Authors
Authors
Introduction
Commercial contracts are vital for most businesses to survive and operate. They govern everything in the relationship between two or more businesses regarding their expectations of each other, and it is therefore vital that these contracts are reflective of the intentions of each party.
However, there will inevitably be situations where disputes arise from commercial contracts, where one party feels that they are not getting what they bargained for. It is important for the aggrieved party to think carefully about how to react to a breach of contract before taking any action.
Where there has been a breach of contract, the innocent party may consider terminating it. Indeed, where there has been an irreconcilable breakdown in business relations between the parties and the breach is sufficiently serious, this may be the most appropriate option. However, there are several reasons why the aggrieved party should also actively consider managing the contract following the breach, rather than simply terminating it. This article will address both contract management and termination as courses of action following a breach, highlighting some of the benefits and drawbacks of each and when they should be considered by businesses.
Contract Termination
Within a commercial contract, there will usually be a provision for termination in the event of a material breach. However, whilst the aggrieved party might wish to exercise this option, they should assess the situation beforehand.
Terminating a contract firstly requires legal analysis of whether the terminating party has the right to do so under the terms of the contract or under the common law: does the contract allow no fault termination, have any triggers for termination arisen or is the alleged breach so serious it substantially deprives one party of the benefit of the contract? Advice should be obtained from external lawyers or an in-house legal team as to the grounds being relied on for termination, and as to the consequence of wrongly terminating a contract, which is likely to be a fundamental breach of contract itself.
There are also logistical implications of termination which a business will need to consider: organising transitional arrangements; the time and costs of contracting with a new supplier (for example); the impact on delivery times of goods and services being supplied to the business; and any impact all of this may have on the ability of the business to perform contracts to its own customers or clients.
Risks of termination
There are a number of risks when terminating a contract or terminating a contract incorrectly, including but not limited to the common risks mentioned below.
Appointing a new supplier or service provider may need to be done urgently if the contract being terminated is business critical. This could be a risk if the new contracting party has not been subject to the usual due diligence process because of the urgency (whether real or perceived) with which they have been put in place.
Terminating the contract may be counterproductive if, for example, the issue giving rise to the termination concerns service delivery and the employment of the very people providing that service transfer to you or the replacement service provider that you appoint in accordance with the Transfer of Undertakings (Protection of Employment) Regulations 2006 when the contract is terminated. In this scenario you fail to get rid of the problem.
In addition to the above, the termination and reasons provided for it may be challenged. If a termination is unlawful or the right to terminate has been waived, the party who has had its contract incorrectly terminated may be entitled to:
- compensation for its lost profit for the remainder of the contract or until the earliest date by which it could have been validly terminated on notice under the contract, subject to any enforceable exclusion or limitation of liability clauses; or
- demand specific performance of the contract – requiring that the parties are obliged to continue performing the contract.
The consequence of this is that terminating a contract may prove to be an expensive, time consuming and stressful experience for a business, with several legal and practical considerations.
This is not to say that termination does not remain a valuable option for a business which has suffered a significant breach of contract. If the breach is major, the business relationship has broken down and the contract is unsalvageable, termination of the contract may well be the most appropriate course of action for a business to take, but that decision has to be made with an understanding of the costs and risks, meaning advice should be sought quickly once a potential termination event is thought to have occurred.
Contract Management
An alternative to termination is to implement a contract management process to monitor and review the performance of the parties in respect of their obligations under the contract as an alternative to immediate termination to see whether performance can be improved over a defined period of time, failing which the right to terminate will be exercised. It is important to make sure the breach is not inadvertently waived and the existence of the contract is affirmed, so that the right to terminate is lost. The longer a contract continues after a breach, the more likely it is that the right to terminate for that breach (or a repeated breach) will be waived, or that a good argument it has been waived can be made.
A contract management process would require key performance indicators (KPI’s) to be monitored to measure adherence of the underperforming party to their contractual obligations. If the contract does not contain KPI’s realistic and reasonable expectations of what good performance look like and how it will be monitored will need to be provided to the party in breach and, ideally, agreed between the parties.
There are several benefits to implementing a contract management process prior to or following a breach. Firstly, it allows a business to have key targets for the parties to comply with in order to fulfil their obligations under a contract, rather than having a disputable definition of what the ‘performance’ of a contract looks like.
Furthermore, a contract management process can also save a business money, as by managing the expectations of the contract, parties can address deficiencies in performance and their consequences quickly and efficiently.
This dialogue which is facilitated by a contract management process can also save a business relationship between two contracting parties, as it allows parties to measure the success of the contract objectively through KPI’s and allows for discussions on addressing any reasons why KPI targets may not be met in a measured and meaningful way.
Therefore, putting in the effort as a business to implement a contract management programme may seem costly and time-consuming at the outset of a contract, but to do so has numerous benefits as outlined above, and this should be a key consideration for any business that wants to avoid uncertainty and maintain business relationships in the event of a contractual breach.
Conclusion
Whilst each commercial contract and business relationship is unique, it is important for a business to consider whether it would be beneficial for them to implement a contract management process, using KPI’s to measure performance, at the outset of the contract. Foresight in this regard can simplify matters at a later date.
Sometimes terminating a contract is appropriate. However, where this is not the case a contract management process can save a significant amount of money and time by defining the parties’ expectations under the contract, providing for discussions which will allow the contract to continue, and maintaining a working relationship between the contracting parties.
This article is not legal advice and should not be relied upon or construed as such. If you need advice on a deteriorating business relationship or possible contract termination, please contact Nick Roberts or Luke Harper in our Commercial and Regulatory Disputes team.