December 04, 2006

A termination for default, if challenged by the contractor, will usually be analyzed under a “material breach” of contract standard. In the Virginia case of Lee vs. Garrett Homes of Va., the circuit court stated that termination of a construction contract must be based on a material breach of the contract, defined as “the failure to do something that is so important or of such a substantial character as to defeat the purpose or object of the contract.”

A Virginia federal court described the difference between a par tial breach, where termination of a contract is not permitted, and a material breach, where termination may be proper, as follows:

When a party does not fully complete its contract, the non breaching party’s remedies turn on whether that failure to perform constitutes a material or a minor breach. A minor breach may allow the aggrieved party to recover damages or a set-off against the breaching party, but it does not excuse that aggrieved party from performing. A material breach, on the other hand, entirely discharges the aggrieved party’s obligation to perform.

In the case of Lubeshkoff vs. Weidner, the court characterized termination for default as a “drastic self-help remedy.” In Lubeshkoff, the court found that the owners on a residential construction project had improperly terminated their agreement with the contractor because the contractor’s deficiencies in performance were inconsequential and thus did not constitute a material breach.

The court noted that “ [i] t is well settled that if one party meets and performs in good faith the conditions of the contract in all material respects, although there may be deviations in trifling or inconsequential particulars, then that party has substantially performed and the other party is not justified in repudiating the contract.”

In evaluating the materiality of a breach, courts typically consider several factors, including:

• The extent to which a party’s breach deprived the injured party of the benefit it reasonably expected,

• The extent of the contract that the breaching party did perform,

• The likelihood that the breaching party will cure its failure to perform, including any reasonable assurances of performance it did or did not give, and

• The extent to which the behavior of the party failing to perform comported with standards of good faith and fair dealing.

Another rule applied in Virginia is that the party seeking to terminate must not have itself committed a prior breach that rises to the level of a material breach. The Virginia courts have made clear that the first party to materially breach a contract is not entitled to enforce the provisions of the contract or assert claims under the contract.

For example, in a case involving the construction of a dormitory at the University of Virginia, the general contractor entered into a subcontract with Shen Valley Masonr y. Shen Valley failed to provide enough workers, contrary to the terms of the contract. However, all five of the general contractor’s payments to Shen Valley Masonry were late, and the final three payments were never made at all. Ultimately, the general contractor hired additional masons (paying them more than it had been paying Shen Valley) and terminated the subcontract.

The court found that the failure to make progress payments is a material breach, and because payment was due to Shen Valley before the understaffing problem arose, the general contractor had committed the first material breach. As a result, the general contractor could not enforce the contract and its termination of Shen Valley was wrongful. This case thus stands for the proposition that nonpayment of the contractor in a timely fashion will almost certainly constitute a material breach.

A termination may also be found to be wrongful if contract provisions covering termination procedures are not followed. For example, many contracts require that a notice of default and opportunity to correct defective work must be given to the nonperforming party before the contract can be terminated. Failure to provide the proper notice and an opportunity to cure may thus result in the termination being later found by a court to have been wrongful.

It should be further noted that even if a contractor’s work is so defective as to constitute a material breach, the owner’s right to terminate may be lost if the owner does not act promptly. If the owner continues to pay the contractor or otherwise acts as though the contract is still in effect, it may be held that the owner has made a binding election to continue the contract and can no longer rely on the prior material breach of the contractor as an excuse to later terminate the contractor for some subsequent, nonmaterial breach.

What are the consequences if it is determined that the contractor was wrongfully terminated? When a contractor is wrongfully terminated, the party wrongfully terminating can no longer enforce the contract, including its payment provisions.

As a result, the contractor’s monetary damages are no longer limited to amounts unpaid under the contract. Rather, the terminated contractor is permitted to recover the actual value of its work, generally measured by the amount the owner would have to pay a similarly situated contractor performing the same work under the same conditions as encountered on the project.

Thus, in a recent case arising in Fairfax County, the court stated that the measure of damages for wrongful termination “is the amount of unpaid work and labor done, money expended and materials furnished as of the date of termination, plus any loss of profits on the work remaining to be done to the extent that the evidence affords sufficient basis for estimating that amount of money with reasonable certainty.”

If the cost of the work performed and lost profits exceed the unpaid balance on the contract at the time of termination, the terminated contractor may thus recover more than if it had been required to complete the contract.

Overall, the issue of whether or not to terminate a construction contract is one which must be taken with the utmost care and concern for not only the present circumstances, but also the future of the project. Failure to adequately consider the contractual requirements regarding termination and the rights of the parties following a termination if it is found to be wrongful, may very well leave the owner in a position more vulnerable to the contractor’s attack than before the owner terminated that contractor.

In short, beyond the owner assuring itself as a factual matter that it is actually supported in its determination of default and its decision to terminate the defaulted contractor, the owner should carefully consider the contractual provisions regarding termination and follow those provisions closely. Then, following the act of termination, it should assemble its damages and costs of completion consistent with those contractual requirements. (Miles Dumville is a partner specializing in construction litigation in Reed Smith’s Richmond off ice and Ed Gentilcore is a partner specializing in construction litigation in Reed Smith’s Pittsburgh office. For more information, Dumville can be reached at [804]-344-3430 or [email protected]. Gentilcore can be reached at [412]-288-4274 or [email protected].) VAB

This article has been reprinted from the Virginia Builder magazine.