Terminating Contracts for the Government’s Convenience: Answers to Frequently Asked Questions
Released: 2015-12-18T00:00:00

T ermination for convenience refers to the exercise of the government's right to bring to an end the performance of all or part of the work provided for under a contract prior to the expiration of the contract "when it is in the Government's interest" to do so. Federal agencies typically incorporate clauses in their procurement contracts which grant them the right to terminate for convenience. However, the right to terminate procurement and other contracts for convenience has also been "read into" contracts which do not expressly provide for it on the grounds that the government has an inherent right to terminate for convenience, or on other related grounds.

The right to terminate for convenience has historically been viewed as protecting the public interest by ensuring that the government does not have to pay for something that it may no longer need or want. However, the exercise of this right generally also entails some compensation for the contractor because there arguably would not be a binding contract if one party were unilaterally able to end the contract with no liability to the other. Failure to pay the contractor for the government's exercise of its right to terminate for convenience would also generally be viewed as unfair to agencies' contracting partners, and could diminish the willingness of vendors to deal with the government. This, in turn, could potentially result in the government having to pay higher prices for lower quality supplies and services, as the pool of potential vendors decreases.

Termination for convenience is a topic of perennial congressional and public interest since any government contract could potentially be so terminated. However, interest in termination for convenience has recently been heightened by the implementation of sequestration under the Budget Control Act (BCA) of 2011. Some contracts were reportedly terminated, or considered for termination, for convenience in FY2013 as a result of sequestration. In addition, because of agencies' diminished budget authority, questions have arisen as to how agencies might be able to reduce the amount that they must generally obligate or otherwise "reserve" to cover potential termination liability so that they can allot additional funds to performance of the contract, particularly early in the course of the contract's performance.

This report provides answers to 12 questions regarding termination for convenience frequently asked by congressional committees and staff. These questions and their answers address everything from the contractual and other bases for the government's right to terminate to post-termination settlements between the government and the contractor. They also address differences between termination for convenience and termination for default, cancellation, and certain other actions that the government may take (e.g., "de-scoping" pursuant to a Changes clause). The questions and answers are organized into three sections, one of which provides background information. The other two address (1) differences between the various types of terminations and other reductions that agencies could make in the work performed under a contract; and (2) potential government liability in the event of a termination for convenience.

The report does not address the termination of agency programs or budget elements. Such terminations could potentially result in the termination of contracts. However, they would not necessarily do so. Similarly, language prohibiting an agency from terminating a "program, project or activity" (PPA) would generally not be construed to bar the agency from terminating contracts for that PPA.

Background

The questions and answers in this section provide background information on termination for convenience, including (1) the legal basis for the government's right to terminate contracts for convenience; and (2) the circumstances in which the government may so terminate.

What Is the Basis for the Government's Right to Terminate for Convenience?

The government's right to terminate contracts for convenience generally arises from the terms of its contracts. The Federal Acquisition Regulation (FAR)—which governs many (although not all) acquisitions by executive branch agencies —requires agencies to incorporate in their procurement contracts standard clauses granting the government the right to terminate the contract for its convenience. The exact language of this clause varies depending upon the type and value of the contract, among other things. However, such clauses typically provide that

[t]he Government may terminate performance of work under [the] contract in whole or, from time to time, in part if the Contracting Officer determines that a termination is in the Government's interest.

These clauses typically also specify the form and content of the government's notice to the contractor when it exercises its right to terminate; the contractor's obligations upon receipt of this notice; disposal of the "termination inventory"; procedures for arriving at a termination settlement; items to be included in a termination settlement if the contractor and the agency fail to agree upon the amount to be paid; and the contractor's retention of records pertaining to the terminated portion of a contract.

However, even when the contract does not expressly provide for the government's right to terminate for convenience, the government is generally still able to exercise this right, although the rationale for construing the right to terminate for convenience as an implied term of government contracts has varied over time. The Supreme Court first articulated the theory that the government could terminate contracts for its convenience in upholding the Secretary of the Navy's determination to "suspend" certain contracts for equipment which was no longer needed because the Civil War had ended. The Navy proposed to pay the contractor a reduced amount as "compensation for partial performance." The contractor objected to both the suspension of its contract and the reduced payment, arguing that the government had breached the contract since the contract did not grant the government the right to take such action. However, the Court found that the government had not breached and, thus, was not liable for anticipatory profits or consequential damages because the right to terminate is a necessary adjunct of the government's authority to contract and an inherent right of the government. The Court based this conclusion, in part, on its view that

it would be of serious detriment to the public service if the power of the head[s] of [federal agencies] did not extend to providing for all … possible contingencies by modification or suspension of the contracts and settlement with the contractors.

Subsequent cases similarly emphasized the "public interest" when affirming the government's right to terminate for convenience contracts that do not expressly provide for this right, but upheld this right for differing reasons. For example, immediately after World War I, when a statute authorized the President to "cancel" contracts, the Supreme Court found that the government's right to terminate was, "by implication, one of the terms" of any government contract, since the statute was "binding," and the contractor "impliedly agree[d]" to the government's right to terminate by contracting with the government. Subsequently, when federal regulations called for termination clauses to be incorporated into federal procurement contracts, the U.S. Court of Claims (acting as the predecessor of today's Court of Appeals for the Federal Circuit) found that such clauses were "incorporated, as a matter of law ... [since] the Regulations can fairly be read as permitting that interpretation." Key to the court's decision was that it viewed termination for convenience as a "deeply ingrained strand of public procurement policy." The court also noted that the contractor is entitled to some recovery when the government terminates contracts for convenience, although "[t]he termination clause limits profit to work actually done, and prohibits the recovery of anticipated but unearned profits [on work not yet performed]."

When Can the Government Terminate a Contract for Convenience?

The standard Termination for Convenience clauses prescribed by the Federal Acquisition Regulation (FAR) all provide that a termination for convenience is based on the "Government's interest," as opposed to the contractor's actual or anticipated failure to perform. The FAR does not define what constitutes the "Government's interest." However, the term has been broadly construed to encompass many—although not all—interests that the government might assert. For example, federal courts and agency boards of contract appeals have recognized the government's interest in terminating a contract when

the government no longer needs the supplies or services covered by the contract; the contractor refuses to accept a modification of the contract; questions have arisen regarding the propriety of the award, or about continued performance of the contract; the contractor ceases to be eligible for the contract awarded; the business relationship between the agency and the contractor has deteriorated; the agency has decided to restructure its contractual arrangements or perform work in-house; the agency seeks to avoid a conflict with the Comptroller General, or a dispute with Congress; or the work contemplated by the contract is proving impossible or too costly.

Terminations in almost any other circumstances could also be found to be in the government's interest.

It is only in unusual circumstances—such as when the government entered the contract with no intention of fulfilling its promises, or purports to terminate the contract for convenience after the contract has expired —that a termination for convenience could be found to be improper. In such situations, the government could be liable for breach, as discussed below (" Could the Government Ever Face Liability for Breach by Terminating for Convenience? "). On the other hand, because the government has a duty to consider only its own best interests in terminating contracts for convenience, it generally would not be found to have behaved improperly if it declined to terminate a contract for convenience in order to assist the contractor.

Types of Terminations and Other Reductions

The questions and answers in this section discuss the differences between the various types of terminations, and between termination for convenience and other actions that the government could take. It covers total and partial terminations for convenience, constructive terminations, terminations for default, cancellation, and other reductions that agencies could make in the work performed under a contract, such as "de-scoping."

How Is a Total Termination Different From a Partial One?

A "total termination" encompasses all the work remaining to be performed under a contract, while a "partial termination" encompasses only some of the work remaining to be performed (e.g., deleting 50% of the work from a contract for cleaning, inspecting, and coating the roofs of family housing units). When the termination is total, the contractor could be entitled to a "termination settlement" covering the costs of work already performed, but not yet paid for; certain costs incurred in anticipation of performance; and the costs of settling the terminated work, among other things. (See " What Could a Termination Settlement Include? ") When the termination is partial, the contractor could be entitled to a similar settlement as to the terminated work, plus an "equitable adjustment" granting it more money and/or time to perform the work remaining to be performed on those portions of the contract that were not terminated. An equitable adjustment granting the contractor more money in the event of a partial termination may seem somewhat counter-intuitive, since terminations often reduce the overall price of the contract by deleting work. However, situations could potentially arise where the contractor's costs in performing the remaining portions of the contract are increased by the deletion of work, and the contractor could be entitled to an equitable adjustment to cover those increases.

A partial termination is not the only means by which the government could delete some—but not all—of the work remaining to be performed under a contract. So long as the reduction is within the scope of the contract, agencies could potentially also rely upon any Changes clause incorporated into the contract to delete work covered by that clause. (See below " What Is the Difference Between Termination for Convenience and De-Scoping and Other Reductions? ")

What Is a Constructive Termination?

The FAR and some of the standard Termination for Convenience clauses used in government contracts require the government to give the contractor written notice of its intent to terminate. This notice is to include, among other things, the effective date of the termination; the extent of the termination; and any steps that the contractor should take to minimize the impact of the termination on personnel, if the termination will result in a "significant reduction" in the contractor's workforce. The notice also directs the contractor to cease work; furnish notice of the termination to each immediate subcontractor and supplier affected by the termination; and take certain other actions as to the termination inventory and the settlement of subcontracts.

In practice, however, not all terminations for convenience result from such a written notice. In some cases, a court or board of contract appeals finds that the agency has constructively terminated a contract by its conduct even though no termination notice has been issued. The concept of "constructive termination" is a "judge-made doctrine that allows an actual breach by the government to be retroactively justified." Courts and boards of contract appeals may invoke this doctrine in order to avoid finding breach in "situations where the government stops or curtails a contractor's performance for reasons that are later found to be questionable or invalid." Constructive termination for convenience is perhaps most commonly found when an improper termination for default is "converted" into a constructive termination for convenience. (See " How Does a Termination for Default Differ from a Termination for Convenience? ") However, courts and boards of contract appeals have also found constructive termination for convenience in other circumstances, including when (1) the parties fail to agree upon the terms of a definitive contract after the work under a "letter contract" has been completed; (2) the contracting officer improperly repudiates the contract; (3) the government improperly uses a "change order" to delete work beyond the scope of the contract; and (4) the government fails to make any requisite progress payments.

How Does a Termination for Default Differ from a Termination for Convenience?

Unlike a termination for convenience, which is based on the government's interests, a "termination for default" is based on the contractor's anticipated or actual failure to perform substantially as required by the contract. The standard terms of federal procurement contracts grant the government the right to terminate contracts for default, as well as for convenience, by providing that the government may, subject to certain conditions,

terminate this contract in whole or in part if the Contractor fails to (i) [d]eliver the supplies or to perform the services within the time specified in this contract or any extension; (ii) [m]ake progress, so as to endanger performance of this contract ...; or (iii) [p]erform any of the other provisions of this contract ....

The standard terms further provide that "[i]f, after termination, it is determined that the Contractor was not in default, or that the default was excusable, the rights and obligations of the parties shall be the same as if the termination had been issued for the convenience of the Government." In other words, if the government exercises its right to terminate for default, and is later found to have exercised this right improperly, the default termination will be treated as a constructive termination for convenience, as previously discussed (see " What Is a Constructive Termination? "). Thus, the government would generally be liable to the contractor for only a termination settlement, not damages for breach.

When a contract is terminated for default, the contractor may be entitled to payment for any work it has already performed for which it has not been paid. However, it is generally not entitled to profit on costs incurred in anticipation of performance, and it could potentially be liable to the government for liquidated damages, any excess costs of re-procurement, or certain other costs.

How Does Cancellation Differ from Termination for Convenience?

Commentators sometimes use the terms "termination" and "cancellation" as if they were synonymous. The Federal Acquisition Regulation (FAR), however, distinguishes between termination and cancellation. The FAR defines "cancellation" as the bringing to an end of the "total requirements of all remaining program years," and contrasts cancellation with termination on the grounds that

termination can be effected at any time during the life of the contract (cancellation is effected between fiscal years) and can be for the total quantity or partial quantity (where as cancellation must be for all subsequent fiscal years' quantities).

In other words, for purposes of the FAR, cancellation affects only multiyear contracts, and occurs between fiscal years. Termination, in contrast, can affect multiyear contracts (at times other than between years) or other contracts (at any time). A "multiyear contract" is one that extends over more than one year without the government having to establish and exercise options for each program year after the first.

When a multiyear contract is canceled, the contractor is generally paid a "cancellation charge." This charge is like a termination settlement in that it covers

(1) costs (i) incurred by the Contractor and/or subcontractor, (ii) reasonably necessary for performance of the contract, and (iii) that would have been equitably amortized over the entire multiyear contract period but, because of the cancellation, are not so amortized, and (2) a reasonable profit or fee on the costs.

However, cancellation charges generally cannot exceed the "cancellation ceiling" specified in the contract. This ceiling represents the maximum amount that the contractor may recover (although the contractor will not necessarily recover this amount). The ceiling is lowered each year to exclude amounts allocable to items included in the prior year's program requirements.

What Is the Difference Between Termination for Convenience and De-Scoping and Other Reductions?

Termination for convenience is sometimes confused with "de-scoping" or other actions that the government could take pursuant to a contract that would reduce or limit the work that might have been originally contemplated by the parties to the contract. Partial terminations for convenience, in particular, can resemble "de-scoping" pursuant to any Changes clause incorporated in the contract. Many (although not all) federal procurement contracts include a Changes clause that permits the government "at any time ... [to] make changes within the general scope of th[e] contract" to certain terms of the contract, such as (1) the contract specifications; (2) the method or manner of performing the work; (3) any government-furnished property or services to be used in performing the contract; (4) the method of shipping or packing; (5) the place of delivery (for supplies); and (6) the time and place of performance (for services). When the proposed reductions are among those contemplated by any Changes clause and are "within the scope of the contract," the contracting officer generally may either "de-scope" the work pursuant to the Changes clause or partially terminate it for convenience.

Terminations should also be distinguished from determinations not to exercise options, or not to order more than the minimum quantity under an indefinite-quantity/indefinite-delivery (ID/IQ) contract. In both of the latter situations, the contractor ends up not obtaining work that the contractor may have been counting on, or that the parties may have contemplated being performed. However, in these situations, the contractor has no legal entitlement to the work that the government determines not to have performed, which is not the case with terminations. An option is a "a unilateral right in a contract by which, for a specified time, the Government may elect to purchase additional supplies or services called for by the contract, or may elect to extend the term of the contract." If the government decides not to exercise the option, the contractor is entitled to no recovery. Similarly, a contractor under an ID/IQ contract is entitled to only the minimum purchase guaranteed in the contract, and cannot recover if the government fails to make purchases in excess of the minimum. In contrast, when the government wholly or partially terminates a contract for convenience, the government is taking away work that the contractor is legally entitled to perform, and the contractor is potentially entitled to a termination settlement or other remedy.

Government Liability in the Event of Termination for Convenience

The questions and answers in this section focus upon the government's potential liability in the event of a termination for convenience. It begins by addressing how termination settlements are typically arrived at and what they may include before discussing the circumstances in which the government could potentially face liability for breach as a result of the exercise of its contractual and/or inherent right to terminate for convenience.

How Is a Termination Settlement Arrived At?

When the government exercises its right to terminate, it is typically obligated, pursuant to the terms of the contract, to pay the contractor for certain costs, discussed below (see " What Could a Termination Settlement Include? "). This payment is commonly referred to as a "termination settlement," and the contract generally also prescribes the procedures for arriving at the termination settlement. The standard termination clauses prescribed by the Federal Acquisition Regulation (FAR) generally require the contractor to submit a "final termination settlement proposal" to the contracting officer within one year from the effective date of the termination (or any longer period granted by the contracting officer). This proposal can form the basis for an agreement between the contractor and the contracting officer regarding all or part of the amount to be paid because of the termination. However, if the contractor fails to submit a proposal within the requisite time period, the contracting officer may determine the amount, if any, due to the contractor and pay it. Similarly, if the contractor and the contracting officer fail to agree on the "whole amount" to be paid, the contracting officer may determine the amount based upon certain factors specified in the contract (e.g., the price for any completed work that has not already been paid for, costs incurred in performing the terminated work). Such determinations constitute "final decisions" of the contracting officer, and may be appealed pursuant to the contract's Disputes clause, so long as the contractor submitted a final termination settlement proposal within the requisite time period.

Any settlement agreement reached by the parties modifies the contract, and is generally binding upon them.

What Could a Termination Settlement Include?

The standard Termination for Convenience clauses in federal procurement contracts also generally address the specific components of any settlement between the government and the contractor for claims arising from a total or partial termination. These components can vary depending upon the terms of the contract, but generally include (1) payment for work already performed, but not yet paid for; (2) costs incurred in anticipation of performance; (3) costs arising from the termination and settling the termination; and (4) some recovery for profit, in the case of fixed-price contracts, or recovery of award or incentive fees, in the case of cost-reimbursement contracts. A "fixed-price contract" is a contract whereby the contractor agrees to supply certain supplies or services to the government at a predetermined price, while a "cost-reimbursement contract" is one that provides for the government to pay the contractor allowable costs incurred in performing the contract up to a total cost specified in the contract.

Because of this focus upon costs, termination has frequently been described as effectively converting fixed-price contracts into cost-reimbursement contracts, and the cost principles and procedures from Part 31 of the FAR—which typically apply only to cost-reimbursement contracts—generally govern "all costs claimed, agreed to, or determined" under the standard Termination for Convenience clauses. The application of Part 31 is, however, subject to the general principle that the purpose of a termination settlement is to "fairly" compensate the contractor (i.e., the cost principles will not necessarily be strictly applied). Part 31 specifically contemplates the following costs as potentially allowable (i.e., included in settlements under the government contract to which it is allocable) when a contract is wholly or partially terminated:

common items : the costs of items "reasonably usable on the contractor's other work" if these items could not be retained at cost without the contractor sustaining a loss; costs continuing after termination : costs which cannot be discontinued immediately after the termination "[d]espite all reasonable efforts by the contractor"; initial costs : nonrecurring labor, material, and related overhead costs incurred in the early part of production as a result of factors such as training, lack of familiarity with the product, or excess spoilage due to inexperienced labor; and preparatory costs incurred in preparing to perform the terminated work, such as initial plant rearrangement and alterations and production planning; loss of useful value of special tooling, machinery, and equipment, provided that the items are not "reasonably capable of use" in the contractor's other work, and the government's interest is protected; rental under unexpired leases , minus the residual value of such leases, provided that the amount of rent claimed does not exceed the reasonable use value of the property, and the contractor makes "all reasonable efforts" to terminate or otherwise reduce the cost of the lease; alterations of leased property : alterations and reasonable restorations required by the lease, when the alterations were necessary for performing the contract; settlement expenses : accounting, legal, clerical, and similar costs reasonably necessary for preparing settlement claims and for termination and settlement of subcontracts; reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract; and indirect costs related to salary and wages incurred as settlement expenses in relation to the foregoing; and subcontractor claims , including the allocable portion of the claims common to the contract and the contractor's other work, as well as an "appropriate share" of the contractor's indirect expenses, provided that the amount allocated is "reasonably proportionate" to the relative benefits received and is otherwise consistent with Part 31 of the FAR.

Other costs could potentially also be allowable, depending upon the circumstances, because "[t]he purpose of a termination settlement is to compensate a contractor fairly, ... and to make [the contractor] whole for costs incurred in performing the terminated work."

How Much Can a Termination Settlement Cost?

The amount of any termination settlement can vary considerably, depending upon when in the course of the contract's performance the termination occurs and the costs that the contractor incurs as a result of the termination, among other factors. In some cases, contractors may be entitled to—or agree to—a "no cost" settlement. In other cases, the amount of the settlement can be in the billions of dollars . The settlement costs cannot, however, generally exceed the "contract price less payments otherwise made or to be made under the contract," and the Government Accountability Office (GAO) has found that potential termination costs are generally not, in themselves, so large as to justify continued performance of contracts which agencies might otherwise consider terminating.

Because the costs of any termination settlement could potentially be high, and agencies are generally required to obligate or otherwise "reserve" funds to cover potential termination liability, the possibility of termination for convenience can significant affect agencies' financial management practices and other operations, even though the likelihood of terminating any particular contract is low. (See " Why Must Agencies Generally Obligate or Reserve Funds for Termination Liability? ") However, in addition to potentially being "capped" by the contract price, the amount of any termination settlement could also be limited by the operation of certain contract clauses, such as the Special Termination Cost clause included in certain Department of Defense Contracts.

Could the Government Ever Face Liability for Breach by Terminating for Convenience?

As a general rule, the government does not face liability for breach of contract when it terminates a contract for convenience because the government's right to terminate for convenience is an express or implied term of the contract. (See " What Is the Basis for the Government's Right to Terminate for Convenience? ") However, in certain narrow circumstances, the government could potentially face liability for breach because the termination for convenience is found to have been motivated by bad faith or to constitute an abuse of discretion. The number of such cases is arguably limited by the difficulty of proving bad faith or an abuse of discretion on the government's part. Bad faith, in particular, "is an onerous charge that requires 'well-nigh irrefragable proof,'" and public officials are presumed to perform their duties correctly, fairly, in good faith, and in accordance with the laws and regulations.

In certain cases, though, courts and boards of contract appeals have found breach when the government exercises its right to terminate for convenience. Such cases generally involve situations where (1) the government entered the contract with the intent to terminate it, or (2) the government purported to terminate the contract for convenience after the contract expired in order to avoid liability under the contract. These findings impliedly or expressly reflect fundamental principles of the common law of contracts. For example, in finding breach when the government entered the contract with the intent to terminate it, courts and boards have described the government's undisclosed intent to terminate as making a "mockery" of its purported assent to the contract. Mutual agreement by the parties is fundamental to any contract. Similarly, in finding that "retroactive terminations" constitute breach, courts and boards have emphasized that the government "may not use the standard termination for convenience clause to dishonor, with impunity, its contractual obligations." In other words, the government's express or implied contractual right to terminate contracts for convenience expires with the contract, and cannot thereafter be asserted to avoid liability for the government's failure to perform as required during the term of the contract.

Why Must Agencies Generally Obligate or Reserve Funds for Termination Liability?

The Anti-Deficiency Act is a federal statute which generally prohibits the obligation of federal funds in excess of amounts actually appropriated under law. As a result, when a federal agency enters into a contract, the agency must generally have sufficient funds to cover the cost of the contract, plus any liability that may arise if the agency chooses to terminate the contract before it expires. In the case of a typical single-year fixed-price contract, the total recovery by the contractor generally may not exceed the contract price. Therefore, it is generally not necessary for an agency to set aside funds for termination liability for such contracts, as the government's liability would be within the amount required to pay for full performance under the contract.

However, where the contract gives the agency an option to renew, the contractor may have initial outlays that would not be recouped if the government chooses not to renew beyond the base period of the contract. In order to provide some security for the contractor in these situations, renewable (i.e., multiple year) contracts may contain provisions requiring the government to pay some form of "termination charge" in the event that a renewal option is not exercised. Notably, in contrast with a typical single-year contract, here the government may be liable for more than the cost of performance under the contract from its inception up until the refusal to renew. Therefore, the Anti-Deficiency Act generally requires that an agency have sufficient funds to cover any termination charges before entering into such a contract.

The required obligation of termination costs also arises in the context of multiyear contracts authorized under the Federal Acquisition Streamlining Act of 1994 (FASA), as amended, or other authority. Multiyear contracts are defined under FASA as contracts of up to five years in length. Multiyear contracts are an exception to the Anti-Deficiency Act, but FASA imposes its own requirement to set aside termination costs. Specifically, FASA provides that civilian agencies may only enter into multiyear contracts if they either obligate the full cost of the contract over the entire term, or obligate the cost of the first year of the contract plus the estimated costs associated with any termination of the contract.

Termination costs are often obligated from the same fund under which the underlying contract would be funded. Consequently, if an agency were not required to obligate potential termination liability when entering into a contract, the purchasing power of a particular appropriation would be increased. To this end, exceptions to the general requirement to set aside funds for termination liability have been enacted by Congress. For example, Congress has previously specified that a particular federal agency "shall not be required to obligate funds for potential termination liability in connection with" specific programs. Congress has also specifically appropriated or designated additional funds to cover potential termination liability. In other cases, Congress has placed ceilings on the amount of termination liability that an agency may negotiate with a contractor.