A business owner entered into a long-term supply contract with a large New Zealand company. After two years, the business owner began losing money because the company’s charges became too high. Frustrated, the business owner sent a letter to the supplier company stating that he was switching to a cheaper provider and that the supply contract was cancelled.

A few days later, the business owner was surprised to receive a letter from the company claiming that the owner had repudiated the contract and owed a significant amount of damages to the company as a result.

How could this happen?

For a party to cancel a contract early, it must first have the right to cancel the contract under the contract itself, or at law, and then this right must be validly exercised (meaning all the steps required to cancel the contract must be followed).

In the above situation the business owner had no legal right to cancel the contract on the basis of price, and so himself seriously “breached” the contract by asserting to the other party that he no longer intended to be bound by it. As a result of the “breach” the other party could sue him for damages.

Right to cancel early

First, it is important to understand that once you have signed a contract, generally you will be bound by it until the contract says it ends, or until both parties have fully performed all their obligations under the contract.

Often contracts will include terms that provide a party with the right to cancel early in certain circumstances. For example, where the other party has breached an obligation under the contract or has run into financial issues.

The Contract and Commercial Law Act 2017 provides further rights to cancel a contract in other situations, for example where one party has made a misrepresentation to the other.

If a party cancels a contract on the basis of a situation that is not covered by the contract or the Act, the result can be costly.

Accordingly, before you attempt to cancel a contract (even if it seems certain that you have the right to), we recommend seeking professional advice.

Up-front protection

To protect yourself from being “locked-in” to a contract, check the cancellation (or termination) clauses prior to signing the contract.  If you do not feel that you have enough freedom to exit the arrangement, attempt to renegotiate this part of the contract.

Depending on the circumstances of the parties, an ideal cancellation clause will allow a party to “terminate for convenience”, meaning a party can exit for any reason (or no reason) as long as enough notice is provided to the other party.

As always, if you are in doubt about your rights under a contract, have the contract checked out by your professional adviser prior to entering into it.