Falling land values and an uncertain political climate is causing land owners and developers to question the viability of deals made during the past decade. When profitability is questionable, the best option might be to look for ways out of the contract. Katy Humphrey and Jennifer Welby look at how a right to terminate a contract can arise and some of the practical issues around termination.
Do I have a contractual right to terminate?
The first place to check whether a right to terminate arises is the contract itself. Some contracts will terminate automatically after a fixed period of time. Others may require some positive step to be taken by one or both parties to bring about termination.
The contract will specify if there are specific grounds on which either party can terminate. These often include breaches that would justify termination at common law (see below), or related to specific events such as actual or threatened insolvency of a party to the contract, a change of control of a party to the contract, or even more particular circumstances such as refusal or planning permission or Brexit events.
Typically, the contract will provide that a right to terminate will only arise after the defaulting party has had the opportunity to, and has failed to, remedy its breach within a specific period.
Do I have a common law right to terminate?
In addition to contractual provisions allowing for termination, parties also have common law rights provided that they are not excluded from the contract.
The ability to terminate depends on the type of term which has been breached. There are three types: conditions, warranties, and intermediate terms. The breach itself must also be “repudiatory” for the right to terminate to arise.
How do I trigger termination?
Termination is not automatic. When faced with a repudiatory breach, the innocent party may elect to either:
- accept the breach and treat the contract as terminated, or
- affirm the contract and require the defaulting party to perform.
The law does not lay down a particular period within which the election must be made. However, it is important that the innocent party does not do anything to lose the right to elect, either by waiting too long thereby affirming the contract or by inconsistent conduct, for example by discussing ongoing matters/other contract terms/future events with the defaulting party which would lead the defaulting party to believe that the contract is continuing. The innocent party should therefore take care to qualify any correspondence with appropriate reservations of rights when engaging in further business conduct.
It is essential that before exercising its election that the innocent party is sure that there has been a repudiatory breach giving rise to a right to terminate before it elects to terminate. If the court finds otherwise, the innocent party could itself be found to have committed a repudiatory breach and expose itself to a damages claim for wrongful termination.
Similarly, the innocent party should ensure that before terminating it gives the defaulting party time to remedy the breach, if the contract requires this.
If the innocent party elects to terminate, it should check what the contract says about termination and what procedure must be followed. A notice to terminate must be carefully drafted and served to ensure that it complies with any contractual requirements. If not, it risks being invalid.
If the innocent party is prepared to keep the contract on foot but wants to see if it can negotiate compensation or better terms due to the breach, it may want to correspond on a ‘without prejudice’ basis at the same time as sending a notice to terminate. This will open up a dialogue whilst ensuring that any concessions it is willing to make cannot be discussed by the other party in legal proceedings.
What alternatives are there to termination for breach?
Termination of the contract may not be an option if neither party has done anything wrong. Even then, it may not be appropriate if there is an ongoing relationship to preserve.
Opportunities within the contract
If neither party is in breach, another angle is to see whether there is anything in the contract that can be used to advance the position of the party wanting to exit it. For example, there might be the opportunity for that party to withhold consent to changes essential to the performance of the contract which might in turn help to run down time to a long stop date / expiry date or pave the way for a re-negotiation of contract terms.
Damages
A party in breach of contract is required to pay damages for that breach, whether or not a right to terminate arises and whether or not the contract is actually terminated. Where the contract is not terminated, damages will arise from the breach only. This could include the costs of investigating and correcting the problem, and losses as a result of delays to the project. Where the loss is terminated, further losses for the consequences of the loss of the contract may also follow.
The types of damages which can be recovered will vary depending on which termination rights are exercised. In all cases, however, there is a duty on the innocent party to take reasonable steps to mitigate its losses. A party cannot recover damages for any part of a loss which could have been avoided.
Dispute resolution
The parties may negotiate formally or see if the dispute can be resolved through mediation or pursuant to a dispute escalation procedure laid down in the contract.
Frustration
A contract may be discharged on the grounds of frustration if something occurs after the contract has concluded which means it is impossible or will be illegal for one or both parties to perform the contract as intended such that it would be unjust for the contract to continue. This might include destruction of the property by fire, unavailability (and no alternative for) of the materials necessary for the construction, or the cancellation of an expected event for which the deal had been made. However, the courts will permit frustration in very narrow, specific circumstances, and so it cannot be used as a back door to termination.
For example, the High Court recently ruled that Brexit was not sufficiently unexpected to frustrate a property contract between the European Medicine Group and its landlord, the Canary Wharf Group.
Golden rules
- Check the contract for restrictions or procedures as to how the parties must deal with problems.
- Seek advice early to avoid unintentionally waiving the right to terminate.
- Assess the commercial merits of terminating and/or damages alongside the legal rights.
- Ensure a notice to terminate is drafted and served in accordance with the terms of the contract
- The innocent party must ensure that it takes reasonable steps to mitigate its losses.