How to terminate a contract - Part 2 - No Breach

Even if there is no breach of the contract, then the law won’t tie us to it forever. There may be additional grounds that it would be unreasonable for us to continue. Some of them may be more often seen and easier to show than others, but they can be worth considering in cases of doubt. This part 2 follows up part 1 where we considered how to terminate for breach of contract.

How to terminate a contract - Part 2 - No Breach

1. What does the contract say?

Just like where we were claiming that there was a breach of contract, our first step is to look at the contract itself.

a) Expiry/performance

Fairly obviously, the contract may come to an end naturally either when delivery or performance is completed, or just after a certain length of time. We should be on the lookout for “evergreen” clauses where the term can automatically roll over unless either party gives notice. We’re assuming that we have arrived at this position as we don’t want to wait for the end of the initial or extension period that is in place. But if we can, then clearly we should give notice in the required form, place and time at the next opportunity. Possibly only the most organised will diarize these dates, though we really should. We can’t always avoid ongoing payments for unused services or minimum volume commitments but if when drafting the agreement we can, then the urgency to terminate will be reduced later.

b) Convenience

Some contracts give one party or both the right to terminate for convenience or for any reason (or “no reason”). If so, then as above we should give notice using the required methods. Note that this may not always be a “get out of jail free” card. If the other party has been logical, then this right should come with an obligation to pay at least the time and materials spent on the project up to the date of termination and any other unrecoverable costs (usually third party services and products that needed to be contracted in order to perform our main contract). There may also be termination payments, although these need extra care as they could constitute an unenforceable penalty. If the contract is a “commercial agency” contract (where one party promotes the goods – or sometimes services – of the other) then termination payments are very likely to be due – Eden Legal will return to this in another post. Note also that under the UK Consumer Rights Act, termination rights or payments that are unbalanced to the detriment of the consumer may be unenforceable.

c) Force majeure

What we are really dealing with here is a failure by one party to perform its obligations on time or at all, but one that we have agreed to excuse to the extent that it is caussed by unforeseen events. If the event or non-performance continues for a particular period of time then we will often see a right to terminate in order for the unaffected party (usually the customer or buyer) to obtain performance elsewhere. We will want to tailor the period to the reality of the length of time we can wait and also any lead-time in on-boarding another supplier.

d) Insolvency

For very apparent reasons we often would not want to continue to do business with a now insolvent (or bankrupt) person. So we may want a broad clause in our contracts that enables us to terminate as soon as possible after we become aware of this risk. Conversely, in quite a few places (Spain is one) this may be void or restricted as the law favours trying to continue to do business under the contract if this might give the ailing party a fighting chance of survival. We do see alternative rights of termination due to “financial or reputational risks”, which might be ways of achieving the same result, but need additional care if we are effectively saying the same thing using different words.

These clauses range from simple “unable to pay their debts as they become due” to complex laundry lists of different types of, or steps in, proceedings that we want to class as “insolvency” (winding up, appointment of administrators, compromises with creditors, charges over assets, threatening to cease business etc. etc.). As ever, we’ll want to ensure that the circumstances at hand are actually covered by the clause. If the clause is particularly generous to us, permitting us to terminate if we “reasonably suspect” any of these issues, then at least we’ll want to have (and keep on file) some evidence to back this up.

e) Change of control

Some contracts allow a party to terminate if the other undergoes a “change of control”. This can be perfectly reasonable if the new owners/controllers might be competitors of the other party and so obtain access to that other party’s confidential information. Or if they are in a place or on a list of persons embargoed under international law. Or if they for some other objective reason are unacceptable people for us to do business with. But a blanket right to terminate for any change of control at all can be disproportionately broad and open to misuse. These clauses deserve some thought: should this right be automatic or subject at least to some obligation to act reasonably? Should transfers between existing shareholders be excluded? How do we define “control” – share ownership, board control, de facto control? A reference to the definition of parents and subsidiaries in the local companies legislation may be clear enough.

2. The contract doesn’t say anything (or we don’t like what it does say)

Sometimes we may find ourselves looking for another reason. The law will rarely give us carte blanche to do what we like (particularly where we have agreed to do something else). These grounds can be legally esoteric and often applicable only in highly unusual cases and where there is a manifest injustice in allowing the contract to continue. However, they do exist and if nothing else may help concentrate our minds when drafting the contract in the first place.

a) Frustration

A contract is “frustrated” when something happens after we make our contract that makes it physically or commercially impossible to fulfil it (or radically or fundamentally changes the nature of what was agreed to be done).

It’s limited to quite specific situations and this is why contracts often contain force majeure or hardship clauses which are (or should be) more specifically tailored to the particular transaction. So frustration is not so often claimed and the existence of these clauses may exclude its application, as the parties have already considered and made arrangements for future changes in circumstances.

Where it does apply, in reality frustration is not something that we can choose – either the contract has become impossible or drastically changed, or not. And a party cannot rely on it if they are at fault for the event complained of. The classic examples are destruction of something on which a contract is based (a premises, particular unique goods), changes in the law, cancellation of a particular key event, or abnormal delays truly outside the normal expectations of the parties.

b) Illegality

There are some contracts that are not enforceable if they relate to illegal behaviour (commission of a crime, but also a tort) or – more likely in business – on the grounds of public policy (e.g. anti-competitive agreements, including non-compete clauses, which deserve a post all to themselves).

c) Mistake/Duress/Undue Influence

It’s worth also briefly mentioning some legal theories that are not strictly rights of termination but which can apply where there has been some problem in the making of the contract that would make it unfair for it to be upheld.

Certain types of mistake (but only certain types) may fall into this category, e.g.:

  • common mistake where both parties contract in the common belief that something is true (the item being sold being in exisence, an event going to happen etc.) when in fact it turns out not to be;
  • mutual mistake where each party believes something different is true, so there is no true agreement; or
  • unilateral mistake regarding the subject matter, or the identity of the other party.

The court may also rectify the contract or uphold it if it can still reasonably be performed. It’s worth recalling that mistakes by a buyer regarding the potential value of a contract or just bad deals (that aren’t induced by any misrepresentation or fraud by the seller) don’t normally entitle the buyer to terminate.

Finally, even if we have “consent” to a contract, then if such consent was obtained through a threat of violence or other harm then the contract may be voidable by the innocent party. Contracts entered into as a result of abuse of a relationship of trust and confidence may also be voidable.

d. None of the above

If we have an apparently indefinite contract then we may still be able to terminate on “reasonable notice” – see more explanation here.

3. Conclusions

These rights exist for good reason: even if there is no breach of contract then there are times when the law should help avoid unfairness by allowing us to terminate for other reasons. On the other hand, a properly considered and well drafted contract should contain reasonable termination rights that enable the parties to terminate in most foreseeable circumstances. It’s normally better to agree something clear at the outset rather than later having to rely on limited and sometimes theoretical grounds under the general law, which can involve assessments of fairness by the courts and lead to time and resource-consuming arguments. Rhetorical question: In the case of Prevention Inc. vs Cure Corp. who had the lower legal costs?

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