Maryland's Highest Court Finds Implied Duty of Good Faith and Fair Dealing in Termination for Convenience Clauses

Last August, the Maryland Court of Appeals addressed whether a termination for convenience clause in a private construction contract must be exercised in good faith (March 16, 2010).

Last August, Maryland’s highest court, the Court of Appeals, addressed whether a termination for convenience clause in a private construction contract must be exercised in good faith. In Questar Builders, Inc. v. CB Flooring, Inc., 410 Md. 241, 978 A.2d 651 (2009), a general contractor retained a flooring subcontractor to install carpeting throughout an apartment and townhome community in Owings Mills, Maryland. The subcontract permitted the general contractor to terminate the subcontractor for cause and provided that any wrongful termination would be converted into a termination for convenience. The project’s interior designer later altered the type of the carpet to be installed throughout the project and the subcontractor submitted a proposed change order. Allegedly, rather than compensate the subcontractor or negotiate the amount of the proposed change order, the general contractor instead contacted another flooring subcontractor that had also bid the project and requested a revised bid based upon the new carpeting. When the new flooring subcontractor submitted a bid lower than the plaintiff subcontractor, the general contractor terminated the subcontractor for cause, alleging that the subcontractor had acted in bad faith by seeking an increase to the contract sum from the interior designer’s changes. The subcontractor then filed suit to recover its expected profit.

At trial, the court found that the subcontractor had not breached the subcontract and awarded it $243,000 in expectation damages. After the general contractor filed its appeal to the Maryland Court of Special Appeals, the Maryland Court of Appeals issued a writ of certiorari on its own initiative. On appeal, the Court of Appeals considered the question of whether a termination for convenience clause was subject to an implied obligation to exercise the right to terminate in good faith and in accordance with fair dealing.

The court began its analysis with an extensive review of the history of termination for convenience clauses. The concept of termination for convenience began during the American Civil War as a tool to aid the government in avoiding costly procurements which were rendered unnecessary by changing technology, cessation of conflict or mobile forces. The federal government continued to incorporate these clauses into procurement contracts throughout World War I and World War II, and began incorporation into peace-time military contracts in the 1960s. In 1967, the Federal Procurement Regulation made termination for convenience clauses mandatory in most fixed-price supply and construction contracts with the federal government.

The court then analyzed the conflict that arose between the government’s need to avoid economic waste by terminating unnecessary contracts and the common law requirement that contracts contain binding promises to avoid being illusory and unenforceable. The court first discussed the “changed circumstances” test articulated by the U.S. Court of Claims, in which the government must experience a change in circumstances in order to terminate for convenience. The court also discussed the “bad faith/abuse of discretion” test articulated prior to the “changed circumstances” test by the U.S. Court of Claims, in which plaintiff must prove malice or conspiracy in to avoid the effect of a termination for convenience.

Following this discussion, the court turned its attention to the role of termination for convenience clauses in construction contracts and specifically rejected the premise that private contractors enjoyed the government’s almost unlimited authority to terminate contracts for convenience. Under Maryland law, illusory contracts are unenforceable and contracts are generally construed to be effective. Granting an owner or general contractor the unfettered right to terminate a construction contract would make such contracts illusory and, therefore, invalid. In addition, the court noted that, where a contract gives one party discretion to take a certain action, Maryland law implies a contractual obligation to exercise that discretion in good faith. On this basis, the court rejected the general contractor’s arguments that it was entitled to terminate the subcontract for any reason whatsoever. The right to terminate in the absence of another party’s breach did not equate to the right to terminate on a whim. Although recognizing that the power to terminate for convenience provides an effective tool to reduce risk from fluctuating markets, a terminating party cannot prevent the terminated party from receiving the fruits of the contract between them by invoking the provision in order to obtain a better deal.

Because the trial court had not determined whether the contractor had acted in good faith in terminating the subcontract, the Court of Appeals remanded the matter to the trial court to make this factual determination. The Court of Appeals provided guidance to the trial court, stating that if the trial court determined that the general contractor terminated the contract in order to broker a better deal, failed to make efforts to ensure that its continued contractual relationship with the subcontractor remained convenient, or terminated in order to avoid its contractual obligations, the trial court should find that the general contractor acted in bad faith and therefore could not invoke the termination for convenience provision. Upon examination of court records, the trial court has since entered judgment in a reduced amount, and the case has again been noticed for appeal.

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