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Recession Planning: Prepare Ahead if Contract Terminated for Convenience

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With a recession casting a dark shadow on the new year and news of various projects being put on hold, it is a good time to revisit the checklists on what to do if your contract is terminated for convenience.

The federal government has long had at its disposal a series of clauses, “Termination for Convenience of the Government” (FAR 52.249-1 to 52.249-7). These clauses give the government the right to terminate your contract upon notice—going back to World War II when they needed the flexibility to terminate supply contracts when hostilities ceased. These clauses have now made their way into both state public contracts and American Institute of Architects (AIA) standard form contracts for private projects. In short, if the economics of a project turn against successful completion, the owner has a mechanism to hit the brakes on the contract at any time.

Under the standard AIA A-201 General Conditions, only the owner may terminate for convenience. This leaves the contractor seeking payment for all work done up to the time of termination, plus reasonable termination expenses.

Under AIA Document A-201 Section 14.4, “Termination for Convenience,” a contractor may request the cost incurred for work performed through the date of termination, termination costs, and reasonable overhead and profit on work not yet executed. Note, however, that because the clause does not expressly allow the general contractor to seek overhead and profit on work yet to be performed, an owner may reject the claim for lost profits and award only out of pocket costs for work performed prior to termination. This leaves future profit (and possibly the lucrative work anticipated) on the chopping block. If this outcome seems unfair, now is a good time to lock this in through contract negotiation or by seeking modifications or assurances as part of existing work.

Once the notice of termination is delivered from the owner, the contractor must cease their operations, take actions to preserve and protect the pending work, and terminate their subcontracts and purchase orders for the unfinished portion of the project.

Arguably, there are some limitations on the owner’s unilateral right to terminate a contract—even where a clear termination for convenience clause is present. This defense to termination comes from the basic principles of contracting. Both parties to a contract are required to perform in good faith and with the intention of fair dealing so as not to prevent the other party from obtaining the benefit of their bargain (see: 5 Bruner & O’Connor Construction Law § 18:47. Krygoski Constr. Co. v. United States, 94 F.3d 1537, 1541 (Fed. Cl. 1996)). Washington courts—like other states—may likely follow the lead of federal cases and legal authority, but this still remains to be seen. If this issue is on your radar, you should consult with your attorney on what options and remedies might exist.

Additionally, the termination for convenience may allow a contractor to seek contractual attorney fees as the prevailing party (see: Conway Constr. Co. v. City of Puyallup, 197 Wash. 2d 825, 490 P.3d 221 (2021)(breach of duty of good faith in termination for default)).

A termination for convenience can be a disruptive and potentially crippling blow to many small businesses or minority contractors. If a termination for convenience occurs during your contract, here are steps that every contractor should consider.

Five Steps to Take When Your Contract Is Terminated

  1. Initiate the work stoppage plan that has been prepared and discussed with the project team prior to the start of the project. Contact any subcontractors working below the chain of construction and notify them that the termination notice has been received and to stop all work. The key here is that the subcontract incorporates and flows down the same ability to terminate work once notice is received by the prime contractor or owner. Check your subcontracts to ensure this right exists so you do not get stuck losing at one end but paying through completion on the other end.
  2. Alert your financial officer and home office staff that the termination has been received and advise them to start budgeting for the impact on cash flow and work force. Assess what cost you may be entitled to recapture in this transition phase and for future work. This should be clearly communicated in pending contract negotiations to ensure that stopping work does not lead to financial ruin for anticipated profits. This is particularly important on large projects where resources have been committed to run months and years into the future.
  3. Create a new project accounting number or charge code to capture this labor and other costs separately from the actual contract work. Pass the word to everyone who has been working on the project that a new number exists. Capture all costs from the termination date forward.
  4. Seek reimbursement of reasonable costs incurred in the performance of the work that was terminated. Absent the limitation on future profits, you are generally entitled to reimbursement of these costs. This normally would include a reasonable profit, so add that to the review checklist of pending contract terms to avoid waiving that right. Isolate the costs in the newly formed charge number. This is one instance where overhead costs may be billed as direct costs. These settlement expenses can include accounting, legal, and clerical costs. Indirect costs related to salary and wages incurred as settlement expenses can be included as well.
  5. Track any unexpired lease or rental costs continuing after termination as these costs are typically allowed and, if not, add them to your existing contract clauses. After termination, you should submit a timely termination cost bill that outlines all of your expenses requested for reimbursement.

With renewed threats of economic slowdown and the lingering impact of the pandemic, projects that seemed certain to be completed have now been clouded by delays and cancellations. Now is a good opportunity to fine tune your contracts and implement a response plan if a significant project is suddenly terminated for convenience of the owner.

This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.