Legal: A dangerous clause

A party terminating a contract for repudiation or default by the other party will usually be entitled to compensation for losses caused by the default. This will often be a claim for loss of profits for the remaining term of the contract. However, complications can arise where the defaulting party had a contractual right to terminate at will/for convenience. Is the innocent party still able to claim for loss of profits for the remaining duration of the contract on the assumption that the right to termination for convenience would not have been exercised?  Does the mere existence of a termination-at-will clause mean that recovery of lost profit is limited to the period prior to the date on which any valid termination would take effect?

There are different lines of authority on this point. One line asserts that the mere existence of a termination-at-will clause is sufficient to limit a claim for lost profit. This is because if the clause is ignored, it results in a better bargain for the claimant than the one it originally struck – on the basis of the termination-at-will clause, the claimant’s “expectation interest” in the contract should limit a claim for lost profit in these circumstances to the period prior to a valid termination for convenience. The other line of authority asserts that the mere presence of the clause is not sufficient – it is also necessary to review the factual circumstances to establish, in all of the circumstances, if and when the defendant would have exercised its right to terminate for convenience.

“A right to terminate at will is likely to impose a limit on a defaulting party’s liability for loss of profit in the event of termination”

 

The question came up again recently in Redbourn Group Ltd vs Fairgate Developments Ltd. In that case Redbourn had been appointed as development manager by Fairgate in respect of a development in Wembley. The terms for Redbourn’s payment under its appointment broke the fees down into stages, with fixed fees associated with those stages of work, and a bonus for completing on time and budget. The key stages included site assembly, obtaining planning permission and project managing the development to completion. In relation to the fixed fee payable on securing of planning permission, the submission of a planning application was subject to approval by Fairgate. 

Fairgate purported to terminate the contract for material breach by Redbourn. However, its allegations of material breach were rejected by the court in a previous hearing and Fairgate was found to have repudiated the contract. One of Fairgate’s criticisms had been that Redbourn had failed to submit a planning application and to negotiate a lease of part of the site with Network Rail. However, Network Rail had decided at an early stage that the development was not aligned with its own strategy for the land, meaning the lease would never have been agreed. Without the lease, Redbourn could not be criticised for failing to submit a planning application. 

Redbourn claimed damages for Fairgate’s repudiation, comprising the fixed fee for securing planning permission, its project management fee and the bonus. These sums were said to reflect the sums Redbourn would have earned had the contract been carried out. Redbourn’s claim was rejected by the court on two grounds: 

• The contractual discretion given to Fairgate to approve any application for planning permission meant Redbourn never had a guaranteed right to earn the remaining fees under the contract. Redbourn’s appointment could have stalled at the planning permission phase through no fault of its own or Fairgate’s. 
• On the facts Redbourn would never have been able to achieve a key deliverable (namely the lease of the Network Rail land) and the project originally envisaged in Redbourn’s appointment had therefore become unrealistic to pursue. Fairgate would therefore have been justified in deciding not to proceed with the project.

The court’s reasoning does not shed much light on the tension noted above between the different lines of authority (perhaps because it was dealing with a case concerning contractual discretion rather than a termination-at-will clause per se). Parts of the decision appear to be supportive of the line taken where the mere existence of a termination-at-will clause is sufficient. However, it was clear on the facts that Fairway would never have proceeded with the project in any event and therefore the approach of looking at not only the termination-at-will clause but also the facts could be said to be equally applicable. The tension between these two approaches therefore remains.

Nonetheless, the case does provide a valuable reminder that a right to terminate at will is likely to impose a limit on a defaulting party’s liability for loss of profit in the event of termination.  Parties should be aware of this when considering whether to agree to such a clause in a contract.