This article has been written by Arpita Tripathy, from KIIT School of Law. This is an exhaustive article which deals with whether non-adherence of the due procedure can be accepted during the termination of a contract.
An agreement is when one of the parties offers a proposal and the other party accepts it. When the agreement is legally enforceable in the court of law, then such an agreement is called a contract. Entering into contracts with other parties is an important part of the business and day to day transactions. These contracts are governed by the Indian Contract Act, 1872. Whenever there is a question of termination of a contract, then the situation should be handled very carefully.
Termination of contract
Meaning of termination
Termination of a contract means ending the contract. People can enter into an agreement on their free will. They cannot be forced upon with clauses and conditions of the agreement. However, once the party gives assent to the agreement and a contract is formed, then the party has to comply with the clauses of the contract and cannot terminate it on his free will. In other words, a party can easily terminate the offer to contract because no party is bound to the contract. However, once the contract has been accepted then it is difficult to terminate it. An offer is also terminated if it is rejected by the party or the time period to accept the same has expired. If a counter-offer is made even then the offer is terminated.
Termination on convenience
Termination without cause is also called termination on convenience. The termination of convenience can be invoked after completion of a specific time period without communicating the reason behind it. Termination of convenience is a type of termination which does not require a person to send notice to the other party for such a termination. It can be done at convenience. Recently the employers have adopted this policy, where the employee is removed through termination of convenience then sufficient compensation should be provided to him.
When a party terminates the contract on the basis of termination of convenience without giving any proper reason then the court might direct for performance on the part of their contract. The court can direct the performance of contracts under the Specific Performance Act, 1963. However, when the termination clause allows termination by convenience without giving any notice then such termination is termed as a ‘determinable’ contract under Section 14 of the Specific Relief Act, 1963.
Termination by default
The most common type of termination is termination by default which is done due to the default of the party. Under termination of default, the contract is terminated when one of the parties fails to do his assigned performance. Before the termination by default takes place it has to be ensured that the party who did not perform is given a fair chance of explanation.
It should also be seen if the termination is in accordance with the termination clause of the contract. Termination should not, however, be proceeded with if the default of the party can be excused or if the default is because of the Act of God. If the termination clause of the contract requires a termination notice to be served then mandatorily a notice has to be served for termination. The notice for termination is served for the party to perform the task he had to perform. When there is no termination clause in the contract then the termination will be in accordance with the Federal laws.
Notice of termination
While serving the notice of termination, it has to be seen that the notice should contain all the reasons in detail for the termination of the contract. It should also be mentioned under which ground of termination of the contract is being sought. It has to be also mentioned that when the termination of the contract will take effect.
- While terminating the contract it has to be first seen if the party has the right to terminate it. If the party does not have the right to terminate and without such a right the contract is terminated then it is in itself a breach of contract. This purpose is served by the termination clause of the contract.
- The termination clause of a contract specifies the events and conditions which if occurs would lead to termination of the contract. If the termination clause is not according to law then it would be termed as ‘termination bad in law.’ Termination clause can have a fundamental breach. A fundamental breach means such a breach that makes the contract stagnant. The contract will not be able to move forward because of the breach. Material breach means the same as a fundamental breach under construction law.
- The termination clause should not be biased towards one party and disadvantageous to the weaker party. If the clause is favourable only to one party of the contract then it is called an unconscionable contract. If the termination clause is unconscionable then the court can strike down such a contract.
- This precedent was laid down in the case, Central Inland Water Corporation v. Brojo Nath. Here, Central Inland Water Corporation which was a government company had taken over another insolvent company, Rivers Steam Navigation Company. Brojo Nath was an employee at Rivers Steam Navigation Company. After taking over the company by the Central Inland Water Corporation, Brojo Nath was selected as the Deputy Chief Accounts Officer.
- After a few days, a notice was sent regarding his negligence towards his work, and was asked for a reply. Brojo Nath gave a detailed reply and explanation. Later, a letter of termination was sent to Brojo Nath. The court held that the termination clause was unconscionable. Among the parties when one is weaker and has less bargaining power and clauses are biased towards the dominating party then the unconscionable contract can be struck down by the court.
- The court will only strike down such a contract if it is evidently shown that one of the parties is weak. If both the parties have the same bargaining power then the contract is not unconscionable. The court also highlighted the provisions of the Constitution which provide for economic justice. This precedent has been a landmark judgment and has also been applied in several other judgments.
Reasons for termination of the contract
The Indian Contract Act, 1872 does not specifically provide the reasons for termination of the contract. Parties can insert the termination clause according to their business preferences. A contract contains many clauses relating to the specifications of the goods, the price, the mode of transfer, etc. Along with these clauses, a clause for termination of the contract is also included in the contract. Termination of a contract means putting an end to the contract. The clause for termination defines how and when the parties can go for termination of the contract. The termination of contracts is basically of two types, termination with cause and termination without cause.
When the termination is intended to have legal enforceability then the termination is written. When the contract is oral then the termination of such contracts can be made orally. Sometimes the termination clause also contains the provision of penalty for termination. The termination of the contract can be because of many reasons, which have been listed below:
For termination of mutual consent, a termination clause is important. When the parties agree to terminate the contract on a happening or not happening of an event, there can be various reasons for such termination of the contract. When the clause specifies that non-performance of the contract would lead to termination of contract then if one of the parties stops performing his part then the contract will be terminated automatically. For example, the seller of goods might have stopped producing the goods.
Breach of contract
The contracts are also terminated when there is a breach of clauses mentioned in the contract. When a seller promises to sell high-quality goods but fails to do so and instead send low-quality products then when such a contract is breached and this contract can be terminated. When one of the parties does an act that has been prohibited, then such an act is a breach of contract. It has also been witnessed that one of the parties refuses to perform their specific performance or stops the other party from performing their part. In such cases, a contract is breached. However, it has to be seen if such clauses that have been violated are important to the contract or not. If it is not important then the contract might not be terminated.
Breach of contracts can be of many types. The party to the contract might breach his promise, or might not complete his duty towards the contract, breaches can also be regarding the warranty of quality, no damages, etc. Sometimes parties also vocalize their intention not to perform their promise or duty in the future, this breach is called an anticipatory breach.
A breach of contract leads to a huge loss of the suffering party. Therefore, when there is a termination of the contract because of breach of contract then, generally compensation is demanded by the breaching party. Sometimes, it is just a small amount just as an acknowledgement of the breach. Another type of compensation that is demanded is where the party who breached the contract is demanded money as if the contract had never been breached. However, when the contract is such that the compensation would not fulfill the person, then in some cases, the court also orders specific performance of the contract.
Waiver of rights
Sometimes, it may so happen that the quality of goods supplied has been consistently poor. The suffering party should not accept the goods, because complaining later about the damaged goods would not be useful. A person cannot keep on accepting bad quality goods and suddenly one day, come up and complain about the goods of bad quality.
Frustration of contract
Parties usually try to perform their part of the contract. However, sometimes, such situations arise which makes the contract impossible to perform. This is called frustration of contract. The frustration of a contract is not the same as a void contract. The frustration of a contract occurs when there is a sudden change in circumstances. The frustration of a contract can be because of various reasons. A natural calamity or can be called an ‘act of god’, might make the contract impossible to perform. For example, the coronavirus pandemic was an unforeseen event that can be termed as an act of god and might lead to situations where there is frustration of contract. Even the change in governmental policies of the country might lead to frustration of contract.
The recession of contracts means cancellation of the contract. The recession of a contract cannot be done in parts, the contract has to be cancelled as a whole. The main purpose behind the recession of the contract is to bring back the positions of the parties to the contract like they were used to before the contract was entered into. The parties to the contract should try to get back to their previous positions.
This remedy by bringing back the parties to the original position poses an equitable remedy. If one of the parties has gained profits then the recession of the contract will not be possible in the case. Breach of contract and rescission of the contract are two different terms. The breach of contract recognizes the existence of the contract and termination happens just after the point of the breach. In the recession of a contract, the parties go to the original position even before the parties had entered into the contract. There are many reasons for the recession of contracts. Some of them have been listed below:
Section 14 of the Indian Contract Act manifests free consent as a consent which is free from any kind of coercion, undue influence, fraud, misrepresentation or mistake. If any consent is forced on a person with these weapons then such consent is not free and valid. This is subject to the provisions of Sections 20, 21 and 22. Consent will only be valid without the elements mentioned in section 14.
‘Consensus ad idem’ means both the parties should have understood the subject matter in the same sense. It is not sufficient to give consent but the consent should be free and voluntary. According to Section 14, if consent is affected by coercion, undue influence, fraud, misrepresentation then the consent will not be said to be voluntary.
According to Section 15 of the Indian Contract Act, coercion means any act which contravenes the provisions of the Indian Penal Code. If a person detains the property or threatens to detain the property so as to influence the consent of a party then it is coercion under the section. The section does not specifically talk about the act in question to be against the party to contract, the coercive action can be against even a third party. In the case of Ranganayakaama V. Alwar Sethi, a widow was threatened that her husband’s body will not be removed if she does not adopt.
This was held to be coercive and consequently, she was not bound to adopt. In another case, the husband threatened to commit suicide if the wife and his son did not execute a release deed. The act of the husband threatening to commit suicide was held to violate the provision of the Indian Penal Code and thus, the contract was held not to be valid.
When one of the parties is in a position of dominance over the other and uses his position to influence the will and force a person to make a contract, then a contract made under such undue influence is not a valid one. Sometimes a person is in a relationship of confidence or dependence that puts them in a position to exercise an influence which can be unfairly used. It has been stated by many authors that undue influence is a subtle kind of coercion and the result is brought by fear. There should be essentially two features to prove undue influence. Firstly, the relationship should be of trust and confidence, secondly, there is an element of unfair persuasion and also the will of the other person being affected by the influence.
According to Section 17 of the Indian Contract Act, fraud includes any fact which the person making it knows it to be false. When a person actively conceals a fact it is also fraud. Any act which is done to deceive another person or an act which law has declared as a fraudulent act.
Fraud is committed when one person asserts something to the other one which he himself believes to be false. There should be an intention to deceive the other party. The fraudulent statement should be such that it can influence a reasonable man’s decision as to whether or not to enter into the contract. Mere silence does not amount to fraud. But, active concealment will amount to fraud.
The landmark case of Derry V. Peek established the meaning of fraud. In this case, a company was authorized to run trams by animal power, and if the Board of Directors agree then by steam or mechanical power. They believed that the Board of Directors would give the consent as they had already put an application for the same before the Board. Therefore, the company on its prospectus mentioned that they are allowed to run trams by steam and mechanical power.
Believing in such a representation, Peek bought shares of the company. Later, the Board denied giving approval and the company was wound up. Peek brought a suit on the grounds of fraud. The court held that the company was not liable. The court added that fraud will only take place when the representation is false and is made knowingly. The person making the representation does not believe in it. The person is careless whether it is true or false.
Under Section 18 of the Act, misrepresentation has been defined. Misrepresentation means asserting a fact which the person making it believes it to be true even if the statement made by him is false. If a person breaches his duty and gains an advantage then it is misrepresentation even if such a breach of duty is innocent even then it is a misrepresentation. There is a difference between misrepresentation and fraud. Misrepresentation means asserting a statement which is false but he innocently makes it believing it to be true. However, fraud means intentionally trying to deceive the other party.
When a person makes a false statement which he himself believes to be true is called misrepresentation. The person might not have an intention to deceive the other party. The statement must have induced the other party to enter into the contract. The contract is voidable at the option of the other party whose decision was induced.
When one of the parties gives consent to a contract because of a misunderstanding then that consent is said to be given under ‘mistake’. The mistake is divided into two parts under the Act:
Mistake of law
Even if someone does not know the law that does not mean that he may escape from the liability. The maxim ignorantia juris non excusat explains that no knowledge of the law is not an excuse. If the person contracts under a mistake of law then it cannot be a voidable contract, because every citizen of the country should have knowledge about the law.
Mistake of fact
If both the parties believe in the existence of the subject matter but it does not exist then the contract can be void. Even when there is a mistake of material fact of a contract then the contract is held to be void but if the fact mistaken is not material then, the contract will not be affected.
Consequences of termination of the contract
When a contract is terminated then the parties have to pay the consideration for the duties which have been performed by the parties. When there has been fulfilment of a promise by the parties then payment has to be made. If the termination of the contract is because of a breach of clauses in the contract then the party who has breached the contract should pay compensation. The amount of compensation should be decided in accordance with the termination clause of the contract. The termination of the contract will put an end to the rights and liabilities of each party. Termination of the contract will also lead to restitution. Restitution here means that the parties will go back to their respective positions as was before they entered the contract.
Due process in the contract
- When a party breaches the contract in such a manner that the rights of the other party under the contract are adversely affected then such a breach is called a repudiatory breach. When there is repudiatory breach by a party under the contract then the other party will be left with two options. Either repair the contract or terminate it. Sometimes the breach is such that the contract is beyond repair. When a contract is terminated the principles of natural justice should be followed. However, occasionally, instances can be observed where the termination of contract might not need to follow the principles of natural justice.
- The Indian courts have accepted that sometimes, non-adherence to the due process can also be accepted. For non-adherence to be accepted it is to be shown that the circumstances were such that adherence to natural justice was not possible. However, if natural justice is not followed then the party violating natural justice and not following the due process then the party terminating will have to pay compensation. In the case of Air India Ltd. v. Gati, a wet lease freighter agreement was entered into between Gati Ltd. and Indian Airlines for the lease of aircraft. The clause of termination mentioned that a notice should be served before 120 days and on expiry of such a period, the contract will be terminated. GATI through a letter terminated the agreement. Air India protested the termination of the contract through a letter. These events led to the parties approaching arbitration. The arbitration clause was invoked by GATI and alleged different claims against Air India. The claims of GATI were that Air India did not comply with the timelines and there were continuous delays. According to the High Court of Delhi, termination of the contract was a valid one because sometimes, non-adherence to the due process can be allowed because of the inaction of the party. There were a number of repudiatory breaches of contract.
- In the case of Deva Builders v. Nathpa Jhakri Joint Venture, the parties entered into a contract for the construction of civil work for a project site. The contract assigned work to the plaintiff. The defendant had assured the plaintiff that he would be given sufficient work. When the plaintiff was carrying on with the work, the defendant showed very uncooperative behaviour. After some time, the defendant after providing lame reasons stopped allotting the plaintiff with any work. Plaintiff made several requests to the defendant but to no avail. The defendant unilaterally determined the contract. The plaintiff came under huge debt because of the uncooperative attitude of the defendant. However, the defendant claimed that the plaintiff did not complete its work properly. The Hon’ble High Court of Himachal Pradesh held that even if the defendant had not given any notice of termination and the contract was terminated unilaterally, even then the termination is valid because the plaintiff had not performed its part performance.
- In the case, Bharat Petroleum Corporation Ltd v. Jethanand Thakordas Karachiwala, the plaintiff entered into an agreement for the agency of Brushan Gas. The plaintiff company was performing its liability under the contract. However, some people from the defendant company came to the office and took records of the Bharat Gas Company. The contract of the Bharat Petroleum Corporation was terminated without providing proper notice. The plaintiff filed a case regarding illegal termination of the contract. The defendant contended that there were huge losses because of the contract and therefore, the contract was terminated. The Hon’ble High Court of Bombay held that the plaintiff had actually defrauded the defendants and therefore, the termination of the contract is justified even without proper notice.
When one of the parties does not perform the assigned performance under the contract then the other party has to face consequences regarding the same. When such a default makes the further performance of the contract impossible then a party will be left with only two options, either try to improve things or to terminate the contract. The termination of a contract should be in accordance with the termination clause of the contract. The termination clause should specify the conditions under which the contract can be terminated. Before termination, prior notice should be sent to the party which is being terminated. The notice sent is like a warning so that the party can rectify the default made. There are many reasons for the termination of a contract. The contract can be terminated due to the default of one of the parties or mutual consent or frustration of the contract or rescission of the contract.
The termination of the contract should be according to the principles of natural justice. Due process should be followed while terminating the contract. However, if the termination is because of some default of the party then sometimes, the court allows the termination without adhering to the due-process.
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