Checklist: What to consider when terminating a contract (USA)

Introduction

This checklist provides guidance to in-house counsel and private practice practitioners when terminating a contractual relationship for convenience, breach of contract, or other termination event.

The checklist addresses the following:

1. Reasons for termination of the contract
2. Reviewing the contract
3. Termination of the contract

The checklist presents a list of requirements to be addressed. Explanatory and specific notes corresponding to the relevant steps in the checklist appear at the end of the document.

This checklist can be read in conjunction with Checklist: What to consider to ensure a contract is valid.

Step 1 – Should the contract be terminated?

Step 2 – Reviewing the contract

Step 3 – Termination of the contract

Explanatory notes

Legal framework

This checklist provides a summary of issues that may arise in relation to the termination of a contract.

The discussion should be taken as a general statement of the laws applicable in most US jurisdictions. The law applicable to a specific contract may vary, depending upon the subject matter and nature of the agreement; the location of the parties; the goods or services to be provided pursuant to the agreement; and any choice of law provision in the agreement. You are advised to consult local laws before providing advice or taking other action relating to a specific contract termination.

The importance of legal review

There are probable consequences associated with breaching a valid contract. For example, litigation risk, claims for economic damage, or requests for injunctive relief may arise in the event of a breach. Careful review of the contract agreement can help counsel render advice designed to mitigate or avoid costly repercussions resulting from the termination of an agreement.

When is legal review necessary?

Legal counsel should be involved and guidance should be sought in advance of termination whenever possible. Once an agreement has been terminated, the utility of legal review and consultation is necessarily limited. Care should be taken to minimize potential repercussions when a client terminates a contract prior to consultation with legal counsel.

Termination rationale

When possible, a termination rationale should first be established with the advice of counsel. Available documents, written communications, telephonic recordings – provided they are lawfully made – or other evidence must support the rationale which should be consistent with either one of the articulated grounds for termination found within the agreement or authorized by applicable contract law.

For example, a contract may include a clause allowing for early termination due to impossibility of performance. A contractor may use such a clause when supply chain issues prevent it from honoring the agreement. Alternatively, state law may allow for early termination of an agreement upon discovery that one party misrepresented facts upon which the other party relied.

In rare circumstances, state law may deem a contract automatically void or voidable. In this case, termination is allowed without any intervening rationale. An example of a void contract is a contract involving illegal goods or services. A voidable contract may exist where it fails to meet the documentation requirements of the state’s version of the Statute of Frauds.

Termination notice

A well-crafted agreement should include terms relating to how and when a party seeking to terminate the contract must provide notice of its intent to do so to the other party. Absent a state-specific exception allowing for early contract termination, it is essential for the party seeking to end the agreement to identify and adhere to the requirements set forth in the contract and any addenda, amendments, or riders to the contract. At times, the agreement may require such notices be submitted months in advance with explicit liquidated damages provisions upon breach of a contract. Counsel is advised to take caution when advising a client regarding the potential consequences of termination of a contract that contains specific termination notice and related liquidated damages provisions. Depending upon the terms of the agreement, early termination may prove cost prohibitive.

Step 1 - Reasons for termination of the contract

1.1 End of contract duration

An agreement which ends on a specific date is void after that date. Unless otherwise agreed by the parties, the obligations of the parties end upon reaching the specified date. In such an instance, providing a notice of contract termination may still be advisable, in order to avoid any future conflict or confusion regarding the expiration of the contract.

An agreement may provide an option for renewal. The renewal may be automatic, at the option of an individual party, or upon the mutual agreement of the parties. If a client does not wish to renew the agreement, legal counsel should identify the provisions regarding the duration of the contract, renewal terms, and notice requirements. Upon due consideration, counsel should then submit appropriate written notice of non-renewal.

1.2 Purpose fulfilled

The duration of an agreement can at times be tied to its purpose. For example, an agreement for the construction of a building necessarily ends when the building is complete and operational; while a services agreement for moving furniture is finished when the move is complete. In those circumstances, satisfaction of the aim of the agreement may itself be sufficient grounds for ending the contract. In this case, the agreement itself may not be ‘terminated’; rather, the duties under the agreement will have been discharged. Written correspondence confirming the discharge of contractual duties may still be in the best interest of the organization.

1.3 Non-performance or breach by other party

In some instances, a client may wish to terminate a contract due to non-performance or breach on the part of the other party. However, not every failure to adhere to the agreement’s provisions will be grounds for termination. Counsel should carefully review the terms of the agreement, the alleged breach, and the facts surrounding the breach before claiming non-performance as a reason for contract termination.

Reviewing courts, and often specific provisions in the agreement itself, can limit the ability of a party to terminate an agreement to only those circumstances involving a ‘material breach.’ A ‘material breach’ involves ‘a failure to perform a substantial part of the contract or one or more of its essential terms or conditions, or if there is such a breach as substantially defeats the purpose’ of the agreement. Kanza Constr, Inc v Kan City Southern Rys Co, 311 So 3d 1246, 1251 (Miss. Ct. App. 2021).  Other courts have held that in order for a breach to be material, it must ‘go to the essence of the contract.’ See, eg, Gen Motors Corp v New A C Chevrolet, Inc, 263 F 3d 296 , 315 (3d Cir. 2001).

For example, a commercially reasonable substitution of a particular product may not involve a material breach that would justify contract termination. Counsel should also carefully examine the facts related to the breach for any argument of waiver on the part of the client. If a party knowingly refrains from taking action in a circumstance that would have warranted termination, the breaching party may be able to later claim that the right to terminate the agreement due to the breach has been waived. Waiver is a defense to a breach of contract claim and must be proved by the party relying upon the defense.(Safety Signs, LLC v Niles-Wiese Constr Co, 840 NW2d 34, 42 (Minn. 2013).  Standard contract clauses often provide the parties flexibility in the circumstances that involve breach without risking waiver.

In addition, sometimes a claim of non-performance as the reason for terminating an agreement is not allowed because the contract provides the party in default an opportunity to ‘cure,’ or fix, the deficiency. Agreements that include a right to cure essentially contain an additional step that must be satisfied before the non-breaching party can assert a breach of the agreement.

1.4 Reasons for non-performance by terminating party

1.4.1 Impossibility

The obligation to perform under a contract can be discharged due to impossibility. This situation can arise when unforeseen events have frustrated the ability to offer the goods or services contemplated by the contract. For example, a services agreement entered into between an individual and a corporation becomes impossible if the individual who is to provide the services becomes incapacitated or dies.

1.4.2 Unforeseen events

An agreement can also be rendered impractical by unforeseen events that frustrate the parties’ ability to perform under the agreement. For example, a temporary lockdown caused by public safety or public health circumstances may render the performance of a specific provision of an agreement impractical. Bush v Protravel Intl, Inc, 192 Misc 2d 743, 746 N Y S 2d 790 (N.Y.C. Civ. Ct. 2002), In a delay in cancelling a travel reservation was excused when the city was under a lockdown. However, see also City Natl Bank v Baby Blue Distributions, Inc, 199 A D 3d 559, 560, 158 N Y S 3d 65, 66 (1st Dept 2021),where it was stated that ‘[T]he [COVID-19] pandemic did not destroy the subject matter of the contract, ie, defendants’ loan from plaintiff. Defendants still possessed or made use of the loaned funds. Nor did the pandemic destroy the means of performance’ [ie, repayment of the loan]). Note that force majeure clauses can protect the parties from liability if the cause of the breach was an uncontrollable and/or unforeseen event. (See 1.4.6 below)

1.4.3 Impracticability

Impracticability occurs when performance of the agreement would cause ‘extreme and unreasonable difficulty, expense, injury, or loss to one of the parties.’ Raytheon Co v White, 305 F.3d 1354, 1367 (Fed. Cir. 2002).  However, impracticability may not be sufficient to relieve the contracting party of its obligations when it is foreseeable. See, eg,  Sunflower Elec Coop v Tomlinson Oil Co, 7 Kan App 2d 131, 638 P 2d 963 (Ct. App. 1981), where the court concluded that the lack of oil reserves required to fulfil the contract was foreseeable by the supplier and also concluded that the supplier assumed the risk that such would be the case.

1.4.4 Unforeseen change of circumstances

An unforeseen change of circumstances may frustrate the purpose of the agreement, causing the obligation to be discharged. For example, a property owner may enter into an agreement for the remodel of an office building in an effort to lease space within a building. If a fire heavily damages the office building in question, it still may be possible for the remodel to occur; however, as the very purpose of the agreement has been frustrated, the obligation under the agreement may be discharged.

1.4.5 Void contract

A void contract is one that is unlawful when it is made and is therefore unenforceable. Examples include contracts to perform an unlawful act (eg, to deliver controlled substances in violation of federal, state or local law, or those contracts that involve price gouging related to essential supplies or services). If the contract is void, legal counsel should consider whether it might be possible to draft a lawful agreement to accomplish the same purpose as the void agreement.

1.4.6 Force majeure

Most contracts contain a force majeure clause that allows both parties to be free from liability under the contract if some event happens that is out of the control of either party. Examples of such events might include natural disasters, fires, or other ‘acts of God.’ If there is no force majeure clause, neither party is excused from performance unless performance has become impossible or impracticable under state law.

Force majeure clauses are interpreted narrowly and only excuse non-performance when the specific event is explicitly listed in the contract (see Kyocera Corp v Hemlock Semiconductor, LLC, 886 N W 2d 445, 451 (Mich. Ct. App. 2015) (Kyocera Corp)). In addition, the party seeking to be excused from performance must show that the event was the proximate cause of nonperformance of the contract. 1600 Walnut Corp v Cole Haan Co Store, 530 F Supp 3d 555, 559 (E.D. Pa. 2021). Traditionally, increased costs due to tariffs and government actions are considered standard business risks, not force majeure events. International trade contracts typically allocate these risks through delivery terms, often using Incoterms, which specify who is responsible for duties and customs clearance.

Courts generally uphold the risk allocation established by the contract, even if it leads to economic hardship. Kyocera Corp, 886 N.W.2d at 453, stated that ‘allowing a force-majeure clause to provide a party with relief from an unprofitable market downturn would defeat the purpose of a take-or-pay contract… The very reason for entering the take-or-pay contracts [is] to insure payment to the producer in the event of substantial change in the marketplace.’ Therefore, courts typically reject force majeure claims based on government actions, like tariffs, that increase costs. The rationale is that force majeure addresses events directly impacting the ability to perform, not the ability to profit. Consequently, unless the contract states otherwise, increased costs, including those from government actions, do not constitute force majeure.

Parties can, however, freely allocate these risks explicitly in their agreements. The COVID-19 pandemic and resulting supply chain disruptions have prompted many to broaden their force majeure clauses to include such events. Reviewing contract terms is essential to determine if the current language adequately addresses these risks or requires revision.

Insolvency alone does not necessarily excuse performance. In some types of bankruptcy or insolvency proceedings, the debtor is given the option of accepting and continuing to perform an executory contract or rejecting that contract. Some contracts contain clauses declaring that the contract is terminated if one party files a bankruptcy petition. These clauses are unenforceable under the US Bankruptcy Code. See 11 USC 365(e)(1), 541(a),(c). Another important consideration is whether the Bankruptcy Court will allow performance or modification of the contract. This will depend on the party’s assets and secured or unsecured debts, as well as the chapter of bankruptcy filed and whether it involves liquidation of the corporate entity or reorganization of its business. 

1.5 Business continuity

Before taking steps to terminate any agreement, it is vital that legal counsel consider both present and future business needs. If there is an ongoing obligation to maintain a business relationship with the vendor in question, alternatives to termination—such as renegotiation of the agreement—may need to be considered. Otherwise, your organization should carefully consider how to proceed with termination in a manner that maintains the relationship’s viability.

Switching a contract from one vendor to another risks harming the relationship with the former vendor or, in the case of a tight knit community, earning a reputation for treating vendors in a socially unacceptable manner. It is wise to include provisions in all agreements that require limited ongoing transition assistance from a current vendor in the event that duties are switched to a replacement. Alternatively, the parties may need to negotiate an arrangement to ensure a smooth transition to the replacement vendor.

1.6 Third-party considerations

When considering whether to terminate an agreement, it is important to consider the impact on third parties as well. For example, the well-established rule in Illinois is that if a contract is entered into for the direct benefit of a third person, the third person may sue for a breach of the contract in his or her own name, even though the third person is a stranger to the contract and the consideration  (Joslyn v Joslyn, 386 Ill 387, 400, 54 N E 2d 475, 481 (1944)).

1.6.1 Subcontractors

Subcontractors provide discrete services as a part of a larger transaction. While a subcontractor has a direct contractual relationship only with its contracting partner, certain state laws provide protection to subcontractors by allowing them to pursue non-contract claims against beneficiaries of their goods or services. If you are considering terminating a contractor, it is worthwhile to consider how and when subcontractors will be paid and whether there is a bond or insurance provision that will help cover such costs.

1.6.2 Third-party contractors

Statutes in some states allow providers of specified goods or services to place liens on property to help assure timely payment. For example, a mechanic’s lien that benefits third-party contractors can apply to a building or other real estate that has been the subject of improvement. See, eg, Iowa Code 572.2(1) (‘Every person who furnishes any material or labor for, or performs any labor upon, any building or land for improvement, alteration, or repair thereof, … by virtue of any contract with the owner, owner-builder, general contractor, or subcontractor shall have a lien upon such building or improvement, and land belonging to the owner on which the same is situated or upon the land or lot ... otherwise improved, altered, or repaired, to secure payment for the material or labor furnished or labor performed.’).

Termination of a services agreement can interfere with the ordinary flow of funds in an ongoing contract. The agreement, as well as the applicable state law, should be thoroughly reviewed to see if a termination action may result in liens being placed upon the property of your organization.

1.6.3 Suppliers and service providers

A final third-party factor to consider before terminating a contact is the organization’s use of suppliers or service providers. A business may have ongoing contracts for the provision of goods or services that are necessary to support customers of the business. If you intend to terminate one of these contracts, care should be taken to ensure that you can continue to provide goods and services for your own customer base during the transition without interruption. Furthermore, if the customers are accustomed to or contractually promised a certain brand or type of product, care should be taken to ensure your organization does not subject itself to liability or loss of its customer base during the transition of suppliers or service providers.

1.7 Consequences of termination without explicit authorization in contract

The measure of damages for termination without explicit authorization (also known as breach of contract) will depend, in part, on the jurisdiction in question. Some states have statutory restrictions regarding damage awards. Other states may measure contractual damages differently or cap liquidated damages. In addition, limitation of liability clauses may preclude a party’s ability to recoup certain types of damages.

In general, the non-breaching party can recover general damages and special damages from the agreement. The details regarding both types of recovery are set forth below.

1.7.1 General damages

The general measure of damages for a breach of an agreement is the amount of the loss directly and necessarily incurred by the violation. For a goods agreement, a general measure of damages can be the difference between the market price at the time of the breach and the unpaid contract amount, minus any savings resulting from the breach. In an agreement for services, the damages may be the difference between the price of the services offered and those procured elsewhere. The goal is to put the non-breaching party in as good a position as it would have been had the breach not occurred. See, eg, Beyond the Garden Gate v Northstar, 526 N W 2d 305 (Iowa 1995).  In some cases, however, the amount of damages is governed strictly by the terms of the contract. Such a method of determining damages is known as liquidated damagesand is an agreed upon amount of damages determined by the parties at the time of contracting to be paid in the event of non-performance.

1.7.2 Incidental/consequential damages

In appropriate circumstances, a non-breaching party can recover incidental or consequential damages. Incidental damages are defined as ‘reasonable expenses incident to the delay or other breach,’ and can include affirmative costs incurred relating to inspection, receipt, transportation and disposition of the goods. The standard for determining incidental damages is similar in cases involving services agreements.

Consequential damages are broader than incidental damages and include ‘any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise,’ and can extend to ‘injury to person or property’ that ties back to the breach. See, eg, Beyond the Garden Gate v Northstar, 526 N W 2d 305 (Iowa 1995).

1.7.3 Reputational damages

In general, reputational damages are not recoverable in contract cases Redgrave v Boston Symphony Orchestra, Inc, 855 F 2d 888 (1st Cir 1988), cert den’d 488 US 1043 (1989)).  In the rare instances where such damage claims are permitted, they are considered a subtype of consequential damage.

Step 2 – Reviewing the contract

It is important to review contracts carefully to ensure that you have clarity on your options for, and exposure to, potential methods of termination of the contract. The contract and any modifications thereto serve as the most important bases for terminating the agreement. Modification procedures for termination agreements are the same as general contract modification procedures and must be agreed to by both parties.

2.1 Duration

If the agreement ends on a certain date, it is void after that date. Similarly, if an option to renew a contract is not exercised, the contract will end automatically.

Unless the contract says otherwise, there is no notice required that the duration of a contract has ended. As a matter of courtesy and to preserve a good relationship with the other party, it is common to give notice of the expiration of a contract in advance. Your organization should have a plan for preparing for the ending of a contract well in advance of the termination date.

2.2 Termination clause

The clause may provide specific reasons for which a contract may be terminated and state which party may exercise the right to do so. When the parties have mutually agreed on such limits, breaches of a kind not specified in the termination clause may not be subject to remedy through termination.

A termination clause may set forth the options for the breaching party to address the problem, such as providing an opportunity to cure. The termination clause may also include the expectations of the non-breaching party, such as the requirement to mitigate damages through specified actions.

When the length of an agreement is of the essence, or when a party must incur upfront expenses relating to an agreement, the termination clause may include a financial disincentive in the form of a fee for early termination. Such a fee cannot be a penalty, but instead must constitute a reasonable effort by the parties to resolve what would otherwise be a difficult-to-calculate harm due to breach.

2.3 Non-performance by other party

The termination clause often provides for rescission or termination of the agreement due to a ‘breach of contract,’ or a ‘material breach’ of the contract. As set forth elsewhere in this checklist, it is worthwhile to review the terms of the agreement to ensure that the standard has been reached for termination.

A party that is dissatisfied with performance may be tempted to terminate an agreement. The agreement should be carefully reviewed to ensure that the dissatisfied party has retained the right to terminate on that ground. If the dissatisfaction is not deemed reasonable by a reviewing court, the terminating party could be viewed as committing its own breach of the agreement and could be liable to the other party for damages related to the breach.

A general covenant of good faith and fair dealing is presumed in contracts. However, some contracts also affirmatively require parties to act in good faith and may specify specific events or actions which fall short of that standard.

2.4 Termination procedure

It is important to review and understand clearly the actions required to terminate the contract without triggering adverse consequences.

There may also be a provision in your agreement relating to a ‘right to cure’, which provides a defaulting party an opportunity to ‘cure’, or fix, the deficiency. Agreements that include a right to cure essentially contain an additional step that must be satisfied before the non-breaching party can assert a breach of the agreement. Any right to cure provision should contain specificity as to a commercially reasonable timeframe in which the cure must be executed.

A termination clause may include provisions that impact what, if anything, remains due and owing under the agreement. For example, an agreement can state that termination for breach will not relieve a party from paying amounts for goods or services received up to and past the termination date.

All of these factors must be considered prior to terminating an agreement or costly and long-lasting repercussions to the terminating party may result.

Step 3 – Termination of the contract

3.1 Prepare to terminate

When preparing to terminate an agreement, start by ascertaining whether any of your organization’s property is in possession or control of the other party. If property may be caught up in a termination dispute, consider taking action to secure that property prior to or contemporaneously with termination.

Consider whether the defaulting party has trade secret information that needs continued protection following termination. Upon termination, it is advisable to remove access to the information and remind the breaching party of its continued obligation to maintain the confidentiality of trade secrets post-termination.

The defaulting party may have gained access to your physical premises or electronic systems. A plan to remove or restrict such access should be developed pre-termination and promptly put into effect post-termination.

If the contract involves goods or services for which your business will have an ongoing need, plan how to transition the contract to a new provider prior to executing the termination. This may require help from the current contracting party, so avoiding unnecessary conflict is advisable. The transition is easier if the existing contract contains post-termination transition provisions.

Ensure that any remaining payments have been correctly calculated and remitted. Any withholding from amounts due must be tied to explicit contract provisions and should be clearly and thoroughly noted on any accounting records. The party from whom any amounts have been withheld should be notified of the withholding, and the reasons for same.

If you have ongoing obligations between the provision of a notice of termination and the end of the terminated agreement, make a plan to ensure compliance with those continued obligations to avoid a counterclaim for damages for failure to perform.

Consider and plan for the effect of the termination on customers and take necessary action to protect against claims from contractors or lienholders.

3.2 Give notice of intent to terminate

If the contract calls for notice before termination, notice must be provided in accordance with contract terms to avoid adverse consequences. For example, it may specify how the notice will be delivered and to whom.

3.2.1 Adequate notice

At a minimum, the notice of termination provided should clearly state that the contract in question is being terminated. There should be no ambiguity among the parties as to whether a contract remains active and valid.

If you rely upon specific reasons for termination, those reasons should be clearly articulated in the termination letter. Include all reasons, as additional justifications added later will not necessarily be considered by a reviewing court in a contract dispute.

Any termination notice must also be given far enough in advance that the parties can make appropriate alternative arrangements. A poorly planned termination can leave a party with insufficient time to transition to a new provider, which would lead to the inability to offer the desired goods or services and may detrimentally affect the loyalty of a customer base.

Where the underlying agreement is necessary to provide goods or services to others, make appropriate arrangements to notify third parties. This is especially important if the change requires any affirmative action by those third parties or could impact the benefits provided to those third parties.

3.2.2 Post-notice review

Following the notice of termination, a post-notice review is essential. Meticulously track and confirm the retrieval of all company property from the other party, including physical assets, intellectual property, and confidential information, documenting the return of all assets. Ensure that all final obligations outlined in the contract are fulfilled, including final payments, delivery of outstanding goods or services, or the completion of specific tasks, and obtain written confirmation of the fulfilment of all obligations. Maintain detailed records of all communication, actions, and confirmations related to the termination, as this documentation will be essential in case of any future disputes. 

3.3 Security review

Following the transition from a terminated agreement, a comprehensive security review is essential. Immediately verify the revocation of the other party’s physical access, if any, including key retrieval and lock rekeying, and change all relevant passwords, access codes, and digital credentials, maintaining detailed logs of all security changes. Ensure the terminated party has no residual access to the organization's systems or facilities. Inform all staff members who interacted with the terminated party about the termination, emphasizing the importance of preventing accidental security breaches. Finally, maintain strict vigilance over trade secrets, implementing reasonable measures to protect confidential information, as failure to do so may jeopardize legal recourse in case of misappropriation. See, eg, 18 USC section 1839; Iowa Code section 550.2(4). 

Additional resources

Federal Acquisition Regulations, Part 49: Termination of [Federal Government Procurement] Contracts
U.S. Dept. of Justice, Executory Contracts in Bankruptcy

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Checklists:

International supply of goods contracts 
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What to consider to ensure a contract is valid

Clauses:

Termination
Effect of Termination
Survival

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