To terminate a contract for breach of contract, there is a process you will need to follow. If you get it wrong, the other party may be able make a claim against you. Keep reading to learn how it works.
The three types of termination
There are essentially three different circumstances in which you can terminate a contract.
The first is where the contract gives you an express right to terminate. For example, the contract might give the contractor an express right to terminate the contract if the principal has not given the contractor access to the site within a prescribed period of time.
The second is where your right to terminate exists outside the contract. That is, although the contract does give you an express right to terminate, the circumstances are so serious that you have a right to terminate the contract outside the contract (or 'at common law').
The third is where you have an express right to terminate under the contract, and you have a right to terminate at common law as well.
How to determine your rights
The first step in the process is always to look at the contract, to see if you have an express right to terminate. Most modern contracts will contain a clause, typically towards the end, that deals with default and termination. These clauses will usually contain a list of breaches that give the other party an express right to terminate.
The second step is to decide whether you have a right to terminate outside the contract. This is more difficult, because instead of relying on a clear list, you are instead relying on the general law. You can read more about termination at common law here, and you can read about the concept of repudiation here.
If you don't have a valid reason for terminating the contract, and you go ahead and terminate the contract anyway, you can be taken to have wrongfully terminated (and 'repudiated') the contract. If this occurs, the other party may have a claim against you - even though you feel they are the party in the wrong. This is why it is always a good idea to seek legal advice before terminating a contract, particularly if you are thinking of terminating outside the contract.
Once you have determined whether your right to terminate exists under or outside the contract, the next step is to follow the process.
How to terminate under the Contract
Where you are relying on an express contractual entitlement to terminate the contract, your agreement will usually prescribe a procedure that must be followed.
Where your contract prescribes a procedure, it is critical that you follow it strictly. Otherwise you run the risk that your termination might not be effective (and you could be taken to have repudiated the contract).
These procedures often take the form of 'show cause' clauses. A show cause clause requires the innocent party to give a ‘show cause’ notice to the defaulting party. If the other party doesn't provide an adequate response within the required timeframe, the innocent party is typically given an express right to terminate.
Modern construction contracts are often highly prescriptive around show cause and termination procedures. They will often identify what must be included in the show cause notice. For example, show cause notices are often required to identify:
- the nature of the breach;
- the fact that the notice is being given under a particular clause of the contract;
- the manner, time and place at which cause must be shown;
- the fact that the party giving the notice may terminate the contract if cause is not shown.
For example, in relation to contractor breaches, clause 39.3 of AS 4000 states:
A notice under subclause 39.2 shall state:
a) that it is a notice under clause 39 of these General Conditions of Contract;
b) the alleged substantial breach;
c) that the Contractor is required to show cause in writing why the Principal should not exercise a right referred to in subclause 39.4 [take work out of the Contractor’s hands in whole or part or terminate];
d) the date and time by which the Contractor must show cause (which shall not be less than 7 clear days after the notice is received by the Contractor); and
e) the place at which cause must be shown.
Other contracts, such as GC21, provide for a default notice to be given. Again, in the case of contractor breaches, the principal must give the contractor notice of the breach and an opportunity to remedy the breach within a specified time, or propose steps to remedy the breach that are reasonably acceptable to the principal, before a notice terminating the contract can be given.
If you are the innocent party giving the notice, it is critical that you comply strictly with the termination procedure. Otherwise you may find that your termination is ineffective, and you may also end up being faced with a claim for damages by the other party.
How to terminate a contract at common law
One key difference between termination under the contract and termination at common law is that, if you are terminating at common law, you are not obliged to give the defaulting party an opportunity to remedy their default before you exercise that right. (In practice though, most people will give warnings or other notifications prior to termination, purely as a matter of prudence.)
If you plan to terminate the contract outside of its express terms, there are fundamental requirements:
1. You must have a valid right of termination at the time you elect to terminate the contract.
2. When you terminate the contract, you must provide the other party with a clear and unequivocal statement so that they are left in no doubt that the contract has in fact been terminated.
As a matter of practice, your notice of termination should therefore:
- use clear and unequivocal language stating that the contract is terminated;
- identify the ground or grounds on which you rely to justify your decision to terminate;
- state the date when the termination is to take effect; and
- be properly served on the defaulting party. That is, the notice should be delivered to the correct person at the right address. The onus will be on you to make sure they receive it.
What if you can terminate under the contract and at common law?
If you have an express right to terminate and you also have a right to terminate at common law, you should consider which of those rights you wish to exercise - assuming you don't wish to exercise both of them.
As a matter of practice, many people will state that they are exercising both rights. The advantage of this approach is that, if it turns out that one of your rights does not exist (or is improperly exercised), you have a 'fallback' position.
There could however be situations where you may be better off exercising only one of those rights.
For example, if time is critical and you have a valid basis to terminate at common law, you may prefer to not have to go through a show cause procedure. (If you purport to terminate under the contract and you don't follow the prescribed procedure, that could create its own set of issues.)
Similarly, there can be circumstances where your damages entitlement for terminating at common law is greater than your entitlement for terminating under the contract (or vice versa). Where this is the case, there may be a strategic advantage in justifying your termination by only one type of right, so that there is no doubt as to the approach that should be taken when calculating damages.
It is useful to know that if you rely on one ground for terminating in your notice, you are not necessarily limited by that ground if you need to justify your decision. You may subsequently rely on other grounds, even if you did not know about them at the time of termination.
Unless you wish to make a conscious decision to identify the specific grounds on which you wish to rely on, you might wish to include words in your termination to the effect that you are relying on all grounds that might be available to you. For instance, you might state that you are relying on grounds A, B and C, as well as any other grounds that might justify termination, whether under the contract or otherwise, and including any grounds of which you may not presently be aware.
There are three key messages here.
The first is to be clear, in your own mind, which ground(s) you plan to rely upon to justify your decision to terminate. Specifically, you need to decide whether you are terminating under the contract, at common law, or both.
The second is to ensure that if you are terminating under the contract, you follow the prescribed process.
The third is simply to acknowledge that sometimes it can be difficult to determine whether you have a valid right to terminate, particularly if you are thinking of terminating at common law. And because the consequences of getting it wrong are so serious, we would always suggest seeking legal advice before you take action.