Typical Issues
Termination valuation involves verifying the value of any work done. This encompasses any in progress procurement and the direct consequences of termination. The following issues tend to arise in this area:
- Termination is primarily a contractual mechanism, whereby an Employer or a Contractor asserts its contractual right to give notice of termination under the Contract. The triggering of this mechanism depends upon the circumstances – it can be triggered by default, convenience or at will, and will involve different terms of valuation.
- Termination disputes often turn on the facts, which can cause the basis of termination to be challenged, matters to become complex and prolong project delivery; it is common to see allegations of wrongful termination and counterclaims.
- A common feature of termination is the valuation of progress at the point of triggering termination. This depends upon the records of the works completed by the Main Contractor and its Subcontractors. The supply of any materials procured or subject to partial procurement at the date of termination. More fundamentally the Employer may take a position with regard to overpayment and value for money.
Insight
In our experience, different valuations are proffered by Contractors and Employers. The Contractor’s valuation at termination will seek recompense for any direct costs and loss of opportunity arising out of the termination, while the Employer’s valuation will rely upon the tangible benefits gained by the Contractors delivered work, the additional costs post-termination, as well as the retendering and completion values (i.e., the balance of the works to be undertaken post-termination).
There are different methods of termination. Full termination is the standard method, but some Contracts provide for partial termination.
The fractious nature of termination means that progress measurement at termination is not always conducted. A joint record of measurement may result in conflicting interpretations over what value has been achieved, often relying upon the last interim application. Time-related costs or logistics are ordinarily valued on a monthly basis and then paid on the assumption that the works will be completed. However, this may become contentious following termination. Depending on the valuation rules under the Contract, the standard monthly valuation may be replaced by a value-based proportionality test at termination.
If a Contractor submits a termination valuation, this should ideally be supported with a backup audit trail, indicating the progress of works at the time of termination. It may well be that elements of the work are then taken over by the incumbent Subcontractors to the terminated Main Contractor may be novated or new arrangements being put in place with the incumbent Subcontractors for the works subsequently managed by the Client or a follow-on Contractor. The commercial onboarding of the Subcontractors may import legacy issues around payments and progress paid under those Subcontracts. Depending on the subcontract arrangements, the measurement and valuation of the Subcontract works may or may not be on the same progress measurement as that under the Main Contract.
Where the Contractor demobilises significant plant and equipment that was planned for the terminated project and cannot readily be deployed elsewhere, there could be a claim for extended durations of rental charges. Typically, this involves a test of whether the costs arising from the termination can be said to be a direct cost of the termination. This necessitates examining whether the costs were reasonable and properly incurred, which is done on a case-by-case basis.
The Contractor will have ongoing liabilities at the time of termination, which will require the Contractor to negotiate and settle ongoing agreements down its supply chain. The Contractor will have to address any claims that existed prior to and/or arose from the termination. Records of any negotiations and settlements will be important to demonstrate that commitments were sensibly closed, particularly if these are included as part of the Main Contractor’s direct costs of termination.
The Employer will need to make arrangements to complete the works and may claim for any costs this incurs. If the Employer wishes to make such a claim, it is important that the Employer can provide an audit trail of the incomplete scope of the works at termination. Seeking to make a speedy replacement, the Employer often negotiates with merely one potential replacement Contractor or the incumbent Subcontractors. As noted above, the latter option may open the door to a claim for non-payment by the incumbent Subcontractor. As such, an Employer seeking to take this option must be sure to pay due regard to the progress of the works up to termination and the accompanying audit trail.
The Employer should be cautious when placing the follow-on works to ensure that the balance of the completion works is demonstrably linked to the value of the work done at termination. In our experience, the Main Contractor tends to challenge that the subsequently procured completion of the works is done at market rates and that a value for money procurement has been conducted to mitigate any follow-on costs.
Employer claims can become more complex when the Employer expands the scope of the work beyond that set out under the Main Contract through a more relaxed arrangement. Such arrangements may involve a loosening of the commercial terms, a longer timeframe for completion or even a resequencing of sections of the work. Any deviations from the original scope may incur costs that cannot be said to arise from purely completing the original works. Where the Employer seeks to introduce a longer timeframe for the execution of the works and incorporating new scope or specification changes this cannot be said to arise as a consequence of the termination.
The Employer needs to be careful not to fundamentally change the procurement and commercial model and often simply revert to a reimbursable emerging cost basis for the follow-on arrangements. If it previously contracted with the Main Contractor on a lump sum basis again this may import costs which cannot be justified as on the same footing. The Employer could be challenged under the terminated Contract, where the competition and market interest results in inflated tender returns. For these reasons, the Employer needs to have a strategy that shows it has conducted the management of follow-on works in a cost-efficient manner.
It is vitally important that professional advice is sought from an independent third party with knowledge of the complexities of termination valuation.