The proposition that a contractor can be terminated for non-performance is unremarkable and well understood. However, nearly all public project construction contracts and many large private project contracts contain language that permits a general contractor or owner to terminate the contract at any time without cause. Clauses that grant an owner or general contractor the right to terminate the contract without cause are known as “termination for convenience” clauses. Termination for convenience clauses typically spell out the amount of damages a contractor is entitled to if the clause is invoked, which may or may not include lost profits and other consequential damages.
The idea that a party can terminate a contract without cause and without paying the full contract price traces its origins to the Civil War. The doctrine originated because it would be unreasonable for the government to continue wartime contracts after the war was over and continuing a wartime contract during peace time would be against the public interest. Concern for public interest has caused the doctrine to carry over into peacetime public works projects. As one can imagine, there are a variety of economic and political reasons that a government entity would terminate a public works project prior to completion. Generally, if a government contract is terminated for convenience recovery is limited to costs incurred, profit based on work done, and the cost of preparing the settlement proposal. Maxima Corp. v. U.S., 847 F.2d 1549, 1552 (Fed.Cir. 1988).
Termination for convenience clauses have found their way into many private project contracts as well. The amount of damages recoverable when a termination for convenience clause is invoked on a private project is determined by the language of the contract. Contractors, therefore, should carefully review such clauses to see what damages will be recoverable in the event of termination. Often, the termination clause does not permit recovery other than the value of the contractor’s work performed up to the date of termination. Therefore, a contractor will not be permitted to recover lost profits that would have been earned had the entire contract been completed. Finally, these clauses may not clearly state how a terminated contractor will be compensated for work performed off-site or for stored materials. Therefore, a contractor anticipating performing off-site work or storing large quantities of material or pre-fabricated items should consider amending the language of a termination for convenience clause to spell out how it will be compensated for such work and material.
Although termination for convenience clauses suggest a broad set of circumstances which would permit termination without cause, such termination must still be done in good faith. In other words, a party cannot enter into a contract with the intention of not honoring it and avoid liability for breach by hiding behind a broad termination for convenience clause. Torncello v. United States, 681 F.2d 756 (Ct.Cl. 1982); Salsbury Indust. v. U.S., 905 F.2d 1518, 1521 (Fed.Cir. 1990).
Margins on a completed construction contract are tight. Therefore, it is critical to determine whether a contract contains language which permits a party to terminate a contract without cause and without compensating the contractor for lost profit.