Termination of Contracts

The early termination of a contract should always be approached with great care.  As construction and engineering practitioners, we are often asked to advise our clients about this area of the law.

At the outset it is important to identify all possible termination rights, and to carefully choose which one to deploy. The right to terminate can be easily lost if the correct steps are not taken at the correct time. Moreover, if a party purports to end a contract when it doesn’t have the right to do so, it can make that party liable for the other party’s losses arising from the wrongful termination.

It will be appreciated that those losses may be very significant, particularly when the contract is ended in its in its early stages i.e., near the beginning of the project.

A party can have either a common law right to terminate, or a contractual right to terminate, or in certain circumstances it may have both.

Common law rights to terminate and contractual rights to terminate are considered separately in this article.

Common law right to terminate

The common law gives every contracting party the right to terminate a contract if there has been an act of ‘repudiation’ by the other party.  Each of the following constitutes a repudiation:

1. A breach of ‘condition’.
2. A serious breach of an ‘intermediate term’.
3. An outright refusal to perform (which is known as ‘renunciation’).

Let’s look at each of these in more detail.

Breach of condition

A ‘condition’ is a major term of a contract i.e., a provision which is of such vital importance that it goes to the root of the transaction.  If there is a breach of a condition, the innocent party will be entitled to terminate the contract, no matter how minor the consequence of the breach.  In contrast a breach of a ‘warranty’ will never give rise to the right to terminate, no matter how serious the breach.  The only remedy for a breach of warranty is damages.

Since the emergence of the legal concept of ‘intermediate terms’ (see below) in the 1950s, it is increasingly rare for terms to be treated as either ‘conditions’ at one end of the range, or ‘warranties’ at the other end of the range.  The Court of Appeal has said that most terms reside somewhere in the middle and are intermediate unless the contract makes clear a contrary intention. Consequently, unless the contract is very clear that a term should be treated as a condition, the court will rarely interpret such term as a condition.  Indeed, even if a term is labelled as a ‘condition’ the court won’t always treat the term as a condition if it is clear from the nature of the contract that the consequences of breaching the term are inconsistent with it being designated as a condition.  Although the courts may be slower to disregard the wording of the contract in favour of commercial common sense in the wake of Arnold v Britton and others [2015] UKSC 36.

When assessing the likely status of a term it can be helpful to ask oneself whether termination would always be an appropriate response to a breach of the term – if the answer is ‘no’ then it probably is not a ‘condition’.  If the consequence of a breach ranges from the trivial to the serious then it is more likely to be an ‘intermediate term’, and not a ‘condition’ or a ‘warranty’.

A typical term of contract that might properly be classified as a condition is one that makes “time of the essence” where there is a vital contractual deadline, even a slight deviation from which would have a drastic effect which cannot be adequately compensated by an award of damages.  For example, a stadium being built to host a sporting event that cannot be postponed.

A serious breach of an ‘intermediate term’

‘Intermediate terms’ are sometimes called ‘innominate terms’ because they are not named or classified.  They represent the huge swathe of terms that are neither a ‘condition’ or a ‘warranty’. Termination will only be justified if the breach is sufficiently serious.  The breach 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.  These requirements were considered in one of the leading cases on termination: Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kaisaha Ltd [1961] EWCA Civ 7.

All of these requirements must be considered at the time of termination, not when the contract was made or when the breach was first committed. See Telford Homes (Creekside) Ltd v Ampurius Nu Homes Holdings Ltd [2013] EWCA Civ 577.

To know whether common law termination is appropriate, it is not relevant to ask whether the breached term would have been a “deal-breaker” in negotiations. Even if a party would not have entered the contract without, say, a promise to pay the price on time, it does not follow that every breach of that term should justify termination (see Maurice Macneill Iona Ltd v C21 London Estates [2018] EWCA Civ 1823, paragraph 15).

A failure to complete by a stipulated deadline will usually be an intermediate term, rather than a condition.  It follows that delay will not usually be treated as a repudiation and the innocent party will not have a right to terminate.  There are three exceptions to this:

1. Where time is of the essence (and the contract makes this clear) i.e., where time for performance is a ‘condition’ of the contract (as to which see above).
2. Where the contract is silent, but the circumstances of the contract indicate that any delay is unacceptable so that the right to terminate must arise in the event of even a slight delay.
3. Where a party is already in delay, and where the other party (who is ready willing and able to comply with the contract) has given notice to the defaulting party requiring completion in a reasonable time. The purpose of the notice is to evidence that time is being made “of the essence”, so that any further delay is more likely to be treated as a repudiation.  Despite its name, a notice “making time of the essence” does not change the contract terms – it merely provides evidence of the defaulting party’s repudiation of the contract if the extended deadline isn’t observed.

Refusal to perform (known as ‘renunciation’)

A renunciation occurs if one party, by words or conduct, evinces an intention to abandon further performance of the contract, or an intention not to perform some essential aspect of the contract, or declares that they will be unable to perform the contract in some essential respect.

The test is to ascertain whether the actions of the defaulting party would lead a reasonable person to conclude that the party no longer intends to be bound by the contract, and whether the non-performance of that obligation would entitle the innocent party to treat the contract as discharged. 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 amounts to a repudiation, 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.

If a party repudiates the contract before performance is due by indicating its intention not to perform its obligations, then this type of repudiatory breach is often referred to as an “anticipatory breach”.

Accepting the repudiatory breach or affirming the contract

If there is a repudiatory breach (resulting from a breach of a condition, a serious breach of an ‘intermediate term’, or a renunciation) it doesn’t automatically terminate the contract.  The innocent party has a choice.  It can either:

1. affirm the contract (if performance by the defaulting party is still possible). The contract may, for example, be affirmed by the innocent party requiring the defaulting party to perform the contract; or
2. Accept the breach and treat the contract as discharged (terminated). Termination requires a clear and unequivocal communication.  The communication should not be a demand for compliance (this will more likely be treated as an affirmation of the contract), and it should not be a threat or a warning.

Contractual right to terminate

Construction and engineering contracts usually contain express termination clauses which provide for termination in specific circumstances.  These circumstances may be events that wouldn’t amount to a repudiation in common law (as noted above).  Indeed, some contracts allow one of the parties to terminate at will.

Contractual termination rights operate in addition to common law rights to terminate unless the latter are clearly excluded.

Some contractual termination clauses function by expressly classifying terms as conditions or warranties, 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 contracts allow termination in the event of there being certain classes of breach e.g., “material breaches” or “substantial breaches”.

Contractual termination clauses will often set out a procedure that has to be carefully followed before a right to terminate arises. Typically, a notice of breach will be required first.  Then, if the defaulting party fails to remedy the notified breach, the innocent party will have the right to serve a notice of termination.  Contracting parties should ensure that they scrupulously follow the process set out in the contract.  Failure to do so can result in the innocent party unwittingly repudiating the contract itself, which can expose the innocent party to a damages claim from the original wrongdoer.

Common law or contractual termination?

Parties must always take great care when terminating under a contractual termination right. Electing to terminate a contract based on a specific contractual termination right may preclude another contractual termination right, or a common law right of termination.  The scope of damages payable for the alternative rights of termination can be different, so it is important to select the optimum clause to terminate under.  See Phones 4U Limited (in administration) v EE Ltd [2018] EWHC 49. In the Phones 4U case, EE unwittingly forfeited a very significant loss of bargain damages claim because EE exercised its right to terminate under a contractual termination clause which arose in the event of insolvency, instead of under the common law right to terminate.  Termination for breach is an essential element of a loss of bargain claim.

Practical considerations

Do:

1. Think carefully about whether termination is available or likely to become available to you or the other contracting party. It is usually a good idea to seek advice from a solicitor if you are faced with a potential termination scenario.
2. Consider whether common law termination and contractual termination are available. The consequences of a common law termination and a contractual termination, and the damages available, can be very different.
3. Follow the contract. Strict adherence to the contract is essential if you wish to avail yourself of contractual termination.  The contract will usually set out a procedure for termination, which may involve a series of notices asserting that the party is in breach, specify the nature of the breach and citing the correct contractual termination clause.  The contract will often require that you give the defaulting party a chance to rectify the breach within a specified period.
4. Check for a repudiatory breach. You need to ensure that there has been an act of repudiation by the other party before exercising a common law right to terminate.
5. Decide whether you wish to continue with the contract. If a repudiatory breach has occurred, elect whether to accept the repudiation and terminate the contract (and claim damages), or to affirm the contract and push for the other party to perform the contract.
6. Mitigate the loss. If you are terminating the contract and seeking damages there is a duty to mitigate, which means that you have to take reasonable steps to limit your additional losses.

Do not:

1. Expose yourself to damages by wrongfully terminating.
2. Delay after the other party’s repudiatory breach. By delaying you or your employees may unwittingly affirm the contract by conduct thereby waiving your right to terminate. If you then stop performing your obligations in the mistaken belief that you have accepted the repudiatory breach, you could expose yourself to damages.

Speak to our specialist Construction and Engineering lawyers

If you have any questions about this blog, speak to one of our construction team on 03456 381381 or email construction@ibblaw.co.uk.