Contract Termination – A Guide For Startups

Building your startup is a long and gruelling exercise. Especially when it comes to the business building side of things. As you bring on more customers and employees you’ll get building a number of contracts. Each contract will outline the roles and responsibilities of the buyer and the seller of your product as well as conditions for contract termination. Although every contract is unique there are common contract clauses and a number of them have similar clauses for termination. Here are some of the common ones to look out for in your contracts.

Termination For Breach

Termination for breach in a startup sales contract refers to a clause that allows one party to terminate the contract if the other party fails to meet its do what it says it will under the agreement. In the context of a SaaS sales contract, this typically means that if the SaaS provider (the seller) or the customer (the buyer) breaches (or breaks) the terms of the contract, the other party has the right to terminate the agreement. Breaches could involve various aspects of the contract, such as:

1. Non-payment: If the customer fails to pay for the SaaS services as specified in the contract, the SaaS provider may have the right to terminate the agreement for breach. There are often clauses in place to charge interest or late penalties before things get to a breach.
2. Service level non-compliance: If the SaaS provider fails to meet the agreed-upon service level agreements (SLAs), such as uptime guarantees, performance standards, or support response times, the customer may have the right to terminate the contract. Keep this in mind for your dev team, the product needs to stay up otherwise it could cost you money and customers.
3. Unauthorized use: If the customer is using the SaaS product beyond the agreed-upon scope, such as exceeding the number of licensed users or sharing passwords, the SaaS provider may have the right to terminate the contract for breach.
4. Data security breaches: If the SaaS provider experiences a data security breach, and it’s found that they did not take adequate security measures as specified in the contract, the customer may have the right to terminate the contract. There is often a number of clauses that will deal with the handling of data breaches. These include notice periods and reporting requirements.
5. Intellectual property infringement: If the SaaS provider’s software infringes upon the intellectual property rights of the customer or a third party, the customer may have the right to terminate the contract for breach of IP.

The termination for breach clause generally outlines the specific conditions and procedures for invoking this right, including any notice requirements, a cure period (a specified time for the breaching party to remedy the breach), and the consequences of termination, which may include ceasing the provision of SaaS services, refunding payments, and addressing data ownership and transition. Refund for breach is a common clause negotiated by B2B customers.

It’s important for both parties in a SaaS sales contract to understand the termination for breach provisions, as they impact the rights and responsibilities of each party in case of a breach. These clauses are typically negotiated and can be an important aspect of the contract and the trust you have with the customer, as they define the consequences of non-compliance with the agreed-upon terms. SaaS legal counsel is often involved in drafting and reviewing such clauses to ensure they align with the parties’ expectations and legal requirements. Keep in mind that invoking a breach clause is similar to throwing a stick into the bike wheel of your business relationship with a customer.

Contract Termination Via Force Majeure

Force majeure is a legal term that refers to an unforeseeable and extraordinary event or circumstance beyond the control of the parties involved in a contract, which makes it impossible or extremely difficult for them to fulfill their contractual obligations. Sometimes referred to as ‘act of God’ events, force majeure events are typically events that are considered acts of nature, such as natural disasters, war, acts of terrorism, or other events that are outside the control of the contracting parties.

The presence of a force majeure clause in a contract allows the affected parties to be excused from their contractual obligations, either temporarily or in some cases permanently, without incurring liability for breach of contract. When a force majeure event occurs, the affected parties are typically not held responsible for the consequences of their failure to perform due to the event.

It’s important to note that the specific definition and application of force majeure can vary depending on the jurisdiction and the language used in the contract. The force majeure clause should outline what events or circumstances are considered force majeure, the procedures to follow when such an event occurs, and the consequences for the parties involved.

The occurrence of a force majeure event does not automatically excuse the parties from their obligations; it typically requires notification and may involve negotiations or legal proceedings to determine the appropriate course of action. One thing to be aware of is the possibility of force majeure events in the different countries or areas you or you suppliers operate in. Data centres, for example are generally not built in earthquake prone areas.

Example Of Force Majeure

Force majeure clauses have gained significant attention during times of global crises, such as the COVID-19 pandemic, when many businesses faced disruptions and sought to rely on these clauses to mitigate the impact on their contracts and obligations. However, the effectiveness and applicability of force majeure clauses can be subject to legal interpretation and may vary from one contract to another. It’s crucial for parties entering into contracts to carefully consider and draft force majeure clauses to account for specific risks and potential disruptions that may affect their ability to perform under the contract.

Termination by Mutual Agreement

Termination by mutual agreement is the termination of a contractual relationship between two parties that is agreed upon by both parties willingly and consensually. In this context, both parties involved in the contract, whether it’s a SaaS sales contract, employment agreement, partnership agreement, or any other type of contract, decide to end the contract through mutual consent.

Key points about termination by mutual agreement:

1. Consensual Decision: Termination by mutual agreement is a voluntary decision made by both parties. They come to an understanding that it is in their best interests to end the contract, and they reach a consensus on the terms and conditions of the termination. If one side isn’t on board then it’s not going to happen.
2. Startup Terms and Conditions: The terms of the termination are typically documented in a termination agreement or an amendment to the original contract. This agreement outlines how the termination will be carried out, including any notice periods, financial settlements, or other obligations the parties may have towards each other upon termination.
3. No Breach Required: Unlike termination for breach, which occurs when one party fails to meet its contractual obligations, termination by mutual agreement does not require a breach of contract. It is based on a mutual desire to end the contract for various reasons, which might include a change in circumstances, shifting business priorities, or the completion of the contractual objectives.
4. Legal Implications: While this type of termination is consensual, it is still a legal process, and the parties should ensure that the terms of the termination agreement are legally sound and that they protect their respective rights and interests.
5. Comprehensive Agreement: The termination agreement should address all relevant issues, including the return of any property, transfer of rights or responsibilities, financial settlements, and any confidentiality or non-disparagement clauses that may remain in effect even after termination.

Termination by mutual agreement can be a practical way for parties to end a contract on amicable terms without resorting to litigation or disputes. It allows both parties to leave the business relationship in a way that respects their original agreement and can be beneficial when the contract no longer serves their interests or when circumstances have changed since the contract’s inception. With this in mind often when the end of a contract comes up parties can get emotionally invested in outcomes if they feel like the result of a mutual termination isn’t in their favor.

Other Forms Of Contract Termination

A startup sales contract can typically be terminated through several means, and the specific termination methods are outlined in the contract itself. Here are common ways a SaaS sales contract can be terminated:

1. Termination for Convenience: Either party, the seller or the customer, may have the option to terminate the contract without cause. This is often referred to as a “termination for convenience.” The contract will specify the notice period and any associated fees or penalties for such termination. We’ve written a lot about this as it is not a good clause for SaaS companies to have in their contracts. Check out our termination for convenience explanation here.
2. Termination for Insolvency: The contract may include provisions for termination in the event of insolvency, bankruptcy, or financial distress of either party. This protects the non-defaulting party in case the other party’s financial situation becomes precarious.
3. Expiry of Contract Term: The contract may specify a fixed term for the SaaS service, and termination occurs automatically at the end of that term unless the parties renew the agreement. If no renewal is agreed upon, the contract expires.
4. Change in Ownership or Control: The contract might include provisions for termination or assignment in the event of a change in ownership or control of either party. This ensures that the original contractual relationship remains aligned with the parties’ intentions. This comes into play a lot when you are being acquired. If there are clauses that state that a customer can break their contract at a change of ownership this can be the cause of a lot of customers leaving.
5. Non-Renewal: If the contract has an automatic renewal clause and one party decides not to renew, this can lead to the termination of the contract at the end of the current term.
6. Default Under Specific Contract Clauses: The contract might specify particular clauses that, if violated, lead to termination. For example, a breach of confidentiality or intellectual property clauses could trigger termination.
7. Notice of Termination: The contract typically requires one party to provide the other with advance notice of their intent to terminate. The notice period is usually stipulated in the contract and may vary based on the specific circumstances.

The exact termination provisions and procedures are negotiated and outlined in the SaaS sales contract. Parties should carefully review and understand these provisions to ensure they align with their expectations and requirements.

Implications Of Contract Termination

Depending on what type of termination has occurred there are generally implications for the decision to end a contract early. Termination clauses can often be used by customers who have purchased your product on an annual basis but are looking to exit from the contract early. On the other hand termination for breach may invoke a liability clause which could cause a large amount of financial distress to your company.

For this reason contract termination clauses can have a very large influence on your business. You should negotiate these wisely, understand the implications and track what you’ve agreed to.