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Cancellations can be highly frustrating when running a business. Unfortunately, with the Covid-19 pandemic, many companies have received a rise in client cancellations. Although, cancellation fee clauses enable some organisations to protect themselves against financial loss. However, these clauses can be unpopular amongst clients. Therefore, exploring the best ways to use them might be a good idea. This article will outline what your business can include within a cancellation clause and when you should include a cancellation fee within your contracts.
What is a Cancellation Charge?
Under the terms of a contract, your business can choose to request payment in the event of cancellation. Businesses often refer to this as a ‘cancellation charge’ or ‘cancellation fee’. Typically, businesses will require a client to make a cancellation payment due to the early termination of the contract.
For example, say your IT company agrees to a 12-month contract with another business requiring them to make 12 monthly payments in exchange for software support. In this case, you might draft a cancellation fee clause to charge the other business a fee to end the contract early.
Three Steps for Safe Use of Cancellation Fees
Firstly, you should outline any cancellation fees within the contract. If you fail to do this, you will unlikely have the legal right to charge a cancellation payment.
Secondly, you should ensure that the wording cancellation clause should be fair and transparent. It is unlikely the courts will enforce unclear or unfair cancellation clauses. Therefore, it is a good idea to have a lawyer draft them to avoid this.
Finally, you should ensure you ask for the correct cancellation fee. For example, say your business runs a gym and provides users with 12-month contracts that request payment of the remaining 12 months upon early termination. In this case, you can not ask for more.
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How Can My Company Calculate a Fair Cancellation Charge?
When a client requests the early termination of a contract, your business will likely face some financial loss. Often, these costs can exceed what the end-user would need to pay for the remainder of the fees due within a fixed-term contract. Therefore, you may consider including additional costs in a cancellation fee. For example, you might factor in:
- set-up costs (for example, if you need to purchase machinery or transport to provide an agreed service);
- administrative fees (these could include the cost of setting up the contract and any initial performance of the contract); or
- fixed penalty charges (some businesses, such as hotels, charge a percentage of the booking charge on a sliding scale as a penalty for cancelling at the last minute).
However, your organisation should only set a cancellation fee you would ordinarily receive under the contractual terms.
For example, let us say that you run an online food delivery service and a client signs up for six months’ worth of weekly food boxes for £100 per month. If everyone carries out the contract, your business will receive £600. In this case, the court is unlikely to consider an early termination fee of £1,000 to be reasonable.
When is It Risky to Charge a Cancellation Fee?
Your business should only request a cancellation charge when it is reasonable. For example, covering your losses through a cancellation fee is usually reasonable if the other party ends the arrangement early, without fair reason or reasonable notice.
However, your organisation may struggle to enforce cancellation fee-wording in some scenarios. Some examples include:
- a client suffering significant injury (such as a car crash or severe illness) making it impossible for them to make use of the booking; or
- an end-user not being legally permitted to carry out the contract (for example, not being able to fly with an airline because the Government of their country does not permit flights due to a short-notice lockdown).
Key Takeaways
Having a solid cancellation clause can be the difference between losing vital funds or being able to recover lost earnings. Further, it is crucial to set out when a cancellation charge may apply and how much it may cost the defaulting party. Additionally, if a specific contract has a high value to your business, you may wish to consider obtaining expert legal advice on the wording of the written agreement.
If you are considering the use or negotiation of cancellation fee clauses, our experienced commercial contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
While many different types of companies include cancellation fees within their contracts, the most common sectors tend to include subscription-based businesses and those that book rooms or seats (such as hotels or airlines).
Our common law prohibits organisations from charging excessive amounts for early termination because this is an unfair practice.
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