All's Well that Ends Well --- Cancellation Clause in Service Agreements

All’s Well that Ends Well --- Cancellation Clause in Service Agreements

To minimize risk and set expectations, many businesses plan for the conclusion, or even premature conclusion, of their services by incorporating termination and cancellation clauses in their service agreements. Such clauses are essential in safeguarding the company’s rights and interests when providing services to clients. In this article, we will focus on cancellation clauses.

What are Cancellation Clauses?

In simple words, a cancellation clause is any provision in an agreement that stipulates which party can cancel the contract, as well as why and how. Although the clause itself seems self-explanatory, there is actually a variety of cancellation clauses out there. An example is shown below:

This is a cancellation fee clause found in a service agreement, i.e. a contract of services.

It specifies the amount of money payable to the Contractor in the event that the Customer decides to cancel the Service Agreement before the completion of the agreed-upon Services.

At the same time, it explains the rationale behind the cancellation fee – to compensate the Contractor for any resources allocated and work undertaken up to the point of cancellation.

Tautvydas Sutkus, an esteemed Solicitor, Attorney, and Counselor-at-Law with an extensive experience in international dispute resolution, advises that in today's dynamic marketplace, inclusion of cancellation clauses in service agreements is not merely a formality but a strategic imperative. It serves as a safety net, allowing parties to mitigate risks by providing a legal framework for terminating the agreement without undue repercussions.

Why do We Use Cancellation Clauses?

Ben Michael, Attorney, M & A Criminal Defense Attorneys, explains that for the service provider, cancellation clause ensures that cancellations can/will only occur according to specific circumstances, therefore customers won’t simply be able to back out of the deal at any time without notice. For customers, it ensures that there is a way for them to cancel the service if necessary.

Clarity – Clarity is one of the most important qualities of a contract or service agreement. With clear stipulation of terms and conditions, both parties know where they stand from the outset of the business agreement. Thus, specifying the conditions under which cancellation of the agreement may occur, as well as how, can help avoid legal disputes or conflicts in the future. For clients, when the services do not yield the anticipated results, cancellation clauses exist to provide amicable conclusion of the contract, allowing the parties to maintain their business relationship and leave room for future cooperation.

Power – Balance of power between parties is vital to maintaining a harmonious business relationship. Neither the company nor the client wants to feel vulnerable, entrapped, or inferior under the contract. One way to make sure the clients feel valued and recognized is to address their expectations. This is particularly important when, unfortunately, certain services do not produce satisfactory or anticipated results. In such cases, clients should be able to cancel the contract on certain conditions, and the company – the service-provider – should be able to recover any compensation or cost deemed appropriate. Cancellation clauses play a major role in these circumstances. Setting out precisely the conditions under which a service agreement can be cancelled and the right of the service-provider to recover any expenses or cost, they ensure balance of power between a client and a company.

Business Interests – Many start-ups are tight on budget and would not want to suffer loss due to premature conclusion of any service agreement. Cancellation clauses, in fact, serve to protect such business interests. When services provided by the company are deemed unsatisfactory to the clients, they may be able to cancel the service agreements in accordance with the cancellation clauses. Most of these clauses may stipulate a cancellation fee, enabling the company to recover any expenses incurred or cost spent for the performance of the contract. This serves to compensate the company for their effort and input in carrying out tasks within the contract and makes sure business does not suffer great loss due to premature cancellation of the service agreement.

Time for Rearrangement – Most cancellation clauses also contain a term of notice. For example, stipulating that the client must give two weeks’ or even a month’s notice for premature cancellation of the contract.

What Should be Included in a Cancellation Clause?

By the use of the following example, this section guides you through the essential components to be included in a cancellation clause:

¹Notice Period – A cancellation clause should include a notice period during which written notice has to be served to the other party to signal an intention for cancellation. This is an amount of time for before either party can cancel and discharge the service agreement, and the period when parties can readjust their business plans and accommodate to the foreseeable cancellation.

²Grounds for Cancellation – Businesses operate under the principle of reason and clarity. It is important to stipulate in the cancellation clause grounds and reasons with which either party can use to cancel the service agreement. Such grounds may include breach of contract, non-payment, or other material breaches.

³Compensation for the Service-providing Party – As mentioned in the above section, the service-providing party has the right to be compensated for any expenses or cost incurred for the performance of the contract. Even if the service agreement is eventually cancelled prematurely, the service-providing party is usually entitled to recover certain payment. This could be payment for services rendered until cancellation date, or part of the contract price.

⁴Dispute Resolution – Like any other important contractual clauses, it is important for parties to include dispute resolution mechanism(s). When, unfortunately, disputes or conflicts arise out of the cancellation clause, there should be clear procedures and mechanisms for resolving such legal issues. These may include mediation, arbitration, or other dispute resolution methods.

James White, legal consultant with extensive experience in contract law, provides some valuable advice on drafting a cancellation clause. He says that a cancellation clause should include:

• Consequences of cancellation, for example, if prepayments must be made, refund policies, and other linked issues.
• Resolution of disputes i.e. how any cancellation disagreements will be handled through mediation, arbitration, and/or litigation 

What is the Difference between Termination and Cancellation Clauses?

Termination and cancellation clauses are oftentimes used interchangeably. However, fine distinctions exist between the two types of clauses. The following table provides an overview of their differences:

Is Cancellation Clause in a contract a solution or a hindrance? Business Owners share their personal experience.

To gain a broader understanding of whether cancellation clauses in a contract are solution to unforeseen circumstances or a hindrance to business, we reached to business owners to gain insights on practical implications of cancellation clause in real-world scenarios:

Laia Quintana, Head of Marketing and Sales at TeamUp, a B2B SaaS company that provides schedule management solutions to fitness businesses, highlights the practical benefits of including cancellation clause. She shares her firsthand experience in the fitness industry where client needs can shift rapidly and cancellation clause provides both parties an opportunity to exit the agreement without undue repercussions should circumstances change. This builds clients’ confidence in the value of the services and shows that the business understands their need for flexibility.

During the peak shopping season, DealA leveraged the cancellation clause to terminate the collaboration with another company that couldn’t keep up with the users’ demand, encsuring no disruption in the service, explains Oleg Segal, CEO and Founder of DealA.

How about Cancellation Clause in Subscription Contracts? Clay, trends analyst, a website specializing in consumer savings shares the issues consumers face with subscription cancellation and FTC’s view on them:

In the US, the Federal Trade Commission has been cracking down on companies that make subscription cancellation difficult. As per the federal law, “unfair or deceptive” business practices are illegal; and the FTC emphasized that subscription cancellation should be easy and levied a USD 100 million fine on Vonage for making it difficult for consumers to cancel the subscription.

Hence, it is not only important to have a cancellation clause but equally important for companies to make the cancellation process easier and straight forward for consumers.

How Is A Cancellation Clauses An Essential Exit-Strategy In Contracts: Legal Experts Share Insights From Their Professional Experience

Cancellation clauses outline the conditions for cancellation, specify the notice periods and fee / penalties for such cancellation. Hence, serve as a pre-negotiated exit strategy for service providers and clients, according to M. Denzell Moton, Esq, Owner, Moton Legal Group LLC

He further shares that in my legal practice, focusing on personal injury and business litigation, I've witnessed how vital cancellation clauses are in service agreements. For instance, a client involved in a long-term service agreement without a clearly defined cancellation policy found themselves in a predicament when they needed to terminate the agreement due to unforeseen business challenges. The absence of such a clause led to a prolonged legal dispute, emphasizing the critical need for these provisions in any service agreement. While in another case, a well-drafted cancellation clause facilitated the smooth termination of a contractual relationship avoiding unnecessary legal costs and preserving their professional relationship.

Michael Hurckes, Managing Partner, Mahadvising, advises that cancellation clauses not only safeguards operational flexibility but also preserves crucial business relationships. He highlighted an instance where a service agreement for a tech startup required a delicate balance, ensuring protection against sudden shifts in partnership dynamics while accommodating potential pivots intrinsic to the tech industry. The inclusion of tailored cancellation clauses provided a safety net, allowing the company to adapt swiftly to market changes without the burden of protracted legal disputes. 

Cancellation clauses serve as the exit route for all parties by providing a concrete, pre-emptive solution for potential disputes, according to Jonathan Feniak, General Counsel at LLC Attorney. Further, it can protect companies from financial loss by including parameters for ‘termination for convenience’, allowing a company to terminate in the absence of breach when it’s financially prudent.

Frequently Asked Questions

Can I cancel a contract with a cancellation clause?

A contract without cancellation provisions may still be cancelled, subject to negotiation between parties. However, if the other party is unwilling to negotiate or accept cancellation of the contract, you may risk liability for early cancellation/termination damages.

How can I cancel a contract without penalty?

To cancel a contract without penalty, you need to send written notice regarding the cancellation to the other party within the stipulated notification period. If the other party refuses to accept cancellation, you may take the matter to the governing authority or use any dispute resolution mechanisms to resolve the issue.