Termination: a reminder to tread carefully
As the impact of recurrent lockdowns, the effects of Brexit and tightening economic pressure start to take their toll and force parties to re-consider the commercial arrangements they find themselves bound by, we are frequently asked the question: "can we terminate our contract with our supplier/contractor?".
The answer to this question is rarely straightforward and despite what many often think, it does not lie in a simple operation of the contractual provisions.
Contracts are more often than not poured over when they are negotiated, with parties carefully considering the ramifications of the bargain they have struck. Yet the intricacies, potential pitfalls and ramifications of ending those arrangements can often be overlooked when the commercial need to act swiftly becomes the number one driver.
There are numerous reasons why parties may wish to exercise their rights to terminate: this may be as a result of a breach of contract; because the employer no longer wishes to proceed with the project (the contract/project may, for instance, no longer be profitable or cost-effective); or the supplier/contractor may be insolvent. However, in each case, there are a number of fundamental issues which parties wishing to terminate should always first consider.
In this article, we highlight some of those issues and pose a number of questions that parties should be asking themselves when first contemplating whether to exercise their right to terminate.
What is the legal basis for termination?
- This is the point to locate the contract and find out what it says about termination. Is it a standard form contract? Has it been amended? If so, how? If it is a standard form contract, consider whether the termination provisions have been construed in a particular way (or ways) by the courts previously? Does the contract give you (as the contracting party) the right to terminate for the reason that you now wish to use to terminate this contract? If not, what other rights exist and can you look to operate these provisions to exercise your right to terminate instead? When undertaking this exercise, it is important to identify all potential rights to terminate at the outset. Common contractual termination clauses include: termination for breach, convenience (i.e. on notice), insolvency, or change of control of the other party. However, whether a particular clause will allow you to terminate in any given circumstance will very much depend upon the wording of the clause and facts surrounding your desire to terminate.
- Is there a common law basis for termination? It is possible that you may also have rights to terminate at common law where you can evidence that there has been a repudiatory breach of contract. This is, in very high level terms, a breach that is so serious that it allows the innocent party to treat the contract as at an end. Whether a breach is a repudiatory breach depends on the severity of the breach, and this area of law is particularly complex. We would stress that it is important to take legal advice when considering termination at common law, and if there is any doubt about whether there has been a repudiatory breach, then a contractual remedy should instead be considered. This is, not least, because where a party seeking to terminate relies on a repudiatory breach, and it transpires that the breach was not repudiatory in nature, the termination will be treated as a wrongful termination and that party will instead be in breach.
What are the financial, contractual and commercial implications of termination?
- What are the practical consequences of termination and what are the risks to you associated with termination (for instance, are there are any risks associated with it going wrong, and if so what would the legal and financial consequences of this be)? It is important to consider these issues at the outset, as this may have an impact on your decision to terminate, or the route for termination.
- What does the contract say about payment, profit share (if any), delivery of plant/materials, drawings, site clearance, completion of outstanding orders etc.? In a nutshell, what are the financial implications of termination going to be for you? It is important to bear in mind that often different termination provisions, have different financial and contractual implications. Some termination provisions (such as no-fault termination clauses) may provide for the supplier/contractor to be paid compensatory termination payments (which seek to offset the losses that they may suffer by reason of their contract being brought to an end earlier); whereas, other provisions, may entitle you to pay lesser sums to the supplier/contractor on termination but will require a greater burden of proof to enforce the right to terminate (for instance, termination of breach provisions).
- How does termination affect any staff engaged in connection with the project (would TUPE apply)?
- What, if any, obligations do you or the other contracting party (or parties) have on termination?
The act of terminating cannot be considered in the abstract, and must instead be considered in conjunction with the financial, contractual and commercial implications of each of the options available. Only when considered in this context, is it possible to make a truly informed and risk-based decision. Remember: it is too late to think about the consequences after the event.Have you complied with the procedural requirements for drafting a termination notice and/or ensured that your notice clearly set out the grounds for termination?
Whilst this is an exercise that can only be commenced once a decision as to points 1 and 2 have been fully explored and assessed, getting the termination notice right (once these matters have been ironed out and you are sure about your route for termination and have fully assessed the risks) is essential. One wrong turn here could undo all and any good work and risks assessments undertaken at points 1 and 2. For that reason, we would always recommend that any termination notice is drafted with the assistance of legal advice, whether in-house or external. It is crucial that any party exercising a right to terminate ensures that it complies precisely with the contract's requirements for termination, including in relation to the content, timing and service of the termination notice. This is of fundamental importance. Starting from the premise that termination involves ending a party's primary right to perform their duties under the contract, it follows in law that if a notice has been served wrongly, this can itself amount to a repudiatory breach of contract. This entitles the party receiving the defective notice to accept the repudiatory breach and claim damages - depending on the nature of the contract, and the timing of the breach, these damages which could be significant. Not only could this result in a claim for damages, but it is important to bear in mind also that actions for wrongful termination can have adverse reputation consequences for the party who 'wrongfully terminated', with potential wider commercial implications. The moral of the story here really is: do not let this happen to you!
It is important to proceed with caution when it comes to anything to do with termination, whether it be using the termination provisions of your contract or considering whether you have the right to terminate at common law. Disputes ensuing from disputed terminations can be expensive and lengthy, and asking the relevant questions first will enable you to assess the risk of pressing the button before it is too late.
Please note that this article has been written with the termination of downstream contractual arrangements in mind. Parties seeking to terminate upstream contractual arrangements should seek legal advice, as whilst the above principles would likely still apply, there are additional legal considerations to be borne in mind including certain statutory prohibitions on termination.