In these times of persistent inflationary forces and efforts to tame the consequences through rising interest rates, economic uncertainty abounds in the United States and around the world. As an approximately $1 trillion contributor to the economy in the United States (4.2% of GDP in 2021) alone according to the Associated General Contractors of America, the health and the growth of the construction industry is certainly susceptible to these rapidly changing macroeconomic conditions.
Presently, an unanswered question is how project developers will react to unpredictable fluctuations in project costs and interest rates. Although it seems unlikely to be a prevalent response, it is possible that substantial increases in borrowing, labor, or material costs would cause owners to pull the plug on projects that are in the advanced stages of construction. For projects in the nascent stages of development or construction, however, the calculous for owners becomes more tenuous. Both public and private owners may find it more prudent to indefinitely suspend or cancel pending or ongoing projects due to any, or a combination of, forecasted increases in project costs, shrinking funding, higher borrowing costs, or macro-economic uncertainty. Facing this quandary, how would an owner already under contract with a constructor and design team suspend or cancel its project? One potential approach is to invoke a termination for convenience clause found in the parties’ contract.
Boiled down to its basic premise, a termination for convenience clause (“T4C clause”) permits the owner to discontinue the project at any time. The T4C clause has its roots in federal government contracting dating back to the civil war era and has since found a foothold as a risk allocation device in public procurement generally, as well as in private construction contracting. See Torncello v. United States, 681 F.2d 756, 764 (Ct. Cl. 1982). Given the potential for owners to terminate for their convenience to address ever-changing market conditions, it is an important time to revisit the basics of the owner’s authority to issue a termination for convenience under a typical T4C clause.
In most contract matters, the motive behind the exercise of a contract provision is not subject to scrutiny. A termination for convenience is an exception, however. Under federal procurement law, which may be guidance for interpreting analogous public and private T4C clauses in any particular jurisdiction, the owner may exercise its termination for convenience rights so long as the decision was not a product of bad faith or abuse of discretion. See, e.g., Linan-Faye Constr. Co., Inc. v. Housing Auth. of City of Camden, 49 F.3d 915, 917 (3d Cir. 1995); Krygoski Constr. Co., Inc. v. United States, 94 F.3d 1537, 1541 (Fed. Cir. 1996). Proving bad faith or abuse of discretion is a “very weighty” proposition. The contractor must show that the owner acted maliciously or intended to injure the contractor when it decided to terminate for convenience. Kalvar Corp. v. United States, 543 F.2d 1298, 1302 (1976). Stated the other way, “[a]ny legitimate good-faith reason prompted by conditions external or internal to the terminated contract may justify termination for convenience.” Philip L. Bruner & Patrick J. O’connor, Jr., Bruner & O’Connor On Construction Law § 18:47 (July 2022 Update).
Case law provides relevant examples of economic changes, funding challenges, and other external factors, being upheld as the basis for a termination for convenience.
Termination For Convenience To Obtain A Lower Project Cost
The Massachusetts Supreme Judicial Court held in A.L. Prime Energy Consultant, Inc. v. Massachusetts Bay Transportation Authority that a public owner could terminate a contract for convenience when it finds another contractor to perform the same work for a lower price. 95 N.E.3d 547 (Mass. 2018). In the context of a private construction project, a Florida appellate court similarly upheld a termination for convenience exercised for the same reason. In Vila & Son Landscaping v. Posen Constr., Inc., the contractor terminated its subcontract for convenience because it found another entity that was willing to perform the subcontractor’s work for a lower price. 99 So. 3d 563, 564 (Fla. Dist. Ct. App. 2012). The terminated subcontractor argued that the contractor’s attempt to secure the subcontract work from a cheaper option amounted to bad faith. While declining to apply the bad faith standard from federal procurement, the court nevertheless found that the contractor’s termination was proper because the termination for convenience clause allowed it, and invoking the clause was therefore not contrary to the parties’ expectations at the time of contracting.
Termination For Convenience Due To A Loss Of Project Funding
The owner’s loss of expected project funding also may be found to be a legitimate reason for the owner to terminate for its convenience. An example of this outcome is Handi-Van, Inc. v. Broward County, a case heard by a Florida appellate court. 116 So. 3d 530, 533 (Fla. Ct. App. 2013). In Handi-Van, the County procured a para-transit system for compliance with the Americans with Disabilities Act. Subsequently, Florida voters approved an amendment to the Florida constitution that resulted in a $50 million loss in property taxes for the County. Since the property taxes were the County’s main source of funding for the project, the County terminated its contracts for convenience with its para-transit providers once the funding disappeared. In a legal challenge to the County’s termination, the appellate court upheld the termination for convenience because the contract contained an addendum stating that the County can terminate the contract if a cheaper para-transit system is procurable. Thus, the court held that the contractor knew its “contract would be terminated at a later point based on the County’s good faith economic reason for so acting.”
Termination For Convenience Due To External Forces Impacting The Owner’s Project
A termination for convenience also may be justified when the owner desires to change contractors based upon legitimate external factors that are not directly tied to project funding, such as good faith political motives. In Northrop Grumman Corp. v. United States, NASA terminated for convenience a contract to construct a space station. NASA originally contracted with four prime contractors, including Northrop Grumman (“Grumman”) for construction of the space station, but this contract structure led to significant cost overruns. 46 Fed. Cl. 622 (Ct. Fed. Cl. 2000). The cost overruns led to members of Congress and the President expressing political concerns surrounding the space station. As a result, NASA streamlined the contract structure to include only one prime contractor, with the remaining three contractors being “novated” and reassigned as subcontractors to the selected prime contractor. Grumman was dissatisfied with the new contract structure, and NASA ultimately terminated Grumman’s work on the space station for convenience. Grumman argued that the termination for convenience was done in bad faith. The court disagreed, finding that NASA had a good faith reason to terminate Grumman because otherwise, the space station “was in serious jeopardy politically.”
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The cases summarized above provide an important lesson for contractors with a backlog of contracts incorporating termination for convenience clauses. The present uncertain and ever-changing economic conditions may upend that backlog, along with the anticipated profits to be generated from the ongoing projects. Now is a good time for contractors to revisit the specific terms and conditions of any termination for convenience clauses in their agreements and carefully monitor any known financial or other forces that may cause project owners or upper-tier contractors to consider invoking the clause to address potential economic risks to the viability of their projects.
Watt Tieder is one of the largest construction boutique law firms in the United States, with a diverse and experienced team of attorneys representing many of the world’s leading corporations, developers and contractors on both domestic and international projects. We represent more than half of the Top 30 Engineering News Record contractors and most of the nation’s top sureties. With offices in six cities in the United States, the firm is a dynamic, mid-size boutique that provides knowledgeable and practical legal representation to the construction, surety, government contracts and bankruptcy industries world-wide.
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