Commercial entities will, at some time or other, be faced with the termination of a contract they are a party to. Despite the parties’ best intentions at the outset of a contract, circumstances may change, whether through a change in the economy; rising cost of materials; an unforeseen situation whereby one party is unable to perform its obligations under the contract; or the effect of a global pandemic. In such circumstances, termination of the contract may become a consideration, whether for convenience or for breach.

Often the position on termination is more nuanced than might at first appear to be the case. This means careful consideration should be given to a number of issues, including:

1. is termination the right option and are there any alternative outcomes available?
2. whether a party is in fact able to terminate under the contract terms;
3. the practical and procedural steps that will need to be followed in accordance with the contract; and
4. the effects of termination.

Meaning of termination

Termination of a contract is where the contract is brought to an end, such that the parties are released from their continuing obligations effective from the termination date. Termination does not undo the contract and the contract will still be enforceable by both parties in respect of any historic rights or obligations which have accrued prior to the termination date. There are also often terms that will survive termination, for example, post-termination restrictive covenants and/or terms relating to misuse of confidential information. However, the future performance of obligations under the contract will cease on termination.

Entitlement to terminate

The starting point when considering termination is the terms of the contract itself. It may be possible to terminate for convenience, by either party giving notice in the required format and with the specified notice period.

If a party is looking to terminate based on the other party’s alleged breach of the contract, it is important to note that not every breach of a contract gives an entitlement to terminate. Often in commercial contracts, certain events will be specified as being a material breach which give rise to the ability to terminate, for example, the insolvency of the other party.

In the absence of any express termination provisions within the contact relating to breach, it is necessary to consider whether the breach committed entitles the innocent party to terminate. In doing so, it is necessary to consider whether the breached term is a condition, which will enable a party to terminate for breach, a warranty or an intermediate term.

A condition is a fundamental term of the contract, going to the heart of it, and a breach of which will enable the innocent party to terminate the contract and claim damages. Generally, a breach of a condition is not capable of remedy, for example, the main purpose of the contract has not been performed.

By way of contrast, a warranty does not go to the root of the contract and therefore if a warranty term is breached, this will not entitle the aggrieved party to terminate, but their remedy will be limited to damages for any loss suffered; the contract will continue.

There are other terms, which when breached, the remedy for which will depend on the nature and effect of the breach at the time it happens. In this sense the position following the breach will be fact specific and may give rise to an entitlement to terminate.

In the heat of the moment, it may be difficult for commercial parties to ascertain whether the affected term is a such that it gives rise to an entitlement to terminate the contract. Whilst parties will often seek to label a term as a ‘condition’ when looking to terminate a contract, whether or not a term actually is a condition will often require closer consideration. It is therefore often sensible, before taking the decision to terminate a contract, to seek independent legal advice as to your position.

Giving notice

Before taking any steps to terminate the contract, it is necessary to reconsider the specific terms around termination and the necessary steps that must be taken to ensure the termination is effective. Accordingly, it is necessary to have regard to:

• whether the party in breach must first be given a chance to cure a breach of contract;

• the time period within which notice can be given – commercially drafted contracts will often include provisions which preclude the termination of the contract where the innocent party has unduly delayed in exercising their rights under the contract, i.e. they will be taken to have affirmed the breach if the contract has not been terminated within the prescribed period;

• the content of the notice – if terminating for breach, it will be important when giving notice of the termination to clearly set out the grounds for termination, including details of the breach and with reference to the contract terms;

• another consideration on giving notice to terminate, including for convenience, is where a contract is subject to automatic renewal terms, it will be necessary for the party wishing to terminate the contract to consider the period of notice which it is required, so as to avoid the situation whereby the contract is automatically renewed for another period; and
• the means of communicating notice – it will be necessary to consider:

• who can give notice;
• the form of the notice required, i.e. is there a requirement for the notice to be in writing?
• the means of delivering the notice, i.e. is there a requirement for notice to be sent by email to a specified individual and/or by recorded delivery post, and/or by personal service?
• when the notice will be deemed delivered.

Effect of a failure to properly terminate

If a party elects to terminate a contract without sufficient grounds or fails to do so in accordance with the prescribed procedures, it will not be sufficient to terminate the contract and the act of purported termination can itself be a repudiatory breach of the contract entitling the other party to terminate the contract and sue for damages. This is why it is often advisable to seek professional advice when considering the termination of a commercial contract.

Alternatives to termination

By terminating a contract, you are effectively terminating, or at the very least potentially prejudicing, any ongoing business relationship with the other party. In addition, there may be reasons not to terminate a contract if there has been a breach, for example, if you are due to receive payments from the other party and there are no concerns as to their solvency.

Whilst circumstances may allow for termination of a contract, this does not mean it is always the most appropriate course of action to take. If the parties want or need to salvage their ongoing business relationship, other alternatives can be considered, including:

1. the renegotiation of the contract terms and a variation of the contract itself to reflect a change in circumstances; and
2. if an alternative remedy is available and/or if there are any prescribed procedures within the contract in the event of a dispute, for example, arbitration or mediation.

All in all, the termination of commercial contracts should not be rushed, and it is important to ensure that sufficient thought and consideration is given to the position before taking any steps. Seeking advice as to the position and exploring the commercial implications of taking such a step is important, before moving forward to terminate.

If you would like to discuss this blog, please contact Jonny Scholes on 07824 435665 or by email to jonny.scholes@pannonecorporate.com

Exclusion clauses are among the most important clauses within commercial contracts. When a dispute arises, the parties may first turn to the exclusion clauses to assess their respective exposure or any protections from liability.

Exclusion clauses are contractual terms which can either exclude or restrict a party’s exposure to a legal obligation or liability. For instance, exclusion clauses could protect a contracting party from:

• Liability for defects in goods: e.g. “The seller shall not be liable for any defects in the goods after they have been delivered and accepted by the buyer”.
• Liability for non-performance due to specified events: e.g. “The agency shall not be liable for any failure to provide services due to government actions”.
• Liability for the loss of data: e.g. “The service provider shall not be liable for any loss or corruption of data stored on its servers”.

Why are exclusion clauses useful?

Exclusion clauses are useful because they provide a mechanism for parties to manage and allocate risk. They provide predictability and clarity regarding liability and risk management.

By incorporating exclusion clauses into a contract, parties can allocate risk in a manner which is suitable to them. This could involve an equitable sharing of risk or an allocation of risk that reflects the contractual realties of the parties and their respective ability to manage contractual risks.

Controls on Exclusion Clauses:

To be considered enforceable, exclusion clauses must meet certain legal requirements. These requirements are intended to promote fairness and are based on both common law principles and statutory regulations. They are as follows:

1. Incorporation: An exclusion clause can be successfully incorporated into a contract through signature, notice or a consistent course of dealing.

2. Construction: There are two main principles the courts will consider:

• Main Purpose: If an exclusion clause defeats the main purpose of the contract, it may be rendered ineffective. This ensures that exclusion clauses cannot completely undermine the fundamental obligations of the contract.

• Ambiguity: Any ambiguity in the clause will be construed against the party relying on it. This ensures that the party seeking to exclude liability must do so in clear terms.

3. Unfair Contract Terms Act 1977: UCTA applies a reasonableness test to exclusion clauses, particularly in consumer contracts and those involving liability for negligence. This legislation seeks to ensure that exclusion clauses are fair and reasonable in the context of the contract.

Implications for Businesses: Drafting and Allocation of Risk Strategies

While exclusion clauses are a powerful tool that allow parties to limit their exposure to risk when engaging in contractual undertakings, it is advisable that lawyers are engaged at the drafting stage to ensure that the term a party seeks to rely upon does not become void if disputed in court.

Key considerations include:

• Clarity and Precision: Draft exclusion clauses in clear and unambiguous terms.
• Enforcement: Ensure that the clause complies with applicable laws and regulations, such as the Unfair Contract Terms Act 1977.

• Negotiation: Clearly express intentions in the contract and ensure that all parties understand the terms to which they have agreed. This is especially important in “battle of the forms” scenarios, where conflicting standard terms and conditions may exist.

Further Considerations for Effective Risk Management

• Scenario Planning: To test the effectiveness of exclusion clauses, apply them to a variety of hypothetical scenarios. For example, simulate a data breach incident to determine whether the clause adequately limits liability.

• Integration with insurance policies: Insurance combined with exclusion clauses can improve risk management and provide additional protection for businesses. For example, businesses can use insurance policies to cover risks that are not covered by the contract. Exclusion clauses, on the other hand, can be used to close any gaps in risk coverage if an insurance policy excludes certain types of damages. By strategically combining insurance and exclusion clauses, businesses can fortify their risk management strategies and safeguard against unforeseen liabilities.

Conclusion

Exclusion clauses are critical for effective risk management in contracts. Their enforceability and effectiveness depend on clear and precise drafting, legal expertise, and thorough negotiation. By employing the strategies discussed in this article, businesses can better navigate contractual relationships, allocate risks appropriately, and safeguard their interests in a dynamic and evolving marketplace.

What’s next…

Our next blog post in this series will examine the issues to consider and pitfalls which can arise when terminating contracts.

If you would like to discuss this blog, please contact Paul Jonson on 07737 571147 or by email to paul.jonson@pannonecorporate.com.

English law upholds the principle of contractual autonomy, granting parties the freedom to negotiate and establish terms tailored to their specific needs and objectives. Contractual certainty is business critical in order to clearly delineate duties and obligations and to provide recourse for an innocent party in the event of a breach.

For contracting parties, it is important to note that contractual autonomy is not absolute and operates within legal frameworks aimed at ensuring fairness and equity in contractual relationships. This article explores the limitations designed to prevent abuse and safeguard parties from unfair or oppressive clauses.

Understanding Penalty Clauses

A contractual term that specifies predetermined consequences for a breach of contract is known as a “liquidated damages” clause. The purpose of this type of clause is not to punish the breaching party but rather to estimate, in a reasonable and realistic manner, the likely losses that would result from the breach. Importantly, the pre-estimate must be made at the time the contract was made (Clydebank Engineering v. Castaneda). This should not be confused with a penalty clause, which imposes excessive financial penalties to deter breaches and can be unenforceable if challenged in court.

The complexity of distinguishing between these two types of clauses often leads to legal challenges, with courts examining the true nature of the clause and the context of its inclusion in the contract. Factors that can be considered include the rationale behind the clause, the bargaining power of the parties, and whether the sum stipulated is excessively high or unconscionable.

Understanding whether or not a clause may amount to a penalty clause could have costly consequences. If a clause is deemed to amount to a penalty clause, it could be struck out as unenforceable.

Evolution of the Test for Penalty Clauses

The legal framework surrounding penalty clauses in UK law has significantly evolved, especially following key judicial decisions that have reshaped their assessment and enforceability.

Historical Perspective:

Historically, the assessment of penalty clauses revolved around the concept of exorbitance in relation to common law damages. In Dunlop Pneumatic Tyre Co Ltd v. New Garage & Motor Co Ltd [1915], the court held that a clause would be considered a penalty if it was not a genuine pre-estimate of costs or sought to impose a detriment on a party out of proportion to the innocent party’s legitimate interest in enforcing the contract.

Shifts in the legal test:

In recent years, the UK courts have moved away from the strict prohibition of penalty clauses. The Supreme Court judgment in Cavendish Square Holding BV v. Talal El Makdessi and ParkingEye Limited v. Beavis [2015] noted that the Dunlop test had taken on the status of a “quasi-statutory code”, which was never the intention.

Lords Neuberger, Sumption and Carnwath took a more nuanced stance, emphasising that the rule on penalty clauses does not permit the courts in every instance to review the fairness of a contractual term when parties can be said to have equal bargaining power. Instead, the focus will be on whether the term in question is a primary or a secondary obligation.

Key principles when assessing penalty clauses:

• Primary vs. secondary obligations: A primary obligation refers to an obligation that arises independently of a breach of contract, while a secondary obligation is triggered by a breach. The Supreme Court emphasised that the penalty rule applies only to secondary obligations. This distinction is crucial in determining the enforceability of penalty clauses, as primary obligations are not subject to the penalty rule.
• Legitimate interest and proportionality: The court highlighted the importance of assessing the legitimate interest in enforcement of the clause in question. The penalty rule will not be engaged if the clause serves a legitimate commercial purpose and is proportionate to the interest being protected. This requires courts to consider the context and commercial rationale behind the clause when determining its enforceability.
• Unconscionability or exorbitance: Even if a clause constitutes a secondary obligation, it may still be enforceable if it is not unconscionable or exorbitant in relation to the legitimate interest which is served by the clause. The courts will assess whether the clause imposes a penalty that is disproportionate to the loss suffered or the legitimate interest being protected. This requires a contextual analysis that considers the specific circumstances of the case.

The following can act as a checklist when considering whether or not a clause is likely to fall foul of the law of penalties:

In the well-established ruling of Parking Eye, an £85 parking fine for a 56 minute overstay was held not to be a penalty clause because the fine was considered not to be out of proportion to the legitimate interest which was served in managing the maximum parking stay for the retail outlets, their customers and the wider public.

Implications for Businesses: Drafting Strategies

The recent refinements in the test for penalty clauses have significant implications for businesses engaged in contractual negotiations and drafting. Understanding these implications is essential for businesses to ensure compliance with legal requirements while safeguarding their interests.

Key considerations include:

• Clarity and Precision: Where possible, contracts should clearly delineate between primary and secondary obligations to avoid ambiguity and potential disputes over enforceability.
• Commercial Justification: Breach clauses should be supported by legitimate commercial justifications that demonstrate their necessity and proportionality to the legitimate interests being protected.
• Avoiding Unconscionability: Businesses should refrain from including breach clauses that are unconscionable or exorbitant in relation to the loss suffered or the legitimate interest being protected.
• Consideration of Context: Drafters must consider the specific circumstances and commercial context of the contract when drafting breach clauses to ensure they align with the parties’ intentions and expectations.

What’s next…

Our next blog post in this series will examine exclusion clauses and unfair terms, another category of contractual terms which could be scrutinised by the courts.

If you would like to discuss this blog, please contact Sarah Bazaraa on 07920 237599 or by email to sarah.bazaraa@pannonecorporate.com

The ‘battle of the forms’ is a phrase which is used to describe the common scenario in which contracting parties compete to ensure their standard terms and conditions apply.

In the second of our six-part blog series about commercial contracts we look at the practical ways businesses can ensure their terms and conditions are incorporated into their business dealings, and who is likely to come up trumps in the battle of the forms.

The traditional approach

In the first blog in this series we considered what it takes to form a legally binding contract and examined what is meant by an offer and an acceptance (Commercial contracts: a practical guide for businesses – Pannone Corporate). When considering which contract terms apply, these principles again become important as the court will examine whether there has been an offer to contract on specific terms which has been unequivocally accepted.

This traditional approach can give rise to two contrasting examples:

• where a supplier sends its standard terms of business and those terms are accepted by the customer, either expressly or by conduct in continuing to deal with the supplier on those terms, the supplier’s terms will govern the contract.
• where a supplier sends its standard terms of business and a customer responds with its own standard terms of business, the customer has in that case rejected the supplier’s terms and introduced a counter-offer to contract on its terms. The court will then be looking to see whether the supplier accepts the customer’s terms whether expressly or by its conduct.

Where competing terms of business are at play, the court will be looking at the chronology of when offers were sent and the behaviour of the parties in determining the point at which a set of terms has been accepted.

Last shot fired

More often than not, the last set of contractual terms presented without any objections being raised will be deemed as accepted. This is often referred to as the “last shot”.

For example, where a customer places an order on the basis of its standard terms and the supplier responds with its own standard terms, if the customer then proceeds to place the order and accept delivery then the last contractual terms fired will be deemed to govern the relationship (in this case the supplier’s terms).

A misfired shot

A risk for parties is failing to adequately bring terms to another party’s attention.

Standard terms and conditions must be readily available to the other party if they are to be capable of being accepted. If a document is sent by email with terms and conditions on the reverse, those terms must also be emailed if they are to be relied on.

Similarly, if documents are sent with a link to website terms and conditions, the link should be a live link through which the contractual terms can be accessed.

The court will look at all the facts of a case to determine whether or not terms and conditions have sufficiently been brought to another’s attention.

Course of dealing

The last shot fired doctrine can be displaced where the correspondence between the parties or their conduct shows that they intended to contract on some other terms. The court will examine all the evidence in the case to determine the prevailing terms.

For example, where there has been a framework agreement entered into in relation to the terms governing future supplies then a last shot fired may not succeed in overriding that framework. Similarly, where there has been a course of dealing between parties pursuant to one party’s terms then it may be difficult to displace that by shooting across competing terms, without something more.

The wording of a party’s terms may also help to guard against the last shot fired principle. In the case of TRW Ltd v Panasonic Industry Europe Gmbh (2022), the last shot doctrine was not accepted. Instead, the judge concluded that the first set of terms sent (being the seller, Panasonic) applied. Panasonic’s general conditions protected it from falling victim to the “last shot” doctrine, as it disapplied any conditions of TRW that diverged from its own terms, and the parties continued to deal with one another on that basis.

Practical Implications

Losing out in the battle of the forms can have commercially catastrophic consequences for contracting parties. It is therefore important that businesses consider their systems and processes when entering into new contracts to ensure they are legally and commercially protected through the governing terms. In practical terms, businesses should consider:

• including reference to standard terms and conditions on all pre-contract documents, to try to ensure they fire the last shot.
• negotiating and agreeing the contractual terms which will govern relations. This avoids any ambiguity as to whose terms apply.
• requiring parties to sign contractual terms so that it is clear that terms have been accepted.
• whether there has been an earlier framework agreement or a course of dealing which may be regarded as taking priority.
• training staff on the risks that contractual terms presented could be found to be incorporated by conduct. Failure to review and understand these terms could mean that a business could find itself bound by another’s standard terms.
• ensuring its terms and conditions are well drafted in order to provide protection against the last shot, as in the Panasonic example.
• making sure that terms are sufficiently brought to another’s attention. If terms are printed on the reverse of documents being sent electronically, make sure the terms are also sent. If being sent via a website link, make sure this directs to a live copy of the terms and conditions.

Finally, if parties do not in fact intend to be bound by contractual terms until a formal document is signed, or further terms are agreed, they should mark all negotiations, correspondence and draft agreements as being ‘subject to contract’ to avoid inadvertently being bound to draft terms.

If you would like to discuss this blog, please contact Sarah Bazaraa on 07920 237599 or by email to sarah.bazaraa@pannonecorporate.com

In the first of a six-part blog series from Pannone’s dispute resolution team, we take a closer look at commercial contracts, focusing at those elements which give rise to the risk of disputes, and how best to navigate those challenges.

Parties may believe that they are embroiled in a contract dispute, but the first question for the court will be “is there a legally binding contract in the first place?” In this blog, we examine the requirements for the formation of a legally binding and enforceable contract.

The five requirements for a legally binding contract

A contract gives rise to legally enforceable rights, obligations and remedies. It’s therefore important to consider whether or not a legally binding contract has been formed.

It’s not necessary for a contract to be documented in order to be legally binding. A contract can be formed whether made in writing or verbally.

However, there are five key requirements which must be present to form a legally binding agreement. These are:

1. an offer
2. acceptance
3. consideration
4. a mutual intention to create legal relations
5. certainty of terms.

Let’s take a closer look at each of these.

1          Offer

What is an offer?

An offer is defined as “an expression of willingness to contract, made with the intention that it shall become binding upon the person making it, as soon as it is accepted by the person whom it is addressed”. In other words, an offer is a promise made to enter into a contract.

When is an offer not an offer?

It’s important to distinguish between an offer to contract from what is commonly known as an ‘invitation to treat’. Parties need to consider whether the proposal which is made is intended to give rise to a legally binding contract (an offer), or whether it’s made with the intention of entering into negotiations (an invitation to treat). An example commonly given for an invitation to treat are goods displayed in a shop window. An invitation to treat will not amount to an offer to contract.

Can an offer be withdrawn?

An offer can be withdrawn before acceptance has taken place. This can happen in a number of ways. For example, an offer may give a deadline for acceptance. If the offer expires, the offer may not be capable of acceptance. If there’s no specific deadline for acceptance, the courts deem the offer to remain open for a reasonable amount of time. A ‘reasonable amount of time’ will depend on the particular circumstances of the case.

2          Acceptance

When is a contract formed?

A contract is typically formed, and therefore becomes legally binding, at the point of acceptance. Acceptance is the final confirmation that the terms of an offer are agreed. Acknowledging receipt of an offer will not constitute an acceptance. Instead, acceptance should clearly signal an intention to be bound by the terms of the offer. When assessing this, the court will apply the reasonable person test, i.e. would a reasonable person standing in the shoes of the person making an offer find that there is a clear intention to accept the terms of the offer and subsequently form the contract.

Acceptance of an offer can also be demonstrated by way of conduct which evidences an intention to accept the offer.

Is it an acceptance or is it a counteroffer?

In order for an acceptance to give rise to a binding contract, it’s important that the specific terms of the offer have been accepted. If alternative terms are proposed, this will not amount to an acceptance of the offer, but will instead amount to a counteroffer. A counteroffer amounts to a rejection of the original offer so that no contract exists. Querying something, or seeking clarification about the terms of the offer, will not, however, amount to a counteroffer.

3          Consideration

What is consideration?

The requirement for consideration is in essence the principle that you cannot get something for nothing. It’s centres on the idea that a party cannot enforce a promise unless it has given or promised something in exchange for it. The law does not interfere with the bargain struck between two parties and so will not test whether consideration is adequate, so long that the consideration has a value, even if that is a pound.

Who must the consideration move between?

Consideration must move from the party who seeks to enforce a promise, as this is in line with the doctrine of privity to a contract, i.e. only those privy to the contract can enforce the rights under the contract. However, the consideration does not necessarily have to move to the person who makes the promise.

Does past consideration count?

Consideration which is given at some time in the past is not a valid form of consideration, this being an act which has come before the promise was made and therefore not something of value.

4          Intention to create legal relations

Why is this important?

If the courts determine an agreement was reached without a mutual intention to create legal relations, that agreement will not be legally binding.

What is required?

When considering whether the parties had the necessary intention to create legal relations, the courts will consider the conduct of the parties and all the relevant circumstances. If an intention is disputed, the onus is on the party who claims there was no intention to prove this allegation. In order to avoid any ambiguity, it’s beneficial for parties to clearly identify their intentions from the outset.

The business presumption

Businesses should be aware that there is a presumption that there is an intention to create legal relations in commercial circumstances. In the event a party objects to there being a presumed intention, the onus is on that party to prove otherwise.

5          Certainty of terms

Are the terms clear?

For there to be a legally binding contract, there must also be certainty of terms. This requires all the essential terms that form the contract to be complete and free from ambiguity. If an agreement omits a material term or is uncertain, this may lead to the agreement not being capable of being enforced.

The court’s approach

In assessing whether essential terms have been agreed, the court will assess whether an honest and reasonable businessperson would have concluded from the parties’ communications and conduct that they had agreed all the terms they considered to be a precondition to creating legal relations.

Generally speaking, the court will not wish to interfere with agreements reached between two commercial parties. However, in certain circumstances, the court does have the ability to fill in gaps in a contract to give effect to the parties’ intentions. This will depend on all the circumstances of the case.

What’s next…

Our next blog post in this series will examine the ‘battle of the forms’ and how to ensure that your contract terms govern your business relations.

If you would like to discuss this blog, please contact Paul Jonson on 07737571147 or by email to paul.jonson@pannonecorporate.com