Date 2 February 2010
With every recession comes litigation, as people and businesses dispute more when business conditions are tough.
As the recession has unwound over the last 12 months, SA Law’s Commercial Dispute Resolution team have noticed a dramatic increase in clients contacting us at the “pre-litigation” stage. The majority have been doing so to avoid litigation wherever possible. As a result our advice has focused on dispute avoidance more than dispute resolution, as we strive to keep our clients away from expensive disputes and out of the courts wherever possible.
The area where we have been particularly busy is advising our clients on how to terminate or renegotiate existing contracts that, as a direct result of the recession, are now less profitable or even making a loss. In particular, clients working under framework agreements where pricing structures were set in the boom times, and are now obliged to carry out low volumes of work at a low price.
The relationships between a supplier and a customer are usually governed by some kind or contract, which could be a specific contract for a set job, a framework agreement covering all work between the parties, or either party’s standard terms and conditions of business. The contract will usually set the length of the agreement, the prices and the level of service required (sometimes by way of key performance targets) and will usually contain an express provision as to how the contract can be brought to an end.
Many businesses have found themselves wanting to downsize or consolidate their business, and possibly make redundancies, but are either committed to contracts with suppliers whose services they no longer need, or committed to supply services that are no longer economically viable. Getting out of an agreement may not be a straightforward matter; if you breach a contract, you could face a costly claim for damages
Below are our five top tips on what to do if you or your business finds itself in this situation:
1. Read the contract
Before you take any firm action, or start worrying about how to deal with a troublesome contract, the first thing you should do is read the contract thoroughly. By doing this you will make sure that you are properly prepared and appraised of the situation, and can be sure that you know your contractual position, all well in advance of contacting the other party.
Pay particular attention to clauses regarding the term or expiry date of the contract, as well as the termination clause and any notice provision. Next go through the operative clauses of the contract to check that both parties have complied with their obligations, as failure to do so could give you an easy way out.
If you are in any doubt as to the meaning or effect of any of the clauses in the contract, you should seek specialist advice from a solicitor as soon as possible.
2. Consider all options
Before you decide to take any firm action, take stock. Ask yourself whether you are certain that you want to bring the contract to an end, and whether this is the only course of action open to you. If you are reacting impulsively as a result of falling sales or rising overheads, or have found a more profitable or better-value or deal elsewhere, you may be able to talk to your customer/supplier and work out a way forward that suits both parties.
Don’t rush into serving notice or terminating the agreement until you have costed the implications of both leaving the contract and finding an alternative.
The chances are the other party will be feeling the pinch, too, and won't want to lose your custom. They may respond to your concerns by amending prices, increasing quality or changing service provisions, or agreeing to a temporary variation in the contract until sales pick up again.
Once you have considered all of the options above, if you are positive that you want to terminate the contract, you will need to exercise a legal right to exit if you have one. If you do you must ensure that you serve any notice which may be required in accordance with the agreement. Any failure to do so may well invalidate the notice and lead to an expensive dispute about the notice’s validity.
3. Termination clauses
Your contract should include terms that sets out the standard of service expected, the timetable for delivery, each party's responsibilities and the payment terms. It should also detail the conditions under which either side can end the agreement.
The contract may allow you to end the deal at any time, provided you give due notice. Before you do this, check whether you will have to make a penalty payment. Ideally, you will have agreed an exit clause with a minimal penalty. If not, the “fine” may be such that you are effectively locked into the contract. In these cases, it usually pays to be open with the other party and attempt to negotiate a better deal.
Look out for anniversaries in the contract or other key dates that might enable you to leave the contract without penalty. For example, many contracts operate on a rolling yearly term, which is automatically renewed on the anniversary of the term. These contracts can usually be terminated without penalty at the anniversary, but there may be strict notice provisions which, if not adhered to, mean the contract rolls on for another year.
4. Look for a Breach
If the other party has performed poorly or failed to meet its obligations, you might be able to terminate the contract for a breach on its part. Failure to carry out work within a specified time or make payments on time might be a 'material breach' which allows you to end the agreement immediately and possibly even claim additional damages caused by the breach.
You may be able to do the same if you have been the victim of misrepresentation - that is, you signed the contract on the basis of a written or verbal statement that turned out to be misleading or untrue. An example of this could would be if you are promised certain volumes of orders prior to entering a supply agreement, or if supplier tells you their product performs a particular function which it does not.
Neither of the above examples are likely to see you escape the contract without a lengthy legal battle, unless the breach or misrepresentation is blatant or obvious. You should always take legal advice before taking this cause of action as ending the contract in this way could be risky and may cause irreparable damage to your relationship with the other party. As such, although allegations such as these are often mentioned, more often than not they are simply another negotiation tool.
5. Negotiate
The best course is almost always to try to negotiate a mutually beneficial and cordial end to the relationship that leaves open the possibility of working together again the future. Some of the areas that you might consider a compromise are:
- Performing only the parts of the contract that are still profitable for you, and renegotiating the terms of the rest of the contract
- Renegotiating prices so that they are workable for both parties – the other party may prefer to pay slightly more rather than have no service at all
- Making a lump sum settlement payment now rather than continuing to incur losses over the whole contract term
- Do you offer other unused services that could be useful to the other party? Can you offer a good deal on these services in exchange for some flexibility on the main contract?
Finally, remember:
- Read the contract thoroughly
- Take legal advice on the termination clause
- Cost your exit. What will you save by an early exit?
- Once you know your position – contact the other party and begin negotiations.
- Be flexible, a little give and take may save you in the long run.
Hopefully you have found the above article useful, and will assist you if you find yourself in the position where you need to terminate or renegotiate a contract. If you would like more information or advice relating to a specific matter, please contact Robert Griffiths on 01727 798092 or any member of the Commercial Dispute Resolution team.
© SA LAW 2010
Every care is taken in the preparation of our articles. However, no responsibility can be accepted to any person who acts on the basis of information contained in them. You are recommended to obtain specific advice in respect of individual cases.