How Contracts Terminate
There are 4 main ways to terminate a contract:
- Performance: The contract runs its course, and the contract is performed
- Agreement: The parties agree to end the contract by agreement
- Breach: The innocent party elects to terminate the contract when the defaulting party is in repudiatory breach, or another agreed standard of breach specified in the contract
- Frustration: the underlying circumstances of contract change, which material alter the performance requirements of the contract
1. Termination by performance
When both parties to a contract have performed all their obligations under a contract, including all express and implied terms a contract comes to an end.
Each of the parties have performed their obligations with “perfect precision”: exactly as was specified by the contract.
And if the contract is for a fixed time – say 2 years – if the contract has been performed with that perfect precision as at the end of the 2 years.
A few words about contract performance:
- any deviation from the contractual obligations will amount to a breach of contract.
In Bolton v Mahadeva (1972), the contractor was required to install a central heating system. The heating system didn’t work. Contractor couldn’t claim payment: he didn’t fulfil the primary obligation to heat the house.
- In contracts for services, the obligation to perform may not be so strict. The obligation is usually not to achieve a specific result, but just to exercise reasonable care and skill when performing the contractual services.
- Circumstances of the contract may allow payment for part performance of a contract on a quantum meruit basis. A reasonable price is required to be paid for work performed at the request of the other party.
This enables the performing party to get paid fair and reasonable remuneration for their work.
It requires a contract where the obligations to perform are divisible, such as by phases or milestones.
Payment may be recovered for the obligations completed, where:
- partial performance has been accepted by the other party
- the other party prevents complete performance by a party ready willing and able to perform, or
- a substantial part of the contract has been completed.
- A party to a contract "tenders performance" by attempting to perform their obligations under the contract. They are prevented from performing by the other party.
Depending on the type of contract, the tendering party may be considered to have discharged their obligations under the agreement, and the contract terminates.
If the tendered performance is refused by the other party, they may be sued for breach of contract. Further performance is not required but the debt arising under the contract for products or services is not discharged.
In debtor-creditor relationships, if a debtor tenders payment for the debt and the creditor refuses it, then they still need to pay. If the debtor is paid after tendering performance, the money is usually paid into court as part of the defence of tender.
2. Termination by Agreement
It is always open to parties to agree to variations to their contractual arrangements.
That includes terminating it by agreement.
Both parties are able to consent to termination of a contract. When they do, the mutual obligations to perform contractual obligations come to an end.
Variations to Terminate
So, where both parties have performance obligations (ie executory consideration) outstanding under a contract, an agreement to discharge one another from further performance will usually be fresh consideration.
That’s enough to satisfy the requirement for consideration, making the termination by agreement legally binding.
Legally binding variation for Termination
For the agreement to be legally binding there must be either:
- fresh consideration from both parties
- a deed releasing the other party from their obligations – there is no requirement for consideration in a deed
- a separate agreement supported by fresh consideration, to amount to accord and satisfaction, or
- a promissory estoppel applies on the facts.
Broadly speaking, an estoppel is made out when:
- a promise is made to end the contract by one party to the other
- that promise intended to be binding and acted upon by the other party
- the other acts on the promise, and changes their position as a result.
The contract doesn’t need to say that the parties intend to change the agreement in the contract itself.
Even where the contract says that no variations or changes may be made to the contract, changes can be made to it by a varying its terms.
If there is a contractual procedure to change it though, that procedure should be followed.
Terms of contract can be built into a contract to terminate it. These are known as conditions subsequent.
A condition subsequent stipulates a state of affairs which causes existing contractual obligations to come to an end.
The state of affairs - whether an event takes place or does not take place - does not have to be out of the control of the parties.
3. Termination for Breach
Terminating a contract for breach requires a repudiatory breach of contract.
Here’s the tdlr.
Conduct is repudiatory if it “deprives the innocent party of substantially the whole of the benefit”, intended to be received for performance of the obligations under a contract.
This is known as the “substantially the whole benefit” test. It's often expressed as “the breach must go to the root of the contract”.
Is the breach serious enough?
- it needs to be a serious breach – not a breach of warranty - that is:
- a breach of a condition or
- breach of an innominate (aka "intermediate") term which deprives the innocent party of substantially the whole benefit of the contract,
is a repudiatory breach and therefore sufficiently serious to terminate a contract for breach.
- A contract may set out a different standard of breach, such as a:
These alternative terms don’t necessarily mean “repudiatory breach” – it depends on a proper interpretation of those words within the context of the contract.
If the parties agree to terminate by reference to those terms, are they are able to do so.
And just because there’s no express right stated to permit a party to terminate in a contract, doesn’t necessarily mean that it can’t be terminated.
- When one party expresses an intention to:
- not perform their obligations under the contract; or
- perform them in a way in which is inconsistent with the original contractual terms,
it is an anticipatory breach. It entitles the other party to terminate.
- Conduct or behaviour amounting to an anticipatory breach may be either explicit or implicit. Express words or writing aren’t required. Anticipatory breach may be communicated by conduct.
- When a defaulting party commits an anticipatory breach, the innocent party:
- may wait and allow the party in breach to properly perform their obligations. If the part in breach does so, then the right to terminate will be lost.
- may sue for damages as soon as the anticipatory repudiation occurs, and not wait for the date of performance.
- also has the option of affirming the contract by performing their obligations under it.
In the case of White and Carter Limited v McGregor (1962), the defendant tried to terminate the contract.
The claimant refused to accept the termination and continued with performance under the contract, later suing the defendant for the full contract price.
The claimants were successful in recovering the full contract price.
- The option of accepting the repudiation or terminating the contract is not available where the innocent party requires the cooperation of the other party to perform the contract or if they have no real interest in performance of the contract.
When there is a Breach
- When there is a breach of contract, it does not automatically discharge the contract.
- Once you have a right to terminate, it must be exercised to terminate the contract. The exceptions to this rule are rare and limited.
- Until the right has been exercised, the contract continues in force.
- The right to terminate is exercised by telling the party in breach that the contract is terminated (it helps to explain all the reasons why, too when you do).
- When a contract is terminated:
- the performance obligations under that contract are discharged at the date of termination
- however, performance of secondary obligations are not discharged and continue in force, such as:
- maintaining the confidential information of the other party
- the obligation to pay damages for any losses caused to the innocent party.
- Attempting to terminate a contract in the absence of a repudiatory breach is a repudiatory breach in its own right - even if you are mistaken, and think that a repudiatory breach has been committed.
- When that happens, it means that the other party to treat the contract as discharged, and claim damages.
- This happens when an innocent party thinks they have a serious – repudiatory – breach.
And they don’t.
In Federal Commerce and Navigation v Molena Alpha (1979), the owner of a ship wrongly believed it was entitled to repudiate the contract.
The repudiation was wrongful and therefore the other (now innocent, for legal purposes) party could treat the contract as discharged.
That’s because the owner was in repudiatory breach itself.
Remedies for Breach of Contract
The primary remedy for breach of contract is damages.
Injunctions may be available to restrain future breaches of contract (which assumes that the contract has not been terminated).
4. Termination by frustration
Discharge by frustration occurs where it is impossible to perform the obligations under a contract due to a change in circumstances of performance of the contract after it has been signed.
The change of circumstances must change the nature of the outstanding contractual obligations.
The modern test for frustration is outlined in the case of National Carriers v Panalpina (1981). Frustration occurs when:
... there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulation in the new circumstances.
The modern case law on frustration follows that case.
Example situations of Frustration
Frustration might occur in a number of situations:
- the subject matter of the contract has been destroyed, or is unavailable and was intended by both parties to be the primary subject matter of the contract.
In Taylor v Caldwell (1863), a contract to hire a music hall was frustrated when the hall was destroyed by fire
- a party (who is an individual, rather than a separate legal entity) to the contract dies or is seriously incapacitated
- the contract has become illegal to perform due to a change in the law or say an outbreak of war
- the commercial purpose of the contract has failed, such as the failure of an event which the contract was based upon.
Frustration will not apply to discharge a contract:
- Simply because inconvenience has been caused, or there has been an increase in expense or loss of profit.
In Davis Contractors Limited v Fareham UDC (1956), it was agreed that a council estate would be built at a fixed price.
Due to bad weather, strikes and shortages delays ensued. The estate was built at a loss. The contract had not been frustrated. It was just more expensive to perform the contract.
- The contract contains an express provision (force majeure clause), dealing with the eventualities which arose in the argued case for frustration. That’s because the parties contemplated the frustrating event claimed.
- Frustration is self-induced and one of the parties which had a choice regarding performance, or
- The event was reasonably foreseeable by either party as at the date of the agreement.
Other Situations of Termination
There are other limited situations where contracts come to an end or may no longer be enforced:
- one of the parties is made bankrupt
- winding up of a company may lead to termination of a contract
- the Limitations Act operates to create an absolute defence to any claims under the contract made out of time, when it is pleaded as a defence.