18 Oct 2010

Express clauses for terminating a contract: when can you exercise your rights?

by Luke Buchanan, Simone Rees

The case law is not clear, but there are some basic principles which can guide you when creating an express clause allowing termination, or trying to use it.

We've seen before that there are limited bases for terminating a contract at common law. What if the contract itself confers a right of termination in certain circumstances? Is the right to terminate under an express clause unfettered? In particular, must a party be acting in good faith before it can exercise an express termination clause?

As we'll see, the case law is not clear on this point. Nonetheless, there are some basic principles which can guide you when creating an express clause allowing termination, or trying to use it.

Champtaloup - No limits

In Champtaloup v Thomas [1976] 2 NSWLR 264, the NSW Court of Appeal held that where a party has a contractual right to terminate, the right is not restricted or lost in circumstances where it is exercised capriciously, arbitrarily, unreasonably and not bona fide.

In Champtaloup, a purchaser had an express right to rescind a contract if certain events occurred. The events did occur, however, the purchaser admitted in evidence that his decision to rescind had nothing to do with those events.

Despite this, the Court still held that the right was validly exercised – as a matter of construction, the Court refused to read any relevant limitation into the rights given by the contract.

Departure from Champtaloup - there is a limit

The NSW Court of Appeal then handed down its decision in Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234, which is at odds with its earlier decision in Champtaloup, a fact it acknowledged in the decision.

In Renard, if the contractor breached the contract, the principal could call upon it to show cause as to why the contract should not be terminated. The principal was unhappy with the contractor's performance and issued a notice requiring the contractor to show cause. Despite the contractor purporting to show cause as required by the provision, the principal was not satisfied and proceeded to terminate the contract.

The question for the Court was whether the principal, in exercising its right under the show cause provision, was required to act in good faith. It found that the powers of the principal in determining whether to terminate the contract under the show cause provision were to be exercised "reasonably".

Later developments - implying (and excluding) a term of good faith

The NSW Court of Appeal revisited good faith in Vodafone Pacific Limited v Mobile Innovations Limited [2004] NSWCA 15. In Vodafone, Justice Giles indicated that the law had not yet gone as far as to deem commercial contracts to be a class of contract carrying the implied term of good faith as a matter of law.

However, he was willing to assume that "unless excluded by express provision or because inconsistent with the terms of the contract, Vodafone was under an implied obligation to act in good faith and reasonably in exercising its powers under the ASP Agreement".

To the extent there was an implied contractual obligation to exercise contractual rights, including rights of termination, in good faith, then Justice Giles thought it could be excluded.

A later example of where it was held to have been excluded is Solution 1 Pty Limited v Optus Networks Pty Limited [2010] NSWSC 1060. The parties had agreed that Optus would have the "absolute discretion" to terminate on 120 days' notice.

Following earlier authority, Justice Hammerschlag was willing to assume that a term of good faith could to be implied into the contract. The term was excluded however because it was inconsistent with the termination right being an "absolute discretion", and because the contract expressly excluded any implied terms.

What's the situation outside New South Wales?

The law outside NSW is arguably more circumspect.

The Victorian Court of Appeal has been reluctant to conclude that "an obligation of good faith applies indiscriminately to all rights and power [sic] conferred by a commercial contract" (Esso Australia Resources Pty Limited v South Pacific Petroleum NL (Receivers and Managers Appointed) (Administrators Appointed) [2005] VSCA 228).

In Queensland, the Supreme Court expressed the concern that an implied term of good faith may "tend to superimpose an often unwarranted layer of complexity and uncertainty into commercial bargains" (Kendells v Sweeney [2005] QSC 64).

So how do you draft or exercise an express right to terminate?

Renard is arguably persuasive in the context of express termination clauses. However, it is important to emphasise that Renard concerned a show cause provision, which will not be the case with all commercial contracts. Moreover, recent cases suggest courts are reluctant to imply a term of good faith into all commercial contracts.

Without High Court authority on the issue, the law remains unsettled. The critical questions requiring clarification by the High Court include:

  • is there is an obligation to act in good faith when exercising express contractual rights (including an express right to terminate)?
  • when this obligation can arise; and,
  • if the obligation exists, what conduct will amount to a breach of the obligation in the context of commercial contracts?

Ultimately, the following matters should be borne in mind:

  • When drafting a termination clause in a commercial contract, you should consider whether good faith should be expressly excluded. If parties do not wish to run the risk of a court holding that the right of termination can only be exercised in good faith, a clause which excludes the obligation should be included in the contract. That appears to be consistent with the approach taken by Justice Giles in Vodafone.
  • When considering whether to exercise an express right to terminate a contract in which the obligation of good faith is not expressly excluded, there is a risk that a court will find that the right can only be exercised in good faith. The terminating party should at least have regard to the decisions in Renard and Vodafone before exercising such a right, as well as the potential consequences if the court does find that there is an obligation to act in good faith.
  • A duty of good faith does not prevent a party from taking decisions and actions "which are designed to promote the legitimate interests of [that] party" (South Sydney District Rugby League Football Club Ltd v News Ltd (2000) 177 ALR 611). When a party is acting in a manner that is consistent with its contractual rights to promote its legitimate interests, there should be no breach of any implied duty to act in good faith.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.