Pulling the Plug

As a contractor, you may have wondered if your contract can be terminated by the owner for cause after the project has reached substantial completion. The answer is yes.

Under certain circumstances it may be permissible—or even necessary—for a project owner to terminate the contract for cause after the project has reached substantial completion. Although the rights of the parties in any case will depend in large part on the specific contract language, the fact that a project has reached substantial completion is not an absolute bar to termination for cause, particularly when the owner intends to pursue a performance-bond claim.

Completion Versus Performance

Following substantial completion, a contractor typically will have outstanding contractual obligations such as paying its subcontractors and suppliers, bonding off any mechanic’s liens, completing the punch list, remediating defective work, testing and commissioning equipment, providing manufacturer’s warranties and performing its own warranty obligations.

Although certain court decisions have suggested that a contractor cannot be terminated for cause after substantial completion, those cases appear to conflate the concepts of substantial completion of the physical work of the project with substantial performance of all of the contractor’s material contractual obligations. As noted by the New York Supreme Court in March 2020’s McCormack Contracting, Inc. v. Triton Construction Co. LLC, “there must be substantial performance of all material contractual obligations—not just ‘substantial completion’ of the physical work….”

This concept takes on particular significance in the context of performance-bond claims for post-substantial completion obligations. Notably, performance bonds have been held to cover a contractor’s post-completion warranty obligations. For example, in 2012’s Sweetwater Apartments PA LLC v. Ware Construction Services, Inc., a U.S. district court in Alabama held that the surety and the subcontractor were jointly and severally liable for the performance of post-completion warranties. Furthermore, in C&I Enterprises, LLC v. Fidelity & Deposit Co. of Maryland in 2014, a Mississippi district court held that “where a contract covers warranty work, a default can be declared after substantial completion.”

Summary Judgment

The First Circuit Court of Appeals addressed these issues this year in Arch Insurance Co. v. Graphic Builders LLC when it reaffirmed the district court’s granting of summary judgment against a contractor that failed to first terminate a subcontractor prior to bringing a performance-bond claim, as is required under the terms of the bond.

In the case of Graphic Builders, the subcontractor manufactured and installed modular units for a residential construction project. The contractor subsequently put the subcontractor and its surety on notice of defects with the units, including leaking windows, as well as of the subcontractor’s failure to provide the window warranty—but the contractor never formally terminated the subcontractor. The contractor contended that the bond’s termination requirement was inapplicable to claims concerning the remediation of defective workmanship and to the subcontractor’s failure to comply with its post-completion obligation to provide a manufacturer’s warranty. The contractor further contended that, because the subcontractor’s work had reached substantial completion, it was barred as a matter of law from terminating the subcontract.

The court rejected these arguments and held that the contractor was required to terminate the subcontractor before bringing a performance-bond claim, even with respect to the claim for the failure to provide the window manufacturer’s warranty. The court further noted that the contractor had asserted that the work was not substantially complete when the bond claim was initially made.

In conclusion, the fact that the physical work is substantially complete is not necessarily a bar to termination, particularly when it is necessary to pursue a performance-bond claim in order to secure the performance of the contractor’s post-completion obligations.