In an article published in May last year, we examined the right to terminate a contract if the other party was insolvent and the impact of a recent amendment to these “ipso facto” clauses. Termination remains a key issue that needs to be addressed in every contract. However, what happens if you wish to terminate a contract that does not have an end date or address the issue of termination?
In this article, we will consider termination of contractual obligations where there is no agreed end date or provision governing termination.
Is there an implied right to terminate perpetual contracts?
Most contracts specify a term when the contract will expire. However, some contracts are drafted based on an on-going relationship with no specified end date. These contracts are often described as “perpetual” or “indefinite” contracts.
At common law, a term may be implied into a perpetual contract which allows a party to terminate by giving “reasonable notice”. The nature of a business relationship between parties to a contract often leads the courts to conclude that the parties had intended for the arrangement to be terminable and as a result imply a right to terminate.
The termination of contractual obligation in a perpetual contract has been considered by the courts in a number of cases. In the case of Crawford Fitting Co v Sydney Valve & Fittings Pty Ltd (1988) 14 NSWLR 438, McHugh JA stated that:
“When the question arises whether a commercial agreement for an indefinite period may be terminated, the answer depends upon whether the agreement contains an implied term to that effect. The existence of the term is a matter of construction. But the question of construction does not depend only upon textual examination of words or writings of the parties. It also involves consideration of the subject matter of the agreement, the circumstances in which it was made, and the provisions to which the parties have or have not agreed”.
The implied right to terminate will not be implied into all perpetual contracts. In the case of State Bank of New South Wales v Commonwealth Savings Bank Pty (1985) 60 ALR 73, an expressed term in the agreement provided that if the Commonwealth Savings Bank Pty did not breach the terms set out in the agreement, the parties’ contractual obligations would continue. Lockhart J held that no implied right to terminate applied by way of reasonable notice by either party, as there were express terms in the contract to the contrary.
In addition, the courts may be reluctant to imply a term for termination upon “reasonable notice” where the contract has only been in existence for a short period of time. In the case of Finucane v NSW Egg Corporation (1988) 80 ALR 486, there was an arrangement with an indefinite duration which was terminable where certain circumstances eventuated. In this case, the courts were of the view that the parties would have intended the contract to continue until they have recouped the initial money expended or investments made into developing the business.
Where a court is prepared to imply the right to terminate, in the absence of any breach, a party may terminate the contract by giving “reasonable notice” to the other party. The term “reasonable notice” will differ depending on the facts. The assessment of reasonable notice will be taken from the time that notice was given or at the time of termination and not what the parties contemplated when they entered the contract. Some relevant considerations include:
- the nature of the relationship between the parties, such as the level of formality, the length and the level of investments made by each party; and
- the obligations of the parties under the contract in relation to the duration and scope of the obligation.
Historically, the longer the length of a relationship and the higher the level of investment made by each party, the longer the notice period required. In the case of Crawford Fitting Co v Sydney Valve & Fittings Pty Ltd (1988) 14 NSWLR 438, which was affirmed in Software Link (Australia) Pty Ltd v Texada Software Inc  FCA 1072, the court held that the period of time for reasonable notice is as follows:
“the period of notice must be such as to serve the common purpose of the parties: it must be sufficiently long to enable the recipient to deploy his labour and equipment in alternative employment, to carry out his commitments to bring current negotiations to fruition and to wind up the association in a businesslike manner”.
Termination for breach of contract
In general, if there are no provisions in the contract that confer the right to terminate upon a breach, an aggrieved party may still exercise their common law right to terminate a contract for breach. There are generally three grounds that entitle a party to terminate a contract for breach at common law:
- breach of an essential term;
- sufficient breach of non-essential term; and
- repudiatory breach of a contract.
A party that is seeking to terminate a contract by relying on rights derived from common law should exercise caution and seek legal advice where there is any doubt.
Termination for breach of a contractual term
Whether breach of a contractual term will give rise to the right to terminate depends on the nature of the term(s) breached and the construction of the contract. For the purposes of a breach, contractual terms can be classified as either “essential”, “non-essential” or merely a “warranty”. A breach of an essential or non-essential term may give rise to the right to terminate. It is important to note that a breach of a warranty will generally not give rise to the right to terminate and the only available remedy is damages for the particular breach.
An essential term, which is also known as a “condition” or “fundamental term”, is a term that is so important to the contract that if it is breached, the aggrieved party is justified in exercising their right to terminate. The aggrieved party has the onus of establishing that the term was an essential term. The actual consequence of the breach suffered by the aggrieved party is not a relevant consideration for the purposes of termination. However, where an aggrieved party suffered a loss due to the breach of an essential term, it will be entitled to sue for damages.
In general, “non-essential” or “intermediate” terms are expressed terms that are not found to be essential terms and there are also no provisions in the contract that suggest the term is a warranty. However, non-essentials terms can also be implied into an agreement. A non-essential term of a contract may give rise to the right to terminate if the breach is sufficiently serious. The consequence of a sufficiently serious breach generally causes the performance of the contract to be rendered substantially different from the parties’ intentions. The aggrieved party bears the onus of proof in establishing the seriousness of the breach, however the consequence of the breach will ultimately be a factual assessment.
Termination for repudiation
The concept of repudiation focuses on the readiness and willingness of a party to perform contractual obligations.
In the High Court case of Koompahtoo Local Aboriginal Land Council & Anor v Sanpine Pty Ltd & Anor (2007) 233 CLR 115, the court stated that repudiation occurs when a party who has an obligation under the contract has demonstrated its intention of no longer being bound by the contract, or does not intend to fulfill the contract in a manner that is substantially consistent to its obligations under the contract.
The law will treat the aggrieved party as having the power to terminate the contract under the doctrine of repudiation, where the aggrieved party is able to demonstrate the seriousness of the other party’s unwillingness or readiness to perform at the appointed time. An aggrieved party can establish repudiation by referring to (1) the other party’s words and conduct or (2) the other party’s actual position.
Termination does not automatically arise due to a repudiation of an obligation or a breach of a term – unless there are expressed terms in a contract or statute to the contrary. The aggrieved party must elect to terminate the contract and inform the other side. Alternatively, the aggrieved party can elect to affirm the contract and claim for damages for the particular breach.
The election to terminate a contract warrants caution. If a court does not agree with the interpretation of the aggrieved party’s conduct, the aggrieved party itself may be held liable for repudiatory breach. In such circumstances, the other party may be entitled to terminate the contract.
Key points to consider
Below are some key points from this article you should consider when entering into commercial contracts:
- unless you intend for the contract to be in force perpetually, always consider including an express term (i.e. duration) of the contract and a provision setting out the circumstances under which a party may terminate;
- be mindful that the implied right to terminate by giving reasonable notice is subject to the discretion of the courts and is not guaranteed. Prior to terminating under reasonable notice, you should consult lawyers regarding the implied right and length of reasonable notice; and
- where a party intends to terminate a contract for breach of contract or repudiation, it must elect to do so and notify the other party. Termination of contractual obligations is not automatically triggered by a breach or repudiation.