For a number of reasons you may wish to consider whether you can terminate a contractual relationship you have entered into. During periods of economic downturn the instances of this are greater. The other contracting party may be suffering from cash flow problems. There is a greater risk that you will be paid late or won't be paid at all. Performance is more likely to suffer when there are financial restraints on the other contracting party. Terminating a contract can of itself bring risk. There must be a justifiable reason for terminating, otherwise you could be in repudiatory breach of the contract and liable to pay the other side damages.

Here are some of the factors you should consider prior to terminating any contractual relationship:

1. Check the terms of your contract carefully. You have to be sure that the terms of the contract permit you to terminate in the circumstances that exist.

2. Make sure any breach of contract justifies termination. Not every breach of contract justifies terminating the contract. Commercial contracts commonly contain a provision entitling a party to terminate when the other has materially breached its obligations. Quite often, even if the contract terms permit termination, they may be subjective. Just because you consider that the subjective test has been satisfied does not mean that a court will take the same view.

3. Is there a repudiatory breach? There is a common law right for the innocent party to terminate for a repudiatory breach of contract by the "guilty" party. Rights to terminate for repudiatory breach at common law co-exist with express termination rights (unless expressly excluded). The breach of contract must be sufficiently serious to entitle the innocent party to treat the contract as terminated with immediate effect and gives them the right to claim damages. The general rule is that the breach must run to the very heart of the contract and have substantially deprived a party of the very benefit that the contract was intended to deliver. What amounts to a repudiatory breach of contract will vary with each contract.

4. Watch your conduct. Ensure that you don't do anything that could be viewed by the other party (and the court) as waiving the breach of contract, so affirming it. Failure to take action could also have the same effect. Conduct (active or passive) can be used to demonstrate a waiver of the right to terminate.

5. Check the mechanism for termination. Ensure you follow all procedural requirements correctly. If the contract requires written notice to be given check whether the contract stipulates:

  • The party which must give the notice and to whom
  • The information the notice has to contain
  • Where and how the notice is to be served

Then, just as importantly, make sure you know and comply with the time limits for giving the notice before termination can take place.

If any termination procedure is not followed correctly the termination may well be wrongful, a breach of contract and lead to a remedy in damages against you!

6. Plan for the implications of termination. The contract may stipulate that you have to pay compensation to the terminated party (even on a lawful termination). Check, before you terminate, that you can source the goods or services elsewhere and within your time frame. If continuity of service is key to your business and there is no readily available alternative supplier, renegotiation rather than termination may be a better option. Consider whether under the terms of the contract you can withhold payment to the terminated party. If so, the money withheld can then be used to offset the costs incurred in obtaining the goods and services elsewhere.

7. Consider the cost to you. Make sure that the costs to you of terminating do not outweigh the benefits of termination. Action may have to be taken to recover the additional costs incurred as a result of the termination from the original contracting party. If they are insolvent or in financial difficulties they may not have the money to pay you. Although rarely the case, you cannot profit from the termination.

8. Remember insolvency of the other party does not automatically entitle you to terminate. The contract provisions must stipulate that insolvency permits the other party to terminate the contract. Even if there is provision, it is unlikely to apply if the other party is merely in financial difficulties.

9. Failure to be paid. You must have an express contractual right to suspend work or terminate the contract due to non payment. Depending on the circumstances, persistent non payment can amount to a material breach of contract (if your contract entitles termination for material breach) or a repudiatory breach of contract.

10. Making time of the essence. If the contract is silent on the time by when certain obligations have to be fulfilled you may be able, and it may become necessary for you, to expressly make time of the essence so that you can then rely on a failure to perform to justify termination. This is a complex area where specific advice in specific circumstances is vital.

11. Reputational damage. You may need to consider public relations issues arising from a termination and plan accordingly.

12. Teeing up a termination. It is sometimes the case that termination is part of a strategy of escalation to achieve an improved commercial negotiating position. If so, lay the ground carefully with appropriate correspondence and contractual notices so as to be able to demonstrate a breach by the relevant party.