Termination for Convenience Clauses Are Not Illusory Promises and Not Limited By the Implied Covenant of Good Faith and Fair Dealing
Recently, Division I of the Court of Appeals addressed two issues of first impression in private construction contracts: (1) whether a Termination for Convenience (“TforC”) clause is an illusory promise and, therefore, unenforceable; and (2) whether a TforC clause is limited by the implied duty of good faith and fair dealing. Ultimately, the Court held that partial performance of a contract provides adequate consideration to render a TforC clause not illusory, and that the implied duty of good faith and fair dealing does not trump express terms or unambiguous rights in a contract.
The case at issue, SAK & Associates, Inc. v. Ferguson Const., Inc., involved two private construction companies who entered into a fixed-sum subcontract for concrete materials and paving services on the construction of hangars at an airport. The subcontract contained a TforC clause, which permitted the General Contractor to terminate the subcontract “for its own convenience and require Subcontractor to immediately stop work.”[i] A few months into the project, the General Contractor gave notice and terminated the Subcontractor from the project for convenience. Upon termination, the General Contractor paid the Subcontractor the proportionate share of the subcontract price for the work actually performed. The Subcontractor subsequently sued the General Contractor alleging breach of contract for unilateral termination without cause.
A TforC clause, as previously addressed here in our blog, “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.” These clauses have long been employed by the government in contracting and found their way into private contracts. In SAK & Associates, Inc. v. Ferguson Const., Inc., the Subcontractor challenged the enforceability of the TforC clause, arguing it was an “illusory promise” (or that it lacked “consideration”) and was therefore unenforceable. In construction contracts, “consideration” is a requirement that there be reciprocal promises of the parties to perform work and to pay for the work performed. The Court held that because the Subcontractor performed 24% percent of the contract and the General Contractor paid the Subcontractor for that portion of the work, such partial performance provided adequate consideration to make the TforC clause enforceable.[ii]
The Subcontractor also argued the notice given by the General Contractor was merely false and pretextual excuses for increasing its profits from the project. The Court found this argument unpersuasive. The notice stated that, among other reasons, the General Contractor was terminating the Subcontractor for convenience. If the parties wanted termination to be contingent upon meeting a list of demands or certain content of the notice, the parties were free to negotiate and incorporate those contingencies into the subcontract—but they did not do so. Thus, the TforC clause required that nothing more be stated than convenience, and the Court held that the undisputed facts showed that the General Contractor gave such sufficient notice.[iii]
Interestingly, the Court took the opportunity to address whether a TforC clause can be limited by the implied duty of good faith and fair dealing, even though the argument was not even raised by the Subcontractor. The Court quickly admonished the argument stating that, “as a matter of law, there cannot be a breach of the duty of good faith when a party simply stands on its rights to require performance of a contract according to its terms.”[iv] When a party invokes a TforC clause to which both parties agreed, an unambiguous TforC clause will not be limited by the implied duty of good faith and fair dealing. Because the TforC clause in this case was agreed to by the parties and was only contingent upon notice (which was provided), the Court found the clause to be enforceable.
Prior to this decision, it was unclear whether Washington would follow the federal courts’ lead, which allow TforC clauses to be limited. Read our previous post on “Termination for Convenience” clauses here. However, a Washington Court has now spoken to the issue, lending guidance on how Courts will rule in the future. Although the Subcontractor submitted its Petition for Review to the Supreme Court two days late, the Court is currently considering whether to accept its Petition.
Comments: Termination for Convenience clauses can be beneficial in both government and private contracting. However, the parties should negotiate and include any relevant contingencies upon termination that they wish to enforce at a later date. Washington Courts are likely to continue enforcing the express terms of negotiated contracts rather than read in or imply terms that could have been negotiated at the outset, including such terms can help to mitigate unnecessary, timely, and expensive litigation during performance.
[i]198 Wn.App. 405, 357 P.3d 671, 674 (2015)
[ii] Id. at 676.
[iii] Id. at 678.
[iv] Id. at 676 (emphasis added).
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