Forfeiture by Cancellation or Termination - Charles Tiefer

• Publication year: 2003

Forfeiture by Cancellation or Terminationby Charles Tiefer*

I. Introduction

Termination powers¹ and conditions of performance empower one party to treat its own obligations under the contract as discharged or cancelled based on something less, often much less, than material breach² by the other party.³ Perhaps no current topic spanning a diverse subject within basic contract law invites doctrinal development as much as termination powers and conditions. Major examples of such powers include the employer's power to terminate employment at will,⁴ the government's power to terminate public contractors for convenience, the insurer's right not to pay otherwise covered insureds who fail to fulfill conditions,⁵ and the government's right to penalize contractors who violate various public policy conditions. Employers, the government, and insurers each use provisions in their adhesion contracts,⁶ arranging their power to terminate or to cancel for failure of a condition on a self-help basis and to be exercised relatively speedily and easily; thereby, serving their often valid interests of flexibility, control, and fulfillment of public policies.⁷

However, using the power to terminate or cancel for failure of an express condition often amounts to a more extreme and powerful remedy than obtaining damages or specific performance from a party for breach. The terminating or cancelling party⁸ need not make the kind of showing required for cancellations based on ordinary terms, namely, a material breach by the cancelled party,⁹ and also need not show any proportion- ality between the losses or situations it faces and those faced, after cancellation, by the cancelled party.¹⁰ In other words, even an employer, the government, or an insurer justified in invoking such provisions may then inflict, by cancellation, disproportionate losses to the reliance interests—in a word, forfeiture¹¹ —upon a weaker contracting partner.

For the more powerful party to impose termination and condition provisions and then to invoke them has generated major controversy in the evolution of contract doctrine. A long-time stable¹² employee, a government contractor that has prepared expensively to perform, and an insured for whom the feared risk has occurred might all face serious forfeitures from the invocation of a termination or cancellation power. The question is when they should face these forfeitures due to an unbargained for provision when they cannot mitigate cancellation effectively by substitute arrangements without any melioration or compensation.¹³

Throughout the past century, contract law, as reflected in the Restatements (First) and (Second) of Contracts (hereinafter "First Restatement" and "Second Restatement") and leading commentary, has increasingly struggled to ameliorate that potential for harshness.¹⁴

This Article suggests that the line of advance in this doctrinal area has gone, and should go, further than the previously discussed approaches. Contract law has been recognizing, and should further recognize, the next meliorating evolutionary steps in the law of conditions and termination powers: consolidating as a unified issue the potential forfeitures ensuing from express provisions of both conditions and termination, broadening the relevant factors determining the equity of their exercise, and providing sometimes for compensation¹⁵ to the cancelled party. Specifically, invocation of the cancellation remedy ought to turn on a full array of factors.¹⁶ These factors would include the ones already applicable to the cancellation remedy for material breach; interpretive presumptions about provisions of adhesion in contracts that serve important roles in the social safety net (e.g., for stable employment and for consumer insurance);¹⁷ and public policy considerations,¹⁸ particularly those touching on termination and penalization in government contracts. Providing for defined kinds of compensation in light of these factors may sometimes support the interests of both sides because it would authorize the continued exercise of power for ending contracts that serve the needs of employers, the government, and insurers, while meliorating the impact of cancellation on the weaker party.

To study these issues as they have progressed in contemporary controversies, this Article compares and contrasts public and private contracts.¹⁹ Part II provides an overview of the factors relating to cancellation based on termination powers and conditions. In particular, it traces the previous lines of amelioration of the impact of conditions through Jacob & Youngs, Inc. v. Kent²⁰ and the First and Second Restatements.²¹ Respected articles by Professor Corbin in 1919²² and Professor Childres in 1970²³ reflect the evolving academic commentary on how to define appropriate and inappropriate occasions for such harshness without sacrificing the practical usefulness conditions may often have.

Part III turns to the issue of compensating some parties faced with the exercise of a power of termination. It starts with the tremendous recent ferment over employers' power of termination of employment at will.²⁴ About two-thirds of all employees are employees at will,²⁵ and the stable forms of such employment are increasingly considered as a possible relationship contract,²⁶ making the law regarding their termination a matter of general importance. The analysis here draws upon the public policy indicated in federal tax policy²⁷ and the Employee Retirement Income Security Act of 1974 ("ERISA"):²⁸ promoting employment-based pension reliance interests,²⁹ a public policy of increased importance as permanent mass layoffs through downsizing became a major practice, even at stable employers, starting in recent decades and, now, even more so, in the economic slowdown of 20012002.³⁰

Then, Part III turns to another area of termination powers in contracts, the governmental power of termination for convenience and the striking development in 1996, the demise of the Torncello doctrine that expanded contract termination power while keeping it subject to the compensation of public contractors' reliance interests.³¹ The Article then discusses its salient concrete conclusion: that contracts for stable employment should be presumed to have an implied term of severance pay as a form of limited compensation for the reliance interests forfeited by terminated employees. Severance pay serves to temper the harshness of the exercise of termination powers without unacceptably depriving employers of the flexibility and disciplinary capacity they seek in termination powers.

Part IV discusses conditions in two other diverse contexts. The law of conditions in consumer insurance cases has evolved in a way that unfolds the greatest potential in the Second Restatement section 229 on disproportionate forfeiture.³² Moreover, the law of public policy in government contracts³³ has evolved with new federal appellate case law magnifying the role of conditions in penalization for false claims, which is exemplified by the court's major 1997 decision in United States ex rel. Thompson v. Columbia/HCA Healthcare Corp:³⁴

The conclusion puts this Article's analysis in the form of a proposed section for the next Restatement of Contracts entitled "Forfeiture by Cancellation or Termination." This proposed provision treats powers of termination along with conditions and brings a wide range of factors to bear. It builds upon a synthesis of the Second Restatement's section 229 (excuse of condition for disproportionate forfeiture) and sections 241-42 (cancellation for material breach). It would distinguish actually negotiated terms from mere terms of adhesion and stake out an important role for public policy considerations and for the strength of the justification for the condition or termination power. In appropriate circumstances, it would sustain the exercise of a cancellation or termination power while providing a measure of compensation, like severance pay, for the terminated party. The proposed provision codifies, in effect, a direction in which contract law in this important area has been, and should be, developing.

II. First and Second Restatement Views of Cancellation Based

ON Conditions

As Professor Fried describes, in ably recreating the late nineteenth century view of the doctrine of conditions: "Where a term of an agreement is treated as a condition, the result for the party on the losing end of that designation can be sharp and harsh."³⁵ Classic contract doctrine readily treated terms as conditions, in accordance with the nineteenth century "will" theory of contracts. Namely, if a party found its terms unfulfilled, then it had not agreed ("willed") to bind itself to proceed with its own performance. In other words, classic contract doctrine did not treat cancellation as a remedy governed by equitably weighed factors.³⁶ Rather, the classic approach treated failure to fulfill terms in a way that was often both rigidly harsh and, to use a term from discussions of damage remedies, supracompensatory.³⁷

This meant, for example, that nineteenth century life and fire insurers could, and did, insert in their form contracts provisions that let them egregiously evade payout notwithstanding the occurrence of the hazards so often that it created a sort of reverse lottery in which an arbitrarily chosen group of vulnerable insureds was deprived of their paid-for protection for little reason other than to enrich the insurer.³⁸ The related law regarding unilateral powers of termination, such as the employer's power to terminate employees, illustrates similar classical firmness and sometimes harshness. Nineteenth century common law dropped the more moderate English doctrine that presumed an employment arrangement was for a period of time and instead adopted the doctrine that an employee without an expressly specified period of employment was terminable by the employer at will, i.e., at any time for any or no reason.³⁹ Thus...