A cautionary tale on sub-optimal termination

The termination of a contract is a serious matter that can arise all too commonly in the construction industry. It is an area fraught with risk and the consequences for wrongfully terminating a contract – even where you think you have the right to do so – can be severe as an employer learned in the High Court decision of Optimus Build Ltd v Southall [2020] EWHC 3389 (TCC).

Background

Southall engaged Optimus Build Ltd. (“Optimus”) to carry out works on a property in England. A dispute eventually arose as to whether the price of the contract was fixed or whether it was a “cost plus” contract under which Optimus could recover overheads and profits based on its monthly costs.

More interestingly, a dispute also arose as to whether the contract had been terminated and, if so, by which party. Optimus had not been paid and suspended works at the site. It wrote to the employers suggesting a meeting to resolve the payment dispute and clarify the contractual basis on which the works were to be carried out including a programme for future payments. The employers felt that, by suspending the work and requesting a meeting, Optimus was “holding a gun to their heads”.

The employers responded that they intended to seek “alternative arrangements” and demanded that Optimus remove its equipment from the site. Each party accused the other of a repudiatory breach of contract. A repudiatory breach of contract is a term that can have many meanings depending on its context. In these circumstances, it means a serious breach of contract where one party effectively rejects the contract before performance is due by making it clear that it does not intend to comply with its contractual obligations allowing the other “innocent” party to accept the repudiation and bring the contract to an end. This is sometimes also referred to as “anticipatory breach”.

The employers argued that the cessation of works by Optimus amounted to a repudiatory breach as it had no right to suspend the works due to the non-payment. Because of Optimus’s repudiation it approached other contractors to complete the works and sent an email accepting Optimus’s repudiation of the contract and bringing the contract to an end.

Optimus however said that it was not in breach and had not repudiated anything. The employers had repudiated the contract by making alternative arrangements and throwing Optimus off the site. So, Optimus had accepted the employers’ repudiation, left the site and submitted its final account.

Both parties said the contract had been repudiated and it was at an end; but each said the repudiation was by the other.

The court's findings on termination

The court concluded that Optimus’s offer to discuss a solution to the disagreement had arisen between the parties as to payment did not amount to a repudiation of the contract. The court dismissed the employers’ argument and held Optimus was justified in complaining about non-payment and was entitled to seek to agree a programme of payment. The court’s interpretation of Optimus’s actions was that Optimus was saying it wanted a meeting to resolve the issues in dispute between the parties rather than saying it intended to cease all work.

The court then went on to analyse whether the employers had repudiated the contract and, if so, whether this repudiation had been accepted by Optimus. The court had little difficulty in concluding that the employers’ email stating it intended to seek “alternative arrangements” could amount to a repudiatory breach and that Optimus had accepted this when it submitted its final account.

HHJ Stephen Davis awarded Optimus its claim for the work done together with its claim for lost profits and expected overhead on the remainder of the project.

The court also considered whether Optimus’s claims of lost profit should be subject to VAT. Traditionally, claims for damages arising on a breach of contract had not been subject to VAT. However, recent guidance issued by the UK tax authorities stating that early termination payments should be subject to VAT persuaded the court to award VAT on its lost profits claim without ruling on whether such sums were, in fact, chargeable to VAT.

Practical points

Clarity is required in all contractual terms but in few areas is it more important than termination provisions. In most contracts, a serious breach by the other party will give you a right to terminate. However, if you exercise that right wrongly (perhaps the other side is not actually in breach, or the breach is not sufficient to give a right to terminate) then you will have repudiated the contract, and the other party can accept that repudiation, end the contract, and claim damages. Termination is thus always a dangerous thing to do and must be done with the utmost care.

The case before the court on this occasion concerned a contract without properly drafted termination provisions. However, the principles discussed in the case as they related to repudiation and termination apply globally and could bite where a termination clause does not operate in a straightforward manner.