Contracts are legally binding agreements between two parties. Once a contract is signed, it assigns specific duties and obligations on both parties. For example in Service Agreement contracts and Independent Contractor Agreements. Most contracts end after both parties have fulfilled all the obligations or the validity period of the contract has expired. However, in some cases, there arises a need to terminate a contract. This can be done by mutual agreement or by operation of the termination clauses contained within the contract. There are numerous other circumstances where a contract may be terminated. In this guide, we shall look at all these. We shall also look at how to legally terminate a contract and the pitfalls to avoid.
Table of Contents
• Important Parts of Termination of Contract
• Issues that Lead to Termination
• Common Terminology used in Termination of Contract
• Remedies for Contract Termination
• Drafting a Termination of Contract Letter
• Pitfalls to avoid when Terminating a Contract
Important Parts of Termination of Contract
There are certain conditions that are important to take note of before terminating a contract to avoid or reduce damages that will follow. Remember, a contract being a legally binding agreement is enforceable in a court of law. You are bound to fulfill all contractual duties you agreed on. Let’s look at the various ways a contract may be terminated.
Termination by Default
This is when one party fails to abide by the terms of the contract within a specified period. For instance, if a party were to fail to adhere to delivery dates, a contract may be terminated by default. Some contracts explicitly state this in the termination clauses. Others give the parties some time to address the issue with the failure to deliver pursuant to the agreement. This cause termination is common in cases of agreements to purchase property. Note that defaulting on a contract is distinct from breach of contract though both result in termination. To understand defaulting better, check out this 3-minute video by Ask Anslie.
Termination by mutual consent
This is when both parties agree to terminate the contract. This can be triggered by many factors, but the key thing is that both parties mutually agreed to end the contract. Mostly, contracts will provide for termination by agreement upon serving a prescribed notice by any of the parties. Even if the contract doesn’t state, both parties can enter into a new agreement to terminate the other contract.
Termination by Performance
This is the desired way to end a contract. It is when both parties fulfill all their obligations under the contract. The performance is said to be complete and exact. Termination by performance can also be used if a party accepts partial performance by the other party.
Termination by Breach of Contract
A breach of contract will happen if one party fails to perform all or part of their obligations under the contract. Failure to perform may be implied or stated. A party may state clearly that they no longer wish to perform their obligation. It can be implied by poor workmanship. If a contract is breached in any way, a party has the right to terminate the contract. The breaches can either be material, minor, anticipatory, fundamental
To understand breach of contract better and how a breach falls into each of the different categories, check out this short video by Legal Match.
This is when a contract is terminated by activating a clause in the contract. Many contracts have express termination clauses, which state when one party may end the contract. These circumstances must be stated clearly. Before deciding to terminate a contract through this route, it is prudent to give it serious consideration as it can lead to a claim of damages by the other party.
Issues that Lead to Termination
There are other matters that may lead to termination of the contract. These can lead the courts to believe that the contract was void at the time of its creation.
A misrepresentation is when a party gives false information either knowingly, negligently, fraudulently, or unknowingly. If a party knowingly gives false information, this is referred to as Direct Misrepresentation. Otherwise, the act is referred to as Indirect Misrepresentation.
In the context of consumer goods, if a consumer is misled by a manufacturer to purchase an item through the use of deceit or the propagation of misinformation, this is known as fraudulent misrepresentation.
A mistake can lead to the termination of a contract. However, not any mistakes lead to termination. A fundamental mistake that can lead to termination is here one party can genuinely be disadvantaged by it. In contract law, there has to be a meeting of minds between the parties. This leads to offer and acceptance. If there was a mistake as to what was being offered and accepted, then the contract can be invalidated. A mistake as to the identity of one of the parties can lead to termination.
There are also unilateral and mutual mistakes which differ in nature based on whether or not both of the parties are aware of the mistake when forming the contract. Check out this video by HarvardX to better understand the impact of mutual and unilateral mistakes in contract formation.
Frustration/Impossibility of Performance
This is when one party is unable to fulfill its obligations due to an event caused by the other party after the signing of the contract. The event can also be external, but such that they were no way the party could have avoided it. An event such as war can lead to impossibility of performance.
A contract that involves performing an illegal act is null and void. Either party cannot enforce such a contract.
Contracts signed by the use of undue influence are unenforceable. The forced party is at liberty to terminate the contract without facing any damages. To help determine whether you are in legal position to cancel a contract without any repercussions, check out this 2-minute video by LawInfo.com.
Common Terminology used in Termination of Contract
Some contracts make use of legal jargon and some difficult to understand words. It is important to know what they mean before taking any action.
Termination - This refers to ending the contract by any of the means we have discussed above.
Cancellation- This means ending the obligations of one party before they perform. A contract can be canceled to release either party from its obligations only before the performance. Cancellation is normally done due to a breach of the terms. The canceling party retains the rights of remedies.
Rescission- Rescinding means undoing. This is when both parties agree to revert to the position they were in before signing the contract.
Repudiation- This can be said to be the refusal to perform some obligation by either party. The refusal can either be in words or actions.
Revocation- This can refer to several things. One is mutual cancellation of the contract by all parties. Secondly, it can mean withdrawing the offer before acceptance.
Material breach- This refers to a breach of contract that is significant or detrimental to a party. A material breach is specified in the contract to avoid minor breaches from invalidating the whole contract.
Release- This is when one party relinquishes their right to damages.
Remedies for Contract Termination
Terminating a contract will result in either two things. Free you from all obligations or expose you to legal liabilities. In most cases, termination in a manner not envisioned in the contract will result in a legal dispute. Unless the termination was as a result of mutual agreement, by contractual terms or termination by performance, most other circumstances would result in some dispute. The purpose of the dispute is to seek remedies or damages for the loss occasioned by the breach. Let’s look at some remedies that often result from a breach of contract.
Check out this video guide by The Business Professor on the different remedies that the court can resort to when presiding a case of unlawful contract termination and breach of contract. The video also talks about the different types of damages that the court can award and will help you understand the section below.
This is the money that the party responsible for the breach pays to the injured party for their loss. The monetary damages can either be compensatory or punitive damages. Compensatory damages or known as actual help cover the financial loss that the injured party. Punitive damages, sometimes also referred to as exemplary damages, are awarded in addition to compensatory damages to punish the offending party.
Restitution is a remedy where the injured party seeks to go back to the position they were in before the contract. Unlike monetary damages, which can include loss of profits and other incidentals, this remedy involves going back to the pre-contract position. Restitution is normally the preferred remedy when a contract has been voided or when the other party is unable to perform due to extraneous circumstances, not of their making.
This is when a court will rewrite the contract to correct an anomaly or an inequity so as to prevent the termination of the whole contract.
Sometimes, monetary damages may not be enough to compensate for the loss. A court may order a party to perform certain obligations in the contract. This is only used in specific circumstances where other remedies won’t be sufficient. LawInfo presents such circumstances in this 1-minute video.
Drafting a Termination of Contract Letter
Termination of contract letter is a letter that one party to a contract may write to another to indicate that the contract has ended. For this letter to be enforceable, several things must be present.
- Termination clauses stated in the contract must be added. If any notice periods must be given, these must also be strictly adhered to. Sometimes, both parties agree to draft the termination letter jointly. It is good practice to have a witness present.
- Dates must be clearly stated as well as contact info, and the existing relationship between the parties.
- The reason for the termination of the contract must be given.
- If any damages are to be paid, this should be clearly stated.
- In some circumstances, before we get to the termination letter, a demand letter should be written. The demand letter stipulates that certain actions need to be taken, or else, the contract may be terminated and damages sought. The demand letter should state the breach, if any, that was committed.
Pitfalls to avoid when Terminating a Contract
Before you move to terminate a contract, please confirm if the conditions below exist:
- The contract gives you the right to terminate.
- The circumstances leading to termination can be proven and/or provided in the contract.
- You have written a demand letter detailing the breaches whether material or otherwise and offered a cure to the other party.
- You have issued a notice to terminate as required in the contract. The notice should be clear that it is intended for the purposes of contract termination.
- You have followed the procedure of termination as the contract stipulates. Every action should be supported by the relevant clause. These clauses have been outlined for ease of reference.
Contract Termination FAQs
Do all breaches of contract lead to termination?
No, not all breaches will lead to termination. Many contracts specify that the breach has to be material in nature. This means that the breach will significantly disadvantage a party to the contract. For non-material breaches, a warning and a cure may be enough. However, repeated breaches can be a justifiable reason to terminate the contract.
What is novation in relation to contract termination
Novation is a termination made by mutual agreement by parties to an earlier contract. The parties agree to replace the former contract with a new one. In some instances, new parties may be introduced to the new contract. Novation is normally a complex process as all the parties have to agree. This type of agreement is common when companies are restructuring. A new entity formed by the restructuring process may be deemed a new entity.
Can one party impose penalties or nonperformance after terminating a contract?
If a contract has stated that in case of nonperformance, a certain penalty will be paid, then this will be in order. However, the other party will not easily agree to this. in such a case, involving a mediator will be the preferable action. If this fails, then the injured party may go to court to enforce the contract provisions.
Can there be a partial termination of a contract
Yes, this is provided by law. Partial termination, as opposed to total termination, is when a party to a contract no longer requires certain obligations done.
The law affords consenting adults to enter into legally binding agreements known as contracts. Once both parties have signed a contract, they are bound to perform the obligations specified therein.
However, certain circumstances arise that lead to termination of the contract. The law provides for this as well. If the termination is caused by failure by one party to perform its obligations, then damages may be sought by the injured party. In some cases, termination of a contract may not lead to damages. Most of the time, a properly written contract will define the circumstances under which damages are to be paid. In other cases, a court of law will determine if either party is at breach. Before terminating a contract, it is advisable to be aware of any legal liabilities that may follow.