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Breach of Contract

The central issues when dealing with breach of contract are: (1) is there a breach, (2) if so, what type of term was breached (warranty/condition), (3) what is the remedy.

A contract can be breached without any fault on the offending party. When a breach does occur a party may seek damages and, if the term breached was a condition, the right to terminate the contract altogether. The approach taken by the courts to the classification of terms discloses important policy considerations: is it better to make parties stick it out or should a right to terminate be easily available? The courts look not only at the type of term broken but at the consequences of the breach but generally the law does recognise a wider right of termination than other jurisdictions. If the right of termination does arise it is for the innocent party to elect whether they wish to exercise it; the right can be lost if the party is inactive for too long or gives counter-indications. It is important to note that a breach of contract can occur before the time for performance, this is known as an anticipatory breach. An example would be where one party tells the other that they will not be able to perform at the allotted time. This may give rise to a right to terminate immediately or alternatively the innocent party may simply continue with their performance and the breaching party will be required to pay them the price agreed.

 

What is a Breach of Contract?

A breach of contract is a failure to perform a promise without a lawful excuse. The breach can take many forms such as an express refusal to perform, defective performance, perfect performance but late, or incapacitating oneself from performing i.e. disposing of the goods that are meant to be transferred under the contract. A lawful excuse for non-performance would be frustration (where it is impossible to perform due to extraneous causes) or perhaps where the non-performance is non-payment, because the goods were defective.

The fact that breach of contract doesn't require fault (and is 'strict' liability in that sense) has been criticised as unfair on the defaulting party. For example, in a situation where A has a duty to transfer goods to B but A has not yet received the goods from X, because X has been lazy. It is arguably unfair to impose liability on A as it is not their fault that goods have not been transferred. In that situation, however, B could sue A who in turn could sue X, so as long as X is solvent A should recover their money. The situation is worse if, rather than a lazy third party, the reason why A does not have the goods is because they sank on a ship in a storm. In that case A is liable (unless they can argue that the contract has been frustrated) and has no third party to pursue for an indemnity. It is, however, possible to provide clauses in contracts dealing with unforeseeable events called force majeure. Whether liability for breach is strict ultimately depends on the term that is breached. If the term says "the goods must be delivered by 8am", any failure to do so will be a breach. On the other hand if the contract says "best/reasonable endeavors must be made to deliver the goods by 8am", then as long as the deliverer has tried their best there will not be a breach.

 

The Right to Terminate

Most good contracts will contain a termination clause which makes clear when the right to terminate will arise. In contracts where there is no such term, the law provides a right of termination. This right of termination depends on how the term is classified. The classification of a term as a warranty or condition is usually a matter of law, whereas in cases where an innominate (aka intermediate) term is concerned the courts will look at the facts of the case and the seriousness of the breach in order to determine whether a right to terminate arises.

 

Breach of a Condition

Breach of a condition gives rise to a right of termination. It is important to note that the word 'condition' is often used in cases and sometimes contracts to mean the same thing as a 'term' (just like 'warranty' is unused in a non-technical sense as well). There are three ways a term can be classified as a condition:

•  Parliament,

•  The courts,

•  The parties themselves.

There are few examples of statutory specifications of whether a term is a condition. In the Sale of Goods Act 1979 the implied terms that goods must match description, must be of satisfactory quality and fit for purpose, and must correspond with the sample if a sale by sample are conditions (s12(5A), 13(2), 14(6), 15(3)). Section 15A(1) makes clear hat where the buyer is not a consumer and the breach is so slight that it would be unreasonable to allow termination, breaches of ss13-15 will be treated as a breach of warranty. The object of this provision is to prevent buyers from rejecting goods on technical grounds. For example, in Arcos v E A Ronaasen and Son [1933] AC 470, the parties contracted for the sale of timber cut to a ? inch thickness. The buyers alleged that there was a breach because the timber was 9/16 thickness. HL held that they were entitled to reject the goods as "A ton does not mean about a ton, or a yard about a yard. Still less when you descend to minute measurements does ? inch mean about ? inch". This was so even though the HL was aware that the only reason why the buyer wanted to reject the goods was because there had been a fall in the price of timber since the contract and he could but it cheaper from elsewhere. Section 15A adopts a different philosophy. It is possible for the parties to contract out of 15A(1): s15A(2).

The easiest way to create a condition is for the parties themselves to classify a term as such. Where a trivial breach is intended to be a breach of condition it is important for the parties make their intention clear. In Schuler v Wickman Machine Tool Sales [1974] AC 235, the appellants were a German company who manufactured machine tools which were sold exclusively by the respondent in the UK. The contract provided - in Clause 7 - that "it shall be a condition of this Agreement that" the respondent would make a total of 1400 weekly visits to customers who had bought Schuler products during the duration of the contract. At first the respondent failed to make many visits, then there was a slight improvement but still a considerable number of failures. After some correspondence Schuler wrote to the respondent terminating the contract. There was a clause in the contract - Clause 11 - stating that 12 months notice to end the contract is required and can only be if there has been a material breach with 60 days given to remedy it. The respondent argued that the applicant could only end the agreement in accordance with Clause 11, whereas the applicant argued that Clause 7 was a condition and any breach gave rise to automatic right of termination. The court considered whether Clause 11 prevented the contract from being ended except as provided. It was argued that this could not be the case as Clause 11 was not comprehensive and, for example, didn't cover anticipatory breach as well as the fact that Clause 11 didn't provide for situation where the breach could not be remedied within 60 days. As such, it was contended, Clause 11 was not intended to be a comprehensive statement covering all and any eventuality which might bring the contract to an end, thus it was possible for the contract to end by immediate termination. The court held that Clause 11 was in fact intended to apply to all material breaches, including a breach of Clause 7, as long as these breaches were remediable. The question was whether a breach of Clause 7 was capable of being remedied; if not it did not fall within Clause 11 and the appellant was free to end the contract through immediate termination. The court considered the use of the word "condition" in Clause 7 and held that it did not simply mean term, there was intended to be some emphasis, but how much emphasis was the question. The court said that the failure to make visits was not itself a fundamental breach but it is possible that Clause 7 meant that any breach would give rise to a right of termination. The emphasis placed on the word 'condition' was to be understood taking the contract as a whole. The more unreasonable the result the less likely that it is the parties would have intended it to be a condition.

The HL held that it was likely that for whatever reason, there would be some weeks when the respondent could not make a visit i.e. because the respondents were sick or perhaps the recipients of their visit would be unable to receive them that week. In addition, when read in conjunction with Clause 11, the proper interpretation seems to be that no breach would give rise to an automatic right of termination and this right would only be permitted if the breach could not be remedied within 60days. As such, the appellant was wrong to terminate the contract when they did.

There is no doubt that the parties could stipulate Clause 7 as a term if they wanted to, regardless of whether it was unreasonable. The decisive factors for the Lords was the presence of Clause 11. It is easy to understand how a clause like 11 operates in simple facts such as a delivery of defective goods, all that is needed in that case is to deliver satisfactory goods and the problem is remedied. However, it is more difficult to understand how a problem such as that in this case can be remedied. The failure to visit the companies happened in the past and nothing can be done to sure that, all that can be done to 'remedy' the problem is to not miss future appointments. This was sufficient in the Lords' opinions to constitute a remedy. Thus since the breach of Clause 7 could be remedied, this brought the facts of the breach within Clause 11 and the appellant had to comply with the requirements under that clause.

In Lombard North central v Butterworth [1987] QB 527, C leased computers to D for 5 yrs. The contract stated that "time is of the essence" in respect of payment of quarterly rent was very important as well as stating that breach of this clause gave a right of termination and a right to claim all arrears & future payments that would have been due. The D fell into arrears and after giving due notice C repossessed the computers and brought an action for arrears and future payments. The court of appeal held that the clause permitting recuperation of arrears and future payments was invalid because it was a penalty clause but allowed the arrears and future installments to be claimed as damages at common law for the defendant's breach of contract. The court laid out some propositions:

•  Where a breach goes to the root of the contract the injured party can elect termination. The parties are free from any ongoing obligations.

•  The injured party can then claim compensation for the breach before the contract was ended and the loss of opportunity to receive the performance of the promisor's outstanding obligations.

•  It is possible to make any term a condition through drafting and any breach will give rise to termination.

This decision, though no doubt correct, has been considered harsh but it permits a party to stipulate any breach, however minor, as giving rise to a right of repudiation and damages not only for the breach but for loss of future payments. An important aspect of the case is the autonomy given to parties to nominate terms as conditions: freedom of contract prevails.

 

Breach of Warranty

Breach of a warranty only gives rise to a claim in damages. A term can be classified as a warranty the same ways as a term is classified as a condition. The Sale of Goods Act 1979, for example, identifies the rights under s12 (goods will be free from charges and the right of quiet possession) as warranties.

 

Breach of an Intermediate Term

Intermediate/innominate terms give the courts a degree of flexibility in deciding whether to permit termination. Rather than looking at the nature of the term, the courts will consider the seriousness of the breach. While this approach can be more fair than the approaches considered above (a minor breach will not result in repudiation) it is also less certain, which makes it difficult for business people to predict the effect of their actions. The leading case is Hong Kong Fir Shipping v Kawasaki Kisen Kaisha [1962] 2 QB 26 Court of Appeal. The ship-owners agreed to deliver a vessel to the charterers for 24 months. The contract (known as a charterparty) stated in Clause 1 that the vessel was "fitted in every way fitted for ordinary cargo service". When she was delivered the engine room was under staffed and other staff were incompetent rendering the ship unseaworthy. Clause 3 provided that the ship-owners would "maintain her in a thoroughly efficient state in hull and machinery during service". Hire was not payable for any period of repair exceeding 24 hours. The vessel had engine problems almost immediately and was unusable for some months during which time there was a change in cost of hiring a vessel and the contract became unattractive for the charterer. It was held that the ship was not seaworthy when delivered in breach of Clause 1. Clause 1 was held to be an intermediate term because a breach could both be very minor or fundamental to the purpose of the contract. The idea that either every breach of Clause 1 give rise to termination or none of the breaches, was too extreme for the court as they could contemplate factual scenarios that would fall within both.

So the question remains, how serious must the consequences be for the court to decide that a right of termination arises? The answer is very serious. Diplock LJ drew an analogy with frustration in the sense that the innocent party must be deprived substantially of the benefit the contract was intended to confer on them. The court will consider factors such as:

•  Amount of loss,

•  Cost of rectifying it,

•  Willingness of the party to repair the damage,

•  Value of the performance received by the innocent party at that stage,

•  Likelihood of future recurrence,

•  Adequacy of damages.

 

How do the Courts Decide between warranty, intermediate or condition

Where there is statute, previous case law or an agreement between the parties, it should be easy to tell what category a term falls into. The situation considered in this section is what the courts do when they have to adjudicate upon a term which has not been determined yet. In such a situation the courts do not assume that it is an intermediate term but begin a balancing exercise.

In Maredelanto Compania Naviera v Bergbau-Handel [1971] 1 QB 164, the owners lent their vessel to the charterers. Clause 1 stated that the vessel was "expected ready to load under this charter about 1 July 1965". The owners had no reasonable basis for this belief as the vessel was elsewhere and was not expected to return until 13-14 July. The charterers were also having problems as they had chartered the vessel to transport some calcium ore but later discovered that it was not available because of the war in Vietnam. The charterers attempted to cancel the contract on the grounds of force majeure. The ship owners interpreted this as a repudiation of the contract and sought to recover damages. One of the issues before the court was whether Clause 1 was a condition or a condition. The Court of Appeal held that it was the latter which meant that the charterers were entitled to end the contract notwithstanding that initially they had tried to use force majeure as the basis. The court had the following reasons for its decision:

•  The clause was commonly used in contracts of that type and it was important to bring certainty into law. It is difficult to see why certainty couldn't be achieved by making the term a warranty but, as Megaw LJ said "Where justice does not require greater flexibility, there is everything to be said for, and nothing against, a degree of rigidity in legal principle." In other words, if there is no need for the term to be a warranty then it is preferable to have it as a condition.

•  It is rare that a ship owner would ever feel that it is unjust for the charterer to end a contract because of a breach of a clause like this one. If the ship owner states that the ship will be ready on a certain date, there is no injustice in holding them strictly to that promise.

•  Previous case law involving the sale of goods (as opposed to the hiring of a vessel as in this case) suggested that a term stating when the vessel would be ready to load is a condition. There was no reason to distinguish between the cases.

This case can be contrasted with The Hansa Nord [1976] QB 44 where the court found that the term was an intermediate term. The parties entered into two contracts for the sale of citrus pellets. Clause 7 stated "shipment to be made in good condition . each shipment shall be considered a separate contract". The buyers paid ?100,000 but rejected all the goods when they reached the destination because part of the goods were damaged. The goods were then sold (pursuant to a court order, though this is not relevant) and the buyers used a third party to purchase them for ?30,000. The buyers then sought to recover the ?100,000 they had originally paid. They argued that they were entitled to reject the goods in the first place because there was a breach of Clause 7 and also because the goods where not of 'merchantable quality' in breach of s14(2) Sale of Goods Act 1893. The court held that the goods were of merchantable quality and, in respect of whether there had been a right to terminate under Clause 7, that the buyers were only entitled to damages. Clause 7 had not been expressly nominated as a condition and that it was most appropriately classified as an intermediate term. Lord Denning stated that small deviations from the contractual standard of quality should be resolved by a decrease in price and allowing the party to terminate was excessive. The breach of term would have to be "serious and substantial" to permit termination. In contrast to Maredelanto, the court said that courts should not be over ready to classify a term as a condition as "in principle, contracts are made to be performed and not to be avoided". The fact that the buyer later bought the goods through a third party most likely affected the court's opinion of how serious the breach was. However, it is important to note that the court does not examine the motive for why the party wants to cancel the contract. Thus, even though the parties in all the cases above were seeking to escape the contract because a market change made it less profitable to them, this was not taken into consideration.

The next significant House of Lords case, heard in 1981, moved the focus back towards certainty. In Bunge Corporation v Tradax [1981] 1 WLR 711 the time of shipment was at the buyer's option but the port of shipment was up to the sellers. Clause 7 provided that the buyers would give 15 days notice of "probable readiness of vessels". The last day the buyers could give notice was 12 June but they gave notice on 17 June. The sellers refused to accept it and claimed damages on the basis that the buyers had repudiated the contract by their breach. The buyers argued in response that Clause 7 was not a condition but an intermediate term and that the consequences of the breach did not effectively deprive the sellers of a substantial benefit of the contract. They argued that in order for it to be a condition every breach must substantially affect the benefit of the contract. There was no stipulation in the contract as to how the term should be treated. The House of Lords rejected this argument and held that Clause 7 was a condition meaning that the sellers were entitled to terminate it. The factors considered by the HL were:

•  The need for certainty in commercial transactions,

•  The importance of time in commerce, as the products may be bought one day and have to be sold the next,

•  Most businessmen would regard it as a term,

•  Damages for breach of Clause 7 would have been very difficult to assess,

•  HL rejected the submission that in order to be a condition the breach must deprive the innocent party of substantially the whole benefit

The proposition that Bunge stands for is that a term can be classified as a condition if required by business. When the courts are confronted with a term they embark on a balancing exercise, weighing all the factors considered above into the mix i.e. business need, certainty etc. It is also important to consider the language as the use of the word 'guarantee' may show that the parties intended the term to have a strong effect and, as such, a condition: The Seaflower [2001] 1 Lloyd's Rep 341. Factors which weigh against a term being a condition are how easily the term is breached, lack of express stipulation.

 

Termination Clauses

Rather than classify every term in the contract, commercial parties will sometimes include a termination clause which confers on either one or both parties an express right to terminate. Clause 11 in Schuler v Wickman is an example. These clauses can sometimes be drafted very widely but the court will decrease their scope. In Rice v Great Yarmouth Borough Council (The Times, 26 July 2000) the C entered two contracts with the D. The first for maintenance and management of the local sport's facilities and the second for maintenance of the local parks and gardens. C performed some duties late. The D served a number of notices on the C indicating that they had terminated the contract on the basis of Clause 23 which provided "if the contractor commits a breach of any of its obligations under the Contract . the Council may . terminate the Contractor's employment under the Contract by notice in writing having immediate effect." The Court of Appeal held that the D was not entitled to terminate and that the C could recover damages for wrongful termination. Clause 23 seemed "draconian" in that it applied the same result of termination to every term in the contract, regardless of how minor. This would defeat the commercial purpose of the contract. The court looked at the cumulative effects of C's breaches in deciding whether they substantially deprived D of the contract, thus permitting them to terminate. The most significant element of this decision is that the court held that the termination could only be invoked when the counterparty had committed a repudiatory breach i.e. a breach so serious that they can be considered to have effectively said "we no longer want to continue the contract". This is not to say that it is impossible for a termination clause to be invoked for lighter breaches but it would be necessary for the clause to be worded in a very clear manner i.e. "there is a right to terminate in event of any breach, regardless of whether it is repudiatory". If there is any doubt in the effect of the clause the courts will construe it in favour of certainty.

 

The Relevance of Good Faith

A breach of contract is not dependent upon finding that the breaching party is at fault. There is, however, a line of cases where the court has considered the good faith of the party in breach.

In Vaswani v Italian Motors [1996] 1 WLR 270 Privy Council, the D agreed to sell a Ferrari to the C. The contract provided for a deposit with the balance payable upon delivery. Condition 8 stated the deposit would be forfeited if, having been informed by the seller that the car was ready for delivery, the buyer didn't pay the balance within 7 days. Clauses 4 and 5 allowed the seller to raise the price according to some set criteria. The D told C that the car was ready for delivery and that the price had increased by an innocent mistake. C refused the higher price as it was not in accordance with the terms of the contract. After a month of no payment the seller rescinded the contract and the buyer sued for the deposit. There were two questions for the court: (1) were the sellers entitled to the make the price increase and (2) if they were not entitled, did they repudiate the contract by demanding payment. In respect of (1) the court held that they were not entitled to request the extra sum. In respect of (2) the court held that the sellers did not repudiate the contract. The court based their reasoning on the fact that the increased sum was an innocent mistake and that the buyer should have paid the amount he thought was required and then claimed repudiation if they did not accept this as full payment.

This judgment is arguably quite unsatisfactory as it puts buyers in a very difficult decision. If a buyer refuses to pay when faced by an erroneous but good faith demand, he may not be able to show that the seller has repudiated the contract. Instead he must tender the sum he believes is owed and then he is able to argue that the seller repudiated the contract when the full amount is not paid. This means that buyers would have to hand over their money not even knowing if the seller will accept it; if he seller does not they are faced with either paying the full amount or waiting months until the case comes up before a court. In addition to this, how can a buyer distinguish the situation where the seller has made an innocent mistake and where they have made a negligent mistake; unless they employ their own accountant to go over the seller's documentation this may be impossible to find out. The main point behind Vaswani is that the court can sometimes be reluctant to find that a party who has acted in good faith had repudiated the contract. This case sits badly with the general principle that fault is irrelevant to breach. A way of distinguishing Vaswani is to say that it applies to situations involving an anticipatory breach (i.e. where the party adopts one interpretation f the contract and says that it is correct) the courts will not readily infer a repudiation if the party who made the anticipatory belief was merely advancing a good faith interpretation of the contract. Good faith will not be used in cases where there has been an actual breach.

 

Losing the Right to Terminate

The innocent party can lose the right to terminate if they decide to affirm the contract. Affirmation generally has to be completely clear and obvious. The innocent party asking the breaching party to reconsider and perform their obligations will not necessarily be evidence of affirmation, though it is prudent for the innocent party to state that they are reserving their right to terminate: Yukong Line of Korea v Rendsberg Investments [1996] 1 Lloyd's rep 604. However, the innocent party must be cautious as an affirmation cannot be revoked once given, though if it is affirmed and the repudiation continues it may be possible to treat it as a fresh repudiation giving rise to a fresh right to terminate: Safehaven v Springbok (1998) 71 P & CR 59.

The innocent party has no 'middle road' in the sense that they must either choose termination or affirmation; they cannot suspend their performance until the breaching party has corrected the mistake. The innocent party does have a time period within which to consider what action to take: Stocznia Gdanska [2002] EWCA Civ 889. It is important to note that if the innocent party does nothing for too long they will be taken to have affirmed the contract.

 

Anticipatory Breach

Occasionally, before the time of performance, one party informs the other that they will not be able to carry out their obligations under the contract or that they will not be able to do so on time or in the manner contemplated. In Hochester v De la Tour (1853) 2 E & B 678, the D wrote to the C three weeks in advance telling them that their services as courier would no longer needed. The C started an action for damages before the date for performance had arrived and the claim succeeded. Thus the innocent party has no duty to wait for the time of performance to arrive.

It is important to note that not all anticipatory breaches are repudiatory breaches i.e. where the breaching party effectively says they cannot perform the contract. If the breach is repudiatory the innocent party has the decision whether to terminate or affirm; if it is not repudiatory then they can only seek damages.

Any clause which states that a party must pay money upon breach is invalid in English contract law as a penalty clause. The only exception is where the clause was a genuine pre-estimate of the loss. For example, a clause saying ?100 will be claimed if A breaches clause X is invalid unless the party can prove that the loss they would suffer as a result of the breach would be ?100.

Note: it is interesting that this term is only a warranty as it is one of the terms that cannot be excluded (as between seller and consumer) from a contract.

Events like wars or civil unrest are sometimes mentioned in force majeure clauses and can bring the contract to an end if it is impossible to perform the contract.