Traditionally the province of American law and government procurement contracts, we’ve noticed an increasing trend in private Australian energy and resource contracts to include ‘termination for convenience’ (TFC) clauses – and corresponding requests from corporate counsel as to their effect.

In particular, with certain aspects of the economy currently experiencing a downturn in revenue and profit, many principals and contractors are looking at ways to remove themselves from potentially burdensome contracts.

This short note seeks to provide some clarity around this issue.

1. Termination for convenience

At common law, a party may terminate a contract only if:

  1. the contract has been repudiated by the other party;
  2. an essential term of the contract has been breached;
  3. there has been a sufficiently serious breach of an intermediate term; or
  4. the contract has become frustrated.

However, parties may, by clear and unambiguous agreement, confer upon a party an unconditional power to terminate the contract for convenience or at will, irrespective of any default in performance. Such a right may or may not require notice to be given. It’s important to note that whilst a party availing itself of its right to terminate for convenience must adhere to the stipulated notice period, the notice requirement does nothing to impede “the exercise of an otherwise unfettered will” (Cheshire and Fifoot, 2012, at 22.12).

The rationale for TFC clauses is to be viewed through a historical lens, initially being a government mechanism to manage wartime production. Such provisions allowed governments to contract for the vast quantities of materials required for the war effort with the flexibility of being able to immediately halt production when peace arrived without having to pay out now redundant contracts. Today, such clauses ensure companies are not contractually disadvantaged if, for example, corporate priorities change or financing falls through.

Practically, parties will often put a price on this right to terminate for convenience. For example, offshore drilling contracts might provide that whilst the Company may, in its absolute discretion (and for any reason and at its own convenience) terminate the contract – usually with a specified notice period – the exercise of that right will render the Company liable for services up to date of termination, a demobilisation or early termination fee, and possibly the remainder of any contractually stipulated minimum service period.

Like most other contractual rights, a right to terminate for convenience or at will can be waived, lost by an election to affirm the contract, or lost by conduct giving rise to an estoppel.

Two questions dominate the TFC clause landscape in Australia:

  1. whether such a right is impacted upon by the notion or requirement of good faith; and
  2. the impact of a TFC clause on a party’s common law rights to terminate (and thus recover damages for breach).

Each is considered in more detail below.

2. A requirement of good faith?

There is a significant degree of angst throughout the common law world as to the prevalence, extent and content of the implied requirement of “good faith” in commercial contracts. Australia is no different and, unsurprisingly, this debate pervades the law relating to TFC clauses. The decided cases bear this out, being somewhat equivocal as to whether a party exercising its right under a TFC clause must do so “in good faith”.

Perhaps intuitively, one tends towards answering this question in the negative – surely any additional good faith requirement implied and imposed on the contract is antithetical, an impermissible fetter on a party’s otherwise unconditional contractual right? There are certainly cases that adopt this view. For example, in Starlink International Group Pty Ltd v Coles Supermarkets Australia Pty Ltd [2011] NSWSC 1154, the Court considered whether it ought to imply an obligation of good faith into the operation of the contract’s TFC clause. In answering that question in the negative, the Court considered it to be axiomatic that, in invoking such a clause, “parties will act for some reason and sometimes for a reason that may not present to others as a good reason” (at [32]). The Court thought the TFC clause allowed the defendants to terminate for their own reason and to keep that reason to themselves. That was an entitlement the parties had contractually provided to the defendants. To hold otherwise, the Court reasoned, would be “to impose a condition on the defendants inconsistent with the express term of the contract” (at [34]).

However, commentators and courts equally have held that, despite a term conferring an unfettered right to terminate for convenience or at will, a residual requirement of good faith remains. We would err on the side of caution here, and suggest that parties anticipate at least some base requirement of good faith. The question, then, becomes one of content – what exactly does good faith require?

Sandararajah v Teacher’s Federation Health Ltd (2011) [2011] FCA 1031 provides a useful guide in this respect. There, the Federal Court noted the evident discrepancy between a power “given to one party to be exercised in its sole discretion” and “a constraint on the exercise of that power by considerations of reasonableness or good faith” (at [64]). Seeking to navigate a way through this inconsistency, Foster J said “courts will not imply an obligation of good faith unless it operates as an aid and in furtherance of the explicit terms of the contract and will never impose such an obligation if it would be inconsistent with other terms of the contractual relationship” (at [66]). Turning to the actual content of good faith, the Court said the following:

  • Even if an express contractual right to terminate is subject to an implied obligation to exercise that right in good faith and reasonably, such a restriction will not operate so as to prevent or hinder an action designed to protect the legitimate commercial interests of a party (at [67]).
  • Generally speaking, if a contract contains a requirement that the parties act in good faith, they must act honestly, not capriciously, and reasonably. However, good faith does not require a party to act in the interests of the other contracting parties nor to subordinate their own legitimate interests to those of the other parties. It may be that there is no reasonableness requirement in the obligation, should the obligation be implied. The essence of the good faith requirement is honesty (at [68]).

In our view, this is a sensible and clear pronouncement of the obligation of good faith. Parties would be well-advised to keep this in mind when using a TFC clause.

In Carr v Berriman (1953) 89 CLR 327, the High Court said that a principal cannot use a variation clause to remove scope from one contractor so as to have it completed by another (which presumably would be done for cost reasons), and that this would be a repudiation of the Contract by the principal. The issue relevant to this note is whether a court will read this limitation into a TFC context where the clause has been used to this effect. We think this is unlikely – it is antithetical to the nature and purpose of a TFC clause, which makes the reason for termination irrelevant. However, in the interests of certainty, this issue can be avoided by including specific language to the effect that the clause covers the termination of the contract in order to have the work completed by another party.

3. Impact on common law rights

As a matter of law, a TFC clause will not generally exclude the common law right of termination for, amongst other things, repudiation. Said differently, courts have overwhelmingly favoured an interpretation which see the right to terminate for repudiation as supplementary to the right to terminate for convenience (or whatever else is provided by the various termination provisions of the contract). However, as a matter of drafting, best practice would see the express preservation of those common law termination rights. A TFC clause will not “exclude the right to terminate for anticipatory repudiation, that is, a repudiation which precedes the time for performance by the promisor” (Carter on Contract, at [33-100]).

4. The moral(s) of the story

By way of summary, parties should reflect on the following points when considering to include or invoke a TFC clause:

  • TFC clauses provide significant manoeuvrability and flexibility to operations, conferring an ability to terminate if, when and for what a party chooses. Be sure to consider whether such autonomy would suit your contract or project. If a counterparty seeks to include such a clause, be wary of the breadth of such a clause.
  • Be conscious of the potential for an invocation of a TFC clause being a breach or repudiation of the contract itself – make sure to follow carefully any contractual requirements for exercising the power. The observance of a mandatory notice period is the obvious example. An express statement to the effect that ‘exercise of this power to terminate is not a breach of the contract’ is best practice. Similarly, be sure to know the exact nature of any payment obligations triggered by the exercise of a TFC clause.
  • Be conscious of a likely good faith requirement when terminating for convenience. At base, this requirement is one of honesty, and does not require you to subordinate your own legitimate interests to those of your counterparties.
  • A TFC clause does not operate to the exclusion of your common law rights to terminate, however it is prudent to include an express statement to this effect.
  • Ensure that any payment obligation arising upon the exercise of a TFC power is not a penalty under Australian law.
  • Whether the right to terminate for convenience can be exercised by a party itself in breach of the contract is unclear, and is yet to be the subject of detailed judicial consideration. The exercise of a TFC power in this situation would need to be considered on the particular circumstances of the case.