Key Issues to Consider When Negotiating Contractual Termination Rights

When business customers enter a new contract, one of the key questions they will want to know is how to exit it. This is particularly important when working with new suppliers with whom they have yet to establish commercial relationships. As a supplier, it is essential to carefully consider the issue of contract termination rights and how to address them. This article will explore key issues when negotiating contract termination rights with business customers. 

Why Are Contract Termination Rights Important?

When entered into validly, a contract is legally binding between commercial parties. Both parties are bound to comply with their obligations. If one party falls in breach, the other party can have significant remedies – for instance, the right to claim damages. 

The parties must know how to exit a commercial agreement. Several things could happen during a business relationship, for instance:

• the commercial relationship or project may no longer be viable or profitable; 
• the customer may be unhappy with the supplier’s services; or
• the customer could face financial difficulties and be unable to pay the supplier’s fees. 

Clarity on termination rights within a commercial contract is, therefore, vital. Whilst there are ways to end an agreement under common law, contractual termination rights are far preferable. Terminating a contract under common law can lead to various issues and problems, such as arguments about whether a party lawfully or correctly terminated the contract. 

Which Types Of Termination Rights Could Customers Request?

There are several types of termination rights a customer could expect. 

Most commonly, a customer could reasonably request the following:

• the right to terminate if your business goes insolvent; 
• the right to terminate if your business commits a serious breach or repeatedly breaches the agreement; and
• the right to terminate for no specific reason, simply because they no longer want to continue with the contract and want the freedom to exit. 

While some suppliers offer termination rights, others are more willing to if exceptional circumstances apply. This can depend on the nature of the contract and the relevant industry. 

What Should I Consider When Negotiating Termination Rights?

Let us now explore some of the key considerations when negotiating termination rights as a supplier.

1. Consider Flexibility to Keep Your Customers Happy

New customers are likely to be savvy and review your commercial agreements. Termination rights are one of the most heavily negotiated clauses during a contract review. 

Your customers are highly likely to push for termination in certain circumstances, for instance, if:

• your business becomes insolvent; 
• unexpected ‘force majeure’ events occur, which mean you cannot deliver your obligations; or
• you consistently breach any material terms of the contract or specific service levels agreed with the customer. 

In such circumstances, it is reasonable for a customer to request termination rights. Otherwise, they may suffer within a contract you cannot perform or you are failing to perform. 

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If you deny new customers basic termination rights, they may not wish to start working with your business. This could impact your business’s reputation and growth, making this a critical commercial consideration when negotiating termination rights. If you are too harsh, a potential customer could walk away and find another supplier with a more balanced stance.

2. Clear Termination Rights Could Mean Fewer Disputes and Legal Proceedings  

Remember that your customers could seek to terminate the contract under common law rights, even if you do not allow express termination rights. 

For instance, your customer could seek termination if they believe you have committed a ‘repudiatory’ breach of the contract due to consistently poor performance. This severe breach goes to the heart of the contract and deprives the customer of benefits. However, you may contest this and claim you did not commit such a breach, and there is no right to terminate.

As such, including express termination rights as agreed with your customer will give both parties certainty and leave fewer grounds for arguments and disputes to arise. For instance, your contract can include explicit termination clauses specifying which breaches of the agreement by you would entitle your customer to terminate. This could save arguments later down the line. 

3. Understand The Type of Project And What Is Reasonable 

Termination rights and termination clauses under a contract do not always follow a one-size-fits-all approach. 

 For instance: 

• if you are a supplier delivering advisory services, a customer may no longer need to use your services after a while. For example, they may close their business and no longer need your tax advice. As such, granting them the right to terminate your contract on notice may be reasonable; 
• however, for specific contracts (such as software licence agreements), your business model may dictate that your contracts must run for a certain minimum amount of time before the customer can terminate them; or
• if your project is particularly bespoke or requires a large amount of up-front work, you may choose not to let customers terminate. Perhaps because you will lose a lot of potential income by allowing early termination. Or, you could seek to charge customers a fee for early termination. For example, if you are an event planning business and put a lot of time and resources into planning and running bespoke events for your customers. In such a case, termination on notice may not be appropriate. It will then be up to you to explain the reasoning to your customer during commercial negotiations. 

It is essential to understand that contracts and termination rights should be considered case-by-case. You may wish to research your particular industry or sector and consider which termination rights are customary.

You can also seek guidance from a legal advisor who can provide best practice suggestions for your contract and which rights are reasonable, using their industry experience. 

Key Takeaways

As a supplier, it is vital to consider termination rights exceptionally carefully. This topic is likely to arise in your contract negotiations with your customers. You should consider which termination rights are reasonable and appropriate for the nature of the contract. 

Customers are likely to expect termination rights in certain circumstances, so denying them this could result in them losing confidence and you losing business. If you require help determining reasonable wording for your company and industry, you can seek advice on best practices from a commercial lawyer. 

If you need advice on contractual termination rights, LegalVision’s experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers who can answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.