Contract termination in today’s uncertain market

Commercial considerations on terminating contracts

Assuming that grounds for termination have arisen (as to which, see below under ‘Legal considerations on terminating contracts), the following commercial and practical considerations arise:

Is termination a commercially practical decision?

This will depend on the particular business, 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 sue for 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.

Alternatively, it might be more favourable for the business to explore suspension, re-negotiation or alternative dispute resolution [1].

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? This 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’s essential to ensure a legal basis for termination.

The business should consider, and take specialist advice on, the specific contract and all relevant circumstances. It’s vital to ensure termination is executed validly, and to avoid or minimise the risk of 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?

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 many cases, service of a termination notice will be required. The valid and effective service of legal notices is a potential minefield.

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 on 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 unwritten, but nevertheless binding, contracts which may be agreed orally or even implied through a course of dealings. (See our earlier briefing for information and advice on informal contracting [6].) There are myriad factors to consider when terminating such a contract. What’s required, in particular the length of any notice period, will differ depending on the specific facts and circumstances. Parties shouldn’t 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’s ‘reasonable’ will differ on a case-by-case basis.

Where onerous contracts have been identified as part of a due diligence process and termination has been recommended as a post-completion action item, your legal advisors should provide a detailed assessment of the legal mechanisms that must be complied with, as well as the risks involved with such termination. This may be included in the legal due diligence report, or discussed with the buyer separately (often with input from the Buyer’s FDD provider). Either way, detailed consideration must be given to the legal steps of the termination process to avoid any unnecessary liabilities or the risk of a costly wrongful termination, and an easy post-completion termination should not just be assumed.

Contract termination: Practical solutions

Bearing in mind the extensive commercial and legal considerations, not to mention the traps for the unwary, urgent specialist legal advice should be sought immediately once the prospect of contract termination is mooted.

Once a termination strategy has been settled upon, all business colleagues/teams/departments, 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. 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 you’ve obtained the best possible guidance before deciding and proceeding to terminate any commercial contract will help 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.

Similarly, if and when your business finds itself on the receiving end of any contract termination notice or action, we can critically assess validity. We can provide commercially-focused strategic advice 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 Kathryn Vickers or Nick Attwooll, who will be very happy to help.