How to terminate a commercial contract — avoiding the pitfalls

Part and parcel of owning a business is the sourcing, negotiating and entering into contracts with third parties, whether that be for the provision of goods or services, or something else.

Grounds for terminating a contract

If everything runs smoothly and the contract is performed, then there are no issues. However, if one party is looking to terminate a contract, there are two main ways this can be done — either by exercising a contractual right to terminate, or by terminating for a breach of contract which is sufficiently serious — also known as repudiatory breach.

If your company is the innocent party then it may be entitled to claim damages for repudiatory breach.

Before addressing these two instances, it is also possible to terminate a contract by mutual agreement or consent.

Terminating a contract by mutual agreement or consent

There are a number of reasons why some contractual relationships do not work, or go wrong. In some circumstances, it may be possible for the parties to agree between them that the contract is terminated, either immediately or contingent upon a certain event happening. Sometimes, you can negotiate terms to terminate a contract that work for all parties and this then avoids disputes arising and can preserve the commercial relationship. Any such agreement should be recorded in writing as well as the negotiations leading up to it, seeking advice from a specialist solicitor if required.

Exercising a contractual right to terminate

1.Termination Clause

Broadly, most commercial contracts require one party to give notice to the other of their intention to terminate. Even if a contract is for a fixed term, some can stipulate that a party wishing to terminate will need to provide express written notice of that intention, which is usually set out in the termination clause of the contract. If you are looking to end a contract upon the expiry of its term, check the definitions within the contract carefully, as well as the termination clause and the notice requirements.

If the contract sets out a termination clause that allows a party to terminate upon giving written notice, check the terms carefully and give the required notice to the other party, ensuring compliance with the notice clause.

Ineffectively terminating a contract, or acting in breach of the notice requirements may result in a dispute and lead to a claim for damages being brought against you. Therefore, before taking any steps to terminate, seek legal advice to ensure the contract can be terminated without recourse on you.

2. Force majeure clause

Some contracts contain a term which would give a party a right to terminate a contract if another party cannot perform it due to an event outside of its control. Again, check the wording of the contract to ensure you are entitled to terminate in the circumstances.

3. Frustration

Frustration is when an unforeseen event happens which means the contract terms have changed considerably from what was agreed and it is no longer possible for either party to complete it and so both parties are discharged from their obligations and the contract is terminated.

Repudiatory breach of contract

Aside from exercising a contractual right to terminate, in some circumstances, you may be looking to terminate a contract due to a breach i.e. terminating for a cause. In other words, if the other party to the contract is in breach of a term of the contract, that may entitle the other party to terminate the contract, sometimes referred to as repudiatory breach.

What this means is that one party has breached or continues to breach a material term of the contract i.e. by failing to perform its obligations under the contract, entering an insolvency process or breaching confidentiality.

In this situation, the party looking to terminate the contract for repudiatory breach may be entitled to do so, and pursue a claim for damages arising out of the breach.

Repudiatory breach is a serious breach of the contract and must go to the heart of it, depriving one person of the benefit of the contract. For example, refusing to or not being able to perform the primary function of the contract may amount to repudiatory breach.

If you have, for example, signed up to a contract for the supply of services, and your view is that the services are not being provided fully or up to a required standard, it may amount to a repudiatory breach. However, terminating a contract in these circumstances requires careful consideration.

Other reasons to terminate a contract 

If you're still within the fixed term of a contract and you are looking to exit the agreement, and the other party is not in breach of the contract, you should exercise great care when considering your options. Terminating a contract without cause or without agreement can have serious consequences as the innocent party may be entitled to damages arising out of the breach.

For example, if you have signed up to a three year fixed term contract, but you are looking to get out of the contract in year 2, the other party may still be entitled to the contract sum for the remainder of the term as well as seeking damages for consequential losses and fees.

It is therefore immensely important to seek professional advice from a solicitor who will look at the terms of the specific contract and advise appropriately so that the benefits and risks are all understood.

Disputes arising out of terminating a contract

Despite an intention to avoid disputes, sometimes they happen. If the dispute arises out of the way in which a contract has been terminated, one of the first things to do is to check the termination clause, the relevant definitions and the “Dispute Resolution” clause or similar, which will set out if there is a process by which disputes arising out of the contract are dealt with. It is important that the process set out in the contract is followed as far as possible. If an innocent party has suffered loss and damage as a consequence of a contract being terminated incorrectly, it may be possible to consider a claim for damages.

Best practice when terminating a contract

• Before considering terminating a contract, make sure you understand its terms, specifically the key terms such as the termination clause, notice requirements and consequences of termination.
• Once you have reviewed the contract, ensure that you comply with its terms around termination and notice — follow the procedure.
• Ensure that you understand the consequences of termination.
• Even though the contract may have been terminated, some of the terms of the contract may survive such as confidentiality.
• If you are unsure about your position, seek advice before you take any steps to terminate which could save a lot of aggravation further on.