Time to say goodbye – Stuart Evans sets out the 7 steps you need to take before terminating a contractPosted: 11 Jul 2023
Problems with your contractor?
Your business is facing a problem with a business contractor. They could be a customer, supplier, agent or distributor, amongst others. You have reached the point whether you need to cut the cord and terminate the contract. Stuart Evans takes you through the things you need to be thinking about.
Termination could be for convenience, following a review of the relationship and the possibility of you starting a better one with a new counterpart, who may be offering better materials or services on more competitive terms. Nevertheless, letting down the existing contractor gently and effectively needs to be executed carefully.
Often, however, the need to terminate is based upon a breach (or breaches) of the contract by your counterpart. These breaches could be minor, significant, continual or go to the root of the contract; they may be a combination of some or all of these. Typical breaches may be late or non-payments, delays in delivery, defective goods or services and often a threat of insolvency. Your counterpart may also be indicating that they are not going to perform their obligations at all under the contract (this often being termed renunciation).
So, you decide to terminate the agreement and notify your counterpart. You then get a response from them saying that you had no right to terminate, or that your have failed to follow procedure and you are facing a claim from them for wrongful termination. Or they tell you that whether you have terminated correctly or not, you owe them money, goods or services, they owe you nothing or that you are entitled to a very limited recovery. When this happens, anxiety levels increase.
You may of course be on the flip side of all this, progressing a contract on what you believe to be a functioning and satisfactory basis, only to be hit with a notice of termination that knocks you sideways. Again, your blood pressure goes up.
Whichever side you are on, dysfunctional contractual relationships may well impact adversely on cashflow, your supply chain, the reputation of your business and create a worrisome blight on your figure for debtors and creditors (as the case may be) in your balance sheet. If they are terminated by you incorrectly or on the wrong basis, these risks may not be mitigated; in fact, the situation may be about to become a whole lot worse, as you may be facing a claim from your counterpart or needing to progress such a claim, in circumstances where you have no replacement contractor on the stocks.
How to get the best solution on termination
Terminating a contract effectively needs preparation. I set out below 7 steps you need to follow to put you on course to get the outcome that you want.
Step 1 – Get your facts right.
A key component from the outset is to draw together the chronology, the “story” to date, backed up by documents to verify that story. When, and how many times has the counterpart paid late, delayed deliveries or supplied material that needed to be sent back? How did you hear about the counterpart being in financial trouble, was it from them, other suppliers or industry sources, is there anything available online that may be useful?
Once you know the story (which once compiled may often not accord with your recollection), it will be easier to start planning. You don’t want to be starting a process based on unreliable information, as this may be fatal later on.
Step 2 - Review the contract.
A saying amongst some of us in the legal profession is “RTFC”. Leaving aside the impolite adjective, it stands for “read the contract”. Look at it from back to front, armed with the story, to see precisely what contractual termination rights and remedies you have. It is often the case that parties enter into a contract based on standard terms previously used, get going and leave the paperwork to gather dust on a shelf (or in a file deep within the e-filing system). These contracts may not fully cover the day-to-day workings of the contract, where the likes of purchase orders, acknowledgements, delivery notes and invoices, which may contain further terms of their own, serve to muddy the waters. (Streamlining a contract to align with your precise requirements is a matter for another day).
The review of the complete contract will form a further solid base for your planning for termination.
On the flip side, if you have received a notice of termination and want to know where you stand, steps 1 and 2 are essential for you too.
Step 3 – Ascertain your rights and whether they may have been lost
When you have a grasp of the facts and the contractual provisions, you can ascertain your rights and work on an appropriate solution. If you are terminating for convenience, you will have identified the provisions upon which you will rely. If you are basing your plan of action on a breach(es) of the contract, you need to work out if the breach is minor, significant, or going to the heart of the contract, and if such breach has been persistent or a one off. You then need to see if that breach meets specific provisions of the contract relating to termination; again, read these provisions thoroughly.
In addition, in the case of a substantial breach you can look at whether the common law can assist you in providing a separate right to terminate.
One trap for the unwary is the affirmation of any breach of contract that may have enabled you to terminate. This is where an innocent party, often unwittingly, acts in such a way as to indicate that they are abandoning their right to terminate. In effect, with the opportunity to terminate, they have chosen to accept the continued performance of the contract despite the breach. If a breach is affirmed, then the slate is wiped clean and your chance to terminate for that breach will be lost.
Again, on the flip side, if you believe that your counterpart has affirmed any breach, they may have terminated the contract unlawfully, giving you the right to claim damages.
Step 4 – Understand any contractual mechanisms that need to be followed
If you are terminating for convenience, make sure that you follow the procedures to do so, including length of notice and correct mode of service. Commercial contracts often give parties the chance to terminate only at particular times during the progression of the contract – make sure you don’t miss your slot.
If you have found a breach which may lead to a right to terminate, it is not uncommon for the contract also to provide a mechanism for sending a notice to remedy the breach to your counterpart, depending on the severity of the breach. Should this apply, if the breach can be cured your counterpart will have a period of time, often between 14 and 28 days, to put it right. So, if the relevant breach requires a notice to remedy under the contract, you must comply with it. If you jump the gun, you may be terminating unlawfully.
On the flip side, you will carefully audit what your counterpart has done, to check for contractual compliance.
Step 5 – Work out the remedies available to you
The remedies available to you on termination may vary considerably and dictate your planning and decision making. If you are terminating for convenience, the contract may for example provide that each party may just walk away, you may have to settle the outstanding account for the remainder of the contractual term, and your counterpart may need to finish off any work in progress and/or deliver such work in progress or finished goods to you. There will no doubt be other provisions for clearing up at the end of the contract.
If you are terminating for breach, then under the common law if such breach goes to the heart of the contract, or it is a breach of a condition, it may be repudiatory, and you may have grounds to accept such breach and terminate the contract immediately. The contract may also have provisions, breach of which will constitute a repudiatory breach, that will provide an alternative ground for termination. The innocent party will accept the repudiatory breach, thereby terminating the contract. It is a failure to accept a repudiatory breach that can result in an affirmation of it – see step 3 above. (There are circumstances where a defect in the formation or performance of a contract will entitle a party to rescind the contract, meaning it is deemed null and void, as if not contract was ever made. This is a deeper discussion for another time).
In the event of termination for a repudiatory breach, you will be able to claim for, amongst other things, the loss of bargain on the contract. This may entitle you to claim for damages for losses suffered for the duration of the remainder of the contract. So, if you have a five-year supply contract and this is repudiated after one year, a claim will be based on the losses you have suffered as a result of the contract not running its full term, subject to any duty to mitigate and contractual limitations (see step 6 below).
If you are terminating for a breach that is not repudiatory, you will not be able to claim for loss of bargain, but just the losses flowing from that breach. Classifying breaches accurately is therefore essential.
It is possible that you have a series of options available to you. At one end, you may be able to terminate for convenience. At the other end, there may be a breach or breaches that may be repudiatory, entitling you to bring the contract to a swift end. In between, there will be minor, material, or significant breaches that will have to be assessed against the contractual provisions and the common law. The outcomes and benefits of these options may vary considerably.
Importantly, if you have identified more than one basis upon which to terminate, you do not necessarily need to elect for just one ground. It is possible for you to terminate on alternative bases, taking account of which is the most advantageous for you. This will however need to be done with considerable care.
On the flip side, you will be reviewing this all carefully. It may be the case that your counterpart has terminated on a basis that is comparatively advantageous to you, which may dictate how you respond to it.
Step 6 - Understand any limitations on your ability to terminate and your remedies
It is vital that you take account of any statutory restrictions on termination, which we saw for example during the pandemic with insolvent companies. In addition to any contractual restrictions, look closely at any exclusion of liability clauses as well, as these may limit the heads of loss you can claim for and/or put a financial cap on them. It is worth remembering that such clauses may restrict contractual claims, but not necessarily claims under the common law.
It goes without saying that if you terminate unlawfully, you are putting your head in the jaws of your counterpart, which is the last place you want to be. If you terminate lawfully but not on the most advantageous ground, then you will lose potential benefits that would have been available to you.
Again, on the flip side you will be checking whether your counterpart has foundered in the process of its termination or missed the significance of limitation clauses.
Step 7 – Take legal advice if you are in any doubt on your position.
Forgive me, I got to number 7 before putting myself forward, but it could just as easily have been number 1. These steps are not exhaustive, many matters are fact sensitive, often involving novel legal issues, and a proper analysis is essential before you take the plunge and terminate. I have seen businesses, acting without initial assistance, take the wrong course and end up getting sued, or take a course that was not the optimum one, adding insult to injury. Terminating effectively, or taking an alternative course if available, with deliver benefit to your business and take the stress out of a difficult contractual relationship that you may have.
So take advice early on, to look at the options, weigh up the risks, see the best way forward and progress the necessary steps. Work out the grounds, draft the notices so they are clear and accurate and serve them compliantly. We will work with you to maximise your recovery, save you time and costs and avoid the pitfalls of a botched termination.
And again, on the flip side, if you are concerned about your counterparty terminating or have received a notice, please get in touch and we will test whether this course of action has been or will be effective – or ineffective - and what your options will be.
Terminating contracts is not always an easy business, so do take advice to ensure that you end up on the right side of it.
Where to from here?
If you are in a position where you are contemplating the termination of your contract, or facing that prospect, or have any queries about a business dispute or issue that is concerning you, please get in touch with me at [email protected] or call me on 07931 919153 for an initial consultation.
With thanks to Paolo Caldato for his collaboration on this article.
Article written by:
Stuart Evans is a Partner Solicitor at Spencer West. He specialises in Contractual disputes; boardroom disputes; partnership disputes; professional indemnity; construction and engineering disputes; intellectual property disputes; jurisdictional disputes; litigation, arbitration and ADR/mediation
Partner - Commercial Dispute Resolution
+44 (0)7931 919153
Henry Clarke writes about the benefits of taking an entrepreneurial approach to law in Law Society Gazette
With a varied career in law, starting out at a ‘Magic Circle’ firm, holding legal staff roles within the British Army and...
The Everything Summary of Shareholder Disputes – Something to Keep Up Your Sleeve?
I have been advising companies and shareholders in relation to shareholder disputes for over twenty years, and in that time, I...