Termination: managing the way out of a contract

Whenever a party is considering termination, care must be taken to ensure that every step is implemented correctly. This is particularly the case in light of the new Corporate Insolvency and Governance Act 2020. Karen Gidwani and Lucinda Robinson provide practical guidance on the issues you need to consider, whether the termination is at common law or under the contract.

Introduction

Typically termination clauses sit at the back of contracts.  Perhaps because they spell the end of the project’s story.  Perhaps because termination is frightening, so it is a subject best hidden away.  Certainly, a proposed termination is often met with a gasp of shock and rightly so, it is a dramatic step to take. Why is it so feared? Because it involves hard work and is expensive if it goes wrong.  It is a nightmare!  Or is it?  Often the nightmare has already happened; the counter-party has become insolvent or has performed terribly. Termination can facilitate a way out of a bad situation and provide the best commercial outcome, but it must be implemented correctly.  This article explains termination at common law and under a contract, practical steps to address if you plan to terminate and the implications of the Corporate Insolvency and Governance Act 2020. 

Termination at common law

A breach of, or threat to breach, a fundamental term of the contract demonstrates an intention not to be bound by the contract’s terms anymore.  That gives the innocent party a choice.  It can elect to carry on with the contract and claim damages. Alternatively, it can “accept” the repudiation, end the contract and claim damages.  A straightforward concept, but one that poses a significant challenge. 

If the party faced with a repudiatory breach elects to terminate, then it faces two significant risks.  First, the purported termination will be wrongful and constitute a repudiatory breach in its own right, entitling the other party to terminate and claim damages, if the breach relied upon is not repudiatory.  Second, if the innocent party affirms the contract then it will lose its right to terminate. In that event, a belated attempt to terminate will be a repudiatory breach.  These risks must be considered as follows. 

1. Ensuring the breach is “repudiatory”.
   Unless the breach is so significant that it demonstrates a clear intention not to be bound by the terms of the contract, it will not justify termination.  Repudiatory breaches include the contractor failing to start1 or abandoning site2 and the employer preventing the contractor from working by not giving possession3 or instructing another contractor.4  Not every breach will be sufficient.  Delay is rarely a repudiatory breach by the contractor5 and if payment is just late sometimes then that will not be a repudiatory breach by the employer.6  It is always a question of fact and degree.     
2. Acting quickly to terminate and avoiding any affirmation of the contract.
   The injured party does not have an unlimited time to decide whether to bring the contract to an end.  It must act quickly or lose its right to terminate.  Whilst considering its options it should not act in a way consistent with enforcing the contract, such as exercising a contractual right by calling a bond.  Any such actions (such as issuing pay less notices) should be expressly “without prejudice” to the right to terminate and, additionally, all rights should be reserved pending a decision on termination.  

If these challenges are overcome and the termination is effective, the parties must work out what happens next with regard to payments, securing the site, obtaining documents from the counter-party and so forth.  The contract may not provide a map for navigating fallout from a common law termination.

Contractual terminations have an advantage because they tend to prescribe more, and more certain, grounds for termination and usually do clarify what happens next. 

Termination governed by the contract

Termination often takes place where circumstances arise that change the commercial landscape for one or both of the parties, to the extent that it changes what they originally bargained for. These circumstances include issues such as insolvency, serious failure to perform services or continued failure to pay.

Most contracts, and indeed most standard forms, contain contractual provisions relating to termination. There are two main benefits to this. First, at the outset when negotiating the contract, the parties can identify risk which will alter the commercial position so fundamentally that they require a right to terminate. Secondly, when operating the termination clause, the consequences of the termination (and the type of termination) will be specified, giving parties more certainty as to the commercial and practical position after termination. 

There are generally two types of termination provision: clauses that allow for termination for convenience or “at will” and clauses that allow for termination where there has been default on the part of one of the parties. In the default situation there is often a further subdivision: defaults that allow immediate termination, for example the reaching of a long stop date for delay, and defaults where notice of the default is given and the opportunity is provided for the default to be cured. 

A circumstance that is generally included in the list of “defaults” in contract termination clauses is insolvency. There is no common law right to terminate in the event of insolvency but it counts as a significant commercial risk. Contractual termination clauses allow the parties to address this risk. 

Typically, the consequences of a termination for convenience and a termination for default will be different. For example, where an employer terminates for convenience you might have provision for the contractor to be paid its lost profit from the remainder of the contract. In a default situation this is unlikely to be the case.

Unless there are clear words to the contrary in the contract, the common law right to terminate continues to exist in parallel with the contractual right and it is open to a party to terminate on the basis of its contractual right or in the alternative at common law.

Contractual provisions are likely to allow for termination by either employer or contractor but the circumstances in which the right may be exercised will be different depending on who is exercising the right. It is not unusual for the contractor’s right to terminate to be limited to insolvency or repeated failure to pay on the part of the employer, but for the employer’s right to terminate to be referable to a much wider range of contractor defaults.

What to consider on termination 

Termination should not be undertaken lightly. If you are considering termination then it is important to think through very carefully what needs to be done and the consequences of the termination, and whether in fact termination is the appropriate route on the facts of your particular case.

In the first instance, check the contractual provisions for termination. Identify what circumstances allow termination and ask: have they arisen? Are they likely to arise? What procedure is necessary to invoke termination? 

Most termination clauses specify that notice of termination must be given. Again it is important to check the contractual provisions and ask: what sort of notice and in what form? You should check as to whether it is a two-stage process where notice of default must be given and a cure period allowed following which a further notice must be given, or whether one notice is enough. You should also check whether notice needs to be given to anyone else, for example lenders.  Finally, check what the contract says in respect of the consequences of termination: what happens to the site, the plant, equipment and materials, what is the position on retention of title, can subcontracts be assigned, when and how does further payment occur?

With an understanding of the contractual framework and the entitlements and obligations of the parties you should then consider whether termination is the right course of action for your circumstances. Particular considerations include:

• how termination will affect the commercial relationship with the other party;
• whether it is more profitable to continue with the contract; 
• other remedies available, for example performance security such as a bond; 
• whether the matters in contention can be resolved by negotiation or formal dispute resolution, including adjudication.

In summary, it is important not to rush into termination but to consider carefully all the surrounding circumstances and ramifications first.

Consequences of termination 

The first important point to note is that on termination (whether under a contract or at common law) the obligation to perform the main contractual duties ceases. Therefore the parties are no longer bound to provide services or make payment.

However, it is always the case that some clauses of the contract will “survive” termination. Typically, these are clauses such as jurisdiction and dispute resolution. Where a contract sets out a scheme in relation to termination then often there will be a list of clauses set out which are said to survive termination. 

In addition to clauses that survive, unless the contract expressly states otherwise, the parties will retain what are known as accrued rights. This is where a breach has occurred prior to termination and a right to damages has arisen. The wronged party retains its right to claim those damages regardless of the termination.

A question has recently arisen over the ability to view the right to be paid liquidated damages as an accrued right following termination of a contract. In the recent case of Triple Point Technology Inc v PTT Public Company Limited,7 the Court of Appeal held that the employer was not entitled to the liquidated damages that had accrued to the point of termination but instead was entitled to general damages for delay. This decision is currently being appealed to the Supreme Court.

In a repudiatory breach situation, the wronged party will be entitled to damages for breach of contract. In the case of a contractor this will include loss of profit due to the lost contract, and in the case of an employer this will include the “extra over” costs to complete the works (that is, the amount it costs the employer to complete the works less the amount left in the contract price which would otherwise have been paid to the original contractor).

If a party terminates wrongfully then the other party may treat the contract as repudiated at common law. Alternatively, some contracts will specify the consequences that will arise as a result of wrongful termination. For example, the IChemE Red Book (5th edition) states that where an employer wrongfully terminates for contractor default then this is not to be treated as a repudiation and instead shall be considered to be the same as if the employer had terminated for convenience. 

Corporate Insolvency and Governance Act 2020 (“CIGA”)

CIGA came into effect in June this year as part of the Government’s response to the COVID-19 crisis.   The Government has tried to give businesses facing financial difficulties some (what it calls) “breathing space” from creditors.  The idea being that this will help them trade through the difficult times or at least make a rescue more viable. 

CIGA interferes significantly with contractual provisions that allow suppliers of goods and services to terminate on the basis of their customer’s insolvency. These provisions are commonly included in contracts because, as stated above, you cannot terminate for insolvency at common law. They feature, for example, in the JCT 2016, NEC4 and FIDIC 2017 suites. 

Section 14 of the Act introduces a new section 233B to the Insolvency Act 1986.  This makes two important provisions:

If its customer becomes insolvent, a supplier cannot exercise a right to terminate that has arisen, but not been actioned, during the insolvency period.
 

The supplier cannot use contractual provisions to terminate on the grounds of its customer’s insolvency.  Any contractual provisions that allow them to do so will be inoperable. 

In practice, this means that the main contractor cannot terminate the contract with its employer because the employer has gone into administration or insolvency.  Nor can a subcontractor terminate its contract with an insolvent main contractor because of insolvency. Instead, the supply of goods or services should continue in line with the contract.  

Conversely, the contractual rights of the customer to terminate if the supplier becomes insolvent remain intact. A word of caution here though. To terminate on the grounds of insolvency, the nature of the insolvency event being suffered has to fall within the contractual definition of insolvency.  CIGA introduces a new insolvency procedure involving a moratorium, which may not be covered by the contractual definitions.   Also, whilst a winding-up petition might provide grounds under some contracts, they are now temporarily banned by the Act, so that route cannot be relied upon.  

From a supplier’s perspective, this could pose a real challenge. Ultimately, the benefit of a contract to the supplying party is the right to be paid. The insolvency of its customer is going to impact on the likelihood of payment coming through. Not many contractors, subcontractors or suppliers are going to relish the prospect of incurring costs of labour, materials and everything else as they continue with their work, knowing that there is a good chance they will not recover their costs, let alone any profit. However, if they stop supply or leave site, then potential repurcussions could include:

1. paying damages for delay; or 
2. giving the customer the opportunity to terminate for supplier default, or repudiatory breach, and to claim damages; and 
3. falling foul of another new provision within CIGA, being that suppliers should not do “any other thing” on the grounds of their customer’s insolvency.  

What can suppliers do when faced with this dilemma?  There are some options. 

1. Act quickly. The contract might define insolvency more widely than the legislation does.  If it includes early steps in a process that leads to what the contract defines as insolvency, then it might be possible to terminate before the insolvency as defined by CIGA occurs. An example might include the filing of a notice to appoint administrators.  
2. Check if an exemption applies. Companies that meet two of the three criteria in section 15 of CIGA are considered small enough to be exempt and can rely on their contractual provisions.  The criteria are (i) a turnover of under £10.2 million, (ii) net assets on the balance sheet of less than £5.1 million, and (iii) less than 50 employees. 
3. Agree a termination with the insolvency practitioner. Termination is permissible if the insolvency practitioner agrees to it. Whether agreement is forthcoming will depend on the facts and circumstances, and the significance and cost of the supplies to the insolvent customer. 
4. Application to the court on the basis of hardship. The supplier can apply to the court for permission to terminate on the basis that the continued supply will cause the supplier “hardship”.  This principle is not defined, there is no real guidance as to what it means and there is no case law.  However, the threshold is likely to be quite high. A risk of non-payment alone will not be sufficient as that is inevitable if insolvency occurs. The values at stake will need to justify the time and cost of an application. 
5. Rely on another ground for termination.  Suppliers could rely on an alternative ground for termination provided that it arises post-insolvency. For example, the insolvency may lead to a default, which will provide a right to terminate.  
6. Reduce costs. The supplier could look at reducing the cost of what it supplies and also the volume it supplies to the minimum possible without incurring additional risk (such as delay damages). How far that is possible will depend on the individual situation. 
    
7. Prepare for the future. Looking ahead to future contracts, suppliers should do their due diligence on their customers’ financial strength, be wary of contracting with those who may be a risk and consider breaking works packages into small contracts so the risk per contract is smaller.  When negotiating the contracts, it would be worth including more grounds for termination by the supplier and ensuring that the definition of insolvency is wide enough to include early stages of the various  processes so termination is possible before the customer is officially insolvent and the right to terminate is lost.  

Conclusion 

Whilst termination may be seen as a last resort, it is an important remedy to have.  Those entering into contracts should ensure that their termination provisions provide sufficient grounds for termination (taking CIGA into account), spell out who has to do what in the event of termination and are clearly drafted. 

Those seeking to terminate must be sure that they can prove the grounds they rely upon have arisen; understand and prepare themselves to implement the practical steps needed to secure the site, obtain documents and arrange for subcontracts to be assigned; and ensure their notices are valid and correct in content, form and delivery. 

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• 1. Gold Group Properties v BDW Trading [2010] EWHC 1632 (TCC).
• 2. Galway City Council v Samuel Kingston Construction [2010] 3 IR 95.
• 3. Vivergo Fuels v Redhall Engineering Solutions [2013] EWHC 4030 (TCC).
• 4. Sweatfield v Hathaway Roofing (1997) CILL 1235.
• 5. J M Hill & Sons Limited v Camden LBC (1980) 18 BLR 31.
• 6. Alan Auld Associates Ltd v Rick Pollard Associates [2008] EWCA Civ 655.
• 7. [2019] EWCA Civ 230.