Done properly, the act of terminating a commercial contract can be an efficient self-help remedy. It can allow a business to change course, stem losses and move on.
Done improperly or without justification, the act of terminating (or purporting to terminate) a commercial contract can make a problem worse. Potentially much worse.
When can you terminate a commercial contract?
A party may terminate a contract:
- pursuant to a contractual right;
- where the other party breaches an essential term (condition);
- where the other party commits a serious breach of an intermediate term; or
- where the other party ‘repudiates’ the contract.
The first of these is the most common but depends upon the existence of a termination clause enabling termination in the relevant circumstances. A good termination clause very clearly set out the acts and omissions enabling termination.
The remaining possibilities arise from common law principles which, provided they have not been excluded by the contract, provide a potential legal basis for termination. These possibilities are available even when the contract contains a termination clause.
The right to terminate for breach of an
essential term (condition) arises where a party fails to perform, at the relevant time, a term that can properly be regarded as ‘essential’ to the contract. An essential term is a term that goes to the very root of the contract. While parties sometimes stipulate that certain terms are essential terms, it is more often a matter for analysis when non-performance occurs.
The right to terminate for a serious breach of an
intermediate term occurs where a term that is neither essential nor inessential is rendered essential by gravity of the breach in question.
The concept of repudiation is often misunderstood. In short, repudiation can occur by way of anticipatory breach or actual breach. Repudiation by anticipatory breach occurs where the repudiating party indicates an inability or unwillingness to perform a contract before performance is due. Repudiation by actual breach occurs where the repudiating party indicates an inability or unwillingness to perform a contract at the time performance is due.
In circumstances where there is a breach giving rise to a right to terminate or there is a repudiation, the aggrieved party must make an election: it must affirm the contract (that is, continue with it) or terminate it.
If the aggrieved party affirms the contract, it can still claim damages for the losses associated with the breach. Alternatively, if the aggrieved party terminates the contract, both parties will be relieved of their obligations to perform the contract and the aggrieved party can claim damages for loss of the benefit of the contract.
What are the risks?
The biggest risk associated with terminating contracts is the possibility that a Court will later determine that the party purporting to terminate the contract did not have sufficient grounds to do so. In such circumstances, the act of purporting to terminate the contract will usually itself constitute a repudiation of the contract and may inadvertently provide the other party with a damages claim.
A further risk arises from inaction: the aggrieved party may be taken to have affirmed the contract if the election (to affirm or terminate) is not made within a reasonable time.
How can Hicksons help?
Termination of commercial contracts is not without its pitfalls. At Hicksons, we regularly assist our clients to navigate those pitfalls and achieve the best possible outcome.
Find out more about
Hicksons’ Commercial Dispute Resolution services.
Article written by Partner,
Troy Gurnett and Senior Associate,
Liam Maguire.