WSG Article: Unilateral termination clause irrelevant to contract novation

Unilateral termination clause irrelevant to contract novation

June, 2022 - Shoosmiths LLP

In a recent case, a unilateral termination clause in the relevant contract had no bearing on whether termination via agreement between the parties was available, and the court held that novation of the contract by the conduct of the parties was valid.

Background

Novation

Where a contract is novated, the previously existing contract is extinguished and replaced with a new contract in respect of which a third party takes up the rights and obligations which duplicate those of one of the original parties to the agreement. Novation can be inferred from the conduct of the parties if necessary.

The dispute

In this instance, the first claimant took on rights and obligations under a new contract that duplicated those of the second claimant under the original agreement.

The case concerned a claim for unpaid sums under an Aircraft Support Services Agreement. The contract, to provide services for the management and operation of the aircraft, was initially entered into by the second claimant and the defendant in February 2008. The services were performed by the first claimant from April 2017, as the first claimant held the relevant regulatory authority from that point onwards. The defendant paid the second claimant for services delivered until January 2019 when they stopped paying.

The claimant applied for summary judgment in respect of its claim for the unpaid sums (totalling over $1.3 million).

The court’s decision

The defendant’s position, in resisting the claim, was based on the termination provision at clause 1 of the contract, which stated:

"This agreement shall commence from the date of this agreement and shall subject to clause 9 continue until such time as either party gives the other not less than three months' notice in writing of termination of this agreement”.

The defendant argued that clause 1 set out the exclusive basis on which the contract could be terminated, preventing any other form of termination such as novation.

To interpret the clause, the court took into account the following principles of contract interpretation:

the starting point is that the parties mean what they say in the relevant drafting
what the understanding of the clause by a reasonable person, with all the background knowledge reasonably available to the parties at the time of entering into the contract, would be
the commercial consequences of each possible interpretation
where there are two possible interpretations, that which is consistent with business common sense can be selected above the other

On the defendant’s construction of clause 1, the contract could only be terminated by one party giving three months’ notice, even if the parties agreed to terminate sooner. The court found that the construction consistent with commercial common sense was that clause 1 covered unilateral termination only and had no bearing on whether termination by way of agreement between the parties was available. In the absence of any provision in the contract setting up formalities as to how the contract was to be terminated by agreement, there was no bar to termination by novation; clause 1 did not operate to prevent termination by novation and the novation was valid.

The defendant was also estopped from denying the efficacy of the novation.

The application for summary judgment was successful.

Comment

With services having been delivered by the first claimant and paid for by the defendant for almost two years, it would have been surprising for the court to reach any other conclusion other than that the novation of the contract to the first claimant was valid. Nevertheless, it is reassuring to see this decision from the court, and that the English law principles of contract interpretation enable decisions which make clear commercial sense.

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