Contract Termination: Merits Serious Thought
Corporations tend to consider certain types of clauses as “miscellaneous” or “boilerplate” and that, sometimes, includes a termination clause which is relegated to the background. While it is true that each company will usually conduct its own risk analysis and tick off a checklist when considering and/or proceeding to terminate, yet, when executing a contract the termination provision is probably one of the few clauses which is not given the due attention it deserves. It merits equal, if not more, consideration as the payment provisions. The subject is vast and merits a treatise by itself. So, this bulletin describes briefly the common termination provisions in contracts in India, the related principles as well as remedies available to the contracting parties.
Common termination grounds
Under Indian law and custom, generally, the parties terminate a contract in certain specified circumstances which include, amongst others: (i) Termination for convenience i.e. without assigning any reason and, depending on the leverage of the contracting parties, this can be exercised by any party, (ii), Termination for cause which is the often most concrete reason for termination. It could include a variety of specified events including non- performance or breach of a material contractual term (failure to attain specified parameters or non-payment) or liquidation of one of the parties, amongst others, and (iii) Occurrence of a prolonged suspension of the contract due to a force majeure event. These are briefly discussed below.
Termination for convenience is inserted largely to cover circumstances where the parties do not wish to continue with the contract for any reason, which may be difficult to envisage at the time of its execution, even if there is no default by the other party. Parties sometime prefer to have this flexibility built in the termination provision. Termination for cause occurs when the specified triggers occur – for instance, insolvency, appointment of a receiver or administrator or change in management, and last, but not the least, breach.
Occurrence of a force majeure event can also lead to termination provided sufficient time is allowed to pass to ensure that the rigors of the force majeure event makes contractual performance difficult. Such an event may not involve fault of any party or negligence and is not foreseeable, and may include, but are not restricted to, wars or revolutions, fires, floods, epidemics, quarantine restrictions and freight embargoes.
While it is not possible to analyze each of the grounds here, breach merits some extra discussion of the principles. Breach occurs when a contracting party, without lawful excuse, does not fulfill its contractual obligation or by an act makes it impossible to perform its obligation. It confers a right of action for damages on the injured person. Depending upon the circumstances of a particular case, breach of an obligation by a promisor may entitle the promisee to consider the contract as repudiated by the promisor and the promisee may be discharged from further performance. Breach includes actual and anticipatory breach. The former may take place either at the time when the performance is due or during the performance of the contract. Actual breach occurs, when at the time when the performance is due, one person fails or refuses to perform his obligation under the contract. Anticipatory breach occurs when a person to an executory contract (i.e. where the time of performance has not yet arrived) declares his intention of not performing the contract before the performance is due. This may occur by an express renunciation of a contractual obligation or by doing an act such that the performance of the promise becomes impossible.
Every breach of contract does not discharge the innocent party from the performance of his part of the contract. It is a well recognized principle that any breach of contract gives rise to a cause of action; not every breach discharges from liability. For an innocent party to be discharged from further performance the breach should be of a fundamental contractual term. In the absence of parties expressly stipulating whether a term is fundamental or not, the court would probe into the intention of the parties. If the term is not fundamental, the innocent party would only be entitled to claim damages for breach. In our view, there can be no standardization of the termination clauses. While some clauses may be common – for example, nobody wants to deal with an insolvent entity – yet, it is crucial to understand what is going on and anticipate what possible circumstances could arise that could lead to termination and, accordingly, provide for them as unambiguously as possible.
Remedies upon termination
Upon termination, the possible remedies can be:
(i) Seeking specific performance,
(ii) Suit for damages for breach,
(iii) Suit for injunction; and
(iv) Quantum meruit.
As a practical matter, parties can exclude or restrict these remedies contractually. For example, the liability for damages can be limited. Jurisprudence has established that the parties may exclude the right to claim damages for breach and such a provision would be valid on the condition that it is expressed in unambiguous language and is not detrimental to the interest of any party. The courts construe a contract in the light of the facts existing at its formation, i.e., nature and the relevant surrounding circumstances when it was made.
It is important to remember that each of these remedies has certain limits as well. It is true that seeking damages for breach is the most commonly adopted recourse. However, in many instances, the non-defaulting party may take the position that damages would be inadequate; rather, the other party should be compelled to perform its contractual obligations and, so, will seek “specific performance” of the contract. While seeking specific performance, it is possible to apply to the court for interim relief seeking a temporary restraining order injuncting the other party from committing breach. The principles for grant of specific performance are enshrined in the Specific Relief Act, 1963. It is noteworthy that specific performance is discretionary and is generally not granted where (a) monetary compensation is an adequate relief; (b) the contract is of a personal nature; (c) where it is not possible for the court to supervise the performance of the contract; (d) the contract is determinable i.e. when a contracting party can terminate it, and (e) if the act becomes impossible of performance or by reason of some event, which neither party could prevent. While seeking this remedy, it is important to evaluate whether the contract can be specifically enforced or not. If any contract entitles either party to terminate for convenience but with a defined notice period, then, according to the Specific relief Act and the body of judge-made law, such an agreement would qualify as “determinable” in nature and, therefore, not capable of being specifically enforced. Clearly, this would impact almost any and every type of contract. This means that while specific performance may not be a remedy, but, a claim for compensation could lie. However, it is critical that due attention is paid to this by the judiciary so that the net outcome for contracting parties should be fair.
The principle of Quantum Meruit is to ensure that there is no unjust enrichment. Where a party has executed a contract partly and such contract gets terminated, he is entitled to get a proportionate amount for the work done which is not as compensation or pursuant to a claim for damages. The guiding principle is that even when contract ends prior to its term, the performing party should get paid in proportion to the work done by them, be it supplies delivered or services rendered.
Given that India is a common law jurisdiction where judicial precedents carry a lot of weight and are constantly evolving, an understanding of the current jurisprudence is critical. While drafting the termination provisions of any contract, apart from doing the risk analysis, the contracting parties must not relegate this clause to the boiler plate section, but devote adequate time to really understand what is at stake and what could be the consequences should a need arise to terminate the contract. This process must necessarily focus on and follow the jurisprudential trend in interpreting termination provisions else the outcome may mean that the disputing parties end up in court without any tangible outcomes.