Key Clauses: Termination

This post is the eighth in our series on navigating the landscape of US commercial contracts for international businesses. Here, we discuss the significance of termination clauses in contracts between foreign companies and US counterparties.

Under US law, the parties to a contract may agree in advance that certain circumstances give rise to a right to terminate or exit the contract. Such clauses, known as termination clauses, if drafted unfavorably or ambiguously can therefore cause headaches when a business needs them least. Termination clauses can come into play when a joint venture is dissolving, a supplier wants out of a long-term commitment, or a business is winding down. In those moments, absent an effective termination clause the party seeking to end the contract may find itself weighing two bad options: continued performance of an undesirable commitment or breaching the contract and facing the consequences. 

A party can avoid this dilemma at the contract drafting stage by insisting upon a carefully drafted termination clause that anticipates its specific needs and circumstances. And a party with a contract already in place contemplating its termination can walk away with minimal damage when armed with a comprehensive understanding of its rights and obligations. 

What termination clauses do

A termination clause defines when, how, and by whom a contract may be ended. Broadly, these clauses come in three types:

• A termination for cause clause allows a party to exit upon a material breach of the contract or other defined event like insolvency. Often, but not always, termination for cause clauses require notice and an opportunity for the breaching party to cure.
• A termination for convenience clause allows a party to walk away without any breach at all, usually on advance written notice and sometimes after payment of a fee. This flexible contract-driven right may be well suited for businesses that frequently seek new opportunities or that operate in volatile market conditions. 
• An automatic termination clause ends the contract on the occurrence of a specified event, such as expiry of a term or a change of control, without any party needing to act.

Why they matter

As we have noted before in this series, US contract law prizes freedom of contract and rarely fills gaps for the parties to an unambiguous contract. Parties from civil law jurisdictions accustomed to broad statutory termination rights, such as the right to exit for good cause or to demand renegotiation when circumstances change, should be on notice that US courts rarely resort to comparable relief.

Parties should also note that potential exposure for breaching a contract is not always limited to money. In some circumstances a counterparty may seek specific performance, i.e., a court order compelling the contract to continue. US courts generally grant that remedy sparingly, reserving it for cases where damages are inadequate.  But when they do, a party can be required to absorb the cost of continued performance for months or even years. 

Parties should also be on the lookout for asymmetry in the language of termination clauses and be sure to avoid a clause that gives only the counterparty a way out. 

Takeaways

When contracting, draft for the business. Contract drafting teams should work closely with their business counterparts to understand how the business operates to build in the flexibility it needs into termination clauses. A convenience right, a wind-down period, or a transition-services obligation will be valuable for some businesses. Understanding that courts will rarely read in terms to an agreement, drafters should spell out triggers, notice and cure mechanics, and post-termination obligations. 

When facing termination, know your rights before you act. Before terminating a contract or conceding to a counterparty claiming the right to terminate, consult with counsel familiar with US law to review the terms of the contract and map out the likely scenarios under the clause. Understanding potential claims and damages can provide leverage and—where necessary—a way out. 

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For a collection of related previous posts and webinars, please click this link. Additional posts in this series on US commercial contracts for international businesses include: 

• Common Pitfalls in US Commercial Contracts: How to Limit Unnecessary (and Costly!) Legal Exposure
• Don’t Get Lost in Translation: Six US Contract Law Principles Non-US Companies Should Know
• Don’t Hitch Your Wagon to the Wrong Partner: The Importance of Due Diligence in Contracting with US Counterparties
• Don’t Leave the Law Governing Your Contracts to Chance | Freshfields
• Where You Litigate Can Materially Impact the Cost and Outcome of a Contractual Dispute: Forum Selection Clauses in US Contracts | Freshfields
• From Boilerplate to Backbone: Rethinking Arbitration Clauses | Freshfields

• Who Has the Last Word? A Guide to Integration Clauses | Freshfields

   

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