September 11, 2023
The ongoing reality for the Australian construction industry is riddled with labour shortages, increased lead times and material costs eating into profit margins. These issues have, in part, contributed to the growing number of industry related insolvencies. It should be no surprise if principals adopt a “fine, I’ll do it myself” attitude and rely on take out clauses with an aim to reach project completion.
This article will discuss the principal’s right to “step in” and take works out of the contractors’ hands. Importantly, this right differs from issuing a negative variation to have specific works omitted from the contract scope (read more on variations here).
What are step-in rights?
Step in rights allow principals to take back control of the project to progress the works when the contractor is in default without terminating the contract.
For example, clause 39.4 of the AS4902 standard form design and construct contract provides:
“If the Contractor fails to show reasonable cause by the stated date and time, the Principal may by written notice to the Contractor:
- take out of the Contractor’s hands the whole or part of the Work remaining to be completed and suspend payment until it becomes due and payable…”
Take out clause
Where the principal elects to take works out of the contractors’ hands, it steps into the contractor’s shoes to complete the works.
Take out clauses will generally allow the principal to take possession of and use materials, equipment or other items intended for the works under the contract or used by the contractor and contract with subcontractors or suppliers as reasonably required to facilitate the principal’s completion of works, (see clause 39.5 of the AS4902).
Under clause 39.6 of the AS4902, the difference between the costs incurred by the principal and the amount which would otherwise have been paid to the contractor if it had completed the works will become moneys due and payable. If the contractor is subsequently indebted to the principal and fails to pay the debt, the principal may sell any equipment or other items it took possession of to satisfy the debt. That said, the principal must pay any excess amount to the contractor.
When can a Principal step in?
In the construction industry, the most prominent exercise of step in rights by the principal (as opposed to terminating the contract) is in circumstances where the contractor has breached the contract. However, a mere breach will not automatically give rise to the principal’s right to take work out of the hands of the contractor. The breach must be “substantial”.
Depending on the contract, a substantial breach may include:
- departing from the program or failing to proceed with expedition and without delay to project completion;
- wrongful suspension of works;
- failing to use the materials or standard of work required;
- failing to comply with a direction of the superintendent or principal; or
- failing to perform design obligations properly.
Typically, before exercising its right to step in, the principal must issue a notice to show cause, which complies with the form specified under the contract, if the contractor substantially breaches the contract.
For example, under clause 39.3 of the AS4902, a notice to show cause must include:
- a statement that it is a notice under clause 39;
- the alleged substantial breach;
- that the contractor is required to show cause as to why the principal should not exercise its right to step in or terminate the contract;
- the date and time by which the contractor must show cause; and
- the place at which cause must be shown.
Principals should ensure that they comply with all contractual requirements prior to triggering their rights to step in to avoid adverse consequences, including the process being invalidated or their conduct being construed as repudiation of the contract.
Lamont Project & Construction Lawyers
The Lamont Project & Construction Lawyers team has extensive knowledge regarding the principal’s right to take work out of the contractor’s hands under various standard form and bespoke contracts and the circumstances giving rise to such right. Further, our team has experience and a comprehensive understanding of the intricate risks related to taking work out of contractors’ hands. With this knowledge and experience, Lamont Project & Construction Lawyers can provide the required support and advise on major projects with respect to taking work out of the contractor’s hands under the contract.
If you would like to discuss any matters raised in this article as it relates to your specific circumstances, please contact Lamont Project & Construction Lawyers.
The content of this article is for information purposes only and it does not discuss every important topic or matter of law, and it is not to be relied upon as legal advice. Specialist advice should be sought regarding your specific circumstances.
Contact: Peter Lamont or Quinn Hironaka
Email: [email protected] or [email protected]
Phone: (07) 3248 8500
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