In general terms, once a contract has been agreed it becomes binding and the parties will be legally bound to perform according to the contractual terms and conditions. However, in reality it is not always that simple and things can go wrong.
If one party feels the contract is not being upheld, depending on the type of breach, they could either affirm the contract and claim damages ; they could try to terminate the contract, or they might wish to cancel the contract, known legally as rescission.
But how exactly do these actions vary, and what will the impact be on the parties involved? Here we explain how contracts work and what the difference is between rescinding (cancelling) or terminating a contract.
Terminating a contract
Terminating a contract will require either or both parties to meet the obligations within the contract (such as confidentiality clauses or restrictive covenants). It essentially involves bringing the contract to an end to put the parties in the position as if the contract had taken place.
Termination happens by following an express termination clause in the contract itself by giving notice to the other party to terminate the contract. It can also happen if there is an implied clause permitting a party(ies) to terminate under common or statute law or automatically (e.g. if the contract has been frustrated).
Termination clauses can sometimes be unilateral and depending on the wording of the express clause and the circumstances, this could give rise to a unfair contract term argument.
Contracts will, however, often contain provisions for termination in specified circumstances, such as material breaches, or one of the parties to the contract changing control. In addition, parties enjoy common law rights of termination, unless these have been specifically excluded within the contract.
If a termination clause is not expressly included within the contract, the right to terminate after a ‘reasonable notice’ will be implied. What is deemed to be ‘reasonable notice’ will vary, but typically the Courts consider:
- How formal is the relationship between the parties is?
- How long has the commercial relationship existed and how much have the parties invested?
- What is the length and scope of the contract?
- What is standard notice in the industry?
Each case will have to be assessed on an individual basis to ensure “reasonable notice” is given.
Terminating a contract does not always have to take place because a party is in breach. It can happen if one of the parties has become insolvent or it simply wants to bring the contract to an end.
Before terminating a contract, parties should assess whether there needs to be an ongoing relationship. If there does, it might be more prudent to renegotiate the contract, vary its terms or work through a dispute escalation procedure to find a mutually agreeable solution.
Rescinding a contract
Rescinding a contract, however, means both parties are restored to the position they were in before the contract was entered into. When a contract is rescinded, it is set aside entirely – it is as if the contract never existed and it therefore removes the parties’ obligations under the contract.
Rescission is an equitable remedy against a party who has committed a breach of contract, usually for misrepresentation or mistake.
But rescinding is only applicable if the contract has not been affirmed.
Affirming a contract
Affirming a contract refers to the continued application of contractual terms after a repudiatory breach has occurred, with the sole intention of claiming damages in light of that breach.
A repudiatory breach of contract takes place where one party fails or refuses to perform a fundamental term or condition of the contract. The other party can either choose to accept that repudatory breach of contract and rescind the contract, or they can choose to continue with it (affirm it) and claim damages instead; the circumstances will usually dictate which is the better option for the party not in breach.
This is just one reason why action to rescind a contract has to be taken promptly once a sufficient breach has been noted. Any delay could be used by the other party to argue that the contract was affirmed and thus the chance to rescind has been missed.
To rescind or affirm?
Because rescinding renders a contract retrospectively non-existent, the innocent party needs to consider what will give them the best outcome. That could include the return of valuable property being returned to them.
Rescinding a contract is not initiated by a Court, but by either of the contractual parties. The innocent party will inform the offending party of their intentions and if the matter is subject to litigation, the Court will decide whether rescinding the contract was legally valid. If it was, the Court will make orders designed to give effect to the rescission of the contract.
Rescission will not be found valid by the Court if it believes the contract was affirmed, if a third party has acquired rights to any property subject to the rescission, or if it is impossible for the parties to be restored to their positions prior to entering into the contract.
Both sides of the transaction have to be returned to their original position for a contract to be rescinded. In some occurrences, this may prove challenging because the nature of the business or the property involved has been destroyed or substantially altered.
The circumstances therefore have to be analysed before a decision is made to exercise rescission as it cannot be undone.
Are the contract terms fair?
One of the other aspects the parties may need to consider is whether the contract terms are actually fair. Depending on whom the contracting parties are will depend on which legislation will apply: B2B contracts will be governed by the Unfair Contract Terms Act 1977 whilst B2C contracts (entered into before 1 October 2015) will be governed by the Consumer Rights Act 2015.
The starting point on unfair contract terms is to ensure that they are drafted and checked carefully to ensure they cannot be considered unfair in light of the legislation. In doing so, the parties would need to look at is whether or not the contractual term is automatically unfair; for example, attempts to exclude the implied terms as to the quality of goods or digital content, or to exclude liability for death or personal injury caused by negligence will be automatically unfair and in breach of the legislation.
Depending on the contracting parties (B2B or B2C), the next step is to evaluate whether the terms are fair or not. All terms in consumer contracts and notices must be transparent and a lack of transparency may indicate unfairness. Any unfair term will be non-binding on consumers.
In contrast with B2B contracts, the law respects freedom of negotiation between businesses and they are therefore free to enter into whatever contracts they see fit. There is therefore no general fairness or transparency test and for that reason, the best starting point for businesses is always to ensure they are comfortable with the contract terms and their commercial implications before signing them.
However, there are a few arguments that a business could explore to invalidate or tone down the effect of a term that appears unfair by looking at the reasonable test.
The legislation says that a contract term must have been a “fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made“. What this means is each case will be fact specific but the Court will take into account the circumstances the contract was entered into, the size and weight of the parties and whether they took legal advice/had solicitors prepare the draft contract.
Navigating the exit of a contract can be an extremely complex act especially if it depends if one of the parties is in breach or not, and whether a term is also unfair or not. It is not something that should be undertaken without expert legal counsel to advise on the best course of action and failure to do so could be catastrophic for the continuation of a business, both with regard to finances and reputation.