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Study this construction contract clause & learn how to protect each party

Parties enter into contracts to memorialize the terms of an agreement reached with other parties. Each contract should outline the responsibilities and duties of each party in order to hold each contracting party to the agreed-upon terms. Construction contracts are no different and generally contain certain essential terms that include price, scope of work and time for performance. But construction contracts often go beyond these essential terms to include clauses for when a party can terminate the contract.

Historically, parties to construction contracts could only terminate their contract when the other party materially breached it. This “termination for cause” or “termination for default” clause allows a party to terminate the contract upon the occurrence of certain “default” events, such as the other party’s failure to pay, delays, or defective or incomplete work. Termination for cause is often the most utilized clause for terminating a contract, but it is not the only method a party may use.

Construction contracts can also contain a “termination for convenience” clause that allows a party to be terminated in the event a material breach has not occurred. This clause was first introduced by the federal government to allow it to terminate its contract in the absence of a contractor’s default. The “termination for convenience” clause has grown in use and has now migrated to private construction contracts. But unlike termination for cause, which can often be utilized by any party in a construction contract, termination for convenience is usually only a contractual right given to the upstream party of a contract, i.e., the owner in a prime contract, the general contractor in a subcontract and so on.


What Does a ‘Termination for Convenience’ Clause Look Like?

The termination for convenience clause is designed to give the terminated party a more fair and equitable result than if it were terminated for cause since the termination does not result from its wrongful conduct — a breach of the contract. A typical termination for convenience clause should entitle the terminated party to receive the costs for the work it completed on the project, and maybe a portion of its lost profits or overhead, up until the date of termination. These types of costs might include the value of all work satisfactorily performed and material stored on-site, or actual, direct costs plus an allowance or percentage of profit and overhead. Whatever the types of costs the terminated party is entitled to receive, they should be determined during negotiations and clearly stated in the contract so there is no dispute once termination occurs.

The termination for convenience clause should also list what the terminated party’s obligations are once termination occurs. The terminated party should be required to protect any incomplete work and any material or equipment left on the project to be used by the terminating party or a replacement party. The clause should also discuss whether permits should be assigned to the terminating party or a replacement party, and if copies of as-built documents and operation and maintenance manuals should be turned over to the terminating party.


When Are ‘Termination for Convenience’ Clauses Utilized?

Termination for convenience can be used when the upstream party is uncomfortable or would like to sever ties with the downstream party but does not have a reason to terminate for cause. Terminating for convenience often arises when continuing with the project is not financially feasible or desirable. Many contracts also use termination for convenience as a backup to a termination for cause, in which case, if the termination for cause is held to be improper by an arbiter or judge, it is automatically converted to one for convenience.


Considerations for the Terminating Party

If you are an upstream party, there are certain considerations that should be given before deciding whether to utilize termination for convenience. Inspections should occur to document the status and quality of the would-be terminated party’s work prior to termination. Because the terminated party should only be paid for work it has performed, inspections will confirm whether incomplete work is included in the costs sought by the terminated party. Having a detailed as-built record of the work performed is also important to ensure that amounts claimed by the terminated party do not exceed the cost to perform the completed work.

The terminating party should also inspect the would-be terminated party’s completed work for any defects. Failure to check for defective work may result in the terminating party paying for unforeseen repair costs once the terminated party has left the project, likely been paid, and potentially received a release for all claims related to its work. If defective work is evident, then terminating for cause may be more appropriate if substantial repair costs are anticipated.


Considerations for the Terminated Party

If you are the downstream party who has been terminated for convenience, other types of consideration should be given. When a party has been terminated for convenience, the amount of its recovery will heavily depend on the level of supporting documentation kept during the project. Generally, the terminated party has the burden of proving its costs. The failure to keep and maintain adequate records could complicate its claims for recovery. Key support documents include, but are not limited to, pictures of all work performed, invoices and worker time sheets. Documentation is essential for a terminated party because anticipating when a termination for convenience will occur is difficult. The party with the better record-keeping habits will always be in a better position when a termination dispute arises.



Financial Considerations

Terminations for cause are often fought by the terminated party and can result in lengthy and costly legal disputes. These costs can be largely reduced under a termination for convenience because the termination does not require a fact-intensive inquiry into whether the terminated party’s conduct or omissions constituted a default. But, on the other hand, termination for convenience will often result in the terminating party paying some premium related to profit or overhead in addition to the cost of the completed work. 

Determining when to use termination for convenience is fact specific and depends on the circumstances of each case. Often, termination is as much a business decision as a legal decision. Therefore, understating the purpose, general terms and risks involved with a termination for convenience is essential to ensure that each party is adequately protected, and costly disputes are minimized.