While a long-term contract may seem like the holy grail to contractors, they can also be quite confining. Sure, you have a steady stream of income, but what happens when costs go up and your profit margin shrinks? If this has happened to you, it may be time to get out of the contract. The first question is, can you get out of the contract? The second is, how do you do so? Read below for some answers.
What is a long-term contract in construction?
Generally, a long-term contract in construction means an agreement for services over an extended time period, specifically more than just one project. While agreements like this aren’t the norm in the industry, they may be used to lock in contractors for work that is repeated or is consistent over several sites or locations.
Because of the differences between sites, it can be hard to assign a consistent price to a specific scope of work. For example, if a contract is for building a road, site conditions can affect how much excavation and rock is needed, leading to a different price for each location along the route. However, a specific service or material may be able to be provided for the same price over several locations.
Another model for long-term contracts in construction is the use of a master contract with individual work orders for each “project.” In these agreements, all the contract’s main clauses are contained in the master contract, with only the scope of work and price specified in the work order. This model is especially useful when two parties will be working together over a series of projects.
Advantages of long-term contracts
- Long-term contracts usually provide a steady flow of work and income that contractors can count on. This allows them to plan ahead for the efficient use of their workers and plan their cash flow needs.
- These contracts also allow contractors to get to know their client’s needs and wants, so they are better able to serve them. When teams have more time working together, they can effectively look out for each other and work together to address potential issues.
Disadvantages of long-term contracts
- If pricing is included in the contract terms, many of these agreements do not account for cost increases. As we’ve seen over the years since the pandemic began, construction materials pricing can be extremely volatile. Contractors can lose substantial profits if there isn’t a way for them to address price increases within the contract.
- Long-term contracts can be difficult to get out of. Because the agreements are active for potentially years, contractors can get stuck. If the owner and contractor don’t work well together, this could be detrimental to both parties.
How to get out of long-term contracts
The first thing to consider is whether getting out of the contract is the best option. Getting out isn’t always the best way to go. For example, if the problem is that material and labor costs have risen during the contract period, the contractor may want to try proposing adding a price escalation clause to address the situation. This can help the contractor and owner maintain the relationship without breaking the contract.
If you decide that getting out of the contract is the best way to proceed, then you’ll need to read the specific contract terms to determine the required process. These terms are often titled “Termination” or a similar term. Follow the process detailed there to let the owner know you want to terminate the contract. Doing so can come at a potential cost, so be sure to read all the language so you know what the effect will be.
To illustrate the process for getting out of a contract, we’re going to analyze the termination clauses in a couple of standard construction contracts: the AIA A201 General Conditions and ConsensusDocs 200 documents.
The A201 document provides the contract language for all AIA contracts and is widely used in the industry. First let’s look at the terms related to termination.
The AIA A201 states in Article 14.1 that if the project is delayed for 30 consecutive days due to one of the following causes, the contractor can terminate the contract:
- Court order or other public order to stop work
- Government act that requires work to be stopped
- Delays in application for payment approval or payment
- Owner’s failure to provide proof of financing or funds availability
Also, the contractor may terminate if the owner suspends or delays work for the proposed scheduled time of the project or for 120 days in any 365 day period, whichever is less.
Article 14.1.3 states the process for terminating the contract:
- If one of the situations listed above happens, “the Contractor may, upon seven days’ written notice to the Owner and Architect, terminate the Contract and recover from the Owner payment for Work executed, including reasonable overhead and profit, costs incurred by reason of such termination, and damages.”
For example, if the project owner has not paid a contractor’s invoice within the time stated in the contract, and there is no other issue with the payment application, the contractor has the grounds to terminate the contract by sending a letter to the owner and architect stating that they will be stopping work after seven days. The contractor can then bill the owner for work/costs incurred up to that time.
Note that the contractor is not allowed to terminate the contract for no reason. Also, the language states that the delays or problems on the project must not be the fault of the contractor, a subcontractor, or supplier on the project.
Now let’s look at the language in the ConsensusDocs 200, which is similar to the AIA General Conditions. Article 11.5 details the conditions under which a contractor can terminate the contract. The terms require a contractor to send a written notice to the owner if the work has been stopped for thirty days due to:
- Court order or other government order
- National emergency or other governmental act that makes materials not available
- Suspension of the work by the Owner
The notice should stipulate that the contract will be terminated in seven days’ time.
Additionally, if one of the following occurs, the contractor must give the owner seven days’ notice with an additional three-day period to give the owner a chance to correct the situation:
- Owner fails to provide proof of financing or funds availability
- Owner assigns the agreement to someone else despite the contractor’s reasonable objection
- Owner fails to pay the contractor as agreed and the contractor has stopped work
- Owner breaks the contract in some other way
The terms go on to say that the contractor is entitled to receive compensation for all work performed, and for any proven costs in connection with the work, including demobilization costs and reasonable overhead and profit for work that is not performed.
Note that in both the AIA and ConsensusDocs General Conditions the project owner has the right to terminate the agreement without cause, if so desired. The contractor, however, can only terminate the contract under specific conditions.
If you’ve determined that getting out of a long-term contract is the best path for you, read the contract section related to termination and follow the directions for sending notice. You should be able to collect for work and materials provided up to the date of termination.
If the project owner does not accept your notice or fails to pay you for the work you provided, contact a construction attorney.