Termination for Convenience: It's All About 'Good Faith'
Termination for convenience provisions are standard clauses in construction contracts that generally allow one party to terminate a contract even in the absence of fault or breach by the other party, and without suffering the usual financial consequences of a breach.
Absent language imposing a good faith requirement in the provision, can owners and general contractors really terminate another contracting party 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 the public sector, many federal court decisions on termination for convenience provisions hold that the provision cannot be used in bad faith. Even when an owner exercises the provision in good faith, the owner must pay the terminated contractor certain damages either delineated in the contract or as required by applicable law, which generally does not include lost profits.
In the private sector, fewer decisions address termination for convenience provisions.
Federal Decisions on Public Projects
Of the many federal court opinions addressing termination for convenience provisions, Krygoski Construction Co., Inc. v. United States, a 1996 case, provides the best historical summary.
The termination for convenience provision in the 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 the case, the cost of asbestos removal increased from 10 percent of the total contract cost to about 50 percent of the contract cost. The federal government terminated its contract with the low bidder demolition contractor (Krygoski) based on this error after Krygoski began work. The federal government rebid the work; Krygoski was the sixth lowest bidder, so the contract was awarded to another firm.
Krygoski sued in the Court of Federal Claims, which found the federal government improperly terminated the contract under the convenience provision and awarded Krygoski nearly $1.5 million in damages, including anticipatory lost profits.
The appellate court then rejected the trial 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 court stated that this “change in circumstances” test only applied in factual circumstances in which 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.
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, the termination for convenience was upheld. The terminated contractor was entitled to its performance costs, profits on the performance and the termination costs, but not anticipatory profits.
As a result, termination for convenience provisions on federal projects will not be upheld if the contractor can show the federal government acted in bad faith or if the termination contradicts notions of full and open competition.
Federal Decisions on Private Projects
In the private works context, Edo Corp. v. Beech Aircraft Corp., a 1990 case, involved an action by a research and development contractor against an aircraft manufacturer after the manufacturer terminated the contractor’s contract for convenience.
After the district court upheld the termination, the 10th Circuit Court, 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 sufficient evidence showed the termination was in good faith, and it upheld the termination for convenience.
In Harris Corp. v. Giesting & Assoc., Inc. (2002), another contractor versus manufacturer action, the 11th 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 court noted that “termination for convenience clauses may not be used to shield the terminating party from liability for bad faith or fraud.”
Nonetheless, the court upheld the termination because the two parties were sophisticated, the express terms of the contract were controlled and there was no evidence of bad faith.
State Decisions on Public Projects
In RAM Engineering & Construction, Inc. v. University of Louisville (2003), the court found the public entity invoked the termination for convenience provision improperly.
After negotiating with the three lowest bidders on a new stadium project, the University of Lousiville 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 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 uni
versity should not have terminated its original contract. The university rejected the protest, arguing that it had the power to terminate the earlier contract at its convenience.
The university prevailed at the trial court level, with 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, after a detailed analysis of Krygoski and federal case law, the Kentucky Supreme 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 a substantial change in circumstances occurred to justify the termination. If there was, then the termination was in good faith; if not, the termination was in bad faith.
The court determined 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.”
State Decisions on Private Projects
In Questar Builders, Inc. v. CB Flooring, LLC (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.
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.
Relying on Krygoski and state law, the court applied the good faith standard. 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.”
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.