Understanding the Basics of a Termination for Cause
Definition of Termination for Cause
As discussed in the Introduction, a good contract should specifically define "cause". The most common definition of cause is a substantial failure by a party to perform a specific obligation in the agreement. So, what is "substantial" and what are "specific" obligations? The short answer is: probably a lot. The long answer is a little longer.
Typically, a contract that is terminable for cause will define cause as the following: failure to perform a material obligation under the contract, whether willfully, intentionally, or through gross negligence. Alternatively, in other contracts, cause may be defined as a breach of a material term, whether willful, intentional, or through gross negligence.
Sometimes a cause terminable contract will define cause as: failure to perform all duties , whether willful or negligent if such failure results in material harm to the business interests of the other party. In even broader terms, some contracts define cause as a breach of a representation, warranty or covenant under the agreement.
Examples of Conduct Warranting Termination for Cause:
- (1) Failure to follow contracts terms that result in significant damages;
- (2) Failure to pay another party in accordance with the contract (in failure to pay a vendor for goods or services that have been provided, the vendor may claim a mechanics or other lien against property subject to the contract);
- (3) Engaging in conduct that violates express provisions of the contract, where such conduct causes damage to a party’s reputation for which there is no adequate remedy, i.e., defamation;
- (4) Failure to procure mandatory insurance or bonds; and
- (5) Material failure to comply with all applicable laws.
Permissible Grounds for Termination
Legal grounds for termination for cause can arise in a variety of circumstances. Examples of some of these include: Breach of Contract. Parties have an obligation to fulfill the specific provisions of a contract. If they fail to do so, it can sometimes be used as a ground for termination. Failure to Perform. Sometimes the agreement for services itself makes the performance by one of the parties a condition of its effectiveness, and the failure to do so can lead to termination of the contract. Misconduct / Illegal Activity. Violation of a safety code, or a company policy, or the performance of an illegal act can sometimes permit termination. Takeaway: Parties need to carefully review their contracts to identify and determine the appropriate procedure in order to effectively terminate for cause.
How to Terminate a Contract for Cause
The precise steps that a party must take to terminate a contract for cause will depend, first and foremost, on the underlying contract. In almost all cases, however, the aggrieved party must first provide written notice of its termination decision to the other party. This notice may sometimes be referred to as a "termination letter." If the contract specifically requires the aggrieved party to give advance notice before terminating for cause, the terminating party must adhere to the contract’s notice requirements. Often, for example, the terminating party is required to give the other party written notice of the problematic conduct and a reasonable amount of time to cure the problematic conduct. In such cases, the aggrieved party need not give notice if the terminating party believes that the problematic conduct has not been cured. Following a termination of contract, the parties may have a reconciliation period during which the contract is still in effect, to give the aggrieved party an opportunity to fix any problems in order to avoid termination. Notably, if the contract does not require the aggrieved party to follow reconciliation procedures, the aggrieved party may still be entitled to terminate for cause without providing advance notice. Even if advance notice is not required, the contract may have other specific requirements that the aggrieved party must follow in order to validly terminate the contract.
In the absence of the requirement to provide advance notice before terminating for cause, the aggrieved party is usually not required to provide advance warranty of its intent to terminate the contract. Generally, the aggrieved party must, however, provide notice of the termination at the time of the termination. The notice may be provided directly to the other party or in some instances, to a third-party such as an agent or representative of the other party. Notice generally must be made in writing, although an oral notice of termination may be sufficient if provided before or during the time of the contract performance. Of course, these specific requirements may be altered by the terms of the contract itself.
In addition to satisfying any contractual requirements for providing notice, the aggrieved party should preserve proof of such notice, both for the sake of administrability and for the benefit of any future related litigation.
Wrongful Termination Consequences
The legal and financial consequences of wrongfully terminating a contract for cause can be severe. For example, if the aggrieved party wishes to enforce its contractual rights, it may file a breach of contract lawsuit against the wrongfully terminated party. Conversely, where the aggrieved party states that it chooses to waive the non-compliance, the remedy it may pursue is to seek damages for breach of contract due to wrongful termination for cause.
If the contract is of a commercial nature, and the issue of the aggrieved party’s loss has already arisen, a simple damages calculation could be put forward by the aggrieved party, which essentially boils down to the difference between the amounts that would have been payable by the principal debtor in the absence of the default and the amounts actually payable to the creditor. Although the quantum of damages must be established on the balance of probabilities, in the present case, the damages were awarded at 40% of the total value of the contract, based on the tribunal’s expert assessment.
Importantly, to succeed in a damages action, a party cannot recover quantum meruit or unjust enrichment compensation in excess of the amounts of the claim in the underlying contract.
Defenses to a Termination for Cause
In the event of a termination for cause, it is important to seek legal advice. The reasons why the employer believes there is cause must be evaluated and challenged if there is no actual reason to terminate. The facts must be identified and are likely be emotionally challenging because they may include the breakdown of the entire relationship. The termination notice period for termination for cause is zero (0). It is important to seek advice with respect to your entitlements.
If you have a grievance procedure in your contract with your employer, it is important for you to follow the requirements set out in your grievance procedure . Employers often set a time limit in which a grievance must be brought. If you do not bring a grievance within the time limit then in many circumstances you will not be able to make a claim for wrongful dismissal.
A grievance procedure will normally set out what steps must be taken to have an employer provide proof of cause and you should closely follow those requirements. You may wish to ask for:
If you have a unionized job, the grievance procedure in the collective agreement is mandatory. The process is binding on both parties. A unionized employee may have a great deal of contractual rights and benefits which are available and again it is important to closely follow the grievance procedure.
Termination for Cause: Examples
Case Study 1: Termination for Breach of Contractual Obligations
A technology company terminated a software development contract with its developer when the latter failed to deliver code for a new product within the timeframe specified in the contract. The software developer alleged that the software company was not ready to receive the final code since there were still changes it wanted to make to the design of the product. The court ultimately ruled in favor of the software company, finding that the software developer was in breach of the contract for failing to deliver code on time.
Case Study 2: Termination Based on Default and Bankruptcy
An international goods and services company terminated a contract with a supplier when the supplier went through bankruptcy proceedings in another country. The supplier had the right to appeal the termination if it did so within a set timeframe. The supplier appealed the termination but lost both in the initial dispute and in its final appeal. The appeal decision noted that while the default giving rise to the termination occurred in a non-customer jurisdiction that had limited contacts with the contract, the government of the customer jurisdiction had special interests and concerns that entitled it to terminate the contract.
Case Study 3: Contract Termination Based on Impaired Credit Rating
A construction company terminated a contract with a subcontractor. The contract included a clause that allowed the construction company to terminate if the subcontractor’s credit rating fell below a certain level. The subcontractor’s credit rating had fallen below the threshold level, but the subcontractor asserted that, for various reasons, it had not had the chance to cure the breach that had led to the termination. The termination was upheld since the unconditional right of both parties to terminate had been based upon the right of the construction company to terminate for impaired credit and not upon an event of default.
Avoiding a Termination for Cause
To prevent termination for cause, it is important to be aware of what may give rise to a valid termination notice and be conscious of your rights and obligations under the contract. The following tips may help ensure that you do not run afoul of the provision.
Open channels of communication and full transparency are essential in any business relationship. Without it, misunderstandings abound. As with any contractual relationship, poor communication is one of the quickest ways to breach a contract. Make sure you, your employees, and business partners understand the obligations you each undertake. For example, if you are engaged to provide services, familiarize yourself with the time frames for performance in addition to when payment is due. If you make clear efforts to fulfill your duties, you will be better positioned to defend against an untimely termination notice.
As noted above , contractual obligations vary from relationship to relationship and deal to deal. Always adhere to the terms of your contract to ensure compliance. If you find circumstances that will prevent your performance under the contract, be sure to raise that concern as soon as possible with all relevant parties. Timely notice may help resolve the situation or at least inform the other party that you are unable to fulfill your obligations. In some cases, a dispute can be avoided if you provide notice of nonperformance.
For all of the above, timely notice is key. A breach is still a breach whether or not it is curable. However, it will be substantially easier to defend against a claim of breach if you respond to the issues raised directly by the other party and show a willingness to correct them. In the case of long-term contracts, a record of communications regarding prior problems may help you establish a pattern of conduct that demonstrates your commitment to the contract in the first place.