Terminating non-performing contracts

A recent case in which we were involved (Digital Capital Limited v. Genesis Mining Iceland EHF [2021] EWHC 2462 (Comm) raises a perennial problem arising from long-term commercial contracts: how does an aggrieved party go about terminating a contract which it does not believe the other contracting party has performed, or ever will perform?

The law starts from the proposition that both parties to a contract should do what they have promised to do. If one side breaches its promise in some way, that does not mean the other party can walk away from the contract: instead, it should perform its own obligations and sue for the financial losses caused by the other party’s breach. However, if that breach is sufficiently serious, then the law recognises that the contract is at an end.

But who decides what is sufficiently serious? And how?

Like all legal problems, this has a long history. The current formulation of the law most practitioners would accept is that a breach of contract has to be sufficiently serious that it manifests an intention no longer to be bound by the contract. That has the advantage of doing away with the potentially confusing terminology of the past but the disadvantage of requiring detailed analysis of the issues. That takes time and, as all clients know, money.

To navigate these difficult waters, lawyers have taken to drafting termination procedures in long-term contracts which set out mechanisms which usually involve:-

(1) the parties having the right to terminate for no reason provided they give each other sufficient notice; and

(2) in the case of an alleged breach of contract:-

(a) the party who is aggrieved giving a notice of the breach and requiring the other party to remedy it,

(b) the party alleged to be in breach having the opportunity to remedy the breach, and

(c) allowing the party who is aggrieved to terminate the contract if the breach is not remedied.

Few clients realise that this contractual regime exists independently of the common law regime described at the beginning of this article. The Court of Appeal has made it clear that parties cannot be assumed to have given up their common law rights unless it is clear from the contract they have agreed to do so. Clients rarely realise that they had an opportunity – usually before they have called their lawyers – to “accept” a repudiatory breach by a counterparty but have inadvertently “affirmed” the contract and lost that opportunity.

Equally, few practitioners realise that a sufficiently comprehensive termination regime might oust the common law regime. It is all a matter of construction. If the surrounding contract contains an “entire agreement” clause, which is normal, and (less frequently) a clause limiting to the greatest extent permitted all the parties’ other legal rights, it might be sufficient to persuade a Court that the parties have in fact agreed that their termination regime should replace their common law rights. This was a point taken by the judge (on her own initiative – and during closing submissions) in the trial of the case in which we were involved.

To answer the question posed at the beginning of this article, any client considering the termination of a long-term commercial contract needs a clear strategy from the outset. That involves:-

• a careful review of what rights and obligations actually exist,

• evaluating the evidence of the breaches which might be relied upon,

• weighing up the risks and benefits of every course of action available, and

• formulating a clear plan for termination and mitigating any downside risks.

For practical advice and guidance on this and similar issues, please contact us.