When one party breaches a contract the consequences can be severe. If an agreement involving large sums of money has been unlawfully brought to an end by one of the parties, the other party can turn to the law to recover the full range of their losses.
This article examines what happens when a party takes this course of action, in particular the circumstances under which the ‘innocent’ party can terminate the contract following a breach, the damages that can be claimed and how financial issues are resolved.
When is a Contract Breached?
Using literal terms, a contract is breached whenever one party departs, however slightly, from the exact wording of the contract. For example, if a contract for the sale of goods provides for delivery to take place no later than 5.15 and the delivery is made at 5.16 there will be a breach of the contract.
Despite this technical interpretation, the parties will only look to the law of contract when a more serious failure takes place. In a contract there are two types of terms: conditions and warranties. A condition is a term of such importance that it will entitle the ‘innocent’ party to claim the contract has finished if the condition is breached. A warranty, by contrast, only entitles the innocent party to claim damages if it is breached.
While trivial infringements such as the example above will always entitle the innocent party to sue for damages (which will be nominal in this scenario), only important violations (known as ‘repudiatory breaches’) will allow the innocent party to terminate the agreement or claim significant damages.
When Can A Contract Be Terminated?
As explained above, if a condition of the contract is broken, the innocent party has the option of terminating the remainder of the agreement. For example, if a contract states that A must supply B with five instalments of bananas and instalment two actually contains apples, B will have a choice as to whether to continue with the contract or hold it as terminated.
If B decides to continue with the contract, A will have the opportunity of supplying an additional instalment of bananas in order to compensate for the defective second instalment. B will then be able to claim any consequential losses from the second instalment in the future. By contrast, if B decides to terminate the agreement, A will not have to supply any more bananas and B will simply bring a claim for damages suffered in the past.
It is worth repeating that only breaches of conditions will put the innocent party in a position where this choice can be made. Trivial breaches will only create an action for damages. Whether or not a term is a condition will depend either on the law – certain terms, e.g. the requirement for goods to be of satisfactory quality, are implied into every contract and automatically allow the innocent party to terminate if breached – or the circumstances of the contract. In a contract where time is critically important, for example, it is much more likely for late delivery to be considered a breach of condition.
How Are Damages Calculated?
When a claim is brought for breach of contract, the remedy the innocent party is seeking is usually monetary compensation, known in the law as ‘damages’. Damages are intended to compensate for the claimant’s losses: the money he would have gained if the contract was performed according to the terms.
The losses that can be claimed, however, cannot be too remote from the consequences that the parties thought might happen when the contract was formed. In other words, the losses must have been ‘in the reasonable contemplation of the parties’ in order to be recoverable.
In addition, the claimant is expected to ‘mitigate his losses’. This means that after the contract is breached, the claimant must take steps to avoid suffering more loss than is necessary. It is not possible, for obvious reasons, for a claimant to stand idly by and endure further damages so he can claim more money from the defendant later on. Examples of mitigating losses include taking out insurance or attempting to sell products rendered defective as a result of the breach.
The main question in calculating damages is whether the ‘expectation’ or ‘reliance’ basis is used. The expectation loss method aims to put the claimant in the position he would have been in had the contract been performed. There are two ways of assessing damages under the expectation loss method:
- Cost of Cure – where the defendant was supposed to have carried out a certain act, e.g. delivering goods, the cost of cure will be the difference between the market price and the contract price of the goods. This is the measure that is used in most cases.
- Diminution in Value – where there is a contract for services relating to property, and the value of the property diminishes as a result of the breach, the claimant can recover the lost value.
Whether the cost of cure or diminution in value methods are adopted will largely depend on common sense and the nature of the breach in each case. The reliance measure, by contrast, is less common and simply seeks to compensate the claimant for money spent on the performance of a contract.
Can Damages Be Claimed For Emotional Loss?
The short answer to this question is not really. The general rule is that damages can only be claimed for the financial losses the claimant has suffered; any emotional or incalculable losses cannot be recovered.
Exceptions to this rule have, however, been developed in recent years. It is now possible to claim damages arising from loss of enjoyment when a key aspect of the contract was happiness. The main example of such an agreement is in the context of holidays or travel arrangements.
The uncertainty inherent in seeking financial compensation for emotional disappointment is reflected in the fact that any damages awarded in this category should always be modest and restrained. The maximum sum of money that can possibly be claimed is £10,000.
Damages for Misrepresentation
A party can bring a claim for misrepresentation if they are induced to enter into a contract on the basis of false information. The representation must have been a clear statement of fact and reliance on this statement must have been reasonable at the time. False information can be supplied innocently, negligently or fraudulently.
In common with breach of contract cases, claimants for misrepresentation can seek to rescind the contract. Rescission will place both parties in exactly the same position they were in before the contract had been created. This is only possible, however, if the subject-matter of the contract still exists.
Damages for misrepresentation are assessed on the same basis whether the information was provided negligently or fraudulently. Claimants can be entitled to the full range of consequential losses they have suffered as a result of the false statement. As a result if one party lost the ability to perform another contract as a result of defective machinery following misrepresentation, they may be able to sue for the value of the lost contract.
Summary and Key Points
- When a contract is breached the innocent party may be able to terminate the contract and/or claim damages.
- Termination is available if the guilty party has breached a condition of the contract. The effect of this is to free both parties from future obligations. The innocent party may still claim damages.
- When awarding damages, the court will aim to put the parties in the position they would have been in but for the breach of contract.
- Damages will usually be assessed on the basis of what was reasonably foreseeable and necessary in order to compensate for the cost of cure or diminution in value.
- Damages cannot ordinarily be claimed for loss of happiness. The exception to this is in leisure or holiday contracts.
In addition, further damages can be claimed for misrepresentation.