Is Termination After Substantial Completion Inherently Wrong?

By John S. Mrowiec

Owners typically have the right to terminate a contractor "for cause."

An example is the American Institute of Architects' General Conditions of the Contract for Construction Section 14.2 (1997 ed.). Subcontracts give contractors similar rights against subcontractors.

If grounds otherwise exist, may the owner terminate the contract "for cause" after the contractor has achieved substantial completion but before final completion? If the owner does purport to terminate for cause after the contractor's achievement of substantial completion is that termination "wrongful" and a material breach by the owner?

Those questions arose in the case of Cincinnati Insurance Co. v. Jasper City Utility Service Board, 2006 U.S. Dist. LEXIS 63719 (S.D.Ind., Aug. 24, 2006).

Sewer Project in the Gutter

In Jasper City, the owner, Jasper City Utility Service Board, contracted with Titan Contracting Inc. as general contractor. Cincinnati Insurance Co. was the contractor's performance and payment bond surety.

The contract required contractor to construct a sewer extension project. The project involved installing a collection system and restoring damage to the site caused by construction of the collection system. The restoring portion comprised 7 percent of the total value of the project work.

The contract contained a liquidated damages provision applicable to contractor's failure to achieve substantial completion and final completion by specified deadlines. Final completion was to occur 30 days after substantial completion.

The contract defined the date of substantial completion with very common construction-industry contract language:

"[T]hat date certified by the Engineer when the construction of the Project or a specified part thereof is sufficiently completed, in accordance with the Contract Documents, so that the Project, or specified part can be utilized for the purposes for which it was intended."

Notice to proceed was issued March 5, 2002. On Oct. 21, 2002, four days before the contractual date for substantial completion, contractor submitted a schedule showing delayed substantial and final completion. By December 2002-about six weeks after the contractual deadline for substantial completion-weather conditions were such that the restoration segment of the project had to be rescheduled to spring 2003.

On Dec. 17, 2002, the owner issued a letter advising that the liquidated damages would be assessed for the delays. On Feb. 13, 2003, the engineer certified that the collection system had been substantially complete on Feb. 6, 2003. The certification expressly excluded the restoration portion of the project.

On April 3, 2003, the owner sent a letter to the contractor demanding completion. A week later, the contractor advised the owner that future payments should be made to contractor's surety.

A month later, contractor advised that its liability insurance had terminated and that surety would be investigating whether surety would assist contractor to complete or, instead, hire another completion contractor. The owner immediately sent a 10-day notice of termination to the contractor.

Despite the termination, the surety completed the project. The surety sued, alleging wrongful termination and other claims against the owner primarily relating to the owner's assessment of liquidated damages.

Was Termination OK?

The surety contended that the owner could not legally terminate the contractor after the contractor had achieved substantial completion. The decision is silent regarding what the surety contended would be the consequence of any wrongful termination.

Presumably, the surety sought a rebate of liquidated damages owner asserted for failure to achieve the timely final completion of the project.

The owner moved for summary judgment on various issues, including the surety's claim that owner's termination of contractor was wrongful.

The Jasper City trial court first implicitly agreed that the owner could not terminate the contractor after substantial completion. Under the facts of the case, the issue for the court was whether substantial completion of the collection system was substantial completion of enough of the project to prohibit termination.

The governing legal principle was the contractual doctrine of "substantial performance":

"The doctrine of substantial performance applies when performance of a nonessential condition is lacking, so that the benefits received by a party are far greater than the injury done to him by the breach of the other party" Jasper City, 2006 U.S. Dist. LEXIS 63719, *13 quoting Zemco Mf'g, Inc. v. Navistar Int'l Transportation Co., 270 F.3d 1117, 1126 (7th Cir. 2001).

Without addressing the contract's language, the Jasper City court stated that "[a] project should be considered substantially completed when it is capable of being used for its intended purpose" Jasper City, 2006 U.S. Dist. LEXIS 63719, *13 quoting Kinetic Builders, Inc. v. F. Whitten Peters, 226 F.3d 1307, 1315 (Fed. Cir. 2000). "Whether a contract has been substantially completed is a question of fact" Id.

The owner argued that the remaining restoration work was not "nonessential."

The surety argued that once the collection system was substantially complete, the entire project was "capable of being used for its intended purpose" and, thus, the contractor had "substantially performed" and owner could not terminate for cause. That dispute was a "question of fact," the court said.

Thus, the Jasper City court denied summary judgment for owner on that issue.

A trial would be necessary to determine whether contractor had "substantially performed." If so, there was nothing left for the owner to terminate. That would mean the owner's termination would be wrongful and owner might be unable to assert liquidated damages for the contractor's failure to achieve timely final completion. Absent wrongful termination, the owner could retain that portion of liquidated damages.

The Jasper City decision reminds us that if a contractor has "substantially performed the contract," even if not finally complete, the owner may not terminate for cause.

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm's Web site at www.cmcontractors.com.