Can I Terminate a Contract for Another Party's Breach?

Can I Terminate a Contract for Another  Party's Breach?

 

A contract is an agreement between two or more parties to create legal obligations for them to perform specific acts. Each party is legally bound to perform the specified duties such as rendering a payment or delivering goods, generally for mutual benefits. Sadly not all contracts go according to plan. “Do I have the right to terminate because of a breach of contract by another party?” is one of the most common questions asked under contract law. The short answer is – not all breach of contract gives the innocent party the right to terminate, one will need to look at whether the underlying term relates to a breach of warranty, condition or intermediate term.

 

 

Warranties, Conditions and Intermediate Terms

 

Contracts have differentiated between terms of a contract which the courts have described as "conditions" and those which the courts have described as "warranties". Note that "conditions" in this sense is different from a condition which has to be satisfied before a contract exists or a particular obligation becomes enforceable (see below). Warranty in this sense is also different from the way it is used to describe a representation in the contract or a pre-contractual representation (also see below), for example that the seller is the legal and beneficial owner of the goods to be sold.

 

The courts will generally look at the express terms of a contract in deciding whether a term is a warranty or a condition. For example, if the term is found in the warranties section of the contract. However, such determination is not always straightforward and there are numerous exceptions. These are known as “intermediate terms”. The best way for the parties who intend a breach of a particular term to give rise to a right to terminate is to make it absolutely clear in the contract.

 

Condition

If one party to a contract is in breach of a term which is a condition, this entitles the innocent party to choose not to perform his obligations under the contract and claim damages for loss as a result of the breach. This is known as “repudiation”, meaning that the contract is "discharged". The contract continues to exist but the unperformed obligations owed by the parties fall away. The obligations of the party in breach are to pay damages for the breach instead of to perform the contract.

 

Warranty

If a party to a contract is in breach of a term which is a warranty, the innocent party can only claim damages for breach of warranty, but cannot treat himself as discharged from the contract.

 

Intermediate Terms

Terms are sometimes described as "intermediate terms" (breach of these may, depending on the nature and consequences of the breach, entitle the innocent party to treat himself as discharged from the contract) and "fundamental" terms (which go to the heart of the contract, where the substance of the agreement is destroyed if the term is not met). The courts would look at the intention of the parties and the surrounding circumstances to ascertain whether a breach of the term would give rise to a right of termination.

 

 

Affirmation and Waiver

 

A breach that gives rise to a “right to terminate” the contract by the innocent party is known as a “repudiatory breach”. The innocent party can terminate or alternately proceed with the contract by “affirming” the contract expressly or impliedly. Once a contract has been affirmed and this has been communicated to the other party, the innocent party loses its “right to terminate” but can still claim damages for any loss suffered from the breach of contract.

 

Another way for the innocent party to continue the contract is to “waive” the breach. A waiver is given where one party voluntarily agrees to a request not to insist on the other party performing its obligations. Waivers can be given orally or in writing and can be given for repudiatory breaches of contract. Where a party promises or represents to the other party that it will not enforce its rights under the contract and the other party relied on this, the courts will stop the party from reasserting his rights. Once the breach is waived by the innocent party, it would lose its entitlement to terminate or claim damages resulting from the repudiatory breach.

 

As such, it is important for the innocent party not to do anything after a repudiatory breach that could be implied as affirming the contract or waiving the breach so as not to lose the right to termination. It is usual for the contract to include the following boilerplate clauses to avoid any inadvertent waiver:

  • This Agreement may be amended or modified, and any of the terms, covenants, representations, warranties or conditions hereof may be waived only by a written instrument executed by the parties hereto or, in the case of a waiver, by the party waiving compliance.
  • “Any waiver by either party of a breach of any provision of this Agreement shall not be considered as a waiver of any subsequent breach of the same or any other provision.”
  • “The rights to terminate this Agreement given by this Condition shall not prejudice any other right or remedy of either party in respect of the breach concerned (if any) or any other breach.”

Conditional Agreement 

 

The parties may agree on a conditional agreement in advance, which would allow the other party to withdraw or terminate the contract if the condition is not fulfilled. An agreement is conditional if an obligation depends on an event that is not certain to happen. The law is generally unclear as to whether, before the condition is satisfied, there is any right to withdraw from the contract, a duty not to prevent the condition being satisfied or a duty to use reasonable diligence to bring about the event in question. Where the condition is for the benefit of one party, normally the party can waive it. It is also possible for parties to agree that there will be no binding contract between them unless a condition is satisfied.

 

Anticipatory Breach

 

If a party expressly refused to perform a contract or implied by the party’s conduct that would lead a reasonable man to conclude that party has no intention of fulfilling its obligations relating to the contract, such declaration or inference of non-performance of obligations is known as “anticipatory breach”. The renunciation of the contract would give the innocent party a right to terminate the contract. The same test would apply as to whether the anticipatory breach relates to a condition or a warranty. Once the innocent party is aware of such a repudiatory breach, it should indicate whether it would like to terminate or affirm the contract as soon as practicable. Although there is no set timeframe for the innocent party to make the decision, it is important for the innocent party not to do anything to lose the termination right – for example, taking too long to respond, or inadvertently affirm the contract or waive the anticipatory breach by conduct.

 

 

Pre-Contract Representations

 

A party may also seek to terminate a contract by arguing that it has relied on a false statement made by the other party prior to the contract is entered into (a “representation”). The statement can be made fraudulently, negligently or innocently to cause the party to enter into the contract in reliance on the statement. The consequential effect on the contract and remedy would depend on whether the statement has become a term of the contract.

 

A representation can become a term of the contract and can then be a "condition", a "warranty" or an "intermediate term". In some cases, the courts will be prepared to treat a statement intended to have contractual effect as a separate contract or warranty, collateral to another transaction. The courts usually find that there is a collateral contract if one party refuses to enter a contract unless the other party gives him an assurance on a particular point. Consideration for the collateral contract is normally provided by entering into the main contract but a collateral contract may be actionable even if the main contract is unenforceable.

 

If the representation did induce the party to enter into the contract but has not become a term of the contract, the innocent party can still seek the common law remedy of “rescission” provided the representation was made fraudulently or relate to a fact. Rescission means to unwind the contract and bring the parties back to the original position, as if the contract has never existed in the first place. The remedy is different from terminating an existing contract and seeking damages for “loss of bargain” resulting from a repudiatory breach. The latter may entitle the innocent party to claim for the loss of opportunity from the breach of contract whereas rescission merely restores the parties back to their pre-contractual positions.

 

The innocent party can exercise its right to rescind the contract and reverse any performance of rights and obligations. Any unperformed rights and obligations fall away and the original positions of the parties prior to entry into the contract are restored. Again the innocent party will have to take care not to lose the “right to rescind” by making the election (i) in clear and unambiguous statement; (ii) without undue delay; and (iii) not have affirmed the contract by conduct.

 

Entire Agreement and Non-Reliance Clauses

 

To prevent any innocent or unintentional pre-contractual statement from being inadvertently becoming a pre-contractual representation, the parties would usually include an “Entire Agreementclause and / or a “Non-reliance” clause in the contract. 

 

An Entire Agreement clause usually include terms to the effect of: “This Agreement sets out the entire agreement and understanding between the parties with respect to the subject matter of it” - to prevent the parties from adducing extrinsic evidence to affect the document's content.

 

A Non-reliance clause is more common for financial contracts. The parties acknowledge that they have made their own independent decisions to enter into the contract and have not relied on representations made outside of the contract. However, this is subject to various exceptions, including to show the contract is not valid or binding. 

 

 

Exemption Clause

 

Another common question is the converse of our initial question – “Does my counterparty has the right to terminate as a result of my breach of contract?” Service providers often rely on exemptions clauses in the contract to avoid this scenario. Exemption clauses are clauses by which one party seeks to exclude or restrict liability for breach of the contract or for a tort connected with the contract. Generally, they must be clearly expressed and unambiguous or they may be ineffective. Doubts and ambiguities will be resolved against the party seeking to rely on the clause.

 

Whether an exclusion clause protects a party, even if there is a breach of a fundamental term, is a question of construction of the contract. The extent to which one party can exclude or restrict liability is affected by various local statutory provisions. Local legislations may control contract terms which restrict or exclude liability for negligence, breach of certain terms implied by statute or common law in contracts of sale or goods, hire purchase, and other contracts for the supply of goods.

 

Force Majeure Clause

 

Parties would also try to cover breach of contract beyond the parties’ control. A force majeure clause is a provision that allows one or more parties not to perform the contract in whole or part or to delay or suspend performance if a specified event beyond his control occurs. Technically, failure by a party to perform its contractual obligations under a force majeure clause would not be a breach of contract. However, most force majeure clauses would allow for termination of contract should the force majeure events persist for a long period of time. Examples of force majeure events include: “war, riot, national emergency, flood, hurricane, typhoon, earthquake, strike or lockout”. Force majeure is not a term of art in Common law and is wider than Acts of God.

 

Time is of the Essence Clause

 

A provision in a contract as to time (e.g. that the contract must be completed at a particular time) is not treated as being "of the essence" unless:

  • this is either expressly agreed in the contract; or
  • by necessary implication this was intended by the parties; or
  • where one party has not performed the obligation, the other gives notice that the contact must be performed within a reasonable period. 

If time is originally agreed to be of the essence, failure by the relevant party to perform at the relevant time allows the other party to end the contract and claim damages (as though the obligation were a "condition"). This right to terminate may be lost if the innocent party affirms the contract or waives the right to terminate. If time is made of the essence by giving notice, the innocent party cannot turn the relevant obligation into a "condition". As a result, one can only terminate the contract if the failure to comply with the notice goes to the root of the contract.

 

 

Do you really want to exercise your right to termination / rescission?

 

Assume if you have a right to terminate or rescind the contract as a result of the breach of condition or fraudulent representation, you should consider whether it is more beneficial to end the contract or continue with the relationship and claim for damages. There are four main alternatives for you to proceed:

  1. If you are still in a good relationship with the party in breach, you could consider negotiating an amendment to the existing contract or a contractual termination taking into account of the damages from the breach with that party.
  2. If you would like to continue with the contract, you could send a notice of affirmation to the party in breach but reserve the right to claim damages for the breach.

  3. If you would like to rescind the contract, you should ensure that you have relied on a pre-contractual representation that is either fraudulent or factually incorrect when entering into the contract. If there are entire agreement or non-reliance clauses, you should check with a lawyer to ensure that they are not effective in relation to your rescission.

  4. If you would like to terminate the contract and claim for damages, you should ensure that the breach is in relation to a condition or a fundamental intermediate term that goes to the root of the contract. You may also consider terminating under the common law basis for repudiatory breach instead of a mere breach of contract. This would allow you to also claim for the “loss of bargain” in addition to contractual damages. This is a difficult legal area and you may wish to consult a lawyer before doing so.

It is important to note the following when making the above election:

  1. Not to take too long in making the decision to terminate or rescind or you could lose the right to do so.

  2. Not to carry out in a “business as usual” way or other conducts which could be seen as affirming the contract or waiving the breach.

  3. Qualify any future correspondence with the party in breach with a reservation of rights language.

  4. Once the decision to terminate, rescind or continue the contract is communicated to the party in breach, it is final and cannot be changed. If necessary, consult a lawyer before doing so.

 

Please note that this is just a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your local lawyer.

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