Termination For Convenience

Termination for convenience clauses are now present in many contracts. However, problems often arise where the employer has exercised his right to terminate for convenience in order to give the work to an alternative contractor - bringing with it a host of arguments dealt with differently in various jurisdictions.

This article is to be regarded as a taster; there is insufficient space in the KC Construction Update to do full justice to the issues arising in relation to termination for convenience clauses (a substantial main course will be published in due course). This article will identify the main issues arising on the international and domestic authorities and hopes to provide a guide through some of the more knotty arguments.

Termination for convenience clauses are now present in many standard form contracts, including some that include a good faith-type obligation, either as part of the standard form (such as NEC3) or as a bespoke amendment. They vary in format, but usually expressly provide that the employer may terminate on notice for any reason and at any time.

The contract usually provides for what will happen on a termination for convenience: often the contractor is entitled to be paid for work done; less often, the contractor is also entitled to a payment essentially compensating him for his loss of profits.

The main problem in practice arises where the employer has exercised or wishes to exercise his right to terminate for convenience in order to give the work to an alternative contractor, either because he is able to get a cheaper deal or because he has concerns as to the performance of his current contractor and wishes to avoid contention as to whether that performance is sufficiently bad to trigger the termination for default clause.

There has been much more discussion of the enforceability of these clauses in this context in the USA and Australia. Two main strands of attack emerge from the international authorities. These are:

Where there is a duty of good faith, termination for the purpose of appointing an alternative contractor is in breach of that duty (USA and Australia). A construction of the clause that permitted termination in order to appoint an alternative contractor would mean that the employer's obligations were 'illusory' and in fact provided no consideration, because it was entirely at the employer's option whether he performed his obligations or not. The clause would, therefore, not be construed in this way (USA). GOOD FAITH

United States

In the USA, it is generally accepted that there is an obligation to act in good faith in exercising contractual rights. (see Burton & Andersen on Contractual Good Faith: Formation, Performance, Breach, Enforcement (1995) and, for example, the Uniform Commercial Code §1-304). In most contexts, it has been accepted that the duty of good faith does not permit termination to obtain a better bargain elsewhere, as per the common law cases cited in Good Faith in the Termination and Formation of Federal Contracts by Federick W Claybrook Jr, 56 Md. L. Review 555 (1997). In relation to federal contracts, this may be limited to the situation in which the better deal was known about as at the date of the contract formation.

The conclusion seems almost to be assumed: the existence of the good faith duty appears to have led to a narrow construction of the clauses, despite references in judgments and commentary to the fact that good faith should not be used as "a tool for rewriting the parties' Agreement based on unspecified notions of fairness". (General Aviation Inc v Cessna Aircraft Co, 703 F. Supp. 637 at 644 (W.D. Mich. 1988))

Australia

A duty of good faith has also been recognised in numerous Australian authorities (although the question of whether it is a general duty or a term to be implied by reference to the usual tests has not been finally determined: see, for example, Kellogg v Australian Aerospace [2007] VSC 200 at paragraph 56).

In Pacific Brands Sport & Leisure v Underworks [2005] FCA 288 (Federal Court of Australia), the judge described the duty (obiter) as follows:

"... the duty of good faith is an incident (not an ad hoc implied term) of every commercial contract, unless the duty is either excluded expressly or by necessary implication... I presently incline to the view... that the duty is not an independent term of the contract the breach of which would give rise to a remedy, but that it operates as a fetter upon the exercise of the discretions and powers created by the contract, including the power of termination."

The Australian courts are, however, doubtful as to whether the existence of the duty (without more) means that termination to give the work to...