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When the parties have breached the obligations they have agreed to in the contract.
Obligations are those responsibilities or commitments that a party is legally bound to fulfil in an agreement.
Example:
Let’s say two parties have entered a contract for the sale of certain goods.
One of the most important obligations for the buyer will be to pay for the goods by a certain date.
The seller’s obligations will include the obligation to deliver the goods being purchased by a particular date and an obligation to ensure the goods meet certain requirements regarding quality.
Should the seller or buyer fail to meet any of these obligations, they will commit a breach of contract.
What happens after a breach of contract?
Depending upon the severity of the breach and how much you value your commercial relationship with the other party, you may attempt to deal with the breach informally or formally
In order to deal with a breach informally, you may have an informal conversation with the breaching party. Through this conversation, you may ask the breaching party to continue performing their obligations under the contract and agree to an informal settlement with them to compensate you for any losses caused by the breach.
If your informal attempts fail, you may decide to institute formal legal proceedings. The first step, as part of such formal legal proceedings, is normally for the innocent party to prepare and send a document called a “Letter Before Action” to the defaulting party.
A letter before action is a document which will describe the breach committed by the defaulting party and offers an opportunity for the breaching party to rectify the breach by a certain stated deadline.
If the issue remains unresolved by the deadline stated in the letter of action, then the innocent party may institute formal legal proceedings. These formal legal proceedings would involve filing a lawsuit against the guilty party.
If formal legal proceedings are instituted, what are the possible liabilities of the defaulting party?
The possible liabilities of the defaulting party will vary depending on the type of term that has been breached.
The law distinguishes between three types of contractual terms: conditions, warranties, and innominate terms.
A condition is a major term that is central to the agreement. It goes to the root of the contract. Note that conditions, in this sense are different from a condition which must be satisfied before a contract exists or a particular obligation becomes enforceable.
A warranty is a minor term that is not essential for the existence of the contract. Note that the term “warranty” is also different from the way it is used to describe a representation in the contract or a pre-contractual representation, for example, that the seller is the legal and beneficial owner of the goods to be sold.
An innominate term is an intermediate term which is neither major nor minor enough to be defined as a “condition” or a “warranty”.
The courts will generally look at the express terms of a contract in deciding whether a term is a condition, warranty or innominate term. For example, a term might explicitly be said to be a condition. The context may also influence the decision. For instance, if the term is found in the warranties section of the contract, it will likely be treated as a warranty. Past dealings between the parties (if any) and any customs of the trade may also influence the decision.
Based on the type of term breached, the defaulting party will be liable as follows:
- If a condition has been breached, the innocent party has a right to terminate the contract and claim damages for any loss resulting from the breach.
- If a warranty has been breached, the innocent party has a right to claim damages for any loss resulting from the breach but does not have a right to terminate the contract.
- If an innominate term has been breached, the innocent party may, depending on the nature and consequences of the breach, have a right to terminate the contract. The innocent party will have a right to claim damages for the breach.
Generally, the innocent party, following a breach of contract can do one of three things:
- Terminate the contract and sue for compensation for losses (if a condition or innominate term giving rise to a right to terminate has been breached)
- Continue to perform obligations under the contract, but sue for compensation (if the condition is breached, but a contract is affirmed; if a warranty is breached; if an innominate term is breached which does not give rise to a right to terminate);
- Request an order for specific performance, rectification, injunction, or rescission
(*Specific performance is an order requiring that a particular party carry out a specified act – such as to perform their contractual obligations. An injunction is an order made by a court requiring that a party in breach stop doing a specified act. Rescission is where a contract is set aside, and the parties are put back into the position in which they were in before the contract was made (e.g. a party may be required to refund any money paid or return any goods delivered).
Duty to mitigate loss
A party who is suing another for damages for breach of contract has a duty to mitigate their losses. In essence, this duty requires that the claimant take reasonable steps to reduce any further loss from occurring. If such reasonable steps are not taken, the claimant may not be fully compensated for the damage caused by the breach.
