Q&A: contract termination in USA

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?

Many commercial contracts will specifically provide for termination rights. Termination clauses often cover when a contract can be terminated for cause, when it can be terminated at the discretion of a party and when it can be terminated for force majeure. Termination clauses will typically control the relation of parties to a contract.

When a contract involves the sale of goods and is controlled by the Uniform Commercial Code (UCC), the contract will last for a ‘reasonable time’ and, absent agreement of the parties otherwise, will be terminable after reasonable notice. What constitutes reasonable notice can be fact-intensive and may vary by state and circumstance. 

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

When a contract involves the sale of goods and is controlled by the UCC, the contract will last for a ‘reasonable time’ and, absent agreement of the parties otherwise, will be terminable after reasonable notice. What constitutes reasonable notice can be fact-intensive and may vary by state and circumstance. 

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

This is more of a question of US bankruptcy law than it is contract law. Although contracts often provide for termination upon insolvency or bankruptcy, the US Bankruptcy Code prohibits the automatic application of these ipso facto provisions in the context of bankruptcy. Accordingly, a party may be able to enforce an ipso facto clause if an insolvent counterparty has not yet filed for bankruptcy protection, but should not expect to be able to rely on the clause once a bankruptcy is initiated.

Parties who are contracting with an entity for which bankruptcy is a risk should seek the advice of US bankruptcy counsel to understand precisely how a contract with an ipso facto clause will be treated. 

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

Yes. The US bankruptcy code has limits on when contracts with a bankrupt entity can be terminated. If a counterparty is in distress but has not yet filed for bankruptcy, a contract with them might be terminable if they have otherwise defaulted or have triggered an enforceable ipso facto clause. A party who has questions about whether a counterparty can perform can also seek ‘reasonable assurances’ under the UCC. Absent such assurances, it can suspend performance and terminate. This ‘reasonable assurances’ mechanism applies to contracts outside of the UCC in some states, so options for dealing with a distressed counterparty differ by state. 

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

Yes. Commercial contracts often include force majeure events, including acts of God, war, terrorism, nature disasters and other events beyond the control of either party. As we learned at the beginning of the covid-19 pandemic, some force majeure clauses specifically include pandemics, and others do not. 

The specific contract terms of a force majeure clause will dictate how they are applied. Absent a force majeure clause, parties might be able to rely on concepts like impossibility to excuse performance in the event of extraordinary events. For this to succeed, the event must have been completely unforeseeable. If the event was at all foreseeable, courts will typically not excuse non-performance.