Whether you (the client/customer) have an obligation to pay when a contract has been terminated depends on the reason for termination, the timing of the termination, which party terminated the contract, and the terms of the contract. Mostly, it depends on what the contract says!
The short answer is that you may have to pay depending on what circumstances surround the termination. Below are some important points to keep in mind.
Breach of Contract
If you’re responsible for a material breach of the contract, you may be required to pay damages or liquified damages (an amount agreed upon in the contract in advance as the damage caused by the breach). Keep in mind that it must be a material breach, which is one that goes to the core of the agreement and not something minor that would not affect the completion of the service agreed upon.
Let’s take a software development contract for the creation of a mobile app, as an example. As a client, a material breach could be your failure to provide the developer with essential information required to develop your app, or your failure to make payments under the contract as they become due. If you cause a material breach and the contract is terminated as a result, you could be responsible for payment.
If the other party causes a material breach of the contract, they might be responsible to you for damages and, depending on the terms of the contract, it’ likely that you’ll not have any further responsibility under the contract. For example, in the mobile app development contract, if the developer fails to meet the milestones (either in terms of timing or quality of the work product) and the defects are not curable within the time period set out in the contract, the contract may provide that you have the right to terminate the contract. Whether you’ll be responsible for any further payments will depend on the terms of the contract. Source
Your contract should include clauses dealing with termination rights. Often the contract will provide that one or both parties have the right to terminate for cause (usually a breach by the other party) and that this termination will be effective as soon as notice of termination is given to the other party. If there’s a cure period, then the party will have the right to terminate if the matter is not cured (or cannot be cured) within the stated period.
The contract may also provide that one or both parties have a right to terminate for convenience. This means a party can terminate for any or no reason, effective a specified time period following provision of written notice to the other party. If the contract is terminated according to the termination clauses, then termination itself will not be a breach of the contract which requires payment of damages as compensation for the termination.
Payment Upon Termination
Many contracts contain clauses which deal with the question of whether/what payments must be made upon termination of the contract. These clauses are often closely negotiated, and the terms can vary greatly from contract to contract.
Continuing with our software development contract example, the developer will want to include a clause that requires the client to pay for all work done to the date of termination, as well as an additional amount for all resources (eg. personnel) that cannot be reallocated to another project within, for example, 3 weeks of termination, regardless of the reason for termination or who terminated the contract.
The client will want this clause to provide for no payments past the date of termination, or, payment only for work completed and accepted by the client before the date of termination. Large clients with strong bargaining power may have standard software development contracts of their own, which can include clauses that state that the client can terminate if the work product is not accepted by the client, and that if the contract is terminated, the developer will be obliged to refund all payments made under the contract.
Check your contract carefully to see what type of payment upon termination clauses it contains, if any!
Early Termination Fees
Some contracts, especially contracts for services (such as data storage, business telephone/internet bundles etc.), provide that in the event that the client wishes to terminate the contract early, the client will be obliged to pay a termination fee. The termination fee is often stipulated to be the product of the monthly fee times the number of months remaining in the contract term. In other words, the termination fee is the cost of the remaining payments that would otherwise have been made under the contract.
Check your contract carefully to see what type of early termination clauses it contains, if any!
Survival of Payment Clauses
Most contracts will contain a ‘survival clause’ which provides that certain provisions of the contract will survive termination of the contract, meaning that they continue in effect even if the rest of the contractual obligations have been terminated. Payment clauses are usually included in the list of clauses that survive termination - any payments you were obligated to make before the contract was terminated, you’re still obligated to make after the termination.
Your Contract Terms Will Govern
So, will you, the client, have to pay if you terminate the contract? It’s unlikely that you can avoid payment you’re otherwise required to make simply by terminating the contract. It all depends on the terms of your contract. Before you sign, check your contract carefully to see what type of payment clauses it contains!
This blog was co-authored by Vi Vo.