The Legal View: Termination for Convenience
This article originally appeared in Outsource Magazine Issue #29 Autumn 2012
Termination is often the last thing on the parties’ minds at the outset of a new project or business relationship. Motivated by a need and excitement to just get started, the parties (and consequently the contract) may be focussed on the services to be supplied, on SLAs, on price and payment – essentially the core elements of performance. But what if you haven’t planned quite so elaborately for the end?
“This is the end, Beautiful friend, […] the end, Of our elaborate plans.” (‘The End’ – The Doors)
In this article, I consider how a party might terminate a contract in which the end has not been provided for. In particular, in circumstances where:
- the contract is of no specific duration;
- there is no serious breach or risk of breach by the other party; and
- there is no termination for convenience mechanism.
First, however, let’s look at what a termination-for-convenience mechanism is and why it can be useful.
It is sometimes easy for the parties to forget at the outset that they may not want to continue providing (or receiving) the services indefinitely, even in situations where there is no significant breach or threat of breach by the other party.
Consider, for example, the following situations (particularly relevant to the current economic climate):
- market pressures and changes have impacted costs such that the contract is no longer as commercially viable or profitable as it was at the outset (and the parties cannot agree changes to the contract to account for this); or
- there has been a company restructuring and the services are either no longer needed by the customer or are no longer a core part of the supplier’s business; or
- there has been some breakdown in the relationship but nothing so serious as to give rise to any termination rights for material breach.
A termination-for-convenience mechanism (otherwise known as a “no-fault” termination right) does what it says on the tin and allows a party to terminate the contract unilaterally, simply because it suits it to do so (with certain limitations which I will touch on later).
“No-fault” termination can be an attractive option where grounds for termination are uncertain or insubstantial. The terminating party is not faced with making the argument that a material or fundamental breach giving rise to termination rights has occurred or with the concurrent risks of getting such an assessment wrong (the danger of the latter being that the terminating party might, in turn, face a claim for damages by the other party for “wrongful termination” of contract) – they simply need to give notice.
Depending on such factors as the complexity and value of the contract, the implementation costs and the bargaining strength of the parties, a contractual termination-for-convenience mechanism might be as simple as a statement that a party (or either party) may terminate the contract by written notice, of a specific duration, to the other.
Contracts normally provide for such termination to be effective only after an agreed initial period has passed. The initial period provides some security to the supplier: allowing it to get on with its job without the fear or uncertainty of termination-for-convenience hanging over it. The no-fault termination right should also allow the supplier to recover implementation costs. The clause itself could be mutual or only give one party rights. It could also place limitations on the circumstances in which the right may be used.
In larger outsourcing contracts, the termination-for-convenience mechanism is likely to be a much more sophisticated affair and to provide for payment by the customer to the supplier of “early-termination” or “break-option” compensation payments to allow the supplier to recover unamortised costs and even loss of profits.
Voluntary “no-cause” termination rights are more common in long-term contracts and those of unspecified duration. However, what is less commonly known is that termination-for-convenience may also be available in certain situations to a party where it is not expressly written in to the contract.
In such circumstances, first heed the warning that any such implied termination right should be used cautiously. It is a principle of contract law that the contract confers on a contractor not only a duty to carry out the work but a right to do so. There is also a general rule that a party is still liable to perform a contract even where it has become considerably more difficult or expensive for it to do so. A right to terminate for convenience is more likely to be implied or justifiable where an informal contract, or a formal contract that does not properly address termination, has been rolling on for a long time (perhaps several years).
Where the contract is silent on termination, and balancing implied rights to terminate against duties to perform the contract, the rule is that the contract is terminable on “reasonable notice”. So what constitutes “reasonable notice”?
Clearly this can be a sensitive issue for a party on the receiving end of an unwelcome or unexpected termination notice. Getting the notice period right (and communicating it to the other party effectively) requires careful forethought in order to mitigate upset, avoid a dispute or to ensure defensibility if disputed. The terminating party should consider the following factors when deciding what should constitute “reasonable notice”:
- the length of the existing relationship between the parties (the longer the relationship, the longer the notice period should be);
- the importance of the contract to the business of the non-terminating party (e.g. percentage turnover/core supplier);
- the extent of early investment by the non-terminating party (sunk costs);
- the terminating party’s own notice requirements (if any), in related contracts under which it can be terminated for convenience;
- the degree of formality to the contract – the more formal the contract, the more that termination of it should be governed by the rights set out in the contract;
- how long it would (reasonably) take the non-terminating party to replace the contract in an orderly way (i.e. either to procure another supplier or to replace the business lost);
- connected to the point above, what the comparable notice periods in the relevant industry are (i.e. what is deemed standard in the industry as a handover period or is common as a notice period in contracts of a similar kind within the industry); and
- any other considerations that may be relevant in the circumstances (for example: have new employees or business premises been taken on, at least in part, to service the contract; are there any other factors that could impact the reasonableness of the notice period?).
As illustrated by this list of considerations, what is a “reasonable notice period” in the circumstances will always be dependent on the facts relevant to the particular contract and the parties. It might be helpful to note, however, that the English Courts have been reluctant to enforce notice periods of less than six (and in some cases nine) months when terminating a long-term contract, for convenience.
These considerations apply equally to notice periods for express rights of termination for convenience in formal contracts, and parties should be aware that a very short notice period may be open to dispute, and ultimately unenforceable, if it is not “reasonable”. It should certainly be longer than any notice periods necessitating more immediate termination (such as for insolvency or irremediable material breach) and should take into account all of the same factors described above.
Be aware too that whilst the factors described would apply to most contracts for goods and services, additional factors may apply to other types of contracts. For example, certain statutory minimums apply to termination notice periods in employment contracts.
So, the time has come to let your supplier or customer know that you wish to part ways. How should you do it? Technically, written notice is unnecessary provided that communication of the notice is clear and provided also that there is no requirement in the contract that notice be in writing. However, it is obviously an advantage for evidential purposes (and for the parties’ own reference) if notice is in writing or, if made verbally, then immediately followed up in writing.
Be clear that it is a notice of termination and state the exact date from which termination will be effective (i.e. the length of the notice you are giving). It may also help to refer in the notice to the basis on which you have made your assessment for the notice period. Aside from showing the other party that you have given serious thought to what is reasonable in the circumstances; it may act as a useful self-reference checkpoint to ensure that you have done so.
Lastly, don’t forget that where all parties to a contract are generally in agreement that the contract should end, the cleanest exit would be a negotiated one agreed by the parties in writing. The fact that the original contract was made informally does not preclude the parties from agreeing variations to it, or terminating it, by mutual agreement. The end might not have been planned at the outset but it does not need to be apocalyptic.
About the Author
Lou Oliver is an associate in the commercial, outsourcing and technology group at international law firm Stephenson Harwood LLP. She regularly advises on ITOs/BPOs and a wide variety of commercial arrangements.