If you deal with many agreements, you are likely to run into one where the party’s failure to meet its contractual obligations resulted in a breach of contract.
You cannot control any of the party’s performance involved in a binding agreement, but you can mitigate risks by educating yourself on how to best reduce vulnerabilities in contract management, and by drafting contracts with the support of artificial intelligence. Read below to find more about what a breach of contract is.
What is a Breach of Contract?
A breach of contract is a violation of the terms and conditions of a binding agreement, that is, of the contractual obligations that the parties involved agreed upon. Anyone can face the risk of a breach of contract when signing an oral or written contract.
To claim a breach of contract, both the existence of the contract between the parties and the breach that actually occurred must be proven in court. A written document signed by the parties serves the purpose of validating the establishment of the contract.
The enforcement of oral contracts is also possible in contract law, though some types of agreements still require a written contract for it to carry any legal weight, according to the statutes of frauds.
In a contract case, the plaintiff must demonstrate how the breaching party failed to meet their part of the contract. Parties can breach a contract by action, inaction, or even the actions of third parties. The delay of an agreed payment or the failure to deliver a promised asset are two of the most common reasons for an actual breach of contract.
Contracts often include clauses that can remedy the breach of contract. Therefore, the parties involved in the situation may resolve the issue among themselves. Otherwise, they must be solved through legal action in a court of law.
Types of Breaches of Contract
There are four main types of contract breaches. They can be classified by the nature of the breach and the time of breach.
Material Breach of Contract
A material breach of contract occurs when a party’s performance or non-performance deprives the non-breaching party of its bargain and renders the agreement “irreparably broken”. In such cases, the non-breaching party may seek to terminate the agreement and pursue damages.
Non-Material Breach of Contract
A non-material breach occurs when the failure to perform is a minor one. The purpose of the contract remains, and the parties substantially performed in accordance with the terms of the agreement, a party did not receive the full value of the agreement.
Courts will consider many factors in determining whether the breach is material or minor:
- The extent and amount of benefit which the non-breaching party received.
- The possibility of adequately compensating the non-breaching party for damages.
- The extent to which the breaching party actually performed contractual obligations.
- Hardship which affected the breaching party's ability to perform.
- Whether the party who breached the agreement was willful or negligent.
- The likelihood that the party who breached a part of the contract will perform the remainder of the contract.
Anticipatory Breach of Contract
An anticipatory breach of contract occurs when one party in a contract indicates that they cannot or will not perform their contractual obligations. Most jurisdictions require a “clear determination” by the repudiating party not to meet their obligations.
If such anticipatory repudiation would cause a material failure, the non-breaching party may seek damages and other remedies. In some cases, this can be the best option for the parties if such anticipatory repudiation occurs before the parties have incurred significant costs.
Actual Breach of Contract
An actual breach of contract takes place when any of the terms of the contract has been breached. This can arise when the breaching party failed or refused to fulfill their contractual obligations by due date or did it incompletely or inadequately.
Remedies for a Breach of Contract
The parties’ remedies for breach of contract derive from common law, statutes, and the terms of the contracts. The remedies fall into three groups: damages; equitable remedies, and termination.
Damages
Legal remedies for breach of contract provide a non-breaching party with monetary awards. Such compensatory damages serve to restore the non-breaching party to the position they would have been in if the other party had performed as promised.
Since damages are a common law right, few contracts include a damages clause with the rare exception of liquidated damages. However, many contracts include a provision to limit the parties' exposure to damages claims.
Understanding the range of damage claims available can best be examined with an example.
Example
A company signs an agreement with a contractor to build a hotel and pays the contractor $5,000,000. Unfortunately, the building is poorly constructed and does not meet the contract terms. As a result, the hotel fails to meet building code requirements. The company has to hire inspectors at a cost of $25,000 to assess the construction and engage another contractor for a fee of $250,000 to bring the building up to code. In addition, because the construction is delayed, the company loses profits from hotel guests for a period of three months, totaling $300,000.
What damages can the company claim? It depends on the terms of the agreement.
First, we must categorize each of the losses suffered by the company.
- Direct Damages: Direct damages, also known as general damages. They are the losses that naturally result from a breach of contract. In the example, the direct damages is the $250,000 fee paid to the replacement contractor to fix the building.
- Consequential Damages: Unlike direct damages, consequential damages can be described as the harm done as consequence of the breaching party’s actions. They are also known as special damages. The consequential damages in the example are the lost profits in the amount of $300,000.
- Incidental Damages: Incidental damages are reasonable expenses incurred by one party to a contract as a result of the other party’s breach of the contract. In the example, the inspection cost of $25,000 may be considered a reasonable expense to evaluate the deficiencies in the construction.
- Indirect and Special Damages: Indirect damages are those that do not occur as the direct result of the accident but due to other damages that the victim incurred. Such damages may include lost business, damage to reputation, loss of earning capacity, and emotional distress. However, the definition of indirect damages is harder to define than incidental damages. In the example, the inspection fee may be considered both incidental and indirect damages.
- Punitive and Exemplary Damages: While compensatory damages seek to restore an injured party to its bargaining position, punitive or exemplary damages seek to punish the breaching party for some egregious act. They are awarded at the court’s discretion.
It should also be noted that damage claims other than direct, punitive, and exemplary damages require certainty as to the amount of loss, foreseeability of loss incurred as a result of a breach at the time of contracting, and an inability to mitigate loss by cover or otherwise.
Second, we must consider the terms of the agreement and, in particular, the language of any Limitation of Liability (LOL) clause.
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Limitation on Liability. Neither party will be liable to the other, whether based on contract, tort, warranty, or any other grounds, for any consequential, incidental, indirect, exemplary, punitive, or for any special damages of any kind, even if the other party has been advised of the possibility of such damages.
If, in our example, the parties agreed to a LOL clause similar to the example above, the company will only be able to seek direct damages in the amount of $250,000.
Other forms of damages include…
- Liquidated Damages refer to the specific amount agreed between the parties as compensation for a breach of contract. This type of legal remedy is used when an adequate amount of compensatory damages is difficult to calculate. Real estate purchase agreements usually depend on this remedy.
- Nominal Damages may be awarded when the plaintiff fails to support their claim for compensatory damages, nominal damages may be awarded by the court as a legal remedy. By doing this, the court acknowledges that the terms of the agreement have been breached, but little or no harm can be calculated.
Equitable Remedies
Equitable remedies force a party to perform its obligations under the contract.
- Specific Performance is a type of remedy where the court orders the breaching party to fulfill its obligations. Among other types of legal remedies, this is the preferred one when monetary damages are not enough to compensate the non-breaching party.
- Injunction directs someone to stop doing something, such as disclosing confidential information or wrongly soliciting business opportunities if such person agreed by contract not to do so.
Termination
In the event of a material breach, the non-breaching party has the right to terminate the agreement in addition to seeking damages. Typically, contracts will provide the right to end the agreement, but rarely define the term “material breach”.
This presents a challenge for non-breaching. If they are wrong and terminate the agreement, this is itself a material breach giving the other party a claim for damages.
Termination for Cause. Either Party may terminate this Agreement with immediate effect in the event of a material breach of this Agreement, if (a) the non-breaching Party provides written notice of the material breach and (b) a thirty (30) day cure period.
All in all, a breach of contract is an unpleasant situation that anyone can face at any time. Fortunately, it can be solved through several remedies. At Akorda, our experts can give you further legal advice on this and help you prevent any potential vulnerabilities in the drafting of contracts with the support of artificial intelligence.
Kingsley Martin
Kingsley is a founder of Akorda. He holds law degrees from Oxford University (First Class Honours) and Harvard Law School, and has 30 years of experience in the practice of law, software design and development, strategy, and management. Kingsley pioneered the new discipline called contract analysis. He is a founder of KMStandards and has developed software capable of automatically analyzing legal agreements and creating contract standards.
