When your business signed up to a commercial contract you may not have carefully considered whether you could end the contract early, and you may not have paid close attention to the termination provisions. In this article, we explore the importance of getting to know the termination clauses of your contract well ahead of signing on the dotted line, and the necessary guidance and steps to take should you need to terminate a commercial contract for any number of reasons.
We'll be covering:
- What does the termination of a commercial contract mean?
- How can a commercial contract be ended?
- Why are the legal grounds to terminate a commercial contract important?
- Why should you include contractual powers to terminate a commercial contract?
- What is terminating a contract under common law?
- 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 give the wrong grounds for termination of a commercial contract?
- What happens if you don’t follow the termination clause in the contract?
- What is estoppel and termination of a commercial contract?
- What should a business do if it serves an invalid termination notice?
- Are there time limits to terminate a contract?
- Can you delay the termination of a commercial contract?
- Can you reserve the right to terminate a contract?
- Can you change your decision to terminate a commercial contract?
- Special cases and the right to terminate a contract
What does the termination of a commercial contract mean?
The termination of a commercial contract simply means that the contract is at an end. If a commercial contract is terminated, this excuses the parties to the contract from further performance of their contractual obligations after the contract termination date, unless the clauses are said to survive the end of the contract. For example, a confidentiality clause may state that the confidentiality requirement continues after the end of the contract.
Terminating a commercial contract isn’t a complete escape from liabilities as termination of a contract doesn’t extinguish all liabilities. For example, if one party to the contract breached the terms of the contract before it was terminated, they remain liable for the breach.
How can a commercial contract be ended?
Commercial law solicitors often find that the termination clauses in a commercial contract are often only focussed on by the parties to the contract when one or both wants to end their agreement. A commercial contract can be ended in a variety of ways, such as:
- The expiry of a fixed term contract.
- In accordance with the termination provisions contained in the contract, such as the exercise of a break clause or notice clause.
- Performance related issues resulting in the discharge of the contract.
- By agreement between the parties to the contract. This is also referred to as a ‘release’.
- Through rescission of the contract.
- Through the operation of the law. For example, a commercial contract may be discharged by merger.
Why are the legal grounds to terminate a commercial contract important?
When you fall out with someone in business your first reaction may be to cancel your contract with them but that could be an expensive mistake to make without first assessing the legal grounds to terminate the contract. This is because:
- You may think that you have more than one ground to terminate the contract and could choose a breach that doesn’t have a termination right. By invoking a non-existent termination right, you could repudiate the contract and that action could lead to liability for damages.
- If you don’t act in a timely manner you may lose the right to terminate the commercial contract.
- If you lose your right to terminate the contract, then 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 for loss of the contract or payments specified by the contract or limits on liability.
Why should you include contractual powers to terminate a commercial contract?
Commercial solicitors usually recommend termination clauses suited to your business sector and the nature of the contract. That is because you can either terminate a contract under the terms of the contract itself or under common law. Relying on common law may mean that you don’t have the right to terminate when you want to do so, or the remedies are different, or the outcome is less certain. It therefore pays to spend time considering the termination clauses when your commercial solicitor is drafting or reviewing the contract.
What is terminating a contract under common law?
A commercial lawyer will refer to the right to terminate a contract under your contractual rights contained in the contract or under ‘common law’. If you want to terminate a commercial contract it is important to look at all of your contractual and common law termination rights.
Your right to terminate a contract under common law is retained (even if the right isn’t mentioned in the commercial contract) provided that your contract doesn’t exclude your common law rights. That is why it can be important to take legal advice on your termination rights as you may have common law rights that you’re not aware of.
The contractual rights to terminate are contained in the contract and normally the termination clauses allow termination in wider circumstances with different financial implications than termination under common law.
The common law gives you and the other party the right to terminate the contract on grounds of serious breach that is referred to as a repudiation. Examples of repudiation include:
- A breach of a condition (such as a time is of the essence clause)
- Or a repudiatory breach of an intermediate term or renunciation (one party’s refusal to perform all or most of its obligations under the contract).
Whether something is a condition, or an intermediate term is a question of interpretation. Learn more on the subject with our guide on how to deal with an anticipatory breach of contract.
If your contract is not for a fixed term and there is no termination clause the general common law rule is that the contract is terminable on reasonable notice. What amounts to reasonable notice depends on the facts and circumstances. Where notice is disputed the court will consider:
- The length of time you have been in a contractual relationship with the other party.
- The nature of each party’s obligations.
- The ease with which the other party can go elsewhere.
Use of common law to terminate a contract gives rise to uncertainty and dispute. That is why it is strongly recommended carefully drafted termination clauses are included in your commercial contracts to give your business a degree of certainty over termination provisions and to limit the risks of costly litigation in the event of a commercial dispute over the termination of a contract.
For example, if you want the right to terminate without giving a reason for ending the contract it is best to include a contractual term in the contract that gives you the express right to terminate by giving a specified period of notice but without specifying a ground for termination. For example, you may wish to invoke this right if you no longer require the contracted services because of a change in market conditions.
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 legal advice to make sure that you have the grounds to terminate. 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.
- You no longer need the goods or services. For example, because of a change in trading conditions.
How do you terminate a commercial contract?
First and foremost a commercial contract is a legal document and you should only terminate a contract if you have the legal grounds to do so. To avoid the consequences of inappropriately terminating a contract you should take legal advice before informing the other party that you are ending the contract.
Terminating a contract isn’t just about the law. There are potential serious business implications for termination of 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 the 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 terminate the contract. For example, a termination notice is not a demand for compliance with the contract or a request for non-payment or a threat or warning letter saying that you will terminate the commercial contract unless breaches of contract are remedied. In addition, a termination notice that allows parts of the contract to continue whilst also seeking to terminate isn’t sufficient. Giving notice of termination has to 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. For example, some termination clauses in contracts allow notice to be given by email whereas others don’t. If the contract doesn’t specify the notice requirements then, under English law, if you have the grounds to terminate, you can do so by clearly and unequivocally saying that you are exercising your right to terminate. The communication may be written, spoken, or by conduct but it’s recommended that you give written notice to minimise the risk of disputes over whether notice was properly given.
- 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 to the commercial contract 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 the right to do so either contractually or under common law then you could face unexpected financial consequences.
If you serve an unjustified notice of termination then it could amount to a repudiatory breach of contract by you 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 give the wrong grounds for termination of a commercial contract?
There is no hard and fast answer if you give the wrong grounds for the termination of a contract as it all depends on whether you have another ground for termination that hasn’t been lost. If that is the case then you can give notice under that ground to justify the contract termination or reduce any liability for damages.
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 have 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 is estoppel and termination of a commercial contract?
If you lead the other party to the contract to believe that you won’t enforce your strict contractual rights then this is ‘estoppel’ and it is deemed unfair to change your position. Examples of estoppel include you potentially not being able to reactivate grounds for the termination of the contract that you’d previously not actioned. That is why it is so important to get the grounds for termination right and follow the correct process.
What should a business do if it serves an invalid termination notice?
If you serve an invalid notice to terminate the contract then you have options. The best options depend on the circumstances of the notice but include:
- Serving the notice again using the correct contractual procedure.
- 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.
Are there time limits to terminate a contract?
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 because the legal right to terminate a contract can be lost by delay. This is the case whether the right to terminate the contract is a contractual or a common law right.
Can you delay the termination of a commercial contract?
If you wait too long then you may lose your right to terminate the contract depending on whether you are terminating under contractual provisions or under common law. If you are terminating under termination clauses in the contract you should follow the terms of the contract. If you are terminating the contract under common law principles then once you become aware of the breach of contract you normally have a reasonable time to investigate the breach and decide whether to terminate or affirm the contract. Case law says that if you do nothing for too long you can be treated as having affirmed the contract, but the length of reasonable time is a question of fact and can vary from one case to another. It is therefore best to take legal advice on whether you can and should delay making a decision on termination of the contract.
Can you reserve the right to terminate a contract?
If a party to a contract has breached a clause in the contract then you may want to reserve your right to terminate the commercial contract as an incentive for the other party to comply with the terms or to buy yourself more time to make a decision on whether or not to terminate. That may be because although the commercial contract has been breached the contractual source of income or provision of supplies is valued by your business.
When reserving a right to terminate it is best to link it to a requirement for information or investigation but any reservation time frames need to be followed through as although you may be able to reserve the right to terminate a contract that right can be lost by delay or if the reservation of rights is overtaken by events. An example of events overtaking reservation of rights is inconsistent behaviour. If you are not careful then by the time you decide to assert a reserved right to terminate, it might be too late.
Can you change your decision to terminate a commercial contract?
If you have the legal right to terminate a contract, whether that right is contractual or under common law, then once you have given notice of termination you can’t change your mind. This means that:
- You can’t withdraw a termination notice.
- If a contract is terminated, it cannot be revived unless both parties to the contract agree.
- 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 the contract. This is referred to as ‘affirmation’. Affirmation can be inferred from your actions. For example, if you allow the continuation of performance of the contract despite knowing that the contract has been breached and that you have a right to end the contract. In any business, it is important that different departments communicate with one another to avoid the supply department affirming the contract by demanding performance through provision of contracted supplies while the management or accounting team is seeking to terminate the contract.
Special cases and the right to terminate a contract
There are special cases where common law or contractual rights to terminate a commercial contract are affected by legislation. One example is insolvency where there is no common law right to terminate the contract for insolvency, but it is normal to include a termination clause in the contract for insolvency. Insolvency legislation restricts the contractual right to terminate in some cases, for example, through the use of section 233B of the IA 1986 (section 15, Corporate Insolvency and Governance Act 2020).
If you want to terminate a commercial contract it is vital to look at both the business and legal consequences of doing so to protect your business interests. If you end up in a dispute over the termination of a contract then our commercial dispute resolution solicitors can help resolve conflict about terminating commercial contracts.