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Downturn Contract Clause by qzb52899

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									Suspension, Termination, and other Downturn
    Issues for the Construction Industry

                Bernard Ang
              Stephanie Wong
              Mohammed Talib

• Part A: Suspension

• Part B: Termination

• Part C: Procurement Strategy & Downturn Issues
PART A: Suspension - Overview

1) The Right to Suspend

2) Reasons for Suspension

3) Consequences of Suspension

4) Suspension & Other Issues

5) Conclusion
(1) The Right to Suspend

•   No Right to Suspend in Law - Lubenham Fidelities
    •   Architect incorrectly certified sums (retention, delay LDs) to Contractor.
    •   Contractor suspended works, left site.
    •   Contractor liable for damages - breach of contract in suspending.

•   Distinguish - situation where performance conditional upon
    performance by other party.
    •   Express term - payment conditional upon submission of bonds
    •   Advance payment conditional upon submission advance payment bond
    •   Implied - site works conditional upon possession being given

•   Deemed Suspension (e.g. prolonged force Majeure)
•   Deemed Termination (prolonged suspension)
    (1) Building contract for use in HK (2005)
•    Because right does not exist at law, standard forms grant right.

23.3 Architect may issue instructions regarding:
   (a) ..postponement of the Date for Possession of the Site or a part…;
   (b) ..postponement of Commencement Date (whole or part Works) or
   (c) .. postponement or suspension of the whole or part of the Works.

25.1(3)(j) Architect's instruction under clause 23.3 = EOT, unless:
    • Notice of the postponement or suspension is given in Contract; or
    • ..postponement or suspension was caused by a breach of contract
       or other default by the Contractor….;

27.1(2)(e) Qualifying events (entitling contractor to loss and/or expense) =
   Architect's instruction under clause 23.3, unless (same 2 exceptions)
(1) FIDIC Rainbow Suite 1st Ed (1999)
8.8 The Engineer may at any time instruct the Contractor to suspend
    progress of part or all of the Works. During such suspension, the
    Contractor shall protect, store and secure …Works against any
    deterioration, loss or damage.

    The Engineer may also notify the cause for the suspension. If
    …the cause is notified and is the responsibility of the Contractor,
    the following Sub-Clauses 8.9, 810 and 8.11 shall not apply.

8.9 If Contractor suffers delay + incurs Cost complying with
    instructions to suspend, entitled to EOT plus Cost.

8.10 Payment for off-Site Plant and Materials during Suspension

8.11 Prolonged Suspension, continued > 84 days, Contractor may
     request permission to proceed, or else treat suspension as
     omission or terminate.
(1) Govt GCC for Building Works (1999)
54. (1) The Contractor shall upon the written order of the Architect
   suspend the progress of the Works or any part thereof for such time
   or times and in such manner as the Architect may consider
   necessary and shall …properly protect and secure the Works so far
   as is necessary in the opinion of the Architect.
   If ..Surveyor is of the opinion ..Contractor has been involved in
   additional expenditure …ascertain Cost incurred …unless such
   suspension order is:
    (a) Otherwise provided for in the Contract, or
    (b) Necessary by reason of weather conditions affecting the safety
        or quality of the Works or any part thereof, or
    (c) Necessary by reason of some default on the part of the
        Contractor or any person carrying out the Works, or
    (d) Necessary for proper execution of the Works or for safety of the
        Works or any part thereof or for the safety and health of any
        person or the safety of any property on or adjacent to Site ….
(1) The Right to Suspend (Cont)
•   Various suspension clauses - similar in :
    •   No reasons need to be given,
    •   may be exercised at any time,
    •   deal with total or partial suspension
    •   Consequences depend on reason - whose fault or responsibility caused
•   However - FIDIC …
    •   Employer must specify reasons
    •   Differing cost consequences depending on reason specified.
•   HKIA / Govt …
    •   need not give reason at all
    •   Not prejudiced by keeping quiet when suspending, can find excuse later.
•   Reason for suspension
    •   FIDIC (“is the responsibility of the Contractor”) – not necessarily default.
    •   HKIA (“breach of contract or other default”) - wider
    •   Govt (“some default on the part of the Contractor”, “weather”, “health and
        safety”) – widest ???
(2) Reasons for Suspension

•   Express suspension provision
•   How easily can the right be exercised?
•   Right to suspend -v- consequences of suspension
•   Advance Notice – negotiate a realistic period
•   Extent of work in progress paid -v- Mitigation of losses
•   Claims – don’t forget notice requirements!
(3) Consequences of Suspension

• Protect, store and secure
• Cost of suspension
• Removal of equipment and machinery
   • Contractor’s desire to remove/re-deploy equipment/machinery
   • Employer's desire to have quick re-mobilisation
• Performance bonds, insurance, other ancillary contracts
   •   Not suspended automatically
   •   any refund of insurance premiums?
   •   Any release of counter securities?
   •   Lapsing of bonds during suspension + extension?
(4) Suspension and Other Issues

• Main and Sub-contracts - harmonisation

• Suspension & Fluctuations

• Suspension & Ancillary Contracts (Bonds, Guarantees,

• Suspension & Commencement of works (notice to

• Go Slow instead?
(5) Conclusion

• No right to suspend at law – standard forms give
  contractual right

• Consider consequences of suspension early on

• Evaluate impact of suspension not in isolation but in
  conjunction with other issues

• Beware of disputes if suspension not properly thought
PART B: Termination - Overview

1) Termination at Common Law
  1.1   Employer’s Repudiation
  1.2   Contractor’s Repudiation
  1.3   Acting on Repudiation
  1.4   Insolvency as Repudiation

2) Termination Under the Contract
   2.1 Termination for Default
   2.2 Termination for Insolvency
   2.3 Termination for Convenience

3) Excluding the Common Law
4) Termination & Other issues
(1) Termination at Common Law

• Heyman v Darwins - termination includes:
    • Renunciation by a person of his liabilities (won’t perform)
    • Impossibility created by his own act (can’t perform)
    • Total or partial failure of performance (didn’t perform)

• Renunciation (“won’t”) – shows an intent not to be bound by the
  contract, or acts inconsistently with it
• Impossibility (“can’t”) –act/omission makes it impossible to perform
• Failure to perform (“didn’t”) – most common. a.k.a. Repudiation
    •   Repudiatory breach
    •   Does the breach justify repudiation? Depends on gravity and effect
    •   Breach must go to root of the contract
    •   Relevance of case law
(1.1) Repudiation by Employer

• Breach by the Employer that may amount to a
  repudiation e.g:
   • Non-Payment
   • Delayed Site Access

• Non-payment is not repudiatory unless
   • Breach of condition to pay timely (time is of the essence); or
   • Fundamental breach which goes to root of contract; or
   • No longer intend to be bound by contract
(1.1) Repudiation by Employer

• Dalkia Utilities Services Plc v Celtech International Ltd
    • Failure to pay for 3 months out of 15-year contract    not fundamental
    • Proposed realistic settlement by E     intention to remain to be bound
    • No repudiatory breach
• Stocznia Gdanska v Latvian Shipping
    •   Contract stipulates time periods for 5 instalments     time is of essence
    •   Outstanding 2nd instalment = 20% contract sum       fundamental
    •   Renegotiation for 30% price reduction      no longer intend to be bound
    •   Repudiatory breach
• Alan Auld v Rick Pollard Associates
    • Non-payment was 'substantial, persistent and cynical’
    • No good explanation for failure of prompt payment
    • Repudiatory breach
(1.1) Repudiation by Employer (cont.)

• Delayed site access usually not repudiatory
   • But if the delay is long enough so that it appears the Employer ‘won’t
     perform’ his part of the contract – that may amount to repudiation

• No termination, instead
   • Extensions of Time
   • Prolongation costs
   • Increasingly, no costs

• Consider also :
   •   Material price fluctuation
   •   Back to back provisions in sub-contracts
   •   Staff and equipment mobilisation costs
   •   Insurance, site security, other fixed preliminaries
(1.2) Repudiation by the Contractor

• Common scenarios:
   • Abandonment
   • Delayed Performance
   • Defects

• Abandonment
   • Walking away always a repudiatory breach

• Greenore Port v Technical & General
   •   Indirect abandonment?
   •   Contractor let his insurance expire
   •   Started laying off employees
   •   Employer terminated
   •   Contractor became insolvent shortly after
   •   Held: the Contractor had repudiated the contract.
(1.2) Repudiation by the Contractor (cont.)

• Delay in Performance
  •   Difficult ground for termination
  •   Time must be of the essence
  •   Must be in breach at time –v- inevitably be in breach later
  •   Going slow is not a breach – the contractor is free to set the
      progress of the works (Hill v London Borough of Camden)
       • Contractual programme; Milestones
       • Obligation to proceed diligently with the works?

• Defects
  • One defect is unlikely to be enough
  • Accumulation of breaches
  • How much will it affect performance?
(1.3) Acting on Repudiation

• Cannot sit on the fence. Either:
    • Accept the Breach and Terminate
    • Affirm the contract and continue (Failure to choose = affirm).
• Acceptance of breach – effects :
    • Contract obligations replaced by damages
    • Automatic - don’t need to provide for damages
•   Acceptance :
    • Must be communicated
    • An unequivocal act required
    • Inactivity suffices if it shows the unequivocal intent
• Vitol v Norelf
    • Employer repudiates– tells Contractor not to turn up tomorrow
    • Held: contractor’s failure to return conveys acceptance - that the
      contract is over.
(1.3) Acting on Repudiation

• Affirmation of the contract
   •   Continues contract – all obligations for both sides remain in force
   •   Can be express or implied
   •   Simply protesting the breach is not affirmation
   •   The parties have all previous causes of action
   •   Innocent party may still have a right to damages

• Not all action is affirmatory
   •   Protesting [Yukong Line v Rendsburg]
   •   Calling on other side to correct breach [Yukong Line]
   •   Renegotiating the contract [Internet Trading Club v Freeserve]
   •   "The law does not require an injured party to snatch at
(1.4) Insolvency & Repudiation

• Is insolvency itself repudiation?

• Insolvency is not necessarily a breach of contract
    • Re Agra Bank

• If the administrator of the company can find a way to keep the
  company going – especially if the contract is profitable – then the
  contract continues

• Employers should keep an eye out for:
    •   Failure to pay labour, sub-contractors or suppliers
    •   Not replacing leaving staff
    •   Increased defective work due to less supervision
    •   Requests for advance payment or accelerated payment
    •   Decrease in speed of work (but remember that going slow is not a
(2) Termination Under the Contract

•   Contractual termination
     •   no burden of proving breach was fundamental or repudiatory
     •   less risk of wrongful termination
     •   events can be wider than common law
     •   can include ordinary breaches, even events which are not breaches
     •   can also include termination upon insolvency of third party
     •   also include termination at employer’s convenience
     •   Bespoke remedies

•   But be careful
     •   Exact and meticulous compliance with procedural requirements
         •   Drafting termination notice an art
     •   Less flexibility then common law
     •   Contractual remedies must be drafted with care
         •   too wide = penalty, too narrow - restrict Employer’s flexibility
(2.1) Termination for default

• Perceived lack of protection at common law
    (1) enforcing reasonable progress,
    (2) securing prompt rectification of defective works.
•   Unsatisfactory progress
    •   failure to commence work, or to complete by the due date.
    •   failure to proceed as such rate as to complete by completion date.
    •   failure to proceed with due diligence (no reference to completion date)
    •   protection to contractor - “two-tiered” termination
•   Defective work
    •   failure to comply with specification, drawings
    •   modern tenancy - greater precision and fairness of two-tier approach
    •   identity and perceived impartiality of the engineer is crucial.
•   Other grounds for termination
    •   Removal of material from site without permission
    •   Not maintaining the works properly
    •   Subcontracting or assignment without consent
    •   Not complying with engineers orders or directions
    •   Any rightful breach of contract
(2.2) Termination for insolvency
FIDIC 15.2
•   “…becomes bankrupt or insolvent, goes into liquidation, has a receiving or
    administration order made against him, compounds with his creditors, or carries on
    business under a receiver, trustee or manager .., or if any act is done or event occurs
    which (under applicable Laws) has a similar effect to any of these acts or events”
Building Contract for use in HK (HKIA)
•   (a) becomes bankrupt; (b) makes a composition or arrangement with his creditors‘ (c)
    has a petition for compulsory winding-up presented or made against him; (d) enters
    into compulsory or voluntary liquidation (except for …reconstruction; (e) has a
    provisional liquidator or receiver appointed.
Case (Martyn Rose v AKG Group)
•   “any person takes any step (and it is not withdrawn or discharged within 30 days) to
    appoint a liquidator”
•   Held - a winding up petition (even though it was tactical) = step towards insolvency.
Modern Tendency
•   No need actual bankruptcy – include events short of formal insolvency.
•   “where ..suspected on reasonable grounds ..contractor is insolvent…”
(2.3) Termination Without Breach

•   Termination not dependant on default/breach
•   Usually exercisable at discretion of Employer
•   At any time, upon notice
•   No right outside of the contract
•   Compensation regime more generous?
    e.g. FIDIC Rainbow Suite –
     a) Work carried out
     b) Plant and Materials ordered + delivered or liable to accept delivery:
     c) Other liability reasonably incurred in expectation of completing Works;
     d) Removal of equipment and temporary works;
     e) Repatriation of staff and labour.
•   Must be real abandonment.
    •   Not if only reason is to change to cheaper contractor? E.g. FIDIC – “The
        Employer shall not terminate the Contract under this Sub-Clause in order to
        execute the Works himself or to arrange for the Works to be executed by
        another Contractor.”
    •   Loss of confidence?
(3) Excluding the Common Law

• Clear words will allow you to exclude common law termination rights
• Risk – implied exclusion of common law
• Tan Hung Nguyen v Luxury Design Homes
   • Termination included a broad range of termination events, including
     where Contractor “unable or unwilling to complete”
   • Held - clause intended to ‘cover the field’ over all possible termination
   • Therefore oust the common law on repudiation
   • “Bearing in mind the expansive range of events of default provided for
     …seems to me that the parties …intended clause 24 to cover the field,
     in the sense that the common law rights ….were excluded”.

• Perrar v General Surety
   • Common law rights reserved – re termination events
   • Common law rights not expressly reserved – re post-termination rights
   • Court implied – contractual provision for post-termination rights are a
     complete code – and excluded common law rights
(3) Excluding the Common Law

• The order in which you repudiate not decisive – Laing v Aegon
   • Held: It was not inconsistent to terminate using both – even though the
     contract was relied on first – the repudiation was accepted by the
     statement of claim of the Main Contractor.

• Stocznia Gdanska v Latvian Shipping
   • Not inconsistent to rely on contractual and common law rights
   • Where they overlap –harsh to construe one as ousting the other
   • Especially where there has been an express reservation of rights.

• Practical Tips
   •   Draft termination notices with common law first
   •   Unless different damages are recoverable
   •   An express reservation should be used
   •   Common law can rescue an invalid contractual termination + vice versa
(4) Termination & Other issues

Termination and…..
•   … subcontracts (Harmonise terms)
•   … site possession (“right to enter upon site and expel Contractor”)
•   … liquidated damages
•   … suspension of further payments
•   … Property Rights over contractors' equipment
•   … Intellectual Property rights
•   … Performance Bond, security deposits
•   …Arbitration clauses
•   …Confidentiality
•   Any other clauses that survive termination?
(5) Conclusion

• Remember parallel contract and common law termination
• Check contract terms
    • Provisions, notices, remedy period
    • Have you complied with any notice requirements?
    • Any pre-conditions to termination?
• Could termination put you at risk for a claim for damages?
• Will you loose your right to terminate
    • if you threaten to terminate, but do not follow through?
• Alternatives?
    • Can the party in breach survive without this contract?
    • Can you protect yourself in other ways?
• Practice Mitigation
• Don’t perform any obligation under contract which might affirm it
• If you are served with notice
    • Don’t passively accept the notice of termination – contest it!
    • Don’t waive any breach by the other side – reserve your position!
Part C: Procurement Strategy in downturn
1) Pre-Contract Due Diligence – searches, pre-bid agreements
2) Counterparty Insolvency early detection/warning (procedures)
3) Performance Security, on demand bonds
4) Retention of Title
5) Novation & Collateral contract
6) Plant/Equipment, Goods/Materials
7) Payment and cashflow
8) Suspension and Termination
9) Price Escalation and currency fluctuations
10)Making sure your contracts work in an economic downturn
   •   Minimising uncertainty, avoid costly delays and arguments
   •   Keeping contracts up to date, Identify weaknesses
   •   Using the contract to your advantage
   •   Record keeping and Correspondence
(1) Performance Security

• Increased emphasis on security e.g. bonds and guarantees
• GUARANTEES - binding promise of guarantor to be answerable
  to beneficiary, in respect of the debt/obligation of principal debtor.
• Secondary liability – dependent on Principal Debtor’s liability
    • Guarantor liable only to same extent as Principal Debtor
    • Guarantor has same defenses as Contractor
    • may raise set-offs, cross claims etc.
• Conditional or unconditional
• What do you want - secure payment or secure performance?
    • i.e guarantor promise to perform primary obligation
    • or undertake that primary debtor will perform (if not - damages)
• Must beneficiary sue Principal debtor first? E.g. Article 636 Macau
• Parent Guarantees
    • Guarantee by parent (ultimate?) that work will be carried out.
    • Obligation to perform the primary obligation themselves or pay damages
(1) Performance Security

• BONDS - instrument under seal whereby one person binds himself to
    another for payment of specified sum of money either immediately or at
    future date. Primary liability.
•   Totally separate from the construction contract:
     • may have different limits of liability
     • not affected by invalidity of construction contract.
     • not affected by defences underlying contract
• Performance Bonds
     • Conditional -v- unconditional
     • Grounds for a call on the bond - usually set out in bond
• On-demand Bonds - Employer need only:
        • State that the Contractor is in default of the construction contract;
        • Prepare a statement of damages;
        • Comply with formalities required by the bond.
     • Employer does not need to show:
        • Evidence of the default;
        • That it has incurred recoverable losses.
(1) Performance Security

  •   Retention Bonds
  •   Advance Payment Bonds
  •   Payment Guarantees (PRC)
  •   Letters of Credit
  •   Indemnities, Warranties
(1) Comparing Different Security

•   What do you really want? - distinction between bonds, guarantees,
    warranties, indemnities, and parent company guarantees
•   Consider in terms of :-
    •   Length of cover - Time bars
    •   Is Liability primary or secondary?
    •   Measure of damages – cost of cure –v- diminution in value
    •   Timing – must you be out of pocket to make a claim?
    •   Remoteness of damages – common law or contractual?
    •   Duration of security
    •   Credit rating of issuer
    •   Insolvency Risks
    •   Ease of procurement
    •   Self-help?
(1) Comparing Different Security
•   Guarantees -v- Indemnities
    •   Guarantees – guarantor’s liability secondary – principal debtor’s liability
        must exist
    •   Indemnities - contract to keep other harmless against loss. This is an
        independent obligation - does not depend on existence of other
        obligation (i.e. primary).

•   Guarantees -v- Bonds
    •   guarantor's obligation - not simply to pay money but perform if needed
    •   However, performance often commuted to payment of money
    •   Secondary vs primary liability; vitiation of underlying contract

•   Warranties -v- Indemnities
    •   Warranties - any contractually binding promise (e.g. contractual
        statement by the seller regarding the state of goods sold) - damages
    •   Indemnities – reimbursement for loss, damage, or liability in tort i.e.
        beneficiary entitled to claim only when they have incurred expenditure.
        Cannot claim depreciation in value of property due to defects.
(2) Retention of Title

• Title, Possession and Risk

• ROT prevents title in goods from passing until those
  goods have been paid for in full

• Drafting Tips
   • Incorporation
   • Identifiable
   • Simple or All Monies
(3) Novation

• Novation - lessens impact of Contractor’s insolvency
• Turning sub-contractor into a direct trade contractor

                                  Assign security,
                                Retention, insurance

             Contractor                                         Novatee

              Contract                    New

                                                        Mutually agrees to
                                                       future performance
(4) Conclusions

• Suspension and Termination - deserve greater scrutiny in this
  climate, consider early (during contracting) and evaluate in
  conjunction with other issues

• Termination - always consider inter-relationship between contract
  and common law termination. Employers, be careful of over- or

• Bonds/Security - also greater scrutiny, but first know what you really

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