How to terminate a contract correctly

We’ve all been parties to contracts – whether by signing an actual document or entering into one less formally. But how do they end? If the other party does something that conflicts with the contract, does that mean the contract is over? We’ll answer these questions now.

There are basically three ways in which a contract can come to an end:

1. Expiration on the end of its natural term – for example, a 6-month lease may end naturally at the end of the 6 months unless both parties agree to renew. The same may be for a mobile phone contract with Vodafone for example.
2. Early termination pursuant to an express termination right – namely, the parties agreed that if so and so happens, a party is entitled to terminate the contract. A common example is where paying a termination fee (or ‘break fee’) allows you to get out of your long-term gym membership.
3. Early termination for breach – if one party (Breaching Party) breaches the agreement, the other party (Aggrieved Party) may be entitled to terminate the agreement on that ground.

Whilst the first two options are simple enough (they occur according to an express clause in the agreement), termination for breach is more complicated. Not every breach of the agreement gives the Aggrieved Party the right to just terminate the entire agreement. This article will explain how termination for breach works.

Termination for Breach

It would not be fair if any small breach would entitle the Aggrieved Party to end the entire agreement. This simplest example is a slightly late payment or late delivery – it wouldn’t be fair for a landlord to kick a tenant out for being 1 day late in rent. Accordingly, common law has developed to decide what types of breaches entitle a party to terminate.

In basic terms, a termination right arises in the following circumstances:

• a breach of an “essential” term;
• a breach of a non-essential term, if the breach was sufficiently serious; and
• “repudiation” of the agreement.

Essential Terms

Certain terms in a contract are considered “essential” terms (also known as “conditions” or “fundamental” terms). Which terms are considered essential and which aren’t varies from contract to contract and depends on the circumstances. The question the court asks itself to examine this is basically “would a party consider this term so important that it would not have entered the contract without being sure that there will absolutely strict compliance with it?”

As an example, imagine if you are buying a shipment of balloons to be delivered on a certain date, but the balloons arrive a day late.

• In most supply agreements, customers don’t expect strict compliance with delivery dates and accordingly, the delivery date is not considered an essential term. You will not be entitled to terminate the contract.
• However, let’s say the balloons were for a birthday party occurring on the day of delivery. In this case, it’s obvious you would not have entered into the agreement if the balloons were delivered late because you have no use for them now. Accordingly, the delivery date would be an essential term, and you may be entitled to terminate the contract.

Many contracts expressly state that a term is essential, such as contracts which state that “time is of the essence” (eg, any lateness in payment or delivery constitutes a breach of an essential term). Another good example is a lease prohibiting pets on the premises: a landlord may specify in a lease that having no pets on the premises is an essential term (otherwise, it probably won’t be an essential term).

Any breach of an essential term, no matter how small, entitles the Aggrieved Party to terminate the agreement.

A breach of a non-essential term which is sufficiently serious

Breaches of non-essential terms usually do not entitle the Aggrieved Party to terminate. However, sometimes, the right to end a contract can arise from the breach of a non-essential term, if the breach is sufficiently serious.

What is a sufficiently serious breach of a non-essential term? In very basic terms, the court asks whether the breach basically results in the Aggrieved Party losing the main benefit from the contract.

This category is a bit more obscure. A good example would be what’s called ‘cosmetic’ defects in goods:

• Let’s say you ordered a shipment of tiles or stones for your house and it comes with half of the tiles having some scratches or discolouration.
• Generally, a ‘cosmetic’ defect (ie, a defect which goes to the appearance of a product and not its functionality) is not considered a breach of an essential term. Also, it is generally accepted that in a big shipment of goods some products may be refused on inspection and be returned to the seller for a refund.
• However, in this context, about half of the goods had defects, and the effect is really that you have no use for the tiles. You were essentially deprived of the ‘benefit’ you sought from buying the tiles.
• You will most likely be able to terminate for a sufficiently serious breach of an intermediary term.

Repudiation

Repudiation is a complex legal concept which probably merits its own separate article. We will try to just cover it briefly here.

In basic terms, repudiation occurs when one party (Repudiating Party) indicates that it no longer intends or is unable to abide by the contract. This can be achieved in a few ways, primarily:

1. by express words to that effect – eg, “I’m not going to do x” or “I’m not bound by this contract”;
2. by conduct – eg ignoring emails and phonecalls and not performing the agreement, or repeated small breaches;
3. insisting on a wrongful interpretation of the agreement – eg, “The contract says I don’t have to do this”

The first category is relatively straightforward but the other two may need some further explanation. Repeated minor breaches (for example, a tenant who is often late for paying rent, does not keep the property tidy, doesn’t notify the landlord about damage to the property etc) may be considered as a sort of general ‘disrespect’ to the contract and therefore repudiation. Also, a wrongful interpretation may constitute repudiation, such as where a party claims it is entitled to pay rent in arrears as opposed to in advance.

I have the right to terminate! What now?

So you’ve read this article and realise that you have obtained the right to terminate a contract. The process that comes now is called “election”.

As the Aggrieved Party, you have to select whether you wish to press your termination right and actually bring the agreement to an end, or to keep the agreement going (called “affirming” the contract”). Often, parties do not elect to press their termination because the consequences of termination are often not ideal. For example, many landlords simply forgive even serious breaches of a lease (at least initially!) because of the cost and hassle involved with getting a new tenant.

If you elect to terminate, you must do so by expressly notifying the Breaching Party. If you continue to operate under the agreement, you may be taken to have “affirmed” the contract. The most common example is where a landlord decides to keep accepting rent from a tenant – thereby affirming the contract is still going, and forfeiting their right to terminate for past breaches. Moral of the story – if you want to kick a tenant out, stop accepting their rent.

Whilst affirmation of the contract means you can’t terminate anymore, you will still be entitled to get damages (financial compensation) for any damages caused by the breach. For example, interest on late payments, or reimbursements for damage caused to the property.

Aftermath

What happens in a post-termination world? The concept is that any rights/responsibilities the parties had up to the day of termination stay in place, but they are released from any obligations from that day onwards. However, the Aggrieved Party is often entitled to be compensated by the Breaching Party for any loss that the Aggrieved Party suffered due to the fact it had to terminate the contract. For a detailed explanation of how compensation works, read our article What happens when a contract is broken?.

Conclusion

In the last article we wrote, we used romantic relationships as an analogy for restraints of trade. We’ll use it again now for terminating a contract for breach.

In a relationship, there are many ways you can upset your partner (breach a contract). If you cheat on your partner in any way (essential term), they will probably be justified in ending the relationship. Spending time with your friends is probably okay, but if you do it so much that you neglect your partner (serious breach of intermediary term), they may also end the relationship. If you say to your partner that you don’t care about the relationship (repudiation by words), if you constantly do things your partner asked you not to do (repeated small breaches) or that you don’t think it’s wrong to be with other people (insisting on a wrongful interpretation), your partner will probably break up with you. Usually, if your partner does not break up with you for a transgression, it is not fair for them to bring it up again a year later and break up with you (election and affirmation).