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August 20, 2015
Common understanding in the construction industry has long been that an owner or contractor could not terminate a contract for convenience unless it had good cause, sent an abundance of written notice, and provided an opportunity to cure — similar standards to terminating for default. That was the rule, until last week.
On Aug. 10, the state Court of Appeals found that “good faith” and “fair dealing” will no longer restrict the use of an express and unambiguous termination for convenience provision. Deference is given to the negotiated terms and the intent of the parties.
The facts of the case were simple, as the enforcement of a single contract provision was in question. SAK & Associates (subcontractor) entered into a fixed-sum contract with Ferguson Construction (general contractor) to provide concrete materials and paving services for the construction of hangars at an airport.
Ferguson terminated SAK from the project after three months of work, citing a provision of the subcontract that the “contractor may, after providing subcontractor with written notice, terminate (without prejudice to any right or remedy to contractor) the subcontract, or any part of it, for its own convenience and require subcontractor to immediately stop work.”
The provision further stated that the contractor shall be liable only for the “work actually performed in an amount proportionate to the total subcontract price.”
Pursuant to that provision, Ferguson provided written notice of termination and paid SAK approximately $181,000 for its work performed. SAK subsequently sued for the subcontract balance, claiming that Ferguson breached the subcontract for terminating without good cause.
The trial court dismissed the case and SAK appealed. At issue was whether the termination for convenience provision was an invalid illusory promise; or if the clause is limited by the doctrine of good faith and fair dealing. The appellate court disagreed on both counts, upholding Ferguson's termination and the freedom to contract.
Before addressing the legal issues, the court recognized that although termination for convenience clauses are customary in standard construction contracts from groups such as the AIA and AGC, there is a dearth of law interpreting such provisions between private parties.
Turning to the legal analysis, the court first defined an illusory promise as when the promisor's performance is entirely within his discretion or control, in which case the provision is unenforceable for not being supported by consideration.
However, Washington courts do not give effect to interpretations that would render contract obligations illusory.
The court then explained that, generally, termination provisions cannot be illusory if they can be exercised only upon the occurrence of specified conditions, such as providing written notice.
Moreover, the court noted it is well settled that partial performance provides adequate consideration to enforce an otherwise illusory termination provision. In this case, SAK performed and was compensated for over three months of work. The court relied upon that partial performance to find that the termination for convenience provision was not illusory.
It is unclear if the result would have changed had SAK not commenced work before termination.
Moving to the next issue, citing just a single case, the court found that the covenants of good faith and fair dealing do not trump an express termination for convenience provision. The negotiated terms and intent of the parties must prevail. Here, the parties negotiated that Ferguson would have the right to terminate the subcontract for any reason upon written notice and proportional payment of the contract price. Ferguson acted accordingly. The court therefore enforced the provision, while refusing to assess Ferguson's subjective reasons for termination or the quality of SAK's work on the project.
The implications of the court's decision are significant: Termination for convenience provisions will be enforced as bargained for by the parties. Owners and general contractors should use this case as an example of how one can terminate for convenience in confidence and with reduced liability concerns for failing to show good cause or an opportunity to cure.
General contractors and subcontractors on the other side of the table should now negotiate aggressively to limit the application of termination for convenience provisions, with increased procedural and payment obligations.
Joe Stockton is a real estate and construction lawyer in the Seattle office of Schwabe, Williamson & Wyatt.