A poorly drafted termination provisions can result in great harm to businesses
Jose, who owns an office furniture manufacturing company, uses enterprise resource planning software (“ERP”) to help manage the lifecycle of his products’ manufacturing, from the purchase of the wood to the designing and manufacturing of his products– high grade desks and chairs. The company that has integrated this ERP software into Jose’s network and manages the platform is ERP International. Three years before, Jose’s company, My Furniture Inc., and ERP International entered into a contract, which provided the following termination clause:
“Either party may terminate this agreement on 30 days’ notice to the other party.”
One New Years’ eve, the President of ERP international left the following voice message on Jose’s phone.
“Dear Jose: I am afraid our relationship with My Furniture is not working out. You have missed your last payment of our licensing fee invoice and it is our understanding that you recently lost a longstanding client. No hard feelings, but we hereby terminate our agreement.”
Returning to his office after a long and boisterous New Years’ eve night, Jose, a little hung over, accidentally erased the voice mail messages on his phone.
Thirty-one days later, when trying to access the ERP platform, Jose’s floor manager received an error message that the platform did not recognize the user and denied access. Jose promptly contacted ERP International’s customer service only to find out that his agreement with that company had been terminated. Jose, who had spent thousands of dollars creating the platform, and now no longer knew the stage of manufacture of any of his products, was at wits end. He called the President of ERP International to say that not only did ERP terminate his company without any notice but put My Furniture in the impossible position of not being able to determine the manufacturing status of its customer orders. The President of ERP was sympathetic with My Furniture’s situation but insisted that proper notice of termination had been made, playing a recording of the President’s New Years’ Eve message.
Jose was livid at ERP’s conduct but had to admit, after unearthing the contract that had been gathering dust at the bottom of his drawer, and reviewing the termination clause with his lawyer, that although ERP had played dirty pool, it, technically, had complied with the terms of the termination clause which only required 30 days’ notice without specifying any specific kind of notice; nor did the agreement give any guidance what would happen were the agreement terminated. Overall, the termination provision failed to protect My Furniture’s interest in the context of a termination of ERP services. What can we learn from Jose’s unfortunate experience:
- Termination clauses are one of the most important provisions of any contract. How businesses manage the termination of an agreement can be as important as entering into one. Business owners should not leave it to their attorneys to negotiate these provisions without the owner’s input.
- One needs to think through what a termination means, starting with considering what circumstances should result in a termination. The ERP termination provision provided that either party could terminate the agreement at any time and for any reason as long as 30 days’ notice was provided. Given that the ERP platform in question was critical to the operation of My Furniture, another approach to framing the termination clause could have been to allow the parties to terminate only upon the occasion of a material breach, like the failure of My Furniture to pay licensing fees, or the failure of ERP to meet commercial standards of care. And even then, many such “for cause” termination provisions include a cure period, such as 30 days, to allow a party who has breached the agreement, i.e., by failing to make a payment, an opportunity to avoid termination by curing such breach.
- What and how a notice of termination should be communicated to the other party should also be considered. First, a notice to terminate should be in writing. As illustrated by Jose’s experience, the ability to terminate an agreement by oral notice can be a recipe for disaster. Second, most contracts prescribe how written notices should be delivered, i.e., by email, personal service, overnight mail, regular mail, certified mail, return receipt requested, etc. Sometimes, using a combination of methods is required so that it is assured that the party that is being notified has, indeed, been notified. Third, some contracts go even further by defining what it means to actually “deliver” a notice, i.e., notices sent by email shall be deemed to have been delivered on the same day as transmission, while a notice sent by First Class Mail delivery shall be deemed to have been delivered on the third day after mailing.
- If the type of service at issue implicates the need to change vendors or to develop an in-house capacity to maintain a software architecture, then the party receiving the service, i.e., My Furniture, should insist on a transition clause that would have obliged ERP to continue providing its services for an additional period of time (e.g. 180 days) to ensure that, during the transition to a new vendor, My Furniture would still have access to ERP’s platform.
So, what might a helpful termination clause have looked like? There is no right way of drafting any document and every situation may demand a different contract drafting approach, but to illustrate how Jose’s predicament may have been averted see the following two termination clause possibilities.
Possibility No. 1:
“Either party may terminate this agreement based on a material breach on 30 days advanced written Notice of Termination and Opportunity to Cure delivered to the other party. During the 30 days’ notice period the party alleged to be in breach shall have an opportunity to cure its breach. Delivery of the Notice of Termination and Opportunity to Cure shall be by way of email and overnight mail. In the case of email, delivery shall be deemed effective on the same day as transmission; in the case of overnight mail, delivery shall be deemed effective on the day after mailing.
Possibility No. 2:
“Either party may terminate this agreement, with or without cause, on 30 days advanced written notice to the other party, provided that should this agreement be terminated by the service provider, the latter shall afford transition services to the customer comprising continuing services for a period 180 days following termination at licensing rates prevailing as of the date of termination (the “Transition Period”). Additionally, the Service provider shall cooperate with the customer during the Transition Period in facilitating the transition of services to another vendor or to the customer’s inhouse team. For purposes of this section, written Notice of Termination shall be delivered to the other party by way of email and overnight mail. In the case of email, delivery shall be deemed effective on the same day as transmission; in the case of overnight mail, delivery shall be deemed effective on the day after mailing.”
Key take-aways: Poorly drafted termination provisions can result in great harm to businesses, especially if those businesses are highly dependent on the goods and services of the terminating party.
- To reduce risks associated with terminating a business relationship, parties should spend time thinking through the circumstances requiring a termination and the effects of a termination.
- Termination provisions should clarify the circumstances under which a party should have the right to terminate and detail the procedure governing how a notice of termination would be served and the amount of notice to be given.
- Finally, ending a business relationship can be complex, especially where the services being terminated are critical to the effective operation of an enterprise. To address this potential problem the parties should discuss the service provider’s providing transition services, to facilitate the transition of services to a new service provider or facility.
- The parties should not just leave the negotiation and drafting of these provisions to their attorneys but should take an active role in working through the termination scenarios and helping counsel frame the appropriate language so that potentially costly ambiguities can be avoided and the risk of encountering unpleasant surprises at the end of the day can be reduced.