Does Your Contract Contain A Termination For Convenience Clause?
William C. Last, Jr.
Attorney at Law
Most construction contracts include provisions for termination of the contractor’s remaining work on a project under certain pre-defined conditions. These clauses typically are included to define the particular events that will allow the owner to eject the contractor from the project and prevent the contractor from completion of his or her scope of work. Termination under these provisions constitutes termination for cause. Such termination for clause provisions will define what constitutes a default that constitutes sufficient cause for the owner to terminate the contract and enumerates the rights the contractor has under the contract to cure such a default.
Many construction contracts also include a clause that allows the owner or the prime contractor to terminate the contractor’s remaining work on the project at the owner’s convenience. Such a termination is not due to any fault on the part of the contractor. Termination for convenience clauses first were included in federal government procurement contracts. However, such clauses now are becoming common in private contracts. For example, the American Institute of Architect A-201 General Conditions contain such a clause.
Termination for convenience clauses are intended to provide the owner with the option to terminate the remaining balance of the contracted for work for a reason other than the contractor’s default. For example, if the owner cannot obtain additional financing to complete the work, the owner can terminate the balance of the work for convenience so long as there is a termination for convenience clause in the contract. However, if the contract does not contain a termination for convenience clause, and the owner terminates the contract before the work is complete, then the contractor would be entitled to the value of the work completed plus profit that he or she would have earned on the balance of the contract.
In addition to terminating the contract for cause or convenience, an owner can also delete all or a portion of the balance of the remaining scope of work. Should the owner make such a deletion at any time before or during performance of the contract, the contractor must review the contract to determine what his or her rights and obligations may be.
This article will discuss what typically is contained in a termination for convenience clause and restrictions on the owner’s use of such clauses.
What Does A Termination For Convenience Clause State?
Typically, a termination for convenience clause states:
“Owner may at any time and for any reason terminate Contractor’s services and work at Owner's convenience. Upon receipt of such notice, Contractor shall, unless the notice directs otherwise, immediately discontinue the work and placing of orders for materials, facilities and supplies in connection with the performance of this Agreement.
Upon such termination, Contractor shall be entitled to payment only as follows: (1) the actual cost of the work completed in conformity with this Agreement; plus, (2) such other costs actually incurred by Contractor as are permitted by the prime contract and approved by Owner; (3) plus ten percent (10%) of the cost of the work referred to in subparagraph (1) above for overhead and profit. There shall be deducted from such sums as provided in this subparagraph the amount of any payments made to Contractor prior to the date of the termination of this Agreement. Contractor shall not be entitled to any claim or claim of lien against Owner for any additional compensation or damages in the event of such termination and payment.”
From a contractor’s point of view, the owner’s exercise of a termination for convenience clause can impact the contractor’s contract profit. Simply stated, if the contract is terminated for convenience, the contractor will not earn the profit that was anticipated when the contract was executed. If the contract is terminated, the amount paid to the contractor may not recapture the contractor’s home office overhead that was allocated to the contract.
How Does A Termination For Convenience Clause Differ From A Termination For Cause or The Owner’s Deletion of the Balance of the Work?
Most construction contracts include a change order provision. Such change order clauses allow for deductive and additive change orders. However, if a public works project owner attempts to delete all of the remaining work on a contract and subsequently award it to another contractor, the owner will be held to have breached the contract. In such cases, the courts have held that such clauses, in essence, were intended to further the contract, and not to prevent completion. (See, Hensler v. City of Los Angeles (1954) 124 Cal.App. 2nd 71).
However, if the contract in the Hensler matter had included a termination for convenience clause, the public works project owner would have been allowed to terminate the contract and subsequently award the work to a new contractor so long as there was a reasonable purpose behind the termination.
Are There Any Restrictions On the Use of Such A Termination for Convenience Clause?
In every contract there is an implied covenant of good faith and fair dealing. Therefore, it can be argued that if the termination for convenience clause is exercised in bad faith, the termination may be a breach of contract. For example, if the owner chose to exercise the termination for convenience clause when the project work was ninety percent complete in order to avoid paying the balance of the profit on the remaining contract work, the termination could be held to be a bad faith termination and constitute a breach of contract.
The remainder of this discussion on bad faith use of a termination for convenience clause is based on cases interpreting federal government contracts. However, many of the concepts maybe applicable to local government and private contracts.
There are several standards for determining if a termination for convenience was improper. The traditional test is that a termination is improper if it was made in bad faith, or constitutes a clear abuse of discretion. Since this test was established it has proven to be difficult to apply, i.e. to prove that a termination was in bad faith, or was a clear abuse of discretion. In a 1982 case, the United States Court of Claims held that a termination for convenience clause could not be used to avoid paying anticipated profits unless there was a change of circumstances that warranted the use of the clause. Subsequent decisions interpreting this holding have further restricted use of the traditional test for an improper termination for convenience.
Termination for convenience clauses are common in government contracts. If a contract does not include a termination for convenience clause, termination for anything less than cause should entitle the terminated contractor to its loss profits for the project.
Termination for convenience clauses also are becoming increasingly common in private works contracts. If the prime contract contains such a clause, any related subcontracts should also include a similar clause. The amounts paid under the subcontract termination for convenience clause should be complimentary with the prime contract’s termination for convenience clause.
On occasion, an owner may vacillate between terminating a contract for convenience, rather than for cause. Many owners use a termination for convenience clause as a safety valve when they are uncertain if there is sufficient grounds to terminate for cause. If the owner selects termination for convenience, it might be able to avoid the possible contention that termination for cause was improper.
Before executing a subcontract, a subcontractor should always review the termination clauses in that subcontract. If the subcontract contains a clause that if a termination for cause is later determined to have been improper, the termination automatically converts into a termination for convenience, the subcontractor should object to the clause.
©2002, William C. Last, Jr. wrote this article. Mr. Last is an attorney who has been specializing in Construction Law for over 20 years. In addition to belonging to a number of construction trade associations, Mr. Last holds a California “A” and “B” license. He can be contacted at 650-425-7679. A number of his past articles can be found on his website (lhfconstructlaw.com). This bulletin is published periodically to provide general information about current legal issues. The articles are not intended to be a substitute for the advice of an attorney as to a specific problem. If you have a specific legal question or need legal advice, you should contact an attorney.