The Termination for Convenience Clause: A Powerful Weapon in Contractual Disputes

By K&L Gates partner Jason L. Richey

Imagine a contractor who has done an outstanding job of building a magnificent skyscraper in the heart of one of the world’s largest cities.  The skyscraper is 65% complete, expected to be finished on time and within budget.  The contractor has not defaulted, and proudly touts that this construction project will be the centerpiece of the company’s accomplishments.  Suddenly, the owner of the project notifies the contractor that it has been terminated from the job for the owner’s convenience.  To complete the skyscraper, the owner replaces the contractor with one of its competitors.  Can the owner unilaterally terminate the contractor even though the contractor was not in default?  If so, what compensation is the contractor entitled to recover?  The answer to these questions lies within the termination for convenience provision which has become increasingly common in private construction contracts.

 

The termination for convenience provision is one of the most unique provisions in construction contracts.  It allows an owner to unilaterally terminate the contract with or without cause, or even if the owner itself is in default, without incurring a breach of the contract.  Webster’s Collegiate Dictionary defines “convenience” as “something conducive to…ease.”  This definition is consistent with the holdings of many courts that a party has “an absolute unqualified right to terminate a contract on notice pursuant to an unconditional termination clause without court inquiry into whether the termination was activated by ulterior motive.”[1]

Such unilateral power defies the fundamental legal principle of “mutuality of contract.”  Nevertheless, courts throughout the United States are frequently enforcing these provisions despite the consequences.

The termination for convenience provision historically was found almost exclusively in government contracts.  Today, these provisions are increasingly appearing in private construction agreements.  Owners, contractors, and their counsel must use care when drafting and implementing these clauses in private construction contracts so that their rights under the contract are properly protected.  Finally, given the current boom in the commercial construction industry, contractors are in an extremely favorable position to negotiate contracts which either do not include the termination for convenience provision, or at least negotiate terms which equitably allocate between the parties the risk of such termination.

I.          Historical Background of the Termination for Convenience Clause

The concept of terminating for convenience arose at the conclusion of the Civil War in response to the need to end wartime production.[2]  The advent of the “convenience termination allowed the government to conclude a burdensome contract by paying for the work performed (including a profit thereon) without having to pay any anticipated profits.”[3]  As early as 1863, Rule 1179 of the Army Regulations provided that military contracts “shall expressly provide for their termination at such time as the Commissary-General may direct.”[4]  This provision would allow the Government during a war to contract with a manufacturer for the production of 10,000 rifles each year for 10 years and then terminate the contract once peace ensued.  The government, despite its breach, would not be liable to the manufacturer for the anticipated profit it would have made on the guns from the time of the termination through the duration of the contract.

This concept continued to be used in response to the massive procurement efforts that accompanied other wars.[5]  For instance, during World War I, the government entered large procurement contracts to produce weapons.  Once the war ended, the government had no desire to purchase the weapons, but it had a legal obligation to do so under the contracts.  Although the government, like any party to a contract, had the power to terminate the contract, exercise of that power would have amounted to a breach, absent the power to terminate for convenience.[6]  Such a breach would entitle the contractor to receive its anticipated profits – those profits which the contractor would have made if the contract had been completed.

By the middle of the 20^th century, convenience termination clauses were becoming more common.  For example, the 1950 edition of the Armed Services Procurement Regulations contained mandatory termination for convenience clauses to be used in the majority of significant defense contracts.[7]  After World War II, such clauses also began to increasingly appear in non-defense government contracts.[8]  In 1964, the first edition of the Federal Procurement Regulations contained optional termination for convenience clauses for use “whenever an agency considered it necessary or desirable.”[9]  In June 1967, the FPR was revised to make such clauses mandatory, with limited exceptions.[10]

Not surprisingly, convenience termination became a staple of federal construction contracts and was recognized by both the Department of Defense’s Federal Acquisition Regulations and case law.[11]  Most of the law which exists today regarding the termination for convenience provision is a result of its use in government contracts.  It is this government precedent which guides us today in the drafting and interpretation of the termination for convenience provision in the private contract, as little law has yet developed regarding the termination for convenience provision in the private sector.[12]

II.        Enforceability of the Termination for Convenience Clause

The power to terminate for convenience has been written into federal regulations and private contracts with a very broad brush.  For example, FAR 52.249-2(a) provides that “[t]he Government may terminate performance of work under this contract in whole or, from time to time, in part if the Contracting Officer determines that a termination is in the Government’s interest.”  Stressing the “Government’s interest” portion of this formula, the Armed Services Board of Contract Appeals noted that the government has no duty to terminate for convenience to benefit a contractor.[13]  The Court of Claims later held that the government may terminate at will, rather than merely when there is a decreased need for the object of the contract.[14]  Nevertheless, the clause is most frequently invoked in the case of decreased need, or when proof of a default may be difficult.

Since the Supreme Court recognized the government’s right to terminate for convenience in 1875,[15] courts and administrative boards have placed few limits on the right to terminate for convenience.  Termination for convenience essentially gives the terminating party the power to demand contract performance while still reserving the right to terminate that performance if the contract later proves undesirable.  Giving force to such power, the District Court of New Jersey said that the parties enjoy “considerable discretion in deciding when and to what extent a contract may be terminated.”[16]  The question then becomes: under what conditions can a party opposing the termination for convenience attack the enforceability of such a clause?

1.         Consideration — Mutuality of Contract

The doctrine of termination for convenience arose as an exception to the common-law requirement of mutuality of contract.  Indeed, it is difficult at first to see how a contract with a termination for convenience arrangement can contain consideration.  The Restatement provides that “[a] promise or apparent promise is not consideration if by its terms the promisor or purported promisor reserves a choice of alternative performances . . . unless each of the alternative performances would have been consideration if it alone had been bargained for.”[17]  Where one of the alternative performances of a contract is termination, there will be no consideration between the parties to make the contract enforceable. 

Nevertheless, courts have found consideration present merely through the requirement that the contractor be provided notice in the event of a convenience termination.[18]  Both the Tenth Circuit and the Eastern District of Pennsylvania have held that the ability to terminate for convenience does not constitute lack of consideration where the contract requires the corporation to notify the subcontractor of the termination and pay damages after the termination.[19]

The long-standing history of the termination for convenience clause would likely make an attack on the viability of the clause based on consideration unfruitful.  Arguably, the existence of a notice provision and/or the existence of a provision which enumerates the types of damages which can be recovered when a contract is terminated for convenience should satisfy the consideration or mutuality of contract requirement, and thus make the termination for convenience provision enforceable.  However, most jurisdictions have not ruled on this issue, and it is well-established law that “[e]very court which considers a termination for convenience clause must scrutinize the contract to verify that the contract is not illusory or void for want of consideration.”[20]

2.                 Bad Faith Termination of the Contract and the Change in Circumstances Doctrine

Prior to Torncello v. United States, courts usually found that a contractor could successfully challenge a convenience termination only by showing bad faith or an abuse of discretion by the government.[21]  Torncello changed this by stating that the government could not avoid paying anticipated profits through a termination for convenience unless there was a change in circumstances between the time when the contract was executed and when it was terminated. [22] According to the court, this limitation was necessary to avoid creating an illusory contract in which the government has no obligation to the contractor.[23]  Torncello overruled Colonial Metals Co. v. United States,[24] which had held that a termination was proper where the government awarded a contract knowing of a lower price which it subsequently sought.[25]

Later decisions construed the “changed circumstances” test narrowly, as did Chief Judge Friedman in his Torncello concurrence.[26]  For example, one court held that a mere deterioration in a business relationship was sufficient to meet the changed circumstances test.[27]  In Torncello, Chief Judge Friedman understood the majority to hold only that when the government cannot enter into a contract with the intent to not perform under the contract, there can be no constructive termination.[28]  Decisions subsequent to Torncello have not been uniform in adopting the changed circumstances test,[29] and Torncello itself has seen its fair share of criticism.  In 1996, the successor court to the Court of Claims held that a termination for convenience is improper only when the government acts in bad faith.[30]  This contradicts the Torncello rule that there must be a change in circumstances.

Other courts have likewise moved away from the change in circumstances test.  In District of Columbia v. Organization for Environmental Growth, Inc., the District of Columbia Court of Appeals stated that Torncello stands for the “unremarkable proposition” that the government may not claim the benefit of a termination for convenience provision after entering a contract knowing full well it would not honor it.[31]  The court held that the only restriction on the exercise of a termination for convenience clause is for when it is shown that the terminating party acted in bad faith by specifically intending to injure the other party, or that the terminating party’s actions were motivated only by malice.[32]  While the court endorsed the bad faith test, it did note that the changed circumstances test would be met where the government grows dissatisfied through the course of the contract period.[33]

Subsequent cases have made it even more evident that the pendulum is swinging back to the bad faith end of the spectrum.  Courts are refusing the find that the government must demonstrate a change in circumstances in order to validly terminate for convenience.  Instead, they are finding that only a showing of bad faith on the part of the contractor will defeat a termination for convenience.[34]  These cases also illustrate the difficulty of meeting the bad faith standard except in limited circumstances.  For example, a termination based on national origin, if proven, would constitute bad faith.[35]  In addition, courts have held that numerous actions designed to injure the contractor, including making intentionally false statements, amount to bad faith.[36]

Other courts interpreting state law have not been hesitant to reject the unclear Federal common law related to bad faith.[37]  Instead, these courts will strictly interpret the language of the termination for convenience clause and generally treat the contract as terminable at will.[38]  In New York, courts simply will not look at the reason for the termination.[39]  Thus, whether the terminating party acted in bad faith or with malice is irrelevant.

3.         Termination for Default Versus a Termination for Convenience

Case law illustrates that there is occasional confusion as to whether a party has been terminated for default or for convenience.  If the contractor reasonably believes the termination to be for convenience, it will be treated as such even though technical language to that effect is lacking in the notice.[40]  Conversely, if the contractor knows that the termination is for default, a court will treat it as such even though the notice indicates that it is for convenience to “save face” for the contractor.[41]  In such cases, any damages will be awarded in accordance with the rules for default terminations.[42]  However, where there is genuine controversy due to an inadequate notice, the termination will be treated as one for convenience.[43]

Once a termination for convenience has been elected, it may not be converted into a termination for default even though a default existed at the time of termination.[44]  Thus, it is important to weigh one’s options before deciding which path to pursue.  Yet, there is no penalty where the government, and perhaps a private owner, chooses default, then later changes the termination to convenience.[45]  This principle is in accord with the constructive termination for convenience doctrine which is discussed below.

III.       Damages under a Termination for Convenience Clause

1.         Actual Costs Plus Profit

The express language in a contract usually governs the extent to which damages are awarded after a termination for convenience.  The parties often provide in their contract that in the event of a termination for convenience of the Owner, the contractor shall be entitled to full reimbursement of its actual costs plus a measure of profit and overhead.[46]  Stated differently, the basic measure of damages after a convenience termination under this scenario consists of costs incurred by the contractor, plus a reasonable profit based on the value of the work already performed.[47]  Customarily, the contract does not provide for the recovery for unearned or anticipated profit.  Essentially, a convenience termination converts a fixed-price contract into a method of cost reimbursement as to work performed up to the effective date of termination.[48]  Therefore, if the contractor has incurred no costs, there can be no recovery.

These fundamental damages principles have been adopted and applied by many courts including New York’s highest court in Arc Electrical.[49]  In that case, a contractor terminated a subcontractor for convenience.  The termination for convenience provision at issue required the contractor to pay “the entire amount due” at the time of receipt of the termination notice.  However, after the termination, the contractor refused to pay the subcontractor for actual costs incurred because it argued that the architect failed to approve the subcontractor’s work.  The contractor argued that without the architect’s approval, the subcontractor was not due its actual costs.  The Court rejected this argument and pointed out the difference in the payment obligations of the contractor before and after a termination for convenience:

[t]here is considerable difference between the rejection of a claim for a progress payment and the refusal of payment after the contract has been terminated and all work has ceased . . . The withholding of approval, though it may have postponed, did not eliminate Arc’s right to compensation for the work it had performed.  However, once the contract was terminated, preventing the subcontractor from curing any defects, it is reasonable to construe the contract as providing for payment for all work actually performed, even though it may not have been entirely completed.  If there were any deficiencies in performance, they would merely diminish the amount to which Arc would be entitled and would not (and should not) result in the forfeiture of its entire right to be compensated.  Such a construction of the contract, which adequately protects the interests of both parties, comports best with its language . . . .[50]

The court then went on to explain the rationale for allowing Arc to recover its actual costs for all work performed:

[i]ndeed, even if a requirement for the architect’s approval was expressly incorporated [into the contract], it would not be enforceable.  It was Fuller’s own act, in terminating the contract, which rendered it impossible for Arc to take any necessary steps to satisfy the architect.  The law looks with disfavor on contractual provisions that would allow one party, by its own unilateral act, to avoid its obligations by preventing or hindering the other party from fulfilling one of the conditions to the contract.  “[T]he defendant cannot rely on [a] condition precedent . . . where the nonperformance of the condition was caused or consented to by itself”.[51]

As Arc Electrical demonstrates, a termination for convenience clause will not be interpreted in order to work as a forfeiture on the nonterminating party.  It is the cardinal principle of the termination for convenience clause that the contractor receive full reimbursement of its actual costs together with overhead and profit because any nonperformance of the contract is a direct result of actions taken by the terminating party.[52]  Such a result is consistent with well- settled law that a party to a contract cannot rely on the failure of the other party to perform when he has frustrated or prevented the performance.[53]

2.         Reasonable Costs

The costs recoverable under a convenience termination must be reasonable.  This standard is embodied in federal regulations, which state that “[a] cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business.”[54]  A caveat to the above test is that while costs incurred plus profit thereon is the usual measure of damages, the total contract price acts as a cap on the allowable recovery.  This holds true unless there is a separate lawsuit based on some other theory, such as fraud, extraneous to the convenience termination.

The contractor carries the burden of establishing its incurred costs.  Evidence from accounting records is the preferable method of showing costs.  However, if such records are unavailable through no fault of the contractor, evidence of costs may be based on estimates.[55]  Nevertheless, if the contractor uses estimates, it retains the burden of proof as to costs.[56]  A contractor is thus well advised to keep detailed records of costs incurred, along with appropriate documentation.

There are a number of categories of costs that courts have deemed recoverable.  The most obvious costs recoverable are labor and materials used directly in the contract job.  But other, less apparent, costs may sometimes be recovered as well.  For example, in Navgas, Inc., a contractor was allowed to recover the cost of bid preparation.[57]  Moreover, F.A.R. 31.205-42(c) contains a list of allowable initial costs, including training, plant rearrangement, production planning and idle time due to production methods testing.  Nevertheless, these are costs for which the government has been allowed recovery.  Private parties should contract as to which specific items are reimbursable when there is a convenience termination.

 

3.         Consequential Damages

Termination for convenience clauses generally disallow recovery of consequential damages as being too remote.  Such remote damages include the cost of bankruptcy, the loss of future business and the loss of expected profits.[58]  Similarly, loss of production and impairment of credit are disallowed consequential damages.[59]  The cost of retaining employees or of manufacturing products falls on the contractor if such measures are not required to wind up work under the contract.[60]  Moreover, vague concepts such as “moral obligation” are insufficient to support a claim for recovery.[61]

Nevertheless, post-termination costs that are not too remote are generally recoverable.  FAR 31.205-42(b) allows as damages those costs which cannot be discontinued despite the reasonable efforts of the contractor.  Such post-termination costs might include transit for employees stationed at a remote location or continuation of a special manufacturing process where disruption would cause a complete loss on the project.

4.         Owner’s Recovery for Defective Work or Overpayment

“Where [a party] elects to terminate for convenience, as provided in [a construction contract] . . . it cannot counterclaim for the cost of curing any alleged default.”[62]  Such a claim would be inappropriate since the act of terminating for convenience deprives the contractor of the opportunity to cure deficiencies by better performance as the contract is nearing completion.[63]  For courts to hold otherwise would be inconsistent with the nature of a termination for convenience which is not based upon any fault or negligence on the part of the contractor.

In Tishman Const. Co. v. City of New York, the city made the decision to terminate the plaintiff, a contractor, for its own convenience and not for default.  The defendant then counterclaimed against the contractor for, inter alia, “alleged overpayments” for work conducted before the contractor was terminated.[64]  The Appellate Court affirmed the lower court’s granting of plaintiff’s summary judgment motion on defendant’s counterclaim for overpayment.  As the Tishman Court explained, if a party wishes to pursue a claim for the default of a contractor for overpayment, it should terminate under the provision of a contract for default because such provisions enable a party to recoup the expense of curing the contractor’s default.[65]  If, however, the party elects to terminate for convenience, the terminating party loses its ability to recoup its alleged overpayment cost because the termination extinguishes the non-defaulting party’s right to complete the project.[66]  Again, the rationale for this result is that the convenience termination is not based in fault or negligence, and, indeed, the contractor has no control over whether or when a termination for convenience is elected.  Any such recovery for overpayment must derive from a separate action based on fraud or mistake.[67]

5.         Equitable Adjustment

Unlike issues regarding defective work and overpayment, the law in certain equitable circumstances will favor the owner in determining damages.  For instance, if the contractor would have suffered a loss had the contract been completed, as determined at the time of termination, it is fair and appropriate to make a “loss adjustment” to the amount of recovery.  This is to avoid a situation in which the owner or government pays, and the contractor receives, more than it expected to pay or receive on the relevant portion of the contract.  Conceptually, the loss adjustment should yield a result such that the recovery of costs incurred on the completed portion of the contract is reduced in proportion to the amount of loss that would have been suffered on the entire contract.

Another common source of an equitable adjustment, this time favoring contractors, is recovery for unabsorbed overhead.  Where a contract is partially terminated, overhead costs will often be higher relative to the continued portion of the contract than they would have been relative to the entire contract price.  Courts have allowed recovery of this item as an equitable adjustment.[68]  The Fifth Circuit noted that “[t]here seems to be little question that unabsorbed overhead is properly includable in an equitable adjustment if the contractor can prove that changes idled some of its facilities” and diminished direct costs to which overhead was charged.[69]  In other words, if fewer units of a product are produced, or fewer man-hours are worked, and overhead remains the same or similar, the amount of overhead per unit will be greater.[70]  This concept contrasts with unrecoverable absorbed overhead, such as when equipment used on a terminated project is used elsewhere.

An equitable adjustment may also be made where the government, or owner, causes a loss in some other respect.  For example, in Celesco Indus., Inc., the contractor was entitled to an equitable adjustment where it incurred additional costs due to a defective wire resulting from poor government specifications.[71]  The Board did note, though, that the burden of proof under a preponderance standard was on the contractor in establishing the amount of the equitable adjustment.[72]  Moreover, the adjustment would be decreased or nullified if the government is prejudiced by any delay on the part of the contractor in notifying the government of the problem or defect.[73]

IV.       Constructive Termination for Convenience

Sometimes, the government, despite the existence of a termination for convenience provision in the contract, will terminate a contractor for default, which a court later determines to be improper.  One might assume that the government would be liable for damages, including anticipated profits, under a breach of contract theory. However, this is not the case.  When a termination for default is improper, courts have nonetheless absolved the government of the breach by holding that the government could have terminated for convenience.[74]  There is no award of damages for breach of contract, and, instead, the court will award damages only under the convenience termination provision.  Thus, the government’s already broad power to terminate for convenience is greater than it appears at first blush.  The doctrine that began as a method of easing the transition from war to peace has become a tool for limiting damages when the government would otherwise be liable for breach of contract.

In describing this doctrine, the District Court of New Jersey in Linan-Faye stated that: “[c]onstructive termination for convenience is a judge-made doctrine that allows an actual breach by the government to be retroactively justified . . . [T]his doctrine applies in situations where the government stops or curtails a contractor’s performance for reasons that are later found to be questionable or invalid.”[75]  Despite this doctrine’s common-law origins, government regulations now expressly convert improper default terminations into convenience terminations.  F.A.R. 52.249-8(g) states:  “[i]f, after termination, it is determined that the Contractor was not in default, or that the default was excusable, the rights and obligations of the parties shall be the same as if the termination had been issued for the convenience of the Government.”  Thus, a contractor will not be able to recover unearned profits when the government improperly terminates for default, unless bad faith is shown.

Bolstered by the federal regulations, courts find it easy to apply the doctrine of constructive termination for convenience.  Indeed, the court in Linan-Faye noted that when a contractor enters into a contract, it recognizes that if the government invokes the convenience termination clause, the contractor’s remedies for breach, including those committed prior to termination, are limited to the remedies set forth in the termination for convenience clause itself.  In other words, where the parties agree on a method of calculating damages, a court must enforce that method.[76]  One court found that the existence of a default by the government does not bar a convenience termination pursuant to the applicable contractual clause.[77]  The court’s rationale was that the purpose of a convenience termination is to allow the government to avoid paying unearned anticipated profits when it breaches or terminates.[78]

When the government has the choice of terminating for convenience or for an alleged default by the contractor, the course of action is obvious.  Assume a situation where the government believes the contractor has defaulted, yet the contractor has raised potential meritorious defenses.  The question arises whether to terminate for convenience or for default.  The government undoubtedly will terminate for default with little fear of the consequences.  Its worst case scenario is that the court will convert its default termination into a constructive termination for convenience.

Absent explicit contractual language that an improper default termination is automatically converted to a convenience termination (also known as a “Conversion Clause”), the doctrine of constructive termination for convenience may not apply in the private setting.  The sparse case law on this issue does not yield a definitive answer.  The Eastern District of Pennsylvania has stated in Engers:

[t]his Court has not found a single case where a private party was allowed to “constructively” terminate a contract for convenience . . . .  The rationale behind not allowing private parties to “constructively” terminate contracts for convenience is consistent with the maxim that contracts shall not be illusory.[79]

Likewise, a New York court would not allow the conversion from a default to convenience where no Conversion Clause existed.[80]  Perhaps the closest a court has come to allowing a private termination for convenience occurred in Linan-Faye.  In that case, the court allowed a local government to constructively terminate for convenience.[81]

While this does not directly address contracts solely between private parties, Linan-Faye does extend the rationale of the constructive application of the doctrine beyond the realm of federal government contracts, leaving open the possibility that it can be extended even further.  Moreover, the Engers decision involved an attempt to invoke the doctrine absent the relevant contractual language.  Thus, private parties would be wise to not rely on judicial applications of the doctrine, and to expressly provide in their contracts for the automatic conversion of an improper default termination into a convenience termination.  However, even without this language, courts in private contract disputes may choose to invoke the doctrine.

Interestingly, one court has declined to invoke a “constructive termination for convenience” when the doctrine works against the government.  In Diversified Energy, Inc. v. Tennessee Valley Authority,[82] the contractor included a stiff penalty of $14.00 per ton for each ton scheduled for delivery for the remainder of the contract (i.e., $22 million) if the termination for convenience clause was utilized by the Owner.  On appeal, the contractor argued that the governments’ repeated breaches of the contract constituted a constructive invocation of the unilateral termination clause.  However, the Sixth Circuit held that the “constructive termination for convenience doctrine” can only be applied when it limits the government liability. It cannot be applied to increase liability.[83]

V.        Drafting and Implementing a Termination for Convenience Clause

Knowing how to draft a convenience termination clause and being aware of relevant issues can protect both the owner and the contractor.  The owner is protected for obvious reasons by limiting the contractor’s recovery after termination.  If the inclusion of a termination for convenience provision is a possibility, a knowledgeable contractor has the flexibility to protect itself because the terms of the clause are mostly negotiable.  Thus, the contractor can put itself in a more favorable position by knowing all of its options.  For example, the contractor may, like in Diversified Energy, negotiate a liquidated damages provision in the event the clause is utilized, or the contractor may demand a provision requiring the owner to deal exclusively with the contractor for some period of time if the owner decides to continue the project after termination. In other words, though a termination for convenience primarily benefits an owner, a contractor can seek to protect itself by knowing the available options for making the provision more palatable.

Because there is little law on the termination for convenience clause, there is much room for negotiation in drafting such provisions.  Nevertheless, this also means that the owner and contractor must be quite careful that the language chosen fulfills their expectations, and that the result is an effective clause.  If the clause is not drafted carefully, litigation will ensue, thereby nullifying the benefits the parties initially desired.  Contractors need to be especially wary of these clauses and, depending on their relative bargaining position vis-à-vis the owners, should try to either:  (1) exclude the termination for convenience clause altogether; (2) negotiate the provision on the most favorable terms possible; or (3) although nearly unheard of, include a termination for convenience provision which is exercisable by the contractor itself.

1.         Excluding the Termination for Convenience Clause Altogether

If possible, contractors should work to avoid convenience termination altogether for the important reason that it is mainly a weapon which benefits owners.  Current market conditions may make avoidance of this clause easier for contractors.[84]  With the increase in demand, “the volume of work . . . is giving contractors the freedom to turn down onerous contract clauses or simply walk away.”[85]  One contractor notes that his company “has walked away from jobs where the contract terms unfairly shifted risks or contained consequential damages clauses.”[86]  Given this business climate, contractors may be able to avoid the convenience termination clause or, failing that, to negotiate a favorable balance of risks, discussed further in the next section.

2.         Negotiating the Termination for Convenience Clause Contractor

If it is not possible to exclude the termination for convenience clause, contractors should seek to negotiate the best possible terms in the event of termination.  Perhaps the most straightforward example of the termination for convenience clause is contained in the Federal Acquisition Regulations, which provide that “[t]he Government may terminate performance of work under this contract in whole or, from time to time, in part if the Contracting Officer determines that a termination is in the Government’s interest.”[87]  Other standard language for a termination for convenience clause is published by the American Institute of Architects (“AIA”):

14.4.1 The Owner may, at any time, terminate the Contract for the Owner’s convenience and without cause.

14.4.2 Upon receipt of written notice from the Owner of such termination for the Owner’s convenience, the Contractor shall:

.1 Cease operations as directed by the Owner in the notice;

.2 Take actions necessary, or that the Owner may direct, for the protection and preservation of the Work; and

.3 Except for Work directed to be performed prior to the effective date of termination stated in the notice, terminate all existing Subcontracts and purchase orders and enter into no further Subcontracts and purchase orders.

14.4.3 In case of such termination for the Owner’s convenience, the Contractor shall be entitled to receive payment from the Owner on the same basis provided in Subparagraph 14.1.2.

Document A511 “Guide for Supplementary Conditions” (1987 ed.), § 14.4.

Convenience termination provisions, like those contained in federal regulations or the AIA guide, can also be included in subcontracts.  For instance, the Association of General Contractors’ “Standardized Subcontract for Building Construction,” under ¶ 10.5, allows the prime contractor to “suspend, delay or interrupt all or any part of the Subcontractor’s work for such period of time as may be determined to be appropriate for the convenience of the Contractor.”  The subcontractor must then notify the contractor within ten days of the costs the subcontractor has incurred as a result of the termination.  As this clause suggests, it is important to make explicit whether the general contractor can terminate for its own convenience, or only when the owner does so.

While these sample clauses are helpful in assessing the type of language used, they fail to include certain specifics regarding recoverable damages.  The exact manner and language which private parties should use to draft a termination for convenience clause will vary depending on the circumstances, and parties should consult a knowledgeable attorney.  However, a few guiding principles are universal.  Most importantly, as the aforementioned case law indicates, written notice should be universally present in convenience termination provisions because “[p]recedent provides that the clause will not be found unenforceable for lack of consideration if it includes a notice requirement.”[88]

One of the most important parts of a termination for convenience provision, after the granting language and the notice requirement, is a section detailing the measure of damages in the event of a termination.  The basic formula is that the contractor will be paid for actual costs incurred until the effective date of termination, as well as a profit on those costs.  The provision should note precisely which costs may be recovered, as well as the manner in which a profit will be measured.  The manner of calculating profit can vary, but the easiest method of determining this is to add a set percentage to the total costs incurred, with that percentage subject to negotiation.

In addition to specifying damages, such a provision should also note the time within which the contractor must submit a claim to the owner and the time within which the owner must pay the contractor.[89]  An additional protection available to contractors is a provision which would prevent the owner from terminating without first agreeing to pay for all past work completed.[90]  This would protect the contractor if the owner terminates for convenience and then tries to refuse payment because of unsatisfactory work; in that instance, the owner may be in default for failure to terminate correctly.[91]

Other provisions will vary more, based on the requirements of the contract and the relative bargaining power of the owner and contractor.  The clause may allow recovery of unallocated overhead, that which will not be absorbed under other work.  In other words, if equipment goes unused because of a termination, the cost of that equipment will be higher in proportion to the unterminated portion of the contract than it would be in proportion to the contract as a whole.  Such a provision can be dangerous, though, as disputes may arise regarding what overhead is reasonably unabsorbed.  For example, an owner may contend that a contractor could have easily obtained another contract on which to use its equipment.  While the overhead would still be unabsorbed, the issue would be whether this is fairly reimbursable.  An alternative to including such a provision is to increase the percentage of profit added to the costs incurred, and then to state in the clause that unabsorbed overhead is not recoverable.  The contract should expressly state what materials or equipment are unrecoverable “common items.”  Otherwise, some of these may be considered recoverable costs incurred because they may not fit neatly into the category of “overhead.”

Another negotiable provision is a loss adjustment clause.  If it appears at the time of termination that the completion of the contract would have created a loss for the contractor, an owner would desire not to pay the contractor for its full costs incurred.  However, such a determination can only be based on estimates which no doubt would become the subject of contention.  The parties may choose instead to deny recovery of profit in such a case, rather than adjusting the amount of recoverable costs incurred.  While disputes may still arise as to whether the contractor would have suffered a loss, this alternative avoids conflicts as to how much of a loss would have occurred.

Regardless of whether a loss adjustment (or equitable adjustment) provision is included, the contract should still state explicitly that the total contract price serves as a cap on damages.  Moreover, any provision granting or denying a loss adjustment should state whether defective work in the terminated portion of the contract at the time of termination gives rise to an adjustment of damages.  The fairest option is to allow recovery of costs incurred in producing the defective work, because the contractor has no control over when a convenience termination is elected.  However, if a loss adjustment is made, an estimate of the total cost to complete the project should include the estimated cost of correcting the defective work.

As suggested, the equitable adjustment is another potential point of contention.  Where the contractor slants his bid so that greater profit is allocated to one portion of the contract and that portion is later terminated, the contractor will want an adjustment of the contract price with respect to any completed or unterminated part of the contract.  The measure of such an adjustment would probably be less contentious than that of other adjustments because it is an easier amount to prove, but an owner may not wish to pay the contractor more than it sought on a particular portion of the contract.  The solution to this situation will vary, but the potential for an equitable adjustment can be used as leverage in negotiating other portions of the measure of recovery.  As stated above, the owner may forego the possibility of a loss adjustment in exchange for a provision denying an equitable adjustment.  Alternatively, the owner may allow an equitable adjustment if the contractor cannot recover unabsorbed overhead.  Perhaps the easiest solution is to deny an equitable adjustment, while informing the contractor that it should bid in a manner such that profit is spread evenly across all portions of the contract, if possible.

Finally, the termination for convenience clause may also expressly provide for the contractual version of the constructive termination for convenience doctrine.  In other words, the Conversion Clause should state that a default termination, if unjustified, is automatically converted into a termination for convenience, and that damages are limited accordingly.  As much as the equitable and loss adjustments, such a conversion provision will no doubt be subject to negotiation.

3.         Inserting a Termination for Convenience Clause that is Exercisable by the                                 Contractor Against the Owner

There is no case law directly on this point, but it is conceivable that an owner and contractor may find themselves in a bargaining position where it is favorable to include a termination for convenience clause that is exercisable by both parties, or solely by the contractor.[92]  This situation would be ideal for contractors because the risk of termination would fall equally on both parties, or on the owner exclusively.  In a construction boom like that which exists today, it may be possible to negotiate such a provision.  It would allow a contractor to escape from a losing or hostile project.  Such a provision may be upheld by courts, so long as it contains a notice provision and is freely bargained for between the parties.

In today’s strong construction market, contractors should have ample leverage and bargaining power to secure the most favorable allocation of risk, especially when it comes to a termination for convenience clause.  If possible, such a clause should be kept out altogether to prevent owners from denying future profits in the event of breach, default, or termination.  If this cannot be done, contractors should negotiate the clause on terms most favorable to them.  An especially useful way to accomplish that is to insert a provision prohibiting termination for convenience unless all bills that have been submitted by the contractor have been paid.  This will ensure that the contractor is compensated for work actually performed in the event that the owner later attempts to convert the convenience termination into one for default.  Finally, if contractors find themselves in a strong enough position, they may be able to insert a termination for convenience provision exercisable by both parties, or even by the contractor alone.

Though much of the foregoing discussion is based on governmental precedent, this history of the termination for convenience clause will undoubtedly have a large impact on how courts interpret the clause in the private setting.  This history and legal precedent raises many implications for private contracting parties.  One piece of advice, however, bears repeating:  if parties desire to include a termination for convenience provision, they should contemplate every possible circumstance and draft contractual provisions using the most explicit language possible to minimize confusion in the event of a dispute.