On August 10, 2015, Division One of the Washington State Court of Appeals, addressed for the first time in Washington the efficacy of termination for convenience clauses in private construction projects. This is an important decision, not just for Washington, but for the rest of the country as well. Since termination for convenience clauses have their roots in government contracting, specifically where the federal government has the right to terminate a general contractor for convenience, there is very little in the way of case authority addressing termination for convenience in private construction contracts.
The decision in SAK & Associates, Inc. v. Ferguson Construction, Inc. involved a subcontractor, SAK, which agreed to provide concrete materials and paving services for the construction of hangars at an airport for the general contractor, Ferguson. The termination for convenience provision in the contract provided that
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.
SAK commenced work on April 18, 2012, and had completed 24% of the work when it was terminated for convenience by Ferguson on July 27, 2012. SAK sued Ferguson on May 10, 2013 seeking damages of $226,650.68, alleging that Ferguson breached the subcontract by unilaterally terminating “without cause.” Ferguson brought a motion for summary judgment, which was granted by the trial court, successfully arguing it properly exercised the termination for convenience provision in the subcontract, which was enforceable as a matter of law.
SAK appealed the summary judgment ruling arguing that because the termination for convenience clause allows Ferguson to terminate the contract at its discretion, it lacks consideration and is therefore illusory and unenforceable. It also contended that Ferguson’s notice was “false and pretextual”. The appellate court found no merit in either of the arguments and affirmed the trial court ruling.
In addressing SAK’s first argument, the court noted that in Washington, whether a promise is illusory generally turns on whether there is adequate consideration. Citing Washington case law, the court held that if the provisions of an agreement leave the promisor’s (here the promisor is Ferguson) performance is entirely within his discretion and control, the ‘promise’ is illusory and where there is an absence of consideration. The court then stated that consideration in construction contracts usually consists of reciprocal promises to perform the work and pay for the work, noting that standard form contracts such as the AIA and DBIA forms contain termination for convenience clauses which have payment schemes for a termination for convenience situation. Here, the court stated consideration existed because SAK had partially performed the contract and was paid for the work it performed, including profit and overhead on that work. The court also reasoned that agreements which permit one party to cancel an undertaking are not illusory if there is even a slight restriction. The court found the promise here was not illusory because the notice requirement was such a “restriction” on Ferguson’s power to terminate, citing cases from Florida.
The court likewise quickly dismissed SAK’s second argument by holding that the implied covenant of good faith and fair dealing has no place in the analysis of whether or not a termination for convenience was proper. The court stated that as a matter of law, there cannot be a breach of the duty of good faith when a party simply stand on its right to require performance of a contract according to its terms. Therefore, whether a subcontractor believes its termination was “wrongful” or as SAK put it, false and pretextual, is not relevant. A termination for convenience, is valid, according to the court, so long as a written notice is given and payment for the work performed is made proportionate to the total fixed price of the subcontract.
There are a couple of important takeaways from this case:
First, the court was careful to note that it was not faced with a situation where the termination for convenience was invoked before the commencement of work or only after a nominal amount of work was performed. Therefore, all we really know is that the operative question now for contractors, subcontractors and their attorneys is “Has there been at least 24% of the work performed?” We know from the SAK case that 24% or better is valid. We don’t know whether a court will find a T4C valid if performance is less than 24%. Perhaps these clauses now need to address consideration for situations when no work or nominal work has been undertaken when the termination occurs.
Second, although not specifically mentioned by Division 1, the Florida courts to which it cites found that consideration existed when ten days’ notice was provided for in the contract. Why that is a magic number is never discussed in depth, but it might be a good idea to make sure your T4C clause has such a notice provision.
Third, and this can be good or bad depending on where you are the terminator or the terminated, the reason for termination does not matter at all. This is not always the case in other states that have addressed the issue. It also is not the case in federal construction. However, the current state of the law in Washington is as long as there was written notice and proportionate payment is made, the termination is valid and can be for any reason whatsoever (and as long as there has been 24% of the work has been performed).
Given the gravamen of this case, I would not be surprised to see SAK appeal this decision to the Washington Supreme Court, so stay in contact with your construction lawyer for updates to this case.
Richard D. Campbell