This clause specifies the consequences and procedures when either party discovers that performing the contract has become illegal or when legal changes make the contract's performance impossible or unlawful. For example, if a contract involves the sale of a product that is later banned by regulation, or if new sanctions prohibit trade with a particular country, this clause determines how the parties will handle the situation. Typically, a termination-for-illegality clause provides that the affected party may terminate without liability, and it addresses whether any payments already made will be refunded, whether partial performance is compensable, and how quickly the termination must occur after illegality is discovered.
This clause is critical for protecting both parties from liability when circumstances beyond their control make performance impossible or illegal. Without such a clause, a party might be forced to choose between breaching the contract (and facing damages) or performing an illegal act (and facing criminal or regulatory penalties). The clause essentially provides a "force majeure" style exit for legal changes, though it's distinct from typical force majeure clauses because illegality is a legal change rather than a natural disaster or unforeseeable event. The clause also protects against disputes about who bears the financial loss when a contract becomes impossible to perform legally.
Draft this clause to clearly define what constitutes "illegality" (including changes in law, regulatory action, sanctions, or licensing requirements) and require the affected party to notify the other party promptly upon discovering the illegality. Specify that termination is effective immediately upon such notice and that neither party bears liability for non-performance. Address the financial consequences explicitly: clarify whether prepayments are refunded in full, whether partially completed work is compensable on a quantum meruit basis, and whether either party must mitigate losses by seeking alternative performance methods. Include a requirement that the notifying party provide evidence of the illegality (such as a regulatory notice or legal opinion) to prevent bad-faith termination claims. Consider whether the clause should require the parties to attempt to modify the contract to comply with new legal requirements before resorting to termination.
Frequently Asked Questions
What does this clause mean in simple terms?
This clause specifies the consequences and procedures when either party discovers that performing the contract has become illegal or when legal changes make the contract's performance impossible or unlawful.
Why should I care about this clause?
For example, if a contract involves the sale of a product that is later banned by regulation, or if new sanctions prohibit trade with a particular country, this clause determines how the parties will handle the situation.
What are my options?
Typically, a termination-for-illegality clause provides that the affected party may terminate without liability, and it addresses whether any payments already made will be refunded, whether partial performance is compensable, and how quickly the termination must occur after illegality is discovered.
How does this affect small businesses?
This clause is critical for protecting both parties from liability when circumstances beyond their control make performance impossible or illegal.