Substantial Completion and Substantial Performance

By Joseph Dirik, Esq.

The author writes that if a contract does not define or permit substantial completion, a contractor may still recover for the majority of its payments if it has substantially performed.

Joe Dirik is a graduate civil engineer and attorney.

He is a member of the construction law practice group at the Dallas office of Jenkens & Gilchrist, PC.

Every contractor seeks to reach substantial completion on a project at the earliest opportunity. In many contracts, substantial completion entitles a contractor to receive most of its payment, and escape responsibility for liquidated damages. Substantial completion is generally a contract milestone, and often determined by the terms of the contract.

Substantial performance is a similar concept. Texas common law generally requires strict compliance with the terms of a contract. This means that a party seeking payment for its performance must have fully performed before it would be entitled to full payment. The rule has been modified for building and construction contracts by the doctrine of substantial performance. It is an equitable doctrine adopted to allow a contractor who has substantially completed a construction contract to sue on the contract for the owner's failure to pay. The doctrine is important to contractors because the owner cannot use the contractor's failure to fully complete the work as an excuse for non-payment. Substantial performance also requires the contractor to have, in good faith, intended to comply with the contract, and have substantially done so.

When a contract does not define substantial completion, substantial completion is often considered the stage when the project is "ready for its intended use." What does this mean if not defined in the contract? One could determine a project's intended use if it involves a manufacturing facility that requires performance tests to demonstrate that the facility is ready to produce. An office building may be ready for its intended use when issued a certificate of occupancy. The best practice for determining substantial completion is to include an express definition in the contract.

Using the example of a manufacturing facility, it would be easy to define substantial completion as that point in time when the facility produces the product or completes the process for which it was designed. In other contexts, it may be necessary to rely on "satisfaction" clauses, which permit an owner or the owner's agent to refuse acceptance of the work until the performance or aesthetics of the project meet the owner or its agent's satisfaction. Satisfaction clauses are usually based on an objective or subjective standard. Under an objective standard, a reasonable person must have been satisfied. A subjective standard is based on the judgment of the individual who must be satisfied. In Texas, satisfaction clauses generally require the owner act in good faith when claiming dissatisfaction.

Standard form contracts address substantial completion. For example, under Section 8.9.1 of AIA A201-1997, the contractor determines when the work is "sufficiently complete in accordance with the contract documents so that the owner can occupy or utilize the work for its intended use." If the contract does not define intended use, the contractor might face the problems noted above. A well-prepared contract should define intended use or provide substance to permit a contractor to determine when a project is substantially complete.

If its contract does not define or permit substantial completion, a contractor may still recover for the majority of its payments if it has substantially performed. The contract definition of substantial completion is always the first step. A Texas Court of Appeals case, Coastal Chemicals, Inc. v. Brown, dealt with a poorly drafted substantial completion provision. The contract provided that the contractor would be entitled to an early completion bonus if the project was substantially completed by a specific date. The contract did not define substantial completion. The contractor argued that it had successfully installed the improvements by the substantial completion deadline. After discovering latent defects in equipment that prevented the plant from operating, the owner refused to pay the bonus. The court agreed with the contractor, and awarded the bonus. It found the owner had accepted the contractor's work as substantially complete. The court determined the owner would have to rely on the contract's warranty provisions to address latent defects.

In Texas, substantial completion, therefore, generally deals with how the contract defines this important milestone. Substantial performance, on the other hand, is an exception to the common law rule requiring strict performance of contracts in construction and building projects.