Defaults in Construction: Managing Discord and Divorce
By Kamy Molavi


What should you do when a company is not performing as required in a construction contract?  The consequences of this decision are significant, and it merits careful consideration.  The wrong decision can lead to the foreclosure of options and remedies otherwise available, and in the worst case, may result in significant liability.  Engineering the best answer requires, at minimum, estimating the actual and potential impacts of non-performance, assessing the feasibility and costs of alternatives, and critically, understanding your contract.

If you are a contractor, subcontractor or designer dealing with a recalcitrant “upstream” party (an owner or contractor) whose payments are slow or have stopped, you must decide whether and when to stop working.  Among other question, you must establish your “pain threshold,” i.e., how long can you perform without being paid.  You should consider whether, as a practical matter, stopping work will enhance the odds of getting paid or damage them, based on factors that include the nature and state of the project, the strength of your lien and/or bond rights, the financial stability of the upstream party, the reasons for payment problems, and your realistic assessment of your own performance.  In addition, you must read and understand your contract, especially provisions relating to payment terms, and clauses that address notices and other procedures in the event of non-payment. 

If you are either a contractor or an owner dealing with a problematic downstream party, the analysis may be even more complex because construction contracts typically provide as many as four options if a downstream party fails to perform:

  • Tolerate anemic performance by the defaulting party and merely seek to adjust its compensation (or back-charge);
  • Allow the defaulting party to do what it can while supplementing its resources with other contractors so the project’s objectives are met, all the while keeping back-charges in full view;
  • Terminate your contract with the defaulting party on grounds of its default; or
  • Terminate your contract with the defaulting party on grounds of convenience.

Each option has advantages and disadvantages.  Your rights against and obligations to the other party will be vastly different depending on the route you choose, and electing the wrong remedy can be costly.  

The last item, termination for convenience, is designed for circumstances other than default by the other party, such as events that prompt the owner to defer or cancel the project.  That said, termination for convenience may be used in marginal or uncertain default situations, but such use is proper in limited circumstances.  If the contract is terminated for convenience, the non-defaulting party will find it difficult to seek compensation for damages incurred after termination.  The non-defaulting party also will find it more difficult, albeit not impossible, to allege default by the other party as a defense against claims.

As stated above, exercising any of these options requires, at minimum, careful compliance with notice and other procedural requirements contained in the contract.   Even if notices are not expressly required, it is prudent to serve written notice to the other party that you consider it to be in default.  Finally, if the facts are murky and/or the contract is unclear, generally we advise clients to err on the side of continuing to honor and perform the contract.

For more information, contact Kamy Molavi at 770.818.1416 or [email protected] of the Construction Law Practice Group.

 



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