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“Termination For Convenience” Clause Spells Trouble For Construction Contractors

There are many issues for a contractor to consider when entering into a construction contract. One of those considerations is whether the contract includes what is known as a “termination for convenience” clause.

Nearly all construction contracts provide for the owner to terminate a contract if the contractor defaults on its performance in certain defined ways. Such clauses are referred to as “termination for cause” provisions. Termination for convenience clauses, however, are intended to provide the owner with the option to terminate the work at any time without regard to the contractor’s performance. Such a clause generally gives the owner the right to terminate “for any reason or no reason.” The primary purpose of the clause is to quantify the amount of compensation the contractor is entitled in the event of a termination for convenience and to allow the owner to avoid the duty to pay the contractor the profit that the contractor would have earned on the balance of the contract. If a contract does not include a termination for convenience provision and the contractor is not in default, the contractor is generally entitled to compensation for work actually performed and profit it would have realized on the uncompleted work.

A typical termination for convenience clause states:

Owner may at any time and for any reason terminate contractor’s services work at owner’s convenience. Upon receipt of such notice, contractor shall, unless the notice directs otherwise, immediately discontinue the work and placing of orders for materials, facilities and supplies in connection with the performance of this agreement.

Upon such termination, contractor shall be entitled to payment only as follows: (1) the actual cost of the work completed in conformity with this agreement; plus, (2) such other costs actually incurred by contractor as are permitted by the prime contract and approved by owner; (3) plus 15% of the cost of the work referred to in subparagraph (1) above for overhead and profit. There shall be deducted from such sums as provided in this paragraph the amount of any payments made to contractor prior to the date of the termination of this agreement. Contractor shall not be entitled to any claim or claim of lien against owner for any additional compensation for damages in event of such termination and payment.

Most contractors adjust their bidding plans for future projects based upon the amount of work they have under contract. Obviously, this allows contractors to avoid getting “spread too thin” or not having enough work to pay its employees; all with the goal of maximizing its profit. An owner’s ability to terminate a contract, particularly on a large project, can have a devastating effect on the contractor. The contractor, when a termination for convenience clause is in the contract, will not be entitled to the revenue, and associated profit, from the uncompleted portion of the work.

If a contractor elects to proceed with a project that includes a termination for convenience provision, the contractor should analyze the payment it is entitled to receive if the contract is terminated. It is also important that the contractor include a termination for convenience provision in its subcontracts. Any profit the contractor may have to pay to a subcontractor for terminated work may or may not be costs the contractor is entitled to collect from the owner. This often depends on the specific language in the owner/contractor termination for convenience clause.

There are some limitations on the use of a termination for convenience clause. The primary limitation is that all contracts include an implied covenant of good faith and fair dealing. Essentially, this covenant prohibits the parties to a contract from acting in bad faith. Therefore, if an owner terminates the contract in bad faith, the owner may not be entitled to rely on the termination for convenience clause. Contractors need to be aware, however, that in order to prove bad faith in this scenario, the owner’s actions would generally need to be rare and extreme.

In this difficult economic climate, it is not unusual to see partially completed projects or projects that never “break ground.” As such, it is particularly important for contractors to realize whether a contract includes a termination for convenience clause and, if so, the compensation to which it is entitled under such a provision and the effects a termination may have on its business.