short lines

clause for concern? contractual rights to terminate for breach

October 2004

In Peregrine Systems Limited v Steria Limitted [1], Judge Seymour QC indicated that a clause entitling a party to terminate if the other party "breaches any term of [the said] agreement." did not actually allow what it said literally. Rather, the breach concerned has to be one of a repudiatory nature.
Undoubtedly, this has caused some stir amongst lawyers and contract managers alike, as some have assumed that the express termination rights as drafted in a contract would give the parties rights over and above those existing under common law, and should be construed as such. But is this assumption correct?

This Short Lines considers this question, and looks into the nature of the common law termination right for repudiatory breach, how it interacts with typical termination clauses in commercial contracts, and suggests some drafting tips.

Common Law Position

At common law, a party, 'A' can terminate a contract if the other, 'B' breaches a 'condition' i.e. a term of the contract which substantially deprives A of the benefit of the contract. A may also treat the contract as terminated if B evinces an intention (including by conduct) that he will not perform his obligations in some essential respect. In such a scenario, though a breach has yet to occur, A may regard the breach as inevitable and B is regarded to have committed an anticipatory breach of the contract. Both of these have, at different times, been referred to as a "repudiatory breach".

The outcome of either type of repudiatory breach is the same: A can either elect to terminate the Agreement concerned and sue for damages, or can affirm the Agreement and just sue for damages.

It is against this backdrop that parties draw up express termination rights in their contracts.

Typical Termination Clauses for Breach

It would be an exceptional commercial contract that does not have an express right of termination for the innocent party if the other party was in breach. Typically, termination clauses would allow the innocent party to terminate if the other was in "any breach", "fundamental breach", "material breach" or "substantial breach" "deliberate breach" etc. of the contract. This section looks at the various qualifications that are typically used and considers what they mean.

Any Breach

Until the relatively recent cases of Rice v Great Yarmouth Borough Council [2] and Peregrine, lawyers and commercial contract managers have thought a right to terminate for any breach of contract means what it says literally.

However, the judges in both Rice and Peregrine disagree. In Rice, the Court of Appeal said that construing such a clause to allow the defendant to terminate a services contract at any time for any breach would "fly in the face of commercial common sense". Judge Seymour in Peregrine concurred (although this case was decided on another point so it is persuasive, rather than legally binding). Both courts held that "any breach" in a commercial contract must mean a repudiatory breach of contract.

Material Breach

More typically, parties agree the innocent party may only terminate if other party is in material or substantial breach of the agreement. Only in more lopsided relationships is the stronger party likely to be able to insist on a right to terminate for any breach of the agreement, and the weaker party should now sleep better in light of the decisions in Rice and Peregrine. But what of the "material breach"? On one view if "any breach" equates to repudiatory breach, then conditioning the termination right with words like "material" or "substantial" must surely present an even stronger case that the breach concerned must be repudiatory too?

The judge in National Power plc v United Gas Company Limited [3] rejected this argument. Colman J said the word "material" is clearly meant by the parties to convey the magnitude of the breach and since it is a commercial contract, the magnitude must refer to reasonably foreseeable commercial consequences if the breach is unremedied. He added that some breaches may not immediately bring about consequences which may be tantamount to a breach of a 'condition' or amount to a 'repudiation' of the contract, but if such breaches were left unremedied, it could in time have such a consequence. He thought it distinctly unlikely that commercial parties would have intended to exclude from their right to terminate such types of breaches. To do so would be tautologous, as the termination clause would merely restate the common law position.

He concluded therefore that a 'material breach' is one which in all the circumstances is likely to have a serious effect on the benefit which the innocent party would derive from the performance of the contract.

Substantial Breach

Many draftsmen also think that "material" and "substantial" are interchangeable. The Court of Appeal in Crane Co v Wittenborg A/S [4] suggests that this is probably an ill advised assumption. The Court concluded that a "substantial breach" is unlikely to be any different to a repudiatory breach because a repudiatory breach is after all sometimes described as a "substantial deprivation of the contractual benefit". The Court also considered that the only other alternative meaning would be a breach which was not de minimis . It refused to accept that this could be a possible meaning of the word because this would have allowed a party to terminate even if the breach would have resulted in limited damages (and it would be odd to use the word "substantial" for an event where the actual effect is anything but "substantial"). Unfortunately, the National Power case was not referred to in Crane so the court did not consider whether the word 'substantial' could have the same meaning as 'material'.

Fundamental Breach

Some contracts use the phrase "fundamental breach". It has been suggested that this is a breach which is more serious than a repudiatory breach. This has now been held by the House of Lords as incorrect [5]. In the event, the use of this phrase is likely to construe nothing other than a repudiatory breach of contract.

Deliberate Breach

The common law does not concern itself with whether breaches are deliberate. However, whether or not an express term allowing termination for a deliberate breach (even if it is trivial) would be enforceable remains untested. In any event, it may be difficult for an innocent party to prove the actual state of mind of the party in breach.

Conclusion and Suggestions

It is difficult to reconcile why "any breach" is regarded as more serious than a "material breach". But the courts in Peregrine and Rice, did not and were not asked to consider what "any breach" meant in light of National Power's decision on the meaning of "material breach". This is perhaps the issue. None of the cases discussed here considered the meaning of the words before them in the context of other typical 'qualifications' used in commercial contracts. Consequently, whilst they may provide good authority for the specific points discussed therein, overall, they do not necessarily reveal a consistent trend.

As a result, it is clear that the drafting and the construction of a termination clause is somewhat coloured by legal terms of art and underlying common law principles but the extent to which common law contractual principles override express contractual provisions remain uncertain.

Draftsmen will need to be careful in wording their termination clauses for breach. We offer some drafting suggestions.

1. In contracts with multiple phases or stages, taxonomise and classify each set of major obligations e.g. in a software development and integration contract set out the development, testing, installation and other ancillary services (e.g. training) separately. This will better demonstrate to the courts that each set of obligations is of itself a fundamental piece in the overall jigsaw and that each set of obligations is equally as important, therefore providing the commercial rationale for affording a party the right to terminate the contract in the event of breach of the phase's or stage's obligations.

In Fortman Holdings Ltd v Modem Holdings Ltd [6] the Court held that a failure to comply with the payment of one instalment was a total non-compliance with the obligation to pay that particular instalment and not just a minor breach of the entire payment obligation (as it was only the first instalment in this case). By analogy, a failure to perform a category of tasks could be viewed as a complete failure to perform those tasks, as opposed to an insignificant breach when considered as only part of the entire software development and integration contract as a whole.

2. Where an obligation is important but it is not necessarily clear that it would be a 'condition', make it express that the clause is a condition or alternatively that its breach would be regarded as 'material'. In this way, there can be no ambiguity as to whether, upon a breach of such an obligation, the innocent party has the right to terminate.

3. In contracts with multiple 'non-material' obligations but which are repetitively performed and are of importance to the party receiving the benefit, consider having the right to terminate for 'persistent' breaches of such 'non-material' obligations. This provides an alternative to terminating for non-material and non-repudiatory breach without using the words "any breach".

4. Where parties require a right to terminate for less than a repudiatory breach or a material breach, parties should consider defining "breach" to include breaches whether of a condition, warranty and regardless of whether the breach amounts to a repudiation. There is no guarantee that this would not be regarded as against "commercial common sense" (see Rice, above), but at least, it would be clear to the courts that the parties had addressed their minds to the issue and had as explicitly as possible made clear their commercial intentions.

Denis Low

[1] [2004] EWHC 275 ( TCC )

[2] unreported, Court of Appeal 20 June 2000

[3] [1998] All ER (D) 321

[4] unreported, Court of Appeal 21 Dec 1999

[5] Suisse Atlantique [1967] 1 AC 361, and Photo Production Ltd v Securicor Transport Ltd [1980] AC 827

[6] [2001] EWCA Civ 1235