Q&A: contract termination in India

Termination

Do special rules apply to termination of a supply contract that will be implied by law into a contract? Can these terms be excluded or limited by including appropriate language in the contract?

There are no special implied rules under Indian law that apply to the termination of a supply contract. It is common for parties to include clear, specific and situational-based termination rights in contracts in India. There is growing jurisprudence in India that even in the absence of a termination clause, in a private commercial transaction, the agreement can be terminated without assigning any reason by serving a notice. In such cases, if the termination is found to be bad in law for any reason, the remedy would be to seek compensation for wrongful termination, but there cannot be a claim for specific performance. However, courts have taken a divergent view on this. In some cases, courts have held that in a contract where termination was contingent on specific events unless such events have occurred, the contract cannot be terminated.

In addition, if a contract in India does not fulfil all the essentials of the contract as specified under the Contract Act, which includes that the contract should be for lawful object and consideration, such contracts are void ab initio. No clause for exclusion or limitation in a contract could make such void contracts valid and legally enforceable. Similarly, in case a contract is contingent on an impossible event, such contract is void, even if the impossibility of the event is known or not to the parties to the agreement at the time when it is made.

If a contract does not include a notice period to terminate a contract, how is it calculated?

While the Contract Act generally does not prescribe any mandatory or any minimum notice period for termination of a contract, in the case of an agency, the Contract Act requires a reasonable notice to be given by either the principal or agent before revocation or renunciation of an agency. If such reasonable notice of termination is not provided, then the party who incurs damages as a result of such termination must be reimbursed by the other party.

The rent control and tenancy laws in certain states require landlords to give notice before increasing rent, making structural changes or before terminating the rent or lease agreement. Similarly, if the tenant wishes to sub-let the premises, the tenant needs to provide a prior notice to the landlord.

It may also be relevant to note that for employment agreements, there are central and state-specific laws that prescribe the requirement for a notice period for termination of contracts.

Will a commercial contract terminate automatically on insolvency of the other party?

There is no requirement under Indian law that provides for automatic termination of commercial contracts in case of insolvency. However, it is a common practice for parties to retain the rights to terminate the contract in the case of insolvency, liquidation and/or bankruptcy of the other party. Indian courts also recognise the clean slate mechanism under insolvency and bankruptcy laws where a party that has undergone a corporate insolvency resolution process is not bound by any previous obligations unless the same is retained in the resolution plan.

Are there restrictions on terminating a contract if the other party is in financial distress?

From a contract law perspective, there are no restrictions in terminating a contract when the other contracting party is in financial distress, provided such ground for termination is incorporated in the contract.

Having said that, the Insolvency and Bankruptcy Code 2016, which is the primary law governing insolvency and bankruptcy proceedings, prohibits termination of contracts for goods or services that are critical to protect and preserve the value of the contracting party against whom insolvency petition has been admitted and to ensure that it continues to be a going concern, except in scenario where payment is not made to the supplier of such goods or services.

Is force majeure recognised in your jurisdiction? What are the consequences of a force majeure event?

The concept of ‘force majeure’ is a well-established and recognised principle in India under the Contract Act and is an essential part of most contracts.

In order to enforce a force majeure clause, the party seeking discharge of its obligations must demonstrate circumstances have arisen that make it impossible for it to perform on account of such event, even after putting reasonable and practicable efforts to resolve or mitigate the effect of the force majeure event.

Generally, in the event parties are unable to perform under a contract due to a force majeure event, parties may, unless otherwise provided under law, agree to suspend the performance of obligations, extend the term of the contract, or even terminate the contract if such force majeure event continues beyond a period.