Why Do Termination Clauses Matter?
Termination provisions are important in a variety of contexts because they govern contract parties’ rights and obligations in the event that the business transaction between the parties becomes unsustainable. Generally, negotiations and discussions precede termination, and therefore termination is for the most part, a last resort.
Commercial Contracts: Having a handle on what an organization’s commercial contracts say about termination is important because contracting parties need to understand what their rights and obligations are if certain unforeseen events occur–such as, a party’s failure to perform, a material breach, among other things. In order to minimize risks and losses in connection with a commercial contract, understanding the language addressing how to exit a commercial agreement is critical.
M&A Due Diligence: Reviewing a target company’s material contracts for termination provisions is a key part of the M&A due diligence process because of the impact such provisions can have on the value of the seller’s business. In representing a prospective M&A purchaser, thorough consideration of factors such as whether the counterparty may easily terminate a valuable and important agreement with a target company, and what costs may be associated with termination of certain agreements, is needed in connection with the valuation of the target company’s business, as well as with respect to risk assessment relating to the completion of the transaction.
M&A Transaction Agreements: Termination provisions are among the most highly negotiated provisions in M&A transactions. Whether due to changing global circumstances or issues in relation to a target company’s financial performance resulting in a material adverse change, failure to obtain antitrust approval, or the presence of a superior proposal, contemplating or setting the wheels in motion for the termination of an M&A transaction is significant because of the value at stake and the potential of ensuing litigation. Termination fees are also almost always included–and if an M&A transaction is not terminated mutually, identifying a breach by one party could make the difference in which party pays those fees. Accordingly, knowing what the termination provisions of the agreement say is imperative.
Real Estate: In commercial real estate, a tenant may wish to terminate its lease for any number of reasons, including outgrowing the leased space (or on the other hand, downsizing or closing the business); or in connection with an M&A transaction. Similarly, a landlord may seek to terminate a lease based on the tenant’s failure to pay rent, or the violation of other lease provisions. Either way, careful review of termination provisions is necessary to ensure that lease parties’ actions in connection with early termination are in accordance with the specific terms set forth in the lease.
