When you draft contracts do you give your customers a chance to get out of them? Are your contracts about the terms of service, but not a specified amount of time. Why?
Have you even thought about your reason? Are you afraid your customers will not sign up for a specified term? If you gave them a reason, do you think they would?
If you rent an apartment, have you ever noticed that it is more expensive to rent on a month-to-month basis than for a whole year? The ability to get out of a contract does not mean that there is no contract, it simply means that the contract is only effective as long as you want it to be.
The right to terminate a contract at any time is what companies really mean when they say they have a service or product with “no contracts”. They really mean “no contract term” or, more specifically, “you can terminate your contract whenever you want to”. This is often called “termination for convenience”. That means you have a contract, but you can end it at any time you want (if you follow the contract term that outlines how you terminate the agreement). That, of course, does not play well in a 30 second commercial (or on a billboard).
So, what does a termination clause in a contract look like?
- Termination. Either party may terminate this agreement at any time with 15 days’ written notice.
- Fees on Termination. If this agreement is terminated for any reason, Client must pay Service Company the full value of the Project as outlined in this agreement immediately upon termination of this agreement.
- Costs of Collection. Client agrees to pay any cost of collection for unpaid invoices, including but not limited to, court costs, and attorneys’ fees. Client agrees to pay interest at the rate of 1.5% per month, or the highest interest rate allowable by law (whichever is less), payable monthly on any past due payment due under this agreement.
- Remedy for Nonpayment. Service Company reserves the right to cease providing any additional services until all invoices have been paid in full. Withholding of services, in such an instance, shall not be considered a breach or default by Service Company.
This termination clause allows either party to terminate the contract with notice. It also establishes what happens if the contract is terminated. It also includes what does not happen. As this clause is from a software development contract it includes the intellectual property rights, that would be treated differently if the contract were completed. This termination clause gives the client a right to terminate if they want, but gives the Service Company leverage to keep the client from terminating. There is no required reason for termination, but there are consequences to terminating before the end of the contract.
Termination rights help you determine how much to charge.
This is a prime way you can value your business relationship. It helps determine your pricing structure. If you have twelve month agreements with no termination rights, you can value the agreement over the life of the contract. If, however, you have an agreement with a twelve month term, but a right to terminate at any time (like the example above), your contract is only worth the value of the next month’s payment.
Termination rights are tricky. People want to know that they can get out of a contract if something comes up. People also want to lock in the best possible rate. That is why you pay more money if you have a right to get out of a contract. Sticking with the lease examples, a month-to-month lease is substantially more expensive than a 12 month lease, which is more expensive than a five year lease. The right to get out of a contract is one of the most valuable rights you can have. Therefore it will cost additional money.
For the contract drafting party, you also need to know if you can get out of a contract. You need to determine if you must have a reason (called “termination for cause”) or if you can simply terminate for convenience (like in the example above). Termination for cause is an often neglected part of the contract drafting process. It is always important to include, at a minimum, a right to cease services for failure to pay.
If you want to learn more about termination rights and how they pair with contract terms and renewal rights, listen to episode 10 from the Legal to English Podcast.