How to Correctly Terminate a Contract
Written by Julian Canlas
Many scenarios may warrant contract termination. Understand the clauses in your contract as well as your rights under general contract law to ensure that your termination of contract is effective and, most importantly, lawful.
Wrongful termination is a real possibility and can leave your company in threat of legal proceedings. This article will help you understand which circumstances permit you to legally terminate a contract.
We’ll look at different termination clauses typically written into contracts, and then follow with terminations warranted by general contract law. Finally, we’ll give you practical steps to ensure your notice to terminate is correctly delivered and show you how
Contract Hound can help your company access your contracts quickly and easily should any issues arise.
What Does “Terminating a Contract” Mean?
A contract is an agreement between two parties that can be legally enforced. Contracts can be written or oral, though to keep things transparent, it is always advisable to have written documentation of the terms of the agreement signed by both parties.
Once a contract has been made, both parties are under a legal obligation to fulfill the terms of the contract. If they do not, they are in breach of contract and liable to be taken to court.
“Terminating a contract” is when either party decides to legally end the contract before the terms are fulfilled.
Understand Your Contract: Termination Clauses
When you’re still at the consideration stage of drawing up a contract, your company needs to plan an exit strategy. Anticipate what reasonable scenarios would warrant a contract termination, and write them into your contract.
Most contracts have a termination clause. They usually fall into one of two categories:
Termination for Cause
This is when a contract can be terminated as a result of one or both parties’ action or inaction.
This is known as a “breach of contract”. For example, if you contract a bakery to make a cake for your nephew’s birthday and the cake doesn’t arrive until the day after the party, the bakery is in material breach of contract by inaction (and you owe your nephew a cake).
Although material breaches of contract are generally covered by general contract law, writing a specific clause into your contract ensures that both parties are clear on what is and isn’t acceptable. After all, not all breaches can legally warrant automatic termination. Additionally, you can include and make allowances for minor or insignificant breaches.
For this reason, termination for cause clauses can get very specific, while other times they can be very vague.
Termination for Convenience
With a termination for convenience clause, either party can end the contract with or without cause and will not face a penalty.
Termination for convenience clauses is a great way of mitigating risk to your company. For example, this can help prevent damages in the event of an uncontrollable situation.
In 2020, the importance of termination for convenience clauses was laid bare when companies who failed to include them in their contracts were forced to fork out for services they no longer needed as a result of the pandemic. Those with clauses that covered unforeseen and uncontrollable events fared a lot better.
When determining whether you are within your right to terminate your contract, read carefully to check whether your situation is defined in any of the termination clauses.
Contract Termination Under General Contract Law
Breach of Contract
We’ve already briefly outlined that a breach of contract is when the terms of the contract are not honored by one or both parties. But not all breaches of contract warrant termination under general contract law.
If you haven’t stipulated the breach in the termination clause of your contract, you’ll have to decide if the breach was material or immaterial.
Whether you can legally terminate the contract is dependent on the type and severity of the breach.
Immaterial breaches do not materially affect the outcome of the service. For example, if your baker had substituted a white cake stand (as specified in the contract) for a silver cake stand. These breaches do not generally warrant termination under general contract law.
Material breaches have a substantial effect on the outcome of the service, to the extent that you wouldn’t have ordered the service had you foreseen the breach.
We illustrated an example above: if you had known the cake would not be delivered in time for the birthday, you would not have bought it. In other scenarios, (for example, if you order a pair of jeans online) a 24-hour-late delivery is an immaterial breach that would not warrant legal action.
In general, the injured party has the right to terminate the contract and seek damages in the instance for material breaches.
Impossibility of Performance
If for whatever reason, a service can’t be carried out (performed), it is termed an “impossibility of performance.”
Say, you hired a host for your company event, but she was seriously injured and there was no one to cover for her, you would be within your rights to terminate the contract. Let’s just hope you find another host that is just as extroverted as the last one.
Recission of a contract occurs if one party has misrepresented themselves, has been fraudulent, if the contract was signed under duress, or if it was a mistake. Rescission differs from other terminations in that the contract is deemed void from the beginning. Other terminations simply relieve either party from having to fulfill their obligations in the future.
A contract naturally terminates once both parties have fulfilled the contract. This includes when the contract expires. If you wish to renew the contract, make sure you do so with plenty of time to avoid missing out on the opportunity.
Keeping track of contract deadlines is challenging for even the most organized administrators in your company. Contract Hound keeps everything in order and allows you to set up automated alerts to remind you to renew contracts so you’re never caught off guard by termination by contract completion.
Termination by Prior Agreement
Both parties can agree that the contract may be terminated under pre-defined circumstances. The written agreement must detail the reason for the termination of the contract and what needs to be done by one of the parties to initiate termination.
A common example of termination by prior agreement is a break clause in a tenancy agreement. Should either the landlord or the tenant decide to terminate the contract they must, for example, give your written notice of termination 2 months in advance.
How to Terminate a Contract in Three Steps
IMPORTANT: Before you take any of the steps below, make sure that your termination is lawful and abides by the termination clauses laid out in your contract. Failing to do so could lead to a wrongful termination lawsuit.
1. Check the Notice Period
In the event of a material breach of contract, you may want to allow the offending party to make amends for their breach before deciding to terminate. In this instance, you can give prior notice of your intention to terminate and an “opportunity to cure” within that time frame. Although not strictly necessary, it may place you in a better position should the case end up in litigation.
In the event of termination by prior agreement, things are much more straightforward. Simply read the break clause in your contract and find the notice period required to terminate the contract (e.g. 6 weeks, 30 days). Be aware that some clauses stipulate that notice can only be given within a certain period before the renewal date, so double-check to make sure.
2. Write It Up
Almost all break clauses stipulate that notice must be delivered in writing. There may also be other requirements, such as a signature. Check whether e-signatures count. A few contracts even require notice to be notarized.
Be sure to explicitly include a “date effective” and make sure that date factors in the date it is likely to be delivered. For example, if your termination notice period is 30 days and you’re planning to send your notice by USPS, factor in the days it will take to arrive.
3. Ensure The Document Is Delivered
Some contracts require notice to be delivered by a specific method. Be aware that email may not be accepted.
Here are some more traditional methods of delivery for giving notice:
- Hand delivery
- Certified mail (make sure to request a return receipt of notice)
- Nationally recognized courier
If email is an accepted method, make sure you can show receipts of delivery.
A word of warning to the trigger happy: if a party terminates a contract without due justification (either by what’s written in the termination clause of the contract, or under general contract law) it is deemed to be a wrongful termination.
Wrongful termination is considered a material breach of contract. The tables will turn and it will be you on the back foot of legal proceedings.
Get Organized and Protect Your Business with Software
Here are some key takeaways from this article which you can apply to contract management software (like Contract Hound):
- When considering a contract, make sure you make the necessary amendments to your termination clauses to ensure you are protected against both anticipated and unforeseeable scenarios that are not covered by general contract law.
- Protect your business from the legal implications of wrongful termination by ensuring that you are legally entitled to terminate the contract.
- Set up automated alerts on Contract Hound so you know when contracts are due for renewal.
- Contract Hound also enables you to securely store and organize all of your contracts so that you can easily browse and refer to them should an issue arise.
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