Katarina Morgan, a solicitor in the Commercial Litigation Department at Taylor Walton, discusses the important difference between cancelling and terminating a contract.

 

It is important that suppliers and customers assess their contracts and whether the terms still reflect the needs of both parties in this fast-changing commercial environment. But once signed, can changes be made to the contract?

In general terms, once a contract has been agreed it becomes binding and the parties will be legally bound to perform according to the contractual terms and conditions. However, in reality, it is not always that simple and things can go wrong.

If one party feels the contract is not being upheld, depending on the type of breach, they could either affirm the contract and claim damages; they could try to terminate the contract, or they might wish to cancel the contract, known legally as rescission.

Terminating a contract

Terminating a contract will require either or both parties to meet the obligations within the contract (such as confidentiality clauses or restrictive covenants). It essentially involves bringing the contract to an end to put the parties in the position as if the contract had taken place.

Termination happens by following an express termination clause in the contract itself by giving notice to the other party to terminate the contract. It can also happen if there is an implied clause permitting a party(ies) to terminate under common or statute law or automatically (e.g. if the contract has been frustrated).

Termination clauses can sometimes be unilateral and depending on the wording of the express clause and the circumstances, this could give rise to an unfair contract term argument.

Rescinding a contract

Rescinding a contract, however, means both parties are restored to the position they were in before the contract was entered into. When a contract is rescinded, it is set aside entirely – it is as if the contract never existed, and it therefore removes the parties’ obligations under the contract.

Rescission is an equitable remedy against a party who has committed a breach of contract, usually for misrepresentation or mistake. But rescinding is only applicable if the contract has not been affirmed.

Affirming a contract

Affirming a contract refers to the continued application of contractual terms after a repudiatory breach has occurred, with the sole intention of claiming damages in light of that breach. A repudiatory breach of contract takes place when one party fails or refuses to perform a fundamental term or condition of the contract.

The other party can either choose to accept that repudiatory breach of contract and rescind the contract, or they can choose to continue with it (affirm it) and claim damages instead; the circumstances will usually dictate the better option for the party not in breach.

This is just one reason why action to rescind a contract has to be taken promptly once a sufficient breach has been noted. Any delay could be used by the other party to argue that the contract was affirmed and thus the chance to rescind has been missed.

To rescind or affirm?

Because rescinding renders a contract retrospectively non-existent, the innocent party needs to consider what will give them the best outcome. That could include the return of valuable property being returned to them.

Rescinding a contract is not initiated by a Court, but by either of the contractual parties. The innocent party will inform the offending party of their intentions and if the matter is subject to  litigation, the Court will decide whether rescinding the contract was legally valid. If it was, the Court will make orders designed to give effect to the rescission of the contract.

Rescission will not be found valid by the Court if it believes the contract was affirmed, if a third party has acquired rights to any property subject to the rescission, or if it is impossible for the parties to be restored to their positions before entering into the contract.

Both sides of the transaction have to be returned to their original position for a contract to be rescinded. In some occurrences, this may prove challenging because the nature of the business or the property involved has been destroyed or substantially altered. The circumstances, therefore, have to be analysed before a decision is made to exercise rescission as it cannot be undone.

Navigating the exit of a contract can be extremely complex, especially if it depends on whether one of the parties is in breach or not and is not something to be undertaken without expert legal advice. Failure to do so could be catastrophic for the continuation of a business, both with regard to finances and reputation.