Good Faith in the Exercise of Rights Under Termination For Convenience Clause – A Serious Question To Be Tried –

LAWFUEL – The Legal Newswire – The use and prevalence of termination for convenience clauses in a wide range of commercial contracts is increasing. These have historically been used by Government organisations in their contracts but, progressively, termination for convenience clauses are more frequently included in contracts involving both private sector and Government parties. There are a number of reasons why termination for convenience or, as they are sometimes known, termination at will clauses, are included in contracts. In a Government context, these types of clauses may be used to cater for a change in Government policy. Specifically in a Government context, the Government’s inclusion of the termination for convenience clause stems from the administrative law principle of the doctrine of executive necessity. The doctrine operates to ensure that a Government is able to act freely where it is in the public interest, even though this may interfere with the contractual rights of other parties.

On a broader level, termination for convenience clauses are used to enable parties to reach agreement and conclude contractual negotiations. For example, where normally a party would not agree to the terms and conditions in a contract, the execution of this contract may be expedited if a termination for convenience clause is included. This allows for the contract to be signed and the parties to begin performance with the concerned party knowing that if a circumstance about which it is concerned does eventuate, it can terminate for convenience. Other situations where these types of clauses may be included are high risk contracts where expected benefits may not flow or if approvals are required or pending. These clauses can also be used to provide a simple resolution to situations where parties are simply not getting on, or where there is an allegation of bad performance which is difficult to resolve.

Where the relationship between the parties breaks down or one party is alleged not to be performing its obligations adequately, use of a termination for convenience clause is often challenged as an act not in good faith. The case of Gary Roger Motors (Australia) Pty Ltd v Subaru (Australia) Pty Ltd 1999 FCA903 considered the issue of good faith and termination clauses. In this case the letter of appointment and the terms and conditions provided that either party may terminate the agreement by giving the other party notice in writing. Subaru, following a period of discontent and issues with Gary Roger Motors, issued a notice of termination. In this case it was accepted by all parties that a term requiring good faith and fair dealing was an implied term of the agreement between them. The Court said that the obligation of good faith extended to any exercise of power under the contract which included the power to terminate at will.

This issue of the implied term of good faith and fair dealing in the exercise of the power under a termination for convenience clause has been recently considered in Australia by the Supreme Court of Victoria in the case of Kellogg Brown Root Pty Limited v Australian Aerospace Limited 2007 VSC 200.
This case concerned an interlocutory application whereby Kellogg Brown Root Pty Limited (KBR) sought an injunction restraining Australian Aerospace Limited (AA) from acting under, or in any way relying upon, a notice of termination for convenience.

AA were engaged by the Commonwealth for the supply of 46 helicopters. KBR was engaged as a subcontractor to AA to provide training services for that project. The agreement between the parties provided that any dispute between the parties would become the subject of a dispute resolution process. Certain disputes arose and KBR gave notice commencing the dispute resolution process. In response, AA issued a Notice to Terminate for Convenience.

KBR claimed that AA’s right to terminate for convenience was subject to an implied term of good faith and fair dealing and that the notice should not have been given. The agreement provided that in addition to any other right or remedy it had under the contract AA may terminate the contract or reduce the scope of the contract by notice to KBR. KBR was then entitled to limited compensation, consisting of payment for work performed and expenditure necessarily incurred up to the date of the notice, but was not entitled to any payment for the loss of the bargain constituted by the agreement.

AA argued that it was entitled to terminate based on the terms of the contract and that damages were a sufficient remedy based on the terms of the agreement.

The Court (Hansen J.) found that in the context of this defence related contract, whether the term of good faith was to be implied into this agreement, particularly into this termination for convenience clause, would depend on custom and practice in the defence procurement industry. In particular, the Court had regard to the Defence Materiel Organisation ‘Defence Procurement Policy Manual’ and other Commonwealth government documents suggested that termination of a contract for convenience should be undertaken in good faith and in accordance with principles of fair dealing. The Court found that there was a serious question to be tried, both as to the existence of the term of good faith and, more importantly, its breach and as a consequence granted an injunction preventing AA from relying on its notice of termination.

The Court commented that in giving the Notice of Termination before the dispute resolution process had been allowed to come to a conclusion AA had acted to pre-empt this process and avoid a result which may have been favourable to KBR.

This case is an interesting insight into the importance that the Courts now place on the implied term of good faith and fair dealing in the exercise of termination for convenience clauses. It demonstrates that the Court will consider, depending on the facts, that the exercise of the powers under these types of clauses in good faith raises a serious question to be tried.

The concept of good faith is continuing to be an emerging concept in Australian law and the question which has been evolving through the cases is the existence of such a clause and its impact and consequence on the wider contract. The requirement to act in good faith when exercising rights under a termination for convenience clause was previously considered In Thiess Contractors and Placer (Granny Smith) Pty Limited 2000 16 BCL 255. In this case the Court found that the express obligation to act in good faith embodied in the contract did not necessarily apply to termination for convenience clauses.

In this case the clause stated:

“Placer may, at its option, at any time and for any reason it may deem advisable, cancel and terminate the Contract, in which event the Contractor shall be entitled to receive compensation as follows..“

The Court stated that whilst the operation of the contract brought with it obligations of good faith, the termination for convenience clause was not concerned with the operation of the contract only with its termination. It was held that the contractual right to terminate did not require the parties to have any regard to the other party’s’ interests. This meant that the parties could explore other options and terminate the contract as long as they did so in a legitimate pursuit of a commercial interest. Therefore, the Court said that the obligation to act in good faith is not an obligation to prefer another’s interest over your own. In this case the Court found that the party terminating the contract for convenience acted honestly and reasonably in deciding to exercising its right to terminate.

In a Government contract context, particularly in relation to the Government being considered to be the model contractor, it is interesting to consider good faith and perhaps that a higher duty will be placed on Government, rather than private contractors. This also corresponds with certain administrative law principles which require Government to act in certain ways including the fact that contractors should be able to rely on a legitimate expectation to be dealt with fairly and reasonably.

In summary, there is little doubt that termination for convenience clauses are valid and will be upheld. It is likely that good faith is a requirement in exercising this power but the current cases on good faith suggest that this is not a very onerous control. The recent case of Kellogg Brown Root Pty Limited v Australian Aerospace Limited 2007 VSC 200 of allowing the claim for injunctive relief in Victoria is an indication that the Court will go to some effort to establish whether or not an implied term of good faith exists in relation to these termination for convenience clauses and further as to whether or not there is a serious issue to be tried in this regard.

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