Commercial Contract Breakdown: Red Flags, Rights and How to Preserve Your Leverage

Contracts are the foundation of commercial relationships, but they are also a main cause of strife for organisations when they breakdown. Maybe the contractual relationship with your supplier has deteriorated or maybe a services contract is no longer competitive or suitable for the business’ needs and you want ‘out’. You may be a new executive reviewing the suite of commercial service agreements only to discover your organisation is ‘locked in’ to unfavourable or unreasonable terms.

Organisations are often faced with difficult decisions when a contract stops working. The next steps can have significant legal and commercial consequences. For organisations, it is important to spot the red flags early, maintain negotiating leverage, and minimise business disruption.

This article provides practical guidance for what to do when a commercial agreement is no longer working.

Spotting the Red Flags

Missed delivery deadlines, breach of service standards or KPIs going unaddressed, non-payment, disputed obligations, and breakdowns in communication are some more obvious red flags of when a contract might no longer be working.  A more discrete but common red flag we see is silence and lack of contract management from both parties. Has the contract been tucked away in a folder and not looked at since it was signed? Has a term(s) rolled over without an internal decision of whether the contract is still meeting your commercial needs?

Another warning sign is the scope of work drifting without any formal variation occurring. Often, our clients will have a growing sense of ‘this isn’t what we signed up for’. The earlier you can identify the breakdown and seek advice, the more options you will have to resolve.

Should we terminate – the risks of getting it wrong

Even if a contract is no longer working, you will need to carefully consider what rights and options you have available before terminating. Not every breach leads to a right to terminate the contract, neither does unsatisfactory performance. You may have rights to withhold payment or suspend services. But taking steps that are inconsistent with your obligations under a contract could amount to repudiation. Likewise – terminating without a valid legal basis. Wrongful termination can expose an organisation to potential damages – even in circumstances where you are the party that has been ‘hard done by’.

Alternatively, continuing to accept poor performance or breaches of terms from another party without reservation could inadvertently waive your rights to enforce a breach of contract later on. Documenting breaches contemporaneously, issuing proper notices and following the contractual notice periods is key. A mistake or oversight in the process can switch you from the wronged party to the party in breach.

Enforcement and Resolution Options

One of the first steps you can take in enforcing your contractual rights is to give notice of your concerns / breaches and direct the other party to remedy the breaches. It could be via a formal notice of breach. The terms of the contract may set out the requirements of such notices. There may be other contract specific remedies available to you, such as liquidated damages, suspension rights or rights to withhold payment. Depending on the breach and the terms of the contract, you may have the right to terminate with notice. A contract may set out the dispute resolution steps that are pre-requisites to any formal litigation. Litigation is often a last resort due to the cost and its inherent uncertainty.

Preserving Your Leverage

When dealing with a contractual dispute, maintaining your leverage is important – both legal and commercial. For legal leverage, don’t waive your rights by overlooking breaches or continuing with performance without reservation. Maintain contemporaneous records, both of correspondence and of any breaches or performance data. When corresponding with the other party, try to avoid any statements that could be read as accepting a breach or varying the contract.

For commercial leverage, it can be helpful to assess the value of the contract – are they reliant on your contract? Is there a value to other party in continuing the relationship beyond one contract? Consider the timing, for example, when does the contract come to an end or up for renewal. To prepare for a potential termination, you will also need to consider whether alternative suppliers or providers are available.

Terminating too quickly, continuing to accept the poor performance and stopping payments without a valid basis can all reduce your leverage. Seeking early legal advice can help to understand all the legal and non-legal options available and maintain the strength of your position.

How we can help

The Disputes team at Moores can assist where contracts are strained or no longer working. We offer contract health checks and risk assessments and can also help with drafting and issuing breach or termination notices, ensuring you don’t fall foul of the contract provisions. We are experts in tailored advice for businesses, the education sector, NFPs, and social housing providers.

Contact us

Please contact us for more detailed and tailored help.

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^{Disclaimer: This article provides general information only and is not intended to constitute legal advice. You should seek legal advice regarding the application of the law to you or your organisation.}