Agreement Termination Clause Defined
Agreement termination clauses in contracts generally set out events that can occur that will bring the contract to an end and how the outcome for the parties should be managed. These events could include insolvency, a party being in breach of a certain clause, or a fundamental breach of the agreement.
The termination clause is also key to providing clarity on the position of the parties once the contract is terminated . For example, it may stipulate whether the parties can continue to use the intellectual property created under the agreement, or whether one party should return all of the other party’s confidential information. The example below provides a process for a party to manage the return of any personal data once the contract has been terminated:
On termination of this Agreement for any reason, the Buyer shall, at its option, either delete, destroy or return all copies of the Personal Data to the Supplier (as applicable in each case), save to the extent required by any applicable law.
Termination Clause Types
Termination clauses can take different forms, depending on the situation they will sooner or later govern:
Mutual Termination
Some of the most straightforward clauses simply allow the parties to terminate the agreement by mutual consent. This gives the parties a way out even in the absence of a specific trigger event. A typical mutual termination clause might provide that "[o]nce signed by the parties, this Agreement may be terminated upon mutual written consent of the parties." Because these clauses say nothing about the circumstances under which either party can terminate, they do not require that a party asking to terminate even have a reason to offer. The problem may lie in the fact that, unless the agreement provides the other party with some reasonable advance notice, the consent to early termination might be leveraged by the terminating party to obtain some advantage, for example, to bargain for more favorable terms in a new agreement for the same or related services. Or, in a complex acquisition, the termination may be linked to other matters outside the agreement which the parties may want to be able to terminate in order to close the transaction.
Termination for Cause
Most termination clauses provide the protected party with the right to terminate the agreement without liability when the other party materially breaches it. For example, many turnaround management agreements provide that the manager can terminate the agreement if the company and certain of its senior leaders engage in behavior that could lead to a bankruptcy, including the engagement of an insolvency advisor. Similarly, in some cases a company might be permitted to terminate the agreement early if an executive from the company was "soliciting employees of the company to join a competitor." Termination for Cause clauses differ significantly in how and when a party can exercise the right of termination. Some target specific conduct, such as the filing of a bankruptcy petition against the other party, failure to pay amounts due, but also, more broadly, the material breach of the agreement. In most cases, however, "material breach" constitutes a high standard that is difficult to satisfy because it usually requires a significant impact on the party that is not in breach. A material breach occurring over the course of multiple weeks or months is much easier to identify then something that could be characterized as a single event. As a result, jurisprudence tends to find that a material breach occurred in a limited number of circumstances. Therefore, in some agreements, we see more specific termination for cause clauses that fall in between the two extremes set up in the previous paragraph: they would permit termination in the event a party has materially breached, but not limit the parties’ right to terminate to a small number of specified events.
Termination for Convenience
Some provisions provide the right to early termination for any reason. Although the ability to terminate without cause might appear to reduce the certainty and rely on the parties’ goodwill to honor the agreement, there are good reasons to include this type of clause. In some cases, for example, the affected party may not be willing or able to identify a cause that would allow it to terminate. In other cases, the parties may know that the circumstances in which they may make use of the termination right are limited and a termination for convenience may be the only way to conclude the agreement quickly.
Agreement Termination Clause Jurisprudence
The legal implications that arise after a termination clause has been invoked will depend on the governing law and enforceability of the termination clause itself. As a preliminary matter, a contract may contain clauses which govern the circumstances in which the parties have agreed to terminate the contract and/or any subsequent, post-termination negotiations that are required following termination. An offense can arise in nearly every case with respect to the enforcement of termination clauses, including, but not limited to, timing issues (for example: if sufficient notice was not given), procedural issues (for example: if arbitration was not pursued as required by the termination clause) and substantive issues (for example: whether the performance of one or more of the parties had been materially breached at the time termination was required). Under this last example, disagreements over the precise amount and type of damages that may be awarded can arise, resulting in disputes or litigation.
Draft Your Termination Clause Carefully
When drafting termination clauses, it is essential to use clear and precise language to avoid ambiguity. Use unambiguous terms and phrases that clearly define the circumstances under which either party can terminate the agreement. It is preferable to use "for any reason" instead of "without cause" as courts may find the latter ambiguous.
One example of an ambiguous clause is where the contract may be terminated "for any reason in the sole and unfettered discretion of the terminating party". The problem with this clause is that the termination could be for any reason apart from the reasons set out in the agreement. As a result, there is no clear requirement that the terminating party must act in good faith or for valid reasons. It is better to include a list of reasons for termination. Even if a terminating party is obligated to act with good faith, using "sole and unfettered discretion" gives the party the right to exercise their full discretion, which could be easily interpreted as allowing the terminating party to terminate at will.
It is best practice to require that termination must be notified in writing and include a grace period before termination.
Termination Clause Issues
Notwithstanding the importance of termination provisions as outlined above, often parties do not have them or instead have poorly drafted termination provisions, and while some are drafted without too much fuss, from time to time there can be a lot of ambiguity in termination clauses. Moreover, termination clauses cause a number of disputes as the business needs of the parties change and one party no longer wants to be locked in for an extended period with the other.
Parties often find their circumstances change, so that they would like to exit the contract early without financial penalty. Parties often find that their business changes so that it is not viable to continue, and seek to exit the contract. However, this will often come at a risk of significant claims for breach, sometimes based on loss of anticipated profits.
Termination clauses can present challenges if they contain ambiguity, such as with ambiguous wording or overlap with other clauses in the contract. This can be an issue even if there is no ambiguity at the time of contract drafting, as the termination clause may use wording which is open to interpretation. This can lead to uncertainty and disagreement over how it should be applied.
For example, if a termination clause states simply that a party can terminate on notice, it may not indicate what is meant by "notice", for example whether a verbal or written notice is sufficient. If the contract is terminated orally, the other party could argue that they had not been validly given notice and could seek significant damages .
Additionally, if there is a conflicting clause in the agreement that deals with termination, for example a clause that states that a contract cannot be terminated without a reason, there is an obvious risk of it being difficult to know how these two clauses interact and the likelihood of a dispute between the parties.
A related problem is if the termination provision provides grounds for termination that are so vague that the parties disagree on the meaning of the grounds for termination. For example, a clause which states that a party can terminate where the other "does not conduct themselves in a manner appropriate to the contract" presents an objective standard that is hard to apply. Even if this type of clause is used, it is good practice to include an additional clause which gives specific examples of appropriate conduct.
Sometimes parties may enter contracts on the understanding that certain events, for example a change in economic conditions or a failure on the part of a third party to perform their obligations, would allow their appointment to be terminated without financial penalty. But this is not reflected in a contract where there is no termination clause or the termination clause does not reflect the expectations of the parties.
Well drafted termination clauses avoid ambiguities and the potential for litigation, on the basis that they are tailored to the parties and their business needs. However, they cannot be tailored to account for every eventuality. Even with termination clauses incorporated into a contract there can be practical challenges, including:
Termination Clause Examples
As agreement termination clauses can be found across various industries, here are three real-world examples showcasing how they work in practice:
Telecom Industry: A telecom company enters into an agreement with an equipment supplier to provide 4G service in a metropolitan area. The electronics that the supplier provides are supposed to be upgraded according to the terminated contract terms. However, the supplier decided that the contract was too onerous and decided to exit the market by discontinuing all of its 4G services. As a result, the telecom company was left scrambling to find another supplier to provide the necessary electronics for extending 4G service. If the telecom company had a clear termination clause in the contract, indicating how much notice must be issued when terminating the agreement, they would’ve been able to plan around any sudden changes.
Retail Industry: A dress retail store enters into a sponsorship agreement with a clothing designer who agrees to feature their dresses within their store for a year. The designer decides to dissolve their business earlier than expected, but because of the sponsorship clause in the contract, they are required to disclose the dissolution 30 days in advance. The retail store is now able to have adequate time to form a new sponsorship deal with another designer and ensure the dresses are displayed for as long as possible.
Information Technology Industry: A software company creates an app for a start-up company. The start-up isn’t happy with the work that the software company has provided, so two years into the agreement, they want to terminate. The software company, however, is entitled to a buyout payment for the remaining three years of the contract. The start-up must pay out every penny even if they don’t want the app anymore. If the start-up had drafted the agreement termination clause differently, they could have gotten out of paying the software company a quarterly buyout.
Termination Clause Negotiation
Negotiating termination clauses are crucial components of every agreement. They protect the interests of both parties by allowing for the termination of the contract under certain conditions. These clauses also create a clear roadmap for each party if the other breaches its obligations or if unforeseen events radically change the landscape of the contractual relationship.
In most cases, the initial draft of a termination clause is proposed by the party that seeks to have the most control. But that doesn’t mean it is in the best interest of the party that receives it. For example, the provision could allow a party to exit a business arrangement for any reason or no reason whatsoever, even with full prior notice. Alternatively, a clause may state that a party cannot terminate without cause for a lengthy period of time. Or the provision could be riddled with conditions that must be met to initiate a termination. When negotiating termination clauses, each party should seek to balance flexibility with enforceability.
One of the key terms to clarity of the termination clause is the manner in which the termination notice is delivered. Most agreements stipulate a certain period of advance notice is required, usually ranging from several days to two or three months. The notification period can be adjusted to give one or the other party more or less wiggle room in an effort to balance the power between contracting parties.
If you are a service provider seeking to include a termination clause in an agreement, you may be negotiating from a position of greater strength because the other party may not want to disrupt the relationship by seeking to terminate with little advance notice. If, on the other hand, you are a customer that could have a negative ripple effect throughout your organization if you are a party that seeks to terminate on very short notice, you may be inclined to agree to a longer period of notice to both meet your company’s needs and neutralize that of the other party.
Some contracts have an explicit termination clause stating that if either party is found in breach of its contract obligations, all previous agreements between the two parties would be nullified and voided.
The termination clause should specify the manner in which notice is provided, generally enumerating both the types of acceptable notice (e.g., email, certified mail, fax) and not permitted (i.e., voicemail).
A poorly written agreement termination clause can leave parties unaware of their rights until the moment they have to exercise them, at which point, litigation may be the only option. For instance, if you are a service provider that wants to enter into an agreement with a customer but your lawyer informs you that the termination clause is so unilateral that it might be deemed as significantly skewed in your favor and, therefore, unenforceable, you would need to have lengthy negotiations to be able to finalize its terms. Termination clauses can be relatively easy to include and craft, but they also provide significant leverage and protection for each party to an agreement, so it is critical that they be well-drafted and thoughtfully negotiated.
Termination Clauses: The Bottom Line
A strong, well-drafted termination clause is critical to any contract. No matter how optimistic you are about how long a contract term may last and how positive an experience you may have with a counterparty, it is always good to be prepared in case you need to exit a transaction for any number of reasons. For example, you and your contract counterpart may have an amicable parting of ways, but one party may want out of the contract sooner than originally planned. Or perhaps a portion of the contract must be terminated pending a divestiture, or the relationship deteriorates. Thus , having a clear, unambiguous and properly tailored termination clause does not only benefit the contract’s duration, it governs the exit from the deal.
From M&A transactions to industrial and commercial agreements, clearly written termination clauses will help prevent disputes from arising down the road over whether particular conduct constitutes a termination event (and it can be used by either party to enforce its rights). It is therefore essential that parties give careful consideration to and vet the termination terms of their contracts.
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