Summary: The MBTA entered into a contract with Prime Energy for the supply of diesel fuel. After the contract was under way, MBTA learned that another Massachusetts state agency had entered into a statewide diesel fuel supply contract with a different supplier, at a substantially lower unit price. MBTA was eligible to obtain fuel under the statewide contract, and as a result it terminated the contract with Prime Energy for MBTA’s convenience.
Prime Energy contested the termination, contending that MBTA had breached the supply contract, and had violated the contract’s implied covenant of good faith and fair dealing. Prime argued that federal caselaw that places limits on terminations for convenience should apply.
The termination for convenience clause in question allowed the MBTA “in its sole discretion” to terminate “for its convenience and/or for any reason.” The clause indicated that the contractor’s costs (damages) if terminated for convenience would be calculated in accordance with government contracting principles set out in the Federal Acquisition Regulations.
MBTA moved for dismissal. The trial court denied the motion, ruling that under principles of federal law, the owner may have acted improperly if the termination was based solely on obtaining a better price from another contractor. The issue was then appealed.
Decision: The Supreme Judicial Court held that the termination for convenience clause should be interpreted under general Massachusetts contract principles, not under federal termination caselaw. Because the clause was unambiguous in granting MBTA sole discretion to terminate for any reason, the court concluded that the clause should be enforced on its terms, and therefore MBTA’s motion to dismiss should be granted.
The court noted that the federal caselaw was based on a regulation that allowed a termination “in the Government’s interest”—a different and arguably more limited standard than the one in the MBTA contract. The court also stated that based on its review of the relatively sparse non-federal caselaw on terminations for convenience, there was no consensus among the states as to whether or how to apply the federal standard.
The court was not persuaded that the reference in the MBTA clause to using federal principles to calculate costs necessitated using federal law for determining all issues. On balance, the court concluded that established Massachusetts contract law was adequate to resolve the interpretation of the clause, and there was no need to supplant state law with federal law.
In reviewing the clause under Massachusetts law, the court did acknowledge that despite the broad authority granted to the owner, a termination must be made in good faith. The court concluded that because the owner’s right to terminate was so clear, Prime Energy should have expected from the outset that MBTA would terminate the contract if a reason to do so arose. The court did opine that it was significant that MBTA did not enter into the contract intending to terminate it—doing so might have constituted bad faith. Terminating the contract to pursue a better price was expressly categorized as not a violation of the good faith duty.
Comment: EJCDC’s termination for convenience clause states that owner may “without cause” terminate the contract. This is an essential right that protects the Owner when circumstances change—funding is lost, or the facility is no longer needed. Although associated with public construction (the MBTA case notes that termination for convenience clauses were first used in federal contracts during the Civil War, in case the war came to an end, eliminating the purpose of the contract), the right to terminate for convenience is also important in the private sector, where market and technology changes can suddenly impact the need for the project.
Most courts will imply a duty of good faith and fair dealing in a construction contract. Whether that duty imposes only a slight limitation on a termination for convenience clause (as was the case under Massachusetts law), or a somewhat greater burden (as under federal law) will vary. Whether the opportunity to obtain a better price is a tolerable reason for a termination for convenience is a policy decision that, as contract drafters, we can defer to the courts and state law; or in the alternative we could make a policy choice and revise the clause to expressly address that specific issue, in one direction or the other. However, because of the complexities of pricing a construction project (as opposed to a commodities acquisition), and because of the time needed to terminate and enter into a new contract, and get a second contractor mobilized, terminating a construction contract to seek out a better price would probably be fairly rare even if expressly authorized.