That makes it no longer a contracts case if the theft can be proved. And the victim isn't limited to the awards that might be made in a contract case, but might collect punitive damages to punish the tort and crime.
True - but all that is a matter for the courts. They make the call as to punitive awards, etc. The company can't just unilaterally decide to invoke themselves to act as court/judge/jury.

They may be able to easily win in court. They may be able to talk the contractor into an agreement that pay be reduced to AVOID dealing with courts (and should probably do so as this is the best and easiest path here). But they have no right to unilaterally do so.