Termination Clauses in IT Contracts

Exit routes assume a particular importance when projects for the supply of IT products or services become prolonged or look like stalling. The general principles applicable to the termination of contracts for failure of performance are simple to state, but parties to contracts can seldom be absolutely confident that a court or arbitrator will accept that the events which have or have not occurred are such as to justify the termination of a contract. There is often much scope for argument as to whether what has or has not happened amounts to a repudiatory breach of contract such as to give the innocent party a right of termination. There is no single definition of what amounts to a repudiatory breach. Established tests are to question whether a breach or series of breaches of contract “go to the root of the contract”, or “frustrate the purpose of the venture”, or deprive a party of “substantially the whole benefit which it was the intention of the parties as expressed in the contract that he should obtain”.[i] The answers to these questions are by no means always obvious.

This uncertainty is a particular problem in IT projects when time for performance has not been expressed to be “of the essence” of the contract, or where time has been extended in the belief that completion is within reach.

Many commercial contracts endeavour to inject more certainty as to when a right to terminate will arise by including express termination clauses. Such provisions are now included in many IT contracts.

Typically, express rights of termination may be linked to “any” or any “substantial” or any “material breach”, of contract, and they may provide for the party in default to be given a period of notice in which to remedy a breach of contract before the contract can be determined. Such express rights of termination may be expressed to be in addition to, or in substitution for, any rights of termination under the general law, ie termination for repudiatory breach at common law.

By way of illustration, the two new model agreements for IT Procurement published by the Treasury at the end of 2004[ii] spell out numerous specific grounds upon which the client authority can terminate for “cause”, by giving a written notice. These grounds include circumstances in which the contractor “is in material Default which it has failed to remedy” in accordance with a remedial process, or where “the contractor commits a material breach . which is irremediable”.

In practice, however, such provisions often fail to include the ingredients which will provide the certainty which is the object of the exercise. The meaning of any contractual provision depends in each case upon its precise terms against the background and in the context of all the other terms of the contract of which it forms a part. The true intention of the parties is often a matter of dispute, and the apparent meaning of words used may be overridden by the courts if such meaning “flouts business commonsense”.[iii]

Illustrative Cases

Thus, in The Antaios[iv] it was held that a term in the charter-party of a ship which provided that an owner could withdraw the vessel in the event of “any breach” of the charterparty must be interpreted as meaning “any repudiatory breach”, because literal interpretation flouted business common sense. In Rice (T/A The Garden Guardian) v Great Yarmouth Borough Council,[v] in which a term provided a right of immediate termination in the case of a breach of “any” obligation in a contract which was intended to last for four years, involved substantial investment or substantial undertaking of financial obligations by one party, and included a myriad of obligations of differing importance and varying frequency, it was held that a common-sense interpretation should be imposed upon the strict words of the contract and that a repudiatory breach or an accumulation of breaches that as a whole could properly be described as repudiatory were a pre-condition to termination pursuant to that term.

More recently in Peregrine Systems Ltd v Steria Ltd,[vi] a case concerning the licensing, customisation, and installation of software products, the court had to consider an express right to terminate linked to the breach of “any terms” of the contract which, if remediable, had not been remedied within 30 days of written notice of the breach having been given. The judge held, notwithstanding the notice requirement which afforded an opportunity for any remediable breach to be remedied, that termination under this provision was possible only in respect of a breach of contract which was repudiatory at common law. A right of termination for “any breach” which has not been remedied after 30 days does not, on the face of it, “flaunt business commonsense”, and the outcome at the trial serves to underline the lack of certainty surrounding the outcome of decisions to terminate IT projects even where express termination clauses are provided.

As has been seen, the termination provisions in the model agreements referred to above, like a good many other current IT contract forms, apply the adjective “material” to “default” and “breach”. The model agreements include a definition of “Default” (“any breach of the obligations of the relevant party . etc.”) but do not provide any definition of “material”, “material Default” or “material breach”. Nor do they include any further definition of “irremediable”.

In Glolite Ltd v Jasper,[vii] a case in which a contract provided that a right of immediate termination arose upon any “material and irremediable breach or if a remediable breach was not remedied within 28 days of a notice to do so”, Neuberger J observed that: “Whether a breach of an agreement is ‘material’ must depend upon all the facts of the particular case, including the terms and duration of the agreement in question, the nature of the breach, and the consequences of the breach”. In Phoenix Media Limited v Cobweb Information Limited,[viii] commenting on a similar provision, Neuberger J stated that materiality involved considering “the actual breaches, the consequences of the breaches . (the) . explanation for the breaches, the breaches in the context of the Agreement, the consequences of holding the Agreement determined, and the consequences of holding the Agreement continues.”

Such guidance is helpful, but it serves to illustrate, firstly, the limited nature of any palliative provided by the use of the adjective “material”, and, secondly, that it is a broad term. Probably it does not include a “minimal” or “technical” breach (eg performance a day late) but at one end of the spectrum it might be argued that a minor breach could be “material”, whilst at the other end of the spectrum it is not sufficiently specific to exclude entirely an argument that to be “material” a breach must be repudiatory at common law.

In Glolite Ltd v Jasper[ix] nobody appears to have argued that “material” limited the breach to a repudiatory breach and so it was not necessary for the judge to consider the issue. At present there appears to be no reported decision in which “material breach” has been held to be limited to a repudiatory breach. In DB Rare Books Ltd v Antiqbooks[x] it was held that “material” was to be defined as “serious” or “important” in a partnership deed where the parties agreed that a material breach by one would entitle the other to purchase the interest of the one in breach.

In National Power plc v. United Gas Company Ltd,[xi] in which a contract provided a right of immediate termination if a party “in material breach of any of its obligations” failed to commence to remedy the same within seven days of a notice requiring such remedy, Colman J held that a breach could be “material” even though it was not repudiatory, and that “material breach” meant one which in all the circumstances was wholly or partly remediable and if not remedied, was likely to become serious in the wide sense of having a serious effect on the benefit which the innocent party would otherwise derive from performance of the contract in accordance with its terms. The Court of Appeal in Crane Co v. Wittenberg AS[xii] held that a “substantial breach” meant a “repudiatory breach”.

Material Breach

Since the meaning to be attributed to any specific terms of a contract depends upon the precise terms of the contract itself and the factual matrix in which it is made, it is not possible to provide any categoric statement as to the circumstances in which the adjective “material” will be construed to be a reference to something less than a repudiatory breach or when it will not. However, it can be observed that a contract which reserves the common-law right of termination for repudiatory conduct and also includes a termination clause linked to a breach, or material breach, of contract provides a foundation for construing the express termination clause as being triggered by something less than a repudiatory breach – otherwise the express termination clause will be surplus. The inclusion or exclusion of a provision for notice to provide an opportunity to remedy a breach will also be of assistance: in the absence of such a notice provision, the courts will be reluctant to accept that the parties intended the contract to be terminated summarily except where a breach of contract is repudiatory.

So far as the drafting of contracts is concerned, it may be observed that, if the parties to a contract intend that it should be terminable for a breach of contract which is not repudiatory, it should be possible to devise wording which achieves this effect with clarity. Again, certainty as to the meaning of the expressions “material breach” or “material default” could be enhanced by providing an inclusive definition identifying breaches which will be deemed to be material (eg failure to complete stages or make payments by specific dates), or by identifying consequences (eg a period of prolongation or specified cost or expenditure escalation in respect of the project) which will be deemed to render a breach “material”. Any such definition would need to be inclusive rather than exhaustive because of the impossibility of foreseeing and providing for everything which might occur.

Remediable Breach

As already foreshadowed, the terms “remediable” and “irremediable” also give rise to uncertainties.

On the one hand it may be argued that a breach of contract cannot be “remedied” unless any damage already done is made good, and thus, for example, that an irremediable breach occurs whenever something which is required under a contract to be done by a particular date is not done by that date. On the other hand it can be argued that most defects or shortcomings are remediable as to the future if time and money are no object.

The meaning of the term “remediable” in a distributorship agreement was considered by the House of Lords in L. Schuler AG v Wickman Machine Tool Sales Ltd.[xiii] Lord Reid stated:

“It appears to me that . (the relevant) . clause is intended to apply to all material breaches of the agreement which are capable of being remedied. The question then is what is meant in this context by the word “remedy”. It could mean obviate or nullify the effect of a breach so that any damage already done is in some way made good. Or it could mean cure so that matters are put right for the future. I think that the latter is the more natural meaning. The word is commonly used in connection with diseases or ailments and they would normally be said to be remedied if they were cured although no cure can remove the past effect or result of the disease before the cure took place. And in general it can only be in a rare case that any remedy of something that has gone wrong in the performance of a continuing positive obligation will, in addition to putting it right for the future, remove or nullify damage already incurred before the remedy was applied. To restrict the meaning of remedy to cases where all damage past and future can be put right would leave hardly any scope at all for this clause. On the other hand, there are cases where it would seem a misuse of language to say that a breach can be remedied. For example, a breach of . (a clause restraining) . disclosure of confidential information could not be said to be remedied by a promise not to do it again.”[xiv]

In Expert Clothing Service and Sales Ltd v Hillgate House Ltd,[xv] a case in the Court of Appeal concerning a tenant’s breach of a positive covenant in a lease, it was held that: “. the concept of capability of remedy must be directed to the question whether the harm that has been done to the landlord by the relevant breach is for practicable purposes capable of being retrieved, and that in the ordinary case, the breach of a promise to do something by a certain time could for practical purposes be remedied by the thing being done, even out of time.”

This approach was followed in Peregrine Systems Ltd v Steria Ltd[xvi] where, as indicated above, the right of termination arose only if a breach of contract had not been remedied within 30 days of a notice of the breach. The judge dealt with the point as follows:-

“It seems to me that the whole purpose of a provision in a contract by which a party contemplating the determination of the contract for breach on the part of the other party has to give a notice, if a breach is capable of remedy, is to give the party in default the chance to avoid the consequence of termination of the contract if, in substance, the other party can, at the point at which notice is given, be put in the position in which he would have been but for the breach. It is difficult to see how such a provision could be of any practical utility if the fact that the date for performance of a positive obligation had passed meant that the breach of that obligation was to be taken to be irremediable, even if it could be performed late. Until the last date for performance had passed there was no breach. It would be strange if, in those circumstances, the moment there was a breach that breach was irremediable, however quickly thereafter the obligation could be performed. . In my judgment . the failure of Peregrine to perform by some particular date a positive obligation did not, of itself, mean that the breach was irremediable. Peregrine had 30 days after notice to perform the relevant obligation.”

It may be suggested that the concept of whether a “breach is for practical purposes capable of being retrieved” is a useful one in the context of the question of whether a breach of a contract for the supply of IT products or services is “remediable”. Defective IT development may always be capable of being put right technically, given sufficient time, even if it means starting again from the beginning, and in this sense it may always be “remediable”, but it does not follow that it would for “practical purposes” be “capable of being retrieved”. Where the customer has an entitlement to performance by a particular date or within a particular time-scale, a breach of contract which can technically be remedied but in fact can only be remedied within a time-scale at odds with the customer’s entitlement under the contract may not be regarded as being “capable of being retrieved” for “practical purposes”. Whether it is so regarded will depend upon the facts of each case, and in particular upon the commercial objectives of the customer which the contract was intended to address. Of course, where time is of the essence of a contract, it will be inherently difficult to argue that a breach of contract which is outstanding at the contractual date for completion is remediable. However, such an argument need not by any means be doomed to failure – much will depend upon the nature and seriousness of the consequences of the breach, and the time within which it can be remedied.

Conclusion

It should be noted that, as Neuburger J pointed out in Phoenix Media ltd v Cabaret Information Limited,[xvii] whilst materiality and irremediability are different concepts there is a degree of overlap between them. Thus, for example, if breaches of contract were deliberately committed and dishonestly concealed it would be a factor which would go to both materiality and irremediability; materiality because it would make the breaches graver, and irremediability because it would be easier to argue that the breaches irrevocably and negatively impacted upon what would otherwise be an ongoing business relationship involving trust and confidence between the parties.

So far as drafting is concerned, again it should be possible to inject further definition into the expressions “remediable” and “irremediable”. This might also be done by means of inclusive definitions along the lines suggested above, identifying breaches which will be deemed to be irremediable, or by identifying consequences which, for the purposes of the contract, are to be deemed to render a breach irremediable.

By way of conclusion, therefore, the present verdict on most current IT contract forms, including the model agreements referred to above, is that they still lack definition in important areas, and expressions commonly used to address this problem are not by themselves effective. Whilst a full-proof solution can never be guaranteed, it would not be difficult to inject greater definition into such forms.

David Blunt QC and Michael Taylor are barristers and members of the IT Group at 4 Pump Court, Temple, London, EC4Y 7AN. www.4pumpcourt.com