Termination for Convenience: Not As ‘Convenient’ As It Sounds

What you need to know:

• Termination for Convenience (TfC) clauses are commonly included in government contracts, including the Commonwealth Contracting Suite and ASDEFCON suite of templates.
• Although the Government’s right to terminate a contract “for convenience” originates from the common law doctrine of executive necessity (which provides that the Crown cannot be restricted from exercising its powers in the public interest due to contractual requirements), a contractual right to terminate a contract for convenience is a stand-alone (and additional) right and needs to be exercised in light of the breadth and width of the terms of the specific contract under which that right is sought to be exercised.  Decision makers in Government will need to determine whether exercising its common law right to terminate for executive necessity, or under a specific contractual right for convenience, is the most appropriate in each circumstance.
• Termination is generally the most severe action that can be taken under a contract. As the scope and bounds of TfC provisions are contentious, government parties should expect that relying on TfC rights will be closely scrutinised.

What you need to do:

• When negotiating a TfC clause with contractors, carefully explain the rationale and benefits of including the clause compared to the alternative doctrine of executive necessity.
• When considering relying upon a TfC right, consider:
• the breadth of the right (eg, requirement to give notice, discretionary powers, and reasons for termination - if any),
• the extent to which that exercise will be done in ‘good faith’,
• any other dispute resolution or issue rectification processes available that have not yet been followed-through with the other party, or
• whether there are other more suitable (alternative) termination options available under the contract.
• Before exercising a right to terminate for convenience under a contract, you must seek specialist legal advice that takes into account the specific drafting of the TfC clause in the relevant contract, as well as the surrounding factual circumstances.
• An improper exercise (or purported exercise) of a right to terminate a contract may lead to an entitlement in the other party to repudiate the contract, and associated damages for the original party.

Detailed Insights

The scope and bounds of the Commonwealth's right to terminate a contract for convenience is largely untested.  There is very little case law in Australia - and the few cases which involved the exercise of a TfC clause relate to private sector commercial entities, rather than the Government. This legal insight explores the origins of TfC, common misconceptions, and some clear limitations and considerations on the termination right.

The doctrine of executive necessity: the conceptual origin of TfC

The common law doctrine that gave rise to the use of the TfC clause in Government contracts is the doctrine of executive necessity. This doctrine, as first described by Rowlatt J in Rederiaktiebolaget “Amphitrite” v the King [1921] KB 500 (Amphitrite), holds that the Crown cannot be prevented from freely governing due to its contractual obligations.

In Amphitrite, a contractual undertaking was broken by the Government because of the necessities of war.  The Kings Bench Division of the United Kingdom High Court held that this was permissible as the Government could not be restricted as a result of contractual obligations from undertaking wartime activities that were within its prerogative power.  The example of wartime activities could be considered the ‘high water mark’ of extreme scenarios where the Government would invoke the doctrine of executive necessity to breach or terminate a contract.

The High Court of Australia, in recognising the doctrine of executive necessity in Australia, held that although it was legally sound, it had been ‘expressed too generally’ by Rowlatt J in Amphitrite. In Ansett Transport Industries (Operations) Pty Ltd v Commonwealth (1977) 139 CLR 54 (Ansett), the High Court held that the Commonwealth’s right to terminate a contract when relying on the doctrine of executive necessity should not be exercised as a routine option, as this would result in a loss of public confidence in the Government’s capacity to enter into a valid contract.

Although useful in confirming that the doctrine of executive necessity is legally valid in Australia, Ansett did not comprehensively set out the scenarios where a Government could exercise the doctrine of executive necessity to terminate a contract.

The Northern Territory Supreme Court (sitting as the Court of Appeal) held in Northern Territory of Australia v Skywest Airlines Pty Ltd (1987) 90 FLR 270 (Skywest) that the Northern Territory Government had the ability to terminate a contract by invoking the doctrine of executive necessity where an ‘overriding public interest’ to terminate the contract arose. Notably, Kearney J elaborated in his judgement in Skywest that when a Government terminates a contract for executive necessity, it must do so with the equitable and fair treatment of the other party in mind.

Based on Mason J’s judgement in Ansett and Kearney J’s judgement in Skywest, there are broad requirements for the Government party to only terminate for executive necessity with great caution and reservation, with the fair treatment of the other party in mind, and where there is an overriding public interest in effecting the termination.

Over time, TfC clauses were adopted by Governments to expressly provide that the Government can break a contract in its discretion, with the deliberate intent of overcoming the uncertainties surrounding the exercise of the Government’s right to terminate for executive necessity.

While the doctrine of executive necessity may be the common law ‘ancestor’ of the TfC clause, there appears to be no current binding legal authority to suggest that they are identical or that the limitations applicable to executive necessity are also applicable to TfC provisions. On the one hand, this means that there is a risk that Australian courts may examine whether a TfC right is exercised appropriately by considering the most closely related legal basis for Governments to break contracts - executive necessity.  On the other hand, courts should nonetheless interpret contracts to give effect to the plain words used by the parties, which may be broader than the doctrine of executive necessity. Further, TfC clauses are increasingly being used in private sector commercial arrangements where there is no equivalent doctrine of executive necessity, so the link between executive necessity and TfC provisions may only be speculative.

TfC and good faith

On a strict reading of a TfC clause, the Government may appear to be unconstrained when exercising its TfC right.  However, the breadth and width of the relevant provision will need to be considered carefully to determine the extent to which a Government party must exercise the TfC right in 'good faith'.  To be clear, it is the writer’s view that it is safest for all parties to assume that such an implied term will be read into the relevant clause, and act accordingly, to minimise the risks of an improper exercise of that right.

In the Federal Court case of GEC Marconi Systems Pty Ltd v BHP Information Technology Pty Ltd [2003] FCA 50 (Marconi), Finn J held, that there was a duty to act in good faith in seeking to rely upon the particular TfC clause contained in that contract. This is consistent with Kellogg, Brown & Root Pty Ltd v Australian Aerospace Ltd [2007] VSC 200 (Australian Aerospace), in which the Victorian Supreme Court granted an injunction on the basis that exercise of the TfC right may be subject to an implied obligation of good faith and that obligation may have been breached.  

The meaning and scope of good faith in the context of Government contracts is somewhat uncertain.  Australian courts have held that acting in good faith, depending on the circumstances and the relevant clauses of the contract at hand, may include acting honestly, not acting capriciously, and doing what is necessary to enable the other party to have the full benefit of the agreement (see Vodafone Pacific Ltd v Mobile Innovations Ltd [2004] NSWCA 15 and Garry Rogers Motors (Aust) Pty Ltd v Subaru (Aust) Pty Ltd (1999) ATPR 41-703).

As an example, Australian Aerospace illustrates circumstances in which a party may have exercised a TfC right not acting in good faith:

• Australian Aerospace Ltd (AA) had erroneously subcontracted out a profitable portion of the work to its subcontractor, Kellogg, Brown & Root Pty Ltd (KBR);
• Upon realising that it had made this mistake, AA allegedly attempted to remove KBR from the agreement and retain its portion of the work for themselves;
• AA first issued notices of poor performance to Kellogg, Brown & Root Pty Ltd and subsequently attempted to exercise a right to terminate for convenience that was ‘flowed down’ from a Department of Defence head contract; and
• KBR submitted that AA breached the implied duty of good faith by depriving KBR of the benefit of the agreement and attempting to avoid the dispute resolution processes in the contract (with a neutral third party finding that AA’s prior notices of poor performance were without substance). Hansen J determined that there was a serious question to be tried based on KBR's submissions.

This demonstrates that Government parties should exercise TfC rights with great caution, as TfC is one of the most contentious rights available under a contract and its use will be scrutinised heavily by courts. When considering whether a TfC clause can be appropriately exercised under your contract, seek specialist legal advice that takes into account the specific drafting of the TfC clause as well as the surrounding factual circumstances.

Sensitivities of including TfC clauses in contracts

It is common for contractors to raise major concerns with the inclusion of a TfC clause in a Government contract.  Accordingly, it can be useful to ‘frame’ and explain the purpose to contractors during negotiations.

In particular, Government negotiators should outline to the prospective contractor that the use of a TfC clause creates a more certain financial and legal outcome for the contractor than the Government’s reliance on executive necessity.  This is because  TfC clauses typically (or should) include a subclause which provides the contractor with an entitlement to costs reasonably attributable to the termination. This also ring-fences the Government party’s liability for compensation to the contractor.  In this way, from the contractor's perspective, a TfC right may be viewed as the ‘lesser of two evils’.

Through the early explanation of the TfC clause in a Government contract, the Government party can pre-emptively address the sensitivities and issues that prospective contractors may have with the inclusion of a TfC clause.

Exercising TfC rights under a contract – practical considerations

While it may be easy (especially for lawyers) to focus solely on the legal limitations applicable to the right to terminate for convenience under Government contracts, it is important to remember that exercising a TfC right has very real practical implications. That is, just because you can, does not always mean that you should - particularly given the risks of improperly doing so.

Before exercising a right to terminate a contract for convenience, a Government party should first assess:

• first and foremost, the drafting of the TfC included in the relevant contract;
• whether it has taken all available steps to resolve issues and disputes under the contract before considering the option to terminate;
• whether other available rights of termination (such as those for default or general rights of termination) are available and more suitable (and pose less risk) in the circumstances;
• the amount of compensation that will be payable to the contractor as a direct result of the termination for convenience, and whether exercising other rights of termination may be more advantageous or certain for the Government party;
• whether any representations were made to the contractor about the circumstances in which the right to terminate for convenience would (or would not) be exercised, and what impact this may have on the proposed exercise of the right in this particular instance, including in respect of estoppel or any implied term;
• what impact exercising the right to terminate for convenience may have on the future relationship with the contractor (ie, the impact this may have on separate contractual arrangements or future procurements from the same supplier); and
• any reputational damage that exercising the right to terminate for convenience may have on the Government party (ie, whether it would be seen to be dealing fairly with the contractor by invoking its right to terminate for convenience, and what ‘flow-on’ effects this may have on its bargaining power in future contractual arrangements with that supplier or others).

It is important to note that, if the use of the right to terminate for convenience under Government contracts becomes commonplace, there is a risk that it will undermine industry’s willingness to contract with the Government - reducing competition and inhibiting the Government’s purchasing power in the market.

With a proper understanding of both the legal constraints on the use of a TfC clause, and the practical implications of exercising a right to terminate a contract for convenience, the Government party can better understand whether it is the most legally, financially and practically advantageous way forward in the circumstances.

Further Information

If you have any questions, or require specific advice on a particular termination for convenience clause that may be relevant for your organisation, please reach out to our team for support.

Authors:

Rory Alexander, Principal

Nick Faulks, Senior Associate

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