Termination For Convenience Clauses – Will The Requirement For ´Good Faith´ Prove To Be Very Inconvenient?

'Termination for convenience' clauses are common in many contracts within the construction industry, and operate to provide the Principal or Head Contractor with a right to terminate the contract or sub-contract, at any time, and without any breach of the contract by the other contracting party, but merely for the Principal's 'convenience'. There is some recent judicial comment that indicates that Principals may be required to demonstrate that such a provision is being exercised in good faith.

Such clauses create a simple 'exit strategy' that can, to an extent, be costed and invoked in situations where the continuance of the contract or project is no longer appealing to the Principal. This could be due to a number of reasons, including financial changes or pressures within the Principal's business, a desire to allocate capital and time to other potentially more profitable projects, or a matter as simple as wishing to no longer work with the Contractor.

When exercising a termination for convenience clause, the Principal is generally required to pay to the Contractor the value of the work completed up to the date of termination, the costs of materials reasonably ordered by the Contractor (subject to such materials becoming the property of the Principal on payment) and the reasonable costs of removal of construction plant. So, typically, a Principal could terminate for convenience for any reason at all, by providing notice in writing and making the payments detailed above, and then be free of any other obligations whatsoever to the Contractor.

Shifting Sands?

The recent Supreme Court of Victoria decision of Kellog Brown & Root Pty Ltd v Australian Aerospace Ltd suggests that this landscape may be changing. The case demonstrates a potentially growing judicial willingness to intervene in the Principal/Contractor relationship in the area of termination for convenience clauses and may eventually develop into a requirement that such clauses be invoked in 'good faith'.

The case was an application for an interlocutory injunction to prevent the Principal from relying on a notice to terminate for convenience, on the basis that the right to terminate for convenience was subject to an implied term of good faith and fair dealing and as such, the notice should not have been given in the circumstances. The relevant contract was in the area of defence procurement, and the termination for convenience was exercised after the dispute resolution process under the contract had been invoked.

As the application sought injunctive relief, Justice Hansen was not required to determine whether the termination was or was not in good faith, but rather to determine if there was a 'serious question to be tried'. The parties ultimately agreed that there was a 'serious question to be tried', and his Honour determined that the balance of convenience rested with the granting of the injunction.

Mitigating The Risk In Termination For Convenience Clauses

With the law developing in this area, it is important that Principals and Head Contractors consider mitigating the risk of the requirement for good faith being implied. It is impossible to predict how a court may impose any obligation of 'good faith' in such circumstances, however an amendment to termination for convenience clauses to include a percentage of profit or margin on the sums otherwise payable may go some way to establishing an absence of 'bad faith'.

By providing the Contractor with a percentage of profit or margin on the sums payable as a consequence of exercising a termination for convenience, the Contractor is not robbed of any of its bargain up to the date for termination. Without the payment for profit and margin on the sums otherwise payable under a termination for convenience clause, it could be argued that the Principal obtained a direct benefit, if such profit and margin would have been payable but for the exercise of the termination for convenience clause.

Contract administration and considered application of termination for convenience clauses will also minimise the 'good faith' risk. Exercising a termination for convenience clause after the commencement of the dispute resolution process, and in an apparent attempt to defeat or avoid the dispute resolution process under the contract, will more clearly demonstrate a lack of 'good faith' than the exercise of such a clause prior to the commencement of the dispute resolution process. Similarly, exercising such a clause purely for the purpose of awarding the work to a third party may also be indicative of bad faith.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.