Termination of contracts – is there a safe way out?

At the outset of a new commercial relationship, many issues are considered by those involved, a number of which are of immediate urgency. What is not often considered – or if it is considered, may be considered only briefly – is how and when that new relationship can be brought to an end. This is understandable, as no business wants to start a new relationship assuming that it will fail. The reality is, however, that contractual relationships do turn sour or circumstances occur that neither party expected.

Most commercial businesses will operate on standard terms and conditions which contain provision for termination. However, our experience suggests that some commercial organisations do not take sufficient account of the relevant provisions regarding termination when analysing the commercial benefit of the contract. What may look like a good commercial deal may become anything but if circumstances change without any safe way to bring the relationship to an end. The Covid-19 emergency, with its associated lockdown, social distancing rules and travel bans, has been the perfect example of such unforeseen circumstances. Are you/your client locked in or can anything be done to release you from your obligations?

Disputes concerning termination arise regularly, partly because adequate consideration is not given to termination and its consequences early enough. We set out below a brief summary of the ways in which a party may bring a contractual relationship to an end, together with some relevant commercial considerations.

Prevention rather than cure

In order to avoid facing difficulties around termination, it is, of course, best to understand the likely position on termination before entering the contract. This will not cover every possible basis (as you are unlikely to have knowledge of, for example, misrepresentation or catastrophic events at this stage) but will ensure that you or your client are at least entering the relationship with some understanding of how it might end.

As a minimum, we suggest that before entering any contract the contract review process includes the following:

• Consideration of what you/your client want out of the commercial relationship and how important it is strategically.
• Proper review of any standard terms and conditions which apply, or may apply, with particular reference to provisions relating to contract duration, notice and termination, including any charges payable on termination.
• Analysis of the risks arising from any restrictions on the ability to terminate as against the commercial benefit of the relationship in the short and long term.
• If required, negotiation of specific terms relating to termination.
• Diarising any key dates for providing notice to terminate, particularly in relation to contracts which roll over at the expiry of an initial fixed term.

You should ensure that those with authority to enter into contracts are aware of the potential significant of the question of termination and carry out the review process set out above. If there is any doubt, legal advice is necessary. Even if negotiation of specific terms is not achievable, it is invaluable to understand the obligations that exist.

Methods of termination

What happens if you or your client are already in a contractual relationship and want to bring it to an end? How can this be achieved, and what are the risks?

Termination under the contract terms and on notice

In the majority of cases, there are specific contractual provisions allowing the parties to bring the contract to an early end. These may apply in certain circumstances (e.g. where a party is at fault) or generally, or that may not apply at all to a particular party. They will almost always require notice to be given, and in many cases where a contract is for ongoing services, there will be specific restrictions on when notice must be given (for example, notice may be required to expire on an anniversary of the contractual start date).

It is essential that a party which wishes to rely on a contractual right to terminate complies with the contractual provisions strictly and precisely. Any notices must be sent by the methods and to the addresses prescribed in the contract, taking account of any provisions for deemed service. Many contracts provide that in the case of termination for fault, a letter outlining the breach must be sent, giving the other party a specified time to take remedial steps. Any such letter should contain as much detail as possible, including the steps required to rectify the breach, so that it can be relied upon at a later date.

Where a contact provides that a contract may be terminated for a material breach, sufficient investigation must be undertaken to ensure that the breach is material. Ideally it would be defined as ‘material’ in the contract; if not, very careful consideration must be given as to the severity of the breach. If it is a technical breach that carries no significant consequences, it would be very risky to classify it as ‘material’ so as to use it as a pretext for terminating the contract. (On this note, it is unlikely that a series of trivial breaches would be cumulatively considered ‘material’.)

Failure to comply with the relevant provisions is likely to result in the notice being held to be invalid, even if the failure to comply appears minimal (such as missing the required date for notice to be served by one day). In this case, service of the notice could be classified as a repudiatory breach (see below). Clearly if you or your client are in receipt of a notice to terminate, you need to check the contractual provisions to determine whether there is any basis to reject the notice and either insist on performance of the contract or claim a repudiatory breach and seek damages.

If the contract is silent as to its term and termination, then the court will probably imply a term to the effect that the contract can be terminated on ‘reasonable’ notice. To determine whether a notice is reasonable, the court will look at the duration of the contract, degree of formality of the relationship, the length of the relationship and the parties’ knowledge and timing of negotiations. Each case will turn on its own facts and the difficulty arises in that neither party will be able to predict with any certainty precisely what the court will consider to be reasonable notice.

Clearly, in such circumstances it is sensible to err on the side of caution and provide ‘too much’ notice rather than ‘too little’: if you can persuasively argue that the notice given is more than reasonable, you will minimise the chance that it will be disputed by the other party. Again, there is the risk that if notice is not ‘reasonable’ in duration, it will not be valid for the purposes of terminating the contract but may be accepted by the receiving party as a repudiatory breach (again, see below).

Before making the decision to serve a contractual notice of termination, you should always check to see whether the contract specifies if any charges will be payable on termination. For example, contracts for services may permit termination by the customer before the end of the fixed term but may also provide that, in such a case, the terminating customer is liable to pay a sum in respect of the charges which the supplier would have raised up to the end of the term but for the termination.

The starting point is that these charges, which can appear penal in nature, would nonetheless be recoverable by the supplier as a liquidated sum. In many cases, contracts specify that a party can request a summary of the fees which would be payable on termination before terminating. It would be prudent to request such figures (on a ‘without prejudice’ basis) before electing to serve a notice of termination. This may in itself prompt the other party to agree some concessions in order to persuade you not to terminate.

Finally, even if a party validly terminates a contract in accordance with the relevant contractual provisions, this will not prevent any claims relating to previous breaches of contract.

Termination for repudiatory breach

In addition to any contractual rights to terminate, a party generally has a common law right to terminate a contract if the other party has repudiated the contract, either by expressly renouncing liabilities (either at the time or in respect of future liabilities), intentionally making performance impossible, or failure to perform an obligation which goes to the root of the contract (including an obligation where time was of the essence). The first and last of these are likely to occur in the current unprecedented circumstances. It is, however, worth bearing in mind that the common law right may be expressly (or in some cases impliedly) excluded by a term in the contract.

Again, it is not always clear whether any particular breach will be so serious as to be repudiatory, and this will depend on the facts of each case. It is relatively unusual for there to be a complete failure in the performance of obligations, and in many cases a number of arguments can be raised on either side as to whether a particular breach in a complicated contract would be repudiatory. Termination for repudiatory breach is therefore inherently risky, and is not something which should be done lightly without a proper analysis of the risks and merits.

As set out above, an invalid notice to terminate a contract can be classified as an anticipatory repudiatory breach. In addition, an allegation of repudiatory breach which, on analysis, is shown to be a breach of lesser significance, can itself constitute a repudiatory breach.

A repudiatory breach will not of itself bring the contract to an end. The party faced with a repudiatory breach must make, and clearly and unequivocally communicate, a decision as to whether to accept the breach and bring the contract to an end (releasing it from future obligations), or affirm the ongoing existence of the contract and (if it wishes) claim damages for the breach. Whilst a party will have some time to make this decision, it cannot reserve its position indefinitely. A party which does not elect to treat the contract as discharged sufficiently quickly risks being deemed to have affirmed the contract, thereby losing the right to terminate.

Termination under the contract, common law or both?

The damages recoverable may vary significantly, depending on whether a contract is terminated by contractual notice or under the common law and this may be a relevant consideration when deciding how to proceed, if both options are open.

When terminating using contractual provisions, the terminating party can maintain a claim for any damages arising out of prior breaches of contract together with any damages (or other charges) specifically provided for in the contract. Where termination is without fault, or based on a breach in respect of which no real damage has been suffered, contractual termination may not entail a significant financial claim.

The position is different when termination is under the common law for a material breach. In this case, a party who terminates can claim damages relating to the loss of bargain it has suffered. This will equate to the value of the benefit it expected to receive over the whole life of the contract, subject, of course, to a duty to mitigate its losses. However, the “least onerous obligation” rule may reduce common law damages if it applies. This rule provides that, but for the repudiatory breach, the court will assume that the defaulting party would have satisfied their contractual obligations in the least onerous manner possible. This will be relevant when the defaulting party would have been able to terminate using the contractual provisions. In such a case, the court will probably say that, but for the breach, the defaulting party would have elected to terminate under the contract as soon as possible. The loss of bargain is therefore likely to be limited to the period of notice the defaulting party would have been required to give to terminate the contract.

It is also worth bearing in mind any clauses (such as confidentiality or restrictive covenants) which are stated to survive contractual termination. Even if you or your client are able to successfully terminate the contract using the contractual provisions, you may find that you or your client are subject to ongoing restrictions which hinder commercial operation. If it is possible to terminate under common law, that discharges you/your client from any ongoing obligations, which may itself be of significant commercial benefit.

If you or your client will be significantly better off terminating under either the common law or the contractual provisions and both options are available, the notice of termination should make it clear which option is being used to avoid any ambiguity. On the other hand, if there is some doubt over the ability to terminate under, say, the common law, the notice may state (if applicable) that the termination is under the contract and the common law.

Rescission

In addition to terminating the contract, there may also be grounds to bring the relationship to an end by rescinding the contract, i.e. treating it as if it had never existed. These grounds arise because the consent of one (or more) of the contracting parties was not valid. We will touch on these grounds briefly.

The most common ground for rescission in the commercial context is misrepresentation – that is, where a party was induced to enter into a contract relying on a false statement of fact or law. Allegations of misrepresentation are relatively common, as all manner of promises can be made during the course of negotiations. However, the prevalence of entire agreement and misrepresentation clauses means that a successful claim may be unlikely. The misrepresentation may be fraudulent, negligent or innocent, and the parties’ rights and remedies will vary accordingly. In some cases, damages may be awarded in addition to or in lieu of rescission.

Rescission may also be available where there is a unilateral mistake, where one party misunderstood the terms and the other party was aware of this at the time.

Finally, rescission may be available where there was undue influence or duress, that is, where a party was improperly compelled to enter into a contract. Such claims are rare, and will require more than simple commercial pressure.

If a contract is rescinded, the parties should be put back in the position they were in before entering the contract. There is no question of damages for a loss of bargain.

Even though there may be grounds for rescission, it will not be possible if the party entitled to rescind has affirmed the contract, if it is not possible to restore the parties to their pre-contractual positions (because, for example, an obligation that has already been performed cannot be reversed) or if rescission would adversely affect the rights of third parties.

Frustration and force majeure

Given current circumstances, there has been much written in relation to the contractual doctrine of frustration and the power of force majeure clauses. This article in particular may assist with navigating these complex legal solutions in the context of a commercial contract.

In essence, it is an implied term of a contract under the law of England and Wales that the contract will be frustrated if performance has become impossible or radically changed by an unforeseen event. However, the rules regarding impossibility are stringent. It will not be enough that performance was made more difficult or the performance could be late, except with regard to contracts where ‘time is of the essence’.

Force majeure (FM) on the other hand is a contractual instrument which can be written into a contract. The rules regarding what constitutes an FM event are considerably more flexible than those for frustration because by its very nature the definition is created by the contracting parties. However, this initial flexibility comes with its own problems because unlike in many civil law jurisdictions, there is no definition of FM in the law of England and Wales, so FM clauses will be read to their exact wording. If the clause does not mention ‘epidemic’, ‘disease’ or some catch-all wording, it is possible that the pandemic will not be covered by such a clause. 

Discharge by release or agreement

It is always possible for the parties to bring about the early end of a contract by agreement. This may be done amicably if circumstances permit (by release, waiver or variation) or may be part of a settlement agreement following a dispute. In the current Covid-19 crisis, where contractual relationships are being put into disarray, this may be a commercially sensible option if parties are intending to contract again once restrictions have been lifted. Relevant contractual principles will apply, so unless consideration is provided (which will include mutual waiver of rights), it may be necessary to formalise the agreement reached in a deed.

How to proceed?

If you or your client decide to end a contractual relationship, the options will of course depend on the circumstances, and may be restricted. In some cases, the reality will be that you cannot unilaterally bring the contract to an end, at least not without committing a breach and exposing yourself to risk of a claim.

Make sure that you or your client fully understand the legal options and the potential risks before simply making a decision to terminate the contract. Some time spent in carrying out a proper analysis may save significant costs and time later. Irrespective of the legal position, there may always be scope for ‘without prejudice’ negotiations and creative commercial solutions, especially in exceptional circumstances.

This article does not constitute legal advice. Specific legal advice should be taken before acting on any of the issues covered.