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In this third quarter issue of Master Builders Journal for 2010, BK Burns & Ong Sdn Bhd, a subsidiary of BK Asia Pacific, a regional group providing project, commercial and contractual management services joins with Entrusty Group, a multi-disciplinary group, collectively named as BK Entrusty, presents a new series of contract and management articles in construction related areas of project, commercial, contracts, risks, quality and value, on “Can the Contractor’s employment be determined or its contract terminated upon substantial completion of the Works ?”

Introduction

The construction industry is a complex industry with many parties involved in its process and operations, often brought together to work for a particular project. Due to its multi- faceted nature and involvement of numerous parties, disputes are often inevitable. One common dispute in the construction industry is the issue of ‘determination’ of the Contractor’s employment or termination of the contract by the Employer or the Contractor itself.

In this article, BK Entrusty aims to provide readers with an overview and understanding of this pertinent issue as to whether the employment of a Contractor (or even Sub-Contractor) can be determined or its contract (or Sub-Contract, as the case may be) terminated when the progress and/or stage of the Works is substantially completed.

The following are the sub-headings to the contents of this article;

• Introduction

• Distinction between Determination and Termination

• Common Law Termination

• Contractual Determination / Termination

• Termination for Convenience

• Can Determination or Termination occur when the Works is substantially completed ?

• Conclusion

• References / Bibliography

We shall first explain the distinction or difference between the terms “Determination” and “Termination” in construction contracts, then examine and review the common routes of termination existing in the laws of Malaysia, followed by the pertinent contractual clauses on determination and/or termination in the standard forms of construction contract commonly used in Malaysia.

Distinction between Determination and Termination

One of the common problems in the construction industry which often has serious implication on the project and the parties concerned is the determination of the Contractor’s employment under the contract or termination of the construction contract. The Contractor’s employment can be determined or a construction contract can be terminated by an express term in the contract such as determination/termination clauses, or termination at common law.

Termination is not the same as Determination. It is the Contractor’s employment which is determined, not terminated, whereas a contract can be terminated, but not determined. When the employment of the Contractor has been determined, the procedures, mechanisms and forms of recovery and remedies are as provided in accordance with the provisions of the contract. On the other hand, when a contract has been terminated, then such recovery

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and/remedies are to be dealt with outside the contract i.e. at law, when there is no express provision under the contract.

From the foregoing two judicial decisions, it can be noted that not every breach gives rise to an entitlement to terminate the contract. Only repudiatory breach that goes to the root of the contract will entitle the innocent party to terminate the said contract, if the innocent party accepts such repudiation by rescinding the contract.

In Malaysia, a contract can be terminated in law under Section 40 of the Contracts Act 1950, which reads:

“When a party to a contract has refused to perform, or disabled himself from performing, his promise in its entirety, the promisee may put an end to the contract, unless he has signified by words or conduct, his acquiescence in its continuance.”

Contractual Determination / Termination

Most construction contracts whether in bespoke forms or standard forms of contract, would normally incorporate an express provision and/or clause, setting out the parties’ rights and remedies in the event of determination of the Contractor’s employment or termination of the contract.

Clauses 25 and 26 of PAM 2006 Standard Form of Building Contract provide for the determination of the Contractor’s employment by the Employer and the determination of its own employment by the Contractor, respectively.

Similarly, Clauses 44 and 45 of CIDB 2000 Standard Form of Contract for Building Works provide for determination by the Employer and determination by the Contractor, respectively.

In PWD Form 203 (Rev.2007), Clauses 51, 52 and 53 respectively provide for termination by the Employer, as follows;

• based upon events and consequences of default by the Contractor;

• on national interest; and

• on corruption, respectively.

It is to be noted that although PWD Forms only provide for termination of contract, they envisage the procedures, mechanisms and forms of recovery and remedies to be within the contract, and not outside the contract. There is no express provision for termination by the Contractor, hence any termination by the Contractor can only be

Further reading on the distinction between Determination and Termination can be found in the past MBAM Journal article by Entrusty on “Is Determination

Of Employment And Termination Of Contract The Same In Meaning And Implications” published by MBAM.

Common Law Termination

The termination of contract at common law occurs when a valid and enforceable contract is brought to an end either by it becoming impossible to perform due to unforeseeable circumstances at the time the contract was formed or by the actions of one or both parties.

In Teh Wan Sang & Sons Sdn Bhd v See Teow Chuan [1984], the High Court held that:

“A repudiation in advance by one party to a contract, that he will not perform it before the arrival of the time for the performance by the repudiating party, does not, by itself, amount to a breach of contract, though it may optionally be, of course, regarded as such a breach by the other party in treating it as at an end.”

In Ching Yik Development Sdn Bhd v Setapak Development Sdn Bhd [1996], the High Court held that:

“… where the term that has been flouted is fundamental to the contract, the innocent party is entitled to treat himself as being discharged from further obligations under it. But where the obligation that has been breached is only subsidiary or minor in nature, the innocent party may not treat himself as being free of his obligations under the contract, although he may sue and recover damages for the non-performance of the subsidiary term … A party who terminates a contract or treats it as having come to an end in reliance upon the breach of a non-fundamental term is himself guilty of a breach of a contract.”

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done at law, unless the disputing parties agree to a mutual termination.

Termination for Convenience

Termination for Convenience clauses are predominantly used by Employers to unilaterally terminate a contract without having to prove default of the Contractor. Such clauses have been held by courts to be enforceable, provided that the termination is done in good faith and is not fraudulent.

The following standard forms of construction contracts used locally and internationally have express provisions for Termination for Convenience by the Employer;

Clause 46.1 of CIDB 2000, which reads, as follows;

“Clause 46.1 Right of the Employer to Terminate

The Employer may at any time, give to the Contractor 30-Day notice of termination of the Contract. Upon the expiry of 30 Days from the receipt of such notice the Contract shall be terminated.”

Clause 52.1 of PWD Form 203A (Rev. 2007) and Clause 62.1 of PWD Form DB (Rev. 2007), which reads, as follows;

“Termination

a) Notwithstanding any provision of this Contract, the Government may terminate this Contract by giving not less than thirty (30) days written notice to that effect to the Contract (without any obligation to give any reason thereof) of the Government considers that such termination is necessary for national interest, national policy or national security.”

In a reputable and common international construction contract, FIDIC, Clause 15.5 of FIDIC 1999 Conditions of Contract for Construction of Building and Engineering Works designed by the Employer, provides that;

“Clause 15.5 Employer’s Entitlement to Termination

The Employer shall be entitled to terminate the Contract, at any time for the Employer’s convenience, by giving notice of such termination to the Contractor. The termination shall take effect

28 days after the later of the dates on which the Contractor receives this notice or the Employer returns the Performance Security. The Employer shall not terminate the Contract under this Sub-Clause in order to execute the Works himself or to arrange for the Works to be executed by another Contractor.”

As can be seen from the aforementioned clauses, the Employer has been given a unilateral power to terminate the contract without the necessity to cite reason/s in support for the termination.

In the case of Bains Harding (Malaysia) Sdn Bhd v Arab-Malaysian Merchant Bank Bhd & Others [1996], the Court had discussed at length the issue of good faith in the exercising of such termination of convenience provided under the contract.

Can Determination or Termination occur when the Works is substantially completed?

From the foregoing discussion, it is clear that determination and/or termination can be effected through provisions in the contract based upon specific and/or relevant events of default by the Contractor such as Clause 25 and 26 of PAM 2006 and Clause 51, 52 and 53 of PWD 2007, respectively. However, the position can be ambiguous under the standard forms of conditions of contract as to whether the Contractor’s employment can be determined and/or its contract terminated when the Works has been substantially completed by the Contractor.

In order to answer the aforesaid question, the issue that needs to be first identified would be whether the contract and/or agreement between the parties were a divisible or entire contract. Chitty on Contracts (23rd Edition) Volume 1 states in paragraph 1147, as follows:

“In an entire contract, complete performance by a party is a condition precedent to the liability of the other; in such a contract the consideration is usually a lump sum which is payable only upon complete performance by the other party. The opposite of an entire contract is a divisible contract, which is separable into parts, so that different parts of the consideration may be assigned to severable parts of the performance, e.g., an agreement for payment pro rata. It is a question of construction of the contract whether it is entire or divisible, but in the reported cases (none of which is of recent date) the courts have tended to the view that in

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every lump-sum contract there is an implied term that no part of the price is to be recovered without complete performance. In most modern contracts of any size, however, payments by instalments are specified, so that the law on entire contracts is not often relevant to contracts nowadays.”

In the case of Hoenig v Isaacs [1952], the court held that:

“… first question is whether, on the true construction of the contract, entire performance was a condition precedent to payment. It was a lump sum contract, but that does not mean that entire performance was a condition precedent to payment. When a contract provides for a specific sum to be paid on completion of specified work, the Courts lean against a construction of the contract which would deprive the contractor of any payment at all simply because there are some defects or omissions. The promise to complete the work is therefore construed as a term of the contract, but not as a condition. It is not every breach of that term which absolves the employer from his promise to pay the price, but only a breach which goes to the root of the contract, such as an abandonment of the work when it is only half done. Unless the breach does go to the root of the matter, the employer cannot resist payment of the price. He must pay it and bring a cross-claim for the defects and omissions, or alternatively set them up in diminution of the price. The measure is the amount which the work is worth less by reason of the defects and omissions, and is usually calculated by the cost of making them good.”

In the High Court’s decision of Ming & Co v Leong Ping Ching [1964], it was held that:

“… an entire contract is one in which the entire completion of the work by the contractor is a condition precedent to payment. A contract in respect of which progress payments are made from time to time … is not an entire or lump sum contract …”

Further, the Federal Court in Tan Hock Chan v Kho Tech Seng [1980], held that:

“… contract is clearly not a lump sum contract, in view of the provision for progress payments: Ming & Co v Leong Ping Ching [1964] …”

From the foregoing judicial decisions, it is evident that a lump sum contract is construed to be an entire contract where the complete performance by one party is a condition precedent to the right to call for the fulfilment of the contractual obligations of the other party under the contract. However, a lump sum contract with an express provision for interim progress payment, does not require the Contractor to entirely complete his performance of the Contract before being paid by the Employer. Such contracts are divisible contracts as opposed to an entire or a lump sum contract.

A Contractor would not be entitled to any payment, even partially, if construction contracts are entire contracts, if the works are not fully completed. Therefore, the strict application of the rule of complete and/or entire performance may result in injustice to the Contractor, particularly when he had substantially performed the contract but has not completed or reached the stage of full performance yet, such as minor or inconsequential defects or omissions.

As a result of the legal difficulties in the rule of entire contracts, the doctrine of substantial performance had evolved to allow the Contractor to recover the contract price but subject to it being adjusted to allow for deductions of any cross claims for defective works and the value of the portion of the works that had not been performed.

What is called “substantial completion” or commonly known as “practical completion” in the construction industry usually occurs when the Superintending Officer (hereinafter referred to as “SO”) is of the opinion that the works had been substantially completed and so certifies to that effect. This will trigger the start of the defects liability period and the Contractor can secure the release of the first half of the retention money.

The term ‘substantial completion’ is however not explicitly stated in most forms of standard construction contract, including PAM 2006 or in PWD Forms. Consequently, one will need to look to common law for its definition.

In Hoenig v Isaacs [1952], Lord Justice Denning (as he then was) said that,

“…under the doctrine of substantial performance, a promisor who has substantially performed his side of the contract may sue on the contract for the agreed sum, although he remains liable

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in damages for his partial failure to fulfil his contractual obligations.”

From the aforesaid doctrine, it is apparent that the promise to complete the work is construed as a term of the contract as opposed to a condition. Therefore, if substantial performance of the contract does not contribute to the partial failure to fulfil the Contractor’s contractual obligations that goes to the root of the contract, termination of the contract may not be possible.

From the aforesaid judgment, it is clear that the doctrine applies only to cases and/or circumstances where there has been part or substantial performance to the contractual obligations under the contract or where only a minor part of the contract is incomplete or where performance is defective. It has no application when there has been no performance at all.

In a Singapore High Court case of Sapiahtoon v Lim SiewHui [1963], Buttrose J held that:

“… upon its true construction, the agreement between the parties was an agreement … for a lump sum … and that under the exact or strict performance rule, it would be necessary for the defendant to show that he had performed his obligations fully and completely … But the rigour of the exact performance rule is mitigated by the doctrine of substantial performance … the defendant was entitled to the $1,500 withheld by the plaintiff subject to the plaintiff’s claim for the cost of completing the building … as well as remedial work …”

The next issue that required to be examined would be whether the contract can be terminated if the Contractor had substantially completed its contractual obligations under the contract, where works or defects of a minor nature are still to be executed?

The strict application of the rule of complete performance would mean that the party could reject such performance, when there are trivial deficiencies. However, it is not the position of the law as such a circumstance is relieved by the legal maxim of de minimis which means that ‘the law does not concern itself with trifles’.

In the case of Bolton v Mahadeva [1972], the English Court of Appeal indicated that:

“… where a contract has been substantially performed, the test was substantial performance and not whether the defects were of such a trifling nature that they could be disregarded under the de minimis rule and in considering whether there had been substantial performance it was relevant to take into account both the nature of the defects and the proportion between the cost of rectifying them and contract price.”

In addition to the above and as reported in the book of ‘Contract Law in Malaysia’, in Shipton, Anderson & Co v Weil Brothers & Co [1912] where there was a contract for the sale of a cargo of wheat. The contract provided for the delivery of not more than 4,590 tons. The plaintiff delivered a surplus of 55 pounds, not claiming for the surplus, but the defendant buyer rejected the whole cargo. The court held that:

“… the excess was so trifling that it could be ignored.”

From the foregoing judicial decisions, it is apparent that substantial performance had been achieved.

It is also evident from judicial decisions, as described hereinafter, that de minimis defective works do not amount to abandonment and/or refusal to perform the contract. It is merely a carelessness and/or negligence insofar as workmanship is concerned.

In the English Court of Appeal’s case of H Dakin & Co Limited v Lee [1916], Lord Cozens-Hardy MR dealt with the case, as follows;

“… in a contract … for a lump sum, the defect in some of the items in the specification, or the failure to do every item contained in the specification, puts an end to the whole contract, and prevents the builders from making any claim upon it; and therefore, where there is no ground for presuming any fresh contract, he cannot obtain any payment. The matter has been treated in the argument as though the omission to do every item perfectly was an abandonment of the contract. That seems to me, with great respect, to be absolutely and entirely wrong …”

In another Court of Appeal’s case of Young (t/a All Counties Tarmacadam) v Thames Properties Ltd and Another [1999], the Court held that:

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“… as one of negligence and bad workmanship, and not as a case where there has been an omission of any one of the items in the specification. The builders … had done all that was intended to be done in reference to the contract; and I suppose the defects are due to carelessness on the part of some of the workmen or of the foreman: but the existence of these defects does not amount to a refusal … to perform part of the contract …”

Further, Pickford L J agreed and said in his judgment:

“… I cannot accept the proposition that if a man agrees to do a certain amount of work for lump sum every breach which he makes of that contract by doing his work badly, or by omitting some small portion of it, is an abandonment of his contract …”

From the foregoing judicial decisions, it is obvious that in a situation where a Contractor has committed de minimis defective works when its works reached the stage of substantial completion, the Employer may not be able to terminate the contract in the absence of a contractual provision entitling the Employer to do so.

The remaining question is whether the Employer can terminate the contract with a “termination for convenience” clause when the physical works on site have reached the stage of substantial completion. The answer may lies in whether the termination was exercised in bad faith such as when the termination was for the purpose of avoiding paying for the balance of the profit on the remaining works. Such termination will constitute as a breach of contract and wrong at law.

Conclusion

Substantial completion of Works for a construction contract certainly constitutes incomplete fulfilment of the Contractor’s contractual obligations under the contract. However, whether it is a ground for termination or determination is very much dependent on the intention/action of the contracting parties. In common law termination, substantial completion with de minimis defective works may not be sufficient for the Employer to rescind or terminate the contract unless the breach is so serious and fundamental that goes to the root of the contract, such that the Employer cannot use it for its intended purposes.

In view of the above, Employers must exercise with care and be absolutely sure with respect to determination of employment or termination of a construction contract when it reaches the stage of substantial completion, otherwise the Employer determining or terminating can be in repudiatory breach situation and liable for damages on wrongful termination.

In the next issue of the MBAM journal, BK Entrusty article will deal with a common contractual issue on “What is Head Office Overheads claim ?”

References/Bibliography

1. Chitty on Contracts (23rd Edition) Volume 1.

2. Sir Anthony May, Adrian Williamson & John Uff, ‘Keating On Building Contracts’ (6 Edition) 1995.

3. John Uff, ‘Construction Law’ (Ninth Edition) 2005.

4. Sundra Rajoo, Dato’ WSW Davidson &Ir Harban Singh KS, ‘The PAM 2006 Standard Form of Building Contract’ 2010.

5. Krishnan Arjunan, Abdul Majid bin NabiBaksh, ‘Contract Law in Malaysia’ (2008).

6. Entrusty Group, ‘Is Determination Of Employment And Termination Of Contract The Same In Meaning And Implications ?’, Master Builders Journal (2nd Quarter 2008), MBAM.

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Entrusty Group is a multidisciplinary group of companies which comprises Entrusty Consultancy Sdn Bhd (formerly known as J.D. Kingsfield (M) Sdn Bhd), BK Burns & Ong Sdn Bhd (a member of BK Asia Pacific Ltd, Hong Kong), Pro-Value Management Sdn Bhd (in association with Applied Facilitation & Training, Australia) ,International Master Trainers Sdn Bhd (in association with Master Trainer of New York), Agensi Pekerjaan Proforce Sdn Bhd, Alpha-Omega Matrix and Entrusty International

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Pte Ltd. The Group provides comprehensive consultancy, advisory and management services in project, commercial, contracts, construction, facilities, risks, quality and value management, cost management, executive search/personnel recruitment and corporate training/seminars/workshops to various industries particularly in construction, petrochemical, manufacturing and IT, both locally and internationally. For further details, visit www.entrusty.com.

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BK Asia Pacific is group of companies incorporated in the Asia Pacific Region providing a comprehensive network of project management, commercial and contract management services to the international construction industry, with offices in Cambodia, China (Hong Kong, Shanghai), Malaysia, Philippines, Singapore, Thailand, Vietnam, United Kingdom and United Arab Emirates. For further details, visit www.bkasiapacific.com.

BK Entrusty provides 30 minutes of free consultancy (with prior appointment) to MBAM members in the areas of project, commercial, contracts, risks, quality and value management, For enquiries, please contact HT Ong at BK Entrusty, 22-1& 2 Jalan 2/109E, Desa Business Park, Taman Desa, 58100 Kuala Lumpur, Malaysia. Tel: 6(03)-7982 2123 Fax: 6(03)-7982 3122 Email: htong@entrusty.com.my or htong@bkasiapacific.com

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