Terminating contracts: breaking up is never easy...
12 February 2020
The UK has now left the EU. However, the precise terms of our departure are as yet unclear. In the face of uncertainty, prudent businesses are assessing contracts, their cost base and their exposure to currency fluctuations. As part of such a review, the well-prepared need to develop exit strategies where arrangements have become, or will become, unprofitable.
Exploring these issues, Mark Lim and Fraser McKeating from our commercial dispute resolution team hosted a seminar on strategies for terminating commercial contracts, how to operate contractual provisions and the risks arising when you get it wrong. This is a summary of some of the key points discussed.
What do we mean by “termination”?
“Termination” means the discharge of a relationship arising under a contract. It does not mean that the contract is treated as though it never existed (which is a different legal concept known as “rescission”).
Contractual routes to termination
Rights to terminate under the contract will depend on the precise terms and prescribed mechanisms set out in the contract in question. There is no obligation to operate contractual termination provisions in good faith (recently confirmed in TAQA Bratani Ltd and others v RockRose  EWHC 58 (Comm)).
Contractual routes: breach clauses
Termination rights are sometimes only triggered when breaches are sufficiently serious. Classifying the breach can be difficult:
- “Serious” or “material” breach – the courts have provided some guidance on what will amount to this kind of breach (for example, “more than trivial, but need not be repudiatory”), but ultimately have not adopted a consistent approach. The courts tend to look at the effect of the breach on the innocent party;
- “Substantial” breach – again there is some inconsistency in treatment. The term is reminiscent of the common law standard for repudiation. The Court of Appeal has held that the level of contractual deprivation which would give rise to the right to terminate a contract for substantial breach was no different from a repudiatory breach;
- “Any” breach – the literal meaning of a clause specifying that a breach of any obligation gives rise to a right to terminate means every duty is effectively a “condition”, no matter how trivial. In the past the courts have been unwilling to adopt such a literal approach on grounds of business common sense, but there appears to be increasing willingness towards greater contractual freedom;
- “Remediable” breach – the innocent party must check whether the contract sets out a cure period, with a mechanism for giving the counterparty an opportunity to remedy breaches before a right to terminate arises.
Contractual routes: by event
Another contractual route to termination is by event. For example, the contract may give a right to terminate for:
- counterparty insolvency (depending on how “insolvency” is defined in the contract);
- a specified force majeure event (including arising from law of action taken by government). However not only must the circumstance come within the language, the issue needs to be the sole cause that prevents, hinders, or delays a party from performing its obligations; and
- possibly even Brexit itself if there is a relevant Brexit or material adverse change (MAC) clause that can be relied on.
Termination at common law: repudiatory breach
Operating independently from any rights to terminate under contract is the right to terminate for repudiatory breach at common law. This is subject to very clear contractual language which may operate to exclude the right. To be repudiatory, the breach typically needs to go to the root or heart of the contract and, depending on the facts, may arise from a combination of breaches.
Where a party is in repudiatory breach, the effect is not automatically to bring the contract to an end. Rather, it gives the innocent party the option either to: (a) affirm the contract; or (b) accept the repudiation and bring the contract to an end.
The innocent party must take great care not to affirm the contract inadvertently, either through conduct or delay. In some circumstances it may make commercial sense to affirm the contract (for example, where the counterparty is one of a limited number of suppliers of particular goods or services) or seek a variation.
Another common law route to termination is frustration. This is a very narrow doctrine. It excuses further performance of contractual obligations. It arises following a supervening event which strikes at the root of the contract (illegality or impossibility).
The doctrine was raised recently in the context of Brexit last year. However, the European Medicines Agency failed to convince the High Court that Brexit had made the lease illegal and it was not a supervening event either because it was within the parties’ contemplation when they entered into the lease. The case was heading to the Court of Appeal but has now settled.
Contracts of indeterminate duration or those without termination provisions
It is possible for parties to terminate open-ended, or “rolling” contracts. This will require the implication of a term that the contract is terminable on reasonable notice. If the parties drafted one-way termination rights or the contract is to last a fixed term, it is far more difficult to imply such a provision.
So you’ve decided to terminate – getting it right
Fraser took us through the practicalities of termination and tips for avoiding potential pitfalls. If the business does decide to terminate, what does it need to consider to put itself in the best possible position? What does the business need to do (and not do) to ensure that the termination is effective?
Parties need to take time to assess the position, and to avoid knee-jerk reactions. In that context, they may use reservation of rights notices. They may also make use of notices making “time of the essence” in respect of specific contractual obligations.
Once a decision to terminate has been made, a clear, unequivocal communication is normally required (whether terminating at common law or under the contract). If the contract is silent on the point, common law does not prescribe any form that that notice is to take. However, in the vast majority of cases, notice of termination will be being provided or confirmed in writing (either for certainty, or because the contract requires it).
Once notice has been given, it cannot be amended or withdrawn without the counterparty’s consent. Therefore, the innocent party must carefully consider whether it has grounds to terminate and, if so, on what basis and then set those grounds out clearly in the notice. The consequences of getting it wrong can be serious:
- terminating without a right to do so may well amount to a repudiatory breach, which the counterparty could accept and then sue for damages;
- terminating on the wrong legal basis may rule out valuable claims or counterclaims (as EE found out to its cost – to the tune of hundreds of millions of pounds – in Phones 4U Ltd (in Administration) v EE Limited  EWHC 49 (Comm)); and
- it is important to strictly adhere to any contractually prescribed regime to ensure service of any termination notice is effective.
Fraser rounded off the session with a helpful checklist of practical pointers, which you can download using the button below.
The UK left the EU at 11pm (UK time) on 31 January 2020, and the transition period came to an end on 31 December 2020. The Trade and Cooperation Agreement reached on Christmas Eve 2020 sets out the shape of the ongoing future relationship between the UK and the EU and provides some degree of certainty for UK businesses.