News - Construction News

Terminating contracts: The common pitfalls

3 Apr 18

As is well documented now, construction giant Carillion went into liquidation in January 2018. At the time of liquidation, the company’s debts were estimated at around £1.5Bn. It was the UK’s second biggest construction company. One of the key lenders to Carillion, Barclays, voted to provide more money to the company alongside HSBC. But with other banks refusing to lend, the firm was forced to wind up. This has caused uncertainty and legal issues for some companies and provided opportunities for others.

Mark James.

In the aftermath of the collapse, termination of contracts is a more prominent issue than ever. The issues surrounding repudiatory breaches and when companies can terminate contracts has once again been put in the spotlight in a recent case. Whilst not a construction case, the issues regarding termination are to be recognised by the construction industry and companies should take note of the impact.

The recent case of Phones 4U Ltd (in administration) v EE Ltd [2018] emphasises that getting the correct termination clause in a contract is a common risk. The case goes to show that prior to terminating a contract a party must analyse the full extent of the provisions to ensure it is not in breach.

The case revolved around EE terminating a trading agreement. Phones 4U (P4U) was to sell consumer pay-monthly contracts. P4U ceased to trade in September 2014. Clause 14.1 of the agreement gave either party the right, at any time, to terminate with immediate effect by giving notice in writing if there was a material breach committed to the other. EE sent a termination letter to P4U.

Clause 14.1.2 allowed for termination if any party is ‘unable to pay its debts or takes any steps to: initiate a composition, scheme, or other arrangement with any of its creditors.’ It was understood that the appointment of administrators gave EE the right to terminate in writing. However, P4U was also not under a breach of contract or involved in a breach if administrators were appointed.

Following termination of the contract, P4U brought proceedings against EE seeking unpaid commission fees. EE counterclaimed, and stated that P4U’s inability to continue trading amounted to a common law repudiatory breach, allowing it to terminate on the grounds of repudiation and further entitled it to a claim in damages. P4U had failed to engage in normal trading activity as authorised seller of EE products and EE stated this was a repudiatory breach. The amount was in the region of £200m.

The case of Hong Kong Fir Shipping Co. Ltd v Kawasaki Kisen Kaisha Ltd [1962] established that a repudiatory breach of contract will usually “go to the root of the contract”, “frustrate the commercial purpose” of the contract or “deprive the party not in default of substantially the whole benefit” of the contract. It is usually argued where there has been a fundamental breach of contract.

However, whether this amounted to a repudiatory breach of contract was not really the issue in the P4U case. The issue is what they said in the notice. P4U argued that EE’s counterclaim was unjustifiable because the wording in the original termination letter referred to a contractual right of termination, clause 14.1.2 of the contract, which therefore precluded the right to terminate on the common law grounds of repudiatory breach of contract.

The court agreed with P4U and stated that the termination letter was an express communication of contractual termination, unrelated to the common law right to terminate arising out of repudiatory breach. EE had to show that the contract was terminated by the exercise of its common law right to terminate for a repudiatory breach and it could not.

The letter sent by EE only communicated the contractual termination and it did not matter that EE could have terminated for other reasons. The judge held: “…it communicated unequivocally that EE was terminating in exercise of, and only of, its right to do so under clause 14.1.2, a right independent of any breach. Phones 4U was not accused of breach.”

The judge also commented in his judgment: “…but what EE cannot do is re-characterise the events after the fact and claim that it terminated for breach when that is simply not what it did. Nor can it say that it treated Phones 4U’s renunciation (as now alleged) as bringing the contract to an end when that, again, is just not what actually happened.”

This case, whilst not about a construction contract, shows once again in the wake of the Carillion collapse that termination of contracts can become a contentious issue. Where there are differences in a party’s stance, a terminating party cannot rely upon both contractual and common law termination rights. Termination grounds are mutually exclusive, and the notice must clearly define which grounds are relied upon.

In circumstances such as the P4U case and in many construction cases where there is both a contractual and the common law right to terminate, the terminating party must consider which method of termination will provide them with the best result. Parties can face further disputes should the notice not be supplied in the correct way, or if a party wrongly purports to terminate a contract, which may itself sometimes amount to a repudiatory breach of contract.