Terminating long term agreements that do not contain a termination clause

We received a query recently from an overseas client which wished to terminate its existing distribution arrangements with its Australian distributor and appoint a new distributor to take over its Australian distribution network. The Australian Distributor had been acting as the principal’s Australian distributor for the last 20 years and there had been no formal contract between them (well, none that they could find!). The overseas principal asked us what would be the legal, typical or acceptable notice period if it were to terminate the distribution agreement with its Australian distributor?

What we advised

If no notice period is prescribed in a contract, a court will require that ‘reasonable’ notice of termination be given. What is reasonable depends on the facts and context of the situation. Some of the factors a court may look at could include:

1. How long has the Distributor been acting as the Principal’s distributor? If the distributor has been acting as the Principal’s agent for a significant period of time a longer notice period would be expected.
2. How long would it take the Distributor to deploy its labour and equipment in alternative usage? This would be a significant factor if the Distributorship formed all or most of the Distributor’s business.  In such cases, a longer notice period would normally be considered appropriate in order for the Distributor to re-structure its business dealings. 
3. How long would it take the Distributor to carry out its existing commitments to third parties? The Principal would need to give the Distributor sufficient notice so that the Distributor could:
1. satisfy the requirements of any existing supply agreements with third parties; and 
2. bring any current negotiations to fruition.
4. Has the Distributor made extraordinary expenditure or effort for which it has yet to receive a reward? This would be a factor in situations where, for example, the Distributor has made significant expenditure on a new warehouse, but would not see the reward from this expenditure for some time, particularly if the Principal were aware of and had ‘approved’ the expenditure.
5. Has the Principal made any representations to the Distributor as to how long the Distributorship would continue? If the Principal has represented that the distribution agreement will continue on for some period, the Principal may be bound to those representations.
6. Could there be a conflict of interest between the parties if a long period of notice were given? If there is a real possibility that the Distributor could begin distributing products that compete with the products that it distributes for the Principal, a court may decide that a shorter period of notice is reasonably required.

Upshot

Our client was relieved to know that it could terminate the distribution agreement even though it did not have the right to do so under a formal written contract. After weighing up the facts in this case we were able to advise our client on a reasonable period of notice for termination.

Can you terminate a contract at common law for failure to pay?

A client was recently negotiating a government contract which did not allow the client an express right to terminate the contract for breach. Our client asked  us whether it could rely on its right to terminate a contract for breach of a fundamental term at common law if the government agency were to fail to make payment under the contract. Given that payment of our client’s fee was the only obligation that the government agency had under the contract surely our client would have the right to terminate the agreement if the government agency failed to carry out this essential obligation? Right? Wrong.

In a standard contract which requires one party to make payments to another party over a period of time (as distinct from a lump sum contract), it is actually unlikely that non-payment will give rise to a right to terminate at common law. A right to terminate at common law arises in three circumstances:

1. breach of condition or fundamental term
2. fundamental breach, and
3. repudiation.

The courts are reluctant to characterise non-payment as a breach of a condition, a fundamental breach or a repudiation of contract. Instead, the courts consider damages an appropriate remedy and will strive to keep the contract on foot. In the ordinary case unequivocal words or conduct, such as a statement to the effect that ‘we are not going to pay’ (i.e. repudiation), are necessary before a right to terminate will arise at common law. Even an express provision that payment is essential or is a condition of the contract may not give rise to a right to terminate. If a party does not say ‘we are not going to pay’ and simply does nothing, or says, ‘the cheque is in the mail’, this conduct may not be sufficient to give rise to a right to terminate a contract at common law.

To get around this problem, we negotiated a clause in the contract which gave our client a very narrow right to terminate. The right arose only in respect of payment of an undisputed invoice. The undisputed invoice was to exceed a specified sum and our client was required to give the government agency a longer than usual period of notice was before it could exercise its right to terminate the agreement. This small concession gave our client comfort that it had a way to exit the contract if it were not being paid. This case illustrates the importance of ensuring that your contract always contains an express right to terminate for breach. Without such a provision, a party could be left having to perform the services under the contract while it fights in court to be paid.