Tuesday, March 20, 2012

Managing Terminations

The main things that impact how you terminate a contract are the termination rights reserved in the contract and whether the termination is being done for cause or without cause.

Termination without cause.
If you have the right to terminate a contract without cause, in most cases all that’s required is a notice of termination as provided for under the contract. That notice of termination can be in the form of a letter where you reference the contract number and specific section of the contract that allows termination for convenience. You inform the other party that the agreement is being terminated in accordance with that section on a specified date. As that letter is functioning as a notice or formal communication between the parties for it to be effective it must be communicated in the manner agreed in the contract for parties to provide form notices or communications to the other party. As termination may create liability for materials or work in progress its best to communicate the termination using a method that shows proof of delivery.

Aside from potentially providing the notice of termination without cause, the contract manager will be responsible for managing the negotiation of any liability associated with the termination. The scope of the negotiation will be dependent upon the language included in the termination without cause section. For example assume that section says:
“Buyer may terminate without Cause effective immediately or as otherwise specified in such notice, and will compensate Supplier for the actual and reasonable expenses incurred by Supplier for work in process up to and including the date of termination, provided that:
(i)Supplier uses reasonable efforts to mitigate Buyer’s liability under this Subsection by, among other actions, accepting the return of, returning to its suppliers, selling to others, or otherwise using the canceled Products (including raw materials or works in process), and
(ii)Such expenses do not exceed the Prices.
Upon termination, in accordance with Buyer’s written direction, Supplier will immediately:
1. Cease work;
2. Prepare and submit to Buyer an itemization of all completed and partially completed Products and Services;
3. Deliver to Buyer Products satisfactorily completed up to the date of termination at the agreed upon Prices; and
4. Deliver upon request any work in process.”

With that language the contract manager would be responsible to:
1.Determine that the amounts being charged are actual and reasonable. This would include performing a detailed review of all costs being charged to ensure that each charge meets those two criteria.
2.Review whether the supplier used reasonable efforts to mitigate those costs as in this case mitigation of the liability was a condition of payment. Understand what efforts they took to mitigate the liability and whether those efforts met the standard or “reasonable” efforts.
3.Verify if the amounts being charged to ensure that the total of those charges do not exceed the price of the item being cancelled.
4.Review whether the work was ceased immediately as work performed after the effective date to the termination is not to be performed.
5.Review the inventory of all completed and partially completed work, potentially determining to have certain work completed.
6.Ensure satisfactorily completed work is delivered and inspected to ensure compliance with acceptance procedures.
7.Determine internally whether any partially completed work should be shipped to the buyer or be scraped or disposed of paying the supplier for those scrap or disposal costs.
8.You would manage the return of any buyer owned materials or products being held at the supplier under separate agreements and withhold any final payments until the receipt of those.

Termination for Cause.
In terminating for cause you normally would have two letters. The first is a cure letter notifying the other party that they are in breach of the contract. In those notice you provide the objective reasons for the other party being in breach of the agreement. This is usually a list of all the things that they were supposed to do or deliver which have not been performed. In that you reference the obligation they had, when they had to meet that obligation and what their actual performance or progress was. Next in the cure notice you need to tell them they need to cure the breach (if they have the right to cure) within the specified cure period. If there was no specified cure period a reasonable cure period would be required and you would still establish the date by which you want the breach cured.

If the other party can’t cure the breach (such as would occur with a wrongful disclosure of confidential information), or fails to cure within the allowable time frame. The second notice is the actual termination notice. Below is a simple example of each.

If they didn't have the right to cure or the breach was something that isn't curable, I would combine the content of the two letters into one listing the specific breach or breaches that occurred and notifying them of the termination. The key is to terminate for cause it must be a material breach and you need to tell them what their obligations were and how they failed to meet those obligations making it a material breach of the agreement.


ABC Company
One Main Street
Anytown, Anystate Anyzip

ATTENTION: John Q. Public

SUBJECT: Notice to Cure of SOW 49xxxxxxxx / PO 500xxxxxxx / Customer XYZ

Dear Mr. Public:

This letter is being sent as formal notification that Buyer considers Supplier to be in material breach of its agreement for failure to deliver the required quantities of acceptable Work Product by the scheduled delivery date.

1. Supplier is required to deliver _____ units and has delivered __________
2. Of the ____ units delivered by Supplier, ____ fail to meet the quality requirements set forth in the Specification .
3. Attempts to address the quality problems have continued to fail to provide acceptable work product.
4. The agreement required delivery of ______ units by _________and Supplier has failed to delivery the required quantities of acceptable work product.

You are hereby notified that you have until _______ to cure such breaches. If you fail to cure these breaches by this date, Buyer may terminate the Agreement for cause in accordance with Section __ of the Agreement by issuing a notice of termination.



ABC Company
One Main Street
Anytown, Anystate Anyzip

ATTENTION: John Q. Public

SUBJECT: Notice of Termination of SOW 49xxxxxxxx / PO 500xxxxxxx / Customer XYZ

Dear Mr. Public:

On ___________ you were provided with Notice to Cure for the following Breaches of the Agreement.

As you have failed to cure those breaches within the cure period, this letter is formal notification that the Agreement (has been/ will be) terminated for cause in accordance with Section ___ of the Agreement effective ___________.


The contract manager’s responsibilities when there is a termination for cause will depend upon what the agreement says. I’ve run into Suppliers that want to be compensated for costs they have incurred prior to the date of termination. While that may be a reasonable price to pay for the right to terminate without cause, my usual response when it comes to termination for cause is to do so would be rewarding them for their non-performance. That is not something that I’m not going to agree upon. The last thing you want is to have a supplier who is failing to perform to be able to continue along incurring costs your expense when there is no hope they will cure the breach.

Since termination is a right, not a duty, of the non-breaching party, you are not bound to establish a specific date for termination. For example, in a termination without cause you could establish the termination date out in the future so that your interim needs are still met. In a termination for cause, once the Supplier has failed to cure you don’t need to have the termination be immediate. Once you have issued a notice to cure, if the Supplier isn’t confident that they will be able to cure in time their natural tendency would be to wind down the work to minimize the costs they could wind up bearing. Here’s where a little common sense needs to come into play. If you need them to perform, at that point you could discuss assuming certain potential liability in conjunction with what the actual termination date you may have planned. While under the contract you may not be obligated to assume those costs, you may want to assume certain costs to ensure that you have a continuing flow of products or services. I can sometimes be better to get some performance or deliveries rather than none. If you make it all at the Supplier’s risk, they may simply not be willing to assume the potential risk to continue to perform.

In most termination for cause situations where you assume no liability if they breach the agreement the primary responsibility of the contract manager is to:
1.Manage the acceptance and payment for good items that were received prior to the effective date of the termination.
2.To work with the users to determine what effective date works best for them and include that in the termination notice.
3.If you need the supplier to continue to be producing and not abandon work in the interim you could agree accept completed products delivered up to a specific date.
4.You would manage the return of any buyer owned materials or products being held at the supplier under separate agreements and withhold any final payments until the receipt of those.

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