Termination for Convenience –
Can You Really?
QUESTION: When you have a termination for convenience clause in your contract, can you really terminate for any reason or no reason at all without liability?
ANSWER: No, not if termination breaches an implied covenant of good faith and fair dealing! One solution is to provide in the clause that if the contract is terminated for convenience, the seller shall deliver all services and deliverables completed or in progress up to the date of termination, and the buyer shall pay the seller on a prorated basis for those services and deliverables and for any non-cancelable expenses actually incurred in connection with them prior to the notice of termination. But that certainly is NOT termination without liability.
HERE’S WHY: If the contract had a real termination for convenience clause, one that really meant what it said – that a party had the right to terminate for any reason or no reason at all without liability to the other party for terminating – that would make the contract “illusory”. The reason is that the party that has the right to terminate has not really promised anything. In “law-speak”, that party has given no consideration. A contract that is not supported by consideration is not valid.
So what do some courts do to avoid finding that a contract is illusory? They imply a covenant of good faith and fair dealing into the contract, or at least into the termination clause. The party that would like to terminate for convenience may only do so if it would not breach this implied covenant. Otherwise, the party will be liable for breach!
PRACTICAL LIMITS: In practical terms, what sorts of limits or conditions does this implied covenant put on terminating for convenience? Here are a few that have been suggested (they may not hold true in your state):
- The terminating party may not terminate simply to get a better deal from another party.
- The terminating party may terminate if the contract has become economically unfeasible for that party to perform, but not if it has just become more expensive to perform.
- If the terminating party is apprehensive about the other party’s ability to perform, the terminating party must at least tell the other party about that apprehension before terminating.
- The terminating party may not terminate simply to prevent the other party from obtaining a commission or some other important contract benefit which the other party is just about to get and has already expended significant time and effort to get.
HOW TO AVOID: Is it possible to draft a real termination for convenience clause without having a covenant of good faith and fair dealing implied into it and without having an illusory contract? Probably not in states where the covenant of good faith and fair dealing is implied by courts into virtually every clause of every contract. But where it is only implied into specific clauses to save the contract from being illusory, here are three alternatives:
- Provide that the right to terminate may only be exercised upon 30 days’ written notice. This idea is to create a contract for at least 30 days, in an effort to avoid the illusory contract challenge. Maryland seems to accept this approach. Other states may not.
- Provide in the clause that the terminating party shall pay all costs that the other party has reasonably incurred in performing the contract prior to receipt of the notice to terminate. This is fair and reasonable, but may cost some “real money” and it a bit open-ended.
- Provide in the clause that if the contract is terminated for convenience, the seller shall deliver all services and deliverables completed or in progress up to the date of termination, and the buyer shall pay the seller on a prorated basis for those services and deliverables and for any non-cancelable expenses actually incurred in connection with them prior to the notice of termination.
CASES: Here are some cases that relate to this Q&A:
- Questar Builders, Inc. v. CB Flooring, LLC, 410 Md. 241, 978 A.2d 651 (2009). This is the main source for this Q&A. The court implied a covenant of good faith and fair dealing in order to avoid finding a contract illusory because it had a termination for convenience clause. This case has some interesting historical background on such clauses.
- Piantes v. Pepperidge Farm, Inc.,875 F.Supp. 929 (D. Mass. 1995). The court held that if a franchise agreement has a termination for convenience clause that requires the franchisor to pay the franchisee 125% of the fair market value of the franchise, it is virtually impossible for the franchisor to breach the implied covenant of good faith and fair dealing by terminating. This opinion also contains general statements (a) that Massachusetts law implies in every contract a covenant of good faith and fair dealing and (b) that the absence of good cause is not the same as the absence of good faith.
- Hobin v. Coldwell Banker Residential Affiliates, Inc.,144 NH 626, 744 A.2d 1134 (NH 2000). The court held that it may not imply a covenant of good faith and fair dealing where, regardless of the discretionary power reserved to one party, the contract is supported by adequate consideration. Here no such covenant was implied where a franchisor appointed a second franchisee in the first franchisee’s territory and where the contract with the first franchisee provided many types of benefits for the franchisee (e.g., trademark license, national ads and promotions, ongoing advice and assistance, and on-site visits).
- Haines v. Great Northern Paper, Inc., 2002 ME 157, 808 A.2d 1246 (ME 2002) (land covenant). Maine has “declined to impose a duty of good faith and fair dealing except in circumstances governed by specific provisions of the Uniform Commercial Code.” Followed in Camden National Bank v. Crest Construction, Inc., et al, 2008 ME 113, 952 A.2d 213 (ME 2008) (real estate mortgage). As to UCC, see below.
- Shanon v. Mathers, 271 OR 148, 531 P.2d 705 (OR 1975). The earnest money agreement for the sale of a house was made subject to buyers’ “acceptance of the preliminary title report”. The buyers backed out based on this condition. The court held that this condition “is not to be understood as giving the purchasers unlimited discretion to relieve themselves of all obligation under the contract for whatever reason they chose or for no reason at all, thus rendering the contract illusory.” Instead the court held that in light of “common expectations of those engaged in real estate sales”, the buyers were entitled to rely on the condition “only if they rejected the preliminary title report for material defects in title which the defendants could not correct within a reasonable time.”
UCC: Section 1-203 of the Uniform Commercial Code (“UCC”) provides, “Every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.” MGL 106:1-203; MRS 11:1-1304; NHRS 382-A:1-304; ORS 71.3040. Section 1-201(19) of the UCC provides, “‘Good faith’ means honesty in fact in the conduct or transaction concerned.” MGL 106:1-201(19). This may be a pretty low standard. However, Section 2-103(1)(b) provides a higher standard for merchants selling goods: “‘Good faith’” in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade.” MGL 106:2-103(1)(b). In Maine, New Hampshire, and Oregon, this higher standard applies more generally to transactions covered by the UCC, not just to merchants selling goods. MRS 11:1-1201(20); NHRS 382-A:1-201(20); ORS 71.2010(2)(t). Section 1-102(3) of the UCC provides, “The effect of provisions of this Act may be varied by agreement, except as otherwise provided in this Act and except that the obligations of good faith, diligence, reasonableness and care prescribed by this Act may not be disclaimed by agreement but the parties may by agreement determine the standards by which the performance of such obligations is to be measured if such standards are not manifestly unreasonable.” MGL 106:1-102(3); MRS 11: 1-1302; NHRS 382-A:1-302(a) and (b); ORS 71.302(a) and (b). MGL refers to Mass. General Laws; MRS refers to Maine Revised Statutes; ORS refers to Oregon Revised Statutes; and NHRS refers to NH Revised Statutes.
DISCLAIMER (of course): This is NOT legal advice. Moreover, the contract law of each state varies. Seek competent legal advice for your contract matter.