Terminating Contracts in an Uncertain World Arnondo Chakrabarti, Jonathan Hitchin & James Partridge Allen & Overy LLP

Coming up… Termination for breach (where no express provisions) Express termination provisions - Events of Default MAC Event of Default Market Disruption Clauses

Do I have a right to terminate for breach? Two separate issues Breach Failure to perform a term or terms of the contract Remedy – damages for losses caused by breach of the clause or clauses Repudiation Manifesting an intention not to be bound Remedy – option to terminate prospectively and claim damages for loss of the contract “Anticipatory breach” is not a case of breach at all but, rather, of repudiation

Do I have a right to terminate for breach? The first step – classification of terms Condition Warranty Innominate terms The types of repudiatory breach Breach of condition Serious breach of innominate terms Repeated other breaches in exceptional cases

Options for the Innocent Party Terminate contract and sue for loss of bargain Affirm contract – lose right to terminate “No waiver” clause not sufficient to prevent affirmation by conduct (Tele2 International Card Co SA & ors v Post Office Ltd [2009] EWCA Civ 9)

Risk of wrongful termination Wrongful termination is, itself, a repudiatory breach For example A has a loan facility with B Bank B Bank is in difficulty and it seems certain that it will be unable to transfer funds on time Bridging finance will cost A £1m A replacement facility will cost A £15m B Bank’s profit on the facility is £20m If A sues on the breach alone he recovers £1m If A terminates with cause he recovers £15m If A terminates wrongfully, B Bank can sue for £19m

Other ways of bringing contract to an end Vitiation (eg. for misrepresentation or mistake) Frustration Very narrow test – Davis Contractors Ltd v Fareham UDC “Frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.” Automatic termination – no election required Must not be due to the act or election of the party seeking to rely on it Expiration in accordance with terms of contract

Express termination provisions Two types of express termination clauses: Failed performance (“Events of Default”) Circumstantial events (“Termination Events”) eg. Insolvency

Interpreting termination provisions Do I have to give notice or can I terminate immediately? Can I terminate for breach even if the breach is trivial? What is a “material” or a “substantial” breach? Can I still claim damages if I terminate?

Interpreting termination provisions Do I have to give notice before terminating? Will depend on wording of contract Generally: Notice often not required if breach cannot be remedied If can be fixed, usually have to give chance to do so – failure to rectify following notice adds to seriousness of breach

Interpreting termination provisions Can I terminate for breach even if the breach is trivial? Garden Guardian case: a cautionary tale Court rejected argument that “any breach” could cause the right of termination to arise Alan Auld Associates: repeated minor breaches can be repudiatory if they deprive the innocent party of substantially the whole benefit of the contract

Interpreting termination provisions What is a “material” breach? Not the same as a repudiatory breach National Power – remediable breach likely to have serious effect on counterparty if not rectified Dalkia Utilities – look at nature of breach – failure to pay three monthly instalments (out of 173) in a row was material Why does “any breach” have to be a repudiatory breach while a “material breach” does not?

Interpreting termination provisions What is a “substantial” breach? Crane Co v Wittemborg – essentially the same as repudiatory breach So why is “substantial” any different from “material”? Anticipatory breach was not a breach for the purpose of this clause

Interpreting termination provisions Can I still claim damages if I exercise contractual right of termination? Yes – but depends on construction of contract Stocznia Gydnia v Gearbulk Holdings Ltd 2009 [EWCA] Damages limited if breach is not also repudiatory: Will recover loss suffered to date Won’t get “loss of bargain” damages unless contract specifically provides for it

Drafting tips Be specific: Breaches for which a party can terminate What is meant by terms such as “material”, “substantial”, or “material adverse change” Steps that are required to terminate (e.g. notice) Consequences of termination e.g. damages for loss of bargain?

Events of Default Compared to termination clauses Variety of uses Material Adverse Change (MAC) clauses

MAC Clauses Types of clauses and their purpose Inherent uncertainty Relationship to frustration

Business MAC “Any event or series of events occurs which, in the opinion of the Majority Lenders, is reasonably likely to have a Material Adverse Effect.” “Material Adverse Effect means a material adverse effect on: (a) the business or financial coundition of any member of the Group or the Group as a whole; (b) the ability of any Obligor to perform its obligations under any Finance Document; or (c) the validity or enforceability of any Finance Document.”

Elements of MAC clause Adverse effect on what? A subjective test? Paragon Finance v Staunton (2001) What counts as material? What degree of certainty is required? What if event was foreseeable? M&A context – WPP/Tempus

Practical steps Document reasons for invoking MAC (eg. board minutes) Compare borrower’s position at time agreement signed against position when seek to invoke MAC Record alternative options Seek support of other lenders? Any other relevant provisions of agreement? (eg. other Events of Default)

Risks of invoking MAC MAC clauses narrowly interpreted Burden of proof on party seeking to rely on clause Risk of breach of loan agreement Damages may include: Losses from cross-defaults Cost of arranging alternative financing Increased cost of alternative finance Loss of business opportunities Loss of going concern value if borrower becomes insolvent

Conclusions on MAC Consider actual wording Fact specific Getting it wrong could lead to large damages But leverage in negotiations

Market Disruption Market Disruption clauses in loan agreements - How do they work? LIBOR does not currently represent the cost of funds of Banks Current approach – are these clauses being invoked?

Issues with the Market Disruption Clause Reputational Risk? Practicalities for Facility Agent Competition Law concerns How is interest calculated where a market disruption clause is invoked?

Possible Solutions? Lower the threshold Disclose only blended rates to borrowers A documented process for exploring appetite for invoking the clause Use Reference Banks rather than Screen Rate Higher of a screen rate and a Reference Bank rate Adjustment to Screen Rate Reference to CDS spreads Increasing upfront margin

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