It is common for contracts to provide parties with a right to terminate in certain circumstances. If a situation has arisen causing you to consider ending a contract, it is important that any attempt to terminate is considered carefully. This article will explain the options that may be available to you.
What is termination?
Termination excuses the parties to a contract from having to perform their primary obligations after the termination date. Some duties survive, however, any future primary obligations (for example, a future obligation to pay) will not.
A party may wish to terminate a contract for any number of reasons, for example, the non-performance of the contract by the other party, there being no need for the contract to continue, or upon the insolvency of one of the parties.
No matter the grounds for termination, you must act. It is rare for a contract to allow for automatic termination and therefore positive action is generally required to terminate. Furthermore, if you delay, there is a risk you could lose your right to terminate even if you have reserved your right to do so.
Most contracts include a clause stating the term of the contract and what will happen at the end of that term. For example, the contract may be for a fixed term, with automatic termination at the end of the term. The contract is also likely to give the parties the right to terminate before the expiry of its term if, for example:
- the other party commits a breach of the contract;
- there is a change of control of a party to the contract;
- the other party suffers an event which prevents its due performance of the contract, such as insolvency; or
- where a party is unable to perform the contract for a prolonged period of time.
The contract may give the party in breach the opportunity to remedy the breach within a set period and, if this is the case, the innocent party must give the party in breach the opportunity to remedy the breach before proceeding to terminate.
If a breach is not remedied, or capable of remedy, there typically needs to be a “material” or “repudiatory” breach of the contract to justify termination for breach. Repudiation is a common law concept and is discussed below. In order to terminate for a “material” breach the contract must include a provision to do so. The courts have confirmed that all the commercial circumstances of a case will be taken into account when determining if there has been a sufficiently material breach to justify termination and “material” could be interpreted in ways ranging from “not trivial” to “serious”.
The parties to a commercial contract should therefore consider spelling out expressly in the contract what they would consider to be a material breach and should set out whether, and in what circumstances, repeated breaches will give rise to a right to terminate, even if, individually, the breaches would not.
Becoming insolvent or being in financial difficulty does not normally result in the automatic termination a contract. A contract will need to include a clause allowing termination on the grounds of insolvency or financial difficulty. Such a clause may not be valid in the future, however, because the government has announced its intention to invalidate termination clauses in contracts for goods or services when a company enters a formal insolvency procedure, except where continuing the supply would threaten the supplier’s own solvency.
Non-contractual rights to terminate
If a contract does not include a right to terminate, it is possible for a right to terminate on reasonable notice to be implied into the contract. This will not be the case in every circumstance and what is “reasonable notice” will depend on the facts. It is therefore preferable to have express clauses in the contract dealing with termination if possible.
Even if the contract does include express provisions to terminate, the parties are entitled to rely on the non-contractual right to terminate for repudiation, provided the ability to do so hasn’t been expressly waived in the contract.
Repudiation occurs when a party commits a breach of contract that is sufficiently serious that it entitles the innocent party to treat the contract as terminated with immediate effect and to sue for damages for breach of contract. Whether a breach is repudiatory will depend upon the severity and effect of the breach, and whether it goes to the root of the contract. Examples include a refusal by a supplier to carry out the services under the contract or a continued failure by a customer to give the supplier access to the premises or materials necessary for the supplier to perform the contract.
The effect of a repudiatory breach is that the innocent party will gain the right to choose whether to either affirm the contract or to accept the repudiation and terminate the contract. By electing to terminate the contract, the innocent party is released from performance of its obligations under the contract and from any obligation to accept further performance by the party in breach.
If the innocent party elects to affirm the contract, it will remain obliged to perform its duties under the contract, but can seek damages from the party in breach.
Difficulties can arise if the innocent party inadvertently affirms the contract instead of accepting the repudiation by acting in a way that contradicts acceptance of the repudiation. Case law has shown there is a danger that if sufficient time passes without the innocent party making an election, it will be deemed to have affirmed the contract.
A party considering termination may wish to consider the following questions before terminating:
- Are there any transitional arrangements in place? For example, if a software provider terminates a contract and stops providing access to the software, what will the consequences be? Is it possible for transitional arrangements to be put in place?
- What will happen to the ownership and maintenance of equipment, information and licences provided during performance of the contract?
- Do any duties arise on termination (such as a duty to destroy or return confidential information and personal data)?
- What contractual duties survive termination?
- How would the termination affect staff? Might employees of a terminated supplier be transferred to the customer or to another provider?
- What are the risks for the business of getting termination wrong?
Termination is an important stage in the life of any contract. Although the parties may be reluctant to focus on the end of the contract before it has even begun, this is the best time, while the relationship between them is positive, for the parties to negotiate and agree how to deal with any disputes which may arise during the term of the contract and how the contract can be terminated in the event that a dispute cannot be resolved.
Termination is not always the most appropriate way to address a grievance. The parties may wish to renegotiate the contract, for example, or there may be a dispute resolution clause in the contract that prescribes what the parties should do if a disagreement arises. You can find more information on dispute avoidance and alternative dispute resolution in our articles on avoiding and managing disputes.
A terminating party should exercise caution when terminating a contract for breach. It is advisable to take legal advice in advance as the possible consequences of seeking to terminate in circumstances where the materiality of the breach is questionable are potentially extremely serious. The party allegedly in breach may, upon receipt of a termination notice, seek to argue that the purported termination is itself a repudiation of the contract by the terminating party which could see the terminating party facing a substantial damages claim itself.