Commercial Notes
No. 27
3 June 2008
Termination for convenience
When entering into agreements, Commonwealth agencies
often need to consider the possibility that a change
in government requirements may require an agreement to
be terminated or the scope of the agreement to be reduced.
This note discusses some of the issues that agencies
need to consider in relation to this type of non-fault-based
termination or reduction, which is often referred to
as ‘termination or reduction for convenience’.
Many Commonwealth procurement or funding agreements contain
a termination for convenience clause. These clauses operate
to allow the Commonwealth to terminate the agreement where
there is no fault by the other party. Typically, these
clauses provide that the Commonwealth may, at any time,
by providing notice to the contractor or funding recipient,
terminate the agreement in whole or in part. If the Commonwealth
exercises its rights under such a clause, the clause will
typically state that the Commonwealth will be liable only
for direct costs (excluding any loss of prospective profits)
incurred by the contractor or funding recipient which are
directly attributable to the termination or partial termination.
The principal reason for the inclusion of termination
for convenience clauses is to enable the Commonwealth to
terminate its commitment in the event of a change of government
policy or other related government exigencies. The decision
to include these clauses in agreements is a matter for
individual agencies (in the case of FMA agencies, acting
in accordance with their Chief Executive Instructions and
having regard to the requirements of the financial management
framework1). If an agency purports to terminate
an agreement where the agency does not actually have a
right to terminate, the other party may be able to successfully
challenge the termination with a resultant claim for damages
or other relief. For this reason it is important to understand
the circumstances in which an agreement may be terminated
for convenience.
Doctrine of executive necessity
A termination for convenience clause is usually justified
in Commonwealth agreements as reflecting the doctrine of
executive necessity. Broadly stated, the doctrine is simply
that the law permits the government to fulfil the fundamental
purposes for which it was created, even though this may
interfere with contractual rights. This doctrine reflects
public policy considerations in that a government (or perhaps
more particularly a future government) should not be prevented
from making future changes to government policy.
Even where a termination for convenience clause is not
included in the procurement or funding agreement, the Commonwealth
may still be able to terminate by relying on the doctrine
of executive necessity. It is prudent to seek legal advice
before relying on the doctrine of executive necessity as
a basis for terminating an agreement.
Drafting and negotiating the agreement
Obviously, it is important to consider what termination
rights the agency requires at the time the agreement is
being drafted.
Illusory consideration?
It has been argued that a strict interpretation of a termination
for convenience clause would render an entire agreement
void and therefore unenforceable. This argument is based
on the premise that, as the clause would permit the government
to terminate the agreement at any time at its convenience,
the government’s performance of its obligations is
arguably ‘optional’: the government promises
nothing and thus provides no consideration for the agreement;
hence, there is no agreement.
The inclusion of the requirement for the Commonwealth
to pay compensation to the contractor or funding recipient
upon termination mitigates against this risk. Rather than
rendering performance optional, the clause permits the
Commonwealth to decide how it will perform the agreement
(either by seeing the agreement through to the end or by
paying the contractor compensation). Consequently, it is
unlikely that a court would find a procurement or funding
agreement void and unenforceable by virtue of the inclusion
of a termination for convenience clause.
Developing termination provisions
There are many factors that need to be considered in developing
the termination provisions to be included in an agreement.
For simpler agreements, more standard provisions may be
adequate, but for more complex agreements it may be necessary
to tailor the termination provisions to the transaction.
Examples of some of the issues that may need to be considered
are as follows.
Some issues to consider in
developing the agreement
- Ascertain whether your agency’s Chief
Executive Instructions or other internal procedures
require the inclusion of a termination for convenience
clause in the relevant agreement. It can be helpful
to refer to this requirement if a potential contractor
queries the inclusion of the clause.
- Whether the agency presses for a termination
for convenience clause in a particular agreement
should be informed by the overall requirements
of the financial framework and, in the case of
FMA agencies undertaking procurements, against
value for money criteria. For example, if the inclusion
of a termination for convenience clause will significantly
increase the price at which the contractor is prepared
to enter into the agreement, this would need to
be weighed up against the benefit derived from
the termination right.
- Determine whether the agency requires a right
to terminate for convenience in whole or part.
Consider the appropriateness of the provisions
in the event of a termination which results in
a reduction of the scope of the agreement. Ascertain
what contractor actions and obligations should
continue in the event of a reduction of the scope
of the agreement.
- One of the key reasons for including a termination
for convenience clause is to limit the compensation
that is payable to a contractor in the event that
the termination proceeds; in particular, to focus
the compensation on the payment of reasonable costs
following from the termination and avoid the need
to pay compensation for loss of future profits
or other benefits. Accordingly, it is important
to carefully consider how the compensation is described
in the agreement. For example:
- Is compensation for future profits excluded?
- Is there a limit on the maximum liability
of the agency in relation to direct costs (for
example, to the unpaid balance of the agreement
price or, under a funding agreement, to the unpaid
balance of the funds at the time of termination)?
If there is no limit, a claim might exceed the
cost of leaving the agreement afoot.
- In the case of agreements which enable the
contractor or funding recipient to acquire assets
from the procurement or funding payments, how
are those assets to be dealt with at the time
of termination and is this relevant to determining
what compensation is payable?
- Consider the impact of payments to subcontractors
in the event of termination. To limit the direct
costs unavoidably incurred by a contractor in
the event of termination for convenience, will
the contractor’s agreements with subcontractors
be required to contain provisions that the subcontract
is terminated if the head contract is terminated
for convenience (with restrictions on any compensation
payable to the subcontractor)?
- What mechanism will be needed to verify any
claim for compensation in the event of termination
for convenience? Access to contractor records
and the ability to audit a compensation claim
may be necessary to determine the reasonableness
of the contractor’s claim.
- Consider the duration of the agreement: termination
for convenience is often a more significant consideration
for longer-term agreements.
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Negotiating termination provisions
In negotiating the inclusion of a termination for convenience
clause, it can be useful to point out that the Commonwealth
may still be able to terminate by relying on the doctrine
of executive necessity and that the payment of compensation
in such circumstances is not certain. In contrast, termination
for convenience clauses typically provide for the payment
of compensation for loss incurred as a result of the termination.
However, in doing so, agencies should take care not to
represent that the right to terminate for convenience provided
in the agreement can or will be exercised only in limited
circumstances (such as where the doctrine of executive
necessity would otherwise have been applicable or where
there is a major change in government policy), as, by making
these representations, agencies may inadvertently restrict
the scope of the contractual clause.
Must termination for convenience rights only be exercised
in good faith?
One of the issues that needs to be considered when determining
whether to terminate an agreement on the basis of a termination
for convenience clause is whether the clause can be taken
at face value or whether there are limitations on the agency’s
right to terminate such that the exercise of the right
to terminate is not free from risk. In particular, is the
agency required to act in good faith in exercising a right
to terminate? If so, what does that mean?
Is there an implied term requiring the parties to act
in good faith?
There are no clear answers to this question under Australian
case law. The High Court has yet to endorse the implication
of a term of good faith into a commercial agreement.2
However, lower courts have endorsed the implication of
a term of good faith, but such a term has been implied
in some cases as a matter of fact and in others as a matter
of law. Implication of the term in law has been on the
basis that such a term will ordinarily be implied in some,
or perhaps all, commercial agreements as a ‘legal
incident of the relationship’.3 The result
of implying the term in law is that the term is implied
into all contracts belonging to that class, although the
express terms of a particular contract can exclude it.
In contrast, the Victorian Court of Appeal seems to hold
a preference for such a term to be implied, if at all,
in fact rather than in law, meaning that the implied term
of good faith is implied on an ad-hoc basis to give effect
to the presumed intention of the parties. Those who argue
for a duty of good faith to be implied as a matter of fact
(i.e. on a case-by-case basis) argue that to imply a duty
of good faith as a matter of law (i.e. to all contracts
in a particular class) would undermine certainty in commercial
contracting and ignore the traditional test for an implied
term, including that it be capable of clear expression
and be so obvious that it goes without saying.4
In the recent Victorian Supreme Court case of Kellogg
Brown & Root Pty Ltd v Australian Aerospace Ltd [2007]
VSC 200 (Kellogg), Hansen J commented that:
... perusal of the authorities reveals a deal of obiter
on the issue. Further, the High Court is yet to consider
the issue. The question, of course, is whether in the
particular case in question the terms of the subject
contract permit the implication of the suggested term.
In this case, Australian Aerospace (AA) mirrored in its
subcontract with Kellogg Brown the termination for convenience
clause which was in its own contract with the Commonwealth.
When AA exercised that right of termination for convenience
by giving Kellogg Brown a notice of termination, Kellogg
Brown contested the matter, arguing that the notice constituted
a breach of an implied term in that it was not given in
good faith and reasonably, for just cause, or upon proper
and reasonable grounds. Judgment has not been given in
this case. Once it has, the issues of termination for convenience
and the existence of a duty of good faith implied in such
clauses will hopefully be clearer.
Aside from the comments of Hansen J in Kellogg,
recent cases in various Australian jurisdictions have tended
to proceed on the basis that there may be implied, as a
legal incident of a commercial contract, a term of good
faith. However, given that the position in Australian law
(and particularly in Victoria) is not clear, it may be
that a duty to act in good faith is not to be implied generally
into all commercial agreements. Such a term would be implied
only if the particular facts and circumstances of the commercial
arrangement required or supported this.
Regardless of the uncertainty about whether such a term
is to be implied and if so how, agencies need to be aware
of the risk that the exercise of the right to terminate
for convenience may be limited by a duty to act in good
faith.
If there is a duty of good faith, what does it encompass?
If there is a duty to act in good faith in relation to
a particular agreement, whether expressly provided for
or implied as discussed above, the scope of that duty is
also not entirely clear.
It would appear from authorities that reasonableness now
seems to be regarded as a significant ingredient of good
faith and, in many cases, there is little distinction made
between the two concepts.5 Beyond the reasonableness
requirement, cases on the topic have not clarified the
meaning of ‘good faith’ or its practical requirements
but have suggested that good faith could perhaps mean:
- acting honestly6
- not acting capriciously7 and
- doing what is necessary to enable the party to have
the benefit of the agreement.8
It is equally unclear what circumstances would be found
to constitute bad faith or an abuse of discretion. Some
have argued that using the power for an exterior or ulterior
purpose such as seeking a better commercial deal elsewhere,
or to avoid potential liability for default under the agreement
or preventing other parties from exercising their rights,
would not comply with a duty of good faith and fair dealing.
If these arguments were upheld, it would mean that a termination
for convenience clause could not simply be used according
to its literal terms; that is, for the ‘convenience’ of
the government.
Even if a good faith duty is expressly included in the
agreement, the rights under a termination for convenience
clause will not necessarily be restricted. Authorities
have suggested that the duty of good faith is not a fiduciary
duty and will not prevent a contracting party from taking
actions which promote its legitimate interests and accord
with express contractual terms.9 In particular,
such authorities have expressed the view that:
- an express term in an agreement that the parties would
act in good faith did not limit the operation of the
termination for convenience clause
- a clear and unambiguous power of termination, expressed
as an absolute and uncontrolled discretion, is not required
to be exercised reasonably merely by virtue of the existence
of a requirement to act in good faith
- a contractual obligation of good faith does not prevent
either party pursuing legitimate commercial interests,
even though the pursuit of those interests may result
in the renegotiation or termination of the agreement
- a term could not be implied that the termination power
was limited to situations where the principal had a reasonable
reason for terminating, because such an implied term
would be contrary to the express termination provision
- the implication of any terms (such as the term of
good faith) which inhibited the operation of the express
words of the agreement would be contrary to principle;
it is clear that an implied term of good faith must be
consistent with the express terms of an agreement
- the obligation of good faith cannot prevent the use
of terms actually appearing in the agreement.
Termination for convenience in the government context
Termination for convenience clauses in government agreements
are not often exercised and there has been no consideration
of this type of termination in the government context by
Australian, United Kingdom or New Zealand courts. The United
States has a long history of dealing with termination for
convenience clauses in the government context. Therefore,
if such a clause came before an Australian court, the court
may look to United States case law for assistance.
In Torncello v United States 681 F 2d 756 (1982)
(Torncello), the court held that the US Government
could exercise a standard termination for convenience clause
only in circumstances where ‘the bargain of expectations
of the parties have changed sufficiently that the clause
serves only to allocate risk’. Subsequent US cases
have interpreted the Torncello decision as broadly
requiring a change in circumstances as a prerequisite to
a valid termination for convenience. However, more recent
cases have rejected or limited the Torncello decision.10
Following the decision in Krygoski Construction Company
v United States 94 F 3d 1537 (1996), the position
in the US appears to be that use of a termination for
convenience clause will be improper only where the government
has acted in bad faith or there has been an abuse of
discretion. Examples of bad faith include where the clause
is used to acquire a better bargain from another source,
or where the government enters into an agreement with
no intention of fulfilling its promises.11
If a court followed the trend in the United States, it
might find that the Commonwealth may only exercise the
right to terminate for convenience in ‘good faith’.
As noted above, under Australian law, it is unclear whether
a duty to act in good faith exists generally in contractual
dealings as a matter of law. However, even if there is
no general duty of good faith and fair dealing, it is possible
that a court would consider that such an obligation should
be implied as a matter of fact into a particular Commonwealth
agreement; for example, on the basis of the particular
circumstances that apply to the agreement.
In Hughes Aircraft Systems International v Airservices
Australia (1997) 146 ALR 1, Finn J found that, in
a pre-award or tender process agreement, the then Civil
Aviation Authority (CAA) owed an implied contractual
duty to tenderers to deal with them fairly. His Honour’s
principal finding was that there was a preliminary ‘process’ agreement
governing the conduct of the tender before the award
and that there had been breaches of that agreement, the
primary breach being that the CAA had ‘failed to
evaluate tenders in accordance with the priorities and
methodology prescribed in the RFT’.12
The case is quite fact specific and does not necessarily
stand for the proposition that there is a general duty
of good faith in government agreements.
Conclusion on good faith
Given the uncertainty in the state of the law on good
faith in contracting generally and the absence of specific
authorities in Australia on termination for convenience
clauses, it is important to take specific advice before
any decision to terminate for convenience is taken. If
a duty of good faith is applicable, the precise requirements
of that duty might also vary depending on the nature of
the agreement.
Practical considerations when terminating for convenience
Some of the issues that are required to be considered
in the context of a termination for convenience are similar
to those that may need to be considered on expiry of an
agreement (for example, transitional type issues) or on
a termination for default. Other issues are more specific
to a termination for convenience.
The following are examples of some of the issues that
may require consideration depending on the nature of the
agreement.
Some issues when considering
terminating for convenience
- Consider whether, in making the decision to
terminate for convenience, the agency has acted
in good faith.
- Ascertain whether the termination is for the
entire agreement or is limited to a reduction of
the scope of the agreement.
- Determine the extent of the agency’s obligation
to compensate the other party in the event of termination
for convenience. Unless the agreement limits the
agency’s liability to compensation for costs
unavoidably incurred, a compensation claim may
exceed the total agreement price or the total amount
of funds to be advanced.
- Ascertain the steps that may need to be taken
to verify the claim for compensation and the resources
required to undertake the verification.
- Consider the transitional issues that will need
to be dealt with as a result of the termination
and how these are provided for in the agreement
(for example, in relation to the treatment of records,
finalisation of accounts or reports, or treatment
of assets).
- Consider the potential impact on any future
relationship with the other party and other participants
in the relevant market as well as any impact on
the Commonwealth’s broader policy or program
goals.
- Consider whether any representations were made
by either party during negotiation of the agreement
in relation to the circumstances in which the right
to terminate for convenience could be exercised.
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John Scala is
AGS’s Chief Counsel Commercial. His specialist
expertise in corporate and commercial law includes tendering
and contracting, procurement, corporate governance, privatisation,
probity and process advice and auditing, banking and
finance, property and leasing, and outsourcing projects.
Over his 28 years in commercial law, John has worked
for a wide range of Commonwealth departments and agencies.
Paul Lang is Special
Counsel in our Commercial practice. Paul has advised
the Australian Government on many significant and complex
projects. He has an extensive background in public sector
procurement, tendering and contracting, probity and process
advice, privatisation, corporatisation, outsourcing,
and grants and funding agreements.
Deborah Browitt is
a Senior Lawyer in our Commercial practice with extensive
experience in developing and advising on commercial contracts
and funding agreements, providing legal and probity advice
on procurements and developing procurement and funding
documentation.
Notes
- There are a number of requirements and policies that
make up the financial management framework; for example,
the Financial Management and Accountability Act 1997,
the Financial Management and Accountability Regulations
1997 and the Commonwealth Procurement Guidelines.
- As noted by Dodds-Streeton J in Meridian Retail
v Australian Unity Retail Network [2006] VSC 223,
referring to Royal Botanical Gardens and Domain
Trust v South Sydney City Council (2002) 186 ALR
289.
- Finkelstein J in Garry Rogers Motors (Aust) Pty
Ltd v Subaru (Aust) Pty Ltd (1999) ATPR 41-703
(Garry Rogers) and more recently in Pacific
Brands Sport & Leisure Pty Ltd v Underworks Pty
Ltd [2005] FCA 288. Finn J of the Federal Court
also supported this view in GEC Marconi Systems
Pty Ltd v BHP Information Technology Pty Ltd (2003)
128 FCR 1 (at 173-174).
- For example, Buchanan JA (with whom Warren CJ and
Osborn AJA agreed) in Esso Australia Resources Pty
Ltd v Southern Pacific Petroleum NL [2005] VSCA 228
(Esso) at para [25], Warren CJ in Esso,
and Hansen J in Playcorp Pty Ltd v Taiyo Kogyo Ltd [2003]
VSC 108 at [267]. The decision of Giles JA in Vodafone
Pacific Ltd v Mobile Innovations Ltd [2004] NSWCA
15 (20 February 2004) (Vodafone) is cited in the
judgment for an opposite approach.
- Renard Constructions (ME) Pty Ltd v Minister for
Public Works (1992) 26 NSWLR 234; Burger King
v Hungry Jack’s Pty Ltd [2001] NSWCA 187
(Burger King).
- Giles JA in Vodafone at para [192].
- Finkelstein J in Garry Rogers at para [37].
- Giles JA in Vodafone at para [192].
- Burger King; Thiess Contractors Pty Ltd
v Placer (Granny Smith) Pty Ltd (2000) 16 BCL 255;
Dodds-Streeton J in Meridian Retail v Australian
Unity Retail Network [2006] VSC 223, referring
to Central Exchange Ltd v Anaconda Nickel Ltd (2002)
26 WAR 33; Commonwealth Bank v Spira [2002]
NSWSC 905. See also relevant English authority Hadley
Design Associates Ltd v The Lord Mayor and Citizens
of the City of Westminster [2003] EWHC 1617 (TCC).
- For example, Krygoski Construction Company v United
States 94 F 3d 1537 (1996).
- See Northrop Grumann Corp v United States Fed
Cl, 7 April 2000; T & M Distributors Inc v United
States 905 F2d 1518 1990; Caldwell & Santymer
Inc v Glickman 55 F3d 1578 1995; Travel Centre
v General Services Administration GSBCA 14057, 26
November 1997.
- (1997) 146 ALR 118.
AGS contacts
Linda Richardson National
Practice Leader, Commercial
T 02 6253 7207 F 02 6253 7301
linda.richardson@ags.gov.au
AGS has a national team of lawyers specialising in procurement,
contracting, grants and funding agreements. For further
information on the article in this issue or any other contract
matters, please contact the authors, Linda Richardson or
any of the lawyers listed below.
Canberra
|
Tony Beal
Philip Crisp
Henry Addison
Rachel Chua
Terry De Martin
Peter Kidd
Kym Lockley
Andrew Miles
John Snell
Adrian Snooks
|
02 6253 7231
02 6253 7159
02 6253 7264
02 6253 7086
02 6253 7093
02 6253 7210
02 6253 7461
02 6253 7100
02 6253 7025
02 6253 7192
|
Sydney
|
John Berg
Simon Konecny
|
02 9581 7624
02 9581 7585
|
Melbourne
|
Paul Lang
Garth Cooke
Kenneth Eagle
Lynette Lenaz
Teresa Miraglia
Cathy Reid
Josephine Ziino
|
03 9242 1322
03 9242 1490
03 9242 1290
03 9242 1358
03 9242 1493
03 9242 1203
03 9242 1312
|
Brisbane
|
Peter Blennerhassett
|
07 3360 5767
|
Perth
|
Lee-Sai Choo
|
08 9268 1137
|
Adelaide
|
Peter Whatson
|
08 8205 4287
|
Hobart
|
Peter Bowen
|
03 6210 2104
|
Darwin
|
James Docherty
|
08 8943 1405
|
The material in these notes is provided to AGS clients
for general information only and should not be relied
upon for the purpose of a particular matter. Please
contact AGS before any action or decision is taken
on the basis of any of the material in these notes. © AGS
All rights reserved
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Government Solicitor
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