Terminating construction contracts under Saudi Law

Termination clauses feature in virtually every construction contract. They are particularly important in the construction industry due to the long duration of performance of construction projects, the sizeable payments involved and the complex arrangements with suppliers, vendors and subcontractors that may be impacted upon termination of an employer-contractor or contractor-subcontractor relationship. Given recent instability from the pandemic, soaring supply costs, extreme currency fluctuation and global conflicts, these clauses are coming under increased scrutiny as some contracts become increasing non-viable.

In addition to describing the circumstances justifying cancellation of the contract, a termination clause usually sets out the procedures to be followed before this exceptional step can be exercised and the financial and other consequences ensue.

Terminating a construction contract is often a measure of last-resort. Parties might be tempted to ‘pull the trigger’ as a retaliatory measure when the relationship sours over performance and/or payment. The significant consequences of termination (particularly if the termination is subsequently found to be wrongful) mean that contracting parties must carefully consider the relevant contractual provisions, both when drafting the agreement and when seeking to exercise that option. Even if the right to terminate is exercised lawfully, in practice, termination tends to trigger disputes and the intervention of a court or arbitral tribunal may be necessary. But termination clauses are even more important in Saudi Arabia because, apart from the regulations applicable to government contracts, there are no detailed rules on termination at law.

This blog post discusses the general principles governing the termination of construction contracts under Saudi law and the restrictions that may apply. It focuses on termination rights in three scenarios: (i) termination for cause; (ii) termination for convenience; and (iii) termination of government contracts.

Termination for cause

Termination for cause provisions define the conditions for termination in the event of one or more breaches of contract by either party. Whether it is the contractor or employer that exercises this right, the terminating party may also be entitled to payment or damages.

In principle, a contract is validly terminated if the termination accords with the agreed termination provisions. To the extent that the breaching party has prevented the terminating party from complying with a particular precondition to termination, Saudi courts might consider that the precondition has nevertheless been satisfied based on an estoppel-like rule under Sharia law.

In addition, the terminating party may be able to terminate the contract for fundamental breach at law, such as fraud.

Termination for contractor’s default

Not every breach by the contractor justifies termination. This remedy is normally reserved for specific breaches that are sufficiently substantial to compromise the contractor’s ability to perform (often referred to as “material breach”, or “breach of a material obligation”).  But what amounts to a material breach can be subjective. It is therefore crucial for employers to ensure that important obligations are clearly set out in the contract and expressly described as being material.

Common examples of contractual grounds for termination include the contractor’s failure to mobilise and proceed with the work, assigning the contract or subcontracting the whole of the works without the employer’s consent, failure to provide or renew a bank guarantee within a prescribed timeframe, failure to comply with a notice to cure a breach, abandoning the works, bankruptcy, offering a bribe in relation to the contract and/or other serious regulatory offences. Some of these breaches, such as the contractor’s bankruptcy or involvement in corrupt practices, may justify termination of the contract at law even absent an explicit contractual provision to that effect. The employer will generally be required to meet a higher evidentiary threshold when it looks outside the contract for grounds for termination.

If exercised lawfully, termination for the contractor’s default allows the employer to seek damages at law or under the contract in compensation for its actual losses, including any additional costs incurred to arrange for a substitute contractor to complete the work of the terminated contractor.

Termination for employer’s default

The contractor’s right to terminate for an employer breach is usually narrower than the employer’s, not least because construction contracts often favour the employer. For example, in industry standard contracts, the contractor may be allowed to terminate due to the employer’s failure to provide access to the site, the engineer’s failure to issue payment certificates, the employer’s failure to make outstanding payments, the employer’s failure to provide evidence of arrangements to finance the works, excessive descoping of the works, and/or a substantial failure to perform the employer’s obligations.

Generally speaking, because demobilisation is costly, the contractor should not terminate the contract without being confident that it is not legally obliged to return to the site.

Termination for convenience

One of the distinctive features of construction contracts is the employer’s unilateral option to terminate the contract at any time for reasons unrelated to the contractor’s performance and without being in breach of the contract, known as “termination for convenience” or “termination at will”. The practice has emerged in the construction industry in recognition of the long-term nature of construction projects.

Some MENA jurisdictions (e.g. Egypt, Kuwait, Qatar and Bahrain) provide in their respective civil codes for the employer’s entitlement to terminate a construction contract for convenience. In these jurisdictions, a termination for convenience clause serves the function of quantifying (and limiting) the contractor’s compensation when the employer exercises this option. Absent that clause, the employer would have to compensate the contractor not only for its actual costs but also for the profit and overhead contribution it would have earned on the balance of the contract.

The position in KSA can be different. In principle, Saudi courts enforce contractual provisions empowering the employer to terminate the contract unilaterally at will. But even without a contractual provision to that effect, termination is likely to produce almost the same outcome—the contractor will be entitled to its actual costs only given the general limitations on the recovery of damages under Saudi law (see our previous blog post).

However, termination cannot be exercised in a manner contrary to Shari’a—that is, in an abusive manner or bad faith. This is consistent with the implied covenant of good faith in all Saudi contracts and the overarching obligation of fair dealing in all transactions (see our previous blog post). For example, a Saudi court might hesitate to enforce a clause that seeks to automatically convert the employer’s termination for cause into a termination for convenience if it transpires that the contractor was not in default (or that the contractor’s breach was minor or inconsequential), as such a provision may be seen as abusive.

It is worth noting that, if the termination is unlawful, the scope of actual losses for which the employer is liable may be expanded—for example, the employer may be ordered to bear the cost of demobilising any temporary works that it was otherwise not responsible to pay for.

To protect its interests in this scenario, if negotiation is possible, the contractor may want to include (i) an obligation for the employer to make expedited payment of the contractor’s dues in full following termination for convenience; and (ii) a pass-through clause in its contracts with subcontractors and suppliers on the same project.

Terminating Government contracts

Government contracts in Saudi Arabia are governed by the Government Tenders and Procurements Law of 2019 (GTPL). The GTPL enables government authorities to terminate the contract and seek damages for the contractor’s default in certain circumstances, such as bribery, bankruptcy, unauthorised assignment and any breach of the contract which is not cured on 15 days’ written notice.

Liquidated damages are recoverable after termination but capped at 10% of the value of the contract unless otherwise provided by a court order or the parties’ agreement. However, Saudi courts may adjust liquidated damages to reflect the actual loss incurred rather than defer to the parties’ pre-agreed assessment. The treatment of liquidated damages under Saudi law resembles the approach in neighbouring jurisdictions where Shari’a principles have inspired the law on damages, except that these jurisdictions may still allow the recovery of lost profit as part of the adjustment of liquidated damages.

Other grounds for termination

Saudi courts recognise that the contract can be terminated when performance becomes impossible without exposing the terminating party to an award of damages. This principle finds its source in Shari’a law and therefore applies even if it was not expressly incorporated into the contract. In contrast, hardship is not a valid ground for termination (although it can allow a rebalancing of the parties’ respective obligations under the contract).

Conclusion

The current law on contract termination in Saudi Arabia allows for termination under limited circumstances. Contracting parties should seek clearly to define the conditions for termination to manage risk and uncertainty given the long-term nature of construction projects. In doing so, they should be mindful of the unique features of Saudi law.

This is part of a series of blog posts on managing risk in commercial and construction disputes under Saudi law. Click here to see other posts in the series.