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Terminating Onerous Supply Contracts

In the last issue of Smart News, we addressed the same issue from the perspective of an employment contract.  In this article we will focus on supply contracts.  Your business may be suffering from cash flow problems or may be at risk of late/non payment for supplies.  Unilateral variation of supply contacts is usually not an option when you are not in a position of strength.  Most businesses in this situation may consider terminating the contract.  It is sometimes the case that termination is part of a strategy of escalation to achieve an improved commercial negotiating position. If so, lay the ground carefully with appropriate correspondence and contractual notices so as to be able to achieve your objective without damaging the relationship with the supplier. Terminating a contract can of itself bring risk. There must be a justifiable reason for terminating, otherwise you could be in breach of the contract and liable to pay the other side damages. Here are some of the steps to consider prior to terminating any contractual relationship:

  1. Check the terms of your contract carefully. Most appropriately drafted contract will provide for termination under certain circumstances, (e.g. breach by the other party, change of control of a party to the contract, excessive fluctuation in the cost of components or currency (in international contracts), or simply termination without cause (i.e. termination on service of notice)).
  2. Make sure any breach of contract justifies termination. Where the circumstance in your case is a breach by the other party, note that not every breach of contract justifies terminating the contract. Commercial contracts commonly contain a provision entitling a party to terminate when the other has materially breached its obligations. What is material breach has been the subject of numerous litigation and it is best to seek legal advice on this matter.  Even where the breach is thought not to be material, it may still provide you with a bargain tool in negotiation with the other side.
  3. Is there a repudiatory (serious) breach? Generally under common law, an innocent party to a contract has the right to terminate the contract for a repudiatory breach of contract by the “guilty” party. The breach of contract must be sufficiently serious to entitle the innocent party to treat the contract as terminated with immediate effect and gives them the right to claim damages. The general rule is that the breach must run to the very heart of the contract and have substantially deprived a party of the very benefit that the contract was intended to deliver. What amounts to a repudiatory breach of contract will vary with each contract.
  4. Watch your conduct. Ensure that you don’t do anything that could be viewed by the other party (and the court) as waiving the breach of contract, so affirming it. Failure to take action could also have the same effect. Conduct (active or passive) can be used to demonstrate a waiver of the right to terminate.
  5. Check the mechanism for termination. Ensure you follow all procedural requirements correctly. If the contract requires written notice to be given check whether the contract stipulates:
    • The party which must give the notice and to whom
    • The information the notice has to contain
    • Where and how the notice is to be served

Then, just as importantly, make sure you know and comply with the time limits for giving the notice before termination can take place.  If any termination procedure is not followed correctly the termination may well be wrongful, a breach of contract and lead to a remedy in damages against you.Where termination is not an option, businesses in this position may want to consider assignment of the contract to another supplier.  We will address the issue of assignment of supply contracts in the next issue of Smart News.