Converting Improper Termination for Cause into Termination for Convenience

At the beginning of every construction project, the parties’ preference is obviously to have the job completed on time and within budget, and for everyone working on the project to be paid in full. However, circumstances such as performance issues, delay, changes in the owner’s financing or plans for the project, insolvency, market changes, and government intervention can arise that create an untenable situation and cause an owner to terminate the contract (and, in some cases, the project). Over time, and following principles in federal contracting, parties to public and private construction contracts have developed contractual provisions to address these circumstances and provide an off-ramp for the contractual relationship through a termination for cause (i.e., default) or convenience.

Under the common law, a party can terminate a construction contract if the other party materially breaches the contract. See Zulla Steel v. A&M Gregos, 174 N.J. Super. 124, 131-32 (App. Div. 1980) (holding that subcontractor could terminate for prolonged non-payment). Termination for cause provisions contractually define the specific circumstances in which a party may terminate for fault. See, e.g., American Institute of Architects (“AIA”) A201TM-2017 (General Conditions of the Contract for Construction), Art. 14.2.1; Titan Stone, Tile & Masonry v. Hunt Construction Group, 2010 U.S. App. LEXIS 19495, *37-39 (3d Cir. Sept. 20, 2010). Conversely, termination for convenience is not fault-based and provides an owner with broad discretion to terminate the contractual relationship at any time and for any reason, provided the termination is not made in bad faith. See, e.g., AIA A201TM-2017, Art. 14.4.1, Interstate Indus. Corp. v. State, 2008 N.J. Super. Unpub. LEXIS 1495, *36-41 (App. Div. July 28, 2008).

Although the parameters of termination provisions will be governed by the specific terms of the contract, there are typically some key distinctions between a termination for cause and termination for convenience. These distinctions include: (1) the role of fault; (2) while both an owner and contractor can typically terminate for cause (although the grounds for a contractor to do so are generally more limited), only the owner can terminate for convenience; (3) a termination for cause often requires additional procedural steps (e.g., a specific determination of default made by a third party or the individual administering the contract); and (4) a termination for cause permits an owner to withhold payment to the contractor until the work is finished (assuming there is any unpaid balance remaining after the contractor completes the project), whereas a termination for convenience typically entitles the contractor to an immediate payment.

An interesting issue arises when the owner’s termination for cause is improper (either for failure to follow the required termination procedure or because the contractual grounds for such a termination did not exist). Logic seemingly dictates that an owner’s improper termination for cause is itself a breach of contract, entitling the contractor to sue for breach, and courts have held that a contractor can seek to recover damages for wrongful termination under such circumstances. See Ingrassia Const. Co. v. Vernon Tp. Bd. of Educ., 345 N.J. Super. 130, 136-37 (App. Div. 2001) (noting that when an owner failed to follow the procedural requirements for a termination for cause, “the parties are left to their common-law causes of action for breach of contract”). However, the doctrine of constructive termination for convenience and contractual provisions incorporating this doctrine may bar such claims by a contractor improperly terminated for cause.

Constructive termination for convenience is a creature of federal common law, whereby courts essentially convert an improper termination for cause to a termination for convenience, limiting the contractor to redress under the contract’s termination for convenience provision. The underlying rationale is that the government could have exercised the contractual right to terminate the contractor for convenience at any time and, as such, it is not unfair to apply the termination for convenience clause when the owner improperly terminates. See, e.g., Kalvar Corp. v. United States, 543 F.2d 1298, 1306 (Ct. Cl. 1976). In Linan-Faye Constr. Co. v. Housing Auth., the Court of Appeals for the Third Circuit applied the constructive termination for convenience doctrine, predicting that New Jersey courts would recognize the doctrine. 49 F.3d 915, 926 (3d Cir. 1995).

Some construction contracts contain “termination conversion” clauses, which expressly incorporate the constructive termination for convenience doctrine. Specifically, these clauses mandate that if the owner improperly terminates a contractor for cause, the termination will be treated as a termination for convenience. Such clauses are routine in public construction contracts, see, e.g., New Jersey Department of Transportation, Standard Specifications for Road and Bridge Construction (2019), Spec. 108.14 (“[i]f, after declaration of default, the Department determines for any reason that the Contractor was not in default or that the delay was excusable … [or] a court determines for any reason that the Department’s default of the Contract was legally improper, the rights and obligations of the parties are the same as if the Department had issued an order of termination for convenience”), but are also becoming more prevalent in contracts for private projects, see, e.g., Cnj Constr. Corp. v. Autobuilders Gen. Contr. Servs., 2020 N.J. Super. Unpub. LEXIS 223, *1-3 (App. Div. Jan. 31, 2020) (termination conversion clause present in subcontract relating to construction of a car dealership). Significantly, New Jersey courts have enforced such provisions in the absence of bad faith by the owner. See, e.g., Stony Brook Constr. Co. v. College of N.J., 2008 N.J. Super. Unpub. LEXIS 799, *20 (App. Div. June. 16, 2008) (enforcing “a clear express provision by which the parties agreed to apply the [constructive termination for convenience] doctrine to their contractual undertaking”).

There are benefits to converting an improper termination for cause to a termination for convenience, particularly for an owner. A termination for convenience provides a process for winding up the contractual relationship and, absent potential bad faith allegations against the terminating party, should help to end any dispute between the parties. Moreover, the costs the owner must pay to the contractor under a termination for convenience are typically defined and likely far less than if the contractor were to assert a breach of contract claim for wrongful termination—a savings that ultimately inures to the benefit of taxpayers on a public project. Nevertheless, conversion to a termination for convenience, whether constructive or contractual, implicates questions of fairness for contractors who are wrongfully terminated for default.

First, converting to a termination for convenience is not always a bargained-for outcome. In the case of a constructive termination for convenience, it is based on a judicially made doctrine rather than any explicit contract requirement. Further, public contracts are typically “take it or leave it,” and, as such, contractors cannot negotiate away contractual termination conversion clauses.

Second, an owner is protected from a wrongful decision to default a contractor because the owner’s downside risk is limited to the termination for convenience provisions. Indeed, while terminating for cause can have drastic consequences for the contractor, owners can essentially avoid adverse claims for this decision because it is extremely difficult for a contractor to show bad faith. See Interstate Indus., 2008 N.J. Super. Unpub. LEXIS 1495, at *38 (“government officials are presumed to act in good faith and, as a result, the contractor has a very heavy burden of proof”).

Third, the contractor is unable to seek full redress for the wrongful termination. While the contractor would ordinarily be entitled to greater (and quicker) recovery than in the case of a proper termination for cause, the contractor’s recovery under a termination for convenience provision may not approximate the actual damage the contractor suffers from the termination for convenience. See, e.g., Capital Safety v. State, Div. of Bldgs. and Const., 369 N.J. Super. 295, 303 (App. Div. 2004) (contractor limited to liquidated damages for each work day up to the date of issuance of a notice to proceed or order of termination for convenience). Moreover, when a termination for cause is converted to a termination for convenience, it is a different scenario than an ordinary termination for convenience—the contractor has been forced to address a wrongful termination for default. In addition to incurring injury to its reputation, an improperly terminated contractor often expends significant resources and money disputing and overturning the default, responding to claims by its subcontractors, and addressing issues with its surety if there is a performance bond. Such adverse impacts might be recoverable in a breach of contract action for wrongful termination. However, converting to a termination for convenience likely forecloses the contractor’s opportunity to be made whole because its recoverable costs will be limited to those authorized by the contract’s termination for convenience clause. See City of Perth Amboy v. Interstate Indus. Corp., 2017 N.J. Super. Unpub. LEXIS 1209, *34-35 (App. Div. May 17, 2017) (contractor terminated for convenience limited to “all reasonable shutdown costs as agreed to by both parties” in the contract, stating the contractor failed “to explain how, having been properly terminated for convenience, it can nonetheless recover any kind of damages beyond those permitted by the contract”).

There is not a lot of New Jersey case law concerning contractual termination conversion clauses, and even less regarding constructive termination. Nevertheless, it seems likely such contractual provisions will be enforced by New Jersey courts in the absence of bad faith, and the Linan-Faye Constr. case suggests New Jersey courts would apply the constructive termination for convenience doctrine (at least in public contracts). Thus, when a proposed contract contains a termination conversion clause (or a termination for convenience provision), a contractor should note the potential risk that, if it is improperly terminated for default, it may be prohibited from asserting a breach of contract claim and left only with its rights under the contract’s termination for convenience provision. A contractor contracting with a public entity likely must accept the risk if it wants the work, but contractors on private projects should consider negotiating to eliminate such provisions and/or to increase the contractually compensable costs for a termination for convenience.

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Reprinted with permission from the October 26, 2020 issue of the New Jersey Law Journal. © 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved. For information, contact 877-257-3382 or reprints@alm.com or visit www.almreprints.com.