When Lemonade turns to Lemons: Terminating commercial contracts with a safe exit [updated 2020]

Tips on how to go about ending a contract with your customer or client

Turning lemons into lemonade is the metaphor often used for turning a sour situation in to something sweeter. Your sweet relationships with your business counterparties can also turn sour - unfortunately. When relationships start to wane, it’s important to know how to manage the exit as safely as possible to retain as much of the residual sweetness of the “lemonade” as possible.

The key, as is often the way, is to prepare for the end at the beginning.

It's almost inevitable that you will excitedly sign a contract with a new client or customer for a new project and then later want to get out of the contract for some reason. 50% of marriages in the US end in divorce. Business relationships also break up. Maybe you want to exit a contract, because you have found out that your counterparty’s values and vision don’t quite align with yours as you first thought, or perhaps they have not paid you the last couple of invoices, or it could be that they are trying to change the scope of the terms so that you do more for them for the same amount of payment (we call this “scope creep” and it comes up often as projects progress). What ever the cause, the shift in the realtionship can make you feel uncomfortable and less trusting, and you may end up feeling it is time to end things and move on.

In this sense, entering contracts can be a bit like preparing to get married. Starting business with a new customer can be all-aluring at first, but then some of the shine wears off as you discover some of their strange habits and different beliefs that have a tendancy to come to the surface after you have begun to live together for a while.

Preparing for “lemonade turning into lemons” - safely exiting a contract part way through

Though we may not want to even consider thinking about a relationship break up when it is only just starting, for business relationships it is really important not to ignore the reality that the relationship may sour, and therefore do all you can to equip yourself as well as possible for that eventuality.

If you are a business owner and you come to me to have your contract designed or to request me to review a contract you received from your business counterparty here are the two basic steps I will take you through:

First, I will encourage you to take a step back and first look at the business relationship like you would any other relationship, and to think broadly about your vision of what you would like a greaceful separation to look like, where you each retain your dignity and are able to move on and start anew on new ventures with others.

That usually means thinking about how much time you think you would need to tie up ends before the split becomes final. It also means thinking about how you would like to notify anyone impacted by the separation that you are both going your separate ways. You will also need to turn your mind to what documents or equipment has to be returned to each other, and what restictions you want to avoid, that may hamper your ability to do similar business with another counterparty/competitor etc (so-called “restraint of trade”).

Second, after going through the possible scenarios with you, I would set to and draft up a solid “termination clause” or cancellation clause” as part of the agreement which will formally address the way that things will be brought to an end if the relationship sours, covering the above points and any other concerns you have.

Exiting a contract at the natural end of the project or when something goes wrong

A dating relationship might end because the initial spark naturally fizzles out, or the relationship has taken its natural course. In a business relationship things may end because you have finished providing the work or performed the services, and the client has paid you so the project has come to its natural completion. How can a business terminate a contract in this scenario?

There are two basic ways to end a contact and a well-drafted and crafted contract will address both of these ways. These are:

1. Termination “for convenience” and
2. Termination “for cause”.

Let’s look at both of these a bit more deeply.

Termination for convenience:

This is where you can give notice to the other party to terminate the contract for any reason specified in the contract. The notice period will usually be written into the contract (e.g. a “six (6) months” or “10 business days”).

A termination for convenience is a contractual provision that enables one person to the contract to terminate for reasons other than the other person’s default (breach of the contract terms).  A party may not have to state a reason for terminating the contract, but you can always negotiate to restrict each other’s right to terminate the contract for convenience to certain things such as where the other person failed to get the necessary government permit or other authorization or if they have some financial inability to proceed with the project.

In the “financial inability” example above, the other person may have become insolvent or is unable to pay their debts. Another example that can arise in countries such as Japan, where natural disasters can occur, is where you or the other person cannot contiue to perform the contract because of events outside your control e.g. tsunami, flooding, earthquake - these are called 'force majeure' events.. This scenario arose suddenly with the impact of the #COVID19 Pandemic in 2020. Remember that in order to terminate for convenience you still need to specify the circumstances that allow you to do that.

You cannot just end a contract just because it no longer meets your business needs or you want to go off on a different tangent. It is therefore really imporatant to turn your mind to the kinds of things that you want to include in the contract to allow you to terminate for convenience, and make sure that your lawyer puts these in to the agreement . Talk over all the scenarios with your lawyer and tailor them for how things work in your specific industry or field of work. To think of these later on when things start to sour is too late as inevitably it is like shutting the gate after the horse has already bolted.

Termination for cause - This is the second and more stringent way of cancelling a contract. This method can be tricky to navigate so before you “up and cancel” any contract for “cause”, always check with a lawyer that the reason is covered under the contract.

A termination for cause can only take place if one person is not able to completely fulfill their contractual duties. An example of this would be an executive coach deciding to terminate their coaching contract for cause because the person they are coaching didn’t pay the coach in the time that was set out in the contract and the person didn’t rectify that non-payment situation for a period of time.

Termination for cause is an area to take care. All too often the wrong reason is provided, or peopek rush to cancel by email and after they calm down they find they have not followed the prescribed method to terminate the agreement.

This rash approach often invalidates the termination, by which time you have given the other person a heads up that you are ending the relationship which can then make negotiating your way out more difficult.

So if you are a business owner looking to cancel an agreement for “cause” then you need to give consideration to the terms of the agreement and consequences of termination as well as checking the method by which the parties agreed in advance to terminate the agreement. Usually a “cause” will be a “reason” such the non-rectified-non-payment example provided above - where the other party defaulted or failed to perform an important element of the agreement, or they haven’t rectified a default within a certain grace period allowed to them to resolve the default.

With my business clients, we take time to talk about the kinds of scenarios that might arise and what sorts of pre-conditions to termination the client would like in such cases, and then we wrap wording around those concerns. Getting the termination clauses wrong can be cost consuming in time and money if it’s done wrong so seeking advice at the front end is critical.  

How do you send a termination notice? - the “technical bit”

When it comes down to actually cancelling the contract, usually saying it verbally isn’t enough. Most arrangements require that notice is provided in writing to be valid. In addition, usually the way in which the notice shoudl be provided is agreed to in the contract. For example, sending the written notice by postal mail, registered mail or by email. Also, the lead time for the written notice is usually stated clearly in a well-drafted contract. You must comply with all of the stated requirements for the notice to be valid. Often people can fall down by not checking the contract first to confirm the method, and so the notice is invalidated.

Dig out your contract and take a look inside. The notice clause should be headed up “Notice to terminate” or something similar.  The paragraph should set out who you should send the notice to (often it is a nominated person in sales and copied to a person in the legal department) and how the notice is to be sent, as mentioned above, such as registered postal mail, fax, or by email.

Tips to help businesses navigate a safe exit from a contract

Here are some of my top tips for business-people to navigate a safe exit from a commercial contract: 

• Review the contract from top to bottom: remember to also review any standard terms and conditions that are referenced, or additional contracts or documents referred to in the contract.

• Follow the correct procedure to terminate the contract: pay particular attention to any notice periods or deadlines and the method of cancelling before taking the step to serve notice to terminate. For example, giving notice by email may or may not be recognized as a valid method, so you have to check what “notice in writing” actually means in context.

• Be clear you understand what are the risks of terminating before you act: check any financial or other consequences which may apply on termination, such as payment of cancellation fees or return of property. 

• Just because a contract is terminated doesn’t mean everything is over: check whether any clauses in the contract will “survive” contractual termination. For example, often the clauses related to confidentiality continue beyond the termination date. Have your lawyer explain to you what these ongoing obligations mean so that you fully understand how these will have an ongoing impact on your business relationships with others in the future.

• Always seek professional advice: if you have any doubt about your rights to terminate a contract, what procedure to follow, the reasons you can rely upon, or the consequences of terminating a contract, please seek specialist legal advice.

Obtaining legal advice is an investment in your business not an expense for your business! We regularly advise businesses in a range of industries/sectors about how to draft sturdy termination clauses to suit their business needs. We also advise on your rights to terminate contracts and the risks of terminating a contract.

☑️ We are here to help you design a termination clause that will protect you in the future.

☑️ We can also help you review the termination and notice clauses in agreements you receive from others.

☑️ If you are unsure what each of your contracts stipulate regarding cancellation and providing notice we can run a Legal Health Check on your contracts. This is where we pull out all of your contracts (from the cloud or your cabinet) and do a mini-audit on the current status, providing you with a report and roadmap so you can fix any issues and know what lies ahead when you want to end a contract in the future.

👉 Contact a member of my team at admin@catherineoconnelllaw.com or call on me directly at catherine@catherineoconnelllaw.com.

Disclaimer: The contents above are for educational and informational purposes only and do not create an attorney-client relationship. If you have specific questions make sure you contact a lawyer for advice.

Revised Date: December 2020