Nordisk 101: Termination of a Contract

A question often posed to us, is whether a contract can be legally terminated and, if so, how?  In this article, we will set out to answer these questions by looking at the legal requirements and options for termination available under English law.

We start by noting that when a contract is legally terminated, it comes to an end and neither party has any future obligations or rights under it.  The contract continues to exist, however, in the sense that there may be claims for damages arising under it prior to or in connection with its termination.

The facts may be such that a common law right of termination arises alongside a contractual right.  How are those termination options best exercised?

When? Circumstances allowing Termination
Repudiatory Breach
Under common law legal principles, a contract may be terminated for repudiatory breach.  A repudiatory breach is one which is so serious or fundamental to the contract as to allow the innocent or non-breaching party the right to terminate the contract and claim damages, including the loss of the benefit of the contract.  As described in our earlier articles, in determining when a contract may be terminated, the law classifies contractual terms into three categories: (1) conditions, (2) warranties and (3) intermediate or innominate terms.

To determine which category a particular term falls into is not always an easy task.  The parties may label a term as one of the three in their contract, but this will not guarantee that the courts will agree with that label.  In classifying a particular term, the courts will consider the words used by the parties, but they will also look at the contract as a whole as well as the commercial background to see if the parties intended that a right of termination would arise for breach of the term and in what circumstances.

Examples of each type may help to understand this system of classification.  An example of a condition is the owners’ obligation to proceed on a voyage without unjustifiable deviation.  A classic warranty is the promise that a vessel will perform at a given speed on a stated consumption of fuel.  An example of an intermediate term is the obligation to provide a seaworthy vessel.  In circumstances where the breach of that obligation results in a breakdown of the main engine for a few days while repairs are made, the charterers would not have a right to terminate and could be readily compensated with monetary damages.

If, however, the repairs would take an inordinate amount of time, judged against the length of the contractual period, such a breach would most likely be repudiatory and allow for termination in addition to monetary damages.

Refusal to Perform as a Repudiatory Breach
If one party to a contract unequivocally indicates that it will not perform its obligations or no longer considers itself bound to do so, the other party may have the right to terminate.  A party’s refusal to perform can be by express declaration, such as where a charterer states that it cannot and will not continue to pay hire.  This would also be what is called an anticipatory breach, which occurs when a party states it will not honour its contractual obligations in the future.

A refusal to perform may also be inferred from conduct.  Whether such a refusal is a repudiatory breach will depend upon whether the non-performance amounts to a breach of a condition or deprives the innocent party substantially of the whole benefit of the contract.  The test for determining whether repudiation has occurred expressly or by conduct is an objective one: whether in light of all the circumstances a reasonable person would conclude that the other party will not continue to perform or carry out its obligations under the contract.

Contractual Provisions for Termination
Many contracts and charterparties, contain express provisions allowing one or both parties an option to terminate the contract upon the occurrence of a specific event or circumstance, even where this does not amount to a breach, repudiatory or otherwise.  Common examples include where a vessel is off hire for a stated period of time or where one party becomes insolvent during the course of the contract.

To claim damages in addition to exercising the option to cancel, the terminator will in most cases also need to establish a breach by the other party.  For example, where charterers have the option to terminate if the vessel does not meet the cancelling date in a voyage charter, to claim damages they must also show a breach such as the owners’ absolute obligation to commence the approach voyage in time to arrive by that date.

How?  Electing to Terminate a Contract
Accepting the Repudiation or Affirming the Contract
Termination for a repudiatory breach is not automatic.  The innocent or non-breaching party must elect whether to accept the repudiation, bringing the contract to an end, or to affirm the contract and insist that the breaching party perform.  The law does not require such an election to be made within a specified time, but generally it must be exercised within a reasonable time, considering the surrounding circumstances.  For example, in a volatile freight market, an election should be made relatively quickly.

In addition, the innocent party must be careful not to lose the right of election, for example by waiting too long to decide how to respond or by acting in such a way as to affirm the contract.  Once an election is made it cannot be changed, so it is crucial the innocent party proceed cautiously and preferably with legal advice.

Exercising the Option to a Contractual Right of Termination
Once a terminating event under a contract has occurred, the party seeking to terminate must exercise its option to do so within a reasonable time.  What is reasonable will depend upon the facts and circumstances in each case, but generally our advice is to do so quickly so as not to jeopardize the option.

In addition, some contracts provide for termination only if a particular incident or problem is not rectified or cured within a specific period of time.  In those circumstances, the party seeking to terminate must allow the other side the agreed time before it may exercise its option. Furthermore, most if not all contractual termination provisions require written notice to be given to the other party of the exercise of the option.  All details of a termination clause must be followed to the letter or the termination may be unlawful and itself constitute a repudiatory breach of contract with resulting liability for damages.

Contractual termination rights are in addition to the right to terminate for repudiatory breach, unless the latter right is expressly or impliedly excluded in the contract.  However, a party electing to end a contract pursuant to a contractual termination right alone, risks losing the right to sue for damages for a repudiatory breach. To preserve the innocent party’s right to claim damages, specifically and importantly the loss of its bargain, the notice of termination must clearly state that the termination is for a repudiatory breach.

As explained above, the non-breaching party must elect to accept a repudiation within a reasonable time to preserve the right to make a claim for damages for future losses, such as loss of profit. A mere statement in a contractual termination notice that all the non-breaching party’s rights are reserved will not be enough to maintain a damages claim for repudiatory breach.  As stated by the court in the leading decision on this point, “a right merely reserved is a right not exercised.[1]

Damages Resulting from Termination
The losses that may be claimed by way of damages when a contract ends depends upon the termination rights that were exercised.  Damages for repudiatory breach are meant to put the innocent party in the position it would have been in had the contract been performed, subject to the usual rules on causation, foreseeability and mitigation.  Thus, an innocent party that accepts a repudiatory breach is entitled to “loss of bargain damages” to compensate for the lost opportunity for future benefits, such as loss of profits.  If the innocent party chooses to affirm the contract, rather than terminate, a claim for damages for losses suffered as a result of the breach may still be made, but of course, there would be no claim for future losses as the contract would remain on foot.

Where a contract is terminated pursuant to a contractual provision, damages will usually be limited to any losses suffered up to the date of termination.  In other words, there is no right to recover loss of bargain damages.  The difference in damages for repudiatory breach and contractual termination can, therefore, be quite significant.

Practical Issues and Several Warnings
Deciding whether you have a right to terminate a contract and how to legally bring about termination can be difficult.  If you terminate on the basis of a repudiatory breach and the requirements for establishing such a breach are not met, then you and not your contractual partner may be in repudiatory breach and exposed to significant damages claim.

Terminating on the basis of a contractual provision alone requires carefully fulfilling the requirements for exercising the option and may not give you a claim for any damages.  How to terminate and how the decision is communicated can be complicated where the party has both contractual and common law rights based on repudiatory breach to terminate.

One solution in that situation may be to notify the other side of an election to terminate for repudiation and, in the alternative, assert the contractual right.  Although such a notice has yet to be tested in the courts, at least one English judge has indicated that it would protect the innocent party’s common law and contractual rights of termination.[2]

In any event, a notice of termination should be carefully drafted and state the precise basis for termination.     In short, caution must be exercised, and legal assistance should be sought both in reaching a decision on whether to terminate and then drafting an appropriate notice so as to protect a right to damages, if any, and reduce the risk of being found in breach yourself.

[1] Phone 4U (in administration) v. EE Ltd. [2018] 1 Lloyd’s Law Rep. 204, at p. 228.
[2] See Shell Egypt West Manzala GMBH v. Dana Gas Egypt Limited (formerly Centurion Petroleum Corporate) [2010] EWHC 465 at para. 34.