Termination for Convenience clause in EPC Agreements: Need for a restrained invocation?

  • Naman Katyal

Introduction

Termination for convenience clause 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.

The idea developed as a potent tool by government agencies during the period of World War I to relieve the government of the risk of receiving futile goods, when the US Congress legislated for the government termination for convenience. The legislation provided that the government could terminate a contract for convenience by compensating the contractor for only the actual cost incurred and that there was no requirement by law to pay the contractor the loss of profits.

A subsequent decision in 1982 by the US Court of Claims in Torncello v. United States(‘Torncello’)provided some respite to the unnerved business community. The court held that the refusal to reimburse the lost profits could not be so generally justified and some change in circumstances must be shown in order to terminate the contract. The respite turned out to be short-lived and the successor court to the Court of Claims, the Federal Circuit in 1996 delivered the coup de grace against Torncello in Krygoski Construction Co. v. United States. The court elaborated on the justifications for such termination and pointed out how the key statements in Torncello were “dicta”, it also held that termination for convenience is improper only when the government acts in bad faith.

Developments in India

In the context of India, the courts and legislations haven’t dealt with ‘termination for convenience’ per se but Section 14(1)(c) of the Specific Relief Act, 1963 does state that contracts which are determinable in nature cannot be specifically enforced. The Delhi High Court in the case of Rajasthan Breweries Ltd. v. The Stroh Brewery Companyvery aptly put forwarded the meaning of determinable in the context of contracts;

determination is putting of a thing to an end… meaning thereby, all revocable deeds and voidable contracts may fall within “determinable” contracts and the principle on which specific performance of such an agreement would not be granted is that the Court will not go through the idle ceremony of ordering the execution of a deed or an instrument, which is revocable at the will of the executant.

The judgment rendered by the High Court consequently meant that determinable contracts may be explained as contracts that can be put to an end.

This effectively means that contracts incorporating termination for convenience clause cannot be specifically enforced. The reason being that various courts have held that an agreement incorporating a clause enabling either party to terminate the agreement unilaterally without any reason would be determinable in nature. In Indian Oil Corporation Ltd. v. Amritsar Gas Services, the Supreme Court held termination of a distributorship agreement by the Indian Oil Corporation for its convenience by giving thirty days’ notice without any reason to be determinable in nature. The court thus declined to order specific performance of the contract, it further declined compensation for the anticipated loss of profits claimed for the remaining distributorship period.

Unfettered use of termination for convenience clause by the government is detrimental for investments

In termination for convenience, the government finds a valuable asset to tackle hefty compensation and distressing litigation associated with terminating obsolete projects. Further,the public interest demands the government to cut on inapt expenses and termination for convenience clause allows for the same.

For the same reason, this clause has found copious use in several Engineering, Procurement, Construction agreements (‘EPC Agreements’) entered into by contracting government agencies of India. But, over time the invocation of the clause has turned unfettered. Politicians on being sworn into constitutional positions employ the clause at the drop of a hat to score political points without minding the ill effects on future investments.

Case in point: YS Jaganmohan Reddy was sworn as the Chief Minister of Andhra Pradesh in May 2019, and within six months of taking the oath, the Andhra Pradesh government shelved the ambitious Amaravati Start-Up Area project initiated by the previous government due it being ‘not feasible’. On similar lines, several other projects faced similar fate including LuLu Group’s planned International Convention Centre and other associated facilities in Visakhapatnam. Subsequent to this, the LuLu Group vowed to never invest in Andhra Pradesh, claiming it had incurred massive expenditure on initial developments and appointing international consultants and architects.

A fervent resolve to adhere to contracts is the need of the hour for government agencies in India. The recently released World Bank Ease of Doing Business rankings, 2020(‘rankings’)indicate the same. In the 2015 rankings, India’s overall rank was 142nd, while in the sub-category of enforcing contracts the rank was 186th. In the next five-years India could better its overall rank drastically and attained the 63rd rank in the overall category, while in the enforcing contracts sub-category, it could only achieve an awful 163rd rank.

The ranking is indicative of the government’s failure in the sphere of enforcement of contracts.

Denial of specific performance as a remedy is unjust

The passage of the Specific Relief (Amendment) Act, 2018 (‘Amendment Act’) has bought in several important changes in the civil dispute redressed mechanism in India. The foremost being the making of specific performance of a contract the rule instead of being an alternative as was the case before. Before the passage of the Amendment Act, the authority to direct the specific performance of a contract laid in the discretion of the court under Section 10 of the Act.

However, exceptions continue to exist. Section 14 of the Amendment Act specifies the contracts which cannot be specifically enforced; a contract which is determinable in nature is one such contract. Contracts incorporating termination for convenience clause being determinable in nature by virtue of Supreme Court judgments cannot be, therefore, specifically enforced.

Consequently, the only remedy that lies is to claim damages. However, the amount of damages compensated often turn out to be inadequate largely for two reasons.

First, the government agencies utilize their dominant position in relation to the contractors in framing the terms of the contract to the fullest of their advantage. Clause 21.6.2 of NITI Aayog’s Model Engineering, Procurement, Construction Agreement(‘Model Agreement’) indicates the same. The clause states that the contractor shall be only entitled to an amount equal to the (i) Valuation of Unpaid Works; (ii) the reasonable cost, as determined by the Authority’s Engineer of the Plant and Materials procured by the Contractor; (iii) the reasonable cost of temporary works, as determined by the Authority’s Engineer; and (iv) 10% of the cost of the works that are not commenced or not completed, in case the authority terminates the contract for its convenience.

Additionally, Clause 23.5 of the Model Agreement bars the claim of any consequential damages, including any loss of profit. This essentially limits the contractor’s ability to claim adequate compensation.

Second, it is not always possible to prove the amount of lost profits with certainty and this puts the contractor in an unfavourable position. Doctrines of causation and remoteness, foreseeability, and mitigation which restrict compensation, act as hurdles to calculation and in the grant of full compensation, and also increase litigation costs.

Further, even the courts manifest inclination to grant the amount of loss of profits without going into minute details. In the matter of Mohd. Salamatullah v. Govt. of A.P, the Supreme Court entitled the contractor to claim 15% of the contract price as loss of profits. The court further justified the calculation of the amount by the trial court even if the amount was calculated on the basis of guesswork. This could result in the inaccurate calculation and hence as a consequence, inadequate compensation.

The way ahead

At a time when substantial efforts to increase the inflow of FDI are being made, the uncalled for termination for the EPC Agreement stand the subsequent denial of specific remedy tends to damper the inflow of FDI.

While it is true that a government does have a key duty to guard itself against imprudent expenses and it must enjoy the authority to terminate agreements when they are not in the government’s best interest. But the government’s broad discretion to exercise its right to terminate should only be exercised in good faith and not merely to escape contractual obligations.

Termination in instances where the contract was illegally awarded in contravention of rules and regulations could be permitted whereas instances, where the termination clause is invoked only to drive political mileage, should be discouraged.

Further, the well-nigh irrefragable proof standard which presumes good faith on the part of government agencies in contract law makes it harder for the contractors to show bad faith on the part of government agencies. An acknowledgment that the government is subject to the same good faith duties as a private party would go a long way in attracting FDI.

the author is 2nd Year law student at GNLU, Gandhinagar

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