Quickguide - Terminating contracts under English law
23 August 2022
23 August 2022
Can I terminate this contract? Is the other party entitled to get out of this contract? These are questions commonly raised when the implementation of a commercial contract does not go to plan. This guide provides a summary of the legal options and remedies available for terminating contracts under English law. It also looks at another common question, namely whether an innocent party can escape a contract on the ground that something said during the pre-contractual negotiations turns out not to be true.
First, it is worth clarifying the legal terminology used in this area.
Rights to "terminate" at common law are confounded by definitional difficulties and inconsistencies. Strictly speaking, "termination" means that the contract is "discharged". In other words, the future, unaccrued obligations owed by the parties fall away. The contract does not actually cease to exist. Rather, once the innocent party has elected to terminate, the primary obligations of the party in breach to perform the contract are replaced by secondary obligations to pay damages for the loss arising from the breach. References to termination in this guide are to termination in this strict sense.
"Rescission", on the other hand, refers to the retrospective avoidance of a voidable contract. Here the contractual rights and obligations remain in place until the innocent party opts to rescind the contract, at which point the rescission operates to render the contract a nullity.
Finally, in the following section we use the term "repudiatory breach" in its broadest sense, to encompass all common law termination grounds.
Not every breach gives the innocent party the right to terminate. The breach has to be a "repudiatory breach". Whether it is "repudiatory" depends on a range of factors, including the nature of the term that has been breached, the nature of the breach, and the consequences of breach. In the past the courts focussed on the nature of the term, but in recent years the focus has shifted towards the seriousness of the breach and its consequences.
As such, each of the following constitutes a repudiatory breach of contract justifying termination at common law:
The innocent party will be discharged from future performance of the contract if the term breached qualifies as a condition, i.e. a vital term. Provided the term is a condition, the innocent party will be entitled to terminate the contract, no matter how minor the consequences of the breach. A breach of warranty, on the other hand, does not absolve the affected party from future performance, no matter how serious.1 The contract continues, the parties remain obliged to perform their future obligations under the contract, and the only remedy for the breach is damages.2
A breach of an intermediate or innominate term, i.e. neither a condition nor a warranty, only justifies termination if the breach is sufficiently serious. It must "go to the root of the contract", "frustrate the commercial purpose" of the contract or "deprive the party not in default of substantially the whole benefit" of the contract.3 In every case, the court will look at the nature and consequences of the breach to decide whether termination is justified.
Deciding this question is not always straightforward. In some cases, statute may dictate or influence the classification. For example, certain provisions in the Sale of Goods Act 1979 specify whether certain terms should be regarded as conditions or warranties. The courts will also pay regard to the express terms of a contract: if the parties expressly identify a term as a condition or warranty, the courts will generally treat it as such. However, there are exceptions such as where statute provides otherwise or where, in the circumstances, the court considers that the parties cannot have intended a breach of that term to result in automatic termination. In those cases, the courts usually construe the term as being intermediate and look to the surrounding circumstances to ascertain whether the breach is sufficiently serious to justify termination.4 As such, labels on their own may not guarantee that a term will be interpreted as being a condition or a warranty. If the parties intend any breach of a particular term to give rise to automatic termination, the contract should make that clear.
Where time is of the essence in a contract, even a short delay can trigger a common law right to terminate for breach as the term is considered a condition of the contract.5
However, as a matter of English law, where a contract stipulates deadlines, time will not be treated as being "of the essence" unless one of the exceptions applies.6 Consequently, where a party defaults by failing to perform within a specified time, their default will not amount to a repudiation and the innocent party will not have a common law right to terminate.
There are three exceptions to the general position that time is not of the essence:
Where a party declares an unequivocal intention to abandon further performance of the contract, or an intention not to perform some essential aspect of the contract, the innocent party is entitled to treat himself as discharged from further performance. Not every declaration of non-performance is a repudiatory breach. Sometimes a party will refuse to perform some, rather than all, of its contractual obligations or indicates that they will only perform them in a particular manner. In determining whether the breach is repudiatory the court will consider whether the non-performance amounts to a breach of condition or deprives the innocent party of substantially the whole benefit of the contract (see above).
A declaration of non-performance can be either an express refusal to perform or it can be inferred from the party's conduct if they behave in a manner which would lead a reasonable person to conclude that they have no intention of fulfilling their obligations.10 If a party threatens non-performance prior to the time fixed for performance, this is known as anticipatory breach.
Termination is not automatic. Once a party is in repudiatory breach, the innocent party has a choice: accept the breach and treat the contract as discharged or affirm the contract and press the party in breach to perform.11 A party cannot affirm a contract following a repudiatory breach unless they have a full understanding of the facts leading to that breach12 and are aware of the right they have to choose between acceptance and affirmation.13
The law does not lay down a particular period in which the election must be made.14 However, it is crucial for the innocent party not to do anything to jeopardise the right of election, either by waiting too long to decide how to respond,15 or by losing the right of election by inconsistent conduct.
In practice this area can be fraught with difficulty because, while the innocent party is deciding how to treat the contract, they risk taking a step which constitutes an election to affirm it and, once an affirmation has been made, it cannot be revoked.16
Commercial contracts often contain express termination clauses which provide for termination in certain specified circumstances, including for breaches other than repudiatory breaches. These termination rights operate in addition to common law rights to terminate unless the latter are clearly excluded.17
Some contractual termination clauses work by expressly classifying terms as conditions or warranties so as to make clear those circumstances in which the contract can be brought to an end and those which only give a right to claim damages. Some contractual provisions attempt to give rights to terminate for "material" or "substantial" breaches, for "any" breaches (however minor) or for repeated breaches. Termination clauses require careful drafting and careful attention should be paid to the way in which the courts approach such provisions.
Contractual termination provisions will often set out the process that has to be followed in order to exercise those termination rights. Typically, a notice of termination will be required. Contracting parties should always ensure that any termination rights are exercised in accordance with these contractual requirements.
Careful consideration should always be given whenever terminating under a contractual termination right, particularly if the innocent party also has a common law right to terminate. Electing to terminate a contract on the basis of a contractual termination right may preclude a common law claim for future loss of bargain as a result of a repudiatory breach.
Deciding whether you have a right to terminate a contract and how to bring about that termination can be difficult. The compensation that can be claimed by way of damages can vary depending on which termination rights are exercised.
Damages for repudiatory breach are assessed according to normal principles. This means that the innocent party is, as far as possible, put in the position in which it would have been if the contract had been properly performed, subject to the usual rules on causation, forseeability and mitigation. At common law, in addition to claiming recompense for losses resulting from the breach or breaches prior to the termination, an innocent party accepting a repudiatory breach of contract is entitled to claim "loss of bargain" damages (an amount to compensate for the lost opportunity to receive future performance of the contract).18
Contractual provisions may entitle a party to terminate where the breach in question does not amount to a repudiatory breach at common law, or where there has been no breach. Often the contract will specify the remedies available. However, in those circumstances it may not be possible to recover "loss of bargain" damages. Where the breach is not also repudiatory at common law, damages will usually be limited to loss suffered up to the date of termination unless the contract expressly provides otherwise. The difference can be considerable.
Where a party has both common law and contractual rights to terminate, but elects to terminate using a contractual termination entitlement rather than alleging repudiatory breach, it may be prevented from claiming loss of future bargain damages.19 Careful consideration should therefore always be given where an innocent party has both a contractual and common law entitlement to terminate (see below).
An innocent party who instead decides to affirm the contract, rather than terminating, can claim damages in the normal way for loss suffered as a result of the breach or breaches.
Before terminating a contract, consider whether you want the relationship to end or whether you should continue with the contract but reserve the right to claim damages for any breach. You may want to renegotiate the contract. If you decide to terminate, you should also check whether there is a prescribed dispute resolution procedure to reach a solution and whether the party in default has a contractual right to remedy the breach within a certain period.
Although an election to terminate need not be made immediately, you should be careful not to take too long or engage in conduct which could be seen as an affirmation of the contract. Take care to qualify any correspondence with appropriate reservations of rights when engaging in further business related conduct. Once communicated, an election to terminate cannot be withdrawn without the other party's consent. If a contract is terminated but the parties proceed for a time on "business as usual" terms, a new or supplementary contract might be created, potentially on the same terms as previously, which could be a commercially undesirable outcome.
The decision to terminate, and how you communicate that decision, can become more complicated where a party has both contractual and common law rights to terminate. The consequences of this choice can be significant.
If a contracting party wants to be in a position to claim loss of bargain damages, the notice of termination should make it clear that it is terminating pursuant to its common law right to terminate for repudiatory breach. Terminating on the basis of a contractual right alone may preclude a claim for future loss of bargain damages.20
However, terminating solely on the basis of a common law right carries the risk that the party terminating will itself be in repudiatory breach if the breach relied on for the common law termination is not found to be repudiatory.
Can you avoid the dilemma by exercising both rights to terminate at the same time, so provide both grounds to terminate in the notice to terminate? This is possible provided that there is no inconsistency between the exercise of the two rights.21 Put another way, is it possible to exercise both rights concurrently? If yes, then the notice should make it clear that both rights are being exercised.
If not, then you must choose between them and clearly communicate which right is being exercised. If you purport to terminate on both grounds, the notice of termination will be invalid. An alternative approach may be to terminate on the basis of a repudiatory breach while reserving the contractual right to terminate in the event the common law claim is misconceived. The law is unclear on this, but it has been suggested that there should be no reason why a party could not serve a notice accepting a repudiatory breach, but assert in the alternative their contractual right to terminate.22
Where there is a clause in the contract covering termination, it is important to follow any specified notification requirements and time limits. You may also be obliged to give the party in default an opportunity to remedy the breach within a certain time.
If a party wants to terminate on the grounds of a delay, consideration needs to be given as to whether time is of the essence. If there are no express contractual terms and no facts allowing an implication of time being of the essence, then the party will have to serve a notice requiring completion in a reasonable time. This will then cause any further delay to be classed as a sufficiently serious breach of a contractual term, and will justify termination at common law.
Where time is of the essence, even a short delay will be a repudiatory breach and will engage a common law right to terminate.
A party cannot recover damages for any part of a loss which could reasonably have been avoided, so it is important to consider ways to prevent or reduce loss. The duty to mitigate requires a party to act reasonably, which will depend on the individual circumstances of each situation. However, the claimant need only take steps which are "in the ordinary course of business"23 and is not required to engage in commercially risky conduct. Expenses, costs or further loss incurred in taking steps to mitigate the loss can be recovered. As for timing, once the innocent party becomes aware of the breach, or ought to have known of it, it has a reasonable time within which to take steps to mitigate.
An actionable misrepresentation is a false statement (made fraudulently, negligently or innocently) that causes the representee to alter its position in reliance on the statement. One of the ways in which a representee may alter its position is by entering into a contract. The legal options available and the consequent effect on the contract depend on whether the statement has become a term of the contract, the type of misrepresentation, the cause of action relied on and the remedy claimed.
If a statement made during pre-contractual negotiations has become a term of the contract, then normal principles apply to determining whether the contract can be terminated. The court will ask whether the representor promised in the contract that the statement in question was true. If so, has that promise been broken so as to constitute a repudiatory breach at common law or trigger contractual termination provisions as outlined above? If that is the case, the innocent party may terminate the agreement for breach.
Where the false statement has induced the representee to enter into the contract but the misrepresentation has not become embodied as a term of the contract, the relevant remedy at common law is rescission of the contract.24 If the representee chooses to exercise its right of rescission the contract is then treated retrospectively as a nullity. This means that performance is reversed, all rights and obligations fall away, the parties' pre-contract position is restored and the agreement is treated as if it had never existed.
Rescission is by election. The representee must give a clear indication that they intend to be bound by the contract no longer. The representee does not have to go to court to obtain rescission, although if there is a dispute they may have to seek an order of the court that the election was valid. The rescission will be valid provided the representee can show that either:
and, in either case, that it operated to induce him to enter into the contract. This establishes a prima facie right to rescind. However, rescission may be barred on a number of different grounds:
As to this last point, if the representee has elected to rescind the contract on the basis of a misrepresentation that is fraudulent,27 the court has no power to declare that the contract is still in existence.28 For innocent and negligent misrepresentations, however, there is no absolute right to rescind. The remedy under the Misrepresentation Act is either rescission or damages in lieu (see below). The court decides which of these remedies is the most appropriate and equitable, exercising a very broad discretion which includes considering the likely effect on both parties of permitting the contract to continue.
The topic of damages for misrepresentation is more complex than damages for breach of contract because of the different ways in which the claim can be framed and associated tactical considerations. Options include:
The starting point for the tortious measure of damages is that the claimant should be put back in the position in which they would have been had the tort not been committed, that is, here, had the misrepresentation not been made.
Damages for deceit can be especially generous because they are awarded to compensate the representee for all the losses they have suffered as a result of their reliance on the fraudulent misrepresentation.29 The representee has a duty to mitigate their loss once they discover the fraud. Subject to this and the requirement to demonstrate a causal link, they may recover all actual loss suffered as a result of his having entered into the transaction. Furthermore, the normal requirement that the losses claimed must have been reasonably foreseeable does not apply.30 Therefore the innocent party can recover all losses flowing from the fraud, even if they are unforeseeable.
Section 2(1) of the Misrepresentation Act 1967 provides for recovery where a person has entered into a contract in reliance on a misrepresentation. It covers negligent and even wholly innocent misrepresentations and there is no need to prove fraud. However, as noted above, where the misrepresentation is not fraudulent the court can decide to declare the contract as subsisting. Under section 2(2) it can award damages but, consistent with the fact that the contract subsists, these will be on the contractual measure.
Parties often want to avoid the uncertainty of claims being made based on matters that are outside the terms of the contract. Therefore contracts often contain provisions that purport to exclude or limit liability for pre-contractual statements or to exclude or limit the available remedies. For example, it may provide that damages are the only remedy and that the contract cannot be rescinded. Whether such clauses are effective depends on their construction and whether any statutory restrictions apply (see footnote 17 above).
To this end "entire agreement" clauses are commonly used, e.g. "This agreement together with any other documents referred to in this agreement constitutes the entire and only agreement between the parties..." as well as "non-reliance" clauses acknowledging that the parties have not relied on representations made outside of the contract. The aim is to restrict claims to matters that have become embodied in the contract. However, for these clauses to be effective, they must be drafted carefully.
There is no general requirement under English law for parties negotiating a contract to disclose information to one another. In some circumstances a party's silence will amount to a misrepresentation, for example, where it gives only half the truth which has the effect of misleading the other party. If this is the case the contract can be rescinded for misrepresentation as above. Liability for pure non-disclosure is more difficult to establish as the claimant must prove that there was a positive duty on the other party to provide the relevant information. This duty can derive from the particular kind of contract (for example, insurance contracts) or from the relationship between the parties, e.g. trustee and beneficiary.
Not all mistakes affect the validity of the contract. The doctrine of offer and acceptance relies upon a meeting of minds between the parties as to what is being offered and what is being accepted. If there has been a mistake about something fundamental like the identity of the party with whom the contract is made or its subject matter, there is no true agreement. In this situation the court will set it aside and restore the parties to their pre-contract position. In other situations of mistake the contract is not necessarily void. The court's view will depend on whether it is still possible to perform the contract, notwithstanding the mistake.31
A frustrating event is an extreme supervening event occurring after the formation of the contract which makes further performance impossible, or so radically different to that envisaged, that it would be unjust for the contract to continue. For example, the outbreak of war32 or seizure of property by a foreign government.33 At common law the effect is to terminate the contract, releasing the parties from all further performance. This consequence is automatic34 but the scope for frustration can be cut down by including in the contract express provisions (force majeure) setting out what should happen to the contract if something unforeseen occurs.
Contracts involving the commission of crimes, torts or unreasonable restraint of trade are void and unenforceable. Contracts involving transactions prohibited by law are generally void and cannot be enforced by either party.
Contracts induced by actual or threatened violence (physical or economic) are voidable by the injured party. For example, economic duress, a threat to breach a contract or coercion which invalidates consent.35 Undue influence arises, and can be presumed, in situations where there is a fiduciary relationship.
Entitles the innocent party to treat future obligations to perform as discharged.
Discharge is not automatic. The innocent party may elect either to accept the breach and treat all future obligations as discharged or affirm the contract and press the party in breach to perform.
Damages: where the contract is treated as discharged, damages are claimable at common law for both losses to date resulting from the breach plus "loss of bargain" damages, subject to causation, foreseeability and mitigation. Where the contract is affirmed, damages can be claimed for the loss suffered as a result of the breach in the normal way.
|Contractual termination clause triggered
Contract may provide for calculation of damages.
Common law remedies available in addition unless contract excludes them.
"Loss of bargain" damages may not be claimable if the breach does not constitute a repudiatory breach at common law or if the party has terminated on a contractual basis alone notwithstanding the existence of a repudiatory breach.
|False statement, made fraudulently, negligently or innocently, that causes the representee to alter its position.
If the misrepresentation has become a term of the contract, the breach of which justifies termination, the representee can treat the contract as discharged for breach as above.
If it has not become a contractual term but the representee can show that it was a statement of fact, or was made fraudulently, and it induced him to enter into the contract, there is a prima facie right to rescission subject to bars (affirmation, delay, impossibility of restitution or effect on third party rights).
Depending on the way in which the claim is made, damages can be on the more generous fraud measure.
The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.