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Most contracts in New Zealand will be set for a fixed period. This means that as long as the contract is binding, it will continue to have legal effect until the end of that period. At the end of that period, there will either be a right of renewal for both parties, or the contract will be over, and both parties will be free of any continuing responsibility.  In some situations, your contracting party may want to get out of the contract early. This could cause you to incur a loss as the contract is finishing earlier than you expected. Some contracts will have an early termination fee to cover any loss. This article will outline when you can charge an early termination fee and how it might impact your contracts.

What Is an Early Termination Fee?

As the name suggests, an early termination fee is a levy charged on a consumer to cancel a contract before the initial ending date. There are many reasons why somebody might want to terminate a contract, including finding a new contract or not needing the contract anymore. An early termination fee is usually levied for the contracting party to recoup any loss incurred by the early termination. 

What Is a Fixed Contract?

A fixed contract is a type of contract that has a set end date. The date is usually agreed upon by the parties when the contract is formed. For example, a commercial lease agreement may have a nine-year lease attached to it.

Right of Renewal

Some contracts will include a right of renewal. A right of renewal allows either party to renew the contract once the contract is coming to an end. This renewal is usually for the same amount of time as the original contract. When either party activates the right of renewal, the contract is usually re-negotiated to keep up with any changes needed. To activate a right of renewal, either party must write to the other party asking them to renew the contract. 

When Can a Termination Fee Not Be Charged?

As with any term, if the courts consider the early termination fee unfair, it will be unenforceable. A term is considered unfair if it:

  • causes an imbalance between the parties;
  • is not necessary to shelter your business’ legitimate interests; and
  • would cause harm or detriment to your customer if you enforced it. 

Harm or detriment does not have to be purely financial.

When Can I Charge an Early Termination Fee?

You can only charge a cancellation fee if it is within the terms of your contract and it is reasonable. One of the elements of a binding contract is that the terms in the contract must be certain. This means there can be no ambiguity in the wording. If your early termination clause is ambiguous, a court may deem that clause to be unenforceable. 

Clear Terms

There must be an early termination fee clause if you want to charge a termination fee. You cannot charge a termination fee if it was not in the original contract formed with your contracting party. To ensure your terms are clear, hiring a lawyer to draft your contract is always good. 

Reasonableness

You can charge an early termination fee if it is reasonable in the circumstances to do so. This usually means you have incurred some sort of loss because of the cancellation. Terminating a contract is a type of breach; there has to be loss suffered from charging an early termination fee.

An example of this is someone cancelling a restaurant booking a week in advance. A week is plenty of time for the restaurant to make another booking, so the restaurant incurs no loss. However, if someone cancels their booking half an hour before their booking, it would be reasonable to charge an early termination fee as it would be difficult for the restaurant to find another booking in time.

Key Takeaways

A fixed contract allows parties to form an agreement for a certain amount of time. Once the contract has come to an end, the parties can decide to renew it, or they can decide to cancel it. This means both parties are free of any obligations under the contract. However, sometimes parties want to leave their contracts early. This may cause a detriment to the other party. To balance this, early termination fees are levied on the party leaving the contract. They are legally enforceable as long as they are clear and reasonable. However, if they are considered unfair, the courts will not enforce them, and the party leaving the contract early will not have to pay it. 

For legal assistance drafting an early termination fee, contact LegalVision’s contract lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

Can I take a person to court over unfair contract terms?

No, only the Commerce Commission can find a contractual term unfair. This means that usually, only contracts with a significant impact on the commercial industry will be taken to court.

Can I charge as much as I want for an early termination fee?

No, it must be reasonable, so the courts may lower this amount if it is too high. 

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