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Terminating for convenience:
Without an explicit clause, the supplier has the upper hand
Denis Chamberland
A provision that allows purchasers to terminate a contract on short notice for any or no reason is commonly called a ‘termination for convenience’ clause. Such a clause is most often found in long-term contracts where the date of termination is fixed.
A classic example of such contracts is an outsourcing contract, where a business function or activity that would normally have been performed in-house is transferred to a third-party service provider. The reasons for outsourcing a business activity are many, and include costs savings and achieving a higher-quality service, among others.
Outsourcing contracts aren’t like any other services contracts. They can include unique provisions that are not required in typical, short-term services contracts. For example, in an outsourcing contract, people and equipment may be transferred to the service provider at the outset. At termination, the purchaser may want to have a contractual right to repatriate some or all of those same people and/or equipment. The rights reserved in the contract depend on the terms negotiated between the parties.
Changing business strategy
In a recent solid waste and recycling outsourcing contract, the purchaser—a municipality—wanted to terminate the contract well before the expiry of the contract’s fixed date, for reasons unrelated to the performance of the service provider.
In other words, the municipality wanted to terminate the contract for convenience. From the time the outsourcing contract was executed, the municipality had made a strategic business decision about the value of that particular outsourcing contract. It wanted to repatriate the function and perform it in-house, with its own forces.
The problem the municipality was facing is its solid waste and recycling contract didn’t include a termination for convenience provision in favour of the municipality. It’s worth noting such a provision should never be available to a service provider. The reason is simple: The raison d’ętre of a service provider is to supply the services contracted for. The purchaser, on the other hand, needs to operate its business in a predictable environment, and therefore needs to know that any third-party service will remain available for the duration of the contract.
What was the municipality’s legal position, then, without a contractual right to terminate its services contract for convenience?
The merits of a convenience clause
At law, a party whose contract has been terminated for convenience is theoretically entitled to its lost profits, which means the profits the party would have made had the contract expired at the end of the fixed term. The municipality had therefore put itself into a corner. By not including in its solid waste and recycling contract a provision allowing it to terminate the contract for convenience, the municipality de facto gave the service provider the upper hand in its negotiations to terminate the contract.
The negotiations are now focused on how much the municipality will pay the service provider to acquire the right to terminate the contract. Since the municipality will not accept the quantum of damages that flows from the established legal principles, the discussions are bogged down on defining what is “reasonable” in the circumstances. The service provider is not prepared to accept that “reasonable” means much less than what it is legally entitled to, and is trying to extract promises of future work. Any such promise would put the municipality in breach of its own competitive procurement policies.
It’s a good practice for purchasers, whether in the private or public sector, to address upfront and in detail the issue of termination for convenience, first in their bid call documents and next in their outsourcing contracts.
It’s especially important to deal with the matter explicitly and thoroughly in the contract, where the service provider commits to making a significant capital investment upfront and doesn’t expect to recoup its investment nor make a profit until the back end of the contract.
In the absence of such a provision, any attempt by the purchaser to terminate for convenience, especially at the front end of the contract, will inevitably lead to protracted negotiations between the parties. It’s worth remembering that at the exit, the incentives that kept the parties glued to each other during the term of the contract are no longer at play.
Denis Chamberland is a partner with the law firm Aird & Berlis LLP. He is a procurement specialist, focused on public-private partnerships, IT and outsourcing projects. He can be reached at (416) 865-3078 or at dchamberland@airdberlis.com
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