It seems basic that when two parties enter into a construction contract, they are both bound to perform as agreed. Neither side has the right to walk away from the commitment unless there are exceptional circumstances, none of them good.
A contract can be set aside if one side fraudulently induced the other to sign. A contract can be terminated for default when one side breaches the agreement in some significant way. There also are rare instances when contract performance becomes impossible.
But what if one of the contracting parties simply changes its mind and no longer wants the project to be built? Can you imagine a circumstance where a contractor could tell an owner that it changed its mind about doing the work and where it would have a legal right to stop performance?
Contracts are based on mutuality, meaning mutuality of obligations. Where mutuality is absent, the law refers to the agreement as illusory and the contract is unenforceable. “I’ll pay you if I feel like it” would be an illusory promise.
If all this is true, then how is it that termination for convenience clauses show up regularly in construction contracts?
A sample convenience termination clause
The following language is from a subcontract on a pulp and paper mill (similar language has appeared on automotive projects, power plants and even commercial projects): “Contractor may, at its option, terminate for its convenience any Work under this Subcontract, in whole or in part, at any time by written notice to Subcontractor. Upon such termination, as the exclusive remedy of Subcontractor, the Contractor shall pay all amounts due to Subcontractor for Work completed in accordance with the Subcontract through the date of termination.”
Many of you have entered into contracts that contain clauses like this one. If you perform work with the federal government, a convenience termination clause is almost always part of the contract.
History doesn’t repeat itself; it rhymes
The justification of such extraordinary power to end a contract for good reason or no reason seems to go back to the Civil War, particularly the end of the war. Almost overnight, the government lost interest in stockpiling weapons and supplies. After World War I, cancellations of contracts for the construction of ships and other major enterprises were also common.
The courts permitted these terminations, not because contract law allowed them to, but because there would be “serious detriment” if the head of the armed forces did not have the power to do so (United States v. Corliss Steam-Engine Co., 1874).
The door was opened. Over time, these federal end-of-war powers became commonplace. See 48 C.F.R. §49.502 (2009). But does this power belong in the hands of commercial developers?
Any clause that can be used also will be abused
There have been instances where an owner has used a convenience termination because it has located a less expensive contractor. Partial terminations have been used to avoid or lessen delay claims where owner-supplied equipment is late. Changes in market conditions have been the impetus to cancel industrial expansions, as have changes in ownership of the owner.
A convenience termination clause is also used, questionably, as an owner’s safety net. If an owner terminates a contractor for default and a court later finds that the owner’s position was wrong, the contractor can claim all damages recoverable from the breach of contract, including lost profits. The termination clause that accounts for such an owner error converts a wrongful default termination into a convenience termination.
Where the courts stepped in more than 100 years ago to create this unfair owner advantage, the courts are now stepping in to curtail abuse. The means being used are the old contract law standards, including those concerning illusory contracts.
An important case
I remember a particular federal district court judge with a reputation for bluntness. He famously said in a case involving the FBI’s attempted suppression of an ex-agent’s memoirs: “The facts aren’t important.” He was right.
In a recent Maryland case, that state’s highest court used a construction dispute over a condominium project to set a new standard for the use of termination for convenience clauses. For this new standard, the facts weren’t important.
The developer in Questar Bldrs. Inc. v. CB Flooring LLC, Case No. 153, Md. Ct. App. 2009, argued that the clause gave it the right to terminate for any or no reason. This argument was rejected as “a right to terminate for any reason would render the contract illusory.” Courts try to avoid that conclusion if reasonably possible.
Citing an earlier case, Acme Markets Inc. v. Dawson Enters. Inc., 251 A.2d 839 (1969), the court held that “a power to terminate does not invalidate the contract” under conditions where the revoking party was otherwise bound by the agreement in some substantial way. The meaning is unclear.
Perhaps in an effort to clarify this issue, the court in Questar started with a conclusion: that there is a right to terminate a contract for convenience, but that right is “not unlimited.” (Note: you should always be wary of double negatives.) The “not unlimited” phrase means that the right must be exercised in good faith.
Now the question is shifted to what is not good faith. Certainly, bad faith or fraud cannot justify the use of the clause, but what are the other limitations? The Questar court reasoned that, “There undeniably is utility in including a broad termination right in contracts in the context of rapidly changing industries and in contracts for large, long-term build-out projects.”
However, shopping for a better price is not good faith. Nor is an owner’s gut feeling (referenced by the court) as to the contractor’s ability to complete on time.
In short, the terminating party has to justify its decision and give its reasons. If a judge or jury finds that those justifications were not reasonable, then good faith may have been violated. In that instance, the improper termination for convenience becomes a breach of contract.
There are indications that other states would agree generally with Maryland on this important matter. The significance to electrical contractors is that a closer look at your contractual rights is worthwhile if you are “conveniently” terminated.