Terminating contracts: Key considerations

Commercial considerations on terminating contracts

Assuming that grounds for termination have arisen (as to which, see below under ‘Legal considerations on terminating contracts), there are a number of key commercial/practical considerations when it comes to contract termination, such as:

• Is termination a commercially practical decision? This will depend on the business in question, the stage of any ongoing projects or commercial/supply chain arrangements and other factors such as any third party commitments or deadlines which may be impacted from the contract termination. Where a party is in breach of any contract term[s], it might be more commercially favourable for a business to sue for damages or, if the breach is a particularly serious one, to rescind (set aside) the contract and suing for unlimited financial compensation as well.

• Has the business considered alternative solutions? Depending on the circumstances, the contract itself may provide strategies which may offer flexibility and/or commercial assistance. These might include (non-exhaustively) price adjustment clauses, variation/no-oral modification clauses, and material adverse change clauses. It may, alternatively, be more favourable to explore suspension, re-negotiation or alternative dispute resolution [1], for example.

Specialist strategic advice will enable businesses to settle upon the best course of action.

• Is the business prepared for the consequences of contract termination? There are multiple considerations here.  Has an alternate contractor/supplier/customer been sourced and prepared to ensure a smooth transition?  Has the business considered the impact of contract termination with respect to other commercial relationships or stakeholders, or even the counterparty itself (if the business has other projects or arrangements ongoing with the same counterparty)?  Has the [imminent] contract termination been notified across the entire business?  The latter is important because if one part of the business continues to correspond, engage or do business with a counterparty when another part has sought to terminate, the business overall can be taken to have ‘affirmed’ the contract, which undermines the contract termination attempt altogether [2].

Legal considerations on terminating contracts

Alongside commercial considerations, it is essential to ensure, when it comes to contract termination, that there is a legal basis for termination. The contract in question, and all relevant circumstances, should be carefully considered to make sure termination is executed validly, and to avoid or minimise the risk of that consequential counterclaims from the terminated party. In particular:

• What type of contract termination is available/appropriate? The legal and practical steps involved in terminating a contract will differ according to whether the terminating party is relying on: an express contractual termination provision or break option; a common law right to bring an implied contract to an end; a repudiatory breach by the counterparty; force majeure; or the doctrine of frustration [3].

• Has a termination event occurred? This is critical. In some cases it may be clear and uncontentious that a contractually-specified termination or force majeure event has occurred.  In others, a higher degree of assessment and interpretation may be required – for example where a termination provision permits an element of subjectivity or discretion on the part of the terminating party, or where a breach has occurred but may be inconsequential or easily remedial.

• When did the termination event occur? This can be a crucial question.  Depending on the particular contract, a party may not have long to exercise a right of termination. Prevarication or delay may result in affirmation of the contract, and the right to terminate being lost [4].

• Has termination notice been validly served? In very many cases, service of a termination notice or notices will be required. The valid and effective service of legal notices is a potential minefield in itself.  Any termination provision, and all related provisions and service of notice clauses within the contract must be read in full and in conjunction with each other. Questions to consider (non-exhaustively) include: What type[s] of notice[s] is/are required? How much notice is required and how is the notice period to be calculated? How, exactly, must the termination notice be served? Does the contract contain provisions as to what is considered deemed service? Is there a required form of notice?  Does the contract detail how many business or calendar days need to elapse between, say, a notice of intention and notice of termination? And so on.  [5]

• What happens if the contract is unwritten? Surprisingly often, businesses  inadvertently enter into unwritten, but nevertheless binding, contracts which may be agreed orally or even implied through a course of dealings. (See our recent briefing for information and advice on informal contracting.)There are a myriad of factors to consider when terminating such a contract. What is required – in particular the length of any notice period – will differ depending on the particular facts and circumstances.  Parties should not assume that termination can occur instantly.
• What about the duty to mitigate? Even where a party is terminating because its counterparty has committed a breach of contract, the innocent, terminating party may be under a legal duty to take reasonable steps to mitigate its loss. What is ‘reasonable’ will differ on a case-by-case basis.

Contract termination: Practical solutions

Bearing in mind the extensive commercial and legal considerations, not to mention the traps for the unwary, which should be taken into account when terminating contracts, urgent specialist legal advice should be sought immediately the prospect of termination is mooted.

Once a termination strategy has been settled upon, all colleagues/teams/departments throughout the business who may deal with the counterparty in question should be informed and advised as to the position.

Measures should be taken to deal with the commercial and legal effects of contract termination. For example, alternative arrangements should be put into place to minimise disruption to ongoing projects/operations. Arrangements should be made to ensure compliance with any provisions or obligations which survive termination (concerning confidential information, or the possession or use of the counterparty’s intellectual property, for example).

Specialist solicitors should then prepare and issue any necessary notices on the business’ behalf, to minimise any risk of invalid drafting or service.

Clear records and a paper trail should be kept to evidence the fact and circumstances of any breach or other event giving rise to the right to terminate. Records and evidence of the financial and commercial effect of any breach or termination event should also be maintained, in case the contract termination is challenged and needs to be explained in any subsequent dispute or litigation.

Solicitors should handle all communications – internal and well as external – concerning the decision to terminate and the termination itself. Again, this is in anticipation of a challenge to any aspect of the termination, and should help to preserve legal privilege in all relevant documents and communications.

How we can help with terminating contracts

Ensuring that you have obtained the best possible guidance before deciding and proceeding to terminate any commercial contract will help to ensure the best result for your business. Our Commercial Dispute Resolution specialists are experienced and expert in navigating contractual termination queries and dealing with the drafting and serving of notices.

In the same vein, if and when your business finds itself on the receiving end of any contract termination notice or action, we can critically assess validity. If necessary, we can provide commercially-focused strategic advice so as to ensure minimal disruption and losses to your business.

So, if your business needs advice, assistance or training in relation to contract termination, or if you have any queries or concerns in connection to any commercial contracts more generally, please contact Louise Norbury Robinson or Kathryn Vickers,  who will be very happy to help.

[1] See Walker Morris’ recent briefing on ensuring effective dispute resolution

[2] Even worse, affirmation often leads to the counterparty then alleging repudiatory (i.e. serious/devastating) breach of contract on the part of the business which sought to terminate.  Repudiation can leave a business open to recission of the contract, plus a claim for damages relating to what the injured party would have made if the contract had remained in effect

[3] See Walker Morris’ earlier briefings on force majeure and frustration

[4] A very recent example of this occurred in the case of DD Classics Ltd v Chen [2022] EWHC 1404 (Comm)

[5] See Walker Morris’ briefing for advice as to the ‘who, when and how’ of service of legal notices (including termination notices)