When terminating a contract it is vital to closely follow the procedure in the text

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Exercising termination rights correctly is of fundamental importance. If you get it wrong, it could amount to a repudiation of the contract, which if accepted, will bring the contract to an end, and release both parties from their obligations. The injured party may then seek to recover damages for the losses the repudiation caused – essentially compensation for the loss of contractual bargain.

This issue came before the Technology and Construction Court at the end of last year in Interserve Construction Ltd vs Hitachi Zosen Inova AG. HZI was the main EPC contractor for an energy-from-waste (EfW) project in Hartlebury, Worcestershire. The civil works and building facilities were subcontracted to Interserve. In 2015 HZI sought to terminate Interserve’s employment under the contract and Interserve was subsequently removed from site.

Clause 43 of the contract concerned termination for contractor default. Clause 43.1 stated: “If [any termination events occur] then, subject to sub-clause 43.1A […] the purchaser may forthwith by notice terminate the employment of the contractor”.

Clause 43.1A provided: “In the case of a default by the contractor under heads (h), (p) or (q) of sub-clause 43.1, the purchaser may (at its absolute discretion) notify the contractor of the default and if the contractor fails to commence and diligently pursue the rectification of the default within a period of seven days after receipt of notification, the purchaser may by notice terminate the employment of the contractor under the contract.”

The list of termination events in clause 43 contained the usual default events, such as insolvency of the contractor, assignment, failure to complete by longstop dates, exceeding liability caps and commission of prohibited acts. Heads (h), (p) and (q) (referred to in clause 43.1A) related to failure to proceed regularly and diligently with the works, suspension or abandonment of the works, or material breach of contract.

HZI’s termination notice stated that it was given under clause 43, arising from Interserve’s alleged failure to proceed regularly and diligently and/or commission of a material breach. HZI stated that it was “forthwith” terminating Interserve’s employment, and: “For the avoidance of doubt, HZI does not exercise its discretion to provide a seven-day period for rectification under clause 43.1A of the conditions.”

Interserve was not, therefore, given an opportunity to remedy the defaults.

In late 2016 Interserve commenced Part 8 proceedings, seeking a declaration that clauses 43.1 and 43.1A were to be read together, such that HZI could not terminate the contract without first giving notice to Interserve under clause 43.1A.

Deciding in favour of Interserve, the court adopted the same textual approach to interpreting the contract as that advanced in Wood vs Capita. Mrs Justice Jefford was persuaded that the contract was a complex commercial document, which was the subject of careful consideration and drafting, entered into by two sophisticated commercial parties. As such, a textual analysis was appropriate to ascertain the objective meaning of the words.

In this context, the natural meaning of the words “subject to sub-clause 43.1A” in clause 43.1 made the right to terminate conditional on the contractor being given seven days within which to rectify the default under 43.1A.

The judge drew support for this construction from the use of the words “subject to” in the same sense elsewhere in the contract. Furthermore, were HZI’s approach correct (that “subject to” did not create a requirement of seven-day notification, as clause 43.1A was a matter for HZI’s “absolute discretion”), the words “subject to” in clause 43.1 would be redundant, which seemed considerably unlikely in a bespoke contract. Rather, the reference to “absolute discretion” in clause 43.1A emphasised that the decision whether to commence the termination process was a matter for HZI, and failure to do so would not have adverse consequences.

Although the decision in Interserve v HZI turned on a relatively discrete point, it is important for two reasons. Firstly, it is a cursory reminder of the need to exercise termination rights cautiously and carefully. Parties seeking to terminate a contract should take advice to ensure that the process is properly adhered to. In addition, the party wishing to terminate must ensure that it has adequate grounds to terminate, and that these can be evidenced if necessary.

The case is also interesting as it is an example of the courts adopting a more textual approach to interpreting contracts, as in Wood vs Capita and Højgaard vs E.on. Summarising the correct approach to contractual interpretation in Wood vs Capita, Lord Hodge set out the following principles:

  • Interpretation is a unitary exercise, to try to ascertain which interpretation is more consistent with business common sense.
  • This unitary exercise is an iterative process whereby different interpretations are checked against the remainder of the contract to investigate their commercial consequences.
  • Textual and contextual approaches to interpretation are not mutually exclusive. They are tools to ascertain the objective meaning of the language used. The correct approach will depend on the circumstances of each case. Sophisticated, complex agreements, negotiated by skilled professionals, may be successfully interpreted principally by textual analysis.