Practice has shown that when a contract is breached, and the claims process is mishandled, the losses for the party terminating the contract can, even with the most modest calculations, exceed the value of the contract several times over.
Typically, when entering into a contract, parties do not consider what will happen in the event of a breach and how to properly terminate the contract. The issue of contract termination usually arises only when serious disagreements have already emerged between the parties, and the relationship is strained.
Thus, it should be noted that by neglecting the principles of contract termination, a party may find itself “out of the game,” incurring not only its own losses but also causing losses to the other party due to unlawful contract termination.
There are legal mechanisms for terminating a contract in legislation. Termination of a contract is possible if the contract is long-term. A long-term contract refers to an agreement aimed at fulfilling ongoing or recurring obligations (Section 195(3) of the Law of Obligations). A long-term contract is not performed once but over an extended period. Examples of long-term contracts can be found in both business activities and daily life – supply contracts, leases, rentals, sales, etc.
Termination of a contract is, in essence, the unilateral cessation of contractual relations. Termination of a contract is possible in the ordinary course (Section 195 of the Law of Obligations) and in extraordinary circumstances (Section 196 of the Law of Obligations). In this article, we will focus on extraordinary contract termination, as practice shows that more questions arise in this regard compared to ordinary termination.
To clarify the above, let’s model a situation. Company A buys goods from Company B under a five-year contract (the parties agree that A will place monthly orders for a certain amount, and B will fulfill these orders); Company B delivers the goods late, causing Company A to incur losses due to untimely delivery. The question: what should Company A do in this situation if it no longer wishes to cooperate with the unreliable partner? More precisely, what are the steps for terminating the contract?
For example, Company A, having gone through all the stages of the claims process, files a lawsuit to recover damages. What points should be noted based on existing court practice before going to court?
In evaluating the sequence and justification for termination, the following are considered:
First, the party terminating the contract must have a valid reason for termination (material grounds). There must be a significant breach of the contract (see Supreme Court ruling in case 3-2-1-57-11). Sections 116 and 196 of the Law of Obligations do not define what constitutes a significant breach or provide an exhaustive list of such breaches.
The parties can also agree on what type of breach will be considered significant (see Supreme Court ruling in case 3-2-1-100-07). It’s no secret that contracts are entered into to achieve certain financial and legal goals, and if those goals are not met, the party does not receive what they expected from the deal.
Not every breach of contract is significant. Section 196(1) of the Law of Obligations also refers to the significance of the breach, allowing a party to terminate the contract if, considering all circumstances and mutual interests, it is not reasonable to expect the terminating party to continue the contract until the agreed date or the end of the notice period. This means that when there are material grounds for termination, it cannot be assumed that the terminating party will continue the business relationship.
It is necessary to carefully analyze whether a significant provision of the contract is being breached; otherwise, the breach will be deemed insignificant, and the party will unjustifiably terminate the contract, giving the other party the right to claim compensation.
Second, a notice of termination must be presented to the other party (see Supreme Court ruling in case 3-2-1-57-11) (formal grounds for termination). If the parties have not agreed on a specific form for submitting such a notice, it can be done in any form. The law does not require a mandatory form for a termination notice (see Supreme Court ruling in case 3-2-1-143-09). However, if the notice is not given in the required form, it will have no legal consequences.
Third, before terminating the contract, the party must provide the other party with an additional period to fulfill the obligation (Section 196(2) of the Law of Obligations). Providing additional time is not required in cases listed in Section 116(2) paragraphs 2-4 of the Law of Obligations: a) the obligation being breached is of particular interest to the party; b) the breach was intentional or due to gross negligence; c) the breach gives the injured party reasonable grounds to believe that the obligations will not be fulfilled by the other party in the future.
Fourth, when deciding whether to continue or terminate the contract, it is important to ensure that all communications and correspondence with the other party are clear and specific. If a party wishes to terminate the contract, it must explicitly state so, leaving no room for doubt that termination is intended; otherwise, ambiguous hints about whether the business partnership will continue or end will only cause losses for the terminating party.
Fifth, a party may terminate the contract only within a reasonable period after becoming aware of the circumstances that form the basis for termination (Section 196(3) of the Law of Obligations).
Thus, the theoretical part of contract termination is not as complex as its practical application. In practice, due to the specifics of any business (and, in a broader sense, any property relationship), it is often difficult to follow the logic and sequence of actions when terminating a contract, which is why many unresolved issues are later addressed in court. However, by correctly using the mechanisms for contract termination, the situation can be resolved in your favor.
Author: Attorney Ilya Zuev
The article was published in Delovye Vedomosti, www.dv.ee.
