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Subcontract Termination and Anticipatory Profits

In exchange for the right to terminate for convenience, the government agrees to pay prime contractors certain costs associated with the termination. Anticipatory profits, attributed either to the prime contract or to any subcontracts, are excluded from termination settlements. Meaning, a prime cannot expect to receive payment from the government for the loss of its own profits or those of its subcontractors. As a result, subs will look to their primes for reimbursement, as anticipatory profits are recoverable in the private sector. In order to adequately address this risk, it is imperative that prime contractors include a parallel termination for convenience provision in their subcontracts.

While the termination for convenience procedures in the FAR authorize the prime to recover certain costs related to its own subcontractor settlements, they specifically exclude any anticipatory profits and consequential damages resulting from the subcontract termination. This makes the subcontractor’s main avenue of redress legal action against the prime. Without a termination for convenience clause in the subcontract that outlines the scope of the right to terminate and the types of costs recoverable, a prime risks defending a claim for repudiation and liability that may include the remainder of the contracted-for amount.

An exception exists to the general rule that the government excludes payment of anticipatory profits when a subcontractor obtains a judgment against a prime. In this instance, the FAR allows the government to reimburse the prime for what would otherwise be unallowable costs, provided, among other requirements, the prime contractor has made a reasonable effort to settle the claims, diligently defended the suit, and importantly, included a subcontract termination clause or other provision that disallowed payment of anticipatory profits.

Including a termination for convenience provision in subcontracts that apply the same protocols and requirements of the FAR will not only assist primes in paying a judgment-creditor sub but will strengthen a breach of contract defense. Additionally, explicitly excluding recovery of anticipatory profits in the event of a termination for convenience in the same manner as the FAR will all but eliminate a sub’s ability to prevail on a claim for those damages. Subcontractors presented with this type of language should conversely take care to remember they are giving up a legal claim. And if forced to agree to a termination for convenience clause, they should at minimum ensure the clause is narrowly tailored to encompass only a government termination and not accept broad termination rights that also include damages exclusions.

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