Reed Smith Client Alert

Authors: Elinor Crowther Peter Cassidy

Does there need to be a reason for termination?

In addition to a party’s right to bring a contract to an end at common law, most engineering and construction contracts contain provisions allowing the parties to terminate a contract should certain circumstances arise, for example, serious or repeated default or insolvency.

Such termination provisions will usually require notice to be given before the termination can take effect and will often allow the "defaulting" party an opportunity to correct the problem and, thereby, avoid the termination.

It is increasingly the case that engineering and construction contracts will also provide the owner and, sometimes, the contractor, with the ability to terminate the contract "for convenience" or "at will". More often than not, such a provision will permit termination without having to specify a reason.

Whilst such provisions might be envisaged to provide an owner with an escape route should funds run out or where drastic design changes are required, they may also allow it to terminate the contract and retender the works simply to get a cheaper or better deal, or to avoid the difficulties often associated with terminating for default.

What do these "for convenience"/"at will" provisions look like and how will the courts generally construe them?

In his April 2002 paper for the Society for Construction Law, Termination for Convenience, John Tackaberry QC provided this example of a termination for convenience clause:

"In addition to such other rights to terminate the Contract, or the employment of the Contractor under the Contract, whether under the Contract or at law, as the Owner may have, the Owner has the right, at any time whatsoever after the signing of the contract, to terminate this Contract or the said employment or any part thereof for convenience. The exercise of this right shall be at the Owner’s absolute discretion. Accordingly, the exercise of this right shall not be subject to challenge in any tribunal on the ground of insufficiency of reason for termination.

This right shall be exercised by notice in writing, expressly citing this clause and stating whether the whole or part of the Contract, or the whole or part of the Contractor’s employment, as the case may be, is being terminated; and if part, identifying that part with reasonable precision. The said notice is to be delivered by hand to the Contractor’s head office and a receipt obtained. The notice shall have immediate effect upon delivery as aforesaid.

Immediately after receipt of the notice, the Contractor shall secure the whole of the contract or the relevant part as the case may be so as to stabilise protect [and mothball] the work that has been done."

The contract will also typically set out the financial consequences of the termination.

Such clauses must be construed in the context of the contract as a whole and occasionally assistance may also be derived from the matrix of fact (that is, the background to the formation of the contract).

A question that has arisen on a number of occasions is whether the right to terminate for convenience is subject to an obligation of good faith.

Can an obligation of good faith be implied?

Whilst a duty to act in good faith has long been an established principle in most civil law jurisdictions, common law jurisdictions, in particular England and Wales, have generally been reluctant to imply such terms into contracts on the basis that the parties should be permitted to perform them in line with their freely negotiated expressed intentions.

Lately, however, common law jurisdictions such as Australia, Canada and Scotland have begun to recognise an implied duty of good faith in commercial contracts. We have seen the courts in England and Wales, particularly in the past few months, grappling with this area of law.

In the February 2013 case of Yam Seng Pte Ltd v International Trade Corp Ltd, in the High Court, Mr Justice Legatt held that an implied duty of good faith could be applied to English contract law in certain circumstances. The judge said that he doubted English law had reached the stage where it was ready to recognise a requirement of good faith as a duty implied by law, even as a default rule, into all commercial contracts, but he saw no difficulty in implying such a duty in any ordinary commercial contract based on the presumed intention of the parties.

One month later, in Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (Trading as Medirest), the Court of Appeal acknowledged that certain categories of contract contain an implied duty of good faith, but stated that generally if the parties wish to impose such a duty they must do so expressly. The court also emphasised that any clauses purporting to impose such a duty will be construed narrowly with regard to the remainder of the contract.

Is a party required to act in good faith when terminating for convenience?

In 2003, His Honour Judge Richard Seymour QC in Hadley Design Associates Limited v The Lord Mayor and Citizens of the City of Westminster held that a duty to act in good faith would not be implied in relation to a termination for convenience clause.

It was clear from the termination for convenience clause in that case that the contract could be terminated at any time, by either party, on one month’s notice. The clause did not require there to be any reason for the termination. The owner terminated the contract without giving reasons in accordance with this provision. Further, it was clear that the owner would be using another contractor to complete the work. Hadley Design argued, amongst other things, that it was an implied term of the contract that any termination must be carried out in good faith and that the client was in breach of this implied term.

His Honour Judge Richard Seymour QC, after considering the relevant authorities, said:

"In the result it is plain, in my judgment, that no such terms as those contended for in the present case fall to be implied into the 1987 Contract as a matter of law. No relevant principle of law has been established by reference to authority or statute. The implication of a term or terms which inhibit the operation of the clear term of the 1987 Contract providing for termination on one month’s notice would be contrary to principle.

Although conceptually different, the submission that the terms contended for should be implied in order to give business efficacy to the 1987 Contract fails for reasons similar to those which caused the submission that the terms should be implied as a matter of law to fail. There was no necessity for such implication."

Would an express obligation to act in good faith rule out a termination for convenience?

What happens if the contract contains both a termination for convenience and a good faith provision?

Although not a termination for convenience case, in Mid Essex Hospital Services NHS Trust, the Court of Appeal held that an express duty to cooperate in good faith was determined by reference to the two objectives expressed within the same clause. However, there was no general obligation of good faith applicable to the entire contract.

In the May 2013 case of TSG Building Services Ltd v South Anglia Housing Limited, the contract in question contained a termination at will clause. Mr Justice Akenhead held that a partnering clause did not impinge upon either party’s right to terminate at will. The partnering clause required that the parties:

"work together and individually in the spirit of trust, fairness and mutual co-operation for the benefit of the Term Programme, within the scope of their agreed roles, expertise and responsibilities as stated in the Partnering Documents, and all their respective obligations under the

Partnering Contract shall be construed within the scope of such roles, expertise and responsibilities, and in all matters governed by the Partnering Contract they shall act reasonably and without delay."

The judge held that this provision did not apply to the termination provision on the basis that termination at will is not a "responsibility", it does not give rise to a "role" and is not dependent upon any "expertise". He further found that the partnering clause did not require South

Anglia to act reasonably in terminating the contract under the termination at will provision, which did not require any reason to be given. No general duty of good faith was implied. The right to terminate was unqualified and unconditional, and it was obvious that either party could terminate at any time.

Concluding remarks

This is an area of law to watch. Whilst a duty of good faith is still unlikely to be implied generally, the courts now appear to be more open to imply such a duty in certain circumstances.

Absent an express duty of good faith in a contract, it is unlikely that the courts would imply a term that a termination for convenience would have to be exercised in good faith.

Where there is express reference to good faith or similar mutual trust type obligations, the courts will consider and construe such provisions narrowly and in the context of the provisions to which they are meant to apply.

The courts will be very reluctant to fetter a party’s clear right to terminate for convenience/at will unless the contract makes it very clear that it was intended that that right specifically should be exercised in good faith.

Finally, so as to avoid having the type of argument as in TSG Building Services Ltd, if the intention is that the right to terminate for convenience/at will is not to be subject to good faith or similar mutual trust type obligations elsewhere in the contract, then this should be stated expressly in the contract.

Client Alert 2013-202