Back to Basics: Termination of IT Contracts

May 23, 2012

Information technology contracts may come to an end because both parties fulfil all their obligations (discharge through performance). In this age of austerity, however, one or both parties may be unable or unwilling to allow a contract to run its natural course. If the contract runs into difficulties, if it becomes unprofitable, or if it simply becomes too expensive to perform, then one or both parties may wish to consider early termination. 

It may not be necessary to resort to extreme measures. The contract may make provision for termination without cause, often upon payment of a pre-defined fee. Even if that is not the case, it may be possible to negotiate a mutually-acceptable release from obligations.  Sometimes, however, this is not possible.  

This article considers non-consensual termination for cause at a basic level. 

The first step is to distinguish between termination under the terms of the contract, and termination at common law. In some circumstances, either might be available to a party, but the consequences of termination may be significantly different.  

Terminating for cause pursuant to a contractual term 

Most commercial contracts include clauses setting out the circumstances in which each party may bring the contract to an end. Typical termination clauses in IT contracts allow termination if:

 ·         one of the parties undergoes an insolvency event, which include liquidation, administration, the presentation of a winding up petition or a company voluntary arrangement;

·         there is a breach of an irremediable  ‘material term’ in the contract;

·         there is a breach of a remediable ‘material term’ in the contract which is not remedied within a defined number of days of written notification. 

Close attention must be paid to the detail of the termination provisions. It is important, for example, to take care to comply precisely with the requirements for giving notice. Another issue that often arises is whether a breach should be classified as ‘material’. A ‘material’ breach does not necessarily have to amount to a repudiatory breach (as to which, see below); rather, in determining whether a breach is material, a court must look to the magnitude of the commercial consequences of the breach. In doing so, it is relevant to consider not only what the breach consists of, but also the circumstances in which the breach arises.[1] 

Following termination pursuant to the terms of a contract, it is normal to have provisions specifying the consequences of termination. The consequences may depend upon the basis of the termination, but for IT service contracts a key issue that the parties often specify is the ongoing provision of the services during the notice period and for an ‘exit’ period after the termination date.  There may also be issues relating to licensing of software that need to be addressed. 

Termination at common law  

A party can only terminate a contract at common law if there is a sufficiently serious breach of contract (although a contract can be frustrated or discharged in other ways).   

All breaches of contract which result in loss entitle the ‘innocent’ party to damages, but not all breaches of contract bring an entitlement to terminate. The breach has to amount to a ‘repudiation’ of the contract. The key question, therefore, is what amounts to repudiation? 

The traditional approach to this question depended on the classification of contractual terms as ‘conditions’ (breach of which amounted to a repudiation) and ‘warranties’ (breach of which did not amount to repudiation). Although this approach continues to be reflected in the Sale of Goods Act 1979,[2] it is seldom a useful tool for modern analysis.  

Normally, the key test for repudiation is whether the breach of contract was particularly serious. This comes down to a question of whether the innocent party has been ‘deprived of substantially the whole benefit of the contract’, such that it would be ‘unfair to hold him to the contract’.[3] In the case of anticipatory breaches of contract (where a party shows an intention not to perform its future obligations), the question is whether the party shows an intention ‘to abandon and altogether refuse to perform the contract’.[4] 

From a customer’s perspective, a problem that often gives rise to a desire to terminate an IT contract is delay by the supplier in carrying out the implementation. Delay can give rise to its own particular difficulties in demonstrating repudiation: 

·       If ‘time is of the essence’ in the contract, then contractual milestones will be construed as conditions and any breach is likely to entitle the other party to accept the repudiatory breach and terminate the contract. However, if the contract does not stipulate that time is ‘of the essence’, a term to that effect will seldom be implied into an IT contract. 

·       Assuming that time is not of the essence, providing both parties are continuing to make efforts to perform the contract, it will be difficult to show that the tests for repudiation have been met: the parties are unlikely to have been deprived of the whole benefit under the contract, nor to have shown an intention to abandon the contract.[5]  

Whether a party has repudiated is a question of fact. It would be a rare case, therefore, in which any prudent lawyer would advise that terminating at common law was a risk-free step to take. The dangers can be seen by reference to the recent case of De Beers v Atos [2010] EWHC 3276 (TCC).  

Non-acceptance of repudiation 

The innocent party is not required to ‘accept’ any repudiatory breach, thereby terminating the contract. It may, instead, ‘affirm’ the contract (and also sue for damages if it has suffered loss as a result of the breach). Providing the acceptance of the repudiation or the affirmation of the contract is unequivocal, both parties will know where they stand. This is generally seen as a form of election, in that the innocent party must choose between its inconsistent rights.  

A more difficult situation is where one party is aware of the other’s breach but does not take steps either to terminate or to affirm. It is clear that the innocent party is entitled to a reasonable time to consider its options, but there will come a time when it will be considered to have affirmed the contract and will thereby lose any right it otherwise would have had to terminate.[6]  How much time an ‘innocent’ party has to consider its options is another highly fact-sensitive issue. 

In general, affirmation will not be found to have taken place where there are express reservations of rights. However, if a reservation of rights is inconsistent with actions that affirm the contract then there will nevertheless be deemed to have been an election to affirm.[7]   

Retrospective justification at common law 

It is not unusual for a party to state that it accepts the other party’s repudiation, only to have doubt (factual or legal) subsequently cast on its entitlement to do so. The terminating party may nevertheless still be able to justify the termination of the contract if it is subsequently able to show that the other party was in repudiatory breach of the contract in some other way, even though the terminating party did not rely on that breach at the time of termination.[8]  

Interaction between termination under the contract and at common law 

Unless specified in a contract, the termination provisions under a contract do not generally prevent a terminating party from relying on its rights at common law (including the right to terminate at common law, and the right to claim damages). In general, the courts are not inclined to conclude that the parties have given up their ‘valuable right’ to damages, unless that is clear from the language used in the contract.[9] 

Duncan McCall QC and Adam Temple are members of the IT and Telecoms Group at 4 Pump Court, Temple, London, EC4Y 7AN:

[1]     Dalkia Utilities v Celtech International Limited [2006] 1 LLR 559 at [90]–[102].

[2]     Section 11.

[3]     Both are said to amount to the same thing: The Nanfri [1979] AC 757, at 778 per Lord Wilberforce (not quoted verbatim).

[4]     Eminence Property Developments Ltd v Heaney [2010] EWCA Civ 1168 at [61].

[5]     See Shawton Engineering [2005] EWCA Civ 1359 at [32].

[6]     Tele2 v Post Office [2009] EWCA Civ 9.

[7]     Bremer Handelsgesellschaft v C Mackprang Jr [1979] 1 Lloyd’s Rep 221, 225, and see Summer Hill  Business Estate Pty Ltd v Equititrust Ltd [2011] NSWCA 149.

[8]     Recently re-affirmed in Reinwood v Brown [2008] EWCA Civ 1090; [2009] BLR 37 at [51] per Lloyd LJ.

[9]     Stocznia Gdynia SA v Gearbulk Holdings Ltd [2009] EWCA Civ 75; [2010] Q.B. 27, at [22] and [23].