Termination for Convenience: Necessary Evil or Unfair Advantage – Part 2

The use of termination for convenience clauses is on the rise in the private sector.

By Trent Cotney

This is the second installment of a four-part article on terminations for convenience provisions in construction contracts. The previous article discussed the history of terminations for convenience and their modern usage. Now, we will focus on the increasing use of terminations for convenience in the private sector.

A termination for convenience clause is a provision in a construction contract which allows the owner to terminate the contract at any time without cause, if the owner deems that it is the owner’s “best interest.” The owner may use the convenience termination against the contractor for a host of reasons such as lack of funding or frustration of purpose.

A termination for convenience clause allows an owner to terminate a contract without being liable for breach of contract damages such as lost anticipated profits on the work yet to be performed. If the prime contract contains a termination for convenience clause, then the prime contractor is well advised to include a termination for convenience clause in its contracts with subcontractors and suppliers. Otherwise, the prime contractor runs the risk of being liable for breach of contract damages to its subcontractors and suppliers if the owner uses a convenience termination. See T.I. Constr. Co., Inc. v. Kiewit Eastern Co., 1992 WL 382306 *7 (E.D. Pa. 1992).

Although termination for convenience provisions come in a variety of forms, the following is a standard provision that occurs frequently in government contracts: The Contracting Officer, by written notice, may terminate this agreement, in whole or in part, when it is in the best interest of the Government. The Government shall be liable only for payment in accordance with the payment provisions of this agreement for performance which the contractor renders prior to effective date of termination.

See Erwin v. U.S., 19 Cl. Ct. 47 (1989). This provision is common in contracts where the United States is a party, and is prescribed by federal regulations. The regulations, codified in 48 C.F.R. §§1, et. seq., provide detailed information on the use of terminations for convenience and the methodology to be used to determine the terminated contractor’s compensation. Termination for convenience clauses are utilized by government agencies on the federal, state, city, and local government levels, and are increasingly being seen on private projects.

Recall that in Part I of this article we explained that termination for convenience clauses originated in federal government war time supply contracts. The clauses were originally upheld by the courts under the justification that the government needed the flexibility to unilaterally cancel a supply contract when a war ended. On a private construction project, the war time supply flexibility justification does not exist. The inclusion of these provisions in contracts between two private parties has created legal questions such as whether sufficient consideration exists between two privately owned parties to allow and enforce a convenience termination. The cases that examine this issue have used a variety of factors to determine if convenience terminations are enforceable. Engers v. Perini Corp., 1993 WL 235911 at *8 (E.D. Pa. 1993), citing to T.I. Constr. Co., Inc. v. Kiewit Eastern Co., 1992 WL 382306 at *10 (E.D. Pa. 1992).

In Engers, the court utilized a three-prong approach to analyze the enforceability of the termination for convenience in a private supply contract. The Engers Court opined: Although termination for convenience clauses have been extended to private parties, the case holds that their enforceability is subject to three factors: (1) Does the contract arise out of a government funded or government initiated project; (2) is the contract for “quantity certain” or “requirements” agreement; and (3) are the terms by which one party can invoke the termination clause explicitly stated. Engers, 1992 WL 235911 at *8.

The Engers Court reasoned that because the whole idea of terminations for convenience arose out of government contracts (as discussed in part I of this series), a private contractor on a government funded or initiated project may justify the use of a convenience termination.

The Engers court also examined the nature of the contract. Government supply contracts usually take one of three possible forms: (1) “definite quantity” contracts, where the number of items to be purchased and the compensation for the items is clearly delineated; (2) “indefinite quantity” contracts, where the number of items to be purchased is not specified, but a minimum amount is usually specified to avoid lack of consideration problems; and, (3) “requirements” contracts (also referred to as a single source supplier contracts), where the minimum and maximum number of items to be purchased is not identified, but consideration is provided in the form of a promise to purchase all products or services from a single source.

The use of termination for convenience clauses in “definite quantity” and “indefinite quantity” contracts generally are deemed enforceable. However, the use of a termination for convenience clause in a “requirements” contract presents unique contract consideration problems. If a party is allowed to terminate a “requirements” contract at any time without using the services of a subcontractor, or purchasing materials from a supplier, then the contract may lack sufficient consideration. The Engers Court implied that the contract must be examined to determine the parties’ obligations and whether the use of a convenience termination is enforceable between two non-government entities.

Finally, the enforceability of a termination for convenience provision in a private contract depends on whether the provision is clear and unambiguous. Both parties must understand the implications of the termination for convenience and the procedures that must be followed to invoke the provision. In Engers, the court found that the contractor failed to provide the contractually specified written notice to the terminated supplier of the contractor’s intent to use the termination for convenience. Accordingly, the court held that the contractor failed to comply with a condition precedent to the use of the convenience termination clause, thereby allowing the supplier to seek full breach of contract damages against the contractor, i.e. lost profits plus costs, instead of merely reimbursement for the supplier’s out of pocket costs.

The factors addressed in Engers were intended to analyze the enforceability of a termination for convenience between two non-government entities on a government funded project. In Edo Corp. v. Beech Aircraft Corp., 911 F.2d 1447 (10th Cir. 1990), the Court explored the use of a convenience termination between non-government entities and privately-owned and funded projects. In Edo, a contractor sued an aircraft manufacturer for improper termination under a termination for convenience clause. The court analyzed the provision and determined that there was sufficient mutuality of obligation, i.e. consideration, to justify the use of a convenient termination. Under the terms of the contract, the aircraft manufacturer was required to give notice of its intent to terminate and compensate the contractor for its out-of-pocket costs. The court also noted that the manufacturer’s actions evidenced good faith rather than malfeasance. Because the manufacturer’s termination was supported with mutual consideration, the court held that the convenience termination was valid.

By understanding the meaning and effect of termination for convenience clauses, contractors will be in a better position to evaluate the risk involved with signing a contract containing the provision. Next month’s article will focus on the use of constructive terminations for convenience and the defenses used against terminations for convenience.

Author’s note: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.

Trent Cotney is Florida Bar Certified in Construction Law, a member of the National Roofing Contractors Association (NRCA), General Counsel and a director of the Florida Roofing Sheet Metal and Air-Conditioning Contractors Association (FRSA), General Counsel and member of the Governance Committee of the National Women in Roofing (NWIR), the Treasurer of the West Coast Roofing Contractors Association (WCRCA), and affiliated with almost a dozen other roofing associations. For more information, contact the author at 866-303-5868 or visit www.RoofingLawyer.com.