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Understanding Termination Clauses in Commercial Contracts

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If you operate a business and have contractual relationships with other parties, you may consider including termination clauses in your contracts. These clauses, also known as cancellation or exit clauses, outline the conditions and procedures for ending a commercial agreement before the expiration date. These clauses are essential to provide clarity and certainty when ending the contractual relationship. They also minimise the risk of disputes. This article will explore the enforceability of termination clauses, best practices for drafting practical clauses, and how to use these clauses in specific industries in New Zealand.

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Types of Termination Clauses

Commercial contracts have different types of termination clauses for different circumstances. 

Scenario Termination Clause
One party breaches a material term of the agreementA clause allowing the terminating party to provide notice of the other party’s breach and a reasonable opportunity to cure it. Otherwise, the contract can be terminated. 
Either party can terminate the contract without causeA clause allowing either party to provide notice of their intention to end the contract. The notice must be within a specified period and can vary depending on the nature of the contract and the industry in which it operates. This termination clause is useful for contracts subject to changing circumstances or business needs, such as supply agreements or service contracts.
Specific circumstances arise, allowing the contract to automatically terminate A clause allowing parties to end the contract in specific circumstances, such as insolvency or bankruptcy, force majeure events or expiration of a fixed term. This termination clause is helpful for contracts involving significant risks or uncertainties, such as construction contracts or joint venture agreements.

Key Components

Termination clauses typically include several key components that define the terms and conditions of contract termination.

TermConditions
Termination EventsThese clauses identify the events or circumstances that trigger the right to terminate the contract. Common termination events may include breaches of contract, insolvency or bankruptcy, force majeure events, or mutual agreement between the parties.
Notice RequirementsThey set out how much notice must be given before termination, giving time to resolve issues.
ConsequencesTermination clauses explain what happens after termination, including any fees or property arrangements.
Survival ProvisionsSome parts of the contract, like confidentiality obligations, may still apply after termination, as stated in the termination clause.
Early Termination ConsequencesTermination clauses explain what happens after termination, including fees or property arrangements.

Enforceability of Termination Clauses

Under the Contract and Commercial Law Act 2017 (CCLA), contract termination clauses must comply with the general principles of contract law. This includes principles related to interpretation, enforceability, and remedies for breach. The CCLA outlines requirements for contract formation, performance, and termination, which may impact the validity and effectiveness of termination clauses.

The enforceability of termination clauses in New Zealand is subject to various legal principles. While parties are generally free to negotiate and include termination clauses in their contracts, courts will scrutinise these clauses to ensure they are fair, reasonable, and not contrary to public policy.

When drafting your termination clause, you should look out for the following.

Unconscionable ConductIf a termination clause unfairly favours one party, the courts might not uphold it. Factors like unequal bargaining power, lack of transparency, and oppressive terms may invalidate the clause.
Good Faith ObligationsParties to a contract must act in good faith in their dealings with each other. Termination clauses you draft or exercise in bad faith to unfairly benefit one party at the expense of the other may be subject to challenge and potential invalidation.
Statutory ProtectionsCertain laws in New Zealand, such as the Fair Trading Act and the Consumer Guarantees Act, protect consumers and small businesses against unfair contract terms, including termination clauses. Ensure your termination clauses comply with relevant laws to avoid potential challenges to its enforceability.
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Termination Clauses in Specific Industries

Termination clauses may differ across industries in New Zealand, depending on the nature of the contract and the risks involved. For example, such clauses in construction contracts may address issues such as delays, defects, or changes in scope. In contrast, clauses about ending an employment contract may address performance, misconduct, or redundancy issues.

Ensure you tailor your termination clauses to the specific industry you operate in and the risks involved. Likewise, be aware of relevant laws and regulations that apply to your industry, such as the Construction Contracts Act or the Employment Relations Act.

Key Takeaways 

Termination clauses are essential provisions that outline the circumstances in which your business can terminate a contract and the potential consequences. Understanding the key components and enforceability of termination clauses is critical to effectively managing contractual relationships, mitigating risks, and navigating disputes. By carefully negotiating and drafting these clauses following legal principles and best practices, businesses can safeguard their interests and ensure the orderly conclusion of contractual agreements. 

For more information, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.

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Helen Yu

Helen Yu

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