We all know what purpose a termination for convenience clause is supposed to serve: if circumstances have changed such that the owner (or, in the case of a subcontract, the general contractor) believes it is no longer advisable to proceed, the contract is terminated for convenience, the other party is compensated as provided in the contract, and the parties go their separate ways, presumable at least somewhat amiably. Virtually every construction contract has a termination for convenience clause in it, and for good reason. But how often do we pause to consider whether the clauses we draft, negotiate, and sign are actually enforceable? How often do we even consider the possibility that a termination for convenience clause might be drafted, used, or interpreted in a way that would render it unenforceable?
In Torncello v. United States, 681 F.2d 756 (Ct. Cl. 1982), the Court of Claims considered the claim of a subcontractor of a contractor who was terminated after the contract was awarded, but before any work had been performed. The government originally characterized the termination as one for default, but on review the termination was treated as one for convenience pursuant to the automatic conversion clause in the Federal Acquisition Regulations. The government took the position that, because no work had been performed, no termination payment was owed pursuant to the Federal Acquisition Regulations. The contractor argued that, if the government was able to terminate the contract without making any payment, the contract was illusory, because it imposed no real obligation on the government. In a lengthy, and high-detailed, plurality opinion, the Court of Claims agreed with the contractor. While courts have debated (and attempted to limit) the holding in Torncello almost from its issuance, the core of the opinion, in the words of the court, was that the owner could not use a termination for convenience “to dishonor, with impunity, its contractual obligations.”
But in some respects, that’s exactly what a termination for convenience clause does—it allows one party to walk away, provided solely that they comply with the terms of the clause. And, certainly, no one interpreted Torncello as a death knell for terminations for convenience. Understanding that not everything is enforceable, where is the line drawn? In short, how can we ensure an enforceable clause, and an enforceable termination?
One potential answer is found in the American Institute of Architects’ (AIA) contract documents family. The AIA General Conditions (A201) have long allowed the contractor to recover “reasonable overhead and profit on the Work not executed.” The AIA has taken a lot of flak over this provision over the years, and it is fair to say the AIA is the only major contract family that allows the contractor to recover profit on work it did not perform. BUT, that payment creates an enforceable provision. Because the owner will always be on the hook for some payment, the contract is clearly not illusory, and a termination will be enforced.
The battle over enforceability continues to this day. The Washington Court of Appeal recently decided a case, Sak & Associates, Inc. v. Ferguson Construction, Inc., 357 P.3d 671 (Wash.App. 2015), in which the terminated subcontractor argued that the termination for convenience clause rendered the contract illusory. In analyzing the issue, the court recognized “An enforceable contract requires consideration. If the provisions of an agreement leave the promisor’s performance entirely within his discretion and control, the ‘promise’ is illusory. Where there is an absolute right not to perform at all, there is an absence of consideration. Thus, if a promise is illusory, there is no consideration and no enforceable obligation.” (internal quotations omitted) The court then concluded that, because the subcontractor was allowed to partially perform, and was paid for that partial performance, the contract was not illusory. But that analysis proceeds from a flawed assumption—that a contract could be illusory at execution and become non-illusory (lusory?) due to performance. A contract either is or is not illusory. There either is or is not consideration. The promisor’s performance either is or is not entirely within his discretion and control. All of these facts can be determined at the moment the contract is executed, and the parties’ later performance can no more save an illusory contract than they could wreck a non-illusory contract. Put different, a contract cannot become either illusory or non-illusory; it is either one or the other, and the later behavior of the parties cannot affect that.
The Sak & Associates court was kind enough to cite as authority an article I previously wrote on termination for convenience clauses. Without meaning to appear ungracious (a lawyer ought never to argue with a court who has decided to treat him as an authority), part of the point of that article and the accompanying presentation was to warn against the problems inherent in termination for convenience clauses. Relying on a court to rescue an otherwise illusory clause by invoking the later actions of the parties is not a best practice in contract drafting. By far the better course of action is to draft a termination for convenience clause that explicitly ensures mutuality of obligation. An ounce of prevention is, in this instance, worth many pounds of cure.