It's over! When (and how) can you terminate a contract?

Contracts made during the boom times often don't look so rosy when there's a downturn, and some might start looking for a way out. When can you terminate a contract?

The High Court recently had to consider this very question, in Koompahtoo Local Aboriginal Land Council v Sanpine Pty Ltd (2007) 241 ALR 88. It explained the different types of terms in a contract (condition, warranty and intermediate) and when a breach of those terms will allow the other party to terminate at common law.

The contract, the breach, and the termination

Koompahtoo Local Aboriginal Land Council entered into a joint venture agreement with Sanpine Pty Limited for the development of land. Sanpine was responsible for the management of the project, and agreed to do various things, including to engage book-keeping and accounting services for the joint venture and the development and maintain all records and documents of the joint venture.

Six years later an administrator was appointed to Koompahtoo. The administrator attempted to determine the true financial position of the joint venture, and discovered that Sanpine had failed to keep proper books and accounting records. The administrator requested certain information and documents from Sanpine, but the request was not complied with.

The administrator, on behalf of Koompahtoo, purported to terminate the joint venture agreement on the basis that Sanpine's breaches of the joint venture agreement evinced an intention not to be bound by it (amounting to repudiation). Sanpine commenced proceedings, seeking a declaration that the purported termination was invalid and that the joint venture agreement was still on foot.

What is the common law right to terminate?

The High Court confirmed that the common law right of a party to terminate a contract will arise where the other party has repudiated the contract, breached an essential term of the contract, or committed a serious breach of an intermediate term. The focus should be the nature and seriousness of the breaches.

When is a term an essential term of the contract?

An essential term is otherwise known as a condition. Any breach of an essential term will always give the innocent party the right to terminate the contract (so as to discharge performance) and sue for damages.

A breach of a warranty, on the other hand, will never give rise to the right to terminate the contract and in cases where a warranty is breached, the only available remedy is the right to sue for any damage resulting from the breach.

Whether a term is a condition or warranty depends on the common intention of the parties at the time of the contract, that is, the intended importance of the relevant terms and the intended consequences of failing to comply with them. It does not turn on whether a term is so classified in the contract.

The High Court used the test of essentiality set out in Tramways Advertising Pty Ltd v Luna Park (NSW) Ltd (1938) 38 SR (NSW) 632:

"The test of essentiality is whether it appears from the general nature of the contract considered as a whole, or from some particular term or terms, that the promise is of such importance to the promisee that he would not have entered into the contract unless he had been assured of strict or substantial performance of the promise, as the case may be, and that this ought to have been apparent to the promisor.

If the innocent party would not have entered into the contract unless assured of a strict and literal performance of the promise, he may in general treat himself as discharged upon any breach of the promise, however slight".

Where a party breaches a contractual term, it is important that the innocent party applies this test to determine whether the term is an essential term of the contract. If the term isn't an essential term, then the next question is whether there has been a sufficiently serious breach of an intermediate term.

When will a breach of an intermediate term be sufficiently serious?

An intermediate term is neither a condition nor a warranty, and falls somewhere in between conferring an absolute right to terminate and not conferring any right to terminate at all. A breach of an intermediate term must be sufficiently serious to justify termination.

In the case of an intermediate term, the innocent party is entitled to terminate the contract if the breach deprives them of substantially the whole benefit they were intending to obtain by performance of the contract.

How will a court determine whether there has been a substantial deprivation? This will require a consideration of the seriousness of the events that flow from the breach of the term^[1].

In Koompahtoo, the High Court found that the breaches in issue deprived Koompahtoo of a substantial part of the benefit for which it had contracted with Sanpine (ie. the capacity to make informed decisions), and that those breaches justified the termination.

So when can I terminate?

In considering whether or not to terminate a contract, the following questions should, at the very least, be addressed:

Does the contract expressly exclude the common law right to terminate? If the contract contains a complete statement of the circumstances in which the contract can be terminated, the common law will be ousted.

Does the right exist at common law? It exists if the non-terminating party has either:

• repudiated its obligations under the contract;
• breached an essential term (otherwise known as a condition); or
• committed a sufficiently serious breach of an intermediate term.

Are any restrictions on the right to terminate at common law, for example, a waiver or estoppel?

When drafting commercial contracts, terms are often labelled as conditions or warranties. However, the labelling alone will not be sufficient for a term to fall within one of the established classes. The court will always have regard to the intention of the parties at the time of entering the contract. In order to determine intention, the court must construe the contract as a whole.

Termination must always be done carefully, because a party who purports to terminate without any right to do so might be held to have itself repudiated the contract, which would confer upon the non-terminating party the right to treat the contract as being at an end and to claim damages.

^[1] Carter J.W, "Intermediate Terms Arrive in Australia and Singapore" (2008) 24 JCL 226.^{Back to article}