DURATION AND TERMINATION “The breach does less damage with ad hoc clauses”

Luca Davini
Lawyer in Milan and Turin

When a company plans the development of its business abroad, especially if it intends to implement or expand its sales through forms of integrated distribution, it is intrinsic in the logic of things to think in a medium-long term perspective given the investment of time and resources to look for and choose reliable partners. These kinds of relations, as opposed to those that are exhausted at a given moment (such as, for example, the sale) are defined as duration contracts bound to develop over a more or less long period of time: a classic example are agency and distribution contracts, but not only.

Thus, the duration of a contract is one of the aspects that the parties should take care to regulate, in the light of their objectives, because of the practical impact that the regulation of this aspect may have on the timing and modalities of dissolution of the relationship, given that the lack of arrangements will likely lead to the relationship being considered of an indefinite duration.

The fixed-term choice

Given this, the entrepreneur has two general alternatives available: the fixed-term (or term) contract, which ends at the deadline predetermined by the parties, or the indefinite contract (ie without a deadline).

The fixed-term duration provides for several drafting hypotheses. The first concerns the term contract ” pure and simple “(i.e. without automatic extension at expiry); this solution avoids any confusion with the indefinite contract but has the practical drawback of having to enter into a new contract at expiry, with the risk that the counterparty questions its contents.

Added to this is the danger that in the event of a de facto continuation of the relationship after the expiration, it will turn into a permanent contract or it will be considered a new and different relationship not regulated by the previous contract, which could lead to making inapplicable some important clauses agreed upon (for example, those relating to the applicable law and/or the competent forum).

To overcome these critical issues, there can be the stipulation in the contract of the tacit extension clause in case of failure to notify the cancellation within the agreed notice period.

Another possibility is to provide for a futures contract that turns at the expiration (in the absence of termination) into a permanent contract, functional if you want to carry out a trial period.

Otherwise, you can immediately enter into an indefinite contract that will continue until it is dissolved by mutual consent or for the exercise of the ad nutum withdrawal clause on the basis of which it will be possible to opt out of the contract freely, that is, without providing any justification, but normally giving the other party adequate notice, taking into account any mandatory rules provided for in the applicable law (for example, the “European” agency contract imposes notice terms based on the duration of the relationship).

In terms of the assumptions relating to the termination of the contract, it must be stated that almost all national legislation provides for institutions of immediate withdrawal or just cause and resolution for non-performance (of a very similar scope in this context). These are the remedies generally provided for by almost all jurisdictions in the event of contractual violations or exceptional events that, due to their gravity, may lead to the termination of the relationship.

Nevertheless, since their practical application, however subject to court scrutiny, may differ from country to country, it is advisable to provide for in the contract a specific clause that allows each party to exit the relationship with immediate effect in the event of particularly serious violations (for example, non-payment of goods) or exceptional circumstances (such as bankruptcy of a party).

The most usual solution is to define an abstract notion of just cause (or essential non-performance) and of exceptional circumstance, integrating them, if necessary, with a series of examples and expressly listing the clauses of the contract whose violation justifies early termination with immediate effect (avoiding linking this tranchant termination to any breach of contract, to avoid the risk that such an extension could lead judges to reduce -if not cancel-the effectiveness of the clause).

Penalty clauses

At the same time, the so-called penalty clauses should be stipulated, through which, in the event of non-performance or delayed performance, a lump sum is paid.

Such clauses can carry out the following functions:

– provide for a predetermined compensation for the damage, thus avoiding having to prove the extent of the injury suffered;

– provide for a real pecuniary “penalty” (not limited to potential compensation for damage but of a sanctioning nature) to induce the counterparty to fulfill;

– limit any liability for damage to the amount provided for by the penalty itself.

The first function does not give rise to particular problems while the second is not considered admissible in some jurisdictions. In particular, in the law of common law countries, a distinction is made between liquidated damages that are legit (as they predetermine the potential damages quantified in a reasonable amount) and penalties that are invalid (as they provide a disproportionate amount compared to the possible damage).

Therefore, if the applicable law is that of a common law country, special attention must be paid to its drafting, using the correct terminology and setting at reasonable levels the amount of the penalty.

Actually, the same attention must be paid when the applicable law is that of a civil law country. In fact, although the punitive function in these countries is usually admitted, there are some that exclude its validity tout court contrary to public policy and in others it is tempered by the possibility that the court may reduce the amount where deemed excessive.

As for the third function, some jurisdictions (such as Italy) foresee it as a natural consequence of the clause that would prevent, unless otherwise agreed, to achieve the additional damage suffered in practice (that is, higher than that predetermined in the clause); this risk confirms the importance of carefully verifying the specific discipline provided for by the applicable law for the correct drafting of the clause.

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