Termination of a commercial contract: conditions, notice and compensation

Ending a commercial contract often seems simple: you stop ordering, you send a letter, you look for another partner. In practice, a poorly prepared termination exposes the party terminating to a finding of abrupt termination, to damages that can exceed a year of margin, and to litigation that ties up cash for two to three years. The risk depends not only on the reason given: it depends on the notice period granted, the formalities observed and the way any compensation is calculated and then accounted for. This guide sets out the conditions for a secure termination, the notice rules under the French Commercial Code, the method of calculating compensation and its accounting treatment, for the business that terminates and for the one that suffers the termination alike.

Identify the type of termination before any decision

The first mistake is to treat all contracts in the same way. The applicable regime depends on the nature of the contract and its duration.

Fixed-term contracts: the force of the term

A fixed-term contract (commercial CDD: a three-year distribution contract, a services contract with a fixed expiry date, a derogatory lease (bail dérogatoire), etc.) binds the parties until its term. Ending it before expiry without a ground provided for in the contract is a wrongful termination. Article 1231-1 of the French Civil Code then gives the other party a right to compensation for the loss suffered, which in principle corresponds to the margin it would have earned up to the agreed term.

In practical terms, a supplier that terminates a two-year supply contract after six months risks having to compensate eighteen months of lost margin. Security therefore depends on a precise termination clause (clause résolutoire), listing the breaches that allow early termination, and on scrupulous compliance with the procedure it lays down.

Open-ended contracts: regulated freedom

An open-ended contract (CDI) can always be terminated unilaterally: no one is bound by a perpetual commitment. Article 1211 of the French Civil Code nevertheless requires compliance with a notice period provided for by the contract or, failing that, a reasonable period. The freedom to terminate therefore exists, but it is paid for in time: it is the notice period that protects the displaced partner and that, in return, protects the party terminating against a finding of liability.

This distinction between CDD and CDI overlaps with a concept specific to French commercial law, often decisive: abrupt termination of established commercial relationships.

Abrupt termination of established commercial relationships

The rule is now found in Article L442-1 II of the French Commercial Code, introduced by Ordinance No. 2019-359 of 24 April 2019, which reformed the former Article L442-6 I 5°. It is the basis most frequently relied on in disputes over the termination of a commercial contract.

Any person carrying on production, distribution or service activities incurs liability and must compensate the loss caused where it abruptly terminates, even partially, an established commercial relationship, in the absence of written notice taking account in particular of the length of the commercial relationship, by reference to trade usages or inter-professional agreements.

Three elements must be present for this provision to apply.

First, an established commercial relationship: an ongoing, stable and regular relationship, the continuity of which the partner could reasonably anticipate. A succession of one-off contracts renewed over several years is enough; a single isolated contract is not.

Second, a termination, total or partial. A significant and sudden fall in the volume of orders is treated as a partial termination, just as punishable as a complete stop. Situations of reduced orders and delisting amounting to partial termination are analysed in our article on that concept.

Third, an abrupt character, that is, the absence of sufficient written notice. This is the point on which disputes concentrate: what is wrongful is not the fact of terminating, but terminating without giving the partner time to reorganise.

One essential point must be understood: this regime applies regardless of whether there is a written contract and even if the contract provides for a notice period. A clause fixing one month's notice does not remove liability if that period is found to be insufficient given the length of the relationship. Mandatory (public policy) law prevails over the contractual stipulation.

Notice: length, calculation and securing it

The notice period for terminating a contract is at the heart of risk management. Sufficient notice turns a potentially abrupt termination into a lawful one.

How sufficient notice is determined

No statutory scale sets a general length. The courts assess each case on its facts according to several converging criteria:

• the length of the commercial relationship, the predominant criterion
• the volume of business done and how it has developed
• the degree of economic dependence of the displaced partner
• the difficulty of finding an equivalent outlet or source of supply
• the specific investments made for the relationship
• the professional usages or inter-professional agreements of the sector

As a practical benchmark, court practice frequently adopts an order of magnitude of around one month's notice per year of relationship, adjusted to the circumstances, without this empirical rule having the value of a scale. Strong economic dependence or dedicated investments justify a longer period. The framework for reading the criteria and translating them into months of notice is set out in our article on the length of sufficient notice in cases of abrupt termination.

The eighteen-month ceiling

The 2019 reform introduced a major element of legal certainty. Article L442-1 II provides:

In the event of a dispute between the parties over the length of notice, the liability of the party terminating cannot be engaged on the ground of insufficient length where it has given notice of eighteen months.

In other words, eighteen months' written notice protects the party terminating from any finding of abruptness, whatever the length of the relationship. This ceiling does not mean that eighteen months must always be given: for a three-year relationship, a few months will generally suffice. It is an upper limit that secures very long-standing relationships.

Notice must be performed in good faith

Granting notice on paper is not enough: it must be real. During its course, the relationship must continue on the previous terms. Abruptly reducing volumes, unilaterally changing prices or worsening payment terms during the notice period empties it of substance and restores the abrupt character of the termination. Twelve months' notice during which orders are divided by three amounts, in the eyes of the court, to truncated notice.

Grounds allowing immediate termination

Notice is not always required. Two situations allow termination without delay.

The first is sufficiently serious non-performance by the other party. Article L442-1 II expressly reserves the case where termination occurs in the event of non-performance by the other party of its obligations. Repeated defective deliveries, persistent payment defaults, breach of an exclusivity obligation: these breaches justify immediate termination, provided they are established and documented. Termination then rests on Article 1224 of the French Civil Code, which allows termination of the contract in the event of serious non-performance.

The second is force majeure, defined in Article 1218 of the French Civil Code as an event beyond the debtor's control, unforeseeable and irresistible, making performance impossible.

Outside these cases, relying on a ground for immediate termination carries a double risk: if the ground is found insufficient, the termination becomes abrupt again and the absence of notice turns against the party terminating. Prudence therefore requires building a solid evidence file (formal notices, recorded findings, written exchanges) before alleging serious fault, rather than merely making assertions.

Formalities: write, notify, prove

A legally sound termination rests on rigorous formalities, which are often neglected.

Notice must be in writing. Article L442-1 II expressly requires this. A verbal or implicit withdrawal, a mere thinning out of orders without formal notification, does not amount to notice and establishes abruptness.

Notification must be made by a means that provides proof: registered letter with acknowledgment of receipt, or any medium making it possible to date the sending and establish receipt. The date of notification starts the notice period running; it must therefore be incontestable.

The letter must state the decision to terminate, the effective date of termination (and therefore the end of the notice period) and, where applicable, the ground relied on where termination is immediate. Where a contract is terminated for non-performance by notification, Article 1226 of the French Civil Code moreover requires, except in urgent cases, a prior formal notice that has gone unanswered, followed by a notification setting out the breaches alleged.

A termination clause in the contract must be applied to the letter: if it provides for a prior formal notice and a period to remedy the breach, skipping that step makes the termination irregular, even if the breach is real.

Calculating termination compensation

Where a termination is found to be abrupt, or wrongful in the case of a CDD, the party terminating must compensate the loss. Understanding the method of calculating compensation for the termination of a commercial contract makes it possible to anticipate the financial exposure and to provision correctly.

The principle: compensating the margin lost during the missing notice

The loss recoverable for abrupt termination is not the total loss of turnover, nor the disappearance of the relationship itself: termination remains lawful in principle. What is compensated is the abruptness, that is, the insufficiency of notice.

The calculation is therefore based on the margin that the displaced partner would have earned during the notice period that should have been granted, less the notice actually given. The case law generally uses the margin on variable costs (sometimes called gross margin), and not simply turnover, in order to reflect the gain actually lost.

The logic of the calculation follows three steps:

• determine the length of notice that would have been reasonable having regard to the length of the relationship and the dependence
• deduct the notice actually granted to obtain the period of shortfall
• apply to that period the average monthly margin earned on the relationship, calculated over the latest representative financial years

Thus, if twelve months' notice would have been justified but only three months were granted, the compensation covers nine months of lost margin.

Additional losses

Other heads of loss may be added to compensation for abrupt termination where they are shown: specific investments rendered useless by the termination (dedicated equipment, stock that has become unsaleable), redundancy costs for staff assigned to the relationship, or damage to reputation where established. These heads are governed by the ordinary law of compensation: they require loss that is certain, direct and proved.

On the other hand, the victim has a duty to mitigate its loss: it cannot remain passive and must seek to redirect its activity. The courts take account of reorganisation efforts, or the lack of them.

Distinguishing contractual compensation from court-awarded compensation

Two sources of compensation coexist. Compensation may be fixed in advance by a penalty clause (Article 1231-5 of the French Civil Code), which provides for a lump sum in the event of termination. The court may reduce it if it is manifestly excessive or derisory. Failing a clause, compensation is fixed by the court using the lost-margin method set out above. A settlement agreement (transaction) (Article 2044 of the French Civil Code) finally allows the dispute to be closed amicably by negotiated compensation, often preferable to the risk and length of litigation. The points to check before signing such an agreement are set out in our article on securing the settlement agreement.

Accounting for termination compensation

The accounting treatment of compensation for termination raises distinct questions depending on whether the business pays or receives the sum, and on its VAT regime. The treatment must be anticipated as soon as the dispute arises.

For the paying business: provision, then expense

As soon as a dispute makes an outflow of resources probable, the prudence principle (Article 121-1 et seq. of the French General Chart of Accounts (plan comptable général)) requires a provision for risks to be set up. The contingent liability is recorded in account 1511 "Provisions for litigation", against an appropriation. The amount provisioned corresponds to the best estimate of the compensation likely to be owed, revised at each year end in light of how the proceedings develop.

Once the compensation becomes certain (settlement signed, final decision), the expense is recorded. Termination compensation, which has the character of damages, falls under exceptional expenses on management transactions (account 6718), the provision previously set up being reversed. Compensation of a contractual nature comparable to a penalty may also pass through this account. The precise classification depends on the characterisation adopted and should be settled with the chartered accountant (expert-comptable).

For the receiving business: income receivable

Symmetrically, the business receiving the compensation records the income only when the claim becomes certain in principle and in amount, in application of the prudence principle, which prohibits recording income that is merely hoped for. The income is then recorded as exceptional income on management transactions (account 7718). Income receivable may be recognised at year end where the agreement is reached but the sum not yet received.

The question of VAT

The VAT treatment of termination compensation depends on its economic characterisation. Where it compensates a loss, without an individualised consideration for the benefit of the debtor, it falls outside VAT: it is not the remuneration of a supply. If, on the other hand, the sum in reality remunerates a service (waiver of a right, non-competition undertaking, identifiable service), it falls within the scope of VAT. This boundary, sometimes a fine one, must be settled before invoicing, because an error exposes the business to a tax reassessment. The drafting of the settlement agreement must therefore expressly characterise the nature of the sums paid.

Conclusion: security is built before termination, not after

Disputes over the termination of a commercial contract almost never penalise the fact of terminating: they penalise the manner of terminating. A business that grants written notice proportionate to the length of the relationship, performs it in good faith on the previous terms and documents its reasons protects itself from most of the risk. Conversely, one that abruptly stops ordering, without anything in writing, relying on a notice clause that is too short, risks having to compensate several months of lost margin.

The position is clear: generous, dated notice is better than a contested ground and immediate termination. Before any decision, three reflexes are needed. Reconstruct the real length of the relationship and the degree of the partner's dependence in order to calibrate the notice. Notify in writing, by registered post, with a precise effective date. Finally, have the exposure quantified, lost margin and accounting provision, before acting, rather than discovering the risk on receipt of the writ. An audit of the relationship and of the termination clause, carried out beforehand with counsel, always costs less than a dispute over abrupt termination.

Frequently asked questions

What length of notice must be given to terminate a commercial contract? No statutory scale sets a general length. Notice must take account of the length of the relationship, the volume of business, the partner's economic dependence and the usages of the sector. Practice often adopts, as an indication, an order of magnitude of around one month per year of relationship, without the force of a rule. Article L442-1 II of the French Commercial Code guarantees that eighteen months' written notice excludes any finding of liability for insufficient length.

Can a commercial contract be terminated without notice? Yes, in two cases only: sufficiently serious non-performance of the other party's obligations (persistent payment defaults, repeated breaches) and force majeure within the meaning of Article 1218 of the French Civil Code. Outside these situations, the absence of notice establishes an abrupt termination penalised by Article L442-1 II. The ground for immediate termination must be solidly documented before being relied on.

How is compensation for the termination of a commercial contract calculated? Compensation for abrupt termination makes good the insufficiency of notice, not the end of the relationship. It corresponds to the margin on variable costs that the partner would have earned during the missing notice period, that is, the difference between the reasonable notice and the notice actually granted. To this base may be added specific investments that have become useless and reorganisation costs, where proved.

Does a notice clause in the contract protect against abrupt termination? Not necessarily. Article L442-1 II is mandatory (public policy): contractual notice found to be too short given the length of the relationship does not remove liability. The clause sets a minimum, but the court may adopt a longer period. Only notice that is actually sufficient, or the eighteen-month ceiling, genuinely secures the termination.

How should compensation for the termination of a commercial contract be accounted for? For the debtor, a provision for litigation (account 1511) is set up as soon as an outflow of resources is probable, and the expense is then recorded as exceptional expenses on management transactions (account 6718) once the compensation is certain. For the recipient, the income is recorded as exceptional income (account 7718) when the claim becomes certain. The precise treatment must be validated with the chartered accountant.

Is termination compensation subject to VAT? In principle not where it compensates a loss, because it does not remunerate any individualised supply. It becomes subject to VAT if it is in reality the consideration for a service (waiver of a right, non-competition undertaking, identifiable service). The characterisation must be settled and stated in the settlement agreement before any invoicing, failing which a tax reassessment may follow.

Is partial termination of a commercial relationship penalised? Yes. Article L442-1 II expressly covers termination "even partial". A significant and sudden fall in order volumes, a unilateral reduction in the scope entrusted or a worsening of commercial terms during the notice period are treated as abrupt partial terminations. The displaced partner may then obtain compensation up to the margin lost on the part of the relationship removed.