What is a Contract Breach Clause?
A contract breach clause is a provision within an agreement designed to set out the rights and obligations of both parties in the event that one of them fails to carry out the implicit contractual promise(s). A contract will generally contain a clause covering breach, even if not explicitly stated as such, in order to provide a clear framework for managing potential disputes .
The aim of a contract breach clause is to establish a clear procedure for a disgruntled party to follow in circumstances where the other party believes they have not been provided with the benefit of their agreement.
Transparent procedures can allow the parties to resolve the matter without the need for formal interventions such as mediation or litigation. Contract breach clauses seeking to agree a course of action, often of a multi-stage nature, are common. Which actions are appropriate to pursue a dispute are generally set out within contract terms and conditions.
Essentials of a Breach Clause
An effective breach clause should be elegantly redundant. As the only reference point for determining whether a breach has occurred, courts and arbitrators reviewing a disputed issue involving a contract shall invariably look first to the contract itself. Even with the clarity of the contract in question, however, corresponding disputes will always arise over the precise interpretation of the contract. Moreover, when an errant party attempts to excuse its own breach as attributable to some unrelated misconduct by the claiming party, the claiming party must be prepared to prove that its conduct occasioned no material breach by the time of the party seeking to avoid its own obligations under the contract. Thus, the clearer the clauses delineating the conditions which may give rise to a claim of breach the better, and the more consistently clear the remedies sought by a party the less likely the inadvertent imposition of non-mutual remedies. At a minimum, the provision should set forth the conditions under which a breach occurs, the relief available for a breach, and the manner in which a party may seek redress after a breach has occurred.
Different Types of Contract Breaches
The type of breach matters. Whether a breach is material, minor or anticipatory will determine whether a breach clause in a contract is enforced on a motion or whether damages will be awarded.
A material breach of contract is a breach, or series of breaches, that are so substantial that they defeat the purpose, often the very reason for the contract making it capable of being performed. A good example is where someone fails to deliver property to a buyer under an agreement for sale when the buyer is ready, willing and able to pay.
A minor breach has occurred when there is a failure to perform some contractual duty or obligation but the breach is not sufficiently significant to justify the non-breaching parties’ abandoning the contract as a whole. Put another way, most of the contract’s benefits are received despite the breach. It has been said that a minor breach involves a contractual promise "that is of little or no practical value in the circumstances to the promisee". Failure to deliver something punctually might fall into this category. Many breaches fall somewhere in between a material and minor breach. For example, a party may be ready, willing and able to perform but delay in performing his obligations under the contract for a few days. Is this a minor or a material breach? The case law generally holds that the time for performance in a relatively minor matter or where the timing of the performance is not of the essence of the contract, a breach of the time provision will be a minor breach. However, if a contract states that "time is the essence" and one party fails to meet the deadline to perform a material obligation of the agreement, then such a failure is a serious contractual breach, rendering the non-breaching party entitled to terminate the contract, even if the period of delay was relatively short. An anticipatory breach is a declaration by a party before performance is due that the party will not perform. Some examples include threatening to commit a breach or pre-emptively refusing to fulfill the obligations of the contract. Such a declaration, whether express or through conduct such as long and continued delay, permits the other party to suspend its own performance of the contract, and may give rise to damages even though no breach has yet occurred.
Effects of Breach Clauses in Law
The legal ramifications of having a breach clause triggered can be significant for both contracting parties. While usually the party in breach fears litigation and the payment of damages, it is not uncommon for the innocent party to also end up facing a lawsuit of some kind, even if it was not the wrong-doer.
In dealing with a breach, a client should remember that a breach clause created by the parties in a contract does not shield them from suit or other legal actions by the other party. If the breached clause is that of a pre-litigation "cure" provision, then that party may find themselves soon after facing a request for mediation or arbitration, or a straight law suit, from the other party to the contract. This may be so even if the party who had the breach provision triggered was in the process of trying to remedy the situation as required by the contract, because the breach was committed and the cure period expired before the party seeking the proposed settlement complied with the cure provision.
Further, while the aggrieved party may settle with its client through the mediation process or via other forms of litigation in the wake of the other party’s breach, there is no provision in the breached contract with that client that ensures the aggrieved party does not later become exposed to a similar type of action or damage claim by the non-breaching party to the original contract. Doing what the party contracted to do does not guarantee that the party will be sheltered by the breach clause if another party to another contract decides to bring a claim, because there may not be a provision in the contract shielding the aggrieved party from a second action in the event they corrected the breach.
Although contracts are meant to take preference over the law and the courts, courts may choose to hold that a contract cannot shield a party from a second breach or action, because to do so would contravene public policy.
Creating a Targeted Breach Clause
When drafting a breach clause, businesses should consider carefully how it will be interpreted. The general rule in Canada is that the more specific an agreement’s covenants are, the better they will be treated by the courts. A vague covenant may give rise to an invitation to misconstrue the contract and, consequently, litigation.
Agreements that are made in the same circumstances, in similar contexts, should be interpreted similarly. For example, if a business is forced to litigate to enforce payment on a breach of payment provision, then it should have been required to litigate to collect penalties on a breach of a non-monetary provision as well. An exception applies in the case of exceptions: Sometimes, non-monetary covenants are so integrated with the activities of the breaching party that it would be inequitable to require them to be exchanged for a monetary payment if the purpose can be achieved in another way.
The objective is to draft clauses that are precise enough to be meaningful, but also general enough to allow the parties to adapt their agreement to the changing circumstances of business. Being precise enough means thinking through what could happen. Specifying the time and manner of notice and of cure , as well as the interactions that should follow, allows all parties to force a breach on course to rectification – if possible. General enough means leaving some room for negotiation of extensions or other compromises that are consistent with the parties’ understanding of their obligations to each other. The less that the other party perceives the breach clause to be a fixed schedule of events that must be followed precisely, the more likely you are to inform and improve whatever contractual relations may have existed between you.
The safest course is to specify what you want and how you want it done. Although it is good practice to make your expectations for a breach clear, it is critical that, in the end, the notice of breach attempt to strike a balance between giving notice of a specific expectation and giving the breaching party an opportunity to come forward with a compromise. While the law is there to protect the vulnerable party to some extent, there is no substitute for a clear, specific and manageable agreement that provides protection for all parties. A court will inevitably caveat any protection that it perceives to be one-sided.
Case Examples of Breach Clause Application
Case Study #1
A large retail company signed various IT contracts with a technical development company. An issue emerged that one of the personnel of the IT development company was also running a similar business on the side. When the retail company terminated the contract, it was requested to follow a dispute resolution process as set out in the IT contracts. The retail company attempted to follow the dispute resolution process and then terminated the contract. The IT development company sued the retail company for breach of contract. The dispute resolution process notwithstanding, the courts found that the retail company had grounds to terminate the IT contracts. The court found that the IT development company had breached the contract and that the retail company could recover damages.
Case Study #2
A large construction company was engaged to build a series of commercial buildings. A significant dispute arose between the construction company and the private owner concerning the delays in the project. There were no clauses in the contract requiring the parties to refer disputes to mediation or to a dispute settlement body. However, the owner and the construction company agreed to try to resolve the dispute by mediation, and the matter was settled. The parties found that the mediation process was effective and timely, and they were able to resolve the dispute amicably. While there was no contractual requirement to attempt to resolve the dispute in this case, the parties were able to make a commercial outcome so the importance of the mediation process can be inferred.
Case Study #3
A large state-owned engineering company entered into a joint venture with a foreign company for the construction of commercial buildings. During the execution of the projects, a dispute arose between the parties over the construction schedule, and the project fell way behind the schedule. The dispute resolution clause required the parties to first refer the dispute to mediation within 6 months and then to adjudication under the Australian standard form of contract. The parties followed the dispute resolution procedure, and the adjudicator found that both the local and foreign parties were at fault in causing the delay to the schedule; therefore, both parties were responsible for the damages. As demonstrated by this example, it is vital for any party to carefully consider the benefits of resolving a dispute through dispute resolution before commencing any dispute settlement procedure. In this case, the procedure was beneficial because the adjudicator found that the two parties were equally responsible.
Enforcement of a Breach Clause
When a breach occurs there are steps that can be taken in order to avoid costly litigation. In addition to contractual negotiation strategies, there are other avenues outside of the court system that can be pursued as a means of alternative dispute resolution (ADR).
Negotiations First, it is important that the non-breaching party understand the extent of the breach, the exposure in terms of damages, and potential liability moving forward. Thus, a detailed investigation of the breach must be conducted. The investigation should include the background of the contract at issue, as well as the facts and circumstances surrounding the breach. The parties should then each consider their respective legal positions and evaluate the exposure relative to the likelihood of success before resorting to ADR or litigation.
The parties can then begin negotiations to resolve the matter. Oftentimes, discussing the key issues and having these discussions come from the perspective of separate interests can be helpful towards finding a resolution. In other cases, outside understanding, knowledge and neutrality may be the key through the use of a neutral third party.
Alternative Dispute Resolution Contract disputes may be resolved outside the court system through a variety of methods. One method is to agree to binding arbitration. Arbitration is appropriate where the parties do not want to engage in a potentially costly and lengthy discovery and litigation process. Binding arbitration is frequently included in contracts as an alternative to litigation. The parties can also choose to arbitrate on an ad hoc basis. Another option is to seek the assistance of a mediator who will try to negotiate a solution agreeable to both sides. A third option is more comprehensive, most often found in international transactions, and is referred to as conciliation. Like mediation, this process involves the use of a neutral third party to help guide the parties toward resolution, but the conciliator may assist in crafting the terms of a settlement as well as giving their opinion about the merits of the case.
The Importance of Legal Advice on a Breach Clause
Expertise of Legal Counsel in Breach Clauses
The advice of a legal counsellor is indispensable in drafting the appropriate contractual provisions that will be in the best interest of the client. These provisions should include detail as to the nature of the breach, whether it is intentional, inadvertent or negligent, that is, was it made in error or was it the result of carelessness? How significant was the resulting damage? Is the responding party’s economic loss a serious financial matter or is it more in the realm of the inconsequential? Is either party assisted or impeded by a delay in fulfilling the contract? These are some of the specific questions that an experienced legal advisor will consider and address in the context of the particular agreement in question.
The adviser will again find it necessary to ask a variety of specific questions before advising on the language for inclusion in the breach clause. How significant is the breaching party’s business? Is it a substantial corporation or small family owned company? What, if any, remedies has the non-breaching party requested? Does careful language in the breach clause adequately provide protection against the type of breach that has occurred? If so, and if compensation is required, is it in an amount sufficient to compensate the non-breaching party to a degree that will discourage it from future breaches? Are there anticipated future changes in the business that will affect the current contract? Is there a wish or need to facilitate renegotiation of the contract in the event of a breach? Is an obligation of confidence that applies to the entire contract, partial contract or no contract at all?
These and many other questions are contemplated by an experienced legal advisor who will help draft the appropriate wording for a breach clause that makes the consequences clear and provides clues as to the proper steps to take if there is a breach.
Early in the drafting process , the parties to the contract should identify the type of breach that they anticipate might occur. It is possible, as well, that with experience gained from past contracts the parties will have an expectation regarding breaches that is specific to their line of work. The result will be the inclusion in the breach clause of language that is tailored to the objective of the contract and easily understood when read against the background of the work being undertaken.
The language of the clause should let the reader know exactly what the parties mean, and having an experienced legal counselor as one of the negotiators will ensure that legal jargon is avoided and that words with precise meanings are used to describe the actions or inactions that are the subject of the breach clause. When there is an understanding between the parties as to what constitutes a breach that has occurred, aside from the normal and expected delays and setbacks that may arise in the course of the execution of the contract, then the contract can move smoothly from acceptance to completion. Without a clear definition of the breach, however, there is the potential of protracted negotiation over what a "reasonable period to fulfil the contract" might mean or what the parties meant by "serious damage" or whether the word "undue" represents the same category of harm for each of the parties. A legal advisor is in the best position to question the parties and to guide them toward the specific and appropriate language. This skilled counselor will write a breach clause that is unambiguous and clear. A legal advisor versed in commercial contracts cannot be overlooked or taken for granted as an essential member of the negotiating team, any more than a reliable free-market economy can be dispensed with.