How To Avoid Contract Termination Disputes

The contractual clause that allows one party to terminate an agreement is a powerful provision. Drafted correctly, a contract termination clause can mitigate the risk of disputes which can not only be costly in terms of time and money but also reputationally damaging.

Before discussing how disputes can be avoided, it is important to set out the basic law in England and Wales around contract termination.

What is termination of a contract?

If a contract is terminated neither party is obliged to undertake any further performance or make additional payments after the termination date (these are referred to as the primary obligations). However, it is crucial to note that termination does not mean the contract never existed. The contract continues to have legal effect and non-primary obligations and rights can still be enforced. Importantly, clauses related to dispute resolutions such as jurisdiction, choice of law, and arbitration will survive termination.

What are the legal grounds for terminating a contract?

A contract can be terminated on grounds set out in the agreement’s terms or under common law.

The consequences for wrongful termination can be grave, therefore, you should never terminate a contract without first seeking legal advice on the strength of your argument and the risks associated with wrongful termination of the agreement.

Termination at common law

If one party commits an extremely serious breach (known as a repudiatory breach) common law provides that the innocent party can terminate the agreement immediately.

A repudiatory breach strikes at the very heart of the contract. Examples include:

• The breach of a condition. For example, if the contract states that time is of the essence and one party is late performing their obligations, the innocent party may have grounds to terminate the agreement.
• One party performs the contract in a completely unique way than what has been agreed.
• Non-performance by one party is inevitable (known as an anticipatory breach).
• One party refuses to perform all or a crucial part of the contract (referred to as renunciation).

The threshold for a repudiatory breach is high and whether such a breach has occurred and therefore justifies the termination of the contract is judged at the time of termination, not at the time the breach occurred. Furthermore, if the breach could have been put right had the party been made aware of it in suitable time, the Court may refuse to rule that the termination of the contract for a repudiatory breach was justified.

Contractual powers to terminate a contract

Depending on the type of contract and your industry sector, you may want to include a clause (or clauses) providing the right to terminate the contract if one party:

• Becomes insolvent or experiences financial difficulties.
• Commits a material breach of contract. There is no specific case law definition of what constitutes a ‘material’ breach. In Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust [2013] EWCA Civ 200, the Court of Appeal stated that a material breach is “more than trivial but need not be repudiatory”. A well-drafted commercial contract will define ‘material breach’ to minimise the risk of a dispute.
• Does not pay in full by the agreed date.
• Wants to terminate the agreement for convenience (without cause). In most cases, the parties will negotiate a notice period that reflects the value and complexity of the contract.

Disputes can occur where one party believes that the contractual termination clauses displace the right to terminate at common law. However, the common law right of termination will apply unless it has been explicitly excluded.

How can I avoid disputes concerning the termination of a contract?

As with most contractual disputes, preventing disagreements concerning termination provisions developing in the first place is far cheaper and less stressful than allowing a dispute to erupt. Successful risk management around avoiding contractual disputes comes down to three things:

• Having an experienced Solicitor draft the contract after they have listened to what needs to be achieved.
• Careful reading of the contract by the non-drafting party (this is the step that is most often neglected).
• Clarifying and negotiating any ambiguous terms to ensure complete understanding as to what is being agreed.

Most people do not appreciate how intricate contractual disputes can become. For example, in the case of Bains v Arunvill Capital Ltd [2020] EWCA Civ 545, the Appellant, who had been appointed by the Respondents to provide financial consultancy services, argued that because he had responded to a notice of material breach by stating that he intended to perform his contractual obligations the Respondents were not justified in terminating the contract. His Honour Judge Dight, at first instance, stated that telling the Respondents that he planned to undertake the work was not enough for the Appellant to have remedied the material breach. What was required was that work actually began within the timeframe set out in the termination clause.

The Court of Appeal agreed, concluding:

“…the claimant stating, in the letter of 20th April 2016, that “he does intend to perform his contractual obligations” did not remedy the breach in this case. To repeat, what was required, … was that the claimant “had to start providing the Services” within the 21-day period which, (I repeat again) as found by HHJ Dight, he did not.”

What is interesting about this case is that it went all the way (and presumably, with considerable costs) to the Court of Appeal. Although there is nothing in the facts which suggests that a robust dispute resolution clause was not included in the contract, the case highlights how far disputes concerning contract termination can escalate.

To find out more about any matters discussed in this article, please email us at [email protected] 0121 249 2400.

Please note that this article does not constitute legal advice.