Careful how you cancel – a strict approach to following cancellation clauses in construction contracts

Cancellation of a contract is a general remedy for breach of contract recognised in South African law and is often referred to as a drastic remedy as it brings the contract to an end. Terminating a contract may not always be the commercially sensible remedy for breach of contract as it may further delay the completion of the project, increase the project cost and even expose a contracting party to liability. In favour of prolonging the life of a contract, an aggrieved party may opt to offer a contractor an opportunity to remedy the breach and then in the event of non-compliance, cancellation and damages. Hodgkinson addressed the following question: Under what circumstances can such an election be exercised when the agreement governing the parties’ obligations sets out precise requirements for cancellation?

The central facts in Hodgkinson were that the plaintiff (Hodgkinson) employed the first defendant as a contractor to complete certain construction works on the terms and conditions set out in an agreement entered into between the two parties.

The relevant clause in the agreement provided that the employer must deliver a notice setting out the contractor’s default and if the contractor failed to take steps to remedy the default within 14 days after receipt of the first notice, the employer could issue a second notice given within a further 7 days to terminate the agreement.

A few months after the commencement of the works, the employer delivered a written notice to the contractor (first notice) recording its defaults and informing it that unless it took practical steps to remedy the defaults within a period of 7 days, the employer would cancel the agreement. The contractor failed to remedy the defaults within 7 days. Ten days after the delivery of the first notice, the employer delivered another notice (second notice) informing the contractor that he was cancelling the agreement.

Both the first and second notice fell short of the requirements of the cancellation clause which required the contractor first to be given 14 days to remedy, and then a further 7 days’ notice prior to cancellation.

The issue before the court was whether the employer elected to follow the terms of the cancellation clause in the agreement and was therefore bound to follow the cancellation clause or whether the employer was entitled to rely on the contractor’s repudiation of the agreement as a ground for cancellation (and thereby avoid the requirements of the cancellation clause).

The grounds for cancellation put forward by the employer were twofold:

• The first ground was premised on the contractor failing to remedy the breaches set out in the first notice within a 7-day period and within the 14-day period contemplated in the cancellation clause. According to the employer, it did not matter that the period given to remedy the breach (7 days) was shorter than 14 days because the contractor in any event failed to remedy the default within the 14 day period.
  
  
• The second, alternative ground for cancellation, was that the contractor’s conduct exhibited a deliberate and unequivocal intention not to be bound by the agreement - conduct that constituted repudiation of the agreement. The employer argued:

(i)    the first notice constituted an offer to the contractor to remedy its default and not a notice in terms of the cancellation clause therefore the time frame to remedy the breach did not matter; and

(ii)    the second notice did not make reference to the cancellation clause and therefore the cancellation was on a different basis than the cancellation clause.

On this second ground, the court narrowed its inquiry to not deal with whether there was a valid repudiation by the contractor, but rather whether the employer forfeited his entitlement to rely on the repudiation as a ground for cancellation because he elected to invoke the terms of the cancellation clause (by delivering a first and second notice).

On the first ground for cancellation the court found that an aggrieved party cannot expect a defaulting party to read the first notice as if it conferred 14 days to remedy the breach instead of 7 days as stated in the first notice. The first notice was defective and consequently, the plaintiff was obligated to rectify its letter of demand to refer to 14 days in clear terms and in accordance with the cancellation clause.

On the second alternative ground for cancellation, the court held that the first and second notice conveyed an unclear message to the contractor because the notices complied substantially with the cancellation clause but the time periods did not comply with the time periods stipulated. The court found that in the face of a defective letter of demand it would be “untenable” to allow the employer to fall back on the claim that he had in fact intended to allow the contractor an opportunity to remedy the default and if the response was unsatisfactory change his election and cancel the agreement.

The logic endorsed by the court is as follows: When a contract contains a cancellation clause which covers repudiation by the contractor and allows an employer to offer to the contractor to remedy its default and entitles an aggrieved party to issue a notice to cancel following a failure to remedy the default, the aggrieved party must follow the clear route for cancellation prescribed by the cancellation clause. The defaulting contractor cannot be left to guess whether the cancellation clause is being invoked or not.

This case endorses and gives guidance in regard to the fundamental principles of the right to cancel as it pertains to the process that aggrieved parties should follow to enforce their right to cancel a contract against defaulting/repudiating parties where there is a governing cancellation clause. The approach of considering whether an agreement entitles a party to cancel in a certain manner rather than focusing on a party’s expression of an intention to cancel evidences the South African courts’ welcome protection of the principle of certainty in contract.