Consequences of termination of principal building agreements

By Edwin Giesteira
I share some thoughts on the consequences of termination of principal building agreement by the employer due to contractor’s default.  (Part 1 of 3)

South Africa’s ongoing poor economic conditions have eventually led to failures by some of our large contractors. Such failures are normally preceded by poor performance that results from the increasing cash flow constraints. It is therefore not uncommon for contracts to be terminated by the employer, so as to attempt to rescue the project and limit costs of completion and delays.

JBCC00 1The employer is contractually entitled to secure the works on termination and to take over and use materials, plant and machinery that are on site to complete the works. Image credit: Pixabay

When a principal building agreement is terminated, the effect cascades down to numerous subcontractors and suppliers who are most often actually the ultimate risk bearers on behalf of the contractor.

A large number of projects are still using the 2007 Edition of the JBCC 2000 Series documents and it is therefore probably useful to look at what those contracts, in particular the Nominated/Selected (N/S) Subcontract Agreement which is the subject of this commentary, provide and what the consequences are for the N/S subcontractor.
It would seem there are two possible options available to such a subcontractor; namely, to uphold the subcontract and abide by the consequences of the provisions of the principal building agreement which are implemented vis-à-vis the contractor or alternatively to terminate the subcontract in terms of clause 38.3.

If a subcontractor chooses to uphold the subcontract, a particularly onerous provision in the principal building agreement is the effective suspension of payments until the final account for the completed project has been compiled, a final payment certificate is issued, and the damages claimed by way of the recovery statement. The residual sum, if there is any, is paid to the contractor. This could take extremely long, and in all this time, the subcontractor’s legitimately recoverable revenue is not available to it resulting in major hardship. Where insolvency supervenes, this further threatens the subcontractor’s potential recovery of its investment in the project.

The alternative of termination of the N/S agreement in terms of clause 38.3 could provide an attractive alternative. The writer’s thoughts on possible interpretation of those provisions follows… If it stimulates debate, this is to be welcomed as it will serve the industry well if subcontractors start engaging more actively in the standard documents under which they operate.

Termination of N/S subcontract

The N/S agreement provides at clause 38.3: ‘The subcontractor may give summary notice of termination to the contractor in the event of termination by the contractor or employer in terms of the principal agreement.’

It would seem that this clause refers to any termination of the principal building agreement by the employer or the contractor on the grounds of the other’s default. The subcontract specifically and separately provides:

  • At clause 37 for termination by the employer where the works have been destroyed; therefore, this is excluded and dealt with in terms of sub-clauses of this clause.
  • At clause 39 for termination for reasons associated with vis major1 and similarly requires the implementation of the sub-clauses under this heading.

The minute it comes to the subcontractor’s attention that either the employer or contractor has terminated the principal building agreement on grounds excluding those provided for at clauses 37 and 39, it can issue summary notice (without giving advance notice) of its own immediate termination of the subcontract. This should be done immediately as will be seen from the consequences of termination but also dependent on the status of payments on which it could impinge materially.

It is irrelevant to the subcontractor whether the termination of the principal contract was proper or not or on what default it was terminated. To protect its interests, the subcontractor should obtain a written document from some source confirming the termination to justify its actions in terms of clause 38.3.

There are three possible constraints that may impinge on this issue:

  1. Where the contractor rejects the termination – one of the legal options available to the contractor, if applicable, is to allege that the employer is repudiating the contract. Repudiation in such a case means that the employer is acting contrary to the terms of the contract. The relevant facts in such a case are objective and it is irrelevant whether the employer did not realise it was breaching the contract. How this impinges on the subcontractor is that the prejudiced party faced with a repudiation of the contract has a choice. It can either elect to accept the repudiation and sue for breach of contract, which provides a clear-cut termination in terms of clause 38.3, or it can elect to demand specific performance i.e. try to force the employer to abide by the contract. Where an election to demand specific performance from the employer leaves a subcontractor in terms of clause 38.3 becomes dependent on the facts in each case. It is probable that the subcontractor would be entitled to terminate on the basis of the manifestation of the employer’s intention to persist with the termination and argue the question of the legality of the termination in dispute resolution forums. The subcontractor should assess the balance of prejudice it faces and act accordingly.
  2. Where the subcontractor is in ‘material breach’ of contract and is therefore precluded from terminating the subcontract in terms of clause 38.6. It should be noted that such breach could probably be argued and proved after termination if not already alleged prior thereto. The question facing such a subcontractor would probably involve an analysis of its factual position at the time and the balance of prejudice it would suffer. It is submitted that the resultant prejudice the terminated contractor could prove in the event of the subcontractor choosing to terminate the subcontract could be arguable and that the subcontractor would probably find it preferable to terminate and rely on the benefits available to it in terms of clause 38.5 and leave it to the contractor to try to claim damages. The risk in the latter case would lie in the contractor’s ability to recover from the subcontractor’s security.
  3. The potential for the contractor (or the liquidator) to allege an improper termination and recover the funds available from the on-demand JBCC construction guarantee. This is a very real risk and the contractual disputes are not available as a defence to the obligation of the guarantor to pay upon receipt of the properly delivered notices from the contractor.

The effect of termination

Without becoming involved in legal detail, ‘termination’ means broadly that there is no contract and the terms of the contract fall away, leaving only the residual obligations and provisions as provided in the contract. The terms of the subcontract agreement have ongoing significance for purposes of damages claims as the source of the position that would have prevailed had the subcontract not been terminated. The termination clauses include provisions that guide the process and determine the rights and obligations of the various parties to the agreement after termination and these remain in force after termination by contractual stipulation. In terms of clause 38.3, these provisions are listed under sub-clauses 38.5.1 to 38.5.9 and are dealt with individually under the bulleted headings hereunder.

Neither party can force the other to continue the N/S works after termination. It is submitted that, unless the subcontractor is adamantly opposed to completing the N/S works, it is normally in the innocent employer’s interests to try to negotiate a continuation rather than a final parting. Although not always practically accessible (for example, with liquidity issues), the employer who is not in default potentially has a claim for damages to the extent that extra costs are reasonably incurred. Aside from the common law obligation to mitigate damages, an employer also normally has a very keen interest in avoiding delays and excessive costs because of practical limitations on funds available to it and the need for the investment to be financially active and viable. An astute subcontractor is able to gauge through negotiations with the employer, the tipping point where the latter will find the benefits of retaining the subcontractor’s services are outweighed by the burden of the subcontractor’s terms for completion of the N/S works.

All parties have access to urgent interdicts to enforce their immediate rights and should use them without procrastination in the event of any threat to their rights.

Draft notice

Possession, reservation of ownership and liens

It is not uncommon for the employer to issue notice of termination and then to have its security personnel occupy the site and evict all persons from the site shortly after. It is this latter action that may embarrass the employer. The installation of its own security on site is not necessarily an illegal action as, on termination, the employer acquires certain rights such as those in terms of PBA clause 36.5.5 ‘The employer may employ other parties to safeguard the works, complete the outstanding work …” and PBA clause 36.5.6 ‘The employer may use the contractor’s materials… plant… machinery’ which means that the employer is contractually entitled to secure the works on termination and to take over and use materials, plant and machinery that are on site to complete the works.

The danger to the employer, if it takes over the site aggressively and evicts the contractor, is that it could be seen as taking the law into its own hands2 and a spoliation order could be available to the contractor in such cases. Per Gorven J at paragraph 4 in Taddese and others v Peer NO and others (5250/2016) [2016] ZAKZDHC 26 (4 August 2016), quoting in turn from Ivanov v North West Gambling Board & others 2012 (6) SA 67 (SCA) para 19 and based on Voet 41.2.16:

‘There are only two requirements for spoliation relief; that the applicants were in peaceful and undisturbed possession of the disputed premises and that they were deprived of that possession without consent or recourse to law. The fact that the applicants’ possession is wrongful or illegal is irrelevant. The underlying rationale is that persons should not take the law into their own hands. If these two requirements are proved, possession is restored without any enquiry being made into the legal rights of the parties to possession.’

It is submitted that the employer should act decisively in accordance with the terms on which it relies but take great care to avoid any unreasonable force in carrying out its actions so as not to run afoul of these legal principles. If there are potential liens it should ensure they are noted by the principal agent and respected and dealt with to avoid conduct that could also constitute dispossession. It should particularly not prevent reasonable access for senior staff who may need to be involved in assessing the work status report and final account matters and should also not be seen to be taking over any goods of which it is not entitled to take over control or possession.

The subcontractor has similar rights which are equally enforceable, but it may have to found and enforce them differently and should seek legal advice as it would have difficulty proving peaceful and undisturbed possession of a site3. The right to the enforcement of a lien by a subcontractor is only available through a claim for compensation which it secures. The subcontractor should distinguish between its right to ownership of materials not ‘delivered’ to the employer in terms of the applicable common law and the contract (which is, any reservation of ownership it may be entitled to enforce) and a debtor’s lien it may have over goods. The latter requires that the lien protects a sum which is already due and payable. The need for the subcontractor to have well-marked lockable stores for its materials4 and stickers on any definable and detachable goods such as plant, buildings and independent structures, should be evident from these considerations.

In the case of an employer with a legitimate complaint and with honourable intentions there is a degree of benefit if it acts decisively in that all evidence and work is protected. However, where an employer is intent on protecting its own patrimonial interests at all costs, it may well result in the dispossession of the subcontractors’ property and an attempt to alienate its liens leaving it to the subcontractor to attempt to recover revenue from the contractor (see also the Buzzard Electrical vs 158 Jan Smuts Avenue Investments and other 1996 (4) SA 19 (A), which found that the subcontractor has no enrichment claims against the employer). In such cases the establishment of liens and rights of ownership on materials delivered but not yet paid is important and immediate employment of experienced legal practitioners, preferably before the termination is implemented, becomes very important in addition to the enforcement of the NSSA provisions.

Guarantees and security

Although a discussion of the subcontractor’s liability in terms of its guarantees falls outside the scope of this article, a brief mention is appropriate.

1: With regards to payment guarantee by the contractor to the subcontractor (which is an on-demand guarantee), the existing guarantees, in terms of their own provisions, remain in force until the earlier of:

  • the settlement of the final payment advice in terms of the Agreement; or
  • on payment in full of the Guaranteed Sum; or
  • the Guarantee expiry date.

This last option is particularly important because it is not uncommon for the guarantor to seek to insert such a date on the basis of the construction programme. Whilst the contract is in process, there are remedies available to enforce renewal of the guarantee when it expires before the issue of the final payment advice but, after termination there is little a subcontractor can do and for this reason the insertion of an expiry date should be carefully weighed against the effect of and possibility of termination.

2: With regards to the subcontractor’s construction guarantee which at clause 11 specifically provides only for expiry:

  • in terms of clauses 1.1.4 (issue of the final payment advice for variable guarantees); or
  • clause 2.1 (the last certificate of practical completion for fixed guarantees with cash retention until final payment advice); or
  • in terms of clause 14.7.1 (cash retention sum reducing after the issue of the final payment advice).

Therefore, the construction guarantee or cash retention remains in force until the issue of the Final Payment Advice unless a specific expiry date supervenes. It is submitted that, where no call is made on a construction guarantee, its value would be as applicable at the date of termination.

Payment by the guarantor is inter alia dependent on the contractor’s bare allegation of either:

  • a failure to make payment to the contractor in terms of a payment advice statement (which is issued by the contractor); or
  • termination of the subcontract due to the subcontractor’s default.

Both these averments are entirely in the contractor’s control and the guarantor is not able to contest the release of the sum on the basis of any dispute as to the correctness of the contractor’s averment because such a dispute falls outside the terms of the guarantee and only within the provisions of the N/S agreement which are not part of the guarantee. A subcontractor terminating in terms of clause 38.3 could find itself unable to oppose the contractor’s collection of the sum guaranteed and should ensure it has considered this possibility, especially where insolvency of the contractor has supervened and the liquidator is trying to augment the funds available to it5.

3:  The advance payment guarantee, which is a guarantee between the subcontractor and the employer, is dealt with in terms of clause 38.5.8 (to be discussed in the next article).

 *Note: this is not a legal opinion and no liability for reliance on its contents attaches to the writer or sender.

To be continued in an upcoming edition of Cold Link Africa.

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