Contractors, whether prime contractors or subcontractors, terminated for default (also known as termination for cause) want to convert that termination for default into a termination for convenience. The termination for default ultimately means the contractor materially breached the contract and would be liable for any cost overrun associated with completing their contractual scope of work. On the other hand, if the termination for default is converted into a termination for convenience, the contractor would be entitled to get paid for the work performed through the termination along with reasonable profit on the work performed and, depending on the contract, reasonable anticipatory profit on the work NOT performed. A huge difference and the fundamental reason contractors terminated for default should aim to convert that termination for default into a termination for convenience!
Under the Federal Acquisition Regulations, contractors terminated for convenience may recover reasonable profit on work performed, but NOT profit for work not performed. (See F.A.R. s. 52.249-2 and 49.202)
But, under the standard AIA A201 General Conditions, if an owner terminates a general contractor for convenience, “the Contractor shall be entitled to receive payment for Work executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on the Work not executed.” (See AIA A201, para. 14.4.3)
Yet, under the ConsensusDocs 200, “If the Owner terminates this Agreement for Convenience, the Constructor shall be paid: (a) for the Work performed to date including Overhead and profit; and (b) for all demobilization costs and costs incurred as a result of the termination but not including Overhead or profit on Work not performed.” (See Consensus Docs, 200, para. 11.4.2)
As reflected above, a contractual provision will dictate the costs recoverable when there is a termination for convenience. The AIA A201 General Conditions is favorable to a contractor by providing for reasonable overhead and profit on the work not executed. Whether reasonable profit on work not performed is recoverable, the objective should always be converting that termination for default into one for convenience so that at least the contractor can recover for work performed and profit on the work performed along with other associated termination costs that the contract may provide.
When a party is terminated for default, the key issues that will arise will typically be: (a) whether the termination for default was proper, i.e., whether the terminating party procedurally complied with the termination for default provision in the contract, (b) whether the cause or default was material and rose to the level of constituting a default termination, and (c) converting the termination for default into a termination for convenience and the recoverable costs pursuant to the termination for convenience provision in the contract. Again, a termination for default will likely mean that the terminated party owes the terminating party money associated with the overrun for completing their scope of work. A termination for convenience, on the other hand, will likely mean that the terminated party is owed money for work it performed irrespective of any overrun experienced by the terminating party.
A recent ruling in U.S.A. f/u/b/o Ragghianti Foundations III, LLC v. Peter R. Brown Construction, Inc., 2014 WL 4791999 (M.D.Fla. 2014), illustrates a dispute between a prime contractor and a subcontractor on a federal project after the prime contractor default terminated the subcontractor. The prime contractor hired a subcontractor to construct the foundation, slab on grade, and site concrete. As the subcontractor was pouring the slab on grade concrete, it was determined that there were deficiencies in the concrete. The prime contractor sent the subcontractor notice under the subcontract regarding the deficiencies and that the subcontractor needed to provide an action plan prior to future concrete placement. Although the subcontractor responded with a plan including when it was going to demolish the defective portion of the slab, it failed to live up to its own recovery schedule. Accordingly, the prime contractor terminated the subcontractor for default and incurred costs well in excess of the subcontractor’s original subcontract amount to complete the subcontractor’s scope of work. The subcontractor filed suit against the prime contractor and its Miller Act surety and the prime contractor counter-claimed against the subcontractor.
There were numerous interesting issues raised in this case. This article will only touch upon a couple of the legal issues. The first issue was whether the prime contractor properly terminated the subcontractor for default pursuant to the subcontract; if not, the termination should be deemed a termination for convenience. The Court found that the termination was procedurally proper, but declined to determine whether the termination was wrongful, perhaps because the Court determined that once the termination for default was properly implemented pursuant to the subcontract there was no reason to delve into any further analysis. In other words, once the prime contractor procedurally, properly terminated the subcontractor for default pursuant to the subcontract, it appeared irrelevant whether the cause forming the basis of the default was material. This implication is certainly beneficial for the prime contractor and it is uncertain why the Court did not entertain the argument as to whether the procedurally proper termination was wrongful. This determination would seem important because if the termination was wrongful, the terminating contractor would be responsible for its own cost overrun in addition to the costs incurred by the terminated subcontractor. Although, in this case, by the Court finding that the termination for default was procedurally proper, the Court seemed to recognize that there was cause supporting the implementation of the termination for default; otherwise, the termination for default would not have been procedurally proper.
The next issue discussed in this case pertained to recoverable delay-type damages under the Miller Act. The Court expressed:
A Miller Act plaintiff is entitled to recover under the bond the out-of-pocket labor and expenses attributable to delays.
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[A] damage claim against a surety that does not flow directly and immediately from actual performance [of its agreement] is barred by the Miller Act….A subcontractor cannot recover on a Miller Act payment bond for the cost of labor and materials provided after the termination of work under a government construction project, and cannot recover profits on out-of-pocket expenditures attributable to delay.
Ragghianti Foundations, supra, at *18, 19 (internal quotations and citations omitted).
What does this mean? This means that a subcontractor is not entitled to recover against a Miller Act surety: (a) anticipated lost profits on work not performed, (b) delay-related costs that do not flow directly and immediately from actual performance under the subcontract, (c) profit on delay-related costs, and (d) costs incurred after the termination of the work. These are all categories of damages that are applicable to a terminated subcontractor that it will NOT be able to recover against a Miller Act surety. This is important because if a subcontractor is looking to capitalize on its damages for converting a termination for default into one of convenience, it may want to sue the terminating contractor so that it is not leaving any damages on the table by only suing the Miller Act surety.
Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.