Termination of a Contract

From Max-EuP 2012

by Peter Huber

1. Definition and purpose

In European private law, the concept of the termination of a contract (sometimes also referred to as avoidance of a contract) refers to a situation where one party withdraws from a contract as a result of a non-performance by the other party. English law also refers to termination, whereas German law would use the term Rücktritt and French law the term résolution. Termination frees the parties from their respective obligations either as of the date of termination (such as Rücktritt in German law) or with retroactive effect (such as the résolution in the French Code civil). If one or both of the parties have already performed obligations under the contract, termination may lead to the unwinding of the contract (unwinding of contracts). As European private law usually regards the right to terminate the contract as a sanction for a non-performance by the other party, the term termination would not normally apply to an avoidance (or: rescission) of the contract for mistake, for fraud or for duress. Likewise it does not cover the situation where both parties agree to end the contract.

The remedy of termination aims at striking a fair balance between the aggrieved party’s interest in an effective sanction for the non-performance and the other party’s interest in keeping the contract intact. Most legal systems will at some point or other allow the aggrieved party to terminate the contract if there is a non-performance by the other party. The crucial issue, however, is not whether there is a right to terminate the contract, but rather when it will be available to the buyer. In this respect, there is a clear European (and international) trend towards an approach restricting the availability of termination within the system of remedies in favour of other remedies, such as claims for damages (see 3. below).

There are several reasons and policy considerations for curtailing the availability of termination. The first reason can be described by the long-standing principle of pacta sunt servanda. The agreement which the parties have reached by their free will should be honoured and enforced by the law as long as possible or sensible. The second reason for being opposed to termination as a remedy is an economic one. Termination of the contract may lead to a restitution of performances already made and thus to considerable costs and risks which could be avoided if the contract were not terminated and if the aggrieved party’s contractual interest were satisfied by, for example, a claim for damages. Furthermore, termination of the contract may lead to harsh consequences for the non-performing party in that its efforts made in order to effect performance may be frustrated and in that it will have to re-assume the market risk concerning the object of the contract (eg goods or services) which under the contract would have had to be borne by the aggrieved party.

2. Historical background

From a historical perspective, the general right to terminate the contract has not always been universally accepted. Thus, in Roman law, there was no general right to terminate the contract for non-performance. There were, however, exceptions to this general principle. Thus, a sales contract could be terminated under the actio redhibitoria. On that basis, the buyer could terminate the contract if the goods did not have the qualities that had been promised or if the seller had deceived it (see further price reduction). Today, most legal systems provide a general right to terminate the contract, albeit under different conditions and on different theoretical foundations.

3. The modern trend to restrict the scope of termination

From an international perspective, the 20th century brought a clear trend towards restricting the availability of termination as a remedy for non-performance. Several modern sales laws (such as the CISG, the Consumer Sales Directive (Dir 1999/44) (sale of consumer goods) and the new German sales law (sale)) as well as international instruments (such as the UNIDROIT Principles of International Commercial Contracts (PICC), the Principles of European Contract Law (PECL), and the Common Frame of Reference (CFR)) regard termination of the contract as a remedy of last resort which should only be granted if other remedies (such as performance, price reduction or damages) will not lead to an adequate result.

A comparative analysis of the modern rules reveals three instruments which can—on their own or combined with each other—serve to restrain the scope of termination as a remedy: the fundamental breach doctrine, the so-called Nachfrist-mechanism and the concept of the right to cure.

The doctrine of fundamental breach restricts the buyer’s right to terminate the contract to those cases of non-performance which are so serious that the aggrieved party is substantially deprived of what it was entitled to expect under the contract. It is the guiding principle of the CISG (Art 49(1)(a)), the UNIDROIT PICC (Art 7.3.1(1)), the PECL (Art 9:301(1)) and the DCFR (Art III.-3:502). Today, the doctrine of fundamental breach is also part of the Scandinavian Sales Laws and those legal systems which have taken their inspiration from the CISG, such as the new Estonian law of obligations. There are also certain parallels to English law where both the distinction between conditions (the breach of which will entitle the other party to terminate the contract) and warranties (the breach of which will only lead to a claim for damages) is based on similar criteria as the fundamental breach concept of the international texts. Thus, for example, one of the criteria to distinguish between a condition and a warranty looks at whether the other party is substantially deprived of the entire benefit it was entitled to expect; see Hong Kong Fir Shipping Co Ltd v Kawasaki Kisen Kasha Ltd [1962] 2 QB 26, 70 (CA).

The Nachfrist-mechanism is the centre-piece of the new German law of obligations. As a general rule, the aggrieved party may only terminate the contract after an adequate additional period of time has been fixed and has expired. Thus, the aggrieved party has to give the non-performing party a ‘second chance’ by fixing the additional period of time. The Nachfrist-principle has also found its way into the UNIDROIT PICC (Art 7.3.1(3), 7.1.5), the PECL (Art 9:301(2), 8:106(3)), the DCFR (Art III.-3:503) and the CISG (Art 49(1)(b)). Here, however, it is limited to specific types of non-performance, in particular to cases of late performance or non-performance.

Many legal systems give the non-performing party a right to cure (see further under supplementary performance). This approach is closely related to the Nachfrist-mechanism but starts from a different perspective. If the aggrieved party complains about the non-performance, the seller has the right to prevent the termination by performing properly within a reasonable period of time and under adequate circumstances. This differs from the Nachfrist technique in that the initiative which triggers the cure mechanism does not start on the side of the aggrieved party (who would have to fix the Nachfrist), but on the side of the non-performing party who may offer substitute performance if it wants to keep the contract alive. As a general rule, but with differences in detail, the right to cure is acknowledged in the UNIDROIT PICC (Art 7.1.4), in the DCFR (Art III.-3:202) and in the PECL (Art 8:104). Under the CISG, the seller has a right to cure (Art 48) which, however, has triggered a considerable amount of doctrinal controversy with regard to its interrelation with the buyer’s right to terminate the contract. The right to cure is also part of, for example, the American UCC, Dutch law, Italian law and the Scandinavian legal systems, albeit, of course, with differences in detail.

4. The right to terminate in more detail

Rules on the termination of a contract need to answer the following questions: What are the requirements for the right to terminate the contract? How is the right to terminate the contract exercised? What are the consequences of termination? These issues will be dealt with in turn.

a) Grounds for termination

Modern legal instruments are mostly based on a unified concept of non-performance which, for example, would cover a delay in performance (irrespective of whether or not performance is later made), non-conforming performance and the infringement of ancillary duties (see Art 8:101(1) PECL; Art 7.1.1 UNIDROIT PICC; Art 45(1) CISG; Art III.-3:101 DCFR).

On that basis, there are usually two grounds of termination, namely the fundamental non-performance and—to a limited extent—the non-performance after an additional period of time set for performance by the aggrieved party (Nachfrist) has expired (Art 9:301 PECL; Art 7.3.1 UNIDROIT PICC; Art 49(1) CISG; Art III.-3:502, 3:503 (DCFR)).

The instruments differ slightly in how they try to define when a non-performance is fundamental. While the CISG gives a rather general definition in Art 25, the UNIDROIT PICC, the PECL and the DCFR name specific factors that may be taken into account in the fundamental non-performance analysis. A factor which seems to be common to all four instruments is whether the aggrieved party is substantially deprived of what it was entitled to expect under the contract in a way that was foreseeable to the non-performing party (Art 8:103(b) PECL; Art 7.3.1(2)(a) UNIDROIT PICC; Art 25 CISG; Art III.-3:502(2)(a) DCFR). Regard is also to be had to whether strict compliance with the contractual obligations was the essence of the contract. Sometimes, this factor is mentioned explicitly (see Art 8:103(a) PECL; Art 7.3.1(2)(b) UNIDROIT PICC), sometimes it can be taken into account under the general formula (Art 25 CISG; Art 3:502(2)(a) DCFR). Further factors that may be taken into account are the seriousness of the non-performance and—at least according to some instruments—the question whether the aggrieved party could reasonably be expected to use the non-conforming performance in a different way than expected and to claim any financial loss resulting from such other use by way of damages.

As a general rule, fault is not a requirement for the termination of the contract. Specific forms of fault, however, may be regarded as factors indicating a fundamental breach (Art 8:103 (c) PECL; Art 7.3.1(2)(c) UNIDROIT PICC; Art 3:502 (2)(b) DCFR).

Irrespective of whether the non-performance was fundamental, most instruments—to a certain extent—entitle the aggrieved party to terminate the contract if it has fixed an additional period of time of reasonable length for performance and if the other party has not performed within that period (Art 9:301(2) PECL; Art 7.3.1(3) UNIDROIT PICC; Art 49(1)(b) CISG; Art 3:503 DCFR). This Nachfrist-mechanism, however, is usually restricted to certain types of non-performance, in particular to cases of delay.

Finally, the common law concept of anticipatory breach has been accepted by most legal instruments in some form or other (see Art 9:304 PECL; Art 7.3.3 UNIDROIT PICC; Art 72 CISG; Art III.-3:504 DCFR). Thus, for example, there may be a right to terminate where prior to the date of performance it is clear that there will be a fundamental breach by the other party.

b) Operation of the right to terminate

Under the European and international instruments, the right to terminate the contract is usually exercised by notice to the other party (Art 9:303(1) PECL; Art 7.3.2(1) UNIDROIT PICC; Art 26 CISG; Art III.-3:507 DCFR); in that respect the instruments differ from some domestic legal systems (eg France, Belgium, Italy, Spain). The notice has to be given within a reasonable time after the terminating party knew or ought to have known of the non-performance (see, with differences in detail, Art 9:303(2) PECL; Art 7.3.2(2) UNIDROIT PICC; Art 49(2) CISG; Art III.-3:508(1) DCFR). In certain cases it will not be necessary to make a specific declaration of termination. Thus, by way of example, the aggrieved party may in its notice fixing an additional period of time (Nachfrist) provide that the contract shall automatically terminate if the other party fails to perform within that period of time (Art 8:106(3) PECL; Art 7.1.5(3) UNIDROIT PICC; Art III.-3:507(2) DCFR). Another example where a declaration of termination may be unnecessary is the case where performance is impossible (see Art 9:303(4), 8:108 PECL).

c) Consequences of termination

Termination usually releases both parties from their obligations to make (or accept) future performance, but not from their liability for damages. Furthermore, termination usually does not affect provisions for the settlement of disputes or other terms which are meant to operate even after a termination of the contract (Art 9:305 PECL; Art 7.3.5 UNIDROIT PICC; Art 81(1) CISG; Art III.-3:509 DCFR). Despite the fact that termination as a general rule only operates for the future, there will usually be claims resulting from the necessity of unwinding the contract (unwinding of contracts; Art 9:306 ff PECL; Art 7.3.6 UNIDROIT PICC; Art 81(2), 82 CISG; Art III.-3:511 ff DCFR).

Literature

Ernst Rabel, Das Recht des Warenkaufs, vol 1 (1936) and vol 2 (1958); Guenter H Treitel, Remedies for Breach of Contract (1988) 318 ff; Reinhard Zimmermann, The Law of Obligations (1996) 800 ff; Axel Flessner, ‘Befreiung vom Vertrag wegen Nichterfüllung’ (1997) 5 ZEuP 255; Peter Schlechtriem, ‘Abstandnahme vom Vertrag’ in Jürgen Basedow (ed), Europäische Vertragsrechtsvereinheitlichung und deutsches Recht (2000); Christian von Bar and Reinhard Zimmermann (eds), Grundregeln des Europäischen Vertragsrechts (2002) 439 ff, 450 ff, 495 ff; Reinhard Zimmermann, The New German Law of Obligations (2005) 66 ff, 107 ff; Peter Huber, ‘Comparative Sales Law’ in Mathias Reimann and Reinhard Zimmermann (eds), The Oxford Handbook of Comparative Law (2006) 937 ff; Peter Huber and Alastair Mullis, The CISG (2007) 209 ff.

Retrieved from Termination of a Contract – Max-EuP 2012 on 19 May 2022.

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