By Trent Cotney, Trent Cotney PA
Over the past 40 years, construction contracts have become increasingly one-sided in favour of the project owner. Contracts have evolved to include a myriad of provisions to shelter owners from liability. One in particular has allowed owners to gain even more control over the contracting process by creating more favourable termination provisions: the termination for convenience clause.
A termination for convenience clause is a provision in a construction contract that allows the owner of a project to terminate the contract at any time, without cause, if the owner deems that it is in 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 (see Custom Printing Co v United States, 51 Fed. Cl. 729 (2002), finding an owner’s own underestimation of materials needed for a given project satisfactory), or frustration of purpose, and will not be held liable for breach of contract damages.
Terminations for convenience may also be used to limit damages where a “cardinal change” occurs on a construction project. A change order or modification that is minor in scope typically does not trigger this. However, under certain circumstances, the owner may seek such a fundamental change in the nature of the work that it is deemed to be a cardinal change because it dramatically alters the terms of the contract. (See Atlantic Drydock Corporation v US, 773 F.Supp. 335 (MD Fla. 1991).)
Even if the contract includes a “changes clause,” the contractor is not required to perform the changed work and may sue the owner for breach of contract damages. In this situation, an owner may use a termination for convenience to limit the owner’s exposure to damages. See T&M Distributors, Inc v United States, 185 F.3d 1279 (Fed. Cir. 1999) (recognising that convenience terminations are often used because of a cardinal change). The convenience termination allows the owner to terminate the contract and issue a subsequent bid proposal for the remaining work to be performed on the project without the repercussions associated with a breach of contract or an expensive request for an equitable adjustment to the contract.
Termination for convenience clauses originated in federal government wartime supply contracts following the Civil War. 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. (See United States v Corliss Steam-Engine Co., 91 U.S. 321, 23 L.Ed. 397 (1876); Torncello v U.S., 681 F.2d 756, 764 (Ct. Cl. 1982).)
However, unlike earlier periods of American wartime, nowadays, on a private construction project, the wartime-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. (See, for example, 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 utilised a three-pronged approach to analyse the enforceability of the termination for convenience in a private supply contract. These factors were:
The Engers court reasoned that because the whole idea of terminations for convenience arose from government contracts, a private contractor on a project funded or initiated by the government may justify the use of a convenience termination as well.
The Engers court also examined the nature of the contract. Government supply contracts usually take one of three possible forms:
The use of termination for convenience clauses in “definite quantity” and “indefinite quantity” contracts is generally deemed enforceable. However, 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-governmental entities.
Finally, the enforceability of a termination for convenience provision in a private contract depends on whether the provision is clear and unambiguous, and whether both parties understood the implications of including it, and the procedures that may follow. In Engers, the court found that the contractor failed to provide the terminated supplier with the contractually specified written notice of the contractor’s intent to terminate 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, ie, lost profits plus costs, instead of merely reimbursement for the supplier’s out-of-pocket costs.
The factors addressed in Engers were intended to analyse the enforceability of a termination for convenience between two non-governmental 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 analysed the provision and determined that there was sufficient mutuality of obligation, ie, 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. Because the termination was supported with mutual consideration, and they appeared to act in good faith, 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.
Termination for convenience clauses are almost universally upheld. The clauses have survived an onslaught of creative arguments, including that the provision was ambiguous, illusory, and/or unconscionable. See, for example, M Fields v United States, 53 Fed. Cl. 412 (2002).
Although an uphill battle is almost certain, many parties who have been terminated for convenience have argued that the contracting officer or owner acted in bad faith in order to recover breach of contract damages. Nevertheless, many others have faced unsympathetic courts who generally rule in favour of upholding the termination. The bad faith defense is such a tough sell because the standard espoused by courts requires the undeniable proof of bad faith in order for a termination of convenience to be overturned.
This almost insurmountable standard first appeared in Kalvar Corp., Inc v United States, 543 F.2d 1298 (Ct. Cl. 1976). Here, Kalvar Corporation was granted a “primary supply” contract to provide the General Services Administration (GSA) with film. After the contract was awarded, the GSA contracted with the Xidex Corporation to provide film with a different speed rating. Kalvar contended that the GSA breached the sole supplier agreement by contracting with another party. The government then used the termination for convenience clause incorporated into the contract to limit its damages. (Kalvar, 543 F.2d at 1301.)
Kalvar filed suit and argued that the government acted in bad faith because the GSA deliberately withheld information from Kalvar regarding the need for film with a different speed rating. In analysing Kalvar’s claims, the court set the stage for its decision by articulating that there is a “presumption that public officials act ‘conscientiously in the discharge of their duties.’” (Citing Librach v United States, 147 Ct. Cl. 605, 612 (1959).) The court further stated that it requires “well-nigh irrefragable proof” for the court to find bad faith. “Well-nigh irrefragable proof” has been defined as “evidence that ‘cannot be refuted or disproved; incontrovertible, incontestable, indisputable, irrefutable, undeniable.” (Am-Pro Protective Agency, Inc. v United States, 281 F.3d 1234, 1240 (Fed. Cir. 2002).) Irrefragable proof has also been defined as clear and convincing evidence or something which is “stronger than a ‘preponderance of evidence’.”
To prove bad faith, a terminated party must demonstrate that the contracting officer’s actions were “motivated alone by malice” or “actuated by animus toward the plaintiff.” (Kalvar, 543 F.2d at 1302. Applying this standard, the Kalvar court held that GSA’s award of a contract to a party other than Kalvar was insufficient to demonstrate bad faith, and upheld the government’s termination for convenience.
Six years following the decision in Kalvar, Torncello v United States, 681 F.2d 756 (Ct. Cl. 1982) made it radically easier to overcome a termination for convenience by not requiring “irrefragable proof” of bad faith by the owner. Unfortunately for contractors, the death knell for Torncello occurred less than 15 years later in Krygoski Constr. Co., Inc. v United States, 94 F.3d 1537 (Fed. Cir. 1996) (rejecting the Torncello approach and returning to the Kalvar standard).
With post-Krygoski cases continuing to require “irrefragable proof” of the government’s specific intent to injure the terminated party, see for example Rice Systems, Inc v United States, 62 Fed. Cl. 608 (2004), it is not surprising that few terminated parties have been able to prove bad faith. Several courts have noted that bad faith or fraud may be used to defeat a termination for convenience, but few, if any, have actually found bad faith. See, for example, Harris Corp v Giesting & Associates, Inc, 297 F.3d 1270 (11th Cir. 2002); Knotts v United States, 128 Ct. Cl. 630 (1954); Struck Constr Co. v United States, 96 Ct. Cl. 186 (1942).
Concerning what sort of evidence actually constitutes irrefragable proof of bad faith sufficient to avoid convenience terminations, the Kalvar court provided two illustrations of courts holding that a party had indeed demonstrated bad faith. It noted that in Knotts, the plaintiff employee was able to prove a conspiracy on the part of the employer and others to terminate the employee, thus demonstrating malice. Similarly, in Struck Construction Co, it was held that the government repeatedly engaged in an intentional effort to disrupt the contractor, including actively delaying the contractor on the project.
It was stated in a recent Florida case: “[I]f the bad faith limitation were not in place, all parties seeking to contract with the federal government would be forced, without the benefit of negotiation, to endure termination at the government’s whim.” (Handi-Van, Inc v Broward County, 116 So. 3d 530, 538-539 (Fla. 4th Dist. Ct. App. 2013).)
Unfortunately for contractors, it appears that terminations for convenience are here to stay, and have spread from federal government contracts to state and local government contracts, as well as some larger private sector agreements. Before signing any contract with a termination for convenience clause, a contractor should thoroughly review any termination provisions and recognise the limitations on how it will be compensated if a convenience termination occurs.