Terminating a contract
One question we are often asked by a client is whether they can terminate a contract that they have entered into. Whether a party can terminate a contract is a complex question of both fact and law. It will depend on common law principles as well as the wording of the agreement.
When can a termination right be exercised?
- Most contracts set out the circumstances in which a party may terminate. These often include:
- The other party is in breach of the contract and has failed to rectify the breach during a specific “cure period”
- The other party is insolvent
- The contract permits a party to terminate for “convenience” (or for no particular reason) on the provision of a specified notice period.
In most cases written notice is usually required to effect termination.
Before a termination notice is given, a number of issues need to be considered:
- Have the conditions for termination been met?
- Does the termination notice comply with the relevant requirements set out in the contract?
- Does the law imply a duty of good faith into the contract which will affect its termination. There is complex case law on this issue but essentially many contracts imply such a duty. If so, will the termination comply with this requirement?
What if the contract doesn’t have a right of termination?
Some contracts may not include an express right of termination. This often happens where the contract is oral or the terms of the contract are only briefly recorded in writing.
In these circumstances if a party breaches the contract (usually failing to deliver what they promised) then they need to rely on common law (or judge made law) principles to determine whether they can terminate.
At common law, for a party to terminate a contract, the other party must have repudiated the contract, breached an essential term of the contract, or committed a serious breach of an “intermediate” term. The focus should be the nature and seriousness of the breaches.
The first question therefore is to determine whether the term breached is an “essential term”, a “warranty” or an “intermediate term” (which is something in between). Determining whether a term of an agreement falls within any of these categories, will depend on the common intention of the parties at the time of the contract, that is, the intended importance of the relevant terms and the intended consequences of failing to comply with them.
Once this is determined, a terminating party will need to consider:
- Whether the contract excludes the right at common law to terminate. For example, if a contract sets out all the circumstances in which a party may terminate, then the party may not rely on these common law principles
- Whether there is another legal principal which would stop termination. This could include, for example, a “waiver” of rights, an “estoppel” or the misleading and deceptive conduct provisions of the Trade Practices Act.
What are the risks of wrongful termination?
The principles for terminating contracts are quite complex and careful consideration should be given to whether the right to terminate exists, and if so, how to then exercise that right.
If a contract is wrongfully terminated, then the terminating party may itself be held to have repudiated the contract. This may then confer on the non-terminating party the right to terminate the contract and claim damages.
Author: John Sier