Termination Provisions

Glance through the termination provisions of an outsourcing or technology services contract and you’ll quickly notice a one-sidedness to the terms.  Termination provisions provide terms and conditions under which the relationship between a vendor and a customer may be dissolved.  As this post will discuss, the risks involved with the contract are different for the customer and the vendor – which means each side has a different stake in the performance of the contract.  The risk plays out slightly differently whether the contract is terminated for cause or whether it’s terminated for convenience, but both instances illustrate why the contract may often include terms that, on first blush, favor the customer heavily over the vendor.

Generally speaking, termination provisions aren’t mutual between the vendor and the customer because the risk each side bears is substantially different.  If the relationship between the vendor and the customer is terminated, it’s likely that the vendor’s largest loss will be revenue.  The customer, on the other hand, is in a position to lose a service that could bring day-to-day business to a standstill.  For example, if the service that vendor is providing is IT help desk support, a sudden loss of service may be enough to render the whole company’s IT useless or at least less useful.  While, understandably, no company wants to lose a customer or revenue, the vendor’s entire operation isn’t shut down if one contract ends.   The customer, then, has to be much more protective of the instances which would result in the termination of the contract simply because it has more at risk than the vendor.

The difference in risk between the customer and the vendor affects termination for cause and termination for convenience in different ways.  No one – not the vendor and certainly not the customer – wants to be terminated for cause.  In contrast to a termination for convenience, termination for cause arises when one of the parties is not performing an essential function of the contract.  Perhaps the vendor is routinely late in providing the service and has not satisfactorily addressed and fixed the problem after a given period of time.  Termination for cause means not only lost revenue for a vendor but may also impact the ability to acquire new contracts.  New clients will want to know why and under what conditions a former client terminated the contract and terminations for cause will be viewed with great concern.

Even with these downsides to the vendor, the customer is still in an even more vulnerable position of losing a chunk of operational time.  Given the need for the vendor’s uninterrupted service, a customer should very rarely allow the termination of a contract for cause.  This might happen, for example, if the customer is persistently and severely late with payment to the point of non-payment or if the vendor’s intellectual property is breached by a practice adopted by the customer.  It should be noted, though, that there are few instances where a problem that might result in termination for cause couldn’t be remedied through monetary damages (other than non-payment).  As the instances where this could happen are so rare and the customer’s stake in the contract so great, it is mystifying that a customer would allow a termination for cause to happen.

Termination provisions for terminations for convenience, on the other hand, really should be so restrictive that vendors aren’t even permitted to exercise the option.  Termination for convenience occurs when the vendor’s service or the customer’s needs are no longer aligned with the best interests of the business and, as a purely commercial decision, the customer terminates the contract.  Here again, the customer has much more at stake from termination for convenience than the vendor.  As with termination for cause, if the vendor decides to terminate for convenience, the customer is left with the sudden absence of the vendor’s service that, as discussed earlier, could bring business as usual to a halt.  The added disruption that a termination for convenience causes is the unanticipated search for and transition to a new vendor.  This process can be lengthy (possibly reaching up to six months) and highly disruptive.  To ensure a smooth and orderly transition to a new vendor, then, the current vendor really shouldn’t be able to terminate for convenience for the term of the contract.  At the very least, the notice provisions which give the customer fair warning of a possible termination of the vendor’s services need to be far enough in advance to ensure a smooth and (hopefully) seamless transition to a new vendor.

While there is an absence of mutuality here between when the customer and the vendor can terminate for convenience, the restriction is understandable.  Let’s say, for example, the customer and the vendor have entered into an agreement which ultimately turns out to be a losing contract for the vendor.  Knowing that that customer is dependent on the vendor to keep business running smoothly, the vendor could terminate for convenience and then extort a more favorable and lucrative contract from the customer – all because the customer is so reliant on the vendor’s service.  Ultimately, the vendor, not the customer, must take the risk that the price is correct.  Of course, the vendor may protect itself to an extent through cover.  And this is not to say the vendor is left without options.  The vendor can simply choose to not renew the contract at the end of its term.  Or, if it’s a losing contract, it may simply choose to not renew unless the customer agrees to a higher price.

Whether for cause or for convenience, the unexpected end of a contract will likely leave one party at a loss.  The smart contract will have prepared for this and, through adequate termination provisions, will keep the customer’s business up and running.