Andrew Denny, Partner and Richard Farnhill, Senior AssociateAllen & Overy LLP

How do we get out of this? Terminating contracts in a time of financial crisis.

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The three regimes

Common law: repudiatory breaches Conditions precedent The termination provisions in your contract

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Common law

Some myths You can always terminate for breach If you do not terminate for breach, you cannot

recover damages, either Damages for breach are always calculated the

same way

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Common law

Two separate issues Breach

Failure to perform a term or terms of the contract Remedy – damages for losses caused by breach of

the clause or clauses Repudiation

Manifesting an intention not to be bound Remedy – option to terminate prospectively and claim

damages for loss of the contract “Anticipatory breach” is not a case of breach at all

but, rather, of repudiation

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Common law

The risk of wrongful termination Wrongful termination is, itself, a repudiatory breach For example

A has a loan facility with B Bank B Bank is in difficulty and it seems certain that it will be

unable to transfer funds on time Bridging finance will cost A £1m A replacement facility will cost A £15m B Bank’s profit on the facility is £20m If A sues on the breach alone he recovers £1m If A terminates with cause he recovers £15m If A terminates wrongfully, B Bank can sue for £19m

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Common law

The first step – classification of terms Condition Warranty Innominate terms

The types of repudiatory breach Breach of condition Serious breach of innominate terms Repeated other breaches in exceptional cases

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Conditions precedent

Different regime Specified obligations do not take effect Generally, no damages

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Termination Provisions

Two types of express termination clauses:

a) Failed performance (“Events of Default”)

b) Circumstantial events (“Termination Events”)

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Termination Provisions

a) Express provisions for failure to perform

ISDA Master Agreement 2002 Clause 5(a) defines an “Event of Default”, e.g. “failure to pay or deliver”

Clause 6 states what happens if an Event of Default occurs – right to specify Early Termination Date

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Termination Provisions

Frequently asked questions

Do I have to give notice or can I terminate immediately?

Can I terminate for breach even if the breach is trivial?

What is a “material” or a “substantial” breach?

Can I still claim damages if I terminate?

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Termination Provisions

Do I have to give notice before terminating?

Will depend on wording of contract

Generally:

Notice often not required if breach cannot be remedied

If can be fixed, usually have to give chance to do so – failure to rectify following notice adds to seriousness of breach

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Termination Provisions

Can I terminate for breach even if the breach is trivial?

Garden Guardian case: a cautionary tale

Court rejected argument that “any breach” could cause the right of termination to arise

Alan Auld Associates: repeated minor breaches can be repudiatory if they deprive the innocent party of substantially the whole benefit of the contract

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Termination Provisions

What about contractual freedom?

c.f. ISDA 2002 Master:

Clause 5(a)(i) – failure to pay or deliver

Clause 5(a)(ii)(1) – failure to comply with “any agreement or obligation”

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Termination Provisions

What is a “material” breach?

Not the same as a repudiatory breach

National Power – remediable breach likely to have serious effect on counterparty if not rectified

Dalkia Utilities – look at nature of breach – failure to pay three monthly instalments (out of 173) in a row was material

Why does “any breach” have to be a repudiatory breach while a “material breach” does not?

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Termination Provisions

What is a “substantial” breach?

Crane Co v Wittemborg – essentially the same as repudiatory breach

So why is “substantial” any different from “material”?

Anticipatory breach was not a breach for the purpose of this clause

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Termination Provisions

Can I still claim damages if I terminate?

Yes – but limited if breach is not also repudiatory:

Will recover loss suffered to date

Won’t get “loss of bargain” damages unless contract specifically provides for it

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Termination Provisions

b) Contractual provisions for circumstantial events

ISDA Master Agreement 2002, Clause 5(b) defines “Termination Events”, e.g. illegality

Clause 6 sets out consequences - may give only one party the right to terminate e.g. party who is not the Affected Party (if only one Affected Party)

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Termination Provisions

Would market turmoil constitute a “material adverse change”?

Check drafting

MAC clauses narrowly construed – WPP v Tempus

Reliance on a MAC clause can be perceived by the market as a sign of weakness

Alternatives:

Specify events / economic indicators / target performance to constitute a MAC

Texas Pacific Group relied on a termination right connected to Bradford & Bingley’s debt ratings to walk away from proposed £179m investment

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Termination Provisions

Drafting express termination clauses

Be specific re:

Breaches for which a party can terminate

What is meant by terms such as “material”, “substantial”, or “material adverse change”

Steps that are required to terminate (e.g. notice)

Consequences of termination e.g. damages for loss of bargain?

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Conclusions

Important points

Clearest to rely on an express termination clause, but take care if you wish to preserve the full benefit of the contract damages

Keep in mind difference between breach of a condition and condition precedent

Keep in mind the difference between breach and repudiation

For repeated small breaches, consider the cumulative position