To terminate a contract at common law, there must have been a breach of an essential term, a sufficiently serious breach of a non¬essential term or a repudiation of the contract by the other party.

This article provides a brief overview of the grounds for terminating a contract and sets out some key issues to bear in mind when making an election to terminate or affirm.

Grounds for termination

A right to terminate an agreement will arise where there is a contractual stipulation conferring the right or there is a breach or repudiation giving rise to the right under the common law.

A common law right to terminate will arise in three circumstances:

  • a breach of an essential term;
  • a sufficiently serious breach of a non-essential term; or
  • the repudiation or renunciation of the contract by the other party.[1]

Breach of an essential term

Essential terms are also described as “conditions” (as distinct from “warranties”) or “fundamental” terms. The classification of a term as “essential” is a question of construction. The test of “essentiality” depends on whether it was the common intention of the parties, expressed in the language of their contract, that the term be so “essential” that any breach of it would justify termination.[2] A well accepted example of an essential term is where time is expressed to be of the essence.

Sufficiently serious breach of a non-essential term

Breaches of non-essential terms, if sufficiently seri­ous, may also give rise to a right to terminate a contract at common law. In this context, non-essential terms are also referred to as “intermediate” or “innominate” terms and a sufficiently serious breach is described as a breach “going to the root of the contract” or a breach which “substantially deprives the innocent party of the benefit of the contract”.[3]

The decision of the High Court in Koompahtoo affords a good example. In that case, the Koompahtoo local Aboriginal land council (land council) entered into a joint venture with a property developer, Sanpine Pty Ltd (Sanpine), for the development of a large area of land. The land council contributed the land and Sanpine was to manage the development. Sanpine caused liabili­ties of $2 million to be incurred, secured by mortgages over the land. The land was nevertheless not developed. The mortgagee went into possession of the land and the land council was placed into administration. The central issue was whether the administrator of the land council was entitled to terminate the joint venture agreement on the basis that Sanpine had breached its obligation to maintain books of account and financial records of the joint venture.

The majority of the High Court were satisfied that “this was an obligation of basic importance” so as to constitute an essential obligation justifying breach.[4] The majority expressly said, however, that they did not rest their decision on this ground. Rather, they upheld the decision of the trial judge that even if it were accepted that all of the contractual obligations which Sanpine breached were not essential obligations justifying termi­nation for every breach, the breaches “were in a number of respects gross, and their consequences were serious”.[5] The failure of Sanpine to explain the use of all of the funds borrowed against the land and to otherwise maintain proper books of account and financial records of the joint venture “went to the root of the contract” and deprived the land council of “a substantial part of the benefit for which it contracted”, so as to justify termi­nation.[6]

Repudiation

Repudiation extends beyond actual breaches of essen­tial terms and sufficiently serious breaches of non­essential terms justifying termination, to embrace anticipatory breaches of this kind and any other conduct which evinces “an unwillingness or an inability to render substantial performance of the contract” or “an intention no longer to be bound by the contract or to fulfil it only in a manner substantially inconsistent with the party’s obligations”.[7]

It is important to note that a party does not necessar­ily repudiate an agreement by asserting an incorrect view of its construction, although they will most likely fall into repudiation if they persist in their view notwith­standing a clear enunciation of the correct view by the other party. Caution is warranted in this situation. When a party asserts an erroneous interpretation of the contract and the other party does not attempt to correct them but seizes on the error and purports to terminate for repudiation, it may well be that the party purporting to terminate is the repudiating party, giving the mistaken party the opportunity to terminate.[8] This underscores the considerable care that needs to be taken before a party purports to terminate a contract, as a wrongful termina­tion itself constitutes a repudiation entitling the other party to terminate.[9] In fact, the expression “wrongful termination” is a misnomer, because if there are no grounds to terminate, a purported termination is ineffec­tive and simply amounts to repudiation.

Issues to consider when deciding to terminate a contract

Election

If a right to terminate arises, the innocent party needs to decide whether to elect to:

  • affirm the contract and claim damages for the particular breach. It may also be necessary to claim specific performance or injunctive relief to compel the other party to continue to perform (the availability of these remedies is beyond the scope of this article); or
  • terminate the contract and claim full loss of bargain damages.

If a contract is affirmed, it cannot subsequently be terminated in respect of the same breach leading to the affirmation, although some breaches may be, by their nature, continuing breaches giving rise to a subsequent right to terminate.

Termination requires unequivocal words or conduct evincing an intention to terminate.[10] While the terminat­ing party is required to justify termination on the basis that they have a legal right to terminate, they are subsequently entitled to rely on any valid ground exist­ing at the time of election whether or not they were aware of it at the time.[11]

An election to affirm will be inferred from conduct which is consistent only with the continued existence of the contract, such as continued performance.[12]

Having regard to the risk in purporting to terminate when there is no right to terminate and the possibility that if there is a right to terminate, it is lost by affirmation, in many cases parties will attempt to hedge their bets and reserve their rights. A party will not necessarily affirm a contract if they give the party in breach an opportunity to perform in suitably qualified and conditional terms or otherwise continue perfor­mance subject to an express right to terminate.[13] An election cannot, however, be delayed unreasonably.[14]

A party may not be obliged to accept a repudiation and terminate the contract even if it might be said that to do otherwise would be unreasonable. For example, in White and Carter (Councils) Ltd v McGregor,[15] adver­tising contractors agreed with a representative of a garage proprietor to display advertisements for the garage for three years. On the same day, the garage proprietor wrote to the contractors saying that there had been a misunderstanding and purported to cancel the contract. The advertising contractors refused. The House of Lords held that they were entitled to refuse, carry out the contract and claim the full contract price.

Partial termination

In the absence of an express provision, an innocent party may rescind the whole, but not a part of, a contract, although certain secondary or procedural obligations, such as exclusion clauses and arbitration clauses, may survive.[16] For example, a right of partial termination may be conferred by a contract in circumstances where a party is given a right to terminate a purchase order “in whole or in part”.[17]

Right to terminate compared with right to rescind

On termination of a contract, the obligation of the parties to further performance is discharged, while any rights which have accrued prior to termination remain. The innocent party will have a right to damages and one or both parties may have a right to restitution. While accrued rights arising from partial performance prior to termination are not eliminated (for example, amounts due prior to termination must be paid), specific perfor­mance even of accrued obligations will not be available following termination.[18]

Rescission, on the other hand, is an equitable remedy that applies where the contract is void or voidable (because, for example, it is vitiated by misrepresentation or mistake or is contrary to public policy) so as to restore the parties to the position they were in prior to the entry into the contract.

It is important to note that, unless a contract expressly confers a right of rescission, such a right does not arise where there is a right to terminate for breach.[19]

Right to terminate at common law where there is also a right to terminate pursuant to a clause of the contract

If a right to terminate has arisen at common law, the innocent party may also have a right to terminate pursuant to a clause in the contract.

Whether to termi­nate a contract at common law or whether to terminate pursuant to a particular provision of a contract is a matter of strategy and will depend on, among other things, the degree of certainty as to the right to terminate and a comparison of the value of a claim for loss of bargain damages, on the one hand, and any remedy which the contract may confer if the contractual right is exercised (such as a right to liquidated damages), on the other hand.

When both options are available, it is important to consider that:

  • unless there is an express or implied agreement to the contrary, a contractual right to terminate for breach does not displace any right of termination arising by operation of law in respect of breaches of essential terms, sufficiently serious breaches of non-essential terms or repudiation;[20]
  • termination by the exercise of a contractual right does not debar the innocent party from suing for damages for loss of bargain or expectation dam­ages if there is a common law right to terminate;[21]
  • absent a clear intention to the contrary, termination in accordance with a contractual right does not give rise to a right to claim loss of bargain or expectation damages unless termination was also justified at law;[22] and
  • ordinarily, there will be an implied obligation to exercise a contractual right of termination reason­ably and in good faith.[23]

Conclusion

If you are considering terminating a contract at common law, it is important to note that:

  • there needs to have been a breach of an essential term, a sufficiently serious breach of a non­essential term or a repudiation of the contract by the other party;
  • a party does not necessarily repudiate an agree­ment by asserting an incorrect view of its con­struction;
  • if a contract is affirmed, it cannot subsequently be terminated in respect of the same breach leading to the affirmation; and
  • before terminating, it is wise to consider whether it would be better to terminate the contract at common law or pursuant to a term of the contract, if the latter avenue is available.

This article was first published in In-House Counsel, Vol 16 No 6, May 2013