When drafting termination clauses, it is important to consider the intended operation of the clause.

When parties are negotiating contracts, usually one of the key outcomes they are hoping to achieve is certainty. Certainty as to their obligations, certainty as to how their rights can be exercised and certainty as to the consequences if the contract is breached.

Despite the best laid plans (and the unsettled state of the law concerning good faith in Australia at the moment), it is possible to inadvertently fall foul of an implied obligation to act in good faith, particularly when exercising an express right under a contract, such as a right to terminate.

In Burger King Corporation v Hungry Jack’s Pty Ltd,[1] the NSW Court of Appeal found an implied term of reasonableness and good faith on the basis that the clause in question (which set out the procedural framework for the approval of Hungry Jack’s franchises by Burger King) contained such an extraordinary range of detailed considerations that unless such an implied obligation existed, Burger King could, for the slightest of breaches, bring to an end the very valuable rights which Hungry Jack’s had under the agreement.

This article will consider some recent NSW authorities which provide useful guidance as to when a party’s right to terminate a contract may be impacted by an implied obligation of good faith. It will also provide some tips for drafting termination clauses. Careful drafting can be the difference between a court finding that an express right to terminate a contract can only be exercised subject to an implied obligation of good faith, and an alternative finding that good faith is an unwarranted gloss on the express contractual right.

For what purpose was the express power to terminate conferred?

In NSW Rifle Association Inc v Commonwealth,[2] White J found an implied obligation requiring the Commonwealth to act reasonably and in good faith in the exercise of its powers. The Commonwealth and the NSW Rifle Association (NSWRA) entered into a licence deed which provided that the Commonwealth could terminate the deed by written notice if the NSWRA was in default. Clause 10.1(b) provided that the NSWRA was in default if “[the Commonwealth] gives [the NSWRA] a notice asking [it] to remedy any breach of this document and [it] does not remedy the breach within fourteen days or such longer time as is specified in the notice”.

The Commonwealth issued three remedy notices pursuant to cl 10.1(b). Two notices gave the NSWRA 14 days to remedy the specified breach, one notice allowed it more than 14 days. In the court proceedings, the Commonwealth admitted that it would not have been possible for the NSWRA to carry out all of the work required by each remedy notice within the timeframes specified.

Justice White found that a term requiring the Commonwealth to act reasonably and in good faith could be implied on a number of bases, including as a matter of construction.

In that regard, His Honour reasoned that:

  • the purpose of cl 10.1(b) was to give the NSWRA the opportunity to remedy a breach;
  • the power to fix a time longer than 14 days was conferred for the purpose of allowing the breach to be remedied;
  • as a matter of construction, the remedy notice must be given by the Commonwealth for the purpose of allowing NSWRA to remedy the breach, and the power to fix a time greater than 14 days must be exercised having regard to that same purpose; and
  • the above implies (as a matter of construction) that the power under cl 10.1(b) had to be exercised reasonably and in good faith.

Is an implied obligation of good faith inconsistent with the express termination clause?

Starlink International Group Pty Ltd v Coles Super-markets Australia Pty Ltd [3] concerned a special condition in an agreement which provided that Coles “may terminate this agreement at any time without a reason by giving [Starlink] 45 days written notice”. Separate, into the agreement. Justice Hammerschlag found that the general provisions of the agreement in question also contained clauses permitting termination with written notice by one party if the other party had not remedied a material breach within 14 days of receiving notice of it, and termination by Coles with 30 days’ notice if, among other things, Starlink failed to perform in accordance with KPIs. There was also a dispute resolution process.

Coles terminated the agreement pursuant to the special condition after it was made aware of a number of allegations about Starlink’s conduct. Coles did not provide reasons for its decision. Starlink argued that an implied duty of good faith meant that Coles had an obligation to approach Starlink and advise it of the allegations that had been made against it, and give Starlink the opportunity to address them before exercising the power to terminate under the special condition.

Chief Justice Bergin in Eq compared and contrasted the general termination and dispute resolution provisions in the agreement (which referred to the parties’ “wish” to maintain a “continuing commercial relationship”) with the special condition (which included no reference to acting in good faith and no mention of the parties’ wish to maintain a continuing commercial relationship).

Chief Justice Bergin in Eq found that the special condition allowed Coles to terminate for its own reason and to keep that reason to itself. The only prerequisite in the special condition was the requirement to give 45 days’ notice. It was a “special” power identified in a special condition. The implication of a duty to act in good faith in exercising the right under the special condition would be to impose a condition inconsistent with the express term of the contract.

Solution 1 Pty Ltd v Optus Networks Pty Ltd, [4] the relevant termination clause provided that Optus could terminate its agreement with the plaintiff “for any reason and at any time in Optus’ absolute discretion with immediate effect by giving … at least 120 days written notice…”. Optus terminated the agreement pursuant to that clause.

The plaintiff argued that a term requiring Optus to act in good faith towards the plaintiff in exercising its right to terminate, pursuant to that clause, should be implied term was not implied because it was inconsistent with other provisions of the agreement, namely:

  • the termination clause, which expressly entitled Optus to terminate for any reason, at any time and in its absolute discretion, indicating the exclusion of any constraint on Optus of the type contended for; and
  • another clause of the agreement which expressly excluded all terms that would otherwise be implied into the agreement (and accordingly excluded an implied term of good faith).

Considerations when drafting termination clauses

In both Starlink v Coles and Solution 1 v Optus, implied terms of good faith were found to be inconsistent with express termination clauses that, on their face, clearly permitted termination for any reason and with very limited restrictions (in both cases, the only restriction was the period of written notice required).

On the other hand, in NSWRA v Commonwealth, the requirement for a remedy notice and the power to extend the time for remedying the breach suggested that there were constraints on the termination rights under the contract.

Accordingly, when drafting termination clauses, it is important to consider the intended operation of the clause. Is it intended that the right of termination should be constrained in any way, including by notions of good faith and reasonableness? Or, is the intention to confer an absolute right to terminate? If it is the latter intention, the following drafting tips may assist an argument that the express right to terminate is not to be impacted by an implied obligation of good faith:

  • include an entire agreement clause which excludes implied terms (although keep in mind, this will also exclude any other implied terms on which you may later wish to rely);
  • include words such as “for any reason”, “in its absolute discretion”, “at any time” to highlight an intention not to restrict the exercise of the right to terminate; and
  • leave out overly technical and onerous grounds for termination, as these are more likely to leave room for an implied obligation of good faith.

Nadia Latti

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