How do I terminate a legally binding contract?

Contracts form the basis of most business transactions, with people entering into them on a daily basis. However, there may come a time when a contract is breached or is seen as no longer commercially viable. As a result, one party may want to bring the contract to an end prior to the expiry of its term. This note looks at the effect of terminating a contract on the parties’ obligations.  

What is the effect of terminating a contract?

Contract termination excuses all parties from further performance of their main contractual duties (such as delivering goods or services and payment of them) from the termination date. However, the contract itself still exists and continues to bind the parties (State Trading Corp of India Ltd v M Golodetz & Co Inc Ltd [1989] 2 Lloyd's Rep 277, at page 286).

A party wishing to terminate can do so either under the common law right to accept a repudiation (the most serious type of breach) or by exercising a contractual termination right under a written agreement.

From the date of termination, the parties to the contract are normally released from further performance of their main contractual duties. These contractual duties are sometimes referred to as primary obligations. Other contractual duties survive, such as:

1. Secondary obligations – these are clauses having a contractual function that is procedural or ancillary to the subject matter of the contract. For example, a term dealing with the choice of law for the agreement;
2. Accrued rights – these are any rights, remedies, obligations and liabilities of the parties that have already arisen by the time of termination. For example, a seller remains liable to deliver goods that were already due before the termination date;
3. Any provision that the parties intended to survive termination – this is ultimately a question of interpretation (Involnert Management Inc v Aprilgrange Ltd [2015] EWHC 2225 (Comm), paragraph 172-174). Relevant factors when determining whether a contractual duty was intended to survive termination include the other contractual terms, the matter's commercial context, the background matters known to the parties when the contract was formed and the wording of the contractual provision itself. A provision intended to survive termination could include a clause restricting a party from doing something post-termination (i.e. a restrictive covenant).

Clauses that normally survive termination include choice of law, jurisdiction, arbitration or dispute resolution. Limits and exclusions of liability normally survive termination too.  Understandably, it would be unusual if the parties intended any of these clauses to lapse after termination when they might need to rely on them to help resolve a legal dispute. However, it is still a matter of contract interpretation in each case when determining whether a clause survives termination (Photo Production Ltd v Securicor Transport Ltd [1980] UKHL 2).

Survival clauses – are they worth it?

The principle of freedom of contract allows contracting parties to agree on which contractual terms they intend to apply following termination. Survival clauses expressly identify the terms of an agreement that the parties intend to remain in force after termination. Therefore, they help to create certainty around the contractual duties that the parties intended to survive termination.

However, the effort of identifying and listing all the surviving terms in an agreement can be burdensome. It is also likely to outweigh the benefit of preventing arguments that rarely arise in practice, especially for clauses that normally survive without express provision anyway. Consequently, survival clauses are rarely detailed and usually include only the key surviving clauses that survive rather than listing all of them.

The terms that are expressly preserved in the survival clause usually survive termination. The terms that are not expressly preserved in the clause will survive if the parties intended them to do so (as discussed previously).

Provisions on survival are sometimes found in the termination clause itself or other terms dealing with exit provisions and other consequences of termination. They are worth considering when reviewing and negotiating contracts as they can help to reduce uncertainty in some cases.

For more information about contract terminations, please contact David Wozniak on 0191 211 7831 or email [email protected]