Chapter 10
What happens if the contract is breached?
Consequences for a breach of contract
There are a number of consequences for the breach of a contract. Primarily they are:
- an order for damages or the payment of financial compensation by the party making the breach
- an order for specific performance of the contract by the party in breach
- an injunction
- restitution.
Apart from an injunction, they all tend to arise after the contract has been terminated.
Damages
If a party breaches a contract and the suffering party can establish what they have lost arising from the breach, they make a claim to be compensated for that loss. It is necessary for loss to be proved. That loss may be of a number of different types. However, generally in breach of contract claims there are two types of loss covered.
The first is reliance damage. That is the loss that has occurred as a result of relying on the contract and this reliance has caused damage as a result of the breach.
Example
Revisiting our dragline manufacturer example from chapters 2 and 3, assume it entered into a contract with the coal mining company to provide the dragline. It employed further staff, obtained more plant and equipment and turned away other jobs because the contract was so large. Because of changed financial circumstances the buyer no longer seeks to purchase the dragline. The selling company may have a claim against the coal mining company on the basis that it had arranged its affairs and not taken other jobs assuming the contract would be honoured. Relying on the existence of the contract and the binding obligations between the parties, which was subsequently breached, has caused direct loss. The loss is the contracts it did not take up so as to ensure it could service its current deal. This is independent of any profit it may earn under the contract.
On the other hand, say the manufacturing company of the dragline delivered it as not being fit for purpose and of defective design, manufacture and construction. Put simply, it didn’t work well enough. It regularly broke down, and as a consequence the mine suffered significant periods of downtime when production ceased. This is likely to be a breach of the contract.
The other type of claim is loss of profit.
If the contract has been properly drafted, express terms would have been incorporated requiring the manufacturer of the dragline to warrant that it was fit for its purpose and that it was built to a standard of manufacturing quality that was in all circumstances satisfactory for the use to which the company wanted to put it.
If the dragline failed and the loss suffered was significant, the company may assert a claim for loss of profit. That is the loss of production and profit that would have been earned from the mining of coal from the mine. If the breach had not occurred, the profits would have been earned and no loss would have been suffered by the company attributable to the failure of the dragline. The failure of the dragline has caused loss of profit and, as a matter of law, the company will assert that it should be compensated for this.
Damages for breach of contract can be in astronomical terms. A breach can be very, very bad for the victim of the breach and the party who has to pay. No-one wins in these circumstances.
Specific performance
Another consequence of a breach of a contract may be that the court orders specific performance of it. Courts will generally not order specific performance of personal-service contracts. Where a party has to perform an obligation or deliver a service, the court will generally not oblige it to do so. It will leave the party who has suffered the breach of contract to its right to damages against the infringing party. There is a policy in the law against compelling parties to provide labour or services against their will. As a practical consequence it is unlikely, in general terms, that the contract will be performed to its letter when one of the parties to it is being compelled by the court to honour its obligations. Doing the minimum possible to try to scrape through is not considered compliance with the spirit and terms of the contract. A regular consequence of a specific performance order is that this is all the party that has been the victim of the breach gets.
However, where a contract involves the delivery of a good or product, specific performance may be ordered.
Again, take the example of the company and the dragline. If the manufacturer finds a way to do a better deal with a coal mining company for a much higher price on much more satisfactory terms, it may try to terminate the contract in relation to providing the dragline and attempt to enter into a new contract with the new customer. Depending on all the circumstances, it may be open to the company to seek orders for specific performance. That would mean the buyer would invite the court to make orders compelling, by force of law, the manufacturer to deliver the dragline as agreed to in the contract.
Restitution
If a party to a contract receives a benefit at the expense of the other party and it would be unjust to allow them to retain that benefit then the court may order that the proceeds of that benefit be paid to the suffering party. This is called restitution.
Injunction
An injunction is an order of the court that either:
- prohibits an act being done (termination of a contract or a step to be taken in breach of the contract)
- compels a party to take a certain step or do a certain thing under the contract.
Courts are more willing to grant prohibitory injunctions, that is stopping parties from doing things, than they are to compel them to do things. An injunction may be of great value when a party comes to notice the intention of their counterparty to breach the contract. They may want to ‘get their retaliation in first’ by seeking to injunct the recalcitrant party from the actual breach of the contract.
Example
Ripper Mining agrees to sell a fleet of vehicles used in and around the mine to a fledgling business, Phoenix Mining, located nearby. All of the terms of the agreement are set. It is put in writing and a delivery date is determined. Two days before the delivery date Ripper Mining receives a better offer for the vehicles. It is 50 per cent higher than the deal it has done. It writes to the smaller mine operation telling it that it will no longer honour the deal and that all bets are off.
The smaller mine operation seeks an injunction from the court restraining Ripper Mining from selling the vehicles to the other purchaser who is willing to pay a higher price and seeks the specific performance of the contract. The injunction is used to preserve the position. The ultimate claim is for specific performance of the contract.
This is a prohibitory or restraining injunction because it is stopping the party from doing something.
On the other hand, if the contract had effectively been consummated and the money paid by the smaller mine operation, yet the vehicles had not been delivered, a mandatory injunction may be granted compelling delivery of those vehicles by Ripper Mining.
This is relatively infrequently used in breaches of contract. Often it is difficult to have sufficiently clear evidence of the prospective or proposed breach. The court will need more than mere whispers or the beat of a jungle drum that a breach is imminent. It will need quite solid and clear evidence that the other party seeks to breach the contract before orders will be made. As a practical matter this evidence is generally very hard to get.
But I can’t perform the contract anymore — it’s not possible
This is a comment that is often heard from parties to contracts. It can mean any number of things — ‘I don’t want to be bound by contract anymore’, ‘I want to renegotiate and enter into a new contract on better terms’, ‘I am bankrupt or insolvent’, or the most genuine of all, ‘I can’t perform my obligations’.
It is possible to avoid your obligations under the contract. However this occurs in only very rare circumstances. It also requires you being able to prove that your inability to perform your obligations arises from something outside your control.
Frustration
There is a principle of law called frustration. As the name implies, it means the purpose and performance of the contract has been frustrated. This however does not mean that a party can necessarily engineer frustration. Equally unhappiness or emotional frustration about the terms of the contract is not frustration at law.
There are four steps necessary to prove that a contract has been frustrated:
1 An event has taken place causing a fundamental change in the nature of the contractual rights and obligations or in the circumstances of the contract.
2 Neither contracting party caused the event.
3 The event was not contemplated by the parties in entering into the contract, and therefore could not reasonably have been dealt with by a contractual provision or term.
4 It must be unjust to hold the parties to the contract to what they agreed upon in all the circumstances given 1 to 3 above.
Whether a contract has been frustrated is generally a topic of hot controversy. The party wanting to bind the other party to the contract generally alleges that what are alleged to be frustrating circumstances are not in fact so.
Often big factual questions arise like:
- Did the party relying on the frustration of the contract know the event was going to occur? If so, when did it know?
- When was the contract actually frustrated?
- Was the frustrating issue within the contemplation of the parties at the time the contract was entered into?
- What is the impact of the frustrating event on the rights and liabilities of the parties?
Example
Profit Mining runs an open-cut mine. The mine produces a mineral daily that it then supplies to its customers. Those customers require the daily delivery of the mineral for their production of their product. If the daily delivery does not occur, those customers cannot produce. They do not stockpile the mineral.
The mine is not necessarily known to be along a geological fault line. However, an unexpected earthquake occurs that causes a collapse of part of the quarrying walls of the mine and significant damage to plant and equipment. Production is stopped for one month.
The customer complains of breach of contract by the failure of the mining company to deliver the minerals. On the other hand, the mining company says the contract has been frustrated by the earthquake.
There is a real chance the court would find the contract has been frustrated because all the elements set out above apply.
If a contract is frustrated it means that all future obligations are no longer enforceable. However, it does not mean that all claims in relation to past breaches dissolve. Frustration acts to terminate the contract on and from a certain date. It does not resolve the prior rights and obligations of the parties.
Force majeure
As discussed in chapter 5, the other way a party may deal with a generally frustrating event is to include a force majeure clause in their contract. This is an express acknowledgement by the parties that if a supervening event that causes the contract to be frustrated arises, all rights and liabilities on and from that date will be discharged.
This puts a party who is the victim of an unfortunate event in a much stronger position. Courts will, as a practical matter, be much more willing to find that a contract has been frustrated when a force majeure clause is present. It makes it easier to prove by the party who has been the victim of the event.
A simple acknowledgement that a supervening event is possible of itself is extremely useful to show the parties to the contract were conscious there were circumstances that might arise that would disallow the contract’s completion.
Example
Paper over the Cracks cosmetics has just undertaken a complete new fit-out of its CBD offices. It is a high-profile public company. For the office fit-out it has sourced and bought expensive and stylish contemporary furniture from France. Prior to the fit-out being completed and the furniture being ready for installation, it is being stored at the factory premises in an industrial part of town. An explosion occurs at an adjoining factory premises. It incinerates the factory storing the furniture and everything in it.
The contract between Paper over the Cracks and the fit-out company had a force majeure clause. It provided that any event reasonably beyond the control of the defaulting party does not give rise to a claim against the defaulting party or cause the defaulting party to be in breach of the agreement.
This gives rise to an odd situation in the context of our discussion above. The fit-out company cannot satisfy its obligations under the contract. It cannot deliver the furniture. This is literally a contract breach. However, given that its failure to be able to deliver the furniture is caused by an event that was not created by itself, it is not considered a breach of the contract relevantly for the purposes of a damages claim.
In this context force majeure clauses are important aspects of contracts when and if you think there are likely to be events of natural disaster or other kind which may militate against your ability to complete the contract.
Force majeure clauses have great weight when contracts are performed in places of political and social instability. It may be that the contract cannot be performed because of this political and social instability. A force majeure clause will allow the defaulting party to avoid liability given the contracting parties contemplated the possibility that the contract would not be able to be performed because of the social context.
If I breach the contract are the consequences the same as if the other party breaches?
As a matter of law, the answer is yes. There is no bigotry of breaches. Just by virtue of being a buyer or a seller you are not better off. A breach of contract has consequences potentially allowing for a right of termination. Even if it does not allow for a right of termination your other party may have a damages claim against you for breach. If the shoe is on the other foot, you are in the same position. You may be able to terminate the contract. Alternatively, you may have a damages claim.
However, there are ways of constructing contracts so you are in a much stronger position when breaches arise.
Regularly contracts will provide different rights. Contracts may allow for one party, generally the drafter of it, to terminate on the basis of either:
- a serious and material breach of the contract (as generally defined in the seller’s favour) by the purchaser
- upon 30 days’ written notice (or some other time it considers appropriate although not generally less than 30 days) at the service provider’s discretion.
There is nothing at law stopping both parties from having this right. Generally the best interest of the more powerful party does not allow this in negotiation. A service provider is given significant flexibility in terminating the contract on terms like this. It allows for immediate termination if the purchaser seriously breaches. On the other hand if it does not like the terms of the contract, and it thinks it could do a better deal with the same counterparty or in the market generally with someone else, it can terminate on 30 days’ notice.
The rights given to the other party to terminate the contract are generally very limited. Often they can only terminate the contract on the basis of a serious or material breach. What is considered a serious or material breach by the drafter of the contract is defined much more narrowly than a breach by the other party. That means there can be two types of material breach definitions. A high standard for the drafter and a lower standard for the other party. The drafter has to do something really bad to materially breach the contract. Conversely, the person who is given the drafted contract may not have to be so remiss to arouse a material breach clause.
Further, there is generally no clause allowing the person given the draft contract to terminate ‘at will’ or without reason.
As is clear, parties can contract an agreed consequence in the event of a breach. While this does not necessarily exclude the law generally and potential unfairness, courts will generally look to uphold the contract between the parties. Therefore if termination clauses are clearly expressed and the terms are clear, the court may uphold the clause and the double termination standard intentionally incorporated in the agreement.
It all depends on what the contract says. It is for this reason that great care should be taken in drafting contractual terms, and in particular, termination clauses. An unhappy contract can be made even more gruesome by your inability to get out of it. For example, it is somehow more daunting and violating when as the purchaser you are stuck in the contract yet the vendor, with whom you have done a bad deal, can terminate at will and for no reason. A lack of attention to this issue at the outset can give rise to significant heartache during the course of the contract.
This again exemplifies the principle that your counterparty does not need to be nice to you in going into the contract.
Again, there are no standard terms. Everything in negotiating a contract is up for play. This is a blessing and a curse. It means you need to be extremely vigilant when going into a contract as to what the terms and conditions are. At the risk of sounding pessimistic, prepare for the best but also plan for the worst.