- Drafting Effective Termination Clauses
- Circumstances of termination
- Termination versus rescission
- Reducing Risk in terminating a contract including limitation of litigation Risk
- Avoiding mistakes in exercising termination rights
All commercial contracts are terminated by definition. By far the majority even if the road is more or less rocky are terminated by completion.
I am want to caution clients that contracts most often are conceived in lust and, regrettably too often terminated in tears.
This paper addresses the tearful set.
Lawyers and their clients in their search for certainty of contract strive to create formulae by which early termination if required may be achieved on grounds more or less advantageous to each of the contracting parties.
In this search for certainty one of the encyclopaedia of legal draughtsmanship exhibits 372 separate examples of termination clauses from the very long and comprehensive to the very short and barely useful.
A prudent draftsperson when drafting a contract and consequently a termination clause(s) will carefully consider that the intention of the parties is to reach completion of the agreed contract to the benefit of all the parties involved and how their draftsmanship can assist the parties to bring the contract to a successful conclusion.
Rather than a naïve insistence that the contract slavishly catalogue a series of rights and remedies wholly to the client’s pre-conceived benefit. The contract is a working document which allows the parties to regulate their commercial dealings to mutual benefit.
Further, the draftsman will take cognisance that apart from the principal and the contractor and depending on the size of the transaction and the complexity of delivery of the contract there are other often many other stakeholders involved in the contract whose interests depend on a contract not being terminated early. For example, employees on both sides, parts manufacturers, carters and third party customers. The commitment of resources and lengthy lead times may impact down a long chain of affected parties. Any one or more of these stakeholders may have rights that are infringed in the event of early termination, whether or not the termination is valid and defensible.
Even when validly terminating the innocent party may find itself embroiled in consequential disputes and/or litigation with 3rd parties including its own customers and other suppliers.
It follows that termination is a very draconian step and may not in fact be to the benefit of an aggrieved contracting party.
A lawyer as a draftsman or as an adviser to a potential litigant will approach the task of drafting a termination clause (or suite of clauses) and of implementing such clauses if not with trepidation with a due degree of caution lest the baby be thrown out with the bath water.
A draftsman will consider what are the critical issues that will lead a party to want to terminate in any particular contract? In any particular contract instructions will need to be taken on what are the post commencement deal killers. Instructions will need to be sought on the consequences of termination in those circumstances and the termination and remedies clauses drafted conscious of those consequences. Consideration needs to be given, so far as it can be done in advance, to alternative remedies to termination.
Consideration needs to be given as to whether a special termination clause needs to be included at all given that while there may be benefits from a contractual right to terminate there are also downside issues when relying on contract termination rights rather than common law termination rights.
HOW DO WE TERMINATE A CONTRACT
- By successful completion
- By Agreement
- In dispute
- Unilaterally – for convenience
The foundation of the right of termination can rest
- Under common law
- by a contractual right
- by a statutory right
DISTINGUISHING TERMINATION FROM RESCISSION
As all enjoying this telecast will know rescission is the avoidance of a contract retrospectively. A rescinded contract is as if it never was and the contract is a nullity. The parties are to be returned so far as is possible to do so to the position as if the contract were never entered into.
To rescind a contract the contract must be void or voidable.
A void or voidable contract has the distinguishing feature that its performance has become impossible due to events beyond the control of either of the parties. Those events having come to light following execution of the contract even though they may have existed prior to execution, for example, illegality or during performance e.g. a natural disaster rendering the contract impossible of performance.
Termination on the other hand is the right of a party to bring a contract to an end during its performance because of the breach by the other party:
- Of a fundamental term
- of an intermediate term in such a way as to fundamentally effect delivery of the contract
- renunciation – i.e. the refusal of a party to perform its obligation(s) under the contract.
Often the cause is classified as repudiation.
Once a contract is terminated the ongoing obligations under the contract are discontinued and are replaced by secondary obligations to pay damages for any losses arising from the breach.
A breach of contract founding a right to terminate is often referred to as a repudiatory breach.
As we will discuss later it is important in the jockeying around termination to ensure any notice of termination is properly founded on a repudiatory breach lest the client fall into the trap of anticipatory breach or renunciation.
BREACH OF A CONDITION – A FUNDAMENTAL TERM
In order to found a termination on a breach of contract the term breached needs to be a term fundamental to the contract. Such a term is referred to as a condition. If the term in breach is not essential to the contract then it will not necessarily found an entitlement in the innocent party to terminate. There may however, be rights to rectification of the breach and/or damages.
BREACH OF AN INTERMEDIATE TERM
A term that is neither a Condition nor a Warranty is referred to as either an intermediate or an innominate term.
Usually, a breach of such a term, would lead to rectification of the breach unless it is so serious as to “frustrate the commercial purpose”, “go to the root of the contract” or “substantially deprive “(the innocent party) of the benefit of the contract. In the later cases a breach of an intermediate term may constitute grounds for termination.
Continuing and ongoing breaches of one or more intermediate term may found grounds for termination. For example continual delivery out of time or continual and significant lateness in payment.
Of course, on time delivery and payment may have been contracted as fundamental terms.
Renunciation is the refusal by a party to carry out their obligations under the contract. e.g. not to deliver the goods to a particular port or the consignee refusing to honour the bill of lading by payment. Clearly these are more egregious examples of breach of a condition. It involves turning ones back on the contract not just failing to perform.
To be a repudiation one party must conduct itself in such a manner as to evince an intention no longer to be bound by its contractual obligations or only to complete the contract in a manner substantially inconsistent with the contract.
MINOR BREACHES OF A CONDITION
Notwithstanding that a term is expressed as being fundamental or is clearly fundamental the court may take the view that the actual breach is minor and the parties could not have intended the minor breach to found the right to terminate. It is therefore important to consider when drafting a termination notice and when advising on response based on a breach of a condition whether the breach is a minor breach and therefore what is in the best commercial interests of the parties when confronted by such a breach.
It is not necessary to enforce every breach of condition. A party may find it commercially expedient to acknowledge the breach and reserve its rights for action at a later time. In doing so the innocent party needs to be careful not by word or conduct to waive the breach or condone it. The innocent party may agree to a variation of the contract and/or combined with damages.
It may be difficult to divine whether a term is a Condition, intermediate term or a warranty.
As we know a warranty is an agreement in respect of a contract but collateral to the main purpose of such contract, the breach of which gives rise to a claim for damages, but not to treat the contract as repudiated (Sale of Goods Act 1929 ( NSW)); e.g. the statutory warranty from SoGA that all goods sold are fit for purpose. That statutory definition is a codification of the common law in respect of warranties.
We are all familiar with the numerous statutory warranties for example arising from the Home Building Acts.
It is not usual that a warrantable claim would occur during the contract term. Though it may, for example long time supply chain contracts and a warranty as to fitness for purpose but would in all likelihood then be dealt with as a breach of a condition or an innominate term.
So a breach of warranty per se is unlikely to lead to termination of a contract.
TERMINATION FOR CONVENIENCE
A less frequently struck basis for termination that needs to be addressed is the so called Termination for Convenience. Some commercial contracts provide that a party usually the Principal may terminate a contract for its own convenience. There is no common law right to terminate for convenience.
Courts are understandably chary of enforcing these clauses which strike at the heart of the contractual bargain.
The contractual term granting a right to terminate for convenience must be clear, unambiguous and exercisable without default.
The right to compensation in consequence must be clear and unequivocal lest a restitution claim be made. Lloyd J in Abbey Developments Ltd. –v- PP Brickwork  EWHC (Technology) 1987 held that termination for convenience clauses:
“frequently provide that the Contractor is to be compensated for its losses, including loss of profit and overheads contribution on the balance of the work. If they do not then they risk being treated as leonine as unenforceable as unconscionable.”
The courts have found the attempt to enforce such clauses simply to replace the contractor with another on more or less identical terms to be a repudiation which would allow the contractor to terminate and sue for damages. (Carr v JA Berriman Pty. Ltd. (1953) 89 CLR 327)
DRAFTING TERMINATION CLAUSES
As noted above the primary consideration when drafting a termination clause is somewhat antipathetically preserving the relationship between the parties. It is taking into account the observations already made important to identify the actually performance critical issues inside the contract relationship for which the parties may wish to terminate and claim damages.
These may include(without being exhaustive) delivery on time, payment on time and within terms, adherence to particular contract specifications, quality of product, insurance of goods in the course of delivery, appropriate registrations and licences of the vendor. Recently, one might consider compliance with anti-slavery and harassment legislation in supply chain contracts as a fundamental condition of a supply contract, especially to retail stores.
Consider when the usual requirements for fairness and notice might be set aside, if at all. Courts have been loathe to uphold gratuitous terminations even when parties are contractually entitled to do so.
One should so far as possible allow for rectification of default in a reasonable time.
If the evil day does arrive and the client cannot avoid terminating the contract due to the counter-party’s default what is necessary?
Practitioners will be aware that without an express provision to the contrary a party may not terminate a contract in part. E.g. it is not unusual in supply contracts to allow for some but not all of the product lines being provided to be cancelled with varying degrees of notice.
When faced with a repudiatory breach the aggrieved party has an election:-
A. Affirm the contract, treat the contract as continuing , seek damages and/or the rectification of the breach.
Affirming the contract may be in the commercial interest of the aggrieved party.
For example in Residential Building work an incoming contractor is obliged to warrant the structural work of the dismissed contractor. Typically this will come at a premium on the cost of completion which at best will be unpalatable to the owner and certainly, in my experience, is very expensive. On occasions the only remedy is to demolish and rebuild.
While the owner still has its rights in damages following termination these will only be paid after typically aggressive litigation. In the meanwhile the job is inordinately delayed and the cost is blown out and a new builder has to be brought on board. In the end the prior builder may just go insolvent, as they are want to do, defeating the damages claim.
So it may be a more palatable outcome to negotiate a resolution which may include compensation and re-working the parameters around delivery of the desired outcome of the contract.
If the contract is affirmed that breach cannot be relied upon again to terminate the contract but any similar later breaches may. Any claim for damages arising from the breach remains.
B. Terminate – accepting the repudiation and claiming damages
In this case the aggrieved party must closely test that there is a repudiatory breach before terminating. If the terminating party is shown to be wrong and does not recant this may well be an anticipatory breach on its part. Thus turning the tables.
If it is shown in the negotiations that inevitably follow service of a breach notice that the view of the original breach was misguided it is in the interests of the aggrieved party to revert to its rights for an intermediate or minor breach and follow the appropriate course which will include rectifying the defect and perhaps damages. But not termination.
At common law the defaulting party is entitled to mitigate any damage. The terminating party is also required to act reasonably in rectifying or completing the contract so as not to be excessive in its rectification costs.
So in most instances there will be a process of notifying the breach or breaches to be relied upon and a period in which the parties seek to remedy the cause.
In this circumstance it can be beneficial to have an intermediary injected into the contract to ensure compliance with the specifications of the contract both during the rectification and following to completion. This will be a 3rd party expert in the relevant field.
DOES AN AGGRIEVED PARTY PROCEED UNDER COMMON LAW RIGHT OR CONTRACTUAL RIGHT?
Whether an aggrieved party proceeds under a common law or a contractual right is a matter of strategy once you have determined that there is a repudiatory breach.
A contract can be terminated for a contractual breach and a common law breach simultaneously.
The critical consideration is the value of the remedy under either basis. Typically, termination under a contractual right does not exclude a claim for common law right loss of bargain damages absent express intention in the contract to that effect. Termination of a contractual right may activate a liquidated damages clause which often is not in the interests of the aggrieved party.
Important considerations therefore are:
- obligation to act in good faith when terminating – a minor breach although providing a contractual right will be looked on with disfavour on review.
- Is there an express term excepting the common law right in favour of the contractual right – if not should we proceed on one or the other or both?
- exercise of the contractual right only provides the remedies in the contract except if the termination is also available under the common law.
AN ASIDE – from this presentation and worthy of a paper on its own is the vexed question of liquidated damages. This little pebble in one’s shoe often arises during a termination dispute. You will see the relevance in this paper shortly.
Many construction contracts and other commercial contracts as well will provide a liquidated damages clause attempting to limit the damages that might be claimed against a contractor, especially in respect of delay damages, to a small sum per day and a very minor total claim. Almost always these clauses if sought to be enforced are subject to successful challenge.
The law in respect of liquidated damages clauses is old and well settled. Liquidated damages to be enforceable must be a genuine pre-estimate of the losses likely to be incurred by the non-defaulting party in the event of default.
A genuine pre-estimate requires an actuarial type process in which both parties participate prior to the execution of the contract to establish the most likely losses to be incurred by a party.
In the home building context it will include but not be limited to interest on the mortgage and any additional finance charges incurred as a consequence of the delay, cost of alternate accommodation, storage for goods and furniture and any number of site specific costs – boarding the dog.
Typically the contractor using one of the proprietary contract forms will simply insert at the appropriate spot in the Schedule a figure – $100 per working day with a cap of $25,000. No discussion takes place with the principal who has never heard of liquidated damages before. We all have seen them. Simply having regard to the contracted number more often than not puts pay to the proposition that any genuine estimate of the probable losses took place prior to contract.
Except in respect of large projects I am yet to see the process required by law undertaken. In my view except in very large contracts drafted by a legal team on both sides Liquidated Damages clauses are to be avoided.
If they are to be used then they are to be a genuine pre-estimate. Not a guess or an arbitrary number.
In an AS4902-2000 Contract I am currently dealing with the contention in respect of a Liquidated Damages Clause is enlivened. The Contractor itself drafted the contract by filling in the standard form. The Contract is for $7.9m + GST with variations it is $8.9m+GST. The developer got the OC 12 months late. The LDs are $500 a working day and a $50,000 cap. In the overrun period the Principal’s finance went into default. Interest on the 12 month delay alone is in excess of $1m. One might draw certain inferences from the disparity between the daily LDs rate and the daily default interest rate. There are also other general damages arising from the pre-sales overrunning the sunset clauses and the general economic slow down reflecting in unit sales causing re-alignment of anticipated sales prices. All of which losses would potentially be available in a loss of profit claim in a common law claim.
It is possible to terminate using both common law and contractual rights.
However, if your client makes an election to rely upon on or other of those rights to the exclusion of the other in the Notice of Termination it may find itself estopped from relying on the other and sometimes better right in the event of litigation.
In the event of proposed reliance on the contractual right the procedure set down under the contract must be carefully followed. Failure to comply with that procedure may lead to the termination being overturned for want of valid notice.
Early Termination (except for convenience) necessarily implies a dispute. If there is a dispute provision in the contract this must be followed prior to the issue of a termination notice.
A simple regime in the HIA NSW Residential Building Contract for New Homes provides (paraphrasing):-
Cl 35 Dispute Resolution – If a dispute arises a party must give notice to another party setting out the matter in dispute. Within 10 working days the parties must meet to try and resolve the dispute.
Cl 27 Ending the Contract – Breach requires a notice of substantial breach to be given and if the breach is not remedied within 10 Working days the aggrieved party may terminate the contract. All Notices under Cl 27 must be given by registered post or served personally.
Clause 29 Sets out the consequences of the builder terminating and gives the builder an election cost of the building work to date plus the material on site or damages . But not both. Loss of Bargain damages are impliedly excluded. OR damages.
Cl 30 provides the consequences of the Owner terminating . the owner must complete the construction work keeping itemised records of the cost, mitigate the loss incurred by the builder, within 5 days of reaching practical completion provide an itemised cost of completion to the builder. If the costs are greater than the contract there is a debt due to the owner, If the cost to complete is less than the contract price then the difference is a cost due to the builder.
On my reading of this contract the question of whether the Owner can terminate both under contract and common law is open.
In my view confronted with drafting a termination Notice under this contract one would be wise if the circumstances allow to draft the notice claiming default under the contract Clause and at common law.
In contra-distinction to this reasonably simple regime is the more complex and comprehensive:-
Default & Insolvency provision Cl 39 of AS 4902-2000. This contract, an Australian Standards Contract, is used for complex construction works including high rise unit blocks
Cl 39.1 expressly preserves the common law rights including damages
Cl 39.2 provides that if a contractor commits “a substantial breach” the Principal may by registered post give the Contractor written Notice to Show Cause.
Cl 39.2 provides a non-exclusive list of 10 substantial breaches by definition.
Cl 39.3 sets out the details to be included in the Notice:-
- that the Notice is a Notice under Cl 39
- the details of the alleged substantial breach
- that the Contractor is required to show cause in writing why the Principal should not either
– remove part or all of the remaining works from the contract and suspend payment then have the Superintendent assess the cost of the take-out and any costs or savings incurred. (39.6)
– Terminate the contract.
Date and time by which the Contractor must show cause being at least 7 clear days after service of the Notice
The place at which cause must be shown.
Cl 39.4 sets out the Principals rights to:
– remove part or all of the remaining works from the contract and suspend payment have the Superintendent assess the cost of the take-out and any costs or savings incurred. (39.6)
– Terminate the contract.
Cl 39.5 sets out what happens when the Principal takes wok out of the contract under Cl 39.4(a). Basically to take over total control of the job and possession and use of plans drawings, consents, sub-contractors and consultants engagement.
Cl 39.6 provides the method of dealing with adjustments for the work taken out on completion of that work.
Cl 39.7 provides the regime for a default by the Principal again the written Notice to Show Cause must be served by registered post or personally.
Cl39.8 Sets out the Terms of the Contractors Notice to the Principal
Cl 39.9 Provides the Contractors rights if the Principal fails to show cause.
– to suspend the works
– if the Principal does not remedy the breach within 28 days of the suspension to terminate the contract
In the event of termination the Superintendent shall certify the damages to the Contractor which then becomes a sum due and payable.
Cl39.10 as noted before preserves all the remedies, rights and liabilities a party may have in addition to this clause 39.
Without going into it deeply Cl 42 of the General Conditions provides a comprehensive dispute resolution procedure including compulsory settlement conference followed by mediation. Again service is by registered post or by hand and the Superintendent needs to be included.
Unless the works are taken out or suspended the works under contract are to continue during the dispute.
Importantly, it is apparent that the Clause does not provide for a Termination Notice. However, in my view, a Termination Notice is required if that option is being chosen by either party as the principal cause of termination is then failure to show cause. The common law remedies as a consequence of the breach having been preserved.
BACK TO THE NOTICE
So essential elements of the Notice will be:-
- Properly Identify the Parties as set out in the Contract
- A comprehensive and defensible recitation of the facts of the default or defaults
- A reasonable time for the defaulting party to remedy the default
- Compliance with any contractual requirements as to form and substance (if any)
- Prior compliance with any dispute regime
- Maintenance or reservation of any common law rights
- Compliance with any Time Limitation for the issue of the actual Notice of Determination of Contract.
- Proper service in accordance with the terms of the contract (if any) or at general law.
EFFECT OF TERMINATION
Leaving aside termination by mutual agreement there are 2 issues which arise from the issue of a valid termination notice:-
- Recovery of damages
- Effect on the Contract
EFFECT ON THE CONTRACT
A valid termination will discharge both parties from any continuing obligations under the contract – excluding ongoing obligations such as warranties and the like.
Essentially, the principal will be relieved from taking delivery of any undelivered portion of the contract and paying for that portion. The contractor will be relieved of the obligation to deliver whatever remains of its consideration for the contract.
However, in the event that the Principal was in default the cost of demobilising will be recoverable by the contractor. It may also be entitled to the cost of paying-out sub-contractors contracts..
If the Contractor is in default the Principal will be bound to complete the contract work using other contractors and the Principal may recover resulting costs and expenses provided the cost results from the breach of contract and not from the act of termination itself. (See Shevill v BLB (1982)149 CLR 620).
In a breach by the Contractor as noted above the Principal’s damages when at large will include any losses incurred as a result of the breach. It can be expected that the completion of the contract will be delayed by a significant time adding to the cost while other contractors are engaged by way of interest, holding charges. storage etc.. The cost to complete is often increased. This reflects the risk undertaken by the incoming contractor in delivering on the partially completed contract platform.
In Home Building cases the incoming builder is unable to exclude the HBA warranties for the work performed by others. Increased costs may simply reflect the increase in materials and labour over time. As long as the additional cost can be seen to proceed from the breach of contract it will be arguable that additional cost is recoverable.
If the contract is silent as to damages then the damages will be at large. However, if the contract provides the damages for termination that will prevail. (See liquidated damages above).
It therefore stands to reason that when drafting termination clauses for commercial contracts no matter which party one is representing clear instructions need to be taken as to the consequences for the party being represented of an early termination. This will be particularly so in contracts the delivery time for which is extended or the contract has separate deliverable parts. Geoff Bartels
Bartels Business Lawyers
Ashursts – Terminating Contracts Under English Law 18 June 2019
J Puglsley & N Christopoulos .. Drafting Effective Termination for Convenience Clauses…4 May 2006
S. Chapple Termination of Contract – video presentation
F Prickett Terminating Contracts; In-house Counsel, V16 No 6 ,T May 2013
A Williams 12 month employment contract . Can I terminate early 27 May 2019
R Johnson 5 Ways to Terminate a Contract 25 January 2019
J Andrews, T Taylor; Termination of Commercial Contracts 15 March 2016
Minter Ellison – Construction Law Made Easy 2019
A READING LIST
Theiss Contractors v Placer(Granny Smith) Pty. Ltd. (2000) 16 BCL 255
Abbey Developments Ltd. –v- PP Brickwork  EWHC (Technology) 1987 (i.e. England & Wales High Court – Technology & Construction Crt)
Carr v JA Berriman Pty. Ltd. (1953) 89 CLR 327
Koompahtoo Local Aboriginal Land Council v Sanpine Pty. Ltd. (2007) 233CLR115; 241 ALR88
Stocznia Gdanska SA v Latvian Shipping C & Ors  1 All ER 883
Ringrow P/L v BP Australia P/L (2005) 22 ALR 306
Shevill v BLB (1982)149 CLR 620).
Berger v Boyles  VR 321
Government of Japan v Global Air Leasing Pty. Ltd.  QSC 221
Ogle -v Comboyuro Investments Pty. Ltd. (1976) 136 CLR 444
Renard Constructions (ME) Pty. >td v minister for Public Works (1992) 26 NSWLR 234
McDonald –v- Dennys Lascelles Ltd. (1933) 48 CLR 457
DTR Nominees Pty. Ltd. v Mona Homes Pty. Ltd. (1978) 138 CLR 423
Secured Income Real Estate (Australia) Ltd v St Martins Investments P/L 91979 144 CLR 596
Concut P/L v Worrell ( 2000) 176 ALR 693
Johnson –v- Agnew  AC 367
Progressive Mailing House P/L v Tabali P/L 91985) 157 CLR 17