Contract Termination

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Terminating Contracts

This publication 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 the information contained in this publication to specific issues or transactions. For more information please contact us at Ashurst LLP, Broadwalk House, 5 Appold Street, London EC2A 2HA T: +44 (0)20 7638 1111 F: +44 (0)20 7638 1112 www.ashurst.com Ashurst LLP and its affiliates operate under the name Ashurst. Ashurst LLP is a limited liability partnership registered in England and Wales under number OC330252. It is a law firm authorised and regulated by the Solicitors Regulation Authority of England and Wales under number 468653. The term "partner" is used to refer to a member of Ashurst LLP or to an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of Ashurst LLP's affiliates. Further details about Ashurst can be found at www.ashurst.com. © Ashurst LLP 2012 Ref: 9091702 July 2012


This guide covers the various grounds on which a contract can be terminated and gives a reminder of the key legal principles, consequences and remedies under English law. Topics covered include:

• In what circumstances can a contract be terminated for breach?

• Some practical issues when faced with an actual or threatened breach of contract

• The effect of pre-contract misrepresentations

• Other matters that may invalidate a contract

• Table: Discharge and rescission of contract: A summary


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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 breach of contract. 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.

Terminology

It is worth clarifying some of 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", that is, the future, unaccrued obligations owed by the parties fall away. The contract does not actually cease to exist. Rather, upon the innocent party electing to treat his liabilities to perform as at an end, 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 dealing with termination for breach we use the term "repudiatory breach" in its broadest sense, to encompass all common law termination grounds, i.e. not just one of the grounds – renunciation – to which some authors confine the expression.

1. In what circumstances can a contract be terminated for breach?

Repudiatory breach of contract

Each of the following constitute a repudiatory breach of contract justifying termination at common law:

(1) a breach of condition (as opposed to warranty);

(2) a refusal to perform, known as "renunciation"; and

(3) a sufficiently serious breach of an intermediate/innominate term.

Breach of condition

Not every breach of contract gives the innocent party the right to terminate. The innocent party will only 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


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party from future performance1, no matter how serious. The contract continues on foot, the parties remain obliged to perform their future obligations under the contract and the only remedy for the breach is damages.2

Refusal to perform/Renunciation

Where a party declares an unequivocal intention, by words or conduct, 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 he 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 below).

A declaration of non-performance can be either an express refusal to perform or it can be inferred from the party's conduct if he behaves in a manner which would lead a reasonable person to conclude that he has no intention of fulfilling his obligations. 3 If a party threatens non-performance prior to the time fixed for performance, this is known as anticipatory breach.

Sufficiently serious breach of an intermediate/innominate term

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"4 of the contract. In every case, the court will look at the nature and consequences of the breach to decide whether termination is justified.

Contractual termination clauses

Commercial contracts often contain express termination clauses which provide for termination for breaches other than repudiatory breaches. 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 or for "any" breaches (however minor) or for repeated breaches. Contractual termination rights will operate in addition to common law rights to terminate unless the latter are expressly (or impliedly) excluded5 by providing that the contract may only be terminated by exercising the contractual rights. Termination clauses require careful drafting and regard must be had to the way in which the courts approach such provisions.

Election – accepting the repudiatory breach or affirming the contract

Termination is not automatic. 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.6 A party cannot affirm a contract following a repudiatory breach unless he has a full understanding of the facts leading to that breach7 and is aware of the right that he has to choose between acceptance and affirmation.8 The law does not lay down a

1 Hong Kong Fir Shipping Co. Ltd -v- Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26. 2 The amount of damages will obviously depend on a number of factors. See Hadley -v- Baxendale [1854] 9 Exch 341. 3 Universal Cargo Carriers Corp. -v- Citati (No.1) [1957] 2 QB 401, at 436. 4 Hong Kong Fir Shipping Co. Ltd -v- Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, at p.70. 5 At common law contractual termination clauses do not have to be reasonable but an attempt to exclude or limit liability for breaches of contract,

or attempts to restrict the available remedies, may be caught by the Unfair Contract Terms Act 1977 or the Unfair Terms in Consumer Contracts Regulations 1999. See Ashurst Quickguide: Limitation and Exclusion Clauses.

6 White and Carter (Councils) Ltd -v- McGregor [1962] AC 413. 7 Matthews -v- Smallwood [1910] 1 Ch 777 at 786. 8 Peyman -v- Lanjani and Others [1985] Ch 457; Kendall -v- Hamilton (1878-79) 4 App. Cas. 504.


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particular period in which the election must be made.9 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,10 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, he risks taking a step which constitutes an election to affirm it and, once an affirmation has been made, it cannot be revoked.11

Damages for breach of contract

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). 12

Contractual provisions may entitle a party to terminate where 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 probably 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.

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.

2. Some practical issues when faced with an actual or threatened breach of contract

Should you terminate?

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.

Contractual termination clauses

Is there a clause in the contract covering termination? If so, it is important to follow any specified notification requirements and time limits.

9 However, the nature of the contract may determine the length of time given to the innocent party. If, for example, time is of the essence or the

contract has been entered into in a volatile market, the time allowed is likely to be relatively short. See Force India Formula One Team Ltd -v- Etihad Airways PJSC [2010] EWCA Civ 1051, [2010] All ER (D) 41 (Oct) at 122.

10 See Stocznia Gdanska SA -v- Latvian Shipping Co (Repudiation) [2002] 2 All ER (Comm) 768. 11 Hain Steamship Co Ltd -v- Tate & Lyle [1936] 2 All ER 597; Bentsen -v- Taylor Sons & Co [1893] 2 QB 274. 12 Lombard North Central plc -v- Butterworth [1987] QB 527.


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What steps should you take to mitigate loss and when?

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"13 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.

3. The effect of pre-contract misrepresentations

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.

Representations that have become contractual terms

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.

Representations that are not contractual terms

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. 14 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.

Electing to rescind and the bars to rescission

Rescission is by election. The representee must give a clear indication that he intends no longer to be bound by the contract. The representee does not have to go to court to obtain rescission, although if there is a dispute he 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:

(i) the false statement was a representation of fact (as opposed to opinion, intention or law); or

(ii) that the statement was made fraudulently;

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:

13 British Westinghouse Electric Co. Ltd -v- Underground Electric Rys [1912] AC 673. 14 Unless excluded – see page 6 - The effect of contractual provisions.


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• the representee has by words or by conduct affirmed15 the contract;

• the representee has delayed unduly;16

• restitution of the parties to their pre-contract positions is impossible;

• third party rights would be prejudiced; or

• the court exercises its statutory discretion under the Misrepresentation Act 1967 to deny rescission where the misrepresentation is not fraudulent.

As to this last point, if the representee has elected to rescind the contract on the basis of a misrepresentation that is fraudulent,17 the court has no power to declare that the contract is still in existence.18 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.

Damages for misrepresentation

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:

(1) provided the representation has become a contract term, terminating for breach and claiming contractual damages;

(2) rescinding the contract for misrepresentation and claiming damages either:

(a) in the tort of deceit if the representation was fraudulent; or

(b) if not fraudulent, under section 2(1) of the Misrepresentation Act 1967, under which damages are assessed using the tort measure.

The starting point for the tortious measure of damages is that the claimant should be put back in the position in which he 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 he has suffered as a result of his reliance on the fraudulent misrepresentation.19 The representee has a duty to mitigate his loss once he discovers the fraud. Subject to this and the requirement to demonstrate a causal link, he 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. 20 Therefore the innocent party can recover all losses flowing from the fraud, even if they are unforeseeable.

15 Ormes -v- Beadel (1860) 2 De GF & J 333. 16 Clough -v- L.&N.W. Rly (1871) LR 7 Ex.26. 17 A false representation made by a party, either in the knowledge that the statement is false, or made recklessly as to its truth. 18 TSB Bank -v- Camfield [1995] 1 WLR 430. 19 Smith New Court Securities Ltd -v- Scrimgeour Vickers (Asset Management) Ltd [1997] AC 254. 20 Doyle -v- Olby (Ironmongers) Ltd [1969] 2 QB 158.


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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.

The effect of contractual provisions

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 5 above).

Entire agreement and non-reliance clauses

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.21

Non-disclosure

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.

4. Other matters that may invalidate a contract

Mistake

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.22

Frustration/Subsequent impossibility

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

21 Thomas Witter Ltd -v- TBP Industries Ltd [1996] 2 All ER 573. 22 In some situations of mistake the court may be willing to rectify the contract, i.e. amend its terms to reflect the true agreement. For more on the

remedy of rectification, see the separate Ashurst Quickguide: Rectification of Contracts.


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contract to continue. For example, the outbreak of war23 or seizure of property by a foreign government.24 At common law the effect is to terminate the contract, releasing the parties from all further performance. This consequence is automatic25 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.

Illegality/Public policy

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.

Duress/Undue influence

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.26 Undue influence arises, and can be presumed, in situations where there is a fiduciary relationship.

23 Robson -v- Premier Oil and Pipe Line Co Ltd [1915] 2 Ch 124. 24 BP Exploration Co (Libya) Ltd -v- Hunt (No.2) [1976] 1 WLR 788. 25 J Lauritzen AS -v- Wijsmuller BV (The Super Servant Two) [1990] 1 Lloyd's Rep 1, at p.8. 26 Lynch -v- DPP of Northern Ireland [1975] AC 653 (a criminal case but the general principles apply to consent in the civil, contractual context).


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5. Discharge and rescission of contract: A summary

Event Test/Definition Consequences/Remedies

Repudiatory breach 1. A breach of condition;

2. refusal to perform/ renunciation; or

3. a sufficiently serious breach of an intermediate or innominate term.

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

Can include:

1. express classification of terms as conditions or warranties; or

2. rights to terminate e.g. for "material", "substantial" or "any breach".

Contract may provide for calculation of damages.

Common law remedies available in addition unless contract excludes.

"Loss of bargain" damages may not be claimable if the breach does not constitute a repudiatory breach at common law (see page 3 – Damages for breach of contract).

Actionable Misrepresentation

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.

Ashurst Quickguides

Ashurst's Quickguides are a regularly updated mini-library of short legal summaries on a range of key issues relevant to businesses. For a full list of current titles and the most up-to-date versions, please visit the publications section of our website (www.ashurst.com).

If you would like further information on this guide, please speak to your usual contact at Ashurst or one of our contacts listed below.

Simon Bromwich Dispute resolution managing partner T: +44 (0)20 7859 1572 E: [email protected]

David Capps T: +44 (0)20 7859 1397 E: [email protected]

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Documents

Contract Termination