5 September, 2016
What you need to know
- Termination of convenience clauses should be included in contracts to provide government with necessary flexibility, however, they need to be well drafted and only used in good faith.
- There is limited case law applying the doctrine of executive necessity or termination for convenience clauses in Australia and questions of law in relation to these clauses remain unsettled.
- Compensation is generally payable when terminating for convenience. What you need to do
- Review any contracts within your portfolio that may not have the support of a newly elected government.
- Proceed with caution before terminating a contract under the doctrine of executive necessity or under a termination for convenience clause.
- Educate non-government contracting parties about the inclusion of the clause in contracts to increase understanding and reduce the likelihood of protracted negotiations concerning them.
Introduction
It has been generally accepted that a special form of privilege exists in relation to governments as a contracting entity.1 This privilege takes the form of a rule that stipulates that a contract cannot fetter a government's right to govern. This rule has its origin in the doctrine of executive necessity, but typically manifests itself in contract through a termination for convenience (TFC) clause. TFC clauses should be included in government contracts to provide governments with the flexibility necessary to govern.
With the results of the federal election yet to be determined, it is timely to consider the extent to which the doctrine
of executive necessity may be relied upon, or TFC clauses used in Australia, particularly in relation to machinery of government changes or the possibility of a newly elected government seeking to rely on either to terminate a commitment made by a previous government. This Commonwealth Alert will explore the doctrine of executive necessity and the government's contractual right to terminate a contract for convenience.
Background
The doctrine of executive necessity is best understood within its historical context. The doctrine is said to have originated in the decision of Justice Rowlatt in Rederiaktiebolaget "Amphitrite" v The King2 (the Amphitrite) where a contractual undertaking was broken by the government. In that decision it was accepted that a government "cannot by contract hamper its freedom of action in matters which concern the welfare of the state". Accordingly, it has been recognised following this case that governments may be allowed to break a contract where it inhibits the business of governing.
- Nicholas Seddon, Government Contracts: Federal, State and Local, Fifth edition (The Federation Press, 2013) 248.
- [1921] 3 KB 500.
The doctrine of executive necessity has been incorporated into contract through the use of TFC clauses. Both Commonwealth contracts and contracts entered into by State and Territory governments usually contain a TFC clause. The clause typically takes its form in drafting similar to the following:
Clause X, Termination for convenience
In addition to any other rights it has under the Contract, the Commonwealth may at any time terminate the Contract or reduce the scope of the Contract by notifying the Contractor in writing.
In many contracts, it may be followed by related provisions that offer limited compensation to the contracting party.
In this respect, the TFC may be seen as the more virtuous cousin of the doctrine of executive necessity that does not
require that any compensation be paid. Many contracting parties unfamiliar with the nuances of contracting with
government are unaware of this doctrine and its operation or the use of a TFC clause. This means that the use of
either provision is often misunderstood and results in unnecessarily protracted negotiations.
Contemporary relevance
Beyond the context of wartime circumstances, the doctrine of executive necessity and TFC clauses continue to pervade modern commercial negotiations, but the inclusion of such clauses is not without criticism.
In Australia, it would appear that the clause is not often actively used and that pragmatic considerations outweigh its practical legal use. Legal commentators have suggested that, while governments may use TFC clauses as a tool, they are ill-advised to use the provision too often as use of them may damage public confidence and draw the attention of international credit rating agencies.3
Depending on the outcome of the 2 July 2016 election there is the possibility that contracts entered into by the Coalition government may seek to be terminated by any new incoming government, should the Opposition form government.
Moreover, if there is a "hung" Parliament, there may be even further uncertainty as to the fate of contracts already in place.
International comparatives
It is useful to consider the United States case law given that there have been so few Australian cases to provide guidance on the application on the doctrine of executive necessity or termination for convenience clauses. The interpretation of termination for convenience clauses in the United States have taken a broad approach.
In Torncello v United States4 the Court held that the clause could only be used where there had been changed circumstances. However, further judgments have broadened the scope further suggesting that, save for not acting in good faith, a government has almost an unfettered right to terminate. By way of example, in McHugh v DLT Solutions, Inc 5 the government was permitted to terminate a contract where it had wrongly entered into a contract for the purchase of software which was not compatible with existing government ICT systems. It has been suggested that the only limit to the use of termination of convenience clauses in the United States may be found in the scenario of government terminating a contract merely "to obtain a better price from another contractor".6
In 2013 the Victorian Napthine Government considered the business case for the East-West Link road project and decided to proceed. The contract contained a termination for convenience clause. The clause provided compensation for the contracting parties estimated to commence at $900 million, subject to the timing of termination. 7
The contract was signed before the caretaker period leading into the November 2014 state election. The Opposition had indicated that it would not defend a legal challenge to the project and there was some suggestion by it that it would not proceed with the project. 8
Example – The Victorian East-West link
3 Ibid 252.
4 681 F 2d 756 (1982) at 760.
5 618 F 3d 1375 (Fed Cir 2010).
6 Ibid 258.
7 Victorian Auditor-General's Office, East West Link Project (December 2015) http://www.audit.vic.gov.au/publications/20151209-East- West-Link/20151209-East-West-Link.pdf at 49.
8 Ibid ix.
Conclusion
The limited case law on the use of doctrine of executive necessity and TFC clauses in Australia suggests that governments must err on the side of caution and adopt a conservative approach when contemplating terminating a contract using either legal provision.
If a new incoming federal government were to review contracts on foot to determine whether to continue with them, it should act carefully. As stressed by Justice Kearney "it would be a serious matter for the rule of law if a government were perceived as refusing without proper cause to perform a contract for services to the public entered into in accordance with all the legal safeguards designed to protect the public interest".18
18 Northern Territory of Australia v Skywest Airlines Pty Ltd (1987) 48 NTR 20.
For further information, please contact:
Sarah Ross-Smith, Partner, Ashurst
sarah.ross-smith@ashurst.com
