Any prime contractor in business for more than a few years has encountered an underperforming subcontractor, and in extreme circumstances, has been confronted with the decision whether to declare a default and seek a replacement. One popular option is to avoid the risk of nasty default termination fight and simply issue a termination for convenience—assuming the subcontract contains a clause allowing such termination. A decision out of Oregon serves as a warning against this practice—unless the termination for convenience clause addresses how subsequently discovered defective work will be handled.
Shelter Products, Inc. v. Steelwood Constr., Inc., 307 P.3d 449 (Or. App. 2013) involved a dispute between a prime contractor on a Home Depot store project and its steel subcontractor. The prime contractor entered into two agreements with the same subcontractor—a purchase order covering fabrication of all steel for the project and a subcontract covering steel erection. The subcontract contained a fairly typical termination for convenience clause providing that the prime could terminate the subcontractor at any time for no reason, in which case the subcontractor would be entitled to the cost of all work performed as of the date of termination.
After the subcontractor delivered all steel required for the project, it invoiced the prime contractor for the entire $300,000 amount of the purchase order. The prime did not pay the invoice immediately, and not long after the subcontractor began erection work, it sent the subcontractor a letter on a Friday outlining concerns it had about the progress and quality of the work on the project. The letter concluded that “on Monday morning we will evaluate where you are and how to best assist you in meeting your contractual obligations.” However, the next day, the prime terminated the contract for convenience, and the subcontractor vacated the site.
The prime refused to make any payment to the subcontractor under the purchase order or for erection performed under the subcontract. It also hired another subcontractor to complete the project and, according to the prime, it incurred additional costs correcting defective work. The prime contended that it spent $61,668 correcting the subcontractor’s defective work, $276 cleaning up debris left by the subcontractor, $150 to hire a locksmith to enter the subcontractor’s materials storage unit, and $13,350 in additional labor and travel costs coordinating and supervising the corrective work.
The subcontractor filed a lien against the project for $369,679.30. Several of the subcontractor’s suppliers and rental vendors also filed liens, which the prime contractor bonded off and then eventually paid in full. In the ensuing litigation, the subcontractor argued that the prime contractor’s claim for costs incurred correcting allegedly deficient work could not be set off from amounts otherwise due and owing because the prime terminated the subcontractor for convenience, not default, and the subcontractor was never given any notice or opportunity to correct the work. The trial court agreed and the prime contractor appealed.
On appeal, the prime contractor argued that even though it terminated the subcontractor for convenience, it continues to have a “right in breach of contract against [the subcontractor] for its breach of the Subcontract by performing its work in a deficient manner.” The subcontractor, on the other hand, argued that the trial court was correct when it rejected the prime’s request for a setoff because the prime terminated the subcontractor for convenience—rather than for default—and that it failed to provide notice to the subcontractor and an opportunity to inspect, cure or complete allegedly defective work. In other words, in the subcontractor’s view, a prime cannot assert a setoff after it has terminated a subcontractor for convenience.
The appeals court agreed with the trial court and the subcontractor, and held that, contrary to the prime contractor’s assertions, “the text of the termination for convenience clause does not, under the circumstances of this case, permit the prime to both terminate the subcontractor without cause and subsequently proceed against the subcontractor as if it had terminated the agreement for cause.” It thus reaffirmed the lower court decision to deny the prime its defective work damages.
The prime’s decision to terminate the subcontractor for convenience rather than for default was, no doubt, a decision aimed at avoiding the fight associated with a wrongful termination. However, this particular court imposed a duty on the prime to provide notice to the subcontractor and an opportunity to cure any subsequently discovered defective work.