Contract termination for material breach

LAW
Debbie Cazan and John I. Spangler III
Most construction projects do not end up in contention and acrimony, but when they do, the design professional is often asked to opine on whether the contractor should be terminated. This occurs as part of the design professional’s role as the ‘initial decision-maker,’ or as counselor and advisor to the owner.

The design professional and the owner should exercise caution before heading down the road to termination—the most draconian of remedies. A declaration of default and termination inevitably delays project completion, adds costs, and all but guarantees the filing of lawsuits or demands for arbitration.

It is essential to understand that not every contractual breach authorizes or entitles the non-breaching party to terminate the contract. Only a total or material breach justifies the remedy of termination.

What is a total or material breach?
The courts characterize a total or material breach as a substantial failure to perform, or a breach so substantial as to defeat the contract’s purpose or object.¹ A material breach goes to the root² or essence³ of the contract; a breach of such significance or materiality as to preclude adequate compensation in money damages.⁴ A material breach is a failure to do something so fundamental to the contract so as to defeat its essential purpose.⁵

The American Institute of Architects (AIA) contract forms use the term “substantial breach” without defining the term “substantial.”⁶ Courts have noted the absence of a definition makes the term ambiguous, and several courts have interpreted substantial to be the equivalent of material.⁷

Future performance and the adequacy of money damages for breach
The standard of materiality is necessarily imprecise and flexible. It is to be applied in light of the facts of each case, and in such a way as to further the purpose of securing for each party its expectation of performance. If the termination is challenged in court or in arbitration, a finder of fact will decide after the fact whether the breach was sufficiently material so as to justify termination.⁸

One significant factor is the likelihood the non-breaching party would have obtained substantial performance of the contract from the breaching party. An unexcused breach is material only when it reasonably compels a clear inference of unwillingness or inability by one party to substantially meet the contractual future performance expectations of the other party.⁹

Another significant factor is the adequacy of money damages as compensation for the breach. Any breach entitles the non-breaching party to recover damages, but a material or total breach is so significant even the recovery of money damages will fail to provide the non-breaching party the equivalent of full performance. In other words, if money damages can provide an equivalent to full performance, then the breach is not material and does not warrant or authorize termination.¹⁰

A termination decision should focus on the impact of the current breach on future contract performance. What is the likelihood of the breach being cured, and of the remaining contract obligations being performed? The adequacy of money damages as compensation for the breach should also be a focus. The more egregious the breach, the more unlikely future performance will occur, and thus the more inadequate money damages will be as compensation for the breach.

Failure of payment as a material breach
Payment obligations are important, and are certain to be viewed as an essential element or term of any construction contract. Withholding payment if authorized under the terms of the contract, or if the withholding does not substantially deprive a party of the benefits of the contract, will not justify termination and does not constitute a material breach. Non-payment that is at odds with the contract requirements, or substantially deprives a party of the benefits of a contract, can constitute a material breach and can justify contract termination.

For example, in Manganaro Corp. v. HITT Contracting, Inc, the court held the contractor’s failure to honor the payment provision in the subcontract constituted a material breach and justified the subcontractor’s cessation of performance.¹¹ Similarly, in In re Stone & Webster, Inc., a bankruptcy court held a prime contractor’s failure to timely pay its subcontractors constituted a material breach of the prime contract and entitled the owner to terminate the prime contract.¹²

Refusing to make payment when a good faith basis exists to challenge the payment does not constitute a material breach. In Pack v. Case, the court held the owner’s refusal to pay disputed amounts claimed by the contractor did not constitute a breach of the contract and did not excuse the contractor from honoring its warranty obligations.¹³

Since the contractor had obtained substantially what it was entitled to receive under the contract, and would be adequately compensated by money damages, the owner’s non-payment was not a material breach and did not justify the contractor’s refusal to honor its warranty obligations.¹⁴

Failure to follow the design documents as a material breach
The failure to follow the design documents can deprive the owner of the benefit of the contract, constitute a material breach, and justify termination. For example, in Strouth v. Pools by Murphy & Sons, the court held the construction of a kidney-shaped pool was a substantial deviation from the peanut-shaped pool required by the contract and constituted a material breach of the pool construction contract. The pool contractor’s refusal to change the pool layout so as to comply with the contract made it unlikely the owner would ever obtain future performance in substantial compliance with the contract and thus justified termination.¹⁵

When termination occurs due to non-compliance with the design documents, the doctrine of substantial performance applies. The contractor is not required to be perfect, but it must substantially comply with the contract. The contractor has substantially performed if any deficiencies in its performance can be remedied, and the owner made whole, by an offsetting allowance against the contract price. The rule applies if the owner can use the property as intended even though relatively minor matters remain to be completed or corrected, and the owner has substantially obtained the benefit of the bargain. The rule does not apply when there are significant defects that are not readily repaired or the defects result in a complete frustration of the purpose of the contract.¹⁶

Timeliness of performance as a material breach
Timeliness of performance as a basis for termination is another frequently litigated topic. A delay in completing the work by the contractual completion is not a material default and does not justify termination unless the time of performance is specified in the contract to be of the essence or unless the circumstances under which the contract was negotiated demonstrate an intention by the parties to make the timeliness of performance an essential or material term.¹⁷

Waiver of a material breach
Another important concept is waiver, as the right to terminate for material breach can be waived if the party having the right to terminate elects not to and continues to receive the benefits of performance from the breaching party.¹⁸ In Madden Phillips, the site contractor breached the contract by suspending performance when a dispute over fill dirt arose. After suspending performance, the site contractor returned and re-commenced. The owner accepted the benefits of the site contractor’s renewed performance for nearly eight months before terminating the contract. By allowing the site contractor to return to the site and to complete 90 percent of the project without further objection, the owner waived its right to assert the site contractor’s suspension of the work was the first material breach of the parties’ contract.¹⁹

Consequences: Discharge of any further performance
In addition to authorizing the termination of a contract for default, the other significant consequence of a material breach is that it excuses the non-breaching party from any further performance under the contract, a right that can have significant consequences. A classic example of this is Mustang Pipeline Co. v. Driver Pipeline Co., where Mustang sued Driver for failing to complete the laying of a 160-km (100-mi) pipeline by the construction deadline stated in the contract.²⁰ Fifty-eight days into the 98-day schedule, Driver had completed only 24 km (15 mi) of pipe, and suspended operations. Mustang declared a default and hired another firm to complete Driver’s work.

Each party sued the other, claiming breach of contract and raising the other party’s prior material breach as an affirmative defense. The trial court entered a judgment awarding Driver $2.3 million against Mustang for wrongful termination.

On appeal, the Texas Supreme Court found Driver had been the first party to materially breach the contract by failing to lay more than 24 km of pipe, notwithstanding the passage of over half of the contract time. Given the time requirements of the contract, the Supreme Court determined as a matter of law that Driver’s breach was material, and Driver’s material breach entitled Mustang to terminate the contract.

The Court also concluded Driver’s material breach discharged Mustang from any further duties under the contract, including any obligation to pay Driver for the work performed. Driver entered the Court with a $2.3 million judgment in its favor and left the Court owing Mustang $2.1 million, all because the Court concluded Driver had committed the first material breach.

Conclusion
Termination of a contract for default can have serious implications. Unfortunately, there is no bright line rule to follow in making this determination. The termination decision must be made based on the totality of the circumstances, focusing on factors such as whether money damages are adequate compensation for the breach and whether the breach can be cured and remaining obligations performed. These decisions are often challenged, so it is critical a party make a reasoned, educated determination as to whether the other contracting party has materially breached the contract such that termination for cause is appropriate.

Deborah Cazan is an experienced construction attorney and dedicated business counselor with Alston & Bird LLP. Her practice focuses on representing clients in litigation, arbitration, and mediation of construction, development, and real estate related disputes. On the transactional side, she has extensive experience drafting and negotiating general contractor and construction management agreements, design-build agreements, program management agreements, project management agreements, and architectural and engineering agreements. Cazan serves as a board member of the Construction Section of the Atlanta Bar Association. She can be reached via e-mail at debbie.cazan@alston.com.

John I. Spangler III is a former co-chair of Alston & Bird’s Construction & Government Contracts Group, and has more than 25 years of experience handling construction disputes and negotiating and drafting design and construction contracts. He is featured in Chambers USA’s America’s Leading Lawyers for Business, and has been listed in The Best Lawyers in America since 2004. John also has been recognized by Who’s Who Legal and Super Lawyers magazine since 2006. He can be contacted at john.spangler@alston.com.

Notes
¹ Brazell, v. Windsor, 682 S.E.2d 824, 826 (S.C. 2009); UHS-Qualicare, Inc. v. Gulf Coast Cmty. Hosp., Inc. 525 So. 2d 746, 756 (Miss. 1987); Wiljeff, LLC, v. United Realty Mgmt. Corp., 920 N.Y.S.2d 495, 497 (N.Y. App. Div. 4^th Dep’t. 2011); Cent. Ark. Found. Homes, LLC v. Choate, 383 S.W.3d 418 (Ark. Ct. App. 2011). (back to article)
² Vidalia Outdoor Prods., Inc. v. Higgins, 701 S.E.2d 217, 219 (Ga. Ct. App. 2010); Forsyth Cnty. v. Waterscape Servs., LLC, 694 S.E.2d 102, 110-112 (Ga. Ct. App. 2010). (back to article)
³ D’Andrea Bros. v. United States, No. 08-286C, 2013 WL 500346 (Fed. Cl. Feb. 8, 2013). (back to article)
⁴ Campbell v. Shaw, 947 S.W.2d 128, 131 (Mo. Ct. App. 1997) (quoting Curt Ogden Equip. Co. v. Murphy Leasing Co., 895 S.W.2d 604, 608–09 (Mo. Ct. App. 1995)). (back to article)
⁵ 23 Williston on Contracts § 63:3 (4^th ed. 2000). (back to article)
⁶ In AIA A201-2007, General Conditions of the Contract for Construction, Article 14.2 “Termination by the Owner for Cause,” provides that “The Owner may terminate the Contract if the Contractor otherwise is guilty of substantial breach of a provision of the Contract Documents” without defining “substantial.” (back to article)
⁷ Schott v. Medrea, No. 106007153, 2011 Conn. Super. LEXIS 2769, at *27-28 (Conn. Super. Ct. Nov.1, 2011) (in the absence of any other guidance, the court interprets the term “substantial breach” as the equivalent of a material breach, citing Brittle v. Shun, No. A08–0445, 2009 WL 1047082 (Minn. Ct. App. Apr. 21, 2009); Nisby v. Michael, No. 1707, 2007 Mass. App. Div. 103, 104 (Mass. App. Ct. June 26, 2007); Rogers v. Relyea, 601 P.2d 37, 41 (1979); Black’s Law Dictionary (7^th ed. 1999); Merriam–Webster Dictionary (2005) (defining substantial as material); and In re DeRosa, 98 B.R. 644, 648 (Bankr. D. R.I.1989). (back to article)
⁸ Wiljeff, 920 N.Y.S.2d at 497; Madden Phillips Constr. Inc. v. GGAT Dev. Corp., 315 S.W.3d 800 (Tenn. Ct. App. 2009); Premier Golf Mo., LLC v. Staley Land Co., 282 S.W. 3d 866, 873 (Mo. Ct. App. 2009); Venture Props., Inc. v Parker, 195 P.3d 470, 489 (Or. Ct. App 2008); Mustang Pipeline Co. v. Driver Pipeline Co., 134 S.W.3d 195 (Tex. 2004). (back to article)
⁹ 5 Philip L. Bruner & Patrick J. O’Connor, Jr., Construction Law, §18:4. (back to article)
¹⁰ Vidalia, 701 S.E.2d at 219; Mayor of Douglasville v. Hildebrand, 333 S.E.2d 674 (Ga. Ct. App. 1985); Campbell, 947 S.W.2d at 131. (back to article)
¹¹ 193 F. Supp. 2d 88 (D.D.C. 2002). (back to article)
¹² 279 B.R. 748, 779-780 (Bankr. D. Del. 2002). (back to article)
¹³ 30 P.3d 436 (Utah Ct. App. 2001). (back to article)
¹⁴ Id. (citing Restatement (Second) of Contracts § 237 (1981)). (back to article)
¹⁵ 829 A.2d 102 (Conn. App. Ct. 2003). (back to article)
¹⁶ 15 Williston on Contracts § 44:57 (4^th ed.); Denver D. Darling, Inc. v. Controlled Env’ts Constr., Inc., 108 Cal. Rptr. 2d 213 (Cal. Ct. App. 2001) (under doctrine of substantial performance, substantial performance is sufficient, and justifies an action on the contract, although the other party is entitled to a reduction in the amount called for by the contract, to compensate for defects); Bentley Sys., Inc. v. Intergraph Corp., 922 So. 2d 61 (Ala. 2005) (substantial performance permits recovery for a breach-of-contract by a party that has not performed all of its obligations under a contract so long as its performance has been substantial); Dexter v. Brake, 269 P.3d 846 (Kan. Ct. App. 2012) (doctrine of substantial performance is intended to protect the right to compensation of those who have performed in all material and substantive particulars, so that their right to compensation is not forfeited by reason of mere technical, inadvertent, or unimportant omissions or defects). (back to article)
¹⁷ Madden Phillips, 315 S.W.3d at 817-20; Merritt v. Anderson, No. CA2008-04-010, 2009 WL 975749 (Ohio Ct. App. Apr. 13, 2009). (back to article)
¹⁸ 23 Williston on Contracts § 63:9 (4^th ed.) (back to article)
¹⁹ Id. at 816. (back to article)
²⁰ 134 S.W.3d 195 (Tex. 2004). (back to article)