15 May 2014

An inconvenient truth with termination for convenience?

by Victor Lau

Whether a principal is entitled to terminate a contract for convenience may depend on whether a term of good faith is implied into the contract.

Construction contracts often contain provisions enabling termination for "convenience", generally allowing the principal to terminate the contract at will, even where the contractor has not done anything wrong.

A question that often arises in disputes concerning termination for convenience clauses is whether the principal is entitled to terminate the contract when it suits him, for any reason, or no reason at all? In short, is there any fetter on a termination for convenience right? There is no common law right to terminate for convenience. The starting point to examining this question is the termination for convenience clause itself: does the clause prescribe a limit in any way on the basis in which the termination for convenience right may be exercised? It is commonplace for such clauses to require written notice to the other party with the termination becoming effective after expiry of the period of notice. There may be further limitations – for example the FIDIC 1999 Red Book contract clause 15.5 provides a termination for convenience right, but it also provides that the principal may not terminate the contract in order to execute the works himself or to arrange for the works to be completed by another contractor.

Quite apart from limitations arising under the express wording, in Australia, some State and Federal courts have imposed limits by endorsing the implication of a term of good faith in exercising a right to terminate a contract, while other courts have been reluctant to endorse the implication of a term of good faith.

The High Court of Australia has not, as yet, expressly endorsed the implication of a term of good faith into a commercial contract. However it bears mentioning that the High Court in 1953 in Carr v Berriman (1953) 89 CLR 327 held that a contract's variation power in absence of express wording did not permit a principal to omit works to provide to another contractor for a more attractive price.

An example of a termination for convenience clause

In Thiess Contractors Pty Ltd v Placer (Granny Smith) Pty Ltd (2000) 16 BCL 130, the Supreme Court of Western Australia was asked to consider a clause which stated "[Placer] may, at its option, at any time and for any reason it may deem advisable, cancel and terminate the Contract, in which event [Thiess] shall be entitled to receive compensation".

Justice Templeman held this clause was "clear and unambiguous" and provided Placer with an absolute right of termination. Justice Templeman's decision on the principal's entitlement to terminate the contract was upheld on appeal.

Why do parties agree to termination for convenience clauses?

A termination for convenience clause is usually expressed as a right that can be exercised at any time and for any reason. It is attractive to a principal for a number of reasons. This is particularly the case during tough economic times when the financial viability of a project is put into question. Principals will often consider a range of options including that for opting out of a contract. In some cases, there may be significant changes in market conditions which the principal is not able to take advantage of if it is bound into an existing contract. There will also be situations where the relationship between a principal and its contractors has significantly deteriorated such that it becomes impossible for the parties to work together.

For governments, public interest considerations may influence policy decisions, and governments may benefit from the flexibility that allows existing contracts to be terminated. For these reasons government procurement contracts often contain such clause.

On a practical level, principals are often attracted to the less onerous procedural requirements that are typically used in termination for convenience clauses, especially when compared with clauses dealing with termination for cause which rely on contractor's default, and which usually require a number of steps by either parties to be undertaken. These steps often include specific notices be issued by the principal, requiring the contractor to show cause in writing to the satisfaction of the principal, and the provisions often require the principal to assess the performance during the cure period.

Principals run the risk of wrongful termination if the procedural requirements are not followed, particularly as courts usually do not favour contract terminations, and would strictly construe and enforce the contractual requirements on terminations.

Limitations to termination for convenience clauses

In Leighton v Arogen [2012] NSWSC 1370, Justice McDougall was disinclined to imply any particular limitations to the Principal's right to terminate. In considering a contract which was part of an upgrade to the electricity supply system of the southern suburbs of Sydney, Justice McDougall granted an order requiring the contractor, Arogen, to vacate the site which effectively meant that the contract was terminated for convenience. In doing so, Justice McDougall commented that it was:

"very hard to see how an entitlement to terminate "for convenience", accompanied by the obligation to pay what the parties must be taken to have agreed would be fair compensation for the consequences of such termination, could be conditioned by any obligation of good faith. On the contrary, I would have thought, such a right was one to be exercised according to idiosyncratic or personal notions of convenience, and not necessarily one constrained by any concept of good faith. In saying this, I accept that it may still be arguable that good faith is a freestanding obligation of the particular contract, and not merely an implied incident of performance of contractual obligations. Of course, if the latter view were correct, it might have little to do with the exercise of a contractual right".

Termination for convenience of a defence related contract for the supply of helicopters was considered by the Victorian Supreme Court in Kellogg Brown Root Pty Ltd v Australian Aerospace Ltd [2007] VSC 200. The decision was an interlocutory, rather than final, judgment but it gave recognition to a duty of good faith and held that there was a serious question to be tried, as to whether the exercise of a right to terminate for convenience would be subject to a duty of good faith.

In the above case, Kellogg Brown Root invoked the dispute resolution process when Australian Aerospace gave notice terminating for convenience. Given this, the court said, by not allowing the dispute resolution process to run its course, Australian Aerospace had acted to pre-empt the dispute resolution process and the risk of a result which may have been favourable to Kellogg Brown Root.

It seems therefore that if a notice of dispute is raised by a contractor in respect of a principal's notice of termination for convenience, the principal should at least consider what was said in this case regarding the consequences in not permitting the dispute resolution process to be followed through.

The implication of a good faith term qualifying the exercise of a right to terminate for convenience was also recognised in Apple Communications v Optus Mobile [2001] NSWC 365. However Justice Windeyer acknowledged that it was not finally established if the good faith term must be implied in all contracts. In that case Justice Windeyer found that there was no reason not to imply the term but found that there was no breach of such a term on the basis that the parties did not act unreasonably. In considering that issue, he said: "If a contract allows for termination for any reason then it does not seem to me to be unreasonable to terminate it for a reason unconnected with conduct of a contracting party". Apple had argued its termination was arbitrary or capricious because the termination reason had nothing to do with its performance as a distributor. Justice Windeyer rejected that argument.


How is the principal required to conduct itself, if a duty of good faith is required in terminating a contract for convenience?

In Australia, there is uncertainty as to the meaning of good faith. Many may argue that a duty of good faith will involve a concept of "reasonableness". In Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234, the NSW Court of Appeal implied a term to act reasonably when exercising power to terminate for failure to show cause. In that decision, Priestley JA said that "the kind of reasonableness I have been discussing seems to me to have much in common with the notions of good faith".

In Sundararajah v Teachers Federation Health Ltd [2009] NSWSC 1443, Justice Davies noted that the content of the duty of good faith has been equated to reasonableness, a duty not to act capriciously, whereas conduct which seeks to prevent the performance of the contract or withholding its benefits, or seeking to further an ulterior or extraneous purpose would indicate breach of the obligation.

Practical tips for dealing with termination for convenience clauses

There are some practical considerations for both contractors and principals in negotiating contracts containing proposed provisions on termination for convenience, in pursuing or defending a purported right to terminate a contract for convenience.

For contractors:

  • in negotiating a contract, aim to exclude such provisions or, if that is not negotiable, limit the circumstances that give rights to terminate. The limitations may include expressly stating that the exercise of a right to terminate for convenience is subject to a duty of good faith. It may also include the circumstances under which principals are not entitled to terminate for convenience;
  • ensure that there is an entitlement to compensation where the right to terminate for convenience is exercised. Importantly, that the categories of losses adequately cover the losses that are likely to occur and adequately compensate for the profits foregone;
  • in the event the principal purport to terminate for convenience, consider all rights that are available to the contractor, including activating the dispute resolution process as discussed earlier in the Kellogg Brown Root case; and
  • consider whether the principal, in purporting to terminate for convenience, has acted in good faith. 

For principals:

  • the Thiess case referred to earlier is a useful reminder of the importance of a clear and unambiguous termination for convenience clause. Similarly, clearly articulate the components of losses or damages that are payable, including whether a maximum liability applies;
  • recognise that in Australia, the right to terminate for convenience may be constrained by the requirement that such a right be exercised in good faith. The circumstances in which such a term is to be implied, if at all, has not been finally determined in Australia; and
  • those who choose to exercise rights to terminate for convenience, always follow the contract procedures on termination, if any are prescribed, otherwise they run the risk of unlawful termination and exposing themselves to damages claims from the contractors.

 

You might also be interested in...

Related Knowledge

Get in Touch

Get in touch information is loading

Disclaimer

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.