Construction Contracts Termination Basics - Part I
This is a two-part blog. This first post addresses "Terminations for Convenience," which will be followed by a post discussing "Terminations for Default."
Terminations are said to be the "unhappy endings of construction contracts."[i] A termination is the decision to stop performance of the contract before it is completed. Termination is a right granted the owner or general contractor and does not have a parallel right for the contractor or subcontractor to "terminate" a contract. A contractor or subcontractor can "abandon" a contract upon breach by the owner or general contractor, but cannot "terminate" the contract.
Terminations come in two flavors: (1) terminations for convenience, and (2) terminations for default. Termination for convenience allows the owner/general contractor to stop the work for "just about any reason" without having to pay for anticipated profit or unperformed work. Termination for default, in contrast, allows the owner/general contractor to procure alternative performance at the contractor/sureties/subcontractors' expense.
- A. Termination for Convenience
A termination for convenience ("TforC") clause affords the owner or general contractor the flexibility to alter its course, and eliminate unnecessary expenditures without repudiating its performance or materially breaching the contract. In absence of a TforC clause, the owner or general contractor would have the right to terminate the contract, but could face the full consequence of breach of contract, including payment of anticipated profits on unperformed work.
Termination for convenience is so important to the federal government that even if the federal contract does not expressly reserve the government's right to terminate, courts will read that right into the contract by operation of law.[ii] Today, termination for convenience clauses are also found in most commercial construction contracts, which gives owners and/or general contractors rights similar to those of the federal government.
A typical termination for convenience clause in the subcontract reads as follows:
Termination/Suspension for Convenience. Upon three (3) calendar day's written notice to Subcontractor, Contractor may terminate this Subcontract in whole or in part for Contractor's convenience and/or at its option. Subcontractor's remedy for such convenience or optional termination is limited to the following: (1) payment pursuant to the terms of this Subcontract for all Work properly performed prior to termination; (2) partial payment for lump sum items of Work on the basis of the percent complete of such items at the time of termination; and (3) Subcontractor's reasonable close-out costs. In no event shall Subcontractor be entitled to any compensation for loss of anticipated profits or unallocated overhead on Work not performed.[iii]
There are, however, limitations on an owner or general contractor's right to terminate for convenience. An owner and/or contractor cannot exercise a TforC clause in bad faith or when abusing its discretion. For example, a general contractor terminating a subcontractor for convenience to convert the lucrative subcontract profits to itself would likely be found to be an abuse of discretion or bad faith. Courts have found that where a contractor is terminated was for reasons unrelated to the performance of the contract, it was actually a pretext for breaching the contract and the contractor would be entitled to its lost anticipated profits. In the government contracting context, the government may have to demonstrate some "changed circumstances" as a precondition to terminating the contract for convenience, taking away the optional unfettered discretion once thought to be the test for convenience terminations. The court and arbitrator may also apply a heightened scrutiny when private TforC clauses are employed to terminate a contractual relationship.
[i] Robert F. Cushman and James J. Meyers, Construction Law Handbook – Volume 1, 989 (1931)
[ii] G. L. Christian & Associates v. U. S., 312 F.2d 418 (Ct. Cl. 1963).
[iii] Associated General Contractors of Washington Subcontract Form (2009).
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