In the rush to sign a business deal many business owners don’t focus on termination provisions in their commercial contracts. This is often because they don’t anticipate a need to end the contract early or think there’s much risk of a dispute.
A good commercial solicitor should advise on sector specific termination clauses when drafting contracts to ensure they’re fit for purpose, whether your business is a start-up or already well established, as all business sectors come with special considerations. Consideration should also be given during the contract life cycle to assess whether you, or the other party to the contract, has the grounds to terminate the contract and the legal implications for your business.
We'll be covering:
- What does termination of a commercial contract mean?
- How can a commercial contract be ended?
- Is terminating the contract the best option?
- Why are the grounds to terminate a commercial contract important?
- Terminating a commercial contract under contractual provisions or common law
- The grounds for termination of contract
- The paperwork to terminate a contract
- Can a contract be ended if there is no termination clause in the contract?
- Do you have to allow a breach of contract to be remedied or can you terminate the contract?
- Terminating a contract for a breach of contract that has been remedied
- When should a business terminate a commercial contract?
- How do you terminate a commercial contract?
- What happens if you end a commercial contract without the right to do so?
- What happens if you don’t follow the termination clause in the contract?
- What should a business do if it serves an invalid termination notice?
- Time limits to terminate a contract and delay
- Changing a decision to terminate a commercial contract
- The decision process to terminate a commercial contract
What does termination of a commercial contract mean?
The termination of a commercial contract means the contract is at an end. The parties are excused from further performance of their contractual obligations after the termination date. There is an exception where clauses in a contract are said to survive termination of the contract. For example, it is usual for a confidentiality clause to state that the confidentiality requirement continues after the end of the contract.
Termination of a commercial contract doesn’t mean that you or the other contracting party will escape from all contractual liabilities. For example, if a party breaches the terms of the contract before termination, the party remains liable for breach of contract.
For more information on breach of contract read our article: Remedies for breach of contract: what are your options?
How can a commercial contract be ended?
A commercial contract can be ended in a variety of ways, including:
- Expiry of a fixed term contract.
- Agreement - this is termination by joint agreement and is referred to as ‘release’.
- Notice - in accordance with the terms of a break or notice clause.
- Performance related issues resulting in the end of the contract.
- Recission of the contract.
- Operation of the law. For example, a commercial contract may be discharged by company merger.
Is terminating the contract the best option?
Whether your business is in life sciences or manufacturing or you are a start-up or a long-established business, you will experience contract issues from time to time. Commercial contract solicitors say some business owners put up with a lot when they should end the contract and walk away whereas others end a contract and then regret it. So, before you make the decision to terminate a contract, it is best to look at your alternatives. They include:
- Varying the agreement – you could renegotiate the contract by agreement. For example, the unit price if the third party can't adhere to the agreed standards or delivery times but you want to maintain a continuing business relationship with them. For more information on renegotiating and reviewing a commercial contract read our article: Why you should regularly update your commercial contracts.
- Saying you will terminate – a threat to terminate and saying you’ll serve notice to terminate can make the other party ‘pull up their socks’ and meet their contractual obligations. However, threats only work if you are prepared to follow through. Otherwise, they are seen as empty threats. You need to work out the reasons for performance issues before you threaten to terminate as the issue may be industry wide and beyond the ability of the other party to solve. This means that ending the contract and forming a new contract with another business won't actually solve the problem as it is not specific to your contracting partner. Remember, saying that you will terminate a contract doesn’t amount to notice. If you do end up deciding to terminate the contract proper notice must be given.
- Contract dispute resolution – sometimes termination of a contract can be avoided with skilled dispute resolution. It is worth considering dispute resolution and assessing whether you’d be likely to face the same or similar issues with a new contracting party. You may find it is best to spend the time resolving the contractual issue rather than allocating time and resources on contract negotiations with a potential new business partner. The contract may specify the contract dispute resolution method that should be used to resolve any dispute.
- Reserve the right to terminate – you can reserve the right to terminate by informing the other party that you are reserving your rights until, for example, you have carried out an investigation into the breaches or have had a meeting with the contracting party. You can lose your reserved right to terminate if you take no action so the right lapses.
Why are the grounds to terminate a commercial contract important?
When you want to cancel a contract, it is important to carefully consider if you have the grounds to do so. Failure to check the contractual terms could be an expensive mistake as you need to assess the legal grounds to terminate the contract. This is because:
- Does the breach of contract include a right to terminate - you may think that you have more than one ground to terminate the contract but you could choose a breach that doesn’t have a termination right. By invoking a non-existent termination right, you could repudiate the contract and your action could lead to your business being liable for damages.
- Timing - if you don’t act in a timely manner, you may lose the right to terminate the contract. Any financial claim may also be lost with the loss of your right to terminate. For example, you could potentially lose your right to claim damages or payments specified in the contract.
Terminating a commercial contract under contractual provisions or common law
You may be able to terminate a contract under contractual provisions or under common law. Commercial solicitors recommend the inclusion of contractual termination clauses that are suited to your particular business needs and the nature of the contract. Relying on common law may mean you don’t have the right to terminate a contract when you want to do so, or the remedies are different, or the outcome is less certain. It is best to get your commercial contract solicitor to draft an agreement and a termination clause that caters for your industry sector and why you may need to end the contract. For example:
- At common law there is no common law right to end a contract for material breach (unless the material breach is deemed to be a repudiation). So, a clause that provides for termination if there is a material breach gives greater certainty and flexibility.
- At common law, if the contract isn’t for a fixed term, reasonable notice can be given. However, if you don’t want a dispute over what amounts to reasonable notice you can include a notice period in the contract to suit your business needs.
You have the right to terminate a contract under common law even if a commercial contract includes a termination clause and even if your common law rights are not expressly preserved in the contract. The key point is that the contract must not exclude your common law rights for you to be able to take advantage of common law.
Common law gives you and the other contracting party the right to terminate a contract on grounds of serious breach. This is referred to as a ‘repudiation’. Examples of repudiation include:
- Breach of a condition - such as a time is of the essence clause.
- Repudiatory breach of an intermediate term or renunciation - the refusal of one party to perform all or most of their obligations under the contract.
Whether something is a condition or an intermediate term of a contract is a question of interpretation. For more information on anticipatory breaches read our article: How to deal with an anticipatory breach of contract.
The grounds for termination of contract
You may think that it is self-evident why you are ending a contract but it is essential that you correctly state the grounds on which you are terminating the contract. If you send off an email without first taking legal advice then the email could cost you a lot of money because:
- Repudiation – you could inadvertently repudiate the contract by your email or notice and that places you in the position of attempting to terminate a contract when you don’t have the right to do so.
- Ineffective or wrong notice – the notice you give may not comply with the contractual requirements for notice and therefore not be effective.
If you have more than one ground to terminate the contract then you need to assess the best ground so you use the most advantageous route for your business.
The paperwork to terminate a contract
You may think commercial lawyers are obsessed with paperwork and paper trails and you are right. That is because commercial contract dispute solicitors know what they have to prove if you end up in court litigation over the termination of a contract as either the party ending the contract or opposing the termination.
If you are terminating the contract you need to keep the supporting paperwork, such as:
- Evidence of the grounds to terminate – for example, failure to meet agreed product or service standards or schedules where standards and time lines for delivery are clearly specified in the contract and give a right to terminate.
- Evidence of opportunity to remedy the breach of contract – if a breach of contract is remediable and you want (or are contractually obliged to allow the third party to attempt to sort out the problem) then you need to evidence the attempts and failures to remedy the breach.
- Evidence of communication – if you have verbal conversations these should be confirmed in writing so there is no dispute over what was said or when. The contract may specify the means of termination so you need evidence that this was followed. For example, you may be able to terminate by email or the contract may say that notice has to be sent by post to be effective.
- Retaining the evidence – you may think that you have terminated a contract and that the problem has gone away but it can resurface with a claim. That is why it is essential your business has procedures to store information and evidence rather than shredding or deleting all information and data as soon as you think that the contract is at an end.
Can a contract be ended if there is no termination clause in the contract?
If your contract isn’t a fixed term contract and there is no termination clause, the general common law rule is that the contract can be ended on reasonable notice. What amounts to reasonable notice depends on the facts and circumstances. Where notice is disputed the court will consider:
- Time - the length of time you have been in a contractual relationship with the other party.
- Obligations - the nature of each party’s obligations.
- Ease - the ease with which the other party can go elsewhere.
Use of common law to terminate a contract gives rise to uncertainty and commercial contract disputes. It is recommended that carefully drafted termination clauses are included in commercial contracts to give your business a degree of certainty and to limit the risks of costly litigation in the event of a commercial dispute over whether a contract can be ended or not.
If you want the right to terminate without giving a reason for ending the contract it is best to include a contractual term giving you the express right to terminate by giving a period of notice but without specifying a ground for termination. For example, you may not have performance issues but you may want to terminate as you no longer require the contracted services because of a change in market conditions.
Do you have to allow a breach of contract to be remedied or can you terminate the contract?
Whether you have to allow a breach of contract to be remedied or you can terminate the contract depends on if you are using common law or contractual rights.
Under common law, you can terminate if there is a repudiation of contract, and you don’t have to wait for the breach of contract to be attempted to be sorted out. Under contract law, the answer depends on the contractual terms as a contract can say that termination notice should only be given after the other party has had chance to resolve a remediable breach. A commercial contract should be clearly drafted to reduce the risk of disputes over whether a breach is capable of remedy or not. Some breaches are not remediable. For example, disclosure of commercial information to a competitor.
Terminating a contract for a breach of contract that has been remedied
It is possible for the party who experienced the breach of contract to end the contract. Whether you can do so depends on common law and the terms of the contract. Therefore, if a party has attempted to remedy a breach of contract it is best to take urgent legal advice to see if you still have the option to end the contract. A commercial contract solicitor will look at whether there is a requirement to act reasonably or not and give guidance on the test of reasonableness.
When should a business terminate a commercial contract?
Whether to terminate a commercial contract is normally a matter of weighing up the pros and cons of termination and taking specialist legal and business advice. Legal advice is needed to make sure that you have the grounds to terminate and business advice may be needed to check you can find an alternate supplier or third party to contract with that can offer competitive terms. If you can't then you may conclude that ending the contract is a bad ideas as contracting with a new third party will increase your overheads or be on less advantageous terms than your current contract.
Common reasons for wanting to terminate a contract include:
- Breach of contract by the other party to the contract - for example, the other party’s performance is unsatisfactory in critical aspects, or they are refusing to perform the contract.
- The contract is no longer profitable - for example, the cost of performance has become prohibitive because of your own supply chain issues or the cost of recruiting specialist employees or cross border issues.
- You no longer need the goods or services - for example, in the case of the tech sector or retail, your consumers are onto the ‘next best thing’.
How do you terminate a commercial contract?
Terminating a contract isn’t just about the law. There are potential serious business implications for ending a commercial contract. For example, the other party may have breached a clause in the contract, but if you terminate the contract, will your business be able to secure a replacement order or contract with a third party on the equivalent terms and rates of pay due to a change in market conditions since your contract was entered into?
If, having assessed the legal grounds and business basis to terminate the contract, you wish to do so then the business should:
- Say that you are terminating the commercial contract and your grounds for doing so - any termination of a commercial contract requires a clear unequivocal communication of the decision to end the contract. For example, a termination notice is not a demand for compliance with the contract. Nor is a termination notice a request for payment. Sending a warning letter saying that you will end the commercial contract unless breaches of contract are remedied is not a termination notice. In addition, a termination notice that allows parts of the contract to continue whilst also seeking to end the contract isn’t sufficient. Giving notice of termination must be coupled with clearly set out the grounds for doing so. Failure to set out the grounds for termination can have legal and financial consequences.
- Comply with any notice requirements - if the contract contains specific notice provisions, the notice to terminate must comply with your contractual obligations. If the contract doesn’t specify notice requirements, then if you have the grounds to terminate, you can do so by stating that you are exercising your right to terminate.
- Ensure that full records are kept - this is important as the termination may be challenged by the other party. Full records of communications are essential as the other party could allege that there were contradictory communications over the notice to terminate. In addition, you should retain any documentary and other evidence supporting your decision to terminate and any opportunities you gave to the other party to remedy a breach.
What happens if you end a commercial contract without the right to do so?
If you serve notice to end a contract, without a contractual right or a right under common law, you could face unexpected financial consequences.
If you serve an unjustified notice of termination this could amount to a repudiatory breach of contract as you have said that you are ending the contract without a contractual or common law right to terminate. If you repudiate the contract the other party could accept the repudiation and sue for damages. The size of the other party’s loss and potential damages would depend on whether you could have lawfully ended the contract within a short time frame. In other circumstances, damages could be significant, for example, if the other party should have been allowed to remedy any breach.
What happens if you don’t follow the termination clause in the contract?
If you serve a contractual notice to terminate you must comply strictly with the contract terms. If you don’t then your notice may be of no effect. Small defects in a notice may not invalidate the notice provided the defects would not confuse a reasonable recipient. However, reading the contract and getting the notice right first-time round will save you time and potentially money as you can’t always remedy a defective notice.
What should a business do if it serves an invalid termination notice?
If you serve an invalid notice to terminate the contract then your options depend on the circumstances of the notice but include:
- Serving the notice again - using the correct contractual procedure.
- Allege waiver or estoppel – by saying that the party receiving the notice accepted it was valid and so waived their right to challenge the notice or is estopped from doing so.
Time limits to terminate a contract and delay
If your business wants to terminate a contract then you can’t delay and take a long time in weighing up the business benefits of ending the contract or in taking legal advice. This is because the legal right to terminate a contract, whether under contract or common law, can be lost by delay.
- Termination under contractual provisions - if you are ending a contract under contractual termination clauses you should follow the terms of the contract.
- Termination under common law - once you become aware of the breach of contract you normally have a reasonable time to investigate the breach and decide whether to end or affirm the contract. Case law says that if you do nothing for too long you can be treated as having affirmed the contract. However, the length of reasonable time is a question of fact and can vary in each case. It is best to take legal advice on whether you should delay making a decision on termination of the contract. Specialist advice will be sector specific and evaluate your circumstances.
Changing a decision to terminate a commercial contract
If you have the legal right to terminate a contract then once you have given notice of termination you can’t change your mind. The implications are:
- No withdrawal – you can’t withdraw a termination notice.
- No revival other than by agreement - if a contract is terminated, it cannot be revived unless both parties to the contract agree.
- Affirmation - you lose the right to terminate a contract if you give the other party notice that you want to continue with the contract, despite their breach of contract. Affirmation can be inferred from your actions. For example, if you allow the continued performance of the contract despite knowing that the contract has been breached and that you have a right to end the contract. Insolvency and the right to terminate a contract
The decision process to terminate a commercial contract
If you want to terminate a commercial contract it is vital to look at the business and legal consequences of doing so. The decision should not be taken in anger or in the heat of the moment. As frustrating as a third party can be, they may possess the specialist skills you need or have the advantage over you because they know you can't easily replace them. It can be cost effective to get legal advice on your commercial contract so you know if termination is the best option for your business, having assessed the cost benefit ratio, and weighed up the risks of ending up in a dispute over the termination of a contract and needing specialist legal advice from commercial dispute resolution solicitors to resolve the conflict.
As part of your decision process assess both the legal and practical implications, such as:
- If you serve notice to end the contract, do you need to make interim arrangements until you can find a new contractor? Will any new contractor provide the goods and service on improved or the same terms?
- If you are leasing equipment or using an IP licence and need to terminate the contract, do you have temporary measures in place to enable your workforce to continue to be productive until replacements are sought?
- Is there a duty of confidentiality? Will that duty survive the end of the contract?
- How will the end of a contract affect staff? If you are taking the work in-house, instead of outsourcing it, will you need additional resources, such as a sponsor licence to recruit overseas based workers?
- Is it better to keep the contract in force as if you end the contract, you will lose the chance to get ongoing payments under the contract.
Commercial contracts can be tricky and ending a commercial contract can be just as complex as negotiating a contract at the start of the contract lifecycle. For more information on contracts read our articles: