A guide to managing underperforming contracts - part 2: termination

In an earlier article, we looked various strategies to try to turnaround contractual performance and the potential benefits. If however the contract cannot be turned around, then termination is more likely to be on the cards. If there is one message to take away on the subject of termination, it is Benjamin Franklin's wisdom: "If you fail to plan, you are planning to fail." 

The potential benefits of a carefully managed exit can include minimising risk (financial, operational and possibly reputational), saving costs and management time and preserving relationships.

In developing an exit plan, there are 3 key questions to ask upfront:

• Can we terminate?
• What are the consequences?
• How do we do it?

Can we terminate?

The first step is to assess whether you have a contractual right to terminate.

Termination on notice

Commercial contracts often include a range of provisions allowing parties to terminate, for example: no fault termination on notice for convenience. The upside of this sort of provision is that you can terminate on good or bad grounds or no grounds at all. You do not need to worry about whether you can show that the other party has breached the contract. A notice period will give you opportunity to put in place a new arrangement with another party if needed. The downside can sometimes be that parties wish to exit more speedily than a notice period allows.

If you cannot terminate immediately (eg for breach), but wish to do so more quickly than the contractual notice period, you may wish to explore in a without prejudice negotiation with the counterparty to see whether they will agree to end the contract earlier by mutual consent. They may be willing to agree to this if it frees up their resource to work on other contracts or perhaps in exchange for certainty eg a swift compromise of any claims one or both of the parties may have. If they do, you can then record the agreement on an open basis.

Care should be taken over certain contracts where the counterparty has rights which may not necessarily reflected in the written contract. For example, commercial agents have the right to a minimum notice (and possibly exit payments).[1]

Termination for breach of an express term

Contracts often allow for termination for material, substantial or irremediable breaches. Typically they provide for immediate termination in those circumstances.

You should check your contract to ensure that it does not give the counter party an opportunity to cure or remedy the breach within a specified time. If it does, then you need to follow that process. (In this sense, "remedy" doesn’t mean all damage past and future damage needs to be put right). [2]

Note that in a consumer contracts, any term that unfairly prejudices the consumer (including an unfair termination provision) may be invalid.

If you wish to terminate for breach of an express term, then you should firstly gather and assess the evidence that establishes breach. That process should reveal the strength or otherwise of your case. Sometimes it shows that in reality, one party has simply misunderstood the other's (or their own) obligations.

Could we terminate for breach of an implied term?

The best thing to do first is to analyse whether you can terminate for breach of an express contractual term or whether you have a common law right to terminate. The Courts will not imply a term into a contract to make it fairer or more reasonable[3]. The question is whether the term is necessary to give effect to parties intentions or to achieve their objectives in entering into the contract. (Or to put it another way, in the absence of the implied term, does the contract fail to deliver the bargain which the parties had agreed?[4]) It is a high test.

Change of control of the other party

If you are struggling to prove breach, then this sort of contractual provision may give you an alternative escape route. The reason these clauses tend to be included is so that the new owner of the counterparty maintains focus on performing the contract and does not compete with your business.

Adverse judgment

This is a contractual provision entitling one party to terminate where the other party has a judgment entered against it in the civil proceedings which remains unsatisfied for a prescribed period of time (eg 28 days). It can be worthwhile carrying out a search to see if such a judgment exists.

Insolvency of the other party

There is often provision for you to terminate if the other party becomes insolvent or is at risk of insolvency or stops trading. If this happens, then it's more likely that the other party has not paid in which case you may also have grounds to terminate on that basis.

What if my contract does not include any express termination rights?

The law does not generally provide you with any right to terminate for convenience. However, in certain contracts such as employment contracts, there may an implied term allowing termination on reasonable notice.

If a commercial contract lasts for a fixed term within an agreed termination date, it would be hard to argue that it can be terminated on reasonable notice.

Certain types of breaches can give the agreed party the right to terminate the contract. These include:

• Breach of a condition. (Whether a term is a "condition" for this purpose is whether the parties must have intended to confer the right to terminate for any breach of it. The label in the contract is relevant but not conclusive).
• Repudiatory breach of an intermediate term. (Does the breach deprive the other party of substantially the whole of the benefit of the contract?); or
• Renunciation. (A party's refusal to perform all or substantially all of its obligations under the contract).

Could we lose the right to terminate?

Yes. If it has been a long time since the breach occurred, this increases the likelihood that the other party may argue that you have waived your right to rely on the breach or that you have acquiesced in their conduct. This can happen if by words or actions you have indicated that you choose to be bound by contract. In each given case, it is therefore important to assemble and assess the relevant evidence about this.

If the other party has breached the contract and you wish to avoid waiving the breach whilst you consider your options, you should write to them to reserve any contractual rights and remedies, including to terminate for breach.

Arguments about waiver are often accompanied by an argument that the parties agreed to vary their contractual responsibilities. In many contracts, there is an anti-oral variation clause ie a provision which states that the contract can only be amended by a written document in a prescribed form signed by both parties. In two recent Court of Appeal decisions, the Court:

• Acknowledged that anti-oral variation clauses can be said to promote certainty eg "can usefully prevent a person in a large organisation producing a document which unwittingly and unintentionally is inconsistent with a provision in a contract…"
• Recognised that parties retained the freedom to depart from the original contract and that applied to the subsequent variation of the original contact.

The takeaway point is that the fact that the parties initially agreed to an anti-oral variation clause does not prevent them from subsequently making a new agreement to vary the contract by an oral agreement or by conduct.[5]

In the Globe decision, Moore- Bick LJJ suggested that the effect of anti-oral variation clause may increase the burden of proof in relation to the establishment of a variation. That view was not endorsed in MWB. For the time being, our view is to leave anti-oral variation clauses in contracts, but be aware of their practical limitations.

What happens if I terminate wrongfully?

Ordinarily, the other party would be entitled to damages for your breach. The measure of damages would be as if the contract had been performed. Wrongful termination is an area that is ripe for disputes. You should take legal advice about the strength of your position and the consequences of getting it wrong before terminating.

The consequences of termination

If you are satisfied that you can terminate, then before terminating, it pays to consider the potential consequences. Termination excuses the parties from further performance of their main obligations. Your secondary obligations will survive. Accrued rights survive termination and are still normally enforceable. Some exclusions of liability also normally survive termination (although that is a matter of interpretation in each case). The issues that arise will depend upon the nature of the contract eg whether it is for goods or services. They include the following:

• Who is going to pay for the costs of exit?
• TUPE 2006. Where parties terminate a supply of services agreement or an outsourcing agreement transferring the provision of services to a customer or third party, this may constitute a relevant transfer for the purposes of TUPE. If that is relevant to you then you should factor in the impact of the costs of that.
• You may have to return (or seek the return) of confidential data or other property.
• Consider whether you have any intellectual property that needs to be protected (and if so how that will be done) and vice versa.
• Consider whether there are any non-solicitation provisions in the agreement expressed to survive termination and how you will monitor yours or your counter party's compliance.
• If the contract involved includes personnel on your site, consider the practical issues of security and whether any passes that need to be surrendered?
• How will you implement effective hand over? Can any background preparation be done in advance of serving a termination notice? How important is it to maintain the cooperation of the counterparty? Does the contract require a formal exit plan to be negotiated?
• If you have supplied goods, are you likely to get paid or to be able to collect them? More on retention of title is here
• Oral indemnities tend to survive termination. If you have given any indemnities, you will need to remind the relevant stakeholders that they need to ensure compliance. Conversely if you are the beneficiary of indemnities, you may wish to satisfy yourself that the counter party is still good for the money
•  Possible reputational issues. This will depend upon the nature of each party's respective business and the contract concerned.

Finally, you should consider what you are going to replace the contract with. Is another business partner being lined up to provide a similar service or product? How essential is it? What is the selection process? How long will it take to come on stream? How can you be sure that their product or service will be better? How will any lessons be learned from your current situation? You should prepare a plan to prevent or reduce your loss. You will not be able to recover damages which could have been reasonably avoided.

All of the above sorts of consequences should be a assessed, prioritised and fed into developing an exit strategy. You can then better answer whether termination will deliver your commercial and strategic business needs.

How to terminate

If you serve notice to terminate, then you should comply strictly with the provisions in the contract which sets out how that needs to be done. Although minor defects may not always invalidate the notice,[6] uncompliant notices may have no effect.  Serving an ineffective notice of termination could amount to repudiatory breach of the contract – it shows you have an intention to stop performing it.

Once given, you cannot revoke a termination notice. Once a contract has ended, no party can revive it without the consent of the other party.

In certain types of contracts there are statutory provisions dealing with the services of notices (eg property contracts). If a contract is silent on a point, then there is not any particular form of notice to terminate a commercial contract under a clause in the contract. The notice needs simply to be clear and unequivocal. Best practice is to state the date when you are terminating from, under which contractual provision (or whether it is a common law termination) and set out the details of the alleged breach. If you are claiming damages, then you should ideally set out the details.

You should collate and preserve evidence of the grounds for termination, document those grounds clearly, including any chance to cure a breach and keep records of all communications with the other party about termination. This will give you an advantage if there is any subsequent dispute.

You may wish to try to meet the counterparty to resolve the matter. If you do, then you could accompany your termination notice with a separate without prejudice communication to suggest a meeting.