Drafting Contract Termination Clauses – Termination for Breach by Non-Breaching Party

One of the key issues that must be examined when negotiating or drafting any contract is how the parties may get out of, or “terminate,” that contract. While many attorneys will rest on standard “termination for breach with notice and cure” language, the recent case of Powertech Tech. v. Tessera, Inc. demonstrates how artful drafting can put limitations on a party’s right to terminate. The Opinion in U.S. District Court for the Northern District of California case No. C 11-6121 can be found here.

Powertech and Tessera were parties to a patent license agreement, although the court’s reasoning does not seem limited to only those types of agreements. The license agreement allowed Powertech to use Tessera’s patents in exchange for payment of license fees.

The contract contained the following clause regarding termination for breach:

“Termination for Breach. Either party may terminate this Agreement due to the other party’s breach of this Agreement, such as failure to perform its duties, obligations, or responsibilities herein (including, without limitation, failure to pay royalties and provide reports as set forth herein). The parties agree that such breach will cause substantial damages to the party not in breach. Therefore, the parties agree to work together to mitigate the effect of any such breach; however, the non-breaching party may terminate this Agreement if such breach is not cured or sufficiently mitigated (to the non-breaching party’s satisfaction) within sixty (60) days of notice thereof.”

The court held that Powertech was not permitted to terminate a license agreement with Tessera for Tessera’s breach because Powertech itself was in breach of the agreement by its failure to pay royalties to Tessera.

Acknowledging Powertech’s argument that Tessera was itself in breach, that in and of itself did not give Powertech the right to terminate the contract. Only a “non-breaching” party may terminate the agreement. Said the court “[a]lthough the first sentence of the termination clause is broad – ‘Either party may terminate this Agreement due to the other party’s breach’ — the language of the clause as a whole makes clear that only a non-breaching party may terminate. Reading the clause as a whole, the court concluded “[t]he termination clause refers to a “breaching party” and a “non-breaching party” in every sentence after the first… [therefore]…the clause requires the party seeking to terminate for the other party’s purported breach to be substantially in compliance with its own obligations first.

The Powertech agreement’s termination clause is useful because it put conditions on a party’s ability to terminate the agreement even when the other party was in breach.

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