Washington Court of Appeals Confirms Enforceability of Termination-for-Convenience Clauses and Holds that Implied Covenant of Good Faith Places No Limits on Express Termination-for-Convenience Clauses

By D.C. Wolf, Brad Lewis, and Jesse O. Franklin, K&L Gates, Seattle

The contract law concept of a “termination for convenience” allows one contracting party to terminate a contract that has become inconvenient or unnecessary and settle with the terminated party for partial performance.  The doctrine originated during the U.S. Civil War to give the Union government flexibility when quickly changing battlefield conditions rendered a planned project or procurement overly costly or no longer necessary.[1]

In its recent decision in SAK & Associates, Inc. v. Ferguson Construction, Inc., No. 72258-1-1, 2015 WL 4726912 (Wash. Ct. App. Aug. 10, 2015), the Washington Court of Appeals, Division One, given very limited existing authority, clarified that partial performance of a construction project is sufficient consideration to support a termination-for-convenience clause and rejected the argument that the implied covenant of good faith and fair dealing limits a party’s ability to invoke such a clause.

In SAK, the subcontractor entered into a fixed-sum contract with the general contractor to provide concrete and paving services for the construction of airplane hangars.  Their agreement contained a termination-for-convenience clause, which provided as follows:

In addition to the rights listed above, Contractor may, after providing Subcontractor with written notice, terminate (without prejudice to any right or remedy of Contractor) the Subcontract, or any part of it, for its own convenience and require Subcontractor to immediately stop work.  In such event, the Contractor shall pay the Subcontractor for the work actually performed in an amount proportionate to the total Subcontract price.  Contractor shall not be liable to the Subcontractor for any other costs, including anticipated profits on work not performed or unabsorbed overhead.

After the subcontractor had been working for about four months, the general contractor invoked the termination-for-convenience clause, citing “phasing restrictions, site logistics, and basic convenience,” and required the subcontractor to stop work immediately.  The subcontractor sued, alleging that the contractor had breached their agreement by terminating it without cause.  The trial court granted summary judgment for the contractor, holding that it had properly invoked the termination-for-convenience provision of the contract.  The subcontractor appealed.

The Court of Appeals, Division One, affirmed the grant of summary judgment.  The subcontractor’s primary argument on appeal was that because the disputed clause allowed the contractor to terminate at its discretion, it was an unenforceable, illusory promise.  The Court of Appeals disagreed, noting that so long as there is “some restriction upon the power to terminate,” the right to terminate for convenience is not illusory.  The subcontractor in SAK had completed 24% of the project before being terminated, and the contractor had paid it for that proportion of the fixed contract price.  The court determined that this payment for partial performance was sufficient consideration to render the termination-for-convenience clause valid and enforceable.  Also, as is often the case in negotiated contracts, the contractor and subcontractor in SAK agreed that in the event the contractor exercised its power to terminate, the subcontractor was entitled only to a proportionate share of its overhead and profit based on the completed portion of the work.  The Court of Appeals reasoned that this too made enforcing the termination-for-convenience clause proper, because doing so would effectuate the parties’ intent as shown objectively by the express terms of the contract.

The Court of Appeals also held that the implied covenant of good faith and fair dealing does not limit a party’s ability to invoke a termination for-convenience clause.  Relying on a previous Washington case involving a government contract with a similar clause,[2]  the Court of Appeals held that the covenant of good faith and fair dealing does not trump express contract terms.

The SAK case reinforces the enforceability of termination-for-convenience clauses in Washington.  It also rejects the notion that the implied covenant of good faith precludes a party from invoking a termination-for-convenience clause.  The Court of Appeals cautioned, however, that “[w]e are not faced with an attempt to invoke a termination for convenience clause before the commencement of any work or only after a nominal amount of work.”  Thus, this decision leaves open whether a termination-for-convenience clause is enforceable if invoked before or just after the subcontractor has started work.  It also raises the question of how much restriction upon the power to terminate is sufficient to avoid a finding that the termination-for-convenience clause is illusory.  Parties should carefully consider these issues before invoking a termination-for-convenience clause.

[1] See, e.g., United States v. Corliss Steam-Engine Co., 91 U.S. 321 (1876).

[2] Myers v. State, 152 Wn. App. 823, 828, 218 P.3d 241 (2009).

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