“Termination for Convenience” – What Does it Mean?

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by
Partner, Sedgwick Detert Moran & Arnold, LLP
Special Counsel, Sedgwick Detert Moran & Arnold, LLP

Introduction

Termination for “convenience” provisions are standard clauses in construction contracts seen in both the public and private works settings, generally allowing one party to terminate a contract even in the absence of the other party’s fault or breach, and without suffering the usual financial consequences of a breach. At least one dictionary defines convenience as “suitable or agreeable to the needs or purpose.”1 Absent language in the provision itself imposing a good faith requirement, can owners and/or general contractors (on their subcontracts) really terminate the contract when it suits their needs or purpose? In short, the answer is yes, if the termination is in good faith and does not involve fraud. In other words, most (if not all) courts addressing termination for convenience provisions do impose a good faith requirement.

There are many court decisions in the federal arena addressing termination for convenience provisions. Those decisions hold that an owner cannot used the provision in bad faith. And even when an owner exercises the termination for convenience provision in good faith, the owner must still pay the terminated contractor certain damages either delineated in the contract or as required by applicable law, which generally does not include lost profits.

How about in the non-federal public works or in the private works context? Interestingly, there are much fewer public works decisions addressing such provisions, and even fewer reported decisions in the private works context.
This article provides the construction litigation practitioner a general overview of termination for convenience provisions and what the phrase really means.

Termination for Convenience Provisions
in the Federal Context

Of the many federal court opinions addressing termination for convenience provisions over the years, perhaps Krygoski Construction Co., Inc. v. United States, 94 F.3d 1537 (Fed. Cir. 1996) provides the best historical summary tracing its application in federal court. Krygoski identifies and discusses several key federal court decisions addressing termination for convenience provisions, such as Kalvar Corp. v. United States, 543 F.2d 1298 (Ct. Cl. 1976)[cementing the bad faith/abuse of discretion standard for applying termination for convenience provisions], Torncello v. United States, 681 F.2d 756 (Ct. Cl. 1982)[court of claims adopting a broader “change of circumstances” test for gauging the sufficiency of a convenience termination than Krygoski], Salsbury Indus. v. United States, 905 F.2d 1518 (Fed. Cir. 1990)[rejecting Torncello], and Caldwell & Santmyer, Inc. v. Glickman, 55 F.3d 1578 (Fed. Cir. 1995)[reinforcing the “bad faith” standard and agreeing with Salsbury that Torncello’s “change in circumstances” rule has a narrow application].) Indeed, most, if not all, of the federal decisions since 1996 substantively dealing with termination for convenience provisions cite to Krygoski as the standard.

Turning to Krygoski, the termination for convenience provision in that construction dispute read: “The 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.” In that case, there was an increase in the cost of asbestos removal from what was thought to be ten percent of the total contract cost to about fifty percent of contract cost. The federal government then terminated its contract with the demolition contractor (Krygoski) for convenience based on this error after Krygoski had begun the work. The federal government rebid the work and awarded the contract to another contractor. Krygoski was only the sixth lowest bidder on the rebid.

Krygoski sued in the Court of Federal Claims. Relying on Torncello, the trial court held the federal government improperly terminated the contract under the convenience provision and awarded Krygoski nearly $1.5 million in damages, which included anticipatory lost profits.

The appellate court reversed the trial court. The appellate court rejected the Torncello court’s rule that the federal government could not invoke a convenience termination unless some change in circumstance between the time of award of the contract and the time of termination justified the action. The Krygoski court stated that this “change in circumstances” test only applied in factual circumstances where the federal government enters a contract with no intention of fulfilling its promises. Krygoski adhered to the bad faith standard and, given new legislative enactments under the Competition in Contracting Act, held that termination for convenience satisfies the good faith standard where the termination promulgates full and open competition. Thus, because the federal government showed it terminated the contract to preserve full and open competition and the contracting officer did not act arbitrarily or capriciously (i.e., without bad faith), the court upheld the government’s termination for convenience. The terminated contractor was entitled to its performance costs, profits on that performance, and termination costs, but not anticipatory lost profits.

Thus, courts will not typically uphold termination for convenience provisions on federal projects where the contractor can show that the federal government acted in bad faith and/or where the termination contradicts notions of full and open competition. (See also post-Krygoski decisions, e.g., T&M Distributors, Inc. v. United States, 185 F.3d 1279 (Ct. of App. Fed Cl. 1999), Northrop Grumman Corp. v. United States of America, 46 Fed.Cl. 622 (2000), and Custom Printing Co. v. United States, 51 Fed.Cl. 729 (2002).) It is true, however, that “the contractor’s burden to prove the Government acted in bad faith…is very weighty.” (Krygoski, 94 F.3d at 1541 citing Kalvar, 543 F.2d at 1301.) Thus, “[d]ue to this heavy burden of proof, contractors have rarely succeeded in demonstrating the Government’s bad faith.” (Id.)

Decisions Regarding Termination for Convenience Provisions on Non-Federal Public Works Projects

There are several state court decisions involving non-federal public works contracts worth mentioning.

In RAM Engineering & Construction, Inc. v. University of Louisville, 127 S.W.3d 579 (2003), the court found that the public entity invoked the termination for convenience provision improperly. This case involved the construction of a new stadium for the University of Louisville. The University, after negotiations with the three lowest bidders, declared RAM the lowest bidder at $7.6 million although another contractor, MAC, was initially lower. The University rejected MAC’s protest and issued a notice to proceed to RAM. MAC filed suit, at which point the University reversed course and declared the contract with RAM null and void and, thereafter, rebid the project. This time, RAM was the low bidder at $7 million and the University issued a notice to proceed to RAM. However, RAM filed a protest arguing that it should be entitled to the original price of $7.6 million because the University should not have terminated its original $7.6 million contract. The University rejected the protest arguing, in part, that it had the power to terminate the earlier contract at its convenience.

The University prevailed at the trial court level, the court finding that the MAC lawsuit was a substantial change in circumstances allowing the University to terminate the first contract with RAM for convenience. The appellate court affirmed the trial court’s ruling. However, the Kentucky Supreme Court reversed. After a detailed analysis of Kyrgoski and federal case law, the Court confirmed that the invocation of the termination for convenience provision must be in good faith. The Court held that the standard for determining good faith is whether there was a substantial change in circumstances justifying the termination. If there was, then the termination was in good faith; and if there was not, the termination was in bad faith. Under the set of facts before it, the Court determined that the MAC litigation was not sufficient to justify a termination for convenience and “did not change the circumstances of the bargain or the expectations of the parties significantly enough to justify termination.” (127 S.W.3d at 587.)

In A.J. Temple Marble & Tile, Inc., 659 N.Y.S.2d 412 (1997), a cleaning contractor sued a public railroad after the railroad terminated the contract under the convenience provision. The New York appellate court, acknowledging that the law on termination for convenience provisions developed primarily in the federal courts, looked to federal decisions for guidance, such as Krygoski and Torncello. The court upheld the good faith standard. On its facts, it found that the railroad did not act in bad faith and upheld the termination.

In New Jersey, the appellate court in Capital Safety, Inc. v. State Division of Building and Construction, 848 A.2d 863 (2004) also found that the standard was whether the termination was in bad faith. There, an asbestos removal contractor sued the public agency, which terminated its contract for convenience. Like the New York court in A.J. Temple, the New Jersey court acknowledged that there were no state decisions and that federal law would guide it. The court found that the public agency had no improper motive and that it simply exercised its discretionary authority for ordinary business purposes, i.e., without bad faith.

Decisions Involving Termination for Convenience Provisions in Private Works Settings

For example, Edo Corp. v. Beech Aircraft Corp., 911 F.2d 1447 (10th Cir. 1990) involved an action by a research and development contractor against an aircraft manufacturer after the manufacturer terminated the contractor’s contract for convenience. The district court upheld the termination. The Tenth Circuit, applying Kansas law and guided in part by federal cases, held that the right to terminate for convenience must be in good faith. On its particular facts, the appellate court found that there was sufficient evidence finding that the termination was in good faith and, thus, upheld the termination for convenience.

In Harris Corp. v. Giesting & Assoc., Inc., 297 F.3d 1270 (11th Cir. 2002), another contractor versus manufacturer action, the Eleventh Circuit, analyzing Florida contract law, reversed a jury award in favor of the contractor and held the manufacturer’s termination for convenience was valid. The Eleventh Circuit court noted that “termination for convenience clauses may not be used to shield the terminating party from liability for bad faith or fraud.” (297 F.2d at 1272-1273) Nonetheless, the court upheld the termination because the two parties were sophisticated, the express terms of the contract controlled, and there was no evidence of bad faith.

In Questar Builders, Inc. v. CB Flooring, LLC, 978 A.2d 651 (2009), a Maryland appellate court vacated and remanded a trial court’s judgment awarding a terminated subcontractor’s “expectation” damages against the general contractor for improperly invoking the termination for convenience provision. The appellate court confirmed that the termination for convenience provision did not allow the general contractor to terminate the subcontractor for any reason whatsoever. It held that a termination for convenience right may be enforceable, but it is subject to the implied limitation that the provision be exercised in good faith and in accordance with fair dealing. (978 A.2d at 674.) Relying on Krygoski and state law implying a covenant of good faith and fair dealing in every contract, the court applied the good faith standard. Notably, however, this appellate court recognized the difference between public projects (particularly federal jobs) and private works contracts stating, “we decline to recognize for private parties the near carte-blanche power to terminate that courts have given the federal government under convenience termination clauses.” (978 A.2d at 670.) The appellate court held that courts should apply an objective standard of what constitutes good faith requiring the terminating party to exercise its discretion in accordance with the reasonable expectation of the contracting parties.

What Happens When Wrongful Default Termination is
Deemed Termination for Convenience?

A number of contracts contain a provision similar to the one quoted below:

If the owner terminates the contract for default or cause, and it is later determined that none of the grounds set forth in the termination for default or cause exist, then such termination shall be deemed a termination for convenience.

Traditionally, the amount a contractor can recover resulting from an owner’s termination for convenience is very limited–demobilization costs plus the profit already earned. In some contracts, the owner will pay the profit the contractor would have earned had it been able to complete the project. The story is different where there is a wrongful default termination, which constitutes a breach of contract. Hence, if an owner did not have grounds for terminating for default, it could very well have exposure to the contractor’s consequential damages unless there is (1) a provision similar to the above, or (2) a waiver of consequential damages.

When an owner wrongfully terminates a contractor, it begins a cavalcade of problems for the contractor. First, until the contractor is vindicated by virtue of a pronouncement that the termination was improper, by either court order or settlement, the contractor must indicate on all future pre-qualification forms that it has been default terminated. While some owners may agree to overlook the default termination based on the contractor’s explanation, because default termination is such a serious step, many owners will simply refuse to pre-qualify the contractor until the contractor has resolved the dispute. Moreover, the contractor must explain the situation to its bonding company, hoping that the bonding company can ignore the default termination in its underwriting for the extension of future surety credit. Hence, the contractor has very little choice but to fight the defaulting owner.

Litigation is expensive. However, in the bonding business, cash is king. Therefore, the bonding company will carefully watch the amount of cash expended and could very likely decrease the contractor’s bonding limit based on the contractor’s expenditure of attorney’s fees in fighting the owner’s default termination. However, with the black mark of the default termination, the contractor has little choice but to spend the money to “clear its name.” As its cash diminishes, its bonding line lessens, its bidding opportunities decrease, and it loses profitable business opportunities.

When the contractor finally proves that the owner was wrong in terminating the contractor for default, a year or two later, the contractor is in a much worse position financially than before the termination, having lost out on various profitable projects. However, because of the above-quoted provision, even if the contractor is successful in court, it will only be able to recover the limited amounts available for terminations for convenience.
Admittedly, this provision is common in federal contracts—not so much in private construction or in many public contracts at the state and municipal level. It is not included in either the AIA or ConsensusDocs standard contract forms. However, both the AIA and ConsensusDocs do include a provision waiving consequential damages.

  1. Random House Webster’s College Dictionary (Random House, Inc. 1999).
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