Look Before You Leap: Terminating an Agreement
Making the decision to terminate an agreement is often very difficult. Termination is often only pursued by a party to an agreement if enforcing their… Read more
Making the decision to terminate an agreement is often very difficult. Termination is often only pursued by a party to an agreement if enforcing their existing contractual rights is not enough to address their concerns with the counterparty or the subject matter of the agreement, and renegotiating the agreement can’t achieve the desired outcome.
If you are beginning to think about terminating an agreement, it is useful to undertake a complete review of the agreement in relation to termination options and consequences to help inform the decision. Here are a few key pointers to help with that review.
Be clear as to what you are terminating
Be clear as to what the “agreement” entails. Review all amendments and change notices so that you have a full understanding of what the “agreement” is. Also, consider whether the agreement has been varied through conduct (whilst taking into account the potential difficulties in doing so by virtue of the Rock Advertising case the agreement is sometimes not simply what is written on paper.
Consider your termination triggers
Look at the agreement in full to work out what termination rights you have. Termination triggers, especially in an agreement for the supply of goods and services, typically include rights to terminate:
- for the other party’s material breach (or sometimes persistent breach which amounts to a material breach);
- for convenience;
- upon certain events occurring (such as the other party’s insolvency or change of control, or in the event of force majeure);
- for certain specified breaches (such as confidentiality and IP breaches).
There may also be rights as to partial termination (e.g. by geographies or service towers).
If you are looking to terminate for the types of breach outlined above, is the breach remediable? If so, review the agreement as to the cure period to be granted to the party in breach. Always follow the process set out regarding notification of the breach and timelines for remediation.
Consider whether you have common law rights to terminate the agreement. Common law termination rights can differ to contractual rights. For example, an aggrieved party may terminate an agreement at common law as soon as there is a repudiation, without allowing the party in breach an opportunity to cure the breach. Clear wording in a contract would be required to limit or remove common law rights and remedies.
In addition, bear in mind the impact of relevant legislation on your termination rights. Examples of legislation which may be pertinent are:
- Sale of Goods Act 1979;
- Unfair Contract Terms Act 1977;
- Consumer Rights Act 2015;
- Commercial Agents Regulations 1993;
- Banking Act 2009; and
- Legislation arising out of the current consultations run by the Department for Business, Energy & Industrial Strategy (BEIS) aimed at improving the UK’s corporate governance and insolvency framework.
If the other party is a foreign entity, check whether there are any local laws which may affect or even override your termination rights.
In assessing your right to terminate, keep in mind the consequences of getting this wrong. Purporting to terminate an agreement without a valid right to do so may amount to a repudiation of the agreement. This may entitle the other party to elect whether to accept your repudiation (and sue you for damages for wrongful termination) or affirm the agreement and insist on continued performance. Always consider seeking legal advice early on these issues, so that you can protect your position.
Weigh up the cost of termination
Prepare your business case as to the cost of termination. Different costs may be triggered depending on the basis for termination. Some examples of costs to be addressed by a business case include:
- Termination or Express Fees. Are there any fees associated with the termination? These will usually arise with a termination for convenience (often on a sliding scale). Certain breakage or stranded costs may also arise for other types of termination often classified as “no fault” triggers, for instance change of control of either the customer or the supplier, or where directed by a regulator. Amortised and unrecovered costs are also often included as being expressly payable on termination for any reason.
- Agency Fees. If terminating a commercial agency agreement to which the Commercial Agents Regulations 1993 apply, a mandatory termination payment must be made, which is either calculated as compensation or an indemnity.
- Intellectual Property. Upon termination, will you need to make use of software, data or other information owned by the other party (such as their pre-existing IP or IP created independently)? And if so, does the agreement include a right to use these after the termination of the agreement? If not, you will need to either adapt your systems, data and materials to ensure you no longer depend on the other party’s IP (at your cost), or purchase a licence from them for continued access to their IP (which assumes a licence is on offer).
- Asset Transfer. Are you obliged to purchase, or will you require, any assets upon termination? In the context of a supply of services agreement, these assets may not necessarily be purchased from the supplier under your current arrangement, but may have to be factored into the transition costs with an alternative provider.
- Third Party Contracts. To what extent are there any costs associated with the termination of any subcontracts or third party contracts? Or are there any costs which will be incurred in respect of any assignment of subcontracts or third party contracts to you or your new provider?
- People Costs. Your agreement or even local laws may govern the transfer of staff on termination and exit. In the UK the Transfer of Undertakings (Protection of Employment) Regulations 2006 will govern a service provision change. A transfer of UK-based supplier staff engaged in the provision of the services may take place to the customer or an incoming supplier on their current terms of employment. Check whether you have agreed the apportionment of liability and appropriate indemnities in respect of employment issues and related claims in the agreement. And if supplier employees do not transfer to you or the incoming provider by way of law, are there any employees you would like to employ directly? And can you do so without infringing any non-solicitation clauses in the agreement?
- Obligations Arising on Termination. What obligations might arise on termination (such as a duty to destroy or return confidential information and personal data)? Will there be any associated costs arising from fulfilling these obligations?
- Replacement Supplier. Your business case should also include the cost of engaging with an alternative provider, such as the cost of conducting a request for supplier proposal process, contracting with a replacement supplier, and the costs of transition and transformation thereafter.
Understand what you end up with after termination
If you are terminating a services agreement, do you have sufficient information to understand how the services are currently delivered and what is likely to be required following termination, either to be provided by you or your replacement supplier? Areas to work through include:
- People – how many people and with what skills would you need to replace?
- Equipment and software – what is used to provide the services? Do you know what you will own or have access to after the termination, and what the supplier will own or retain?
- Data – are you relying on the supplier to provide data that you cannot obtain elsewhere? Do you understand what is being processed and the way in which it is being processed?
- Third party service providers – is the supplier subcontracting any services, and to whom? Does the supplier interact with any other providers in your supplier ecosystem and how will that relationship be impacted?
- Process and procedures manuals – are you able to retain these manuals to understand end-to-end service provision?
- Other intellectual property – is there a potential delta between the IP that you own or are licensed to use following termination, and the IP that you will need going forward?
What information regarding the incumbent provider and the services are you contractually able to provide to the new supplier? Are there any contractual provisions regarding knowledge transfer that you can leverage? Alternatively, are there any restrictions around what you can pass on to your replacement supplier that you need to be aware of and comply with?
What is the timing for exit from the current agreement and transition to a new supplier? How can you minimise disruptions at critical times for your business (such as year end or other peak periods)? If you are engaging a new supplier, how long will it take you to find the new supplier and for them to be in a position ready to provide services?
What is the supplier obliged to assist with in terms of exit planning, migration of services and ongoing service provision? If the transition is not going according to plan, is your provider obliged, at your election, to extend the period during which it provides termination assistance? And if so, upon what notice period? Alternatively, can you terminate the supplier’s assistance early?
Review the exit plan and the termination assistance provisions of your agreement. If there is anything that needs to be updated or amended, make sure this is done.
Be clear as to the supplier’s obligations to maintain service levels and avoid disruption to the services. Do you wish to implement any changes to the services or service delivery to assist with migration? For instance, you may wish to stop all non-critical changes (e.g. software changes, hardware updates or personnel changes), taking into account who bears the costs of such changes and whether there is additional disruption to services.
Consider if any intellectual property rights need to be asserted, and whether there are any other legal requirements which must be met for an assignment of IP.
Understand whether there are any other terms of the agreement which survive termination and which must be complied with.
Consider the knock-on effects
Are there any other contracts which will be affected by a termination?
Are there any other contracts which may be terminated automatically as a result? Or does terminating one agreement give you the ability (through cross-termination triggers in an agreement) to terminate other agreements?
Issuing notice of termination
Be aware that you will need to take positive action to terminate an agreement. Even at common law, a repudiation does not automatically terminate an agreement, as the innocent party has options as to how to proceed. Similarly, a termination clause normally gives one or both parties a right to terminate (which the relevant party may then choose to exercise) rather than automatic termination of the contract.
Also, both common law and contractual termination rights can be lost through delay. Do consider your rights and take action promptly to avoid inadvertently either waiving your rights or electing to affirm the contract.
Comply with any procedural requirements specified in the agreement for serving notice of termination, including notice periods, the form the notice must take, and means of service. Keep records to demonstrate compliance with all contractual requirements.
Be clear as to what you are terminating, especially if you are seeking to only terminate part of an agreement or protect certain contracts from the termination. Express clearly the grounds for termination that you are relying on. Where you are terminating for breach, be sure to keep records of the impact of the breach on the business.
This is another area in respect of which legal advice should be sought early, as failure to comply with the contract provisions may invalidate a notice. Serving an invalid notice may even act as a repudiatory breach in some circumstances, giving the other party a right to sue for damages.
The duty to pay damages for a breach already committed under an agreement will survive termination, even if not usually expressly stated. If you are terminating an agreement and know that a breach has been committed, bear that in mind when negotiating any exit fees and termination costs. Be clear as to whether any negotiated termination fee is in full and final settlement of all claims.
And finally, a word of caution. If you are engaged in a dispute with the other party to the agreement, ensure that communications are controlled and documented so as to ensure that legal privilege is not waived and that any matter discussed as to termination and exit is without prejudice to any potential litigation.
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