Oh, never mind

Can a contract be terminated for convenience?

A week before you are to begin a new project as a subcontractor, the general contractor tells you your services no longer are needed; the general contractor has decided to go in another direction. The general contractor follows up with a letter directing you to cancel any existing orders for materials and return to your suppliers any materials you already have obtained. If you have received materials that cannot be returned, you are to furnish those materials and submit documentation of the amount you paid for them and you will be reimbursed for your costs.

Can the general contractor legally do this? And what, if anything, are you entitled to recover?

As is so often the case with legal issues pertaining to construction projects, the answer depends on what the contract states. More specifically, the answer depends on whether the contract contains a termination for convenience clause and exactly what the clause says.

If there is a provision allowing the general contractor to terminate the contract for convenience and pay you only for the value of the work performed on the job at the time the notice of termination is given, you might not be entitled to recover anything if you cannot show any work has been performed.

Terminating for convenience

A contract's termination for convenience provision allows an owner in a contract with a prime contractor or general contractor in a contract with a subcontractor to terminate the contract even though there has been no default or breach of contract by the other party.

In the absence of a termination for convenience clause, neither party can unilaterally terminate a contract if there is no breach.

Just as a subcontractor could not terminate a construction contract with a general contractor because he or she no longer wanted to do the job or determined his or her price was too low, a general contractor or owner cannot terminate a contract with a subcontractor or prime contractor just because the general contractor or owner changed his or her mind or could get a lower price.

If there is no termination for convenience clause and a general contractor or owner terminates a contract without cause, the other party is entitled to recover damages. These damages often are referred to as expectation damages. A subcontractor or prime contractor whose contract has been improperly terminated is entitled to recover the benefit he or she reasonably expected to receive had the contract been performed, which would be the expected profit on the job.

But inclusion of a termination for convenience clause changes the legal outcome. The termination for convenience clause allows a contract to be terminated without a showing of fault or cause and will invariably stipulate and limit the recovery of the party whose contract has been terminated.

The limitation can be severe. If the termination for convenience clause in a general contractor's subcontract form states the general contractor will only pay for the cost of work performed or completed as of the date of the notice of termination and the subcontractor has not yet begun work, the general contractor may contend the subcontractor is not entitled to any recovery.

However, the subcontractor commonly will be able to recover expenses subsequent to the contract's execution and before termination, such as fabricating or purchasing materials, and expenses relating to the contract's cancellation, such as restocking fees, even though construction has not yet begun. The substance of the termination for convenience clause is critical.

Government contracts

Termination for convenience clauses have a long history in government contracts dating to the Civil War.

During the Civil War, the U.S. Army promulgated a rule stating that because commanders did not know how long their troops would be located in an area, all contracts with subsistence stores were to include a provision allowing the Commissary General to terminate the contract at his discretion.

The government's right to terminate contracts for convenience was the subject of a case decided by the U.S. Supreme Court in 1874, United States v. Corliss Steam Engine Company. In this case, the secretary of the Navy terminated the Navy's contract with a shipbuilder because the Civil War had ended.

Corliss Steam Engine Co. sued the government for the full value of its contract. The U.S. Supreme Court ruled the end of the Civil War rendered the contract unnecessary and that under the circumstances, the Navy was justified in settling with Corliss Steam Engine for less than the contract's full value. The Supreme Court recognized the government needed to have broad discretion with respect to terminating war-time contracts.

The Corliss doctrine became an important part of military procurement. The legal reasoning is that if the government no longer needs a procurement that was, for instance, part of an ongoing war effort, the government should be able to cancel the contract and save taxpayers an unnecessary expenditure. The government would pay the costs incurred up to the termination date and reasonable expenses related to the termination.

The underlying legal justification for the government's reliance on a termination for convenience clause was "changed circumstances." Court decisions indicate the government could include and invoke a termination for convenience clause when circumstances changed and justified terminating a contract even though there was no fault by the other party.

Currently, most federal government contracts, many public contracts and an increasing number of private construction contracts contain termination for convenience clauses.

AIA contracts

The inclusion of termination for convenience clauses in private contracts is relatively new. The American Institute of Architects (AIA) first included a termination for convenience provision in its contract forms in 1997.

The termination for convenience provision in the 1997 and 2007 editions of standard AIA construction contracts is unusual. Although explicitly stating an owner may, at any time, terminate a contract for convenience and without cause, the AIA A201 General Conditions go on to state the contractor "shall be entitled to receive payment for Work executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on Work not executed."

AIA's standard subcontract form, AIA Document A401-2007, contains a similar provision stating that if an owner terminates a contract for convenience, the general contractor shall promptly deliver written notice to the subcontractor and the subcontractor "shall be entitled to receive payment for Work executed, and costs incurred by reason of such termination, along with reasonable overhead and profit on Work not executed."

The effect of the AIA termination for convenience clause is that the contractor and subcontractor are afforded the same legal remedy as they would have had in the absence of the termination for convenience clause if the owner or general contractor had wrongfully terminated the contract.

The purpose of the AIA termination for convenience clause is to establish that an owner can terminate the contract without cause and the contractor is entitled to recover anticipated reasonable overhead and profit as though the contract had been fully performed. The owner's termination is not a breach of the contract, and the owner saves the cost of labor and materials that the contractor no longer provided.

Note that a general contractor is entitled to terminate a subcontract for convenience only if the owner terminates the contract with the general contractor for convenience and the remedies provided to the general contractor and subcontractor are identical.

Unfortunately, termination for convenience provisions frequently included in general contractor-drafted subcontract forms bear little resemblance to AIA's termination for convenience clause.

Typically, general contractor-drafted contracts contain no limitation on the termination for convenience clause. With these contracts, if an owner terminates a prime contract for convenience, the remedy available to a subcontractor usually is limited and never includes overhead and profit on work not executed.

Illusory contracts

When reviewing a contract that includes a termination for convenience provision, you should assume the provision will be enforced as written. Nevertheless, the inclusion of a termination for convenience clause in a private contract does not always mean a party who wants to terminate a contract without good reason will be able to do so.

A termination for convenience clause that allows one party to terminate a contract without any reason or justification might not be enforceable.

If a contract can be unilaterally terminated by one party for no reason, the contract may be found to be illusory if a legal challenge is made. An illusory contract appears to contain promises or commitments from both parties but actually does not bind or obligate one of the parties, who can choose to perform or not. This means the party is not really bound to do anything, and courts typically will not enforce illusory contracts.

Will clauses be enforced?

Even if a contract is not considered illusory, a court might not enforce the termination for convenience clause depending on the circumstances.

Relying upon precedents established in cases dealing with federal government contracts, courts often will consider whether there are changed circumstances that justify termination or the party terminating the contract acted in bad faith. If the facts indicate there are not changed circumstances or the party terminating the contract has acted in bad faith, the terminated party may be able to recover damages beyond what was stipulated in the termination for convenience provision depending on case law in the state where the controversy arose.

Although there are relatively few cases pertaining to private construction contracts that discuss termination for convenience clauses, many judicial decisions that have been issued indicate courts will require the terminating party acted in good faith or did not act in bad faith when invoking the termination for convenience clause.

Maryland decision

In 2009, the Maryland Court of Appeals—the highest court in Maryland—issued a lengthy decision in a construction case between a general contractor and subcontractor concerning a general contractor's termination of a subcontract before the start of work.

The court reviewed the history of the termination for convenience clause and discussed the standard that would be applied to determine whether the general contractor was justified in terminating a contract for convenience.

In Questar Builders, Inc. v. CB Flooring, LLC, the Maryland Court of Appeals made clear that a termination for convenience clause does not give a general contractor unlimited power to terminate a contract for no reason or an insufficient reason and that obtaining better pricing is not a valid reason. The court concluded a termination for convenience clause would be enforceable "subject to an implied obligation to exercise the right to terminate in good faith and in accordance with fair dealing."

In reaching its decision, the court started with the principle that Maryland law, similar to laws of other states, implies an obligation by the parties to act in good faith and deal fairly with one another.

The court ruled Questar Builders' contention that it was entitled to terminate the contract for any reason whatsoever went too far.

"To be sure, a right to terminate in the absence of the other party's breach does not equate necessarily with the right to terminate based on a whim," the court said.

The court rejected the general contractor's contention the right to terminate for convenience provision in the contract allowed the general contractor to terminate the contract for any reason whatsoever, including a bad reason or no reason. The court said shopping for a better price after signing a contract did not constitute good faith.

According to the Maryland court, the obligation to act in good faith and deal fairly prohibits a party from terminating a contract (or otherwise exercising its discretion) to recapture an opportunity that it lost upon entering the contract. Upon entering a binding contract for a specified duration, the parties thereto "give up their opportunity to shop around for a better price."

Handling termination

When you are presented with a general contractor's subcontract form, check to see whether it contains a termination for convenience clause. If so, ascertain whether there are any limitations to invoking the termination for convenience clause and what compensation is to be paid to you.

Consistent with AIA standard contracts, the best approach is to limit the general contractor's reliance on the termination for convenience clause to when an owner has terminated the general contractor's contract and to state you, as subcontractor, are entitled to be compensated on the same basis as the owner compensates the general contractor.

The general contractor should not have an unfettered right to terminate the contract, and you should receive reasonable compensation for all your expenses, including overhead, profit, labor and materials.

Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.


Be the first to comment. Please log in to leave a comment.