Exit Strategy Clauses work like a Fire Escape. They give you an “out” in certain defined circumstances, allowing you to exit a potentially damaging relationship or venture.
Exit strategy clauses work just like a Fire Escape – they allow you to exit a potentially damaging venture or relationship with minimum risk.
Just like in real life, your fire escape needs to be included when the building is planned and constructed. Otherwise you might find yourself trying to escape a burning building by jumping out the window or hoping the fire department will rescue you.
A personal story
Many years ago before RP Emery, I was selling an information product to assist with women’s fertility. It was doing really well, but I was getting a little tired of doing the same steps over and over – I needed to automate the process.
I did not have the programming skills needed but found a JV partner who did. I knew the arrangement had to be documented because of I was very protective of my creative baby or intellectual property.
The lawyer drafting the JV agreement, asked me “What will happen if things don’t work out?”
At the time, I thought it was a very negative question. I was full of excitement, couldn’t wait to start and was certain this was going to be a dream partnership.
12 months later when things weren’t working out as we had planned, I would have gladly grabbed that lawyer and kissed her. The exit strategies that had been placed in the contract made it really easy for me to leave the joint venture with full ownership of my IP and the software.
There were no arguments and no hassle. We just followed the procedure we had agreed upon and went our separate ways.
After that experience there is no way I would enter into a contract again without covering “what happens if?”
You must think about how you will exit before you enter a contract
If you are entering into a contract with someone, you need to think about incorporating a few exit strategies into your contract terms at the beginning of the relationship.
It is crucial to address when you will be released from your obligations (when the Contract will come to an end), and how you can exit the Contract earlier if you need to, before you sign on the dotted line.
If unexpected events arise in the future which require you to exit the Contract, you will want to have a clause in place to enable you to do so.
So stop and take stock – things don’t always work out to plan, people don’t always get along and your expectations of others are not always lived up to. Exit strategies allow you to have an escape route, should you need one.
Take a moment to think about “What if?”
Take a few moments to think about some issues that might arise in a worst case scenario, that would give you reason to end the contract early? Jot these down, and think about the mechanics of how this would work within the terms of your contract.
Of course, this would vary depending on the transaction, what it is intended to achieve, and whether your Contract is a short fixed duration or long term project or business venture.
Here are a few unexpected events that might give you reason to end the Contract early:-
- Disagreement – you and your partner cannot agree on important issues or are not getting along and no longer wish to work together;
- Unmet expectations – your partner is not living up to his or her side of the Agreement;
- Breach – your partner commits a serious breach of the agreement;
- Death or disability of you or your partner;
- Retirement – you or your partner wish to retire;
- You (or your partner) are experiencing financial hardship and need to liquidate your assets.
Some mechanisms to exit a contract are:-
- Incorporate a first right of refusal, which requires the exiting party to give written notice to the remaining parties of his/her intention to exit the project, and giving them the first option to purchase their shares.
- Having a put or call option in place. A call option gives you the right to buy out your partner at a certain price. A put option, on the other hand, gives you the right to sell your shares to your partner at a certain price if you choose to do so. The put or call option would be exercisable on certain events happening, or within a certain time frame as agreed;
- Having a clause in the contract which requires the parties to wind up the project on the occurrence of certain circumstances, for example, if the project is not profitable for a specified time period;
- Having a specified end date within the Contract, at which time the Contract will end or a review date whereupon the Contract will be reviewed or renegotiated at certain regular intervals;
- Requiring each partner to have life insurance in place over the lives of the other partners. This will enable the remaining partners to fund the purchase of any deceased partner’s share in the business, rather than the shares going to the estate to be distributed to beneficiaries.
You must exercise caution and abide strictly by the terms of the Contract if you decide to implement an exit clause.
Other things to think about are:-
- If a party has the option to buy another out, how will the shares be valued? Market value, pre-agreed value, by an independent qualified valuer, at cost, etc.
- If a party has breached the contract or failed to perform to certain standards, it is usual practice to give notice to the breaching party specifying his or her breach, and requiring them to rectify the breach within a specified time period, before you are able to terminate the contract. In all fairness, reasonable notice should be given.
Help! I want to terminate a Contract, but I don’t have an exit clause?
If you don’t have a specific exit or termination clause, the common law gives you some rights to terminate in specific circumstances.
Tread carefully if you are purporting to exercise your common law rights to terminate a contract. Give proper notice and due process to the other party and seek legal assistance if necessary.
Common law gives you the right to terminate a contract if the other party has:-
- repudiated the Contract. This means that the other party has made it clear, by his/her words and/or actions, that he or she no longer wishes to be bound by the Contract. For example, he/she may stop performing his/her obligations under the Contract; or
- breached an essential term (condition) of the Contract. An essential term is a condition of the Contract which is fundamental, or goes to the very heart of the Contract. It is not sufficient for there to be a minor transgression for example, breach of a non-essential term such as an administration clause. This will not warrant termination. To rule out any uncertainty, you may expressly state within your Agreement, which of the terms will be considered essential, and warrant termination if they have been breached.
This is a general discussion of ending a contract early only. If you need specific legal advice or assistance in drafting your Agreements, we can put you in touch with a qualified Australian Solicitor.
Related resources
The following agreement templates all include common exit clauses that can be used / modified to suit your situation. We can also assist with other sample exit clauses should the need arise.
Shareholders buy/sell Agreement
Agreement between Joint Owners of Property
(for use by groups of two or more people who have invested in property)