Obtain written estimates from available completion subs..
• Take detailed notes about any efforts to negotiate with all of the available completion subs.