Generally Speaking, Contracts That Can Be Terminated for Convenience Must Be Terminated In Good Faith
It is not uncommon for a construction contract between an owner and a general contractor to state the owner may terminate the contract for convenience. In other words, the owner may be allowed to terminate the contract even if the contractor had not done anything wrong merely because the owner has had a change in circumstance that no longer makes it reasonable to continue with the subject project. General contractors often include similar provisions in their contracts with their subcontractors. The question is whether there are any limits on one party’s right to terminate a contract when the other party has done nothing wrong. In most jurisdictions, there is a limit to such a right but, unfortunately, not in all.
The general rule was expressed by a Maryland an appellate court, which held “that termination for convenience rights … may be enforceable, subject to the implied limitation that they be exercised in good faith and in accordance with fair dealing.” Questar Builders, Inc. v. CB Flooring, LLC, 410 Md. 241, 279 (Md. 2009). By quoting David A. Senter, Role of the Subcontractor, in FUNDAMENTALS OF CONSTRUCTION LAW 133 (italics added), the court stated:
Sometimes an owner is given the right in a contract to terminate for “convenience.” In other words, if it is economically unfeasible to continue the project, the owner may be allowed to terminate and to compensate the general contractor (and its subcontractors) for work performed and any losses incurred up to the date of termination. Although “convenience” implies a very broad spectrum of circumstances, such a termination must be done in good faith, or the owner may have broader liability than the contract provisions contemplate.
Id. at 279-280. “Under the covenant of good faith and fair dealing, a party exercising discretion must refrain from doing anything that will have the effect of frustrating the right of the other party to receive the fruits of the contract between them.” Id. at 279-280. In the case of a construction contract, that means that an owner (or general contractor) may not terminate a contract for convenience merely because it found someone willing to perform the work for a cheaper price. “[T]he obligation to act in good faith and deal fairly prohibits a party from terminating its contract (or otherwise exercising its discretion) to ‘recapture’ an opportunity that it lost upon entering the contract.” Id. In other words, once you sign a contract, the bargain hunting is over.
Surprisingly, however, some jurisdictions hold that “covenants of good faith and fair dealing do not trump express terms or unambiguous rights in a contract. Rather, [a]s a matter of law, there cannot be a breach of the duty of good faith when a party simply stands on its rights to require performance of a contract according to its terms.” SAK & Assocs. v. Ferguson Constr., Inc., 189 Wn. App. 405, 414-415, (Wash. Ct. App. 2015). In those jurisdictions, a contract can be terminated for convenience at the owner’s will even though, in my opinion, such reasoning makes no sense.
Over the years, I have lost track of the number of times I have read a court opinion that stated that every contract contains an implied convent of good faith and fair dealing and that, by entering into a contract, the parties thereto agree not to do anything which interferes with the rights for which the other party contracted. Thus, in my opinion, a contractually implied covenant of good faith and fair dealing is black letter law. Therefore, assuming I am correct, it would be impossible—or, at least, make no sense—for the implied covenant of good faith and fair dealing to apply to the entire contract except the termination for convenience clause.
If an owner were able to invoke a termination for convenience in bad faith, the law of contracts would become meaningless. After one enters a contract, it starts preparing to fulfill its obligations. A termination for convenience would not typically occur immediately after a contract execution if it were exercised in good faith but a bad faith termination for convenience almost certainly would. If there were no restrictions, an owner could use his newly executed agreement to look for better pricing and, if better pricing was found, he could terminate the original contract within a few days. At that point, the contractor may claim that it had incurred costs and damages based upon actions taken in anticipation of fulfilling his contractual obligations but the owner—who we know has no issue acting in bad faith—would most likely claim that there could not be any harm because the agreement was only in place a short amount of time. Thus, incorporating the implied covenant of good faith and fair dealing into a termination for convenience provision is necessary to protect a contracting party’s rights.
Moreover, an owner would be protected from frivolous bad faith claims by virtue of the heightened burden of proof. “The standard of proof required to establish a claim of bad faith is clear and convincing evidence.” Willert v. Russo, 2009 Conn. Super. LEXIS 1212, *18 (Conn. Super. Ct. May 4, 2009). Similarly, it is not easy to claim an action is an unfair trade practice.
[W]e have adopted the criteria set out in the cigarette rule by the federal trade commission for determining when a practice is unfair: (1) whether the practice, without necessarily having been previously considered unlawful, offends public policy as it has been established by statutes, the common law, or otherwise—in other words, it is within at least the penumbra of some common law, statutory, or other established concept of unfairness; (2) whether it is immoral, unethical, oppressive, or unscrupulous; (3) whether it causes substantial injury to consumers, [competitors or other businesspersons] . . . All three criteria do not need to be satisfied to support a finding of unfairness. A practice may be unfair because of the degree to which it meets one of the criteria or because to a lesser extent it meets all three . . .
Birbarie v. C&H Shoreline, LLC, 2014 Conn. Super. LEXIS 2367, *18-20 (Conn. Super. Ct. Sept. 22, 2014). In light of the foregoing, contractors would not be able to bring claims against owners every time a termination for convenience provision is invoked, and, when such claims were brought, a heightened burden of proof would apply. A contractor couldn’t simply claim its termination was done in bad faith unless it had strong evidence of the claim.
Notwithstanding the common sense expressed above, there are a number of jurisdictions in which a termination for convenience is not thought to carry with it the implied covenant of good faith of fair dealing and there are others that have not answered this question. Moreover, it is my opinion that the jurisdictions that have decided not to require a termination for convenience provision to be exercised in good faith should change their rule. Therefore, if you have had your contract terminated for convenience and do not believe it was done in good faith, please give me a call at (860) 760-3317.