[Many citations have been removed as all policy documents are undergoing editorial (as opposed to substantive) revision. Researchers should consult with the applicable grants policy documents for the Agency or Department concerned.]
The policies of the Department of Health and Human Services (HHS), the Public Health Service (PHS) and the authorized Federal (i.e., Government-wide) Grants Policy organization, the Office of Management and Budget (OMB), require the use a contract (i.e., subcontract) to obtain "substantive programmatic work" from organizations other than a federal grantee itself. The same policy organizations require that such contracts include suitable contract clauses allowing "termination for convenience."
"Termination for Convenience" is a specialized procedure required to be a part of all contractual actions taken by the Federal Government. It allows the Government to terminate contractors for almost any reason, with little or no notice. As interpreted by many Federal Court decisions, the procedure is mandatorily included in Federally funded contract activities, and is allowed even when an appropriate implementing clause has specifically not been included in the agreement between the parties.
The Termination for Convenience procedure is mandated for inclusion in all subcontracts under Federal grants by the applicable grants management policies of the Office of Management and Budget, HHS, PHS, and NIH. Grantees are allowed to develop and implement their own subcontract policies as long as they are not in conflict with these policies.
The use of a termination for convenience procedure is encouraged, but not required, for subcontracts under Federal contracts. The Federal Acquisition Regulation discusses this as follows:
(1) General use. The prime contractor may find the clause at 52.249-1, Termination for Convenience of the Government (Fixed-Price) (Short Form), or at 52.249-2, Termination for Convenience of the Government (Fixed-Price), as appropriate, suitable for use in fixed-price subcontracts, except as noted in subparagraph (2) below; provided, that the relationship between the contractor and subcontractor is clearly indicated. Inapplicable conditions (e.g., paragraph (d)) in 52.249-2 should be deleted and the periods reduced for submitting the subcontractor's termination settlement proposal (e.g., 6 months), and for requesting an equitable price adjustment (e.g., 45 days).
(2) Research and development. The prime contractor may find the clause at 52.249-5, Termination for the Convenience of the Government (Educational and Other Nonprofit Institutions), suitable for use in subcontracts placed with educational or nonprofit institutions on a no-profit or no-fee basis; provided, that the relationship between the contractor and subcontractor is clearly indicated. Inapplicable conditions (e.g., paragraph (h)) should be deleted, the period for submitting the subcontractor's termination settlement proposal should be reduced (e.g., 6 months), the subcontract should be placed on a no-profit or no-fee basis, and the subcontract should incorporate or be negotiated on the basis of the cost principles in part 31 of the Federal Acquisition.
48 CFR 49.502, Termination for Convenience of the Government
The Termination for Convenience procedure may be invoked under Federal practice when the contractor is unable to effectively work with the personnel assigned to manage the contract, when the contractor's management or proposed approach is not acceptable to the contract administrators, or when the personnel proposed to be used are unacceptable to the administrators. It can be used when the topic of research is no longer politically acceptable, as happened when President Reagan canceled the "teen sex survey" that was to be conducted by the University of North Carolina. It can be used when the favored Principal Investigator moves to another institution. It can be used for almost any reason, whatsoever, and with almost no reason at all. Prime contractors or grantees using the Federal clause even have the right to terminate subcontractors for convenience solely to bring the work back into the prime institution.
Under the Federal practice, terminations which would otherwise be improper are treated as "constructive" terminations for convenience. Thus, even those terminations that would be in breach of contract are dealt with as if they were under the convenience procedures. Payment to the terminated contractor in such cases is calculated as if the contract were formally terminated for convenience.
Under the Federal practice, payment to terminated contractors is limited to the actual costs incurred by the contractor, including certain costs not otherwise allowable in non-termination situations. Where the original contract provided for profit, the contractor is paid a proportionate amount of profit. Where no profit was allowed under the original contract, no award is made under the termination procedure. Where a contract would have resulted in a loss to the contractor, a proportionate loss is deducted from the settlement amount.
All entities paid on the basis of reimbursement of costs under Federally funded payment instruments (e.g., contracts, grants, subcontracts, subgrants, cooperative agreements, consortium agreements, and "other transactions") are normally paid only the costs of performance which are "allocable and allowable" in accordance with the "cost principles" which apply to the particular entity receiving funds. These cost principles are found (or incorporated) in Title 48, Part 31 of the Code of Federal Regulations, otherwise known as the Federal Acquisition Regulations (FAR). These cost principles include general strictures concerning the costs that may be charged against the Federal funds available, the methods of charging such costs, and many specific standards for whether particular costs may be reimbursed at all. The principles also include requirements for documentation of the costs to be reimbursed.
All costs payable to a "subcontractor" are in turn chargeable to the Federal Government, and therefore should be made subject to the same rules for reimbursement that would apply if the subcontractor were seeking such funds directly from the Government. (There are competing arguments about just how explicit a subcontract must be for these cost-reimbursement rules to be applied.) The Federal Government's interest in the principles to be applied to the agreement between the grantee and the subcontractor is paramount, since the Federal Government is ultimately responsible for the costs incurred, the results of any research, and the conservation of Federal tax dollars spent for health research. However, the Federal Government is equally adamant about separating itself from the subcontractor with a high wall built on the principle of "privity."
Federal Grants managers are not authorized to direct or control the administration of sub-agreements under grants. Longstanding policy strictures require Federal personnel to strictly avoid interfering with the relationship between the prime grantee and any sub-agreement holders. Except where specifically authorized or required, Federal managers do not approve/disapprove of administrative activities of grantees. Therefore the Federal managers normally will not specifically claim that a rule applied to a prime is automatically applied to the subcontractor. Instead, the Government simply refuses to pay the prime more than allowed under the appropriate cost principles.
Title 45 of the Code of Federal Regulations and other Federal policies concerning Federal grants apply to sub-agreements under grants only to the extent specifically stated in that Title. Broad socio-economic policies, such as EEO, environmental policies, and labor protections do apply and are commonly incorporated in subcontracts by referring to the Title as being included in the agreement between the grantee and the subcontractor. Many other Federal policies, including specifically any right to complain to the Federal government about grantee administrative decisions are not applicable to sub-agreement holders of any sort.
Federal policies require grantees to maintain procedures for procurement of services, including research-related services, needed to support grant activities. The grantee may devise its own policies and follow those policies to the extent that the policies do not conflict with Federal guidelines. Many grantees incorporate required Federal policies in their subcontracts and other procurements by blanket incorporation of the prime document.
It is well understood by most government grantees and their subcontractors that such blanket inclusions of Federal grant documents are not meant to make subcontractors into recipients of Federal assistance, directly or indirectly. Only recipients of assistance are considered as having received a grant or sub-grant.
"Subgrants" are normally authorized by Federal law only when a Federal statute contemplates additional transfers of assistance for a public purpose by a first-tier grantee to other organizations which will use the money for assistance purposes. Thus, the normal subgrant is from a State government to a hospital, clinic, local government or other provider of assistance to the public. Subgrants under research grants are extremely rarely authorized under Federal law and are essentially non-existent under NIH procedures.
The termination procedures (and restrictions on the right to terminate) for grantees prescribed in Title 45 of the CFR are not applicable to subcontractors. Subcontractors do not have the right to avoid termination. Even if procedures found in Title 45, which purport to limit the right to terminate were applicable, the process for handling improper terminations and the measure of damages for a grantee's failure to follow such procedures would be conversion of a termination to a termination for convenience and calculation of the loss based upon the actual, allowable, allocable costs incurred by the subcontractor up to the point of termination, and on certain very limited costs incurred thereafter in closing down performance.
Even if a grantee breached its duty to a subcontractor by improperly terminating the subcontract, under Federal common law the damages to be awarded to the subcontractor for such breach are limited to the actual costs incurred, as measured and documented under FAR Part 31, unless the subcontractor proves that the Prime acted in bad faith in terminating the subcontract by "well-nigh irrefragable proof." Kalvar Corp. v. United States, 211 Ct. Cl. 192, 198-99, 543 F.2d 1298 (1976).
The rules applicable to terminations for convenience are highly influenced by the choice of law to be applied to the interpretation of the [sub] contract. Some Federal Circuit Courts have routinely applied Federal "common law" to subcontracts; others apply state law unless the parties otherwise provide; and some apply the principles of the Federal law as State law. That is, even if Federal law is not specifically applicable, Federal law will still be applied. The Fourth Circuit, facing an assertion that federal law should be applied in a subcontract situation, stated:
We . . . agree that the Supreme Court of Virginia would follow federal interpretive precedents.
[The clause at issue] is required not only by the EPA, but by other federal agencies, so that it is found in a variety of contracts, including defense contracts. It has been the subject of litigation in the Court of Claims and in several boards of contract appeals. . . .
 When a standardized provision widely used in construction contracts receives consistent judicial and administrative interpretation, it acquires a gloss that lends color to the words. When the same words are incorporated in later contracts, it may be presumed that the intention of the parties conforms to the earlier, consistent judicial and administrative interpretation. If, at the beginning, the words were ambiguous in the sense that they were open either to a strict, technical construction or to a more liberal construction in furtherance of their purpose, consistent judicial and administrative rulings that they are to be interpreted with liberality dissolve the ambiguity until, finally, there is no room for a contention that they should be construed strictly.
 We are confident that the Supreme Court of Virginia, if called upon to construe or apply this federally mandated provision, would look to the existing body of precedents. That collection of precedents is federal, but it is highly relevant, since the provision is used under federal mandates. There are no comparable precedents in Virginia decisions, and the Virginia courts would recognize the principle that use of the same words in contracts derives life and meaning from earlier consistent judicial and administrative construction of them. Brinderson Corporation v. Hampton Roads Sanitation District, et al., 825 F.2d 41 (4th Cir.1987)
The clearest application of this principle is found in the case of Linan-Faye Construction Co., Inc. v. Housing Authority of the City of Camden, 49 F.3d 915 (3rd Cir. 1995). That case exhaustively discusses whether State or Federal law controls, and finds that State law controls in the case, in part because it did not involve a ". . . subcontract with a United States government prime contractor. . ." but only a grantee and subcontractor under the grant. However, it goes on to apply the doctrine of "constructive termination for convenience." As did the Fourth Circuit in Brinderson, supra, the Third Circuit finds that the State Courts would apply Federal principles to deal with a Federally related subcontract termination situation. Notwithstanding a termination that would otherwise be in breach, the Court finds that an "actual breach" may be "retroactively justified." The Third Circuit Court allowed an improper default termination to be treated as a constructive termination and thereby limited recovery to the actual costs of performance in accordance with the Federal principles of convenience termination. See, also, Sulzer Bingham Pumps, Inc. v. Lockheed Missiles & Space Company, Inc., 947 F.2d 1362 (9th Cir. 1991).