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Sat 11 Oct 2008 04:00 AM

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How to terminate a contract

Michelle Nelson, partner at Pinsent Masons, says the complex nature of contracts must be done in accordance with its requirements, especially when one party wants to end the relationship.

One of the issues coming across our desks more and more is that of termination of a construction contract.

The questions asked are usually: can we terminate this contractor/subcontractor for non-performance? What about termination because we can get a better price elsewhere? Or on the other side of the fence: we were terminated without reason or warning. Can we make a claim?

There are many difficult questions to answer in this area and many different answers and issues to be aware of. The most important thing to consider, however, is that any attempt to terminate a construction contract must be done with the utmost of care and must be done in accordance with the procedural requirements of the contract and/or the prevailing law. Failure to do so can result in extremely serious consequences and a potentially large claim for damages.

Lessons

The lessons on this issue can (and should) be learned by everybody - employers, contractors, engineers and even lawyers advising on such issues. Indeed, I was involved in an arbitration a few years ago which centred upon the question of whether a main contractor had followed the contractual machinery in terminating the sub-contractor.

The arbitral tribunal in that case decided that there were fundamental flaws in the drafting of the termination notice with the consequence that the termination was wrongful - and that termination notice was actually drafted by a well-respected law firm. Not mine, I hasten to add.

Most construction contracts include provisions setting out both the grounds and the procedure for termination of contract - generally for default by one or other of the parties, but sometimes also for convenience - generally on the part of the employer.

For example, the FIDIC contracts contain detailed provisions on termination, including both the allowable grounds for termination and also the process which must be followed. In almost all cases there is also a requirement for giving notice to the defaulting party.

Here in the UAE, the civil code also contains certain provisions in relation to termination of contracts. It is a subject of debate whether a contract can be terminated without an order of the court in the absence of contractual provisions setting out the circumstances in which a contract may be terminated and setting out the mechanism to do so.  This is, however, outside the scope of this article, so I will not consider this further.

What is clear, however, is that the UAE law is particularly concerned that any such termination is done properly and fairly. The key requirement is that anybody seeking to terminate an agreement must give proper notice. Articles 271 and 272 of the UAE civil code provide that parties to a contract may agree that the contract can be terminated in certain circumstances upon giving notice.

Breach

Furthermore, article 877 of the code, which specifically deals with construction contracts, also provides the employer with the ability to terminate a construction contract in circumstances where the contractor's work is defective, or the work has been carried out in breach of contract.

However, the key point to note in relation to this provision is that the contractor must be given the opportunity to make good his work/breach if it is possible to do so, before the employer is free to get somebody else to undertake the work and claim the cost of so doing from the contractor.

This is of course fair and reasonable. If an employer is contemplating removing works from a contractor which he would otherwise be able to carry out, the contractor must be absolutely clear that this is potentially going to happen.

This will then give the contractor the opportunity to remedy its own failings or, if it is unable to do so, or chooses not to do so, he cannot complain about having inadequate warning, or about not having the opportunity to do something about it.

Indeed, not giving the contractor this opportunity is also contrary to the requirement that parties to a contract must perform their obligations in accordance with good faith under article 246 of the code.

One might question why the law is so particular to make sure that a party seeking to terminate a contract does so properly and with good grounds. There are generally no compromises in satisfying the requirements. The answer to this is relatively simple.

Take, for example a situation where a contractor has signed up to a four-year contract to build 20 tower blocks. In signing up to that agreement he has first allocated his resources to that project and secondly made an allowance in his head office figures for a contribution from the project in question. Indeed, he may also have turned down other projects because he has allocated all of his resources to this one.

It would certainly be unfair for an employer to suddenly decide to remove the works from the contractor without good cause and without reference to any procedures agreed in the contract. The moral of the story, therefore, is to ensure that any steps taken to terminate a contract are taken with good grounds and executed in the proper manner. Otherwise, they are likely to be steps which the party in question wishes it had not taken.

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