Contracts 101 for Small-Business Owners: Vol. 2 (Term, Termination, and Renewal)

In a prior post, we outlined why it is important to know who you are contracting with. Another common contract issue that we are asked to analyze and advise business owners about is whether a contract can be terminated, and if so, what the consequences might be. This can come up in situations where our client wants to terminate the contract (e.g., a vendor that isn’t meeting expectations) or doesn’t want a contract to be terminated by the other party (e.g., a customer). Giving attention to such issues before the contract is signed can better protect the business owner when such circumstances arise.

A typical contract will have provisions setting forth the “term” of the agreement, i.e. how long it continues in effect. Frequently contracts are structured such that they continue in effect for an initial term of one or more years, with the term automatically renewing thereafter, on a month-to-month, annual or even multi-year basis. Contracts may instead provide for no renewal unless the parties take some affirmative steps to extend the agreement. Other contracts may provide that they continue in effect until terminated or a specific scope of work is completed. Others may even be entirely silent on the issue (not recommended).

In addition to specifying the term’s mechanics, well-drafted contracts will provide for specific conditions under which the contract can be terminated early by one party or the other. Termination provisions may be of the “for cause” or “for convenience” variety. A “for cause” provision permits termination only if some condition (or cause) has occurred first, typically some bad act on the part of the other party (e.g., a breach of the contract). Termination for convenience provisions, in contrast, permit the contract to be terminated by a party without cause at the terminating party’s convenience (i.e., they don’t need a reason). A termination provision may be limited such that only one party can invoke it or such that it can only be invoked during at certain times (e.g., after the initial term has expired).

With a vendor contract, you’ll want to be aware of how the contract term works and what your rights are to terminate most often in order to evaluate how much of a commitment you will be making if you sign the contract. You should understand when and under what conditions you can terminate the contract, and whether there is an automatic renewal clause that requires prior notice from you to stop the contract from renewing to avoid being automatically committed for a follow-on term. If a contract has an automatic renewal decision deadline, you should schedule that in a calendar system to provide you with a reminder in advance of the deadline so that you can make a timely decision as to whether or not the contract should be renewed (and provide any required notices). For vendor relationships that are mission critical to your business, however, the analysis may be flipped on its head, i.e., you will want to give thought to whether the vendor can terminate the contract prematurely and leave you without a critically needed service, potentially hamstringing your business.

With your customer agreements, you’ll want to understand what rights your customers have to terminate so that you can accurately project resource needs and revenue. If you are making a significant initial investment in bringing a customer on board, you should craft the term and termination rights with this in mind to ensure you have the opportunity to recover this investment over the term of the contract.

When considering a contract, you should also give some thought to what you may want to happen when a contract terminates (and address that in the contract). For example, where a vendor has materials or equipment you provided, or is hosting data for you, you will want to make sure the vendor has the obligation to return those items at the end of the contract. In the case of data services, transition support is often a concern as well. In the customer context, you may want to ensure that they return and/or stop using any of your materials once the contract terminates.

*Photo Credit: http://foter.com/photo/calendar-date-time-month-week-planning-paper/

*NOTE: This is one of a series of blog entries on the subject of contracts directed principally at small business owners. The primary purpose of this blog is to identify areas of concern in typical contracts so that small business owners can be on the lookout for issues that may adversely affect them. However, this series is not intended as a replacement for obtaining the advice of a good contracts or business attorney, ideally before signing a contract. Every situation is unique, and the preceding is very general advice and is not intended nor should it be received as legal advice or creating an attorney-client relationship between the reader and Klein Bussell, PLLC.

**Klein Bussell attorneys do not blog about pending matters handled on behalf of our clients and will never disclose client confidences.