Contract Termination: Overview & Common Termination Reasons

Contract termination is when one party wishes to end the contract before the other party can fulfil the agreement. A simple example would be when a client terminates the services contract with a law firm in line with the termination agreement in the terms and conditions. In this article, we cover contract termination best practices and concepts such as:

• ‍What is contract termination?
• Creating a termination of contract notice
• Why contract termination is important
• The most common reason for terminating contracts

What is Contract Termination?

A contract is a legally binding document that ties two or more parties to an agreed set of terms and conditions. They are the groundwork for a business relationship, establishing each party's obligations. However, the involved parties must have an exit clause if their circumstances change and they cannot meet their agreed terms and conditions.

Contract termination is legally ending a contract before one or more parties have met their obligations. Only the parties that have signed the contract can terminate the contract.

The Right to Terminate a Contract

At the beginning of any new commercial relationship, many issues are considered and negotiated, many of which are immediate priorities. But often overlooked is how the relationship can be terminated.

Typically, there may be an express or implied right to terminate the contract, allowing a party to cease the agreement under a termination clause before the agreed end date. Usually, termination clauses link to causes like a breach of contract and insolvency.

If a contract contains no right of termination, then the terminating party may be able to use common law to terminate the agreement. The common law right to terminate is available to all parties, regardless of a termination clause. The right to terminate under common law exists if there has been a breach of contract, e.g. one party refuses to meet their minimum obligations.

How to Terminate a Contract?

A contract contains an offer, acceptance, and consideration, also known as an exchange of value. They bind the parties to obligations and terms and conditions for a set period.

However, forces outside the parties' control could void the contract and terminate the contractual obligations. So typically, most contracts contain termination clauses that establish the process and steps in detail. There are commonly two contract termination clauses: termination for convenience and termination for cause.

Termination for Convenience

The termination for convenience clause gives the parties the right to terminate the contract without any reason or penalty. The terminating party does not have to prove the other party is in breach. The termination of the agreement is at the discretion of the party providing notice.

A termination for convenience clause provides the involved parties with an exit strategy to minimise risk and mitigate damages where circumstances change or events occur outside the party's control.

Termination for Cause

A contract usually contains one or more scenarios under which a party may terminate the agreement due to actions, inaction, or a breach of contract from the counterparty. A breach of contract occurs when one or more parties do not meet their agreed obligations as stated.

It's common for minor breaches in the contract to occur that don't alter the agreement. Parties can amend contracts and include clauses that allow for the alteration due to the account for minor breaches. However, when material breaches occur, a party can terminate the contract and potentially claim damages related to the other party's violations.

The Date of Contract Termination / The Termination Date

A termination date within a contract refers to when the contract will end. It is the date that the agreement will come to a natural end once the final payment has been made. This means that the terms no longer bind the involved parties.

Sometimes, after the termination date passes, the parties will automatically move onto a rolling contract. The terminating party must then provide notice (usually at least one month in advance) to leave the agreement. This is common with property lease agreements, when the tenants may automatically move to a rolling contract after the termination date has passed. The parties must understand the rights around the contract termination date, as they may face financial consequences.

Termination of Contract Notice

The process of terminating a contract can be complex. A wrong attempt at contract termination or an effort to terminate when the breach is insufficient can have negative impacts and provide the other party with the option to invalidate the contract and even claim damages.

Many contracts require a written document of intent to terminate the agreement. A contract termination notice is a written document stating the intentions of ending a contract. The letter provides the formal notification of the decision of a party to terminate a contract, and many agreements require the notice to be in a specific form and contain certain information.

The original contract may also have specific clauses stating how the notice must be given and to whom. Good contract drafting and negotiation will consider this and provide a clear termination notice and process framework. If these exist in the original agreement, the termination notice must comply with those terms.

How to Write a Contract Termination Notice

If a party decides to terminate the contract, written notice must be used for the termination. Once the party has established the reason for contract termination, they must notify the other party of their intentions. The termination notice should detail the reason for the termination, including the section of the contract that the party breached if required.

Writing a termination of contract notice is challenging, so we have provided a general guideline for any party to begin drafting their termination notice:

1. The contract information of the party writing the termination letter should be visible at the start.
2. The party should open the letter with a statement relaying their intentions to terminate the contract.
3. Secondly, the party should state the information that has led to the contract termination.
4. If the counterparty is in breach, the party writing the letter should state if the breach was significant and cannot be amended.
5. List any damages due to contractual breach, how the party plans to collect damages, and compensations for the damages.

Why is Contract Termination Important?

Businesses will enter contracts of different complexities, and when a company is at the drafting and negotiation stage of the contract lifecycle, several issues are considered: some as a matter of urgency. Focusing on commercial terms such as charges, payments, and contract duration is natural. But a crucial element of every contract is the contract termination clause, and businesses ought to find their exit rights from the offset, or they could face the risk of being tied to a contract that isn't delivering.

Common Reasons for Terminating Contracts

Only some contracts will hold their appeal or value for their lifetime. Terminating the agreement is crucial to minimising financial and operational risk to the business.

There may be many reasons for a business looking to terminate a contract before the agreed date. One of the most common reasons for contract termination is the unsatisfactory performance of the entire or part of the contract by the other party or the refusal of the other party to perform any of the agreements. Every business situation will vary, but some other common reasons might include:

• ‍Termination by breach - A breach of contract violates a party's agreed terms and conditions in a binding agreement. The breach could be anything from a late payment to sharing confidential information.‍
• Termination by recession - Termination by the recession is different from the termination of a contract. Like contract termination, when termination by the recession is available, it unravels the contract as null and void, as if the agreement was never negotiated and signed.‍
• Termination by mutual agreement - Contracts are always open for the parties to concur on other agreements, including the right to terminate by agreement. When terminating by agreement, the parties consent to terminate, and their obligations end.‍
• Impossibility of performance - The impossibility of performance occurs when one party cannot perform their contractual duties due to changes and circumstances that stop them from achieving their duties. Before considering contract termination, it is essential to consider the relationship with your partner. If the relationship is ongoing, an alternative route may be more suitable, such as renegotiating the terms.

It is essential that the party that wishes to terminate the contract assess the relationship between the involved parties before doing so. If the relationship is ongoing, an alternative route may be more suitable, such as renegotiating the terms.

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