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Contracts under the microscope

Katarina Morgan explains the differences between cancelling and terminating a contract, and why these matters are rarely straightforward.

IN most circumstances, once agreed, a contract becomes binding. After this point, the parties involved become legally obliged to perform as per the contractual terms and conditions. However, as with most things in life, these things are rarely straightforward, and in reality, things can go wrong. For example, should one party feel that the contract isn’t being properly upheld by the other, depending on the circumstances, they will then have a difficult decision to make.

They could either affirm the contract and claim damages; they may look to terminate the contract, or they could seek to ‘rescind’ or cancel the contract.

But how do these actions differ, and how do they impact the parties involved? In this article, we explain just how a contract works and address on what grounds signatories can exit a contract-gone-wrong.

Terminating a contract
In order to terminate a contract, those involved must have met the obligations outlined within the contract (such as confidentiality clauses or restrictive covenants). Terminating essentially means you are ‘ending’ a contract, as if the purpose of the contract has been achieved.

One party should give notice of its intent to terminate as per the termination clause in the contract itself, but it can also occur if there is an ‘implied’ clause which permits a party to terminate under common or statute law or automatically (eg where the contract has been frustrated).

On occasion, termination clauses will be unilateral and depending on the exact wording of the express clause and the circumstances, this could present an argument for an ‘unfair’ contract term.

Rescinding a contract
When a contract is ‘rescinded’ both parties will be returned to the position they were in before the contract was agreed on. Essentially, the contract is set aside entirely, as if never existed. This removes both parties’ obligations to fulfil it.

Rescission is an equitable resolution against a party who has committed a breach of contract, usually through misrepresentation or mistake but is only applicable if the contract has not first been affirmed.

Affirming a contract
When contractual duties continue to be carried out even after a repudiatory breach has been discovered, this is referred to as ‘affirming’ a contract. It’s generally done when the wronged party wants to claim damages resulting from that breach.

Repudiatory breaches occur when one party either fails to or refuses to perform a fundamental term or condition of the contract.

At that point, the aggrieved party can choose to either accept that repudiatory breach and rescind the contract, or they could decide to carry on undertaking its duties (thus affirming it) and claim damages instead. The unique circumstances of the breach will usually dictate which is the better resolution.

The decision to rescind should always be taken promptly. Any delay in doing so could allow the opposing party the opportunity to argue that affirmation has already taken place and the chance to rescind will have been missed.

To rescind or affirm?
Because rescinding effectively renders a contract ‘non-existent’, the innocent party will need to fully consider which of these actions will give them a better outcome. For example, would the return of valuable property be more fruitful than any damages they could claim?

The move to rescind isn’t something that will be initiated by a court. It must be undertaken by either of the contractual parties. Usually, the innocent body will inform the offender of its plan to rescind the contract, then 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 which will give effect to the rescission.
If the court believes the contract was affirmed, the rescission will not be valid. The same will be true in the event that a third party has acquired rights to any property subject to the rescission, or if either signatory cannot be restored to their pre-contractual position.

Both parties of the transaction must be returned to their original position for a contract to be rescinded. In some instances, this can be challenging owing to the nature of the business, or when any property involved has been destroyed or substantially altered to meet the need of the contract.
It is imperative, therefore, that the unique circumstances of the case be closely analysed before a decision is made to rescind, as once initiated, it cannot be undone.

Negotiating the exit of a contract is an intricate act, especially where there is doubt over whether one of the parties is in breach or not. Expert legal counsel will be essential to ensure the most appropriate course of action is taken. Failure to do so could be devastating for the future of any business, both with regard to finances and reputation.
Katarina Morgan is a solicitor in the commercial litigation department at Taylor Walton

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