Australia: Termination Traps

Last Updated: 13 January 2008
Article by Alex Hartmann and David Jury

Terminating contracts can be just as tricky as drafting the contract itself. This article looks at what you need to consider when bringing a contract to a close.

Commercial contracts will generally set out the circumstances in which a party may unilaterally bring the contract to an end.  Even if they do not, the common law has developed rules on when and how a party may safely do so.

However, if a relationship breaks down and the aggrieved party wants nothing more than to end it quickly, terminate the contract and move on, mistakes can be made easily in the rush to terminate.  At worst, the party terminating may be held to have repudiated the contract itself  by terminating incorrectly.  In doing so, an 'innocent' terminating party may end up paying out large sums in damages instead of recovering amounts from the other party.

We set out below three common misconceptions regarding termination, and what you can do to avoid them

1. 'The other party has fundamentally breached the contract, so the contract is now at an end and I can walk away'

Even where Party A might have a right to consider that Party B's actions are sufficient to justify termination, either at common law or under the contract terms, a further step is still required.  Party A must choose, or 'elect', whether to continue with the contract anyway, or to take action to terminate it.  The act of election required will normally at the very least involve giving written notice to Party B that Party A is terminating the contract because of Party B's breach, but depending on the contract terms more than this may be required.  For example, it may be necessary to invoke and properly complete a 'show cause' procedure (see No 3 below).

In short, it takes two to terminate.

2. 'I have the evidence that there has been a fundamental breach of the contract, but I can carry on for a while before I decide whether to terminate or not'

This is a tempting position to take, where for example there is some slight hope that the position may improve, or perhaps the aggrieved party does not feel ready to make the hard decision. 

If another fundamental breach occurs, the aggrieved party will have another chance to make that hard decision, but if no further fundamental breach occurs, can the aggrieved party go back and rely on that initial evidence? The problem here is that in the meantime, the aggrieved party may have 'affirmed' the contract, whether he or she is aware of it or not.  An affirmation does not require a formal statement that a party considers the contract is still 'on foot'.  It can occur by conduct, where the aggrieved party continues to fulfil its own part of the bargain and generally to behave as though it does not consider that anything has occurred to bring the contract to an end.

If the 'affirming' party then tries to rely on that earlier conduct as grounds for terminating the contract, it may well be accused of repudiating the contract itself.

3. 'I know the contract says that I'm supposed to give a "show cause" notice and an opportunity to fix the breach, but the performance is so bad that I'm just going to terminate at common law for fundamental breach instead'

The temptation to go straight to the common law remedy when the situation seems hopeless is understandable.  However, in the 1988 case of Amann Aviation Pty Ltd v Commonwealth of Australia, the Federal Court held that where the parties have inserted a clause in the contract which appears to fully regulate the parties' rights to terminate in various circumstances, it may be viewed as showing that the parties intended common law remedies to be excluded.  As the case demonstrates, it all depends on the terms of the particular contract. It is therefore wise to re read the contract carefully before choosing this course of action.

It should also be kept in mind that in recent years courts have been strict in insisting that parties act in good faith in issuing and responding to 'show cause' notices.  Where a party is entitled to be given time to 'show cause' why some particular sanction should not be applied, for example the contract terminated or work taken out of the hands of the contractor and performed by others, it is entitled to have this process dealt with in good faith.  In other words, the enforcing party cannot merely issue a 'show cause' notice then disregard the response from the other party or treat it in a cavalier fashion.

Lessons Learned

The conclusion to be drawn from these examples is that as much care needs to be put into terminating a contract as needs to be put into forming it.  An aggrieved party cannot assume that because the other party has treated the contract with disrespect, he or she can act in a similar fashion in bringing the contract to an end. Following procedures for a 'show cause' notice may also help in avoiding headaches.

Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.

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