Don’t confuse liquidated damages and early termination fees. Liquidated damages compensate a party for the other’s breach of contract. They work like any other damages, except the parties agree on the amount in advance. (The parties liquidate the damages so they won’t have to fight about the amount later, like in court.) Early termination fees, on the other hand, have nothing to do with breach. They’re not damages.
Termination for convenience doesn’t breach the contract, so the fees are not damages
In a termination for convenience clause, one party gets the right to terminate early, without cause. But often the parties agree that the terminating party will pay for that right — at least, where the customer gets the right. If the customer terminates early, it pays an early termination fee.
The early termination fee works like any other contract payment obligation — like fees for software development, for IP rights, for SaaS access, etc. It’s a payment, not damages. It couldn’t qualify as damages, since the customer hasn’t breached. The contract specifically authorizes early termination.
Consequences (aside from looking silly)
If you use liquidated damages in place of early termination fees, you may find you can’t enforce your clause. There’s no breach, so the liquidated damages clause plays no role. Of course, a court might take pity on you and assume both parties intended an early termination fee. That could lead the court to enforce the clause. But we shouldn’t rely on courts to fix our unclear terms. They’re not that reliable.
To learn more about termination for convenience and early termination fees, see Chapter II.V.3 in The Tech Contracts Handbook — and see our clause library for sample language. And for liquidated damages, see Chapter II.N of the Handbook — and the clause library’s sample language for specification of liquidated damages and for justification of those damages.
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Do you have a case where an ET Fee was not enforced because it was cast as an LD (as a penalty or something other)?
I would offer that an ET Fee might also in addition to being simply a fee obligation tied to a contractually created right to terminate the contract early, it might ALSO be cast as a “liquidated damage” provision.
I have heard it said that a termination for convenience is usually very inconvenient to the terminated party. In common law the seller has expectations that it will be allowed to complete the contract, and denial of that opportunity by buyer would be a breach of contract. Only by a contract writing, does seller grant the buyer a right to terminate “for convenience”. Perhaps also functions as implied waiver by seller of breach and damages associated with early termination. Perhaps also there is an implied waiver by buyer that there is no breach by seller, otherwise this would have been a termination for cause. Perhaps a TF convenience implies a mutual waiver of claims (or at least contract breaches and associated damages) between the parties? Can these implications be clarified by an ET Fee that also liquidate those damages?
In any termination, the terminated party can suffer loss of profits, loss of opportunity, unrecovered overheads, and even loss of reputation (indirect or consequential losses). If the termination is wrongful, recovery of litigation costs and attorneys fess may also be recoverable.
LD’s provisions can liquidated damages that either party might incur. A right to early termination “for convenience” is a right created by contract terms, not found in common law, which courts enforce to facilitate risk allocation and and remedies mutually agreed to between parties (so long allowed by law, not unconscionable, or against public policy).
The question is, it is market for seller to agree to an early termination for convenience, and if so, is their bargaining power to exact a fee (and how is that fee determined and set). Conversely, should one or both parties seek to also liquidate (make certain) that the fee also covers any potential damages that seller or buyer might suffer. Procuring the right to do something, as well as liquidating any damages that might be associated with exercising that right?
In the USA, there is generally an obligation upon both parties to act in “good faith”. The customer/client (“Buyer”) is usually the party that desires and benefits from negotiating a right to early termination “for convenience” (which may also imply a waiver or release from any seller breach – careful contract drafting may be required to preserve other breach claims).
The seller usually tries to negotiate an ET Fee to cover those direct costs it likely would suffer if not already covered or to be reimbursed or paid elsewhere in the termination provisions (including subcontractor/supplier cancellation fees, reassignment of personnel), as well as the indirect or consequential losses likely to be incurred.
The Buyer may desire to “liquidate” the damages that could possibly be suffered or claimed by seller. In order to also “liquidate” all claims of possible breach by buyer involved in an exercising its early termination rights, including the possibility or a finding of “wrongful termination” – the buyer may want to cast the ETF as “liquidating damages” including those consequential damages that might be recovered by seller (as a “wrongful termination” may also will likely result in any contractual “wavier of consequential damages” in favor of buyer NOT to be enforced). Buyers often want to include provisions that would direct the court to find remedy under the “termination for convenience” provisions IF it should be determined that a termination for cause was wrongful. Properly liquidating damages by the TFE could make accepting this provision (as opposed to rejecting and allowing common law or statutory remedies to prevail – which often include recovery of litigation costs and attorneys fees) more acceptable to seller IF the ETF was high enough (and if seller was ALSO allowed to recover litigation costs and attorneys fees).
This is not being offered as legal advice or opinion and should not be relied upon – but rather offered for sake of discussion. It was prepared a little in haste, and I am fairly new to technology contracts, as I bring this perspective from contract law and “playbook” from contracts negotiated in other industry and markets. I would be interested in any insight, or correction in law (examples of cases really appreciated).
Marc, good points and questions. You’ve said a lot here, so I’ll focus on key points.
First, I don’t thin any amount of harm to the provider will give it a right to damages if it agreed to early termination for convenience. And there can be no bad faith claim, at least as to the termination itself. If the contract gives the customer the usual right to terminate “for any reason or no reason,” the provider loses nothing in the eyes of the law. It agreed that profits might stop, overhead might be wasted, reputation might be harmed, opportunities might be missed, etc. Those are not damages. That’s just the arrangement agreed between the parties.
If you drafted an LD clause for early termination, would a court enforce it as if it were an early termination fee? As the article says … maybe. The doctrine of mistake suggests the court should reformulate the clause. And I’d call it a good outcome. But I don’t know the odds. I try not to rely on the hope that a court will fix a mistake, even if it’s likely.
You asked, “it is market for seller to agree to an early termination for convenience”? Yes, in some segments of the industry, with large customers and long-lasting deals. And yes, the provider usually can exact a fee.
You also asked, “should one or both parties seek to also liquidate (make certain) that the fee also covers any potential damages that seller or buyer might suffer”? The provider should. Why not? Except, again, it’s not about “damages.” There are none. If the provider wants the fee to cover its opportunity costs and other costs of early termination, why not? You just can’t go so high that a court would consider the amount unconscionable. And you’d be unwise to go so high that the customer would be better off breaching the obligation to pay the early termination fee, since the provider’s damages for that breach could be less than the fee itself.