Many framework agreements offer a possibility, but not an obligation to place orders or award contracts. Can a principal which terminates such ‘noncommittal’ framework agreement still be liable to pay damages for lost orders? The Court of Appeal of Arnhem-Leeuwarden recently issued an interesting judgment about this question.
In 2018, the Province of Utrecht (the 'Province') entered into a framework agreement with a service provider (the 'BV') for maintenance work on two tram lines. The term of the framework agreement was four years. However, it was agreed that the Province could at any time terminate the framework agreement for convenience with six months' notice.
In the tender, the Province communicated approximately € 500,000 as a turnover forecast. In practice, however, approximately € 346,000 turnover was realized by the BV in the first year. In the second year the realized turnover was again below forecast. When the BV complained about this to the Province in mid-2019, the Province decided to use the termination clause included in the framework agreement. Upon termination, only a limited compensation for unused stock was offered to the BV.
Unlawful termination
The BV believed that termination in these circumstances was unacceptable by standards of reasonableness and fairness and claimed damages from the Province. In first instance, the district court dismissed the BV's claims. On appeal, however, the court of appeal ruled that this did constitute wrongful termination by the Province.
The appellate court came to that conclusion based on a number of circumstances. The BV (and priorly its founder as sole trader) had worked for the Province under successive contracts for over twenty years. The Province had never raised any significant complaints. Moreover, the BV made substantial investments to comply with the framework agreement and depended on the framework agreement for more than half of its turnover. The Province's claim that there was a lack of certification and inadequate quality of service was dismissed as insufficiently substantiated by the appellate court.
In reaching this judgment, the appellate court did not mention the circumstances that (i) the BV agreed to the unilateral termination right for the Province, and (ii) it was a framework agreement with no obligation for the Province to actually place orders or award contracts to the BV. Thus, the court concluded that it was unacceptable by standards of reasonableness and fairness for the Province to invoke the termination clause.
Reasonable compensation
The consequence is that the Province is liable for compensation of the BV's damages as a result of the wrongful termination. To estimate those damages, the appellate court first calculated what the BV's average monthly profit had been so far (€ 19,150). The framework agreement would have continued for another eighteen months had it not been terminated by the Province, so the BV would still have been able to realise (18 x € 19,150 =) € 344,700 in profits from it.
However, the appellate court did not award that full amount as damages. After all, the BV must be placed in the position as if the damaging event had not occurred. According to the appellate court, the damaging event is not the wrongful termination itself, but the lack of an offer to pay reasonable compensation at the time of termination. Therefore, "reasonable compensation" still needed to be determined.
Interestingly, the appellate court did take into account that the BV agreed to the right of the Province to terminate the agreement for convenience with six months' notice when determining this reasonable compensation. The appellate court found it reasonable if the risk of premature termination without serious grounds is shared between the parties. The court concluded that compensation of € 175,000 is reasonable. That is more or less half of the lost profit estimated above due to the early termination.
Disappointing turnover
The BV made further reference to the tender documentation, in which the Province gave an annual turnover forecast of € 500,000. As indicated above, the turnover in practice was disappointing. Only 69% of the forecast was realized in 2018 and even less in 2019. For the disappointing turnover, the BV wanted to be compensated by the Province. But the appellate court did not go along with this.
In this context, the appellate court did consider that this was a framework agreement under which the Province had no obligation to award contracts. Moreover, the forecast assumed the operation of two tram lines, including the Uithof-line which would not be operational until December 2019. The possibility that the BV would not recoup its investments was accepted by it and considered by the appellate court to be part of the normal entrepreneurial risk.
By themselves, these are valid considerations. The question is, however, why the contractually agreed termination right and the absence of an obligation to place orders or award contracts were only cited to limit the obligation to pay damages. These circumstances could also have led to the conclusion that the termination was not wrongful.
Consequences of premature termination of framework agreement
The finding that a termination is unacceptable by standards of reasonableness and fairness (a very high threshold) is based on all the factual circumstances. Therefore, without having reviewed the complete underlying dossier, this is difficult to assess. However, the lesson can be drawn from this judgment that a termination clause does not give the principal carte blanche to terminate the contract without taking into account the reasonable interests of its contractor.
The fact that this was a framework agreement in which the principal had no obligation to place orders or award contracts was apparently not a factor which the appellate court weighed in assessing the wrongfulness of the termination. However the appellate court did consider this circumstance in its rejection of compensation for disappointing turnover. Despite the fact that the BV should have been able to rely to a certain extent on the Province's turnover prognosis, the appellate court ruled that the disappointing turnover was part of the normal entrepreneurial risk.
On the other hand, to the appellate court termination (in accordance with the agreed termination clause) with a six-month notice period does not appear to be part of the BV's entrepreneurial risk. According to the appellate court, reasonable compensation for termination of the framework agreement comprises half of the expected profit for the full remainder of the term, or eighteen months. Therefore, the BV effectively receives profit over a period longer than the notice period it agreed to.
Conclusions
The judgment provides some guidance on the calculation of damages in case of wrongful termination of a long-term contract. At the same time, this judgment shows that such an assessment can go both ways. Unlike the appellate court, the district court did find that the termination was lawful. Also, the appellate court's reasoning for rejecting the claim on account of disappointing turnover would not have been out of place as substantiation of a rejection of the BV’s claim of wrongful termination.
Finally, the question arises as to what would have happened if the Province had not terminated the framework agreement, but simply served out its term without issuing new orders to the BV. According to the appellate court's view, there would be no claim for disappointing turnover - this is seen as the normal entrepreneurial risk. Nor can there be any reasonable compensation for wrongful termination if there is no termination in the first place.
With a fixed-term framework agreement, it is therefore advisable to carefully consider whether early termination is prudent, or whether this will require the payment of damages that might not have been due if the framework agreement had remained dormant.
