The coronavirus pandemic and global economic and political uncertainties mean that more businesses than ever are tied into unprofitable contracts or are required to purchase unwanted goods and services. Alternatively, they may find themselves facing refusals to perform contracts by their contractual counterparties. Absent a commercial resolution, companies may need to consider whether and how a contract can validly be terminated. Following on from our blog post on ir/remediable breaches in termination events, in this post we look at termination more generally and set out key considerations to avoid frequent pitfalls.
What is termination?
Termination releases both parties from further performance of their main contractual duties, although the innocent party will retain a claim for damages for breach of contract. Termination can be consensual. If not, a contracting party can (seek to) unilaterally terminate by accepting a counter-party’s refusal to perform as a ‘repudiation’ of the contract to bring it to an end, or by using contractual termination rights. The route that is chosen may have an impact on the damages that can subsequently be claimed.
Unilateral termination invariably creates legal risk. Whether there is a right to terminate is often not clear-cut and may be disputed. It is also possible to waive and irrevocably lose a right to terminate, sometimes not expressly but through delay or by conduct such as continued contractual performance or by making demands for performance (‘no waiver’ clauses can mitigate this risk but are not fail-safe). Innocent parties typically have a ‘reasonable’ time to evaluate a breach and decide whether or not to terminate however, assessing what is ‘reasonable’ can be difficult to determine.
Terminating without legal justification, or terminating without following the correct procedure, may be ineffective and worse, may be a breach of contract entitling a counterparty itself to terminate and seek damages for any loss that it suffers.
Companies need to be mindful of these risks when trying to extricate themselves from contractual obligations (or when dealing with other parties not performing). The existence of termination rights, and termination strategy, can be highly complex areas to navigate, particularly if a contract contains ‘cure provisions’ requiring a defaulting party to be given the opportunity to change course.
The consequences for getting termination wrong can be costly, and sometimes more burdensome than the cost of performing the contract in the first place.
The factors to consider before terminating will depend on the contractual terms and the circumstances, but may include the following:
- Preserve the right to terminate whilst evaluating the position, and avoid taking steps that will affirm the contract (unless the goal is to maintain the contract) – reserving rights is not always effective (eg if your actions give a contrary message) but helps to buy some time to consider the position.
- Clarify the factual position – there may well be disputes as to whether the events said to justify termination actually happened.
- Assess the contractual position and the legal grounds for termination – local laws may sometimes be relevant, in addition to the contractual position.
- Evaluate the implications of termination versus continued performance.
- Consider whether a ‘cure notice’ to remedy a breach is required – many contracts allow termination only after a breaching party has had a chance to remedy the breach within a specified time.
- Consider giving notice of intended termination – this can help to demonstrate that a terminating party gave its counterparty every opportunity to perform before terminating.
- Do not delay making a decision – while parties will be able to reserve their right to terminate for some time in order to evaluate the factual and legal position, that right may be deemed to have been waived if not exercised in reasonable time.
- Follow contractual procedures and clearly communicate termination.
- Above all, assess your options with the benefit of legal advice.