‘What do we pay a contractor we’ve sacked?’

This month’s contract clinic question is from a client which has booted an underperforming contractor off a project – and wants to know what it should pay them. Aqeel Haque replies.

The question

We’re a developer of old factories in north Manchester and we’re keen to ensure everyone performs to their best. The contractor we had working for us to redevelop one building was, in our view, underperforming. We therefore kicked them off the project for non-performance. How do we now establish the sums due to the contractor?

The answer

In the intricate world of construction contracts, the termination of a contract is a pivotal yet complex manoeuvre. It’s often viewed as a last resort. The decision to terminate, while necessary under certain circumstances, brings a multitude of legal, financial and practical implications.

Termination of a construction contract arises typically under dire circumstances. These include non-performance, insolvency or breach of a critical contract term. Termination is designed to protect against prolonged disputes and financial losses. However, it requires careful navigation to avoid complications.

Calculating sums due to the contractor

Most standard construction contracts include provisions for terminating a contractor due to default or insolvency. Following termination, the contract administrator must calculate sums due to the contractor.

The process of calculating the amount due can vary across different contract forms. This article will examine differences across the JCT, FIDIC and NEC contracts.

Under the JCT Standard Building Contract 2016, the cost payable to a contractor post termination is determined after practical completion. Within three months, the architect/contract administrator compiles a final account statement.

This includes:

  • the sum that would have been due for the works as per the contract terms;
  • the expense incurred because of employing others to complete the works; and
  • the expenses borne by the employer for any direct loss and/or damage for which the contractor is responsible.

Similarly, under FIDIC, the engineer/contract administrator must conduct a valuation post termination. This is set out in sub-clause 15.3.

The purpose of the valuation is to decide the sums owed to the contractor and define the extent of the remaining works. The employer is entitled to withhold payments until all costs, losses and/or damages related to the completion of the works are determined.

The employer can set off from monies owed to the contractor:

  • the additional cost of completing the works;
  • any losses and damages suffered by the employer in completing the works; and
  • delay damages.

NEC contract

The NEC form of contracts takes a more prospective approach. In some instances, this requires the project manager to forecast the cost impact of termination. Under clause 53.1, the project manager assesses the final amount due and certifies a final payment. If payment is due, this happens no later than 13 weeks after the project manager issues a termination certificate.

The project manager in his assessment takes into consideration:

  • the amounts due to the contractor at termination;
  • a deduction of the forecast cost of removing equipment;
  • a deduction of the forecast additional cost to the client of completing the whole of the works; and 
  • a fee percentage applied to the work done to date.

This prospective approach benefits the contractor by not delaying payment until finalisation of costs or the end of the project. However, it introduces inherent risks for both parties. Reliance on forecast and estimations adds unpredictability and subjectivity to the termination cost calculations. It also increases the risk of disputes.

Practical advice

Regardless of whether the contract explicitly requires the parties to agree on the valuation of the works completed, try to reach an agreement swiftly. This approach provides clarity on remaining work and decreases the chances of a dispute.

The quantification of costs should come from evidence. It’s important for both parties to keep adequate and accurate records. Particularly where the employer is making deductions for additional expenses and losses, calculations should be robustly prepared.

When the contract is being drafted, careful consideration should be given to termination. This includes establishing a clear procedure for handling termination and considering key contractual elements. These elements might include:

  • rights to ownership of materials;
  • provisions for stepping in with key suppliers and subcontractors;
  • the option for direct payment to subcontractors; and
  • requirements for evidence of payments made to subcontractors.

It may not be feasible to anticipate termination, but a contingency plan is wise. Consideration should be given to insurance policies, bonds, collateral warranties and project bank accounts to hedge against the impact. The latter are particularly useful where termination arises due to contractor insolvency. 

Finally, despite the importance of prompt action, it is crucial not to act prematurely. Given the complexities and consequences of termination, it is vital to seek appropriate legal advice before proceeding with any contract termination.

Aqeel Haque is a senior consultant with Decipher – a DeSimone Company.

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