Heading for the exit

The current climate has left some businesses seeking to pull out of their existing arrangements and terminate contracts with suppliers but any exit should be carefully considered.

Lawyers can assist a business in achieving its commercial aims with advice on tactics and in negotiation of the termination arrangements. It may be that the client wishes to reach a deal with its supplier that is outside of the terms of the original agreement, and lawyers can help to formulate and assess the options and backstop positions.

The decision in the recent case of Data Direct Technologies Limited (DDT) v Marks & Spencer plc [2009] EWHC 6 illustrates the consequences of not assessing the termination options correctly at an early stage. In this case, Marks & Spencer believed that it had an option to renew maintenance under a software licence with DDT for another year, and so did not need to exercise a right to terminate the services under the agreement.

However, the agreement actually provided that Marks & Spencer had to terminate the maintenance contract on notice before the start of the year. This cost Marks & Spencer an additional year's maintenance (which amounted to £135,844 plus VAT) in order to exit the arrangements.

Considering the exit

Severing the relationship will inevitably involve a consideration of the current arrangements both at an operational level and a legal level. The reason for the exit strategy may well have an impact on the tactics to be adopted. For example, is the termination to save costs, or is the supplier under-performing? It may be that the services are simply no longer required by the client, or there may be another reason to terminate the relationship. The client, for instance, may wish to appoint a new provider in the context of a global strategy, or it may want to change direction to bring back the services in house given the economic climate. If a termination is to be negotiated in the context of cost savings, this can make the situation particularly sensitive. These are all considerations to assess at the commencement of the project and are issues which can impact on the overarching strategy and practical approach to be adopted.

The process of termination

What governs the relationship?

First, establish which terms govern the relationship between the parties. In an ideal world the terms of the arrangements will be evidenced by a signed agreement with appropriately documented change control and variation agreements.

However, it is not unusual to be faced with a draft agreement which the parties may be acting on, unwritten terms established by conduct, or possibly a mixture of different terms (some written, some not). Consider therefore if there are any other provisions outside of the main written contract terms (e.g. a side letter or other correspondence) that could also impact on the commercial arrangements between the parties.

Which termination right?

A useful starting point is to assess the contractual termination rights which may be of benefit. Does either party have a right to terminate on notice? If seeking to rely on termination on the basis of another ground '“ e.g. insolvency or material breach by the supplier '“ the exact definition of the termination trigger and the relevant facts will need to be considered to determine whether this is commercially achievable.

The contractual prescribed process for termination (e.g. the notices clause) should also be complied with. Bear in mind also that an old breach may no longer be useful to rely on if it has been waived. In Tele 2 International Card Company SA v Post Office Limited [ 2009] EWCA Civ 9 the court held that a no waiver clause did not remedy failing to act on a breach for a 12-month period.

Similarly, not all breaches will be sufficiently material to allow a customer to terminate. In Dalkia Utilities Services plc v Celtech International Limited [2006] EWHC 63, for example, the court looked both at the circumstances surrounding non payment as well as the actual amounts which remained unpaid when considering whether non payment itself amounted material breach.

If there are no written terms then it may be that you consider whether the contract can be terminated on reasonable notice. The recent case of Jackson Distribution Limited v Tum Yeto Inc [2009] EWHC 982 (QB) acts as a reminder that the question of what is 'reasonable' will depend on the circumstances. Jackson was a distributor appointed on unwritten terms despite drafts having passed between the parties. The parties worked together for two years and Jackson had incurred investment costs. The court held a reasonable notice period in these circumstances was nine months. Jackson had argued two years, whereas Tum Yeto had originally purported to give only six months notice. Until this case was determined, lawyers may well have advised a shorter period in the circumstances.

Another tactic is to consider purposely 'walking away' from the contract while seeking to rely on the limits on liability. However, the courts recently held in Internet Broadcasting Corporation Limited (1) NETTV Hedge Funds (2) v Mar LLC [2009] EWHC 844 (Ch) that an exclusion or limit on liability in a contract which uses anything other than 'strong, clear language' to explicitly cover a deliberate, repudiatory breach will not cover such an action.

Tactics and other considerations

If terminating the contract on notice with a view to negotiating an earlier exit, other considerations come into play:

• The client will be without a provider upon the termination taking effect '“ is this commercially acceptable?
• During the notice the service provider may be less willing to go that extra mile '“ it may therefore be in both parties interests to agree an earlier termination date.
• Is the client prepared to pay a settlement sum to bring the arrangements to an early end and negotiate on a 'without prejudice basis'?
• Consider the amounts to be offered to bring the contract to an earlier close '“ should the settlement figure reduce if the negotiations are prolonged and meanwhile the contract has been running?
• Is the contract non-exclusive, or has the supplier been granted exclusivity? If any element of the contract is non-exclusive, it may be that the client can dual source instead of terminating.
• Can the client partially terminate, for example, in respect of a specific territory or end one element of the services? The existing contract may envisage a right to terminate in part.
• Similarly, is either party entitled to suspend in whole or in part? While a useful tool, be aware it can be used by a supplier against a client to greater detrimental effect.
• Does the existing contract contain any restrictions (e.g. non-solicitation clauses or post-termination restrictive covenants) that will hamper either party's position commercially? Do these need to be renegotiated or imposed as part of the negotiation process?

Is an exit agreement necessary?

If the circumstances surrounding termination are complex, it can be beneficial to deal with the handover of the services and settle the position between the parties by means of a separate exit/settlementagreement.

A key factor that will influence whether a separate negotiation and exit agreement is required will be whether the existing contract already deals adequately with post-termination issues.

Consider the following commercial terms:

• Handover arrangements '“ does the contract provide for an exit strategy or does one need to be agreed between the parties? Is the supplier obliged to help with the handover of services? Consider the adequacy of further assurance clauses and provisions which survive termination.
• Are there any particular items of equipment, records or information that the client or the new supplier will require?
• Ownership of intellectual property rights '“ which party will own the IPRs in anything created under the contract on a termination? Does the contract deal with who will retain the IPRs in the designs and materials that each party may want to use going forwards or does this need to form part of the negotiation?
• Employees/Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) '“ are there any employees dedicated to the provision of the services that will transfer back in house on a termination under TUPE or to a new provider? Does the contract deal with cost allocation under TUPE?
• Is there anything else that needs to be retained or shared after a termination? For example, software licences?
• Costs underwriting '“ if exiting early, are there any specific costs underwriting clauses or indemnities which need to be examined which may cover the suppliers costs of early exit? (Examine these so there are no unpleasant surprises.)

Settlement terms

If the parties have agreed a settlement sum to allow for early termination then as part of the arrangements a settlement agreement may be appropriate.

Consider the structure of the settlement so that it reflects a favourable tax position. If any agreed 'pay-off' is a payment of charges due to the supplier under the agreement then VAT may be payable, but if it is purely a settlement sum VAT may not be due. In addition to the commercial terms set out above consider the following:

• acknowledging the agreed date of termination and the fact that no claim is brought as a result of any early termination;
• whether the payment of a settlement sum is in 'full and final' settlement of all prior claims;
• a waiver of future claims by either party (or possibly just the supplier);
• an indemnity (covering the cost of future claims brought in breach of the waiver);
• any specific deal agreed exit provisions (to cover off the commercial terms above); and
• acknowledging any terms under the terminated contract which survive.

The road to a successful exit can be a rocky one. Time spent on tactics and understanding the commercial issues prior to actioning the termination can be beneficial to all parties in the long term.