The Army stopped work on the initial US$879 million development contract in September after deciding the Embraer aircraft Lockheed it planned to use was too small to fly the gear needed for its intelligence and surveillance work.
The contract was terminated at the end of a 60-day period during which Army officials weighed four alternatives offered by Lockheed, the Pentagon's top supplier.
"After carefully evaluating Lockheed's proposals, we decided that the prudent course of action at this time was to terminate the contract," Claude Bolton, the Army's chief weapons buyer, said in a statement.
Left in the lurch was Lockheed's main partner in the project, Embraer, the Brazilian company whose ERJ-145 jet proved too light.
In August 2004, Lockheed beat Los Angeles-based Northrop Grumman Corp for the system design and development contract for the plane known as the Aerial Common Sensor.
An Army spokesman, Timothy Rider, said the contract was terminated for "convenience of the government," as opposed to any Lockheed failure to perform.
Lockheed will submit a settlement proposal in line with federal acquisition rules designed to make it whole, said Judy Gan, a spokeswoman.
The company said in a statement it accepted "responsibility for the execution issues that arose" under the contract.