Contract termination tends to generate disputes – even when the termination is the exercise of an agreed entitlement to terminate for convenience, or “without cause” which is the subject of today’s discussion.

Termination for convenience is a particularly common feature in construction contracts in the Gulf region, notwithstanding there are some potential issues as to enforceability of those provisions under local laws – which we have looked at before.

For today, we’re not looking at validity of the termination itself but at the consequences; in particular, the contractor’s recovery of costs incurred (or commitment to incur future costs) at the point of termination. A common approach upon termination for convenience (or, indeed, following termination for owner default) is that the contractor is kept whole on the original bargain by entitlement to a sum in lieu of lost profit and overhead contribution from not performing the remainder of the works, together with sums reasonably incurred or committed to be incurred in expectation of completing the works. So, what would be reasonably incurred?

A recent court decision looked at this. The Water and Sewerage Authority of Trinidad and Tobago (the Authority) engaged Waterworks (Trinidad and Tobago) Ltd on two contracts based on the FIDIC First Edition 1999 Contract for Plant and Design-Build (the Yellow Book) for the construction of two water treatment plants. The contracts included termination for convenience. They did not allow for contractor recovery of lost profits but they did allow for “any other Cost or liability which in the circumstances was reasonably incurred…in the expectation of completing the Works”.

Of course, the contracts were terminated for convenience and Waterworks presented its claim for cost liabilities incurred, which included cancellation charges on equipment supply subcontracts which comprised, by value, most of the equipment required for the works. The Authority refused to pay those costs and the matter came to court – eventually to the Judicial Committee of the Privy Council which, in its judgment earlier this year, agreed with the Authority that these costs were not recoverable. Relevant factors included:

•             The subcontracts were entered into more than a year before the main contracts were terminated;

•             The subcontracts were based on preliminary designs only;

•             The subcontracts had not been materially performed by the time the main contracts were terminated; and

•             The cancellation costs were high, at 30 per cent of the total supply price.

The ruling was driven by the facts; these unusual factors making it unreasonable for the contractor to have incurred these particular charges. The court, however, noted that contractors have schedule obligations that require them to get on with their own procurement. In this case, the obligation to proceed “with due expedition and without delay” as well as to complete on time. On that basis, the court rejected the argument that a contractor working under a contract containing a provision for termination for convenience, should be more circumspect in its procurement.

Contractors’ schedule obligations are usually similar to those in this case, especially in the Gulf region, given its reliance on FIDIC forms of contract. The express FIDIC obligation to proceed “with due expedition and without delay” no doubt assisted the court because it is clearly not an obligation to “do everything at the first possible opportunity”.

Whenever entitlement is based on reasonableness, we must of course balance all the factors but the court was clear in saying that the mere presence of a provision for termination for convenience, is not a reason for contractors to do anything other than proceed “with due expedition”. They are entitled to proceed (in fact, should proceed) on the assumption that the provision will not be triggered.

So, can contractors ignore the provision unless and until it is triggered? What if an owner notifies the contractor that it is likely to be triggered? Or that there is a high, or increased, possibility? Does the assumption hold, or is the contractor then at an increased risk of not recovering breakage costs on subcontracts entered into after that notice is given?

In the usual way, the solution lies in good communications. The owner has given an incomplete message and the contractor should draw out the rest of it by stating its procurement plans and inviting an instruction if the owner wants those plans to change. This instruction might be a variation (change) order (depending on the contract definition of variation or change) or a partial suspension of works.

And it’s not just about timing. This 30 per cent cancellation charge obligation was assumed on day one; many months before any work was needed to be done. Whilst high cancellation charges are not unreasonable per se; they should be justified by whatever needs to be done further down the supply chain in (for instance) raw materials purchase, manufacturing capacity reservation, engineering etc. Unfortunately, Waterworks did not bring evidence like this to try to justify the charges.

In practice, parties generally work to avoid surprises like this. Contractor procurement of long lead items is often managed through a procurement schedule and through requirements to disclose breakage costs in main supply subcontracts.

* Dubai-based Stuart Jordan is the Global Head of Construction for Baker Botts, a leading international law firm.  He has extensive experience in the Middle East, Russia and the UK.