The requirements for the termination of a construction contract

The termination of a construction contract by an employer can have very serious financial repercussions for the contractor. This is why, in most construction contracts, the employer must first give the contractor “one last chance”, by issuing a default notice requiring the contractor to put things right within a specified amount of time.

It is important that the termination provisions do not leave any room for doubt, because if the employer gets it wrong (e.g. by not issuing a default notice before terminating), it may find itself in breach of the contract itself, and potentially responsible for losses that the contractor sustains as a result (e.g. loss of profits on the remainder of the contract).

This was highlighted in the recent case of Interserve Construction Ltd v Hitachi Zosen Inova AG [2017] (TCC). Here, a construction contract between Hitachi (the employer) and Interserve (the contractor), provided a right for Hitachi to terminate the contract if Interserve failed to “proceed regularly and diligently with the Works”. This right was “subject to” the next clause (43.1A), which provided that Hitachi “may (at its absolute discretion) notify the Contractor of the default and if the Contractor fails to commence and diligently pursue the rectification of the default within a period of seven (7) Days after receipt of notification” Hitachi could terminate the contract.

Hitachi wished to terminate Interserve’s employment on the grounds that Interserve had failed to proceed regularly and diligently with the works. However, it believed that clause 43.1A meant that it did not have to issue a default notice before terminating the contact, but could do so “at its absolute discretion”. It therefore decided not to issue the default notice before issuing the notice of termination.

Interserve, of course, objected. It said that Hitachi’s right to issue a notice to terminate on the grounds of failure to proceed regularly and diligently with the works was subject to Hitachi first of all issuing a default notice and allowing Interserve to rectify the default. As to Hitachi’s right to exercise “absolute discretion”, this applied to Hitachi’s decision as to whether to terminate the contract, and not to the requirement to issue a default notice.

On first reading these termination provisions, most people would probably agree with Hitachi. It does appear to give Hitachi an “absolute discretion” as to whether to issue a default notice before issuing a notice to terminate.

The Technology & Construction Court, however, agreed with Interserve. The phrase “subject to” was critical. The construction contract had been carefully drafted by skilled and experienced lawyers, and so there must have been some purpose to the phrase “subject to”. That purpose was to make Hitachi’s right to issue a notice to terminate conditional on issuing a default notice before the notice to terminate. If Hitachi’s interpretation was correct, the phrase “subject to” was effectively redundant, and that could not have been the intention in such a carefully-worded document.

In terms of what Hitachi’s “absolute discretion” related to, the TCC said that this applied to Hitachi’s decision as to whether to terminate the contract, and not as to whether it would issue a default notice.

Conclusion

It looks like it is more important than ever to make sure that the contractual mechanism for terminating the contract (including the issuing of a default notice) is strictly adhered to. Where there is some ambiguity in the contract as to whether such a default notice has to be served, err on the side of caution and issue one in any event.