Termination for Convenience in Construction Contracts
A termination for convenience (‘TFC’) clause in a construction contract allows a principal to terminate a contract with the contractor at its option, regardless of whether the contractor has committed a default or breach of that contract. TFC clauses essentially entitle a principal to terminate the contract at any time and without cause for its own ‘convenience’. TFC clauses provide flexibility for principals to response to contingencies in performing the contract, and reflect the evolving need for principals’ to respond to changes in current economic conditions affecting construction projects.
The right of a principal to terminate for convenience is usually qualified by an obligation to pay compensation for the cost of such termination, namely payment for works completed, and in some circumstances the direct and substantiated costs the contactor has incurred as a result of termination.
A typical TFC clause will include words to the following effect:
"[The principal] may, at its option, at any time and for any reason it may deem advisable, cancel and terminate the Contract, in which event [the contractor] shall be entitled to receive compensation….".
How does it affect you?
Depending on whether you are a contractor or principal, a TFC clause can be both advantageous and disadvantageous. It is therefore important to consider the potential implications of a TFC clause before entering into a construction contract.
If you are a principal under a contract, a TFC clause will generally operate to your benefit. Such provisions provide flexibility to principals to deal with contingencies that may arise during the course of the construction contract with a contractor. For example, during poor economic conditions, which reduce the financial viability of a construction project. Here, a TFC clause gives the principal an ability to exit the contract without significant legal risk and to deal with the effects of such contingency. Such clauses are also less onerous compared to other termination provisions in terms of the procedure required to be undertaken to terminate the contract.
However, principals should be aware that the right to terminate may be limited. One question that has commonly arisen in cases where a principal has terminated a contract for convenience, is whether the principal is obliged to act in good faith in terminating a contract for its convenience. Such issue remains unsettled and the High Court is yet to endorse a duty to act in good faith. However, case law suggests that acting in good faith plays a substantial role in construction contracts generally. Accordingly, principals may run the risk of unlawfully terminating the contract, if such termination is not in good faith.
If you are a contractor, a TFC clause is more likely to have an adverse effect, compared to a principal, particularly where a contractor has directed significant resources into the performance of the contract at the expense of other opportunities. Whilst the contractor is usually entitled to compensation in the event a principal terminates a contract for convenience, such compensation is usually limited to payments owing for work completed as at the date of termination, or for milestones met under the contract. A contractor will not usually be compensated for loss of profits or other consequential loss arising out of such termination.
Considerations for Principals and Contractors
Matters for principals to consider in relation to a TFC clause include:
when the TFC is being contemplated, consider all rights of termination;
ensure the TFC is expressed clearly and in unambiguous terms – it is good practice to set out components of compensation payable and when termination will take effect;
ensure that all terminations for convenience are in good faith – although it has not been affirmatively decided that a duty to terminate in good faith applies in relation to all TFC clauses, a court may nonetheless imply such duty in particular circumstances;
enter into a deed of release to ensure the termination has been properly effected and you (and the contractor) are released from all future actions and obligations.
Matters for contractors to consider in relation to a TFC clause include:
when the TFC is being contemplated, negotiate to limit the circumstances under which a principal may terminate for convenience and ensure those limitations are clearly expressed in the TFC clause;
if possible, attempt to increase the contract price to account for the risk of termination for convenience;
consider whether the principal has acted in good faith in terminating the contract;
be aware of your right to compensation and exercise it.
Both principals and contractors should also carefully consider how TFC clauses are drafted to prevent either party being subjected to unintended rights or obligations.
If you are considering entering into or require advice regarding a construction contract, including advice relating to termination for convenience clauses, please contact:
Ray Frangi, Associate
Phone: +61 9895 9218