In an earlier blog (#62) I discussed the implied covenant of good faith and fair dealing that limits a contracting party’s exercise of the discretion afforded to it by the parties’ contract. A recent New Hampshire Superior Court case applied the covenant to restrict a contractor’s right to terminate a subcontractor “for convenience” – the ultimate exercise of discretion – simply in order to try to obtain a better price.
Operating very much like “at will” employment contracts which permit the employer to fire an employee at any time as long as some specific public policy is not offended, "termination for convenience” provisions purport to allow one party to end a contract at whim, regardless of whether the terminated party has given any cause for the termination. Such a provision was part of a commercial painting subcontract in Hate to Paint, LLC v. Ambrose Development, LLC, No. 218-2020-CV-0585 (Rockingham County, February 26, 2021). The painting sub signed a contract to paint a multi-apartment housing project being constructed in Somersworth for a price of $500,000. This clause was in the parties’ agreement:
TERMINATION FOR CONVENIENCE: The General Contractor may terminate the Contract for convenience upon three (3) days prior written notice. In the event of such termination, the Contractor shall be entitled to receive payment for labor and materials furnished through the date of termination. Contractor shall not be entitled to receive payment for any lost profits.
After the subcontract was signed but before the work started, the general contractor realized that a nearly identical project had been painted by the same sub at a lower per-unit price, and decided to invoke the termination clause, simultaneously inviting the sub to submit a new, lower bid. Desperate for the work it had lined up and could not replace, the sub did bid against itself, but ultimately a lower-priced painter was hired anyway. The jilted sub sued for breach of contract and breach of the Consumer Protection Act.
The Court began by citing prior Supreme Court precedent holding that the implied covenant of good faith and fair dealing could override an express allocation of discretion “when necessary to protect an agreement which otherwise would be rendered illusory and unenforceable.” Because the defendant would not be obliged to perform at all if it terminated the deal prior to the onset of work, this destroyed the mutuality of obligation at the heart of any contract, rendering the contract illusory – and making the implied covenant of good faith applicable to the exercise of discretion found in the termination clause.
Next, the Court had to determine “whether terminating the contract to obtain a better price was a permissible use of Defendants’ discretion.” Distinguishing the case before it from other cases where the terminating party had simply made a bidding error, the Court concluded that “Defendants breached the contract by invoking the termination for convenience clause in order to obtain a better bargain.” Summary judgment was entered for the painting subcontractor on liability, leaving for another day the issue of damages.
Many termination for convenience clauses require the payment of reasonable overhead and profit on unperformed work to a party terminated for convenience. (The AIA’s popular A201 General Conditions form had such a provision in its 2007 version; it was eliminated in the 2017 version in favor of a pre-negotiated termination fee.) This acts as a powerful disincentive for upstream parties to continue to shop a contractor’s price around after the contract has been signed. In Hate to Paint, lost profits after termination for convenience were specifically excluded.
One question unanswered by Hate to Paint is whether a contract may be terminated for convenience to obtain a better price after performance has begun and the terminating party has incurred some obligation to pay for work performed. My guess is that post-commencement termination for convenience clauses will be enforced despite the covenant of good faith and fair dealing. When only one of the contracting parties is bound to the contract, it is illusory. After performance starts, arguably that is no longer the case.
Operating very much like “at will” employment contracts which permit the employer to fire an employee at any time as long as some specific public policy is not offended, "termination for convenience” provisions purport to allow one party to end a contract at whim, regardless of whether the terminated party has given any cause for the termination. Such a provision was part of a commercial painting subcontract in Hate to Paint, LLC v. Ambrose Development, LLC, No. 218-2020-CV-0585 (Rockingham County, February 26, 2021). The painting sub signed a contract to paint a multi-apartment housing project being constructed in Somersworth for a price of $500,000. This clause was in the parties’ agreement:
TERMINATION FOR CONVENIENCE: The General Contractor may terminate the Contract for convenience upon three (3) days prior written notice. In the event of such termination, the Contractor shall be entitled to receive payment for labor and materials furnished through the date of termination. Contractor shall not be entitled to receive payment for any lost profits.
After the subcontract was signed but before the work started, the general contractor realized that a nearly identical project had been painted by the same sub at a lower per-unit price, and decided to invoke the termination clause, simultaneously inviting the sub to submit a new, lower bid. Desperate for the work it had lined up and could not replace, the sub did bid against itself, but ultimately a lower-priced painter was hired anyway. The jilted sub sued for breach of contract and breach of the Consumer Protection Act.
The Court began by citing prior Supreme Court precedent holding that the implied covenant of good faith and fair dealing could override an express allocation of discretion “when necessary to protect an agreement which otherwise would be rendered illusory and unenforceable.” Because the defendant would not be obliged to perform at all if it terminated the deal prior to the onset of work, this destroyed the mutuality of obligation at the heart of any contract, rendering the contract illusory – and making the implied covenant of good faith applicable to the exercise of discretion found in the termination clause.
Next, the Court had to determine “whether terminating the contract to obtain a better price was a permissible use of Defendants’ discretion.” Distinguishing the case before it from other cases where the terminating party had simply made a bidding error, the Court concluded that “Defendants breached the contract by invoking the termination for convenience clause in order to obtain a better bargain.” Summary judgment was entered for the painting subcontractor on liability, leaving for another day the issue of damages.
Many termination for convenience clauses require the payment of reasonable overhead and profit on unperformed work to a party terminated for convenience. (The AIA’s popular A201 General Conditions form had such a provision in its 2007 version; it was eliminated in the 2017 version in favor of a pre-negotiated termination fee.) This acts as a powerful disincentive for upstream parties to continue to shop a contractor’s price around after the contract has been signed. In Hate to Paint, lost profits after termination for convenience were specifically excluded.
One question unanswered by Hate to Paint is whether a contract may be terminated for convenience to obtain a better price after performance has begun and the terminating party has incurred some obligation to pay for work performed. My guess is that post-commencement termination for convenience clauses will be enforced despite the covenant of good faith and fair dealing. When only one of the contracting parties is bound to the contract, it is illusory. After performance starts, arguably that is no longer the case.
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