What Is a Contract’s Termination Clause, and Why Does It Matter?
Contracts exist to clarify expectations in a business relationship. But what happens when that relationship ends on a sour note? Your termination clause should account for such an eventuality.
You’ve probably heard the adage, “all good things must come to an end.” Like it or not, many business relationships don’t last forever.
Entering into an employment agreement, or establishing a new relationship with another business, is an exciting time of growth. After your diligent efforts to ensure a goodness-of-fit and shared vision between the parties, you can’t help but feel optimistic. It feels like the start of an indefinite, mutually beneficial arrangement.
What could possibly go wrong?
A lot! The beginning of this relationship — when the parties share a vision for the future — is exactly the time to prepare for the worst-case scenario. That’s why it’s crucial for your agreement to include provisions that consider the end (or “termination”) of your relationship. In many employment or business contracts, this language is called the “termination clause.” It can be crafted to provide clarity to all parties and minimize the chances of disputes.
What Is a Termination Clause?
A termination clause is contract language that sets forth the terms and conditions surrounding a contract’s cancellation. In other words, it tells the parties what happens when the working relationship ends. Sometimes termination clauses are referred to as “severance clauses.”
A termination clause in a contract aims to minimize the likelihood that the parties will need to litigate any disputes over the end of the contract. Crucially, termination clauses describe how the parties can end their participation in the agreement without breaching the contract. To avoid litigation later, the termination clause can describe the previously agreed-upon circumstances that will trigger the end of the agreement.
To learn more about how the end of a relationship can lead to a costly court battle, see our related blog, “When Partners Disagree: A Case Study.”
Why Include a Termination Clause in My Contract?
Think of a termination clause as a pre-planned safety net. The clause aims to shield the parties from a chaotic end to a business relationship by putting both parties on notice of the conduct required to wrap up the relationship.
Crucially, drafting a termination clause forces you to consider your potential needs if this new business relationship ends. You dedicate an incredible amount of time and resources to your practice operations — you owe it to yourself to ensure a smooth ending to the relationship. By detailing how the relationship should cease, you can give yourself enough runway and notice to adjust to an evolving business environment.
Unfortunately, just because you prepare an explicit termination provision does not guarantee the other party will abide by it. But suppose that party does not give proper notice or otherwise fails to meet their obligations under the termination clause. In that case, you might have grounds to sue them for breaching your contract and violating the termination clause.
What Are the Elements of a Termination Clause?
The components of a termination clause will vary depending on the type of contract and the clause’s intended purpose. Below, we describe some common elements.
Length of the Contract
When does the contract between the parties end? Typically, you find the contract’s start date (often called the “effective date”) elsewhere, but the termination clause often includes the date or circumstances that end the agreement.
The length of an agreement is usually called the “term.” (This is why employment at will is often contrasted with employment for a term, which is anticipated to last for a specific length.) For instance, the termination clause may state that the agreement ends after one year but that the parties can renew it by mutual agreement. Depending upon the purpose of the contract — for example, if it intends to shelter the parties under a healthcare fraud law’s safe harbor provisions — federal or state law may require the term to last for a certain length of time.
Termination clauses regularly include a notice provision. This provision sets forth how much notice each party must provide to the other if they wish to end the agreement. For example, if you want your employee to notify you 30 days before leaving their position with the practice, you would typically include that requirement in the contract’s termination clause.
Duties and Obligations Upon Termination
The clause will likely identify the parties’ duties towards one another once their contractual relationship ends. The scope of these duties and obligations will vary widely depending on the relationship. For example, a physician leaving a practice before their term ends may be required to pay the practice liquidated damages — an amount pre-agreed by the parties to compensate the practice for the expense of recruiting a replacement.
Other duties may include
- Maintaining confidentiality;
- Returning proprietary equipment or information to the appropriate party; and
- Agreeing not to disparage the other party’s reputation. The duties often contain caveats and details specific to the parties’ circumstances. But, generally, it will set forth the standards of conduct that the parties agree to uphold towards each other even after the relationship has ended.
Clarify “For Cause” Termination
The termination provision may clarify when and how the contract may be terminated for cause. “For cause” termination is when a party’s conduct materially breaches a provision of the contract or when a party commits grave misconduct. Common reasons behind for cause termination include violating a law (e.g., HIPAA), sexual misconduct, and poor performance or conduct.
The termination clause may also include the specifics of the severance pay that a terminated employee might receive. In some situations, it may even describe the terms of a potential future separation agreement between the parties. This is most common in an employment agreement. More often, though, employers wait until an employee separation occurs to create a contract specific to the circumstances.
Get Legal Support.
The aspects of a termination clause will vary depending on the nature of the agreement. And as mentioned above, federal and state laws may also dictate the terms of the clause. If you operate in one of the states where we have licensed attorneys, we are happy to help you craft your contract with a termination provision that suits your particular practice needs. Book a free consultation to learn more.
This blog is made for educational purposes and is not intended to be specific legal advice to any particular person. It does not create an attorney-client relationship between our firm and the reader. It should not be used as a substitute for competent legal advice from a licensed attorney in your jurisdiction.