11.04Damages for Termination for Convenience 185

11.01Introduction...... 182

11.02Termination...... 182

11.03For Convenience...... 182

11.04Damages for Termination for Convenience...... 185

11.05Backcharges and Termination for Convenience...... 187

11.06Constructive Termination...... 189

11.07For Default (or Cause)—Common-law...... 190

11.08Contractual Termination for Default after Notice...... 191

11.09Damages for Termination for Cause...... 192

11.10Opportunity to Cure...... 194

11.11Required Notice...... 195

11.12Wrongful Termination...... 196

11.13Damages for Wrongful Termination...... 197

Chapter 11: Termination

11.01 Introduction

A party’s right to terminate its contract may originate from the general principles of contract law, or it may arise out of the terms of the contract itself. In general, the effect of the termination is to discharge the parties from their unperformed obligations under the contract. The reasons for termination will determine whether a contractor is entitled to payment for work performed prior to termination and whether the contractor is responsible for increased costs to complete the remainder of the project.

11.02 Termination

In the construction context, “termination” means to stop a contract before it is fully performed or completed. The contract terms or applicable law determine whether or when each party has a right to terminate the contract.

11.03 For Convenience

Normally, a party to a contract cannot unilaterally terminate a contract with another without just cause. In this case, the contract contains a “termination for convenience” clause. This clause gives the owner the right to terminate the contract without cause or for any reason.

Even though the contract has this provision, the contractor may recover full breach of contract damages if it can show that the owner acted in bad faith by invoking the termination clause.

To show bad faith in this context, the contractor must show that the owner

(1) acted with malicious intent or animus toward the contractor or

(2) entered into the contract knowing full well that it had no intention of honoring the contract.

Comment

Many public contracts, and a growing number of private contracts, contain termination for convenience clauses that give the owner the unilateral right to terminate the contract if it deems the termination to be in its best interest. See, e.g., Federal Acquisition Regulations FAR 52-249-1. Although these clauses typically require that the owner pay the contractor for the value of the work installed and typical contract closeout costs, the owner is usually saved from paying for damages for actual breach of contract, profit and overhead and work not performed, or punitive damages. See Krygoski Constr. Co. v. United States, 94 F.3d 1537 (Fed. Cir. 1996), cert. denied, 137 L. Ed. 2d 819 (1996).

While the government’s right to terminate a contract for convenience is not unlimited, the government is entitled to considerable latitude in making such a decision to terminate. Id. at *6.

Under the “traditional standard,” a contracting officer’s convenience termination is conclusive absent the contractor’s showing that the termination decision either was a product of bad faith or constituted clear abuse of discretion. Id.; see alsoJohn Reiner & Co. v. United States, 325 F.2d 438, 442 (Ct. Cl. 1963). It is the terminated contractor’s burden to show bad faith. Nat’l Factors Inc. v. United States, 492 F.2d 1383 (Ct. Cl. 1974). But see U.S. Genes v. Vial, 923 P.2d 1322 (Or. Ct. App. 1996) (implied covenant of good faith does not limit the right to terminate the contract for its convenience).

Contractors asserting claims of bad faith must overcome the strong presumption that in the absence of clear, contrary evidence, public officials act conscientiously in the discharge of their duties. Cont’l Collection & Disposal Inc. v. United States, 29 Fed. Cl. 644, 652 (Ct Cl. 1993). Since good faith is presumed unless bad faith is demonstrated, the government is prevented only from engaging in actions motivated by a specific intent to harm the plaintiff. Id. The difficult burden of proof for a contractor attempting to show that a government act was undertaken in bad faith has been described as follows: “It requires ‘well-nigh irrefragable proof’ to induce the court to abandon the presumption of good faith dealing.” Kalvar Corp. v. United States, 543 F.2d 1298, 1301–02 (Ct. Cl. 1976), cert. denied, 434 U.S. 830 (1977). In the cases where the court has considered allegations of bad faith, the necessary irrefragable proof has been equated with evidence of some specific intent to injure the plaintiff, motivated solely by malice, or actuated by animus toward the plaintiff. Id. Unsubstantiated suspicions and allegations of bad-faith actions are not enough. To demonstrate bad faith, the contractor must identify specific instances of the government’s ill will directed toward it. Id.

The state of mind of the contracting officer is critical to determining whether a convenience termination was made in bad faith. No less than knowing and intentional conduct on the part of the contracting officer can support a finding of bad faith. Thus, claims of bad faith have been rejected when the contractor can only prove that the convenience termination was an outgrowth of negligent conduct by the contracting officer. Salsbury Indus. v. United States, 905 F.2d 1518, 1521 (Fed. Cir. 1990). Moreover, mere error on the part of the government, even if it would constitute sufficient ground for contractual breach, is insufficient to demonstrate bad faith. Kalvar Corp. v. United States, 543 F.2d 1298 (Ct. Cl. 1976).

A contractor may also attack a contracting officer’s decision to invoke a termination for convenience clause on the grounds that the decision to terminate was an abuse of discretion or arbitrary and capricious. Darwin Constr. Co. v. United States, 811 F.2d 593, 598 (Fed. Cir. 1987). The contractor has the burden of proving arbitrary and capricious conduct. Embry v. United States, 17 Cl. Ct. 617, 625–26 (1989) (holding that two bases of termination—ruined business relations and inadequate performance—supported government’s termination of contractor for convenience). In determining whether a contracting officer has abused his discretion, the Federal Circuit has generally examined the following factors: (1) subjective bad faith on the part of the procuring officials, depriving a bidder of the fair and honest consideration of his proposal; (2) proof that there was no reasonable basis for the decision; (3) the degree of proof of error is ordinarily related to the amount of discretion entrusted to the procurement officer; and (4) proven violation of pertinent statutes or regulations. Id.

In Torncello v. United States, 681 F.2d 756 (Ct. Cl. 1982), the court appeared to alter the “Traditional Standard” described above by requiring the government to demonstrate “changed circumstances” as a precondition to terminating a contract for convenience. According to the plurality opinion, unless the government’s ability to terminate a contract under a termination for convenience clause was limited, the inclusion of the clause created an unenforceable illusory promise. In order to prevent such a result, the court stated that the use of a termination for convenience clause must be limited to situations when “the circumstances of the bargain or the expectations of the parties have changed sufficiently that the clause only serves to allocate risk.” Id. at 771–74. In adopting the changed circumstances test, the plurality rejected the government’s argument that the traditional standard provided an adequate check on the government’s use of termination for convenience clauses so as to provide consideration for the bargain.

However, since Torncello, most courts have declined to apply the changed circumstances test, stating that Torncello merely “stands for the unremarkable proposition that when the government contracts with a party knowing full well that it will not honor the contract, it cannot avoid a breach claim by adverting to the convenience termination clause.” Salsbury Indus. v. United States, 905 F.2d 1518, 1521 (Fed. Cir. 1990).

11.04 Damages for Termination for Convenience

The termination for convenience clause limits the owner’s liability for a termination that would otherwise constitute a breach of contract.

Option A: (specific contract provision):

According to the contract, if the owner terminates the contractor for convenience, the owner must pay the contractor the following amounts:

[list damages from contract: (1) the cost of the work performed, (2) demobilization and closeout costs, and/or (3) a premium for work not performed]

The contractor must prove the amount of such costs with reasonable certainty.

Option B: (no specific contract provision):

The measure of damages available to a contractor terminated for convenience is the cost the contractor actually incurred up to the date of termination, plus a reasonable profit on the work performed prior to termination.

The contractor bears the burden of proof to establish its termination for convenience damages.

Comment

When the government terminates a contractor for convenience, instead of receiving full expectation damages, the contractor’s recovery is defined by the termination for convenience clause. Linan-Faye Constr. Co. v. Hous. Auth. of City of Camden, 49 F.3d 915 923 (3d Cir. 1995).

The overall purpose of a termination for convenience settlement is to fairly compensate the contractor and to make the contractor whole for the costs incurred in connection with the terminated work. Nicon Inc. v. United States, 331 F.3d 878, 885 (Fed. Cir. 2003). Generally, the contractor is entitled to damages in the amount of the cost of the contract work performed before the termination, plus a fair and reasonable profit on the work performed. United Partition Sys. Inc. v. United States, 90 Fed. Cl. 74, 89 (2009); Rhen v. United States, 17 Cl. Ct. 140, 143 (1989).

Unless provided in the contract, many courts determine a contractor terminated for convenience is not entitled to recover anticipated, but unearned, profit. Rhen, 17 Cl. Ct. at 143; Century Marine Inc. v. United States, 153 F.3d 225, 227 (5th Cir. 1998); Mega Constr. Co. v. United States, 29 Fed. Cl. 396, 475 (1993).

The contractor bears the burden of proof to establish termination for convenience damages. White Buffalo Constr. Inc. v. United States, 52 Fed. Cl. 1, 13 (2002); United Partition Sys. Inc., 90 Fed. Cl. at 89.

11.05 Backcharges and Termination for Convenience

If the owner terminates the contractor for convenience, the owner cannot recover damages or withhold money from the contractor associated with either

(1) defective work that the contractor was not given an opportunity to cure or

(2) the cost to complete the contractor’s work by other parties.

Comment

“[A] termination for convenience unequivocally terminates the contract and relieves (the terminated party) from incurring any further obligation associated with the project.” Id. Further, there is “no applicable legal authority to support a position that a termination for convenience may be converted to a termination for cause. A party cannot resuscitate a dead contract so that it may re-terminate it.” Id. After a termination for convenience, it is not appropriate to backcharge the contractor for completion or work not completed or billed by the contractor. Richerson Constr. Corp. v. Gen. Servs. Admin., 93-1 B.C.A. (CCH) ¶ 25,239 (1992). Rather, it is well recognized in the industry that an offset for costs to complete is only available when the contractor is terminated for default. See Tishman Constr. Corp. v. City of N.Y., 228 A.D.2d 292, 293 (N.Y. 1996); Fruin Corp. v. Niagara Frontier Transp. Auth., 180 A.D.2d 222, 233 (N.Y. 1992).

“[W]here a party has terminated a contract for convenience, that party may not then counterclaim for the cost of curing any alleged default.” Shelter Prods. v. Steelwood Constr. Inc., 257 Or. App. 382, 401–03 (2013); see also N.Y. Shipbuilding Co., ASBCA No. 15443, 73-1 BCA ¶ 9852; W. States Painting Co., ASBCA No. 13843, 69-1 BCA ¶ 7616, at 35,379; Paragon Restoration Grp. Inc. v. Cambridge Square Condos., 42 A.D.3d 905, 906 (2007); Tishman Constr., 228 A.D.2d at 293.

This rule was upheld in Paragon Restoration Group Inc. v. Cambridge Square Condominiums, 42 A.D.3d 905 (N.Y. 2007), in which the court held that when an owner terminates a construction contract for convenience, the owner loses its right to counterclaim for the cost of curing alleged defects in the contractor’s performance. Similarly, in Steelwood, the terminating party placed the contractor on notice of potential claims related to deficiencies in the work. Then, immediately after sending the letter and prior to allowing an opportunity to cure, the terminating party “terminated the agreement pursuant to [the termination for convenience provision ‘without cause.’” Steelwood Constr., 257 Or. App. at 402. “Under those circumstances, nothing in the contract permits Catamount to receive an offset against Steelwood’s costs for allegedly defective work done by Steelwood prior to the termination.” Id. The court determined the remedy for the terminating party to charge the contractor for costs to repair was available “pursuant to its right to terminate for cause.” Id. at 401. Yet, the right to terminate was only available after satisfying the contractor’s “opportunity [] to ‘correct, replace and/or re-execute faulty or defective work.’” Id. at 401. As a result, the court upheld the district court’s entry of summary judgment determining that the terminating party “was not entitled to offset any amounts it owed [the contractor] with amounts it incurred in correcting [the contractor’s] allegedly defective work.” Id. at 403.

Similarly, in Fruin-Colnon, the court determined that when the contractor was terminated (purportedly for cause) without the contractually required notice and opportunity to cure, the terminating party could not recover costs to repair deficient work from the contractor. Fruin-Colnon, 180 A.D.2d at 233–34. In upholding the lower court’s denial of such repair damages, the court stated as follows: “[D]efendant had the right to remedy any defect at plaintiff’s expense, but only if plaintiff first had been granted the opportunity to cure the defect and had failed to do so.” Id. (emphasis added). Another court held, “Where the City elects to terminate for convenience, as provided in section 15, whether with or without cause, it cannot counterclaim for the cost of curing any alleged default.” Tishman Constr. Corp., 228 A.D.2d at 292–93. The court explained, “Had the City wished to pursue these claims, plaintiff should have been terminated [for default], which provides for recouping the expense of curing plaintiff’s default.” Id.

11.06 Constructive Termination

The contract between the owner and contractor provides that the owner may terminate the contractor for cause or for its convenience. The contract also provides that in the event the owner wrongfully terminates the contract for cause, such termination shall be deemed to be a termination for convenience.

Here, the owner terminated the contractor for cause. If you find that the owner’s termination for cause was wrongful, you must consider the termination to have been for the owner’s convenience, unless you also find that the termination was in bad faith. “Bad faith” in this context means that the owner acted with malicious intent or animus toward the contractor or by entering into the contract knowing full well that it had no intention of honoring the contract.

Comment

Under most federal government contracts, as well as many state, municipal, and private contracts, a termination for default that is found to be wrongful is automatically converted to a termination for convenience. See Federal Acquisition Regulations FAR 52.249-8(g), FAR 52.249-10(c).

Thus, where a contracting officer has not explicitly invoked the termination for convenience clause, courts have held that if the contract contains a termination for convenience clause and the contracting officer could have invoked the clause instead of terminating, rescinding, or repudiating the contract on some other invalid basis, the court will constructively invoke the clause to retroactively justify the government’s actions, avoid breach, and limit liability. Praecomm Inc. v. United States, 2007 WL 2317519 (Fed. Cl. 2007); see also Best Foam Fabricators Inc. v. United States, 38 Fed. Cl. 627 638 (1997); Hancock Elec. Corp. v. Washington Metro. Area Transit Auth., 81 F.3d 451, 454 (4th Cir. 1996).

Courts have imposed limits, however, on the use of the constructive termination for convenience doctrine. As discussed in Part 11.03, to avoid application of the constructive termination for convenience doctrine, most courts require the contractor to demonstrate that the termination decision either was a product of bad faith or constituted clear abuse of discretion. Kavlar Corp. v. United States, 543 F.2d 1298, 1301 (Ct. Cl. 1976); see also John Reiner & Co. v. United States, 325 F.2d 438, 442 (Ct. Cl. 1963). But see Torncello v. United States, 681 F.2d 756 (Ct. Cl. 1982) (holding that the constructive application of a termination for convenience clause requires some kind of change from the circumstances of the bargain or in the expectations of the parties).

11.07 For Default (or Cause)—Common Law

As a general rule, a party to a contract is entitled to terminate the contract if the other party breached a material term of the agreement and failed to perform as agreed.

To demonstrate the termination was proper, [terminating party] has the burden to demonstrate the following:

(1) [The terminated party] has an obligation under the agreement.

(2) The obligation was a material term.

(3) [The terminated party] failed to perform the obligation.

(4) [The terminating party] performed all of its responsibilities under the contract.

Comment

This instruction is appropriate where contractual language provides that an owner may terminate the contract for dissatisfaction or cause. Some contracts allow an owner to terminate a contract for its convenience, at will, or for no reason whatsoever. In such a circumstance, the owner can usually terminate for any reason. See U.S. Genes v. Vial,923 P.2d 1322 (Or. Ct. App. 1996). If the contract intends to leave a decision to one party, subject only to the requirement of good faith, the court should not impose an additional requirement of reasonableness. See Action Eng’g v. Martin Marietta Aluminum, 670 F.2d 456, 460 (3d Cir. 1982).

A contract may be terminated for default only on a material breach of contract. See Wells Benz Inc. v. United States ex rel. Mercury Elec. Co., 333 F.2d 89, 92 (9th Cir. 1964) (default termination is proper only if “the other’s breach is so gross that the very object of the contract is defeated”); Daff v. United States, 31 Fed. Cl. 682, 689–91 (1994), aff’d, 78 F.3d 1556 (Fed. Cir. 1996).

Virginia courts have determined that any breach of a contract that jeopardizes future interests of the other contracting party is by definition a material breach. Clevert v. Soden, 400 S.E.2d 181, 182 (Va. 1991).

An owner may also be estopped from terminating the contract for a contractor’s failure to perform according to the contractual terms if the owner, after becoming aware of this failure, continued to encourage or allow the contractor to continue. See Indem. Ins. Co. v. United States, 14 Cl. Ct. 219 (1988).

11.08 Contractual Termination for Default after Notice

In this case, [the owner] had a right, under the express terms of the contract, to terminate the contract for cause if the contractor failed to perform a material obligation of the contract. Here, the owner contends that it was entitled to terminate the contractor because [list reason].