Dealing with termination for convenience clauses

There was a time when signing a construction contract meant thecontractor had the right to complete the job and get paid the full price. But, over time, the idea that an owner could terminate a contract for reasons having nothing to do with the contractor's performance became more and more popular. This is the concept of Termination for Convenience (T for C) clause. By inserting this clause into a written contract, an owner avoided being sued for breach of contract if he changed his mind and wanted to pull the plug on a project even without any fault on the part of the contractor.

This concept first appeared in connection with federal government projects. The theory used by courts was that the public interest was not served by requiring the government to either build something it no longer needed or pay damages for not doing so, if in fact there was a compelling sovereign reason to stop. The courts reasoned it didn’t serve the public interest to force the government to continue a project that became unnecessary or otherwise unusable because, for example, a war ended or hazardous materials were found on a site. 

The typical T for C clause provided that the owner would pay costs incurred to date and reasonable termination expenses, meaning unavoidable costs incurred due to an early termination (i.e., un-cancelable material orders, restocking charges, un-expired rental contracts).

Currently, nearly all public contracts, standard form construction contracts and even stand-alone contracts, now contain termination for convenience clauses. The ConsensusDOCs has a provision leaving a blank where the parties are to insert the amount/percent of premium over and above costs incurred that the contactor will receive if the contract is terminated without fault. The AIA General Conditions allow for termination for convenience, but obligate the owner to pay for work executed, costs incurred because of the termination, along with reasonable overhead and profit on the work not executed - in effect, giving the contractor the same profit it would have made had it completed the work. In most cases, the owner seeks to delete the language allowing the contractor to recover his profits.

Aside from the unfairness of losing profit that a contractor was counting on, there are other issues relating to termination for convenience provisions that should concern contractors (and subcontractors because of flow-down provisions). For example, what about the situation in which there really was no compelling reason to terminate the contract? Or what if the owner terminates the contractor merely so that he can get a lower price or better terms from someone else? The typical termination for convenience clause doesn't set any limits on the circumstances under which an owner can just cut the contractor off. Particularly in these days of limited economic resources, it is not unheard of for an owner to want to jump ship to save money.

What can be done?

Unfortunately, not much can be done. Few states have addressed the issue adequately, and those that have generally look to federal guidance for authority. Because all standard termination for convenience clauses are one-way, giving only the owner the right to terminate,  in order to avoid the clause leading to abuse, they have implied into the termination for convenience clause an implied duty of good faith.   

In 1982 the "good faith or abuse of discretion" test was challenged in a case where the U.S. government used the termination for convenience clause to terminate a contract for convenience because another bidder was able to perform the service for less. The court held that the government could not terminate for convenience absent changed circumstances. Since this decision, other federal courts have reviewed terminations for convenience on numerous occasions, until finally in 1996 when it was held that the federal government could get away with using the termination for convenience clause as long as the termination wasn't "tainted by bad faith or an abuse of contracting discretion." Since the government is presumed to have acted in good faith in contracting, contractors have rarely succeeded in demonstrating the government's bad faith. This means you should assume that a court will uphold a termination for convenience clause.

Even so, there are a few things you can do to minimize your risks. First, try to include language that provides for lost profits if the owner terminates the contract for its convenience.  This is your best case, but owners are often reluctant to agree to this. From the contractor's perspective, it's only fair that it not be penalized for the owner's convenience. If the owner won’t agree to this, then you might agree to be let go with no extra payment for lost profits, but only if the project does not go forward for at least a period of time (one or two years), and if anyone else continues with the work in your scope, you are entitled to be paid for your unearned profit. An owner acting in good faith would be hard-pressed to explain why this proposal is not fair. If the owner won't agree to this, then insist upon payment for work completed to date (owner may require properly completed work) plus any costs of termination. Payment for work completed to date should include overhead and profit for that work. Subcontractors, don't forget to review the prime contract, as they often contain "flow down" clauses that give subcontractors similar rights.

Michael Callahan is a partner at Stinson Morrison Hecker LLP (the same firm as long-time columnist Susan McGreevy) where he assists clients with all aspects of their construction law needs, including litigation. Contact him at [email protected].