To walk off or not to walk off

A lesson in subcontract termination actionability

Blog Entry July 07, 2015

Larry Caudle is a principal in Kraftson Caudle LLC, a law firm in McLean, Va., specializing in heavy-highway and transportation construction.

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Thankfully, most disputes between prime and subcontractors do not result in the subcontractor walking off the project or the prime terminating the subcontract.
 
However, most subcontracts address this situation, at least with respect to providing a procedure for a prime to terminate in the event of subcontractor default. Some more two-sided subcontracts, such as those published by industry groups, also include a similar remedy for subcontractors in the event they do not receive timely payments for their work. 
 
In most instances, failing to adhere to the specific steps, procedures and requirements set forth in subcontract termination provisions will be fatal to a contractor’s efforts to terminate a subcontractor or a subcontractor’s effort to legally cease its performance. This is an expensive mistake and can result in the innocent party paying the other’s damages. However, a recent case decided in New York illustrates a rare instance where a court essentially ignores the non-breaching party’s failure to follow subcontract termination procedures. 
 
In U.W. Marx, Inc. v. Koko Contracting, Inc., 2 N.Y.S.3d 276 (Sup. Ct. App. Div. 3d Dept. 2015), a subcontractor performing roofing work for the prime on a Veterans Administration project ceased work when the prime fell three months behind on payments. When workers failed to show up for work, the prime contractor issued a letter giving the subcontractor three days to cure the default or be terminated. On the third day, the subcontractor belatedly provided the prime with a seven-day notice of its suspension of work based upon the prime’s failure to make timely progress payments as called for in Section 4.7.1 of the subcontract. The prime ultimately terminated the subcontract and sued to recover damages incurred hiring another subcontractor to finish the project. The subcontractor filed a counterclaim seeking unpaid invoices and other damages arising from the termination.
 
At trial, the prime’s witnesses testified that the prime’s non-payment of progress applications was justified for reasons associated with the subcontractor’s performance. In the end, however, the court believed the subcontractor’s witnesses were more credible and concluded that no legitimate reason existed for the prime’s failure to make timely progress payments. 
 
Next, the prime argued that even if it materially breached the subcontract by failing to make timely progress payments, the subcontractor wrongfully ceased its performance because it failed to first provide seven days’ written notice as required by the subcontract. That provision stated as follows:
 
If the Contractor does not pay the Subcontractor through no fault of the Subcontractor, within seven days from the time payment should be made as provided in this Agreement, the Subcontractor may, without prejudice to any other available remedies, upon seven additional days’ written notice to the Contractor, stop the [w]ork of this Subcontract until payment of the amount owing has been received. The Subcontract Sum shall, by appropriate adjustment, be increased by the amount of the Subcontractor’s reasonable costs of demobilization, delay and remobilization.
 
The subcontractor clearly did not comply with the notice provision because it had ceased performance a week before giving notice to the prime. However, it countered with a well-established, but rarely enforced legal doctrine known as the “first to breach” rule, which stands for the proposition that once one party materially breaches a contract, the other party is excused from future performance and the breaching party can no longer enforce the contract terms against the non-breaching party for subsequent acts. The court agreed and held that “[the prime] cannot preclude [the subcontractor] from recovering for [the prime’s] material breach of the contract by relying on [the sub’s] subsequent failure to comply with a clause that inures to [the sub’s] benefit.”
 
Although the “first to breach” rule is broadly accepted around the U.S., in practice, courts seem reluctant to apply it regularly. Consequently, although contractors should be aware of the rule and resort to it in argument when required, they should not rely upon it. Also, terminating a subcontractor if you are a prime or walking off the project if you are a subcontractor is an extreme act that should be carried out only in the rarest instances because the cost of being wrong will very often be significantly higher than staying the course and arguing about it through the disputes process. R&B

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