A recent Civilian Board of Contract Appeals (CBCA) case, Sigal Construction Corp., 10-1 BCA ¶ 34442, CBCA 508 (May 13, 2010), provides a timely reminder that the government’s right to terminate a contract for its own convenience is not unlimited, and that the improper exercise of that power will result in the award of damages for lost profits, just as in private contracting.

Sigal Background

In Sigal, the General Services Administration (GSA) issued a contract for the renovation of a federal office building. The contract included provisions calling for the repair of certain building finishes on a square foot basis, at fixed unit prices. At the time of the award, the government found that the unit prices were reasonable and appropriate, but when the volume of work significantly exceeded the contract’s estimated quantities, the government sought to reduce costs. Rather than seek to adjust prices based upon the Variation in Estimated Quantities clause of the contract (see FAR 52.211-8), the government barred the contractor from proceeding with the excess unit price work and brought in another contractor to perform that work, at a reduced price. Sigal filed a claim for the profits it would have earned in performing the deleted work and the government sought to defend under the termination for convenience clause of the standard form government construction contract.

In most circumstances, the termination for convenience clause permits the government to terminate at will and pay only for the cost of, and a reasonable profit on, the work actually done. Thus, the government argued, Sigal was not entitled to recover lost profits for work not yet performed. However, the CBCA ruled that Sigal was entitled to recover profits it would have earned on the deleted work and granted summary relief on the issue of entitlement, leaving the amount of damages to be awarded to be decided at a later date. After first rejecting the government’s arguments that the unit price work above the estimated quantities really wasn’t a part of the contract, and noting that its failure to allow Sigal to proceed with the work amounted to a constructive termination for convenience of that part of the contract, the Board said:

One of the few limitations on the government’s right to terminate for convenience is that the government may not terminate simply to get a better price for performing needed work. Krygoski Construction Co. v. United States, 94 F.3d 1537, 1541 (Fed. Cir. 1996) (“A contracting officer may not terminate for convenience in bad faith, for example, simply to acquire a better bargain from another source. When tainted by bad faith or an abuse of contracting discretion, a termination for convenience causes a contract breach.”) That is what GSA did here. It was a breach of the contract.

How Termination for Convenience Developed

The Sigal decision is both surprising and significant because the termination for convenience clause has become so common as to virtually escape notice. Indeed, termination for convenience clauses are required language in most U.S. government prime contracts, and the FAR (Federal Acquisition Regulation) strongly encourages the contractor to insert that provision in most subcontracts as well. (See FAR 49.108-2(b); failure of the prime contractor to include appropriate termination clause in subcontract will not increase the obligation of the government on termination of the prime contract above what it would have been had such a clause been inserted in the subcontract.)

The termination for convenience clause developed in Civil War shipbuilding contracts and was further refined in U.S. government munitions contracts in World Wars I and II. The theory was that the government needed broad discretion to terminate its wartime contracts at the end of hostilities. The traditional prohibition against “illusory” contracts – i.e., “promises” that are unenforceable because they do not actually bind the promisor – was swept aside in light of the sovereign’s interest in not buying more than it needed to support the war effort. (See Questar Builders, Inc. v. CB Flooring, LLC, 978 A.2d 651, 663-68 (Md. App. 2009); extended discussion of development of termination for convenience clause in federal and state contracting.)

As termination for convenience clauses found their way into more and more contracts, however, contracting officers sought to make use of the clauses in far broader circumstances and the federal courts sought to impose some limits. One set of cases sought to require, as a condition to use of the clause, that the government show that “changed circumstances” had altered its needs. Torncello v. United States, 231 Cl.Ct. 20, 681 F.2d 756 (1982). In Torncello, in an effort to save costs, the government had used in-house Navy personnel to perform pest control services and terminated a contract for convenience without using any of the plaintiff contractor’s services. Looking back at the origins of the clause, the court concluded that to allow the government to terminate a contract simply to exculpate itself from liability for breach would render the contract illusory. To avoid this problem, the court required the government to justify its action with objective proof of a change in circumstances.

A second line of cases required proof of “bad faith” or an “abuse of discretion” by the contracting officer as a limitation on the right to terminate for convenience. Many of these cases nevertheless employed a “strong presumption” that the government acted in good faith in terminating a contract and imposed an almost impossible burden on the contractor to prove by “clear and convincing evidence,” or “well-nigh irrefragable proof” of bad faith, amounting to a “specific intent to injure the plaintiff,” in order to invalidate a termination for convenience and find the government liable for breach of contract. Rice Sys., Inc. v. United States, 62 Fed. Cl. 608, 621-22 (2004) (quoting Am-Pro Protective Agency, Inc. v. United States, 281 F.3d 1234, 1240 (Fed. Cir. 2002)).

Recent Cases

Recent government contracting cases have recognized several types of circumstances where the presumption of good faith can be overturned. One of these is the rule that the government cannot terminate a contract for convenience simply to get a “better bargain from another source.” Krygoski Constr. Co. v. United States, 94 F.3d at 1541. Sigal represents a rare case in which it has been found that such a violation has occurred.

The courts have also relaxed the rules for proving “bad faith” in the context of private contracting, including terminations for convenience in federal government subcontracts. Thus, the Court of Appeals of Maryland declined to apply a presumption of good faith when a general contractor terminated a flooring subcontract for convenience and held that the right to terminate for convenience did not amount to a right to terminate “for any reason whatsoever, including a bad reason or no reason.” Questar Builders, 978 A.2d at 671. Rather, the Maryland court ruled, the right to terminate a private contract is “subject to the implied limitation that [it] be exercised in good faith and in accordance with fair dealing.” Id. at 675.

Current State of the Law

The current state of the law on termination for convenience clauses, then, can be summarized as follows:

  • The government retains broad discretion to terminate a contract for convenience.
  • The decision to terminate cannot however, be exercised in “bad faith,” i.e., merely to get a better price for the work or to “punish” or avoid dealing with a particular contractor.
  • Improper termination for convenience is a breach of contract for which the courts or boards will award lost profits as damages.
  • Federal prime contractors should insert termination for convenience clauses in their subcontracts in order to protect them from liability to the subcontractor should their prime contract be terminated.
  • State and federal courts will generally enforce termination for convenience clauses according to their terms, but they generally give less deference to the prime contractor than to the government in determining whether a termination has been in “bad faith.”