John B. Wyatt III, JD, PDCM, CPP, CPPM Full Professor, Coordinator of CM Programs California State Polytechnic Univers

2. Terminations for Convenience An Unrestrained Power? John B. Wyatt III, JD, PDCM, CPP, CPPM Full Professor, Coordinator of CM Programs California State Polytechnic University, Pomona, CA 91768-4083 Date August 5, 2008 Time 1:50 – 2:50pm

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7. Note “This presentation is provided with the understanding that the presenter is not providing legal, accounting or other specific advice or professional service. If legal advice or other expert assistance is needed, the services of a relevant professional should be sought.” Adapted from the “Declaration of Principles of the American Bar Association and the Committee of Publishers and Associations”

8. Basic Tenets • Gov’t is the Sovereign - lots of contracting power coupled with major responsibilities • King’s Rule • T4C and Unilateral Directed Change Clauses • G.L. Christian Doctrine – Incorporation by Operation of Law/Required Clause • T4C Foundational Historical/ Foundational Case Law is Federal

9. Balancing of Contractual Risks • Fiduciary of Public Funds • Public Policy/Statutory/Regulatory Mandates • Gov’t Must Maintain the Integrity and Public Confidence in Procurement Process Assuring Competition to the Maximum Extent Practicable

10. Rationale for Gov’t Need of the Termination for Convenience Power Inherent Sovereignty/Fiduciary of Public Funds General Consensus of Case Law instructs that the Gov’t needs the T4C power to “terminate contracts made obsolete by technological or other developments” or “rapid changes of war or at war’s end” – in a nutshell – “some kind of change” from the date of contract execution

11. History of T4C Power Historical Basis in Federal Law – Famous Navy Battle – Chesapeake Bay (Hampton Roads VA) Monitor vs. Merrimac (CSS Virginia) Wooden frigates Congress and Cumberland were lost. Ironclad warship technology revolution prevailed.

12. Monitor vs. Merrimack

13. T4C General Truths • Ultimate Oxymoron/”Legal” Breach of Contract • Formula for Contractor Payment • Common Theme is Contractor does NOT Receive unearned anticipatory profit – normal breach of contract damages • Gets paid for the following if AAR: • Work accepted (contract price) (Curve?) • Costs incurred including reasonable profit if would have made profit on completed contract • Winding down and settlement expenses (including legal and accounting in preparing T4C settlement proposal) • Gov’t Procurement Agencies are Presumed to Act in Good Faith - contrary B/P is “clear and convincing”

14. More General Truths • Gov’t Can T4C in Whole or in Part • Must be in Gov’t’s Interest (Best) • Must Give T4C Notice Although Case Law Recognizes Power of Constructive T4C • Breach of Contract Damages (Unearned Anticipatory Profit) if T4C Wrongful • See FAR 52.249-2 (Fixed Price Supply) and KY T4C Clause - 200 KAR 5:312 § 2

15. The Struggle to Achieve an Equitable Contractual Balance • Federal and State courts as well as Administrative Tribunals STRUGGLE with T4C’s so as to achieve balance in: • Protecting the Gov’t’s legitimate needs as a sovereign/fiduciary • Assuring that contractor’s contractual rights are protected and not subject to indiscriminate acts or abuse so as to invoke a fair yet meaningful limitation

16. Six Potential Challenges to a T4C • Bad Faith • Breach of Implied Covenants of Good Faith and Fair Dealing (more objective) • Krygoski standard – No Intent to Honor Contractual Commitments – ie T4C does not justify post award price shopping solely to obtain a better deal. • Abuse of Discretion/Illegality • Illusory Promise – Legal Scholars View • Changed Circumstances – Torncello Rule and “State Champion Cases”

17. Bad Faith/Breach of Implied Covenants • Almost impossible to prove bad faith due to overwhelming presumption that gov’t acts in good faith • Must prove subjective bad faith by clear and convincing evidence (case law interpretation of “well nigh irrefragable proof” • T4C clause does not define bad faith • Fair dealing covenant adds some objectivity

18. Abuse of Discretion/Illegality • Krygoski cites four factors to determine abuse of discretion: • Bad faith; • Reasonableness of decision; • Amount of discretion delegated to the terminating official; and • Arbitrary violation of relevant regulation or statute • Illegality renders contract void or reformed by operation of law

19. Illusory Promise • Noted law professors/scholars (Williston, Corbin and Nash) and many judges have deemed that the indiscriminate exercise of the T4C power without restrictions amounts to an illusory promise • Does not constitute legally sufficient contractual consideration • Restatement of Contracts (2d) agrees

20. “Illusory Promise” Esteemed Law Professors – Williston & Corbin Harvard Law – Prof. Samuel Williston: “[a]n agreement wherein one party reserves the right to cancel at his pleasure cannot create a contract – the promisor may perform or not solely on the condition of his whim, his promise will not serve as consideration” Yale Law – Prof. Arthur Corbin: “[a] party [with T4C power] loses that power if …commits such a breach as goes to the essence [of the bargain]”.

21. Prof. Nash and Restatement 2nd George Washington Law – Prof. Ralph Nash: “[a]n unlimited Gov’t. right to terminate raises serious questions as to whether the Gov’t. furnishes consideration in a contract with the [T4C] clause”. Restatement 2nd: “[a] promise…is not consideration if the promisor reserves a choice of alternative performance unless … the alternative performance would have been consideration if it alone had been bargained for”

22. High Mark of T4C’s Unrestrained • Colonial Metals decision – “high mark” of federal government’s T4C power • U.S. Ct of Claims allowed T4C to stand so that Navy could obtain a better “post award” price on copper from another contractor • Colonial Metals was highly criticized as an “aberration in the precedents of the [ Ct. of Claims] because it allowed unrestricted post-contractual price shopping with T4C clause as an “escape hatch”.

23. Colonial Metals – T4C Means Gov’t Never Loses NO LOSE situation for gov’t whether post award market price of items falls or rises Inequitable effect puts contractors subject to a loss of the benefit of the sale when the market falls but being saddled with a loss when the cost of performing rises”

24. Torncello’s Change of Circumstances Standard Ct of Claims reversed Colonial Metals in Torncello Declared that Gov’t cannot T4C simply to acquire a better bargain from another source. Gov’t can only T4C if there exists a “change in circumstances of the bargain, or in the expectations of the contracting parties occurring after contract award”

25. Torncello - Federal Progeny No changed circumstances exist if the reason for the T4C was known or should have been known to the government before the contract was awarded” T4C clause will not act as a constructive shield to protect the gov’t from its decision to now engage an option considered but rejected before contracting Municipal Leasing Corp v. United States

26. Torncello “Whittled Down” • In Krygoski Constr. Co, v. US, CAFC limited its prior Torncello pronouncements stating that Gov’t may not invoke the T4C clause to avoid breach of contract liability when it enters a contract with contractual obligations it does not intend to honor • Reaffirmed that Gov’t cannot T4C to acquire a better bargain from another source, which constitutes bad faith • Torncello was not expressly overruled; Krygoski used “death by dicta declaration” (legal debate as to why??? – maybe couldn’t be – en banc)

27. Torncello’s State Law Progeny“State Champion Cases” Adopting Changed Circumstances Successful state case law T4C challenges: RAM Engineering v. University of Louisville KY Attorney General Opinion Affirming RAM Ry-Tan Const., Inc. v. Washington School Dist. Arizona Towing v. State of Arizona

28. State Champion Cases “Changed Circumstances” Rule lives on in various state decisions RAM Engineering v. University of Louisville Supreme Court of KY held that fairness and integrity of the state’s procurement system and the public’s confidence demanded nothing less than requiring a substantialchange in circumstances.

29. Kentucky (RAM) Adds “Substantial” The interest of fair treatment and public confidence in the government outweigh possible expenses on the public coffers, within the reasonable limits of a substantial change from the parties’ expectations. If there is no good faith limitation set by a substantial change of circumstances, then the government's contracted-for promise becomes illusory

30. Best Interest of the Gov’t Mandates a Change of Circumstances [i]f we must presume that government officials act in good faith to contract in their best interest at the time of agreement, then a change of circumstances is necessary for the contract to no longer be in the government's best interest when terminating for convenience.

31. T4C Does Not Alleviate Govt’s Good Faith Duty • Although the government may terminate contracts for convenience, that cannot supersede the good faith duty to do ‘everything necessary’ to carry [the contract] out • RAM decision lead to historic Kentucky Attorney General Opinion

32. KY OAG 04-009 Request from KY Speaker of the House to the KY Attorney General concerning “To what extent can the General Assembly modify, amend, alter or terminate contracts and what would be the consequences in terms of remedies available to the parties for such action by the General Assembly.”

33. KY OAG (Cont) Citing RAM Engineering, the Attorney General concluded that “the Commonwealth does not have unfettered discretion to terminate the contract for convenience. A change of circumstance must first be identified. Moreover, the nature of that change could seriously affect the Contractor’s ability to even meet its burden to prove the amount of compensation to which it is entitled under the terms of the contract.

34. Ry-Tan Const., Inc Ry-Tan Const., Inc. v. Washington School Dist , the AZ court of appeals held that “when evaluating a termination for convenience, one cannot ignore hornbook law that a route of complete escape vitiates any other consideration furnished and is incompatible with the existence of a contract. . . . [meaning that the ] application of a termination for convenience clause requires some kind of change from the circumstances of the bargain or in the expectations of the parties”

35. Arizona Towing v. State of Arizona Different AZ Ct of Appeals likewise held state’s T4C of a services contract without changed circumstances constituted an abuse of discretion and breach of the Gov’t duty of good faith and fair dealing in its contractual performance and that such cancellation for convenience creates the impression that the contract was illusory.

36. Recommendations Changed circumstances standard is needed to keep T4C’s from “going wild”. T4C power is arguably excessively broad, especially since case law allows constructive terminations despite Gov’t. failure to follow its own mandated contractual and regulatory requirements prior to exercising T4C powers

37. More Recommendations KY has judiciously recognized the “proper T4C balance” between the (1) presumption that Gov’t. officials act in good faith and (2) Gov't.’s need to avoid paying breach of contract damages is to (3) require substantial change of circumstances that were not known or should have been known by the government.

38. More Recommendations Contractual clauses and regulatory provisions should be modified to include the “substantial change of circumstances ” requirement as a condition precedent to Gov’t exercising its T4C power Such language helps to assure integrity, fairness and maintaining contractor trust in the procurement process and enhancing competition.

39. ABA Section of Public Contract Law Termination for Convenience Project (Nov 15, 1997) Recommended changes to FAR’s termination provisions, which were approved by the Section. http://www.abanet.org/contract/admin/minutes/15nov97.html Subcommittee was wrestling with Krygoski’s restrictions on Torncello’s change of circumstances standard as well as the difficulty in proving bad faith.

40. ABA Recommendation (Cont) Opening Paragraph: An assertion by the contractor that the government when terminating for convenience or default has acted in bad faith shall be assessed objectively based upon standards applicable to private parties in commercial contracts. Among other things, this means that the government, whether knowingly or not, may not attempt to recapture an opportunity foreclosed at the time of contracting. (Emphasis added)

41. ABA Recommendation (Cont) (iv)Termination for convenience to reflect changes in, but not elimination of, the actual needs of the government is appropriate, unless the change arises under and can be addressed by one of the remedy granting clauses of the contract. (Emphasis added)

42. ABA’s Two Big Points Tried to minimize difficulty in proving bad faith by eliminating subjective intent by asserting that bad faith shall be “assess[ed] objectively based upon standards applicable to private parties in commercial contracts”. (Emphasis added). ABA astutely focused on “changes” thereby affirming Torncello’s Changed Circumstances standard

43. ABA Recommendation • Unanimously passed by the Public Contract Law Section • FAR Secretariat did not adopt it

44. Conclusion Changed Circumstances standard is the right compromise as other existing challenges to Gov’t. T4C power are difficult or well nigh impossible to prove. When T4C power goes wild, it allows arbitrary contractual abuse which will discourage suppliers with a “chilling effect” upon competition

45. Final Word • Courts must be ever vigilant in their struggle to achieve justice by not hesitating to prevent abuse of contractual rights and the bastardization of the sanctity of contracts • Adopting the “changed circumstances standard is an excellent tool to assure maintain that just balance. • Ethics and integrity are two-way streets; • Even the King must play by his own rules!

46. Potential Quiz Question • Describe one situation where case law expressly concurs that a T4C is not permissible?

47. QUIZ ANSWER • T4C solely based on obtaining a post award better price from a different source

48. Questions? Thanks for your courtesy and attention Prof. John B. Wyatt III J.D. California State Polytechnic University, Pomona (951) 377-7439 FAX (909) 869-4353 Emails: jwyatt3@aol.comprofprocurement@aol.com; jbwyatt@csupomona.edu

49. References - Textual 6 Corbin On Contracts, section 1266 (1962) Nash et al, “Administration of Government Contracts”, 4th Ed., Wolters Kluwer (CCH) 2006. Williston, Contracts 105 (3d ed. 1957 and Supp 1979). Restatement of Contracts (2d)

50. References (Cases) Colonial Metals v. U.S. 494 F. 2d 1355 (1974) Torncello v. U.S., 331 Ct. Cl. 20; 681 F.2d 756 (1982) Municipal Leasing Corp v. U.S. 7 Cl. Ct. 43 (1984) Krygoski Constr. Co. v. U.S. 94 F. 3d 1537 (1996) RAM Eng’g & Constr, Inc. v. University of Louisville, 127 SW 3d 579; (Ky Sup. Ct. 2003)