When entering into a contract it is important to consider how the parties can go about terminating such contract.
It is commonly known that a contract can provide for termination in the event of a breach. It is also possible however, to provide for “friendly” termination of a contract. Such termination can be affected in the absence of a breach by way of a termination for convenience clause.
This article sets out the advantages and disadvantages of providing for termination for convenience in a contract.
Termination in the event of breach:
Termination in the event of breach ordinarily requires the aggrieved party to prove that a breach of the contract has occurred and to follow the procedure prescribed by the contract in the event of a breach, if any.
Breaches that may warrant termination can occur by way of –
- positive malperformance whereby a party performs in a defective manner or does something that is prohibited by the contract;
- negative malperformance whereby a party fails to do something in terms of the contract; and/or
- anticipatory breach whereby a party renounces the contract or renders performance impossible.
In order for an aggrieved party to terminate a contract in the event of breach, typically the breach would first have to be proved or notice thereof provided to the breaching party. The breaching party would then be allowed an agreed time period to remedy the breach, failing which, the aggrieved party would be allowed to terminate the contract.
This is a time consuming and potentially costly process for the party seeking to terminate contract.
Termination for convenience:
A termination for convenience clause allows for the termination of the contract in the absence of a breach and at the convenience of a party.
The inclusion of a termination for convenience clause has both advantages and disadvantages. The key advantages and disadvantages of including a termination for convenience clause together with how the disadvantages can be mitigated are set out below.
- The aggrieved party is not required to follow an extensive process to terminate the contract, which would otherwise be required in the event of a breach.
- The party receiving a service is allowed greater freedom to move to another service provider as and when required;
- Termination for convenience provides for limited grounds for dispute in the event of termination as the question of whether a breach occurred is no longer relevant; and
- Due to the simplified process and limited grounds for dispute, the termination has the potential to be more cost effective than termination for breach.
- For all parties, the termination for convenience clause introduces a greater level of uncertainty in relation to the contract’s duration and scope;
- For the party supplying the services, a termination for convenience clause –
- allows for termination due to reasons that are not linked to the level of performance in terms of its obligations; and
- potentially causes financial losses in the event of early termination which may impact its ability to meet ongoing obligations; and
- For the party receiving the services, a termination for convenience clause may result in the payment of services which are not completed due to such termination, depending on the payment terms.
Mitigation of disadvantages:
The above disadvantages can be mitigated by including provisions in the contract which increase certainty in relation to the contract’s duration, scope and costs. Such clauses may introduce an initial fixed term in the contract during which the parties are prohibited from invoking the termination for convenience clause and/or termination charges imposed on the terminating party, which can be calculated according to a formula and which can limit losses caused by early termination of the contract.
A termination for convenience clause can be a feasible alternative to a clause that provides for termination in the event of a breach. Such a clause has several advantages for the party receiving a service and this may be a cost-effective manner to effect termination for all parties to a contract.
There are also disadvantages to including a termination for convenience clause in a contract, however such disadvantages can be mitigated by providing for an initial fixed term and/or termination charges.
The question of whether a termination for convenience clause will be suitable or not would depend on the intention of the parties to a contract and the goals and objectives which the parties seek to achieve through their contractual relationship.
VDMA’s team of experts is at your disposal for any assistance that you may require with the drafting, reviewing and/or the amending of contracts.