Termination of the Construction Contract: What to Do When a Project Goes Bad

Posted by David Lindner on December 28, 2011

 

Attorney Frederick M. Lombardi provides the following overview of “for cause” termination of a private construction contract.  The second part of this article will focus on termination “for convenience” and damages arising as a result of termination.

There are many reasons for terminating a construction contract. Some of the most common are nonpayment by the owner or contractor, nonperformance by the contractor or subcontractors, timeliness of performance, lack of communication or simply an inability to get along. These issues should be addressed in a construction contract.

Because termination ends one or both parties’ rights or contractual obligations prior to the completion of the project, careful consideration should be given to the consequences.  The timeliness of project completion and potential added costs, not to mention exposure to damages, require that termination be approached by both parties with extreme caution and after thorough analysis by legal counsel, construction experts, accountants, architects and other pertinent industry experts.

Most construction contract issues can be resolved and every effort should be made to do so through negotiations and, if necessary, compromise before termination. Finding a resolution can help parties avoid the risks of additional delays and costs in the aftermath of termination, exposure to damages, and the uncertainty of legal outcomes when facts are judged and conclusions reached by third-party judges or arbitrators.

“For cause” termination may result when an owner, contractor or subcontractor does not fulfill obligations within the contract. Examples include:

  • owner failing to pay the contractor or the contractor to pay its subcontractors or suppliers;
  • owner failing to properly coordinate a work schedule where separate contracts exist for discrete parts of the construction project;
  • work stoppage by court order through no fault of the contractor (e.g., work stopped by a court or government order due to failure of an architect to issue a certificate of payment that is proper and due, or reasons other than acts of God or force majeure);
  • contractor failing to perform in a timely manner or properly coordinating its subcontractors or suppliers;
  • contractor failing to perform in terms of the quality or quantity of the work and materials furnished in accordance with the construction contract, the plans and/or the specifications.

Even in these extreme situations, a notice of default and an opportunity to cure the default is generally provided for in the contract and, if not, still should be given in most circumstances. The objective is to give the parties one last chance to avoid termination and the risks associated with it.

When termination is necessary, there are some practical considerations for the owner prior to issuing the termination notice.

First, if the project has performance bond coverage, notice should be provided to the surety in order to utilize the surety as another avenue of approach in an effort to encourage the contractor to cure the default.  A surety may take over the project, pay the owner for any liability incurred, find a replacement contractor or deny the claim. The owner should carefully review the terms of the performance bond in order to ensure that all conditions precedent to claiming performance bond coverage have been met.

Second, prior to issuing a termination notice, the owner should consider engaging a qualified construction expert to evaluate the status of the project and to memorialize the existing condition of the project for litigation purposes. A qualified construction expert can advise the owner on the probable cost of completion and the likelihood that the contractor could accelerate or otherwise cure the default. The expert also can provide effective assistance in securing completion of the project.

Based upon the analysis and advice of a qualified construction expert, the owner may find it far preferable to maintain the current contractor and accept a later completion date rather than to terminate under default and suffer even more in terms of completion costs, delays and exposure to litigation.

Ohio Sales and Use Tax in Construction Contracts

Posted by David Lindner on March 01, 2011

Attorney Steve Dimengo presents the following article on Ohio Sales and Use Tax issues in construction contracts:

 

Editor’s note: This is part 1 of a two-part series about tax issues affecting contractors.  Part 2 will address the classification of property – whether an improvement is real or personal property.

In a construction contract, the contractor is deemed the consumer of any tangible personal property purchased that it incorporates into real property and, thus, must pay tax on the purchase of such property. The construction contractor is the consumer even though he may subcontract the actual labor to incorporate the materials into the real property. However, subcontractors who purchase materials for incorporation into a job must pay tax upon the purchase of the materials.

A contractor cannot use tax erroneously paid on the purchase of its materials as an offset against tax that should have been collected. For example, a contractor may erroneously believe property to be constructed is real property and remit the sales tax due on the materials as they are purchased while failing to collect tax upon completion of the project. Under such circumstances, the contractor can only obtain a refund of tax it erroneously paid on its materials. 

To avoid the foregoing problem, a contractor is allowed to request certification from the owner as to the classification of the property – real or personal property – before the contract is executed.  The owner must respond to the request, and the contractor can rely thereon so that the risk of erroneous classification is transferred to the owner.

If in doubt, claim the resale exemption  

Since a contractor cannot always be certain as to whether property being purchased will be incorporated into real property or sold as tangible personal property, he or she should claim the resale exemption for any uncertain purchases. Use tax must then be paid on those materials subsequently incorporated into Ohio real property by the contractor, other than as part of an exempt construction contract .

Claim an exemption for materials used on Exempt Construction Contracts 

A contractor may claim exemption upon the purchase of materials to be incorporated into:

1.    Real property under a construction contract with the U.S. government or its agencies, the State of Ohio, or an Ohio political subdivision;

2.    Real property which is owned or will be accepted for ownership at the time of completion by the U.S. government or its agencies, the State of Ohio or its political subdivisions;

3.    A house of public worship or religious education, or a building used exclusively for charitable purposes by a nonprofit organization operated exclusively for charitable purposes;

4.    The original construction of a sports facility under §307.696 of the Ohio Revised Code; or

5.    A hospital facility entitled to exemption under §140.08 of the Ohio Revised Code.

A contractee claiming one of the above exemptions must execute the Construction Contract Exemption Certificate available on the Ohio Department of Taxation’s website.  A contractor is then protected from liability if it is later determined that the contract did not qualify for exemption; the contractee assumes liability for any unpaid taxes.

Rather than using copies of the Construction Contract Exemption Certificate when making purchases of materials, the contractor or subcontractor may use a Contractor’s Exemption Certificate when purchasing materials to be used for an exempt contract.  However, this certificate only protects the vendor/seller of the materials.