Contract termination - Andrew Smith - ThinkHouse September 2014

David Lowe: One of the thorniest problems for any in-house lawyer is that question, "how do I terminate this contract?" It's never easy. In this interview, Andrew Smith, partner in our litigation team, is going to talk us through how you can terminate a contract and how to avoid those pitfalls.

So Andrew, if you want to terminate the contract, how do you go about it?

Andrew Smith: Well I suppose the easy answer is do it carefully because there are a lot of pitfalls in contract termination but then really the first thing to do is find out what your contractual terms are and the reason that that is important is it will set out the rules by which you can actually effect that termination. So it rather depends on whether you go down a fault termination or a no fault termination.

David Lowe: So is there a different approach depending on whether it is fault or no fault?

Andrew Smith: If there is no fault then you very much have to play by the rules of the game as set out in the contract. If there is fault, i.e. a breach by the other side then as the wronged party you have got a little bit more room to manoeuvre.

David Lowe: Let's take the no fault approach, if the contract is silent on termination what happens then?

Andrew Smith: Well if it is silent you have really got to look at two things.

The first is, is it silent in relation to termination because it's a fixed term contract so for a given period of time that is how long the contract lasts and if that is the case then I am afraid unless you breach the contract you are going to have to wait because a fixed term contract expires, it can't be terminated, it sort of dies of natural causes, and then if it is not a fixed term contract and there are no termination provisions, then you will have a reasonable period of time to terminate implied into the contract.

David Lowe: So, million dollar question, what is reasonable notice?

Andrew Smith: Well it may be a million dollar question but it is also a sort of how long is a piece of string question. The reality is it depends on all of the circumstances of the contract, that is how the courts can obtain for themselves the maximum flexibility.

I know that's not of much help so as a rule of thumb really I would say that if you've got a long term contract where there is quite a lot of dependence between the parties, so it is not an easy contract to terminate, I would say that if you are trying to give three months' notice you are cruising for a bruising.

If you give a year's notice you are pretty safe but then you have got a year of a deteriorating relationship, so where I get to in all this is unless there are very unusual circumstances, between six and nine months, gives you the maximum amount of protection but the minimum amount of time still in the contract you don't want to be in.

David Lowe: So turning now to where there has been a breach, what do you need to consider then?

Andrew Smith: Well again you need to look at the contract because you may have a right under the contract to terminate for that particular kind of breach but in addition to that you should also be looking at whether the breach is sufficiently serious to be a repudiatory breach.

David Lowe: So, repudiatory breach, tell me more.

Andrew Smith: Well a repudiatory breach is a breach that goes to the heart of the contract and as a result of which you can call the whole thing off, you can say the contract is at an end and there are three basic types of repudiatory breach, one that is based in the past and two in the future, so the past would be where there has been a breach and it is so substantial as to go to the root of the contract and then the two future ones, there's renunciation which is effectively where you say I am not going to be bound by the contract, the classic example of that would be by giving three months' notice when you should have given much longer and then impossibility which, as the name suggests, is where you've rendered further performance of that contract impossible so an example of that would be, let us say I was to say to you "yes let us have a contract for me to provide to you a ming vase in two weeks' time" and then in a week's time I would go and sell it to somebody else so it would render the performance of that contract impossible.

David Lowe: So how could I tell whether it is a repudiatory breach or not?

Andrew Smith: The law is never an easy thing but it is a question of feel, how serious is the breach in the circumstances of that particular contract.

Again I recognise that's not particularly helpful so there are some hints that you can glean from the contract so for instance, if a term is expressed to be a condition in the contract then that is effectively shorthand for if you breach that term it will be a repudiatory breach and the corollary of that is if in fact it is a warranty in the contract a breach of that will only entitle you to damages and you won't be able to bring the contract to an end.

Another classic would be time of the essence. If you have time of the essence in the contract, that is effectively telling the other side and the courts and the whole world that breach of that particular time-related term of the contract will bring a termination if you are a minute late, you're late, you can terminate.

David Lowe: In a lot of the contracts that I draft it refers to material breach. Is that the same as a repudiatory breach?

Andrew Smith: No it is not quite the same. Repudiatory breach is the one that goes to the heart of the contract, it does not actually have to say this is a repudiatory breach. A material breach is written into the contract and it's trying to cover off breaches which are sufficiently substantial, i.e. not technical breaches or very small breaches so that it allows you the right to terminate under the contract. It's a similar concept but the courts have been very clear that they are different things.

David Lowe: If the contract already includes a termination right, does that prevent you from taking the repudiation route?

Andrew Smith: No it doesn't. The courts have determined that as well. You have both rights. The difficulty is you have got to really pick a lane, choose which one you go down because if you choose one then it can prejudice your right to go down the other. There are some little tricks of the trade where you can try and maintain both rights which can be advantageous but really they are so complicated I can't really explain them now.

David Lowe: So if I have a choice, what factor should I take into account in making that decision?

Andrew Smith: There are quite a number of quite important choices to be made in relation to your right to terminate under the contract or to accept a repudiatory breach and if you have that choice I would say that the main one is your right to damages because if you terminate under a contract you are entitled to damages up to the date of the termination. If you accept a repudiatory breach which could be on the same facts then you are entitled to what are called loss of bargain damages which can cover future loss.

So, to give you an example, if you had an HP contract and you terminated as the wronged party, for breach under the contract, you would be entitled to all of the missed payments up to the date you terminate. If you accept the repudiatory breach if you are entitled to, then you would be entitled not only to those missed payments but all your future payments under that HP contract.

David Lowe: I can see there is a lot of decisions. What happens if I get it wrong?

Andrew Smith: That's a bit of a problem. It is a big like the scene from Reservoir Dogs where there's one person pointing a gun at your head and you have got a gun against theirs. If you get it wrong then you yourself are committing a repudiatory breach. If you terminate wrongly then that is evidencing the intention no longer to be bound by the contract, it is a renunciation, one of those three types of repudiatory breach I mentioned earlier and that will mean that the other side has the ability to call the whole thing off and claim loss of bargain damages.

So it is something you need to think about long and hard and make the right decisions because if you get it wrong it will go horribly wrong for you.

David Lowe: Given that risk, is there any way I can minimise it?

Andrew Smith: It's really a matter of balancing your legal protection in trying to stop being sued for getting it wrong and for damages and trying to maintain your commercial drivers because actually you wanted to terminate the contract so the longer notice that you give to the other side, the safer you are going to be in litigation terms but commercially that may be unattractive.

When you decide to terminate for breach what you have got to do is think long and hard about what rights you have and how best to go about them.

David Lowe: Andrew, thank you for leading us through what is a really complex area and giving us some really great practical tips.

Andrew Smith: Thank you.