When an owner terminates a prime contractor or a prime contractor terminates a subcontractor, it almost always costs more for the terminating party to complete the work under the contract. Fortunately, if the termination was proper, the owner should be able to recoup the extra cost to complete the work from the terminated contractor. The same is true when a contractor terminates a subcontractor.
Often, the terminated party will argue that the excess completion costs were unreasonable. Generally, the burden will be on the terminated party to prove that the cost to complete the work was unreasonable. This can be very difficult to prove.
In Encon Arizona, LLC v. Kiewit Infrastructure West Company, a prime contractor sued a subcontractor for breach of contract because the prime contractor claimed it was forced to use another subcontractor on a road construction project. The prime contractor contended it had to bring on another subcontractor because the original subcontractor could not meet deadlines for the project. The prime contractor sought, among other things, the additional cost it had to pay the replacement subcontractor to complete the original contractor’s scope of work.
One of the issues in the case was whether the cost for the replacement subcontractor was reasonable. The original subcontractor argued that the cost was unreasonable because, among other reasons, the replacement contractor was an affiliate of the prime contractor. That meant that the profits of the prime contractor and the affiliated replacement subcontractor were funneled to the same company.
Since there was an affiliate relationship between the two companies, the subcontractor suggested that the relationship between the prime contractor and the replacement subcontractor for the work could not have been an arm’s length transaction.
The court noted that although there was a cause of concern about whether it was an arm’s length transaction, there was a lack of evidence presented challenging the reasonableness of the replacement subcontractor’s charges. As such, the court concluded the affiliate relationship between the prime and replacement subcontractor did not preclude the prime contractor recovering the amounts it paid.
The court further concluded that the cost for the replacement subcontractor was reasonable because:
- there was no other entity known to either the prime or original subcontractor that could produce the required materials on short notice;
- there were higher labor costs in the state where the replacement subcontractor was in business;
- there was required labor overtime;
- there was a longer shipping distance from the replacement subcontractor’s place of business to the project; and
- there were higher material costs in the state of the replacement subcontractor.
Based on the above conclusions, the court awarded the prime contractor some of the excess costs to complete the original subcontractor’s scope of work. (There were, however, other costs the prime contractor incurred that were not awarded for other unrelated reasons.)
Bottom Line: When someone is terminated from a project or their work is supplemented, there may be a fight about the costs the terminating party (whether owner or prime contractor) incurred to complete the work. While the terminating party is usually entitled to be paid those costs from the terminated party, the terminated party will almost always argue that the completion costs were unreasonable. As the Encon case illustrates, it can be difficult to prove the cost to complete the work was unreasonable.
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