Termination fees in business-to-business contracts

In commercial agreements, imposing termination fees is a useful tool. However, a termination fee that reflects lost profit or future fees needs to be very carefully drafted to avoid a challenge by the customer on the basis that the supplier is trying to extract an advantage that is disproportionate to the impact of the early termination.

This article breaks down the modern legal standard for compensation for early termination in business-to-business contracts, how to navigate conflicting clauses and why updating your contract language is essential for protecting your commercial interests.

Why do we use agreed termination fees?

In modern commercial contracts, suppliers use agreed termination fees to provide their customers with the flexibility they demand while mitigating the losses those suppliers may incur from early termination.

When can this fee be challenged?

Under English law, an agreed termination fee isn’t automatically vulnerable to challenge simply because it doesn’t follow a precise mathematical formula. Following the landmark Supreme Court ruling in

Cavendish Square Holding BV v Talal El Makdessi [2015], the courts have moved away from the rigid requirement of a ‘genuine pre-estimate of loss’.

Instead, the modern test looks at whether the fee imposes a detriment that is out of proportion to the company’s legitimate interests in enforcing the relevant contractual obligation. A sliding scale may be easier to justify commercially where the percentages reflect increasing exposure as the service commencement date approaches. However, the supplier must be able to substantiate the quantum of these amounts if requested to do so.

While a customer remains entitled to request an explanation, the clause is more likely to be upheld provided the percentages can be justified as proportionate to protecting the company’s broader commercial risks.

Loss of profits and liability exclusions

A tension arises where a supplier wishes to include an element of lost profit in the termination fee, but the contract’s general liability clause explicitly excludes loss of profits.

Under English law, courts interpret contracts as a whole to find the true commercial intention of the parties. A limitation of liability clause is generally understood as a rule governing what happens if a party sues for unliquidated (unspecified) damages. In contrast, an agreed termination fee is viewed as a specific, bespoke remedy for a defined event, although this depends on the exact wording and structure of the contract.

Following the established Gilbert-Ash principle (Gilbert-Ash (Northern) Ltd v Modern Engineering (Bristol) Ltd [1974]), English courts presume that parties do not intend to give up valuable contractual rights, such as an explicitly agreed termination debt, unless the contract uses clear language to that effect. A general limitation clause will not automatically extinguish a specific agreed termination mechanism unless the drafting explicitly states that it does.

However, where an amount is payable on termination, any limitation of liability clause should be carefully drafted to remove ambiguity, ensure the specific remedy takes precedence over the general exclusion and avoid tension between the two provisions.

The danger of outdated language

A concern arises if the terms use wording along the lines of ‘genuine pre-estimate of costs’. This wording frames amounts payable on termination purely as a cost reimbursement, rather than compensation for the loss of future fees or profits, potentially restricting recovery strictly to out-of-pocket expenses.

A better approach is to frame amounts payable as an agreed ‘price’ for the customer’s exercise of its termination right. This requires careful alignment of the supplier’s and customer’s rights, making it more difficult to challenge the provision as disproportionate or unfair.

Conclusion

Managing the risk of contract cancellations requires strict alignment between your financial expectations and your contract’s language. If your terms contain conflicting clauses or rely on outdated, cost-only legal definitions, you risk leaving your profit margins unprotected.
By updating your wording to reflect the modern ‘legitimate interest’ standard and introducing clear carve-outs, you remove ambiguity for your clients, safeguard your revenue and improve the prospects of enforceability under modern English law.