Terminating contracts: getting your notice right

Deciding whether you have a right to terminate a contract and how to bring about that termination can be difficult. Mistakes can be costly. Wrongful termination could result in your contractual counterparty having the right to terminate and claim damages. And the compensation that can be claimed by way of damages can vary depending on which termination rights are exercised.

The decision, and how you communicate that decision, can become more complicated where a party has both contractual and common law rights to terminate. The difficulties that can arise and the financial consequences were highlighted in the recent High Court decision in Phones 4U Ltd (In Administration) v EE Ltd.

Phones 4U was seeking summary judgment in respect of EE's counterclaim for "loss of bargain" damages (estimated at £200 million) arising from Phones 4U's alleged repudiatory breach. EE succeeded in arguing that it had a real prospect of success of establishing repudiatory breach at trial, but failed to show that it had clearly communicated that it was terminating the contract on the basis of that repudiatory breach. As construed, the notice of termination made it clear that EE was exercising a contractual right to terminate only, which had arisen irrespective of any breach. As such, the claim for "loss of bargain" damages failed.

The decision highlights the careful consideration that needs to be given whenever a contracting party is exercising its termination rights. Consider what termination rights are available, and where there are different options, consider the different outcomes and whether more than one can be relied on.

This is particularly important where, as in this case, the innocent party has a contractual right to terminate irrespective of any breach and also has common law rights to terminate. If the 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 repudiation.

Background

Where a party to a contract breaches it in such a way that it is said to have "repudiated" the contract, English common law provides the innocent party with a right to terminate the contract.

Commercial contracts also often contain express termination clauses and specify the remedies available on termination. These contractual termination rights will operate in addition to common law rights to terminate unless the latter are expressly (or impliedly) excluded.

Generally speaking, termination is not automatic. Under common law, the innocent party may elect either to accept the breach and treat the contract as discharged or to affirm the contract and press the party in breach to perform. This requires the innocent party to clearly communicate its decision to its counterparty. Likewise, the exercise of contractual termination rights usually requires notice of termination.

The compensation (damages) an innocent party is entitled to on termination can vary depending on the grounds for termination.

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 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 compensation for losses resulting from the breach(es) prior to the termination, an innocent party accepting a repudiatory breach of contract is entitled to claim "loss of bargain" damages (i.e. a sum to put it in the financial position it would have been in had the contract been performed by the other party).

Contractual provisions often entitle a party to terminate where there is no breach or the breach in question does not amount to a repudiatory breach at common law. However, in this situation 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. If the breach is also repudiatory at common law and the innocent party accepts it, "loss of bargain" damages can be claimed, either under the contract or at common law.

Facts

Before going into administration, Phones 4U Limited had been a mobile phone retailer selling products and services on behalf of EE Limited. The parties' primary relationship was governed by a trading agreement. Clause 14.1.2 entitled EE to terminate that agreement on the appointment of administrators.

Two days after Phones 4U's entry into administration, EE wrote to the administrators as follows:

“In accordance with clause 14.1.2 of the Agreement, we hereby terminate the Agreement with immediate effect.

As a result, we hereby terminate with immediately [sic.] effect your authority to sell and promote all EE products and services contemplated by the Agreement … 

Nothing in this notice shall be construed as a waiver of any rights EE may have with respect to the Agreement... Without limiting the generality of the previous sentence, nothing herein shall be deemed to constitute a waiver of any default or termination event, and EE hereby reserves all rights and remedies it may have under the Agreement...”

EE subsequently sought to claim damages (by way of a counterclaim) for loss of bargain resulting from the termination of the agreement, estimated at over £200 million. Phones 4U applied for summary judgment to dismiss the counterclaim.

The decision

The appointment of administrators did not involve or result in a breach of contract on the part of Phones 4U. As such, and in order to be in a position to claim damages for loss of bargain, EE first had to satisfy the Judge that it had a real prospect of success in arguing at trial that Phones 4U was in repudiatory breach of certain of its contractual obligations at the time of its termination letter. EE was successful.

Having found for EE on the repudiatory breach point, the Judge then had to decide whether the terms of EE’s termination letter defeated any claim by EE for damages for loss of bargain.

In deciding that issue, the Judge went back to first principles and considered how a right to damages for loss of bargain accrues at common law. The cause of action is the repudiatory breach, but damages for loss of bargain are only recoverable if that loss resulted from the breach. In the majority of cases (this one included), the necessary causation is created by the innocent party choosing to treat itself as discharged from further performance of the bargain and communicating that choice to the guilty party in clear and unequivocal terms.

Whether that communication is effective will vary depending on the circumstances. For example, where the contractual right the innocent party is relying on is triggered by breach, the innocent party can say that by terminating it treated the guilty party’s breach as discharging the contract, even though the notice referred only to its contractual right to terminate.  Where, however, the contractual termination is independent of any breach, the innocent party has not treated the contract as discharged by breach. 

The issue was therefore one of construction. Had EE, in its notice of termination, purported to exercise a common law right to terminate for the repudiatory breach now alleged? The answer was no. The notice stated expressly that it was terminating pursuant to a contractual right that arose irrespective of any breach (the appointment of administrators) and no breach was identified.

EE sought to rely on the reservation of rights wording and argued that the question was, whether objectively, the notice conveyed that EE had elected "to exercise only its contractual right to terminate and to forego its common law rights at common law".

The Judge dismissed that argument. He commented that EE had made clear it was not to be taken as waiving any breach that might exist, any rights in respect of which were reserved. "But a right merely reserved is a right not exercised." As such, it was still open to EE to sue upon any breach of contract committed by Phones 4U prior to termination, and pursue all remedies that may be available to it bearing in mind that the contract was terminated under clause 14.1.2 and not for breach. But a reservation of rights did not entitle EE to re-characterise the events after the fact and claim that it terminated for breach "when that is simply not what it did".

The counterclaim for over £200 million was therefore dismissed.

Practical implications

The decision may, on its face, appear harsh. Assuming that EE would have been successful at trial in establishing that Phones 4U was in repudiatory breach at the time the termination notice was sent, it is Phones 4U's good luck that it was able to dodge a £200 million bullet by virtue of the fact that EE had failed to refer to the breach in its termination notice.

However, as the Judge pointed out by reference to Shell Egypt West Manzala GMBH et al. v Dana Gas Egypt (a case in which Ashurst acted for the successful respondent), when it makes its notification, the innocent party makes a choice as to the grounds for termination. Each decision carries with it "a different set of risks and rewards". A party is not deprived of anything by being held to its choice.

From a practical perspective, the decision highlights the careful consideration that needs to be given whenever a contracting party is exercising its termination rights. Consider what termination rights are available, and where there are different options, consider the different outcomes and whether more than one can be relied on. This is particularly important where, as in this case, the innocent party has a contractual right to terminate irrespective of any breach and has common law rights to terminate. If the 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 repudiation.

For more information on contractual termination, see our Quickguide.

Authors: Tom Cummins and Alexander McCarthy

Cases referred to:

Phones 4U Ltd (In Administration) v EE Ltd [2018] EWHC 49 (Comm)
Shell Egypt West Manzala GMBH et al. v Dana Gas Egypt Ltd (formerly Centurion Petroleum Corporation) [2010] EWHC 465 (Comm)