How can a contract be terminated?
Terminating a contract can be a tricky issue to navigate around, especially when there are different consequences depending on the circumstances surrounding the termination. What can you do if you have signed a contract and the other party is not fulfilling their obligations? Or, what if something external occurs to make fulfilment of the contract impossible? This article aims to summarise the main ways in which a contract may be validly terminated. It will also discuss the specific conditions for these reasons.
What is termination?
Termination of contract is a process by which parties to a contract are excused from performance of future obligations in the contract. Termination (or discharge) works prospectively; that is, the contract is not undone and it is a valid and enforceable contract which continues to bind the parties. Any acts done previously to perform the contract still stand, and rights which have already been acquired are not stripped or deprived.
What are the valid reasons for terminating a contract?
There are six main processes by which a contract can be validly terminated:
- Performance in accordance with the terms of the contract
- Breach of contractual obligations
- Delay in fulfilling an obligation
These reasons or conditions for termination will be explained below.
Performance refers to the acts which a party must do to fulfil the duties created by a contract.
Terminating a contract by agreement is the most broad of reasons to terminate as it can be done in various ways.
Firstly, there may be an express or implied term in the contract which automatically terminates the contract when triggered, or that gives one party the right to do so. An express termination clause in the original contract is one that explicitly addresses the way(s) in which parties can terminate the contract. This clause thus provides an express, or specific, power to terminate the contract (e.g. an employer may have the discretion to terminate an employment contract once the employee has been working for 6 months). In the absence of an express clause relating to termination, an implied right to terminate may be inferred by the courts.
Secondly, there can be a mutual agreement between the parties to terminate the contract after it has commenced. In an express agreement (also called mutual or bilateral discharge), the parties agree amongst themselves to bring the contract to an end. Usually, there are no formal requirements to discharge each party. For example, parties can orally discharge each other’s responsibilities from a contract that is required to be in writing. However, to reduce confusion and effectively prepare in case you need to institute legal proceedings in the future, you should get into the habit of writing down mutual agreements and signing them.
Lastly, a waiver, deed of novation, or deed of abandonment may be created or reasoned from the parties’ actions. The courts can infer that a contract is abandoned if the parties’ conduct indicates that, for example:
- Both parties show that they do not think the contract should be performed further; or
- A long period of time passes in which neither party tries to perform the contract.
The above circumstances are treated the same as a subsequent, mutual agreement to terminate the original contract.
Whether a contract may be terminated for breach of contract depends on the type of term they breached. For breach of a condition (an essential or fundamental term of the contract), the innocent party may elect to terminate the contract and claim damages for lost benefits due to non-completion of the contract. Breach of warranty (a guarantee or assurance) does not permit the right to terminate. However, breach of an intermediate term (neither a condition nor a warranty) may allow termination of contract as well as damages depending on the seriousness of the breach.
Termination for delay in fulfilling obligations requires consideration of how time is referred to in the contract. It is generally accepted that if time is not specified in a contract, the contract must be completed in a reasonable time. Where time is not an essential term in the contract, a party may gain the right to terminate if the delay amounts to a repudiation (see below) or a serious breach of an intermediate term.
Repudiation of a contract simply refers to conduct of a party which indicates that they are unwilling or unable to perform the contract sufficiently. This may be done where the party expresses an intention to no longer be bound by the contract, renounces their liabilities under it, or shows that they will only fulfil it in a manner that is inconsistent with their obligations. If a reasonable person could conclude that the repudiating party is not prepared to perform the contract as required, the innocent party may discharge the contract and sue for damages.
Frustration of a contract occurs where a supervening event causes a radical, unforeseen change to the contract, and this event was not caused by the fault of the parties. Frustration exists to protect parties from being unjustly held to the terms of a contract in new circumstances. A contract for personal services may be frustrated, for example, where a party dies, falls ill (or is otherwise incapacitated), is imprisoned, or is called up for military or another essential service. Other examples of events that lead to frustration include change of law or government interference, destruction of subject matter (e.g. natural disaster or other emergencies), or the failure of a specific contingency in the contract to occur.
At the end of the day, whether or not you or someone else can validly terminate a contract depends on the contract itself. When terminating your contract, there may be other circumstances to take into account such as statutory requirements and common law principles. Wrongfully terminating a contract can constitute a breach of contract and thus render you liable to claims for damages, so it is important to seek legal advice before taking any steps towards termination.