Effective contract termination

By Michael Rochester*

In some instances, contracts for these projects have already been awarded and therefore need to be terminated or suspended. However, changing economic fortunes are not in themselves a ground to terminate a contract at law and extra caution must be taken in determining the right way to end or suspend contractual arrangements otherwise a party may find itself in breach of contract and liable for damages.

Termination
Contracts are binding commercial agreements which are not easily set aside or varied. At common law, a party may only terminate a contract if the other party has breached an essential term or repudiated the contract, the latter being where a party has by its conduct evinced an intention not to be bound by the contract.
Not every term of a contract is an ‘essential’ term. Contracts generally contain a number of terms, some being more important and fundamental to the transaction than others. For example, a construction contact may specify that as built drawings must be of a certain size and contain certain information. If a contractor produces drawings of a difference size then it will be in breach of contract but that breach is unlikely to be so fundamental to the transaction that the principal would have a right to terminate.
These lesser terms (or what are called warranties) may entitle the innocent party to claim damages arising from the breach. However, the failure by a contractor to design and construct plant to meet certain performance characteristics may be essential to the transaction and may give rights to the principal to terminate if those performance requirements are not met.
Because of the difficulties in determining what is or is not an essential term, most contracts will specify the procedure when a party is in default and whether the innocent party has the right to terminate because of that default.
Generally, these clauses deal with the non-performance of a party, for example, delay, a failure to pay, a failure to comply with directions and do not deal with external events which may make the contract more difficult or in some cases impossible to perform.
It is for this reason that many contracts, especially those of a long term nature, include a ‘termination for convenience’ clause. As the name suggests, a termination for convenience clauses is intended to allow a party to terminate at its sole convenience for any reason and at any time. Such clauses are often included in mining contracts where, as is being seen at the moment, economic fortunes change so as to make what was once an economic contract an uneconomic contract.
A termination for convenience clause is to be interpreted like any other clause in the contract and therefore to be effective a party must follow its terms. Termination for convenience clauses will generally provide for some payment to the contractor to compensate it for demobilising from site and cancelling any subcontracts or other arrangements. Some clauses may also include payment for the profit the contractor would have earned had it completed the project.
In the present environment, it is likely that termination for convenience clauses are being exercised. However, absent such a clause it is unlikely that a party will have rights to terminate a contract simply because continuing the project has become uneconomic.

Suspension
Whether a principal can direct the contractor to stop work for a period of time again depends upon the terms of the contract.
At law, a party is entitled to receive the benefit of the contract and not be hindered in performing the contract by the other party. Therefore, a contractor who has contracted to perform works by a certain date is entitled to expect that it will not be hindered in performing those works by the principal.
Suspension rights are a common feature of most contracts. Principals often have the right to suspend the works for a number of reasons. However, if the contract is suspended through no fault of the contractor’s action then often a contract provides that the principal must pay the contractor its costs incurred as a result of the suspension. A principal who suspends a contract for economic reasons is likely to be liable to pay the contractor its costs of suspension.
A contract may also allow suspension for external events which effect performance of the contract through what is known as a ‘force majeure’ clause. What is force majeure will depend on the contract but generally most contracts define it to be natural events such as flood, fire, drought etc. and rarely do economic events fall within the definition.

Termination of a contract can be fraught with danger. To be effective, the terms of the contract allowing termination must be followed strictly. Absent any terms, circumstances must arise whereby a party has breached an essential term.
Although times may have changed so that performance of a contract is less profitable or indeed uneconomic, that in itself is unlikely to allow a party to terminate. A party who does not terminate a contract correctly or terminates a contract unlawfully will itself be in breach of contract and liable for damages. Accordingly, any termination must be carefully considered.

* Michael Rochester, McCullough Robertson Lawyers