Construction contracts generally outline various scenarios in which a party can terminate the contract.  In one common scenario, a contractor is permitted to terminate its subcontractor “for cause” if the subcontractor provides deficient work or fails to meet the project schedule.  Contracts often describe this type of deficiency as a “failure or neglect to carry out the work in accordance with the subcontract.”  Similar provisions are found in contracts between owners and general contractors.

Importantly, most contracts require that, before terminating a subcontractor for deficient work, a general contractor must first provide the subcontractor with notice of the default and an opportunity to cure the deficiency (for example, seven days).  Only after providing notice and an opportunity to cure can the contract be terminated, and only if the default remains uncured.  This kind of termination “for cause” is significant because most construction contracts provide that the subcontractor will not be entitled to receive any further payment for work performed until the project is finished.  Even then, the subcontractor will usually be backcharged for the cost of completing and/or remediating its work, and in some cases, the subcontractor may actually owe money back to the general contractor if such costs exceed the balance unpaid to the subcontractor.

The New York Supreme Court, Appellate Division, First Department, recently issued a decision addressing certain key issues surrounding contractual notice-to-cure provisions and what happens when they are not strictly observed in connection with terminations.  See East Empire Construction Inc. v. Borough Construction Group LLC, 2021 NY Slip Op 05455 (Oct. 12, 2021).  There, the First Department held that notice-to-cure provisions for termination of construction contracts can only be ignored in “very limited and rare circumstances,” and that noncompliance can eliminate the general contractor’s right to setoffs for completion and remediation costs arising out of a subcontractor’s nonconforming work.

In East Empire Construction, a general contractor terminated a steel work subcontractor based upon the claim that the subcontractor provided faulty work and had a poor safety record.  The contract required the general contractor to provide a 10-day cure period before terminating the contract for “failure or neglect to carry out the Work.”  The general contractor, however, terminated the subcontractor after providing only a 72-hour cure notice.  The parties’ subcontract permitted the general contractor to backcharge the subcontractor for costs and fees incurred in connection with the subcontractor’s failure to perform and, on that basis, the general contractor withheld payment on certain of the subcontractor’s outstanding invoices.

The terminated subcontractor thereafter sued the general contractor for breach of contract and sought recovery on its outstanding invoices, alleging that it was terminated without appropriate notice and opportunity to cure the alleged default.  The subcontractor also sought to dismiss the general contractor’s claim for setoffs, which the general contractor had asserted as an affirmative defense to the subcontractor’s complaint.

The First Department held that the general contractor’s termination of the subcontractor was “ineffective” because the general contractor failed to provide the contractually required 10-day notice and cure period.  The court described contractual notice-to-cure provisions as “strict” and stated that there are “very rare” and “limited circumstances” where a contractually required notice to cure is not necessary.  Specifically, those cases are limited to cases in which (1) “the other party expressly repudiates the contract or abandons performance” or (2) “the breach is impossible to cure.”

The court found further that neither of those situations was present, and that the general contractor was required to comply with the contractual notice to cure provision.  First, the court found that the subcontractor did not “repudiate” or “abandon” its work.  Second, regarding whether the subcontractor’s breach was “impossible to cure,” the court found that the alleged faulty work constituted nothing more than “defective performance” which is “the very situation to which the cure provision was intended to apply.”  The court also found that a “poor safety record” was also not “impossible to cure.”

As a result, the termination was improper and the subcontractor was entitled to payment on its outstanding invoices.  In addition, because the termination was deemed ineffective, the general contractor was not permitted to backcharge the subcontractor for costs incurred in remediating the allegedly defective work.  The general contractor’s failure to terminate the contract properly was particularly significant because, as noted above, the general contractor would have been permitted to backcharge the subcontractor for fixing the subcontractor’s faulty work, but the general contractor lost that right when it did not comply with the contract’s notice-to-cure provision.

The decision in East Empire Construction is a reminder that parties to construction contracts are well-advised to carefully review and comply with contractual termination provisions and associated notice-to-cure requirements.  As reiterated in this case, it is well-established under New York law that termination procedures in construction contracts are strictly enforced as written.  Therefore, careful adherence to a contract’s termination procedures is crucial to protecting a party’s rights and avoiding the negative consequences that flow from improper termination.