Can a contractor or sub be terminated without good reason? Can they be terminated for nothing at all? When a construction contract features a termination for convenience clause, the answer just might be “yes”. Let’s dig a little deeper.
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What is Termination for Convenience?
Termination for convenience is sort of like at-will employment or a prenup. When a contract is terminated for convenience, the contract is being terminated simply because one party decides to terminate the agreement. It’s not necessarily due to poor performance, and it’s not because one party breached the agreement. However, termination of convenience will only be an option where a contract features a termination for convenience clause. Otherwise, single-handedly quitting a contract is just a good old fashioned breach of contract. And that’s a divorce that can be costly.
Let’s Talk About Breach
What is a Termination for Convenience Clause?
A termination for convenience clause is a clause in a construction contract that allows one or both parties to terminate the agreement without a specific reason for doing so (such as a default or breach of the contract). Termination for convenience clauses are really common in government construction contracts, but they’ve become increasingly common in the private sector, too. Without a termination for convenience clause present, the party who terminates the contract can really only terminate the agreement based on default or breach (or some other term in the contract).
What Does a Termination for Convenience Clause Look Like?
It’s important to be able to identify a termination for convenience clause in the contract. Generally, if there’s a section of the contract that sounds like one party can just walk away from the deal without having to justify their actions, a termination for convenience clause might be in play.
The most common example of a termination for convenience clause might be from the AIA. At 14.4.1 of the A201 contract, it reads:
“The owner may, at any time, terminate the Contract for the owner’s convenience and without cause.”
The next two sections continue to set out exactly how to wind down the agreement. Specifically, it states that upon notice of the termination from the owner, the contractor must cease operations, take actions to preserve and protect the work, and terminate their subcontracts and purchase orders. While this version is geared toward contractors, similar clauses could easily be present in the contract of a subcontractor.
Why Would Anyone Agree to a Termination for Convenience Clause?
Here’s where the prenup comparisons come in.
For one, there isn’t always a choice. While the “freedom to contract” is touted for providing flexibility for businesses, the party in power (the party with the money) will often dictate the terms of the agreement. So, for a contractor or sub who doesn’t have a lot of leverage, a termination for convenience clause might be one of those tough pills you have to swallow.
But there are practical reasons for agreeing to a termination for convenience clause, too. When termination for convenience clauses are present, often, there are some costs associated with terminating the agreement. Meaning, a customer might have to pay for terminating the contract. We’ll discuss that a little later on.
Why Terminate a Contract For Convenience, Anyway?
In all seriousness, there are a variety of reasons why a customer might want to terminate a contract for convenience. For one, terminations based on mere convenience tend to be a much cleaner break than a termination for default. As mentioned in the section above, payments for work performed must be made, and sometimes the customer might also have to pay other amounts like a penalty or wind-down costs. But these costs will pale in comparison the cost of battling out a termination for default dispute in court (especially when considering the chance of losing). Termination for convenience, when the cost of termination is reasonable, will typically be much easier than termination for default.
But there are other reasons for terminating the contract without a default. It’s relatively common for developers to shut down or postpone projects when the market isn’t looking favorable. When the customer realizes they’re going to run out of cash, it might be safer (and cheaper) to terminate the agreement before it’s too late. Honestly, there are any number of reasons why terminating the agreement might be preferable. However, when terminating a contract for convenience, the party terminating the agreement had better do so in good faith.
Payments Owed When a Contract is Terminated for Convenience
When a termination for convenience clause is exercised, it isn’t simply a “pack up your stuff and go” situation. No, there are typically costs the owner must incur in order to terminate the contract.
First, the customer will still have to pay for all work performed prior to the termination. Often, a customer will also have to pay for the costs of winding down any subcontracts or vendor agreements affected by the termination. There could be some liquidated damages clause that sets out a penalty for a termination for convenience, too. Finally, in a best-case scenario, some termination for convenience clauses will even allow for the terminated contractor or sub to be paid for the profits they would have attained at the end of the job if they hadn’t been terminated. This situation more or less mirrors what might happen after a contractor or sub wins a breach of contract action.
Generally, Lost Profits Aren’t Available When a Contract is Terminated for Convenience
Limitations on the Ability to Terminate for Convenience
There are some limitations on the ability to terminate for convenience – even where a clear termination for convenience clause is present. This comes from the basic principles of contracting. Both parties to a contract must enter the agreement (and execute it) in good faith and with the intention of fair dealing. So, where a customer tries to use a termination for convenience clause to game the system, they could run into liability.
A termination for convenience clause can’t be exercised in bad faith. One common example used of bad faith is where a customer terminates their contractor or sub when their work is 90% complete in order to avoid making final payment or in an attempt to keep retainage. Also, the customer can’t enter the agreement intending to terminate prior to completion.
Another example, albeit a trickier one, is terminating a contract for convenience in order to award the remainder of the work to some other contractor or sub. In this situation, there’s probably a good argument for either side re: whether the termination was made in good faith or in bad faith. Keep in mind, though – if another business offers to undercut a contractor or sub who’s already under contract, tortious interference could come into play. More on that idea here: Tortious Interference With a Construction Contract.
Termination for Convenience vs. Deductive Change Orders
We wrote a whole post on this topic, which you can find here: Deductive Change Order vs. Partial Termination | When the Scope of Work is Reduced
If you’re really interested in this subject, you should click the link above. But here’s the short of it: termination for convenience can sometimes be done in a partial manner. Meaning, if it’s allowed under the contract, a customer can cancel part of the work via termination for convenience – all while having their contractor or sub performing some of the work that remains.
This can also be done via deductive change order! While we think of change orders as adding or adjusting the scope of work for a project, they can also be executed in order to narrow the scope of work. Where a contract does not allow for partial termination for convenience, deductive change orders could potentially be utilized to fit the same purpose.
Termination for Convenience and FAR (the Federal Acquisition Regulations)
As mentioned earlier in the article, the origin story of the termination for convenience clause starts with the federal government. The Federal Acquisition Regulations first introduced the clause to allow the government to get out of contracts when it’s in the government’s best interest to do so. It makes sense – if the government no longer needs the goods or services they’re set to receive in the contract, then it’s no longer in the government’s (and, therefore, the taxpayers’) best interest to continue to execute the contract. Offering a way out of that contract seems only fair, as long as the agreement is undone in a responsible and equitable way (i.e. wind-down costs and the cost of canceling subcontracts and vendor agreements is paid for).