Contract Termination
A contract is reciprocal, meaning that both parties have obligations to fulfill pursuant to the terms of the contract. However, certain events may trigger the right to terminate the contract with or without prior notice. There are different types of termination as well. For example, contracts may provide that a party may terminate it "for cause" or "for convenience."
"Termination for cause" is a contractual term that allows one party to terminate the contract when the other party breaches its obligations. Breaches can occur in many different circumstances, such as where a party does not fulfill its obligations or where it otherwise fails to perform as required.
"Termination for convenience" is not tied into a party’s performance. Instead, it allows a party to terminate the contract if it no longer wishes to be bound by its terms.
The type of termination required will depend on the contract , and whether it states that a party may exercise the right to terminate only for cause, only for convenience, or both.
For some government contracts, the right to terminate for convenience is specifically requested by the awardee as a way to protect them financially. For example, the Federal Acquisition Regulation (FAR) is the guiding regulation for the acquisition of supplies and services by the federal government. This law allows the government, in its discretion, to terminate any government contract for its convenience when it is in the best interest of the federal government. Most contractors want the right to terminate for convenience because it protects them from losses or damages for changes to the contract that they could not have foreseen at the time the contract was negotiated.
Requirements of a Valid Termination Notice
In addition to compliance with the terms of the relevant contract, the party serving the termination notice must also comply with any other legal requirements for validly terminating the contract, whether under statute or regulation, or otherwise. The circumstances in which a termination notice may be invalidated are relatively few but nevertheless include the service of a notice by a person without the authority to do so and the existence of an overriding public policy so that the termination would be contrary to the public interest.
However, as a minimum, the following requirements must usually be observed:
in good time or in accordance with a reasonable notice period (as specified in the particular contract), where the right of termination arises by reason of expiration of a fixed term or the attainment of a particular stage of performance;
so as to give the parties reasonable time to perform their remaining obligations in relation to the matter and so as not to disadvantage the terminating party;
in writing, notwithstanding any rule of law to the contrary (which is generally reserved for situations such as the termination of an agency);
in accordance with the terms of the particular contract, or as required by statute or regulation (if applicable).
How to Prepare a Termination Notice
When drafting a termination notice, the first step is to check whether the contract requires any particular form of notice or gives a specific period for termination notice. Deviation from those requirements might affect the effectiveness of the notice. If none is prescribed, then a letter or an email is normally sufficient.
From a practical point of view, however, it is better to provide a clear statement of the basis for the termination and express the party’s intention to terminate – e.g. by notifying "in accordance with Clause 13" or "in accordance with your and the defendant’s letter dated [x date]". This way the impact of the notice should be easier to establish if there is ever a dispute about its validity. Courts tend to require parties to be reasonably specific about the grounds for termination even if the contract gives the party a very free form right to terminate, so in the event of a dispute it would be wise to include the same level of detail in the termination notice.
In addition, a party terminating for breach may have to consider whether or not to hold off until that breach has caused them damage. Some contracts allow the terminating party to terminate on the happening of an event outside its control (force majeure). In this event, premature termination by the other party would usually entitle the party wishing to terminate to seek damages. However, delay in exercising the right to terminate may lead to the other party believing it has a reprieve and actually expecting them to forego their termination rights. In these circumstances, the terminating party should specify that they are reserving their right to terminate upon the expiration of the force majeure event.
Where a time period is specified, it should be calculated according to the terms of the contract – i.e. from the day after the date of posting if it is sent by letter or from the date of sending if it is by email.
Common Errors in a Termination Notice
One of the biggest mistakes a company will make when issuing a termination notice is assuming that a specific amount of notice is not required. Issuing a termination notice, effective immediately, can lead to a wrongful dismissal claim unless a termination clause in the employment contract allows for a shorter notice than the minimum requirements of the Employment Standards Act.
Another common mistake is failing to clearly communicate the reasoning behind the dismissal or failing to provide a clear timeline for the termination notice. A court may decide that the employee was induced to continue working and, therefore, not actually dismissed if prior to the termination either no cause was given, or the termination notice was indefinite . So even if there is no cause for dismissal, it is a good practice to clearly state the reasons for termination.
Finally, it is not uncommon for termination notices to be issued based on false assumptions. For example, if termination notice is not provided because one wrongly assumes the employee has not reached two weeks of service, only to find out later that the employee has in fact been with the company for a number of years, the cost to the company can be significant. It is therefore critical to double check seniority before issuing a termination notice.
Resolving Issues Following Contract Termination
Even if the parties have complied with all their obligations at the time of termination, disputes can arise after a contract has been terminated. For example, the subject of the contract may have been damaged due to negligence (e.g. property damage, where the property is returned in a damaged state), or a party may seek to terminate the contract even though there was no lawful cause to do so and the termination notice was invalidly served or not served at all (more below). The first step should usually be to try and resolve between the parties any issues which may arise after contract termination. Where the parties are unable to resolve their differences, mediation may be an appropriate means by which to settle the dispute. It is recognised that it is almost always in the interests of both parties to attempt to reach an agreement rather than pursue legal proceedings. Returning to the spirit of collaboration which motivated both parties to enter into a contract in the first place is usually the ideal way forward. In some circumstances, court or tribunal proceedings will be speedier and more effective. Legal documents should be drawn up and exchanged before the mediation session takes place, but any such documents should be construed liberally so as to allow for the outcome of the mediation to be fully implemented. If a settlement is not reached the mediation may be adjourned to allow the parties to seek further legal advice before resuming the mediation or withdrawing from it. If mediation or other forms of negotiation have broken down, court action may be the next step if one party is of the view that the other has not complied with the terms of the contract. Court proceedings will usually be expedited and heard more swiftly than arbitration proceedings. It is also the case that cases can be heard by judges within weeks, rather than the years it typically takes for arbitration proceedings to take place. With regard to the powers of the courts, a judge can make many of the powers granted under a contract, such as the power to make an injunction enforceable and the power to assess damages.
Examples of Contract Termination
There are countless situations where contract termination has been successfully conducted or gone terribly wrong. The following are real-world case studies in termination. These scenarios demonstrate the best practices and pitfalls to avoid when terminating a contract.
A jurisdictional clause in the contract indicates that the parties have agreed that the provisions of the contract have to be interpreted in accordance with the laws of California. When the supplier, based on the terms of the contract, sends you a notice of intention to arbitrate the dispute, you refer to a clause which states that the arbitration must proceed under Spanish law. The supplier argues that the clause only applies to pricing issues and that the notice is actually not regulated in the arbitration clause. And in addition, you refer to your domicile in Spain as opposed to California. As you can see, there are several arguments that need to be resolved before even one of the two parties has any certainty over whether the dispute will be resolved in California, Spain or before an arbitrator.
In this particular situation, it would have been beneficial if there was a properly drafted termination notice provision in the contract that identifies each party’s rights and obligations in the event of a dispute and which jurisdiction should apply. The obvious lesson in this case study is not to sign contracts which lack a termination notice clause. However, in cases where there is no such clause, it is worth thinking about the judicial system in California versus what the courts in Brazil would have ruled in the same situation .
In practice, many businesses find that the local courts are unable to make a decision which is satisfactory and fair to all the parties involved. The general sentiment is that we do not actually want to go through the whole litigation process in a local court, however, we have to consider whether we are going to get the same outcome both in California and in Brazil.
A reduction in supply may trigger the contractual termination clause which states that if the volume of the orders does not exceed a certain threshold, for any reason, this will provide for termination of the agreement. However, the reason for the supplier’s reduction in supply may be due to a shortage of raw materials.
The first thing the parties involved would need to consider is how much time has gone past since the delivery of bulk orders and why the delivery was reduced. There might be a good reason behind the actions of the supplier and, if there is, the risk of termination will be limited. If the court is convinced that the supplier did not act in good faith, the supplier would be advised not to breach the contract.
In this scenario, the business would have been better off if they had cooperated with the supplier in order to ensure that the supplier complied with their obligation in the least damaging way possible. The following termination notice clause provision might have been particularly beneficial:
"When the contract is terminated under any provision of this agreement, such termination shall not limit or affect either party’s liability to the other arising under this agreement for any act or failure to act prior to the date of such termination, including without limitation any anticipated or consequential damage.