6 Important Steps when Terminating a Subcontractor – Like most general contractors we place a great deal of effort searching and vetting subcontractors. Unlike many other professions, the process of finding great contractors is far from straight forward and difficult to gauge if they will be a great fit for your business and clients.
Training and mentoring are an investment we must make when hiring a subcontractor, but sometimes there comes a point where you have to decide whether to terminate a subcontractor. This is one of the most difficult and risky decisions a general contractor is faced with and should never be taken lightly.
1 – Verify Owner Approval
It’s critical to determine if a general contractor has the legal right to terminate a subcontractor. Start by reviewing your contracts to determine if the owner and/or architect has the right to object to subcontractor replacements. For example, paragraph 5.2.4 of AIA Document A201-1997 (General Conditions of the Contract for Construction) provides that “the Contractor shall not change a Subcontractor, person or entity previously selected if the Owner or Architect makes reasonable objection to such substitute.” Thus, the general contractor may have to obtain the owner’s and/or architect’s consent to change subcontractors. This consent must be obtained in writing.
2 – Confirm Ground for Termination
Another important steps when terminating a subcontractor is that subcontractors generally should only be terminated for major, recurring performance problems, and only after all avenues for getting the subcontractor to perform have been exhausted. Key in making this determination is the subcontractor agreement, where items such as failure to adequately staff the work, supply adequate and conforming materials, meet the schedule, pay laborers, subcontractors and suppliers, and comply with code and safety requirements as grounds for termination.
Regardless of the particular terms of the subcontract, the law generally permits a party to terminate a contract only when the other party has committed a very serious, or “material”, breach of the contract. A minor or technical breach of the contract will not justify termination, and termination is not appropriate where the subcontractor has substantially performed its contractual obligations.
For example, a subcontractor’s delay of a few days in meeting certain schedule milestones, under most circumstances, would not constitute a “material” breach justifying termination. The general contractor may have a claim for damages caused by the subcontractor’s brief delay (for example, if the owner assessed liquidated damages), but it probably would not be justified in terminating the subcontractor from the project.
A more difficult question — one with no easy answer — is whether a subcontractor’s failure to complete punch list items constitutes a material breach, especially where substantial completion has been achieved or a certificate of occupancy has been issued. Generally, failure to complete punch list work is not a material breach justifying termination. However, a subcontractor’s persistent failure to perform punch list work may constitute a repudiation of the contract, supporting a termination for default.
3 – Review Practical Considerations
Of course, just because the general contractor may have a legal grounds to terminate a subcontractor does not mean that such action would be prudent under the circumstances. Some of the practical considerations involved in deciding whether to terminate a subcontractor are obvious: whether a replacement subcontractor can be obtained to complete the work at a reasonable price; whether the replacement subcontractor will perform any better than the terminated subcontractor; whether the project will be delayed; whether the warranty (either from the subcontractor or a supplier) will be impaired; and whether the terminated subcontractor will file a mechanics’ lien and thereby potentially damage the relationship between the owner and the general contractor. These and other important practical issues should be carefully considered before deciding to terminate a subcontractor.
Because of the potential major consequences, a subcontractor should be terminated only as a “last resort”, after other default remedies have been considered. General contractors should first ask the subcontractor for a “cure and complete” plan, or discuss with the subcontractor other possible ways to cure the default. The general contractor should also consider other less drastic remedies short of termination, including supplementing the subcontractor’s workforce, deleting portions of the subcontractor’s work by deductive change order, and asking the surety to finance the contractor’s completion.
4 – Follow Procedure for Proper Termination
Another of the important steps when terminating a subcontractor to consider – After determining that adequate grounds exist to “legally” terminate a subcontractor and that termination is prudent from a practical perspective, the general contractor should carefully follow the notice and other procedural requirements for termination contained in the subcontract agreement. For example, paragraph 7.1.1 of AIA Document A401 (Subcontract Agreement), requires two seven-day written notice before the subcontractor can be properly terminated.
Correspondence, meeting minutes, schedules, daily construction reports, photographs, videotape and similar “contemporaneous” evidence documenting the subcontractor’s poor performance and the condition and status of the subcontractor’s work and the project as a whole at the time of the termination are critical to proving that adequate grounds existed for termination. The general contractor should also attempt to obtain letters from the owner or architect directing the general contractor to remove the
subcontractor, describing the problems that the subcontractor is causing to the project, or, at a minimum, consenting to the termination and replacement subcontractor.
5 – Mitigating Damages and Documenting Work Completion
Following termination of a subcontractor, the general contractor should take steps to “mitigate” or minimize any additional costs or damages. For example, the general contractor should make sure that the work has been protected until a replacement subcontractor is on site.
If feasible, the general contractor should also solicit bids from several qualified subcontractors before contracting for the work to make sure that a competitive price is obtained. Where possible, the work should be procured on a fixed-price rather than time-and-material basis to avoid an argument by the terminated subcontractor that the replacement contractor was, in effect, given a “blank check”. The bid solicitation process should be documented, and the scope of work should be well-defined.
Finally, the general contractor should require the replacement subcontractor to provide detailed applications for payment, broken down by line item and supported by appropriate backup documentation. If the work can be procured only on a time-and-material basis, it is especially important that the replacement subcontractor maintain detailed backup documentation, including payroll records, equipment and material invoices, and daily construction reports describing the work completed.
6 – Consider Consequences of Improper Termination
The last of the important steps when terminating a subcontractor to consider is the consequences. The conscequences of improperly terminating a subcontractor can be severe. If the general contractor improperly terminates the subcontractor, the subcontractor may have a claim against the general contractor for lost profits plus any additional damages caused by the improper termination, such as amounts owed by the subcontractor to lower tier subcontractors and suppliers. The general contractor would also lose the right to recover from the terminated subcontractor amounts paid to a replacement subcontractor hired to complete the work. In other words, a general contractor that improperly terminates a subcontractor may end up paying at least twice for the remaining work
On the other hand, if the general contractor gives proper notice of the default and can prove that it had adequate grounds to terminate the subcontractor, the general contractor’s exposure to the subcontractor generally will be limited to the total subcontract amount minus the expense of finishing the subcontractor’s work and other damages incurred by the general contractor.