Demystifying Contract Termination: Key Insights for Ontario’s Small Business Landscape

Contracts are essential components of legal and business transactions in Ontario, and understanding the various ways they can be terminated is important for successful dealings in small businesses. In this article, we explore four primary modes of contract termination: fulfilment or performance, agreement, frustration, and breach. Each mode has its own specific criteria and implications, and parties should be aware of the potential outcomes and remedies associated with each type of termination to ensure that their contractual relationships are effectively managed and resolved.

There are several ways a contract can be legally ended or “terminated”. These are primarily based on:

• Fulfilment or Performance: This happens when both parties have fulfilled their respective obligations under the contract. This is usually the most preferred method of ending a contractual relationship.
• Agreement: Parties are always at liberty to mutually decide to terminate their contract. They could choose to abandon their agreement, or one party could compensate the other as part of a settlement to end the contract.
• Frustration: The legal principle of frustration comes into play when, after a contract is formed, a significant and unexpected event occurs. This could be the destruction of the contract’s subject matter or the death or incapacity of a contracting party.
• Breach: A serious violation of the contract can free the innocent party from further obligations under the contract, should they choose to do so. Minor violations usually result in the wronged party being entitled to damages only.

Following this is an exploration of these four modes of termination, along with a synopsis of the remedies for breach of contract.

Termination based on Fulfilment/Performance:

The criteria for termination through performance are contingent upon the contract’s specifics, as demonstrated in the following examples:

• A contract for a corporation’s audit is considered executed when the audit is expertly completed and the auditor’s charges for the delivered services are paid in full.
• A contract for the purchase and sale of a property is fulfilled when the buyer remits the purchase amount and the property’s ownership is transferred to them.
• A contract to supply a custom-made generator is deemed completed when a generator that matches the contract’s stipulations is delivered, and the purchase cost is settled.

In summary, a contract is executed when all its implicit and explicit commitments are accomplished. However, the termination of a contract through performance doesn’t necessarily imply the cessation of the business relationship between the parties. They may choose to engage in further business through the formation of new, ongoing, and concurrent contracts.

Termination by Agreement between Parties

Parties can alter or end a contract if it becomes unfavorable for one or both of them. They can:

• Novate, or create an entirely new contract, which is enforceable by court if it benefits both parties. For instance, a buyer might decide to purchase a different, more luxurious house from a builder, leading them to negotiate a new agreement while cancelling the old one.
• Vary specific terms of the contract. For example, if the buyer wants upgraded bathroom fixtures, they could seek a variation of contract. This typically requires the benefiting party to provide consideration, such as an increased contract price, although certain courts may enforce variations unsupported by consideration in some circumstances.
• Terminate the contract, either by both parties agreeing not to enforce their rights or one party paying the other to end their obligations.
• Substitute a party, where one party’s rights and obligations are transferred to someone else. This requires agreement from all parties, and the old party completely leaves the contract. If the substitution is unsatisfactory, the original party can be asked to fulfill the contract or be sued for breach.

Agreement between parties is generally the most effective way to manage unfavorable events in a contract, as it helps avoid costly and uncertain litigation.

Termination by Frustration

The concept of frustration in contract law refers to an unexpected event after the contract’s formation that renders its performance impossible or drastically different from what was originally agreed upon. This doctrine provides a legal justification for non-performance.

Four key conditions must be met for an event to be considered frustrating:

• The event must be unforeseen.
• The event must not be due to any party’s fault.
• The event should make the contract’s purpose either impossible or significantly harder to achieve.
• The event’s risk should not have been contractually assigned to any party.

When these conditions are fulfilled, the contract ends, and neither party is liable for breach. Notably, this includes situations like an employee’s death or the enactment of prohibitive legislation.

Numerous situations may seem to cause frustration in a contract, but they do not legally constitute frustration. Take, for instance, if Steve discovers that the price of construction materials has surged unexpectedly due to COVID-19 Pandemic, leading to a significant loss on the contract. This situation wouldn’t be considered legal frustration. Even though performing the contract has become financially burdensome, it remains feasible to fulfill it.

In rare cases where a contract is terminated by frustration, the outcome can be unsatisfactory. Any further obligations cease upon frustration, and if one party has begun performance and incurred costs, there is no straightforward way to compensate them, as the contract’s termination wasn’t due to any party’s fault. There are legal nuances and statutory provisions that attempt to address these issues, but they are complex and vary across jurisdictions.

Breach of Contract

Nearly every contract breach entitles the non-breaching party to some form of remedy. When deciding what this remedy should be, courts first determine if the violated term can be categorized as a condition or a warranty. This classification relies on the intentions of the parties involved and is determined through an examination of the circumstances surrounding the contract, including the language used within it.

A condition is an important term; its breach allows the non-breaching party to not only sue for damages but also to consider the contract as ended, thus freeing themselves from any further obligations. For instance, if a contractor repeatedly violates the contract and displays inappropriate behavior, it could be argued that a condition of the agreement has been breached, releasing the other party from the contract.

On the other hand, a warranty is a less significant promise. When a warranty is breached, the non-breaching party is only entitled to damages.

There are instances where a term can’t easily be classified as either a warranty or a condition, known as an innominate term in law. In such situations, the court examines the consequences of the breach to decide whether the non-breaching party can terminate the contract.

However, if the non-breaching party ends the contract based on an incorrect assumption that a serious breach has occurred, they may themselves be in breach and liable for a lawsuit. It’s worth noting that parties can pre-define a term’s classification within the contract itself, and courts typically respect this classification if clearly stated.

Final thoughts

The termination of contracts in Ontario is a complex process that requires careful understanding and execution. Be it fulfilment, agreement, frustration, or breach, each mode of termination carries with it specific implications and potential outcomes that parties should be aware of. It is important that parties understand these modes of termination to ensure that their contractual relationships are effectively managed and resolved. In instances of uncertainty or complexity, the guidance of a small business lawyer can be instrumental, providing expert advice on termination modes, remedies in case of breach, and other nuances of contract law. As the business landscape continues to evolve, the understanding and application of these principles in contract termination will remain a key aspect of successful business transactions.