How to Terminate a Contract
Business is all about relationships, and those relationships are defined by contracts. The start of a new business relationship – and entering into a new contract – are usually an optimistic time, full of hope for the future.
But one of the important reasons that we have contracts is to deal with those times where the relationship doesn’t go as well as planned. An effective contract will therefore set out what should happen in scenarios where the parties decide to go their own ways.
Getting termination right can help bring the relationship to an orderly end. Getting it wrong can create bigger problems. In this article, we take a look at how you should approach terminating a contract, some of the common issues you might encounter – and how you can stay out of trouble.
Check what the contract says
So, you’ve made the decision that you want to bring the contract to an end. Maybe it’s a supplier who isn’t performing as well as you’d hoped. Maybe your business has changed, and you no longer need a particular service.
Whatever the reason, the first step is to check what the contract says about termination.
There might be a clause that specifically deals with termination, or relevant provisions might be scattered through the agreement. Common requirements include:
- Only being able to terminate early if a specified event occurs.
- Needing to provide a certain period of notice.
- Only being able to issue a termination notice within a defined window of time.
It’s also important to check if there are any notice provisions and what they say. Notice may need to be in writing, signed by a nominated person or sent to a nominated address. Complying with these requirements will reduce the risk that the other party might claim the termination wasn’t valid.
What if there is no termination clause?
Sometimes the parties might not have included a termination clause. What happens then?
The contract might have a fixed term or provide for a one-off supply of goods or services. In these types of contracts, the parties usually intend for the contract to come to an end anyway, once the contract is performed. A termination clause might not really be needed.
On the other hand, the parties might intend for a contract to keep running but had not thought about how it should be ended. In these cases, most common law jurisdictions will recognize a right to terminate if reasonable notice is given. What counts as “reasonable” in each case will depend on factors such as:
- How long the existing relationship has been in place (a contract relationship that has been running for several years might deserve a longer notice period).
- The parties’ billing cycle (for example, monthly invoicing might suggest it is a month-to-month arrangement and that one-month notice will be sufficient).
- If the other party has entered into commitments that will need to be ended (for example terminating sub-contractors or selling equipment used for the contract).
It might also be relevant to look at whether the parties have previously contracted and what happened in those cases. It could be implied that the parties intended that the same notice period as the last time should apply. If the parties don’t have any history together, there could also be practices or customs that are well known in that specific industry. These all might give clues as to what should happen.
Different types of termination clause
When checking the contract, there are two categories of termination clauses that you might encounter – termination for convenience and termination for cause.
Termination for convenience
A termination for convenience clause allows either one party, or both parties, a right to terminate the contract during its term without having to have a reason. This is usually included if a party is concerned that its plans might change, or that a better deal might become available in the market.
On the other hand, this is a clause to watch out for if you’re negotiating a long-term contract or a contract for a project that will require one party to make a large investment. After all, there is no point negotiating a contract with a fixed and long term if the other party can terminate at any time on short notice.
Termination for cause
Contracts usually include a provision that allows termination if a particular trigger (or “cause”) occurs. Common triggers include:
- Breach of contract. This might be defined as any breach or could use terminology like a “substantial breach” or a “material breach”. Sometimes, specific scenarios are addressed so that it’s clear the parties will be able to treat that as a breach. It’s also common for a party to be given some time to be able to remedy the breach.
- Change of control. This allows one party to terminate if the other party has a change of ownership or management control.
- Damage to reputation. In some types of contracts, a key consideration for an organization might be the risk that the other party could do something that damages their reputation. In this case, it will be vital to have a right to terminate quickly.
- Force majeure. Often a force majeure clause will specify that if an event or circumstance prevents performance of the contract for a defined amount of time, a party can then terminate.
- Insolvency. Parties may wish to terminate if the other party is insolvent (or it looks like they may become so soon). However, note that some jurisdictions have corporate insolvency laws that make these clauses (known as “ipso facto” clauses) unenforceable.
Getting termination wrong
It’s important to comply with the contract requirements when planning to terminate a contract. A party can get into problems if it attempts to terminate the contract when it has no right to do so.
In this scenario, the other party (who receives the notice) can turn around and claim that the attempted termination is a “repudiation” of the contract. They can claim this shows the first party doesn’t intend to comply with the contract and therefore is itself in breach of the contract. They can then themself also terminate – and claim damages from the party that made the first attempt to end the contract!
That’s why it’s important to be confident there is a valid right to terminate, before attempting to exercise that right.
If you’re not confident that the contract allows you to terminate, another option would be to instead negotiate the termination with the other party. This might have to involve some degree of compromise or compensation – maybe even a termination payment. However, it means the parties will be agreed on the decision to terminate and so will avoid the risk of a dispute. In this type of situation, it’s a good idea for the termination to be documented in a deed of termination. This makes it clear that the original agreement is at an end and sets out any new terms which apply to the termination.
After the termination
Sending a valid termination notice and ending the contract might not always mark the end of the relationship.
Firstly, termination can trigger specific obligations – such as returning confidential information or any of the other party’s property that was being used to perform the contract.
Contracts often contain a survival clause. This specifies that – even after the contract has expired or is terminated – certain provisions of the original contract continue to have effect. Typical examples of clauses that might survive include dispute resolution, choice of law, confidentiality and liability provisions. There may also be important post-termination clauses that have been uniquely negotiated – such as restrictive covenants or restraints of trade clauses (also known as “non-compete” clauses). By their nature, these are intended to continue to apply after the contract has been validly terminated.
Some contracts also contain detailed transitional obligations or handover arrangements. For example, in a long-term supply or outsourcing arrangement, the customer is often highly dependent on the supplier or service provider. If the customer terminates the contract, it may still need the supplier to cooperate in transitioning the services over to a different service provider. To prevent the supplier from withholding its cooperation (effectively holding the customer to ransom), a customer may deal with this issue in the original contract. It will specify that the supplier must provide reasonable levels of support to make the transition go smoothly.
The law of contract exists to make sure that people, businesses and organizations should normally follow through on their contractual promises. In normal circumstances, they shouldn’t be able to terminate the contract – and get out of their obligations – too easily.
There can be situations though when the parties recognize – as the saying goes – that all good things must come to an end. In those cases, it’s important to make sure the termination is managed carefully. Follow the steps in this article – check the contract and comply with any termination provisions. This will go a long way towards making it easy for the parties to go their separate ways.