Termination of Contracts – Lexology

Bizar Male

Welcome back to our new series of ‘back to basics’ blog in which we will provide posts focused on common legal issues. This blog post looks at termination of contract, and the various ways in which contractual obligations could be brought to an end.

Why terminate a contract?

Parties enter into contracts in order to ensure mutually agreed obligations are enforceable by law. However, circumstances may change overtime: the contract may no longer be commercially beneficial, the other party may not be performing their obligations, or external circumstances – such as the COVID-19 pandemic – may render the contract unfeasible or detrimental to a contracting party. As a result, a party may wish to find means by which to bring the contract to end.

General Rule

When a contract is terminated, all future primary obligations under the terms of the contract fall away. However, the contract is not treated as if it had never existed (State Trading Corp of India Ltd v M Golodetz & Co Inc Ltd [1989] 2 Lloyd’s Rep 277). Secondary obligations continue to arise, such as the duty to pay damages for breach of contract, and the obligations of a guarantor under a guarantee. Moreover, survival clauses – those which expressly set out the legal obligations which are to apply after termination – will remain in effect. Boilerplate survival clauses include those related to confidentiality, limitation of liability and arbitration clauses which are intended to preserve the accrued rights and liabilities of the parties.

Grounds for Termination

There are various ways in which a contract may be terminated, at common law or as stated in the contract itself. This blog does not deal with all ways a contract may end, such as: rescission, in which the contract is treated as if it had never existed; affirmation; illegality; frustration; or termination by agreement. Instead, it focuses on the main grounds in which a contract may be terminated by an aggrieved party.

Under Common Law in England

At common law, parties have the right to terminate on grounds of a serious breach of contract. This can include:

  • Breach of an implied term – a term may be implied into a contract where, for example, it is necessary to give business efficacy to the contract (The Moorcock [1889] 14 PD 64) or is so obvious, that it goes without saying (Shirlaw v Southern Foundries (1926) Ltd [1939] 2 KB 206). Such a term will not have been expressly agreed by the parties, but is implied into the contract either by statute or common law. If breached, then a right to terminate may arise.
  • Breach of a condition – a condition is a term goes to the root of a contract (Poussard v Spiers and Pond (1876) 1 QBD 410). If breached, the aggrieved party has the right to either terminate the contract or affirm it, in addition to claiming damages. No matter how minor the consequences, breach of a condition will always trigger the right to terminate. This is in contrast to a warranty, whose breach will not trigger termination no matter how serious the effect, although the innocent party may claim damages.
  • Breach of an innominate term – an innominate term is one that can neither be defined as a ‘condition’ nor a ‘warranty’. Where the breach of such a term would deprive the innocent party of substantially the whole of the benefit of the contract, this is sufficient to give the innocent party a right to terminate and claim damages. Whether such a breach will result in the right to terminate is judged at the time of termination, not when the contract was made (Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisha Ltd [1961] EWCA Civ 7).

Termination as Specified in the Contract

While common law gives the right to terminate when there is a breach of condition or serious breach of an innominate term, the contract itself may provide the possibility to terminate the contract even without such cause. An event of default (EOD) is a predetermined circumstance in a commercial agreement, the occurrence of which will give the non-defaulting party the right to terminate the contract. Typical EODs include insolvency, material adverse change, cross-default breach of covenant and breach of representation. A contract may also stipulate a period of notice to terminate, or specify a minimum term after which termination may be possible

Termination of Charter Parties

Charter Party agreements are ubiquitous in commercial shipping. Standard form agreements are commonly used, with details of the agreement tailored by the parties, their brokers, or shipping lawyers. Whether standardized or bespoke, Charter Party agreements typically contain the following termination provisions:

  • Termination by the Charterer – almost all Charter Parties contain provisions for the Charterer to terminate (“cancel”) if the vessel is not delivered on time or if the vessel is not ready to load by a certain date (Cheikh Boutros Selim El-Khoury v Ceylon Shipping Lines Ltd (The “Madeleine”) [1967] 2 Lloyds Rep 224).
  • Termination by the Owner – an Owner will likely have the right to terminate a time charter for non-payment of hire. In many contracts, the Owner may be required to give notice to a Charterer, stating that unless payment is received during a specified grace period, the Owner will be entitled to terminate the remaining part of the contract (“withdraw the ship”).
  • Termination by the either party – various specified events of default may entitle the innocent party to terminate the contract such as War Cancellation Clauses, under which either party may cancel the contract on the outbreak of war if between certain predefined countries. Boilerplate force majeure wording, which frees both parties from obligations or liabilities when a circumstance beyond the reasonable control of the party arises such that it prevents a party from performing under the contract, may sometimes be included. Lastly, following from contract law, breach of an implied term, condition or innominate term, along with other grounds under English common law, may give the innocent party the right to terminate.

Specific clauses allowing a right to terminate may be negotiated at the time of fixing. It is always advisable as far as possible to take into account changing circumstances at the time of the contract, for example logistical or other difficulties that have arisen as a result of the COVID-19 pandemic, as doing so will help ensure that future performance remains beneficial to the contracting parties.

Exercising Caution

It is important to take any necessary action to terminate the contract, as termination provisions do not normally provide for automatic termination. Moreover, such positive action must not be unduly delayed, as termination rights can be lost by delay. The time permitted for action could be very short indeed. The best course is first to consider the legal basis upon which one is entitled to terminate, ensuring that the termination notice identifies each of the termination rights being exercised; both contractual and under common law.

Care should be taken in the decision making process. Terminating a contract without the right to do so could result in a repudiatory breach of contract and a claim for wrongful termination. If this were to occur, the other party could accept the repudiation and, with the contract ended, sue for damages.

There are various commercial considerations to bear in mind when considering terminating a contract. The business relationship with the party with whom you are contracting may be damaged as a result of the termination. Moreover, if you terminate a contract and later change your mind, you may find yourself in a weakened position when re-negotiating a new contract.

Prior to deciding to terminate a contract, parties should consider alternatives such as varying the contract, which could have the benefits of reducing the associated costs compared to negotiating a new contract and maintaining the commercial relationship with the other contracting party. The terminating party also needs to check that there are no express limits on termination rights, which may constrain a party’s ability to terminate

Finally, following a decision to terminate, parties should review the contract for any clauses that prescribe a dispute resolution procedure, which may include arbitration, mediation or litigation, as this will specify the course of action to be taken in case of a disagreement and have practical implications on the future conduct of the party.

Conclusion

The ability to terminate a contract is an essential function and a necessary commercial consideration in business to protect a party’s position, particularly where a contract becomes unprofitable or is no longer commercially viable. When a party wishes to exercise their right to terminate, they must first carefully consider the legal and commercial consequences of doing so.

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