On a proper construction issue 21: Convenient? Fair? – Termination for convenience clauses in construction contracts

A clause providing a right of termination for convenience (TFC) is a very useful tool, particularly when the viability and commerciality of the contract is dependent on matters outside of a party’s control. A TFC clause provides flexibility when there are unknown contingencies and, when properly drafted, is easily administered. However, it must be drafted carefully and used wisely.

Matters of note include the provision for adequate compensation in a TFC clause, whether or not the Australian Consumer Law (set out in Schedule 2 of the Competition and Consumer Act 2010) (ACL) applies, and what will occur in practice after the TFC clause is exercised.

Key takeaways

• TFC clauses usually consists of a clear and unambiguous right which allows one party to unilaterally terminate the contract without relying on the other party’s default. Ideally, it will also include an entitlement for the other party to be compensated via a pre-agreed payment mechanism.
• Clarity and precision are essential when drafting TFC clauses to ensure the clause is enforceable and that there is no restriction on the discretion to invoke the right to terminate for convenience.
• Recent amendments to the ACL throw a spotlight on “standard form” construction contracts involving a consumer or small business. A one-sided TFC clause in a standard form contract that is not required to protect the legitimate business interests of the proposing party could fall foul of the unfair contracts regime in the ACL, attracting serious penalties in addition to rendering the clause unenforceable.

What is termination for convenience?

TFC clauses are commonly included in construction contracts and allow one party (usually the principal) or both of the parties to terminate the contract for their convenience and without the need to give reasons. These clauses have been in the spotlight recently as they can (depending on how they are drafted) significantly shift the contractual risk allocation in favour of contract principals and deprive the contractor of the benefit of the contract (noting the costs pressures facing contractors in the present market)¹.

Key features of a TFC clause generally include:

1. a clear and unambiguous right permitting the beneficiary of the clause to unilaterally terminate the contract, which right is exercisable without the need to rely upon the other party’s default²; and
2. an entitlement for the other party to be compensated upon termination via a pre-agreed payment mechanism.

Drafting – Key Elements

Subject to the discussion later about the application of recent amendments to the ACL, there are no particular limitations on what the contracting parties can agree or propose in terms of a TFC clause. However, as with all terms, care must be taken to ensure that the TFC clause is expressed in clear language and is unambiguous.

Of course, the proponent of a TFC clause would want to ensure that there are no, or limited, restrictions on the discretion to invoke the right to terminate (e.g., obligations of good faith³) and that the clause provides a code for any compensation that is payable on termination (i.e., no damages other than those calculated in accordance with the regime are payable, including for loss of profit).

Arguably, if a principal failed to provide for any compensation to the contractor upon termination, there is a risk the whole contract is unenforceable – the argument being that the principal could at any point choose not to perform its obligations or pay the contractor for past performance, meaning the consideration (i.e., promise to perform / pay) is illusory and so there is no legally binding contract. To avoid this, the clause should expressly provide for the contractor to be compensated for work done up to the date of termination (including equipment and materials ordered that cannot be returned, provided that ownership will pass to the principal upon payment). Consideration should also be given to:

• other direct costs incurred in anticipation of future works (eg, labour costs); and
• payment of demobilisation costs that will be incurred post notice of termination.

Importantly the clause should address what practically must occur when the TFC clause is exercised, eg:

• transfer of design drawings and other documents and manuals;
• demobilisation plan;
• WH&S responsibilities;
• provision of warranties for the work done;
• timing of the termination payment claim; and
• return of security.

ACL – Small Business or Consumer Standard Form Contracts

Recently introduced amendments to the unfair contract terms (UCT) regime in the ACL (which both expand the scope of contracts falling under the UCT regime and introduce significant penalties) are likely to introduce a sharper focus on TFC clauses moving forward.

If the UCT regime applies to a construction contract, the Court has broad powers to declare the term unfair and therefore void or amended and may now also impose significant penalties⁴ for each instance an unfair contract term is included in a contract or relied upon or sought to be relied upon.

The UCT regime applies to “standard form” contracts where one party is a consumer or small business (ie, a business that has 100 or fewer employees or an annual turnover of $10M or less). A standard form contract is generally one given on a “take it or leave it” basis, to a party with less bargaining power without a real opportunity for the other party to negotiate the terms.

Under the UCT regime⁵, a term is unfair if it causes a significant imbalance in the parties’ rights and obligations, is not reasonably necessary to protect the legitimate interests of the party and would cause financial or other detriment if relied upon.

A unilateral right to terminate for convenience in a consumer or small business standard form contract would conceivably always be unfair⁶ (unless there is some legitimate business interest to protect). To counter the significant imbalance, consider:

• making sure the clause is transparently drafted and clearly and prominently marked as a TFC clause;
• making the TFC clause mutual (although this may not always be commercially practicable in a construction context);
• including a reasonable notice period before the right is exercised, giving the other party an opportunity to prepare and mitigate the effects;
• providing for payment of a termination fee upon termination (in addition to the usual compensation discussed above). That fee might include an element for the loss of profit or margin and might be adjusted depending on when the termination takes effect; and
• if there is a legitimate business interest to be protected, consider narrowing the termination right to circumstances linked to that particular interest eg, in a subcontract context, limit the termination right to termination of the head contract, or in other cases link the termination right to failure to obtain access or approvals or other anticipated contingencies outside of the parties’ control.

Exercising a TFC Clause – Preparatory Considerations

Where a party intends to rely on a TFC clause, seek legal advice before proceeding to exercise the TFC clause to ensure it is being exercised correctly. Depending on the circumstances, it may be helpful to discuss the proposed termination with the counter party in advance of issuing the notice to ensure an orderly exit from the contract.

If the work is still ongoing, a principal may wish to (confidentially) source an alternative contractor prior to terminating to ensure there is someone that is willing to pick up the work following termination.

The party seeking to exercise the clause should also be familiar with, and takes steps to action:

• procedures for handover of design documents and other essential materials;
• assigning the obligations and benefits to the new contractor;
• demobilisation;
• if relevant, requesting additional security to safely and securely take back the site; and
• if relevant, engaging a quantity surveyor to perform an assessment of the value of the works performed to date to avoid an argument that adequate compensation has not been provided.

Conclusion

Moving forward, TFC clauses are likely to face fresh challenges if included in a consumer or small business standard form contract, where consideration must be given to the UCT regime.

In any event, a TFC clause should always provide for adequate compensation to ensure the consideration under the contract is not considered illusory.

As always, if in doubt, reach out to your trusted legal advisor.

This article was written by Natasha Breach, Partner, Darcy Thompson, Senior Associate and Caitlin Grehan, Solicitor.

¹See, e.g., Department of Mines, Industry Regulation and Safety, Explanatory Statement – Draft Building and Construction Industry (Security of Payment) Regulations 2022 and associated matters (November 2021).

²Thiess Contractors v Placer (Granny Smith) Pty Ltd (2000) 16 BCL 255.

³Starlink International Group Pty Ltd v Coles Supermarkets Australia Pty Ltd [2011] NSWSC 1154, [33].

⁴The maximum penalty per contravention for an individual is up to $2.5 million, and for a company is up to the greater of $50 million, 3x the benefit obtained and 30% of the adjusted turnover for the period of the breach, whichever is greater: s224(3A) of the ACL.

⁵s23(2A) of the ACL.

⁶See, e.g., ACCC v Servcorp [2018] FCA 1044.