A Practical Guide to Contract Termination

A Practical Guide to Contract Termination

A vast number of disputes, often involving significant damages claims, arise out of the allegedly wrongful termination of contracts.

Despite the potentially significant consequences of a wrongful contract termination and the relative complexity of the legal issues in-play, in-house lawyers are often tasked with drafting termination notices at short notice.

Below are some practical tips for in-house lawyers dealing with the termination of contracts, to increase the chances that their termination notices are lawful and achieve the desired result:

  1. Identify all potentially available termination rights

There may be a number of termination rights available in any given situation.

It is important to consider both: (i) express termination rights set out within the relevant contract (which may include, for example, a right to terminate on giving a particular period of notice and/or a right to terminate for material breach and/or upon insolvency); and (ii) the common law right to terminate if the contractual counterparty commits a repudiatory breach of contract (although this may be excluded by the terms of the contract).

The most common example of a repudiatory breach is where a party commits a breach of contract which deprives the other party of substantially all the benefit which the parties intended that party to receive under the contract. This is a high threshold to meet. A termination notice based upon a repudiatory breach should set out clearly why the breach in question is repudiatory.

  1. Consider whether the contract has been affirmed

Where you are considering terminating a contract on the basis of the contractual counterparty’s breach of contract, you should ensure that the contract has not been affirmed (i.e. treated as continuing to exist) by someone in your organisation after the breach took place. If the contract has been affirmed, the right to terminate has likely been lost.

In the context of a repudiatory breach, the decision as to whether to terminate is characterised as an election between: (i) “accepting” the repudiatory breach and terminating the contract; and (ii) affirming the contract. If the contract is affirmed, it cannot then be terminated.

Whether or not there has been a repudiatory breach, whilst you are determining whether to terminate, consider whether you should expressly reserve your organisation’s right to terminate the contract, in accordance with its terms and at common law. This may reduce the chances of the contract being deemed to have been affirmed before the termination notice is sent. Note, however, that there is no guarantee that this will prevent affirmation and, the sooner a termination notice is sent, the less likely it is that the contract will have been affirmed.

  1. Consider the consequences of exercising the termination rights available

You should consider carefully the consequences of exercising each of the available termination rights, as this may inform your decision as to which one to rely on.

For example, where you have the option of terminating without cause on giving a particular period of notice, pursuant to an express term of the contract, that is lower risk, in the sense that you do not need to demonstrate a breach of contract by the contractual counterparty.

However, this should be weighed against the fact that when terminating on that basis you are unlikely to have the right to claim “loss of bargain” damages, i.e. damages arising out of the termination of the contract. “Loss of bargain” damages will usually be available if you terminate lawfully on the basis of a repudiatory breach (but not a non-repudiatory breach).

  1. Consider relying on multiple termination rights in the alternative

Where there is more than one termination right available, it may be advisable to rely on multiple rights in the alternative. However, this is only appropriate where the termination rights being exercised have consistent consequences. If they do not, you should choose between the available rights.

  1. Contractual termination rights: check whether you need to send a “notice to cure” first

Some contractual termination rights require the innocent party to serve a notice requiring the other party to remedy the breach within a certain time period, before proceeding to termination. Those provisions (along with any other procedural requirements set out in the contractual termination provisions) should be strictly complied with.

  1. Common law termination: take particular care with multi-party contracts

There is surprisingly little judicial authority on whether a common law right to terminate for repudiatory breach is available where there is a multi-party (as opposed to a bilateral) contract. Keep in mind that the right to terminate at common law may be unavailable where it would be unworkable in practice or produce a wholly unreasonable result.

  1. Check whether there are any particular “notice” requirements

A contract will often contain procedural requirements which apply to notices sent in relation to the contract, which may prescribe to which address the termination notice should be sent, and by what method (e.g. post, email), amongst other things. When sending a termination notice, ensure that these provisions are complied with.

  1. Ensure that the termination notice is drafted clearly

It goes without saying that the termination notice should make clear that the right to terminate is being exercised and should set out the grounds for termination.

In many cases, terminating a contract requires careful consideration and drafting, and seeking specialist legal advice as to the available bases for termination and the drafting of the notice is advisable.

If you would like more information on Contract Termination or related issues, please contact one of our Commercial Litigation team.

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