30 Jan 2023
1 Feb 2020
A contract is a legally enforceable agreement between two or more parties. Upon entering the contract, parties are bound under the terms of the contract and must fulfil the obligations specified. But what do you do if you have been performing your side of the contract diligently but your counter-party has not lived up to expectations? Do you get the right to terminate the contract based on a breach of obligations under the agreement? The answer is yes - but it depends on whether the term is a condition or a warranty. This guide will help you distinguish between conditions and warranties and discuss the range of factors that enable the termination of a contract.
As we briefly mentioned, a contract is an agreement between two or more parties that creates legal obligations for them to perform specific acts. Parties are legally bound to perform the specified duties - this might include rendering a payment or delivering goods, done for mutual benefits.
Unfortunately, not all contracts go according to plan, and breach of contract by one or more parties is not uncommon.
The short answer is that not all breaches of contract give the injured party grounds for termination. One will need to look at whether the underlying term relates to a breach of warranty, condition, or intermediate-term.
A breach of a condition will give rise to the right of termination of the contract, whereas a breach of a warranty will not. Whether a breach of an innominate/intermediate-term gives rise to a right of termination depends on whether it is a ‘fundamental term’ that goes to the heart of the contract. If it does go to the heart of the contract, there is a right to termination.
Next, one should look at whether a termination clause has been included in the original contract, and determine whether this clause gives the innocent party a right to terminate because of the breach at issue.
The courts will generally look at the express terms of a contract in deciding whether a term is a warranty or a condition. This might include, for example, seeing if the term is found in the warranties section of the contract.
However, this kind of determination is not always straightforward and there are numerous exceptions. These are known as "innominate terms" or “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 clear in the contract that the term is a condition.
A condition is a fundamental term that is central to the agreement. It goes to the root of the contract. If one party to a contract is in breach of a term which is a condition, this entitles the innocent party to immediately choose not to perform his obligations under the contract and claim damages for loss as a result of the breach.
Note that "conditions" in this sense are different from a condition that has to be satisfied before a contract exists or a particular obligation becomes enforceable.
A warranty is a minor term that is not essential for the performance and functioning of the contract. If a party to a contract is in breach of a term which is a warranty, the non-breaching party can only claim damages for breach of warranty, but cannot treat himself as discharged from 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 (also see below), for example, that the seller is the legal and beneficial owner of the goods to be sold.
An innominate term is an intermediate-term that is neither major nor minor enough to be categorised as a "condition" or a "warranty". Breach of an intermediate-term may, depending on the nature and consequences of the breach, entitle the innocent party to treat himself as discharged from the contract.
The test is whether the term goes to the heart of the contract, that is, where the substance of the agreement would be destroyed if the term is not met.
The courts typically 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.
A breach that gives rise to a “right to terminate” the contract by the innocent party is known as a “repudiatory breach”. You should note that just because there exists a right to termination does not mean that the non-breaching party has to enforce it if they do not wish to.
This exercise of the right of termination of the contract is known as “repudiation”; it results in a contract that is "discharged". This means that 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 monetary damages for the breach instead of performing the contract.
Instead of terminating a contract resulting from a repudiatory breach, the non-breaching party can 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 repudiatory 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. When 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.
It is important for the innocent party to not do anything after a repudiatory breach that could be implied as affirming the contract or waiving the breach, to ensure they do not 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.”
For other common reservation clauses, you can see them here.
Let’s say that a counter-party has committed a repudiatory breach of contract, and you are electing to terminate the contract. What should you do next? How should you go about actually terminating the contract?
You should serve a notice on the counter-party stating that you are terminating the contract due to a breach of contract. In this notice, you should clearly specify which clause has been breached.
We have created a comprehensive template notice of termination for breach of contract. You can find it here.
Another way to stipulate the right of termination of a contract is through a conditional agreement. The parties can agree on a conditional agreement in advance, which would allow the other party to withdraw or terminate the contract if the condition stipulated is not fulfilled.
An agreement is conditional if future obligations depend on an event that may or may not 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 from 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.
Even in the absence of an actual repudiatory breach, it is still possible for a party to terminate in anticipation of a breach of a condition or a contractual term that goes to the heart of the contract by the other party.
If a party has expressly refused to perform a contract or it is implied by the party’s conduct (that would lead a reasonable man to conclude) that the party has no intention of fulfilling its obligations relating to the contract, this can constitute an anticipatory breach. This 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 their legal rights to terminate – for example, taking too long to respond, or inadvertently affirming the contract or waiving the anticipatory breach by conduct.
A party may also seek to terminate a contract by arguing that they relied on a false statement made by the other party before entering the contract (a “representation”). The statement can be made fraudulently, negligently or innocently, and has to have induced 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 that becomes a term of the contract would just be categorized as either a "condition", a "warranty" or an "intermediate-term".
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 related to a fact.
Rescission is a remedy by which a contract is unwound and parties are brought back to their original positions as if the contract never existed in the first place. This remedy differs from terminating an existing contract and seeking damages for “loss of bargain” resulting from a repudiatory breach. The latter entitles the innocent party to claim for the loss of opportunity from the breach of the contract whereas rescission merely restores the parties 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 before entering 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 an unambiguous statement; (ii) without undue delay, and (iii) not have affirmed the contract by conduct.
In some cases, 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 assurance on a particular point. Consideration for the collateral contract is provided by entering into the main contract but a collateral contract may be actionable even if the main contract is unenforceable.
To prevent an innocent or unintentional pre-contractual statement from being inadvertently becoming a pre-contractual representation, parties usually include an “Entire Agreement” clause and/or a “Non-reliance” clause in the contract.
An Entire Agreement clause usually includes 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 in financial contracts. Essentially, 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. This is nevertheless subject to various exceptions, including that to show the contract is not valid or binding.
Another common question is the converse of our initial question – “Does my counter-party have the right to terminate as a result of my breach of contract?” Exemptions clauses in contracts are often heavily relied on to avoid this scenario.
An exemption clause is a clause in which one party seeks to exclude or restrict liability for breach of the contract or a tort connected with the contract. Exactly what the party seeks to exempt must be clearly expressed and unambiguous or it risks being 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 the 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. They may exclude liability for negligence, breach of certain terms implied by statute or common law in contracts of sale of goods, hire purchase, and other contracts for the supply of goods.
If you want a better idea of what exemption clauses look like, you can refer to our customizable template here.
Sometimes a breach of contract is involuntary and beyond the control of the parties to the agreement. For example, a party may be unable to perform a contract due to an emergency not arising from the fault of the party. In these circumstances, parties can cover the breach of contract through a force majeure clause. Force majeure is not a term of art in Common law and is wider than Acts of God.
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/suspend performance if a specified event beyond their control occurs. Examples of force majeure events include accidents, fires, explosions, failure of equipment or machinery, delays in transportation, war, civil commotions, riots, sabotage, epidemic, change in applicable legislation and regulations, and interruptions by government.
Failure by a party to perform contractual obligations under a force majeure clause does not amount to a breach of contract. Most force majeure clauses allow for termination of the contract even if the force majeure events persist for a long period
For more examples of Force Majeure clauses, you can see our customizable template here: https://docpro.com/doc1647/general-boilerplate-clause-term-force-majeure.
A contract can be terminated if not completed in time only if it has been included as a condition of the contract. This is done through a "time is of the essence" clause to expressly stipulate the intention of the parties. There is a general presumption by the court that minor delay did not cause material harm and would not give rise to a right of termination. "Time is of the essence" is common in property and financial transactions, where the transactions are terminated with payments forfeited if certain deadlines are not met.
Contracting parties often include the provision, ‘time is of the essence'.
"Time is of the essence" is a contractual clause that indicates that the contract must be completed by a specified time. By specifying time as being "of the essence", the need for timely completion will be regarded as an essential condition to the contract.
In general, a term in a contract that pertains to time will not be treated as being "of the essence" unless:
This is either expressly agreed upon 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 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"). Again, you should note that the right to terminate will 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". In these circumstances, one can only terminate the contract if the failure to comply with the notice goes to the root of the contract.
Assuming you have a right to terminate or rescind the contract as a result of the breach of condition or fraudulent representation - you should be considering whether it is more beneficial to end the contract or continue the relationship to claim damages. Here are the four main ways for you to proceed with:
It is important to note the following when making the above election:
Do not undertake the process in a “business as usual” way (or any other conduct) as this could be interpreted by the other party as an affirmation contract/waive of a breach.
Qualify any future correspondence with the party in breach using a reservation of rights language.
Once the decision to terminate, rescind or continue the contract has been communicated to the party in breach, you should remember that it is final and cannot be changed. As such, we would advise that you consult a lawyer before doing so to ensure everything is correct.
A termination clause is a written provision in a contract that outlines the circumstances in which a contract can be terminated.
Common circumstances termination clauses typically cover include:
Termination clauses are often included in contracts for two reasons: clarity and breadth.
First off, they help increase clarity. Termination clauses are often included in contracts as they enable parties to clarify when they want a right to terminate the contract to arise and under what circumstances.
It is often difficult to identify whether a breach of contract is repudiatory, making it hard to determine whether parties have a right to terminate the contract under common law. Termination clauses on the other hand enable parties to expressly outline the circumstances in which a right to terminate will arise, leaving no doubt amongst the parties.
Secondly, termination clauses are often included in contracts to give the parties a right to terminate in a broader range of circumstances than the common law provides and recognises.
For instance, it is common for termination clauses to allow a party to terminate an agreement due to the insolvency or threatened insolvency of a counter-party. No such entitlement arises under common law.
No. Placing a termination clause in a contract does not exclude your common law right to terminate an agreement.
A termination clause can only exclude a common law right to termination if it is explicitly and clearly stated to have this effect.
Here is a sample, exemplar termination clause:
Either party may terminate this Agreement if: (i) the other party is in material breach of this Agreement and fails to cure that breach within thirty days after receipt of written notice; (ii) the other party ceases its business operations or becomes subject to insolvency proceedings and the proceedings are not dismissed within ninety days;
Let’s say that a counter-party is nearing insolvency, and you want to terminate the contract through a termination clause. What are your next steps? How should you go about actually terminating the contract?
Termination does not happen automatically. As, the innocent party, you should first take positive action in the form of giving notice to the other party of the innocent party’s decision to terminate the contract.
The notice should comply with any contractual provisions governing notice and should comply with any instructions for notice stated in the termination clause itself.
The notice should clearly refer to the termination clause and state that termination is on the grounds of the termination clause.
We have created a customizable template notice of termination for breach of contract. You can find it here.
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 lawyer.
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