F4 Chapter 6: Breach of Contract and Remedies PDF

# Breach of Contract and Remedies ## Learning Objectives On completion of this chapter, you should be able to: | Syllabus Reference | Objective | |---|---| | B3(a) | Explain the ways in which a contract may be discharged | | B3(b) | Explain the meaning and effect of breach of contract, and the re...

# Breach of Contract and Remedies ## Learning Objectives On completion of this chapter, you should be able to: | Syllabus Reference | Objective | |---|---| | B3(a) | Explain the ways in which a contract may be discharged | | B3(b) | Explain the meaning and effect of breach of contract, and the remedies available in common law | | B3(c) | Explain the rules relating to the award of damage | | B3(d) | Analyse the equitable remedies for breach of contract | ## Exam Context Most contracts end with the intended result; however, many contracts end with one party breaching the terms of the deal. This chapter examines what breach of contract is and what the remedies are for the innocent party. Damages are monetary compensation for a loss. However, there are rules concerning what damages can be claimed for and how much should be awarded. Liquidated damages and penalty clauses are contractual terms that state how damages will be calculated so both parties agree to them in advance. You should understand when these will and will not be enforced by the court. There are also equitable remedies that can be claimed if damages are not suitable. You should understand all of them. In scenario questions you may be asked to explain whether or not one party can claim damages from another. Knowledge-based questions may require you to identify the circumstances where damages and other remedies would be available. ## 1 Discharge of Contract To discharge a contract means to bring it to an end. There are four ways in which a contract may be discharged. ### 1.1 Methods of Discharge Contracts can be discharged by: * **Agreement:** Where both parties agree to end the agreement and it is supported by consideration. * **Frustration:** Where performance of an obligation is impossible due to specific circumstances occurring after formation of the contract. * **Performance:** The most common method of discharge. The contractual obligations are exactly or substantially met (all contract terms are performed). * **Breach:** Where one party fails to meet its contractual obligations. It is this method of discharge that we will be focusing on in this chapter. ## 2 Breach of Contract A party is said to be in breach of contract where, without lawful excuse, they do not perform their contractual obligations precisely. ### 2.1 Lawful Reasons for Not Performing Contractual Obligations A person has a lawful excuse not to perform contractual obligations, if: * Performance is impossible, perhaps because of some unforeseeable event. * Performance was tendered but it was rejected. * One party made it impossible for the other to perform. * The contract has been discharged through frustration. * The parties have by agreement permitted non-performance. ### 2.2 Effect of Breach on Contractual Obligations Breach of contract gives rise to a secondary obligation to pay damages to the other party. However, the primary obligation to perform the contract's terms remains, unless the party in default has repudiated the contract. **Repudiation:** This can be defined as a breach of contract which entitles the injured party to end the contract if they so choose. Repudiation may be explicit or implicit. In other-words it can occur through an express statement by the defaulting party, or inferred through their actions. ### 2.3 Repudiatory Breach **Repudiatory breach:** This occurs where a party indicates, either by words or by conduct, that they do not intend to honour their contractual obligations or commits a breach of condition or commits a breach which has very serious consequences for the injured party. It usually occurs when performance is due. Repudiatory breach It does not automatically discharge the contract. It gives the injured party a choice. * They can elect to treat the contract as repudiated, recover damages and treat themselves as being discharged from their primary obligations under the contract. * They can elect to affirm the contract. ### 2.3.1 Types of Repudiatory Breach Repudiatory breach arises in the following circumstances. * **Refusal to perform (renunciation):** One party renounces their contractual obligations by showing that they have no intention of performing them. * **Failure to perform an entire obligation:** An entire obligation is said to be one where complete and precise performance of it is a precondition of the other party's performance. * **Incapacitation:** Where a party prevents themselves from performing their contractual obligations they are treated as if they refused to perform them. For instance, where A sells a thing to C even though they promised to sell it to B, they are in repudiatory breach of their contract with B. * **Breach of condition (a fundamental term of the contract):** * **Breach of an innominate term (a term of the contract, the effect of which cannot be determined until the contract is breached)** which has the effect of depriving the injured party of substantially the whole benefit of the contract. ### 2.3.2 Anticipatory Breach A party may break a condition of the contract merely by declaring in advance that they will not perform it, or by some other action which makes future performance impossible, Hochster v De La Tour 1853. The other party may treat this as anticipatory breach. | Option for Injured Party | Consequences | |---|---| | Treat the contract as discharged | Both parties are discharged from their primary obligations. | | Allow the contract to continue until there is an actual breach | The innocent party may continue with their preparations for performance and recover the agreed price for their services. Any claim for damages will be assessed on the basis of what the claimant has really lost, White & Carter (Councils) v McGregor 1961. | ### 2.3.3 Termination for Repudiatory Breach To terminate the contract due to repudiatory breach, the innocent party must notify the other of their decision. The innocent party: * Can claim damages from the defaulter * Can claim reasonable remuneration on a quantum meruit basis for any work they had commenced on the contract * Is not bound by their future or continuing contractual obligations, and cannot be sued on them * Need not accept nor pay for further performance * Can refuse to pay for partial or defective performance already received, unless the contract is severable * Can reclaim money paid to a defaulter if they can and do reject defective performance * Is not discharged from the contractual obligations which were due at the time of termination * Can reclaim money paid to a defaulter if they can and do reject defective performance * Is not discharged from the contractual obligations which were due at the time of termination ### 2.3.4 Affirmation After Repudiatory Breach If a person is aware of the other party's repudiatory breach and of their own right to terminate the contract as a result, but still decides to treat the contract as being in existence, they are said to have affirmed the contract. The contract remains fully in force. ## 3 Damages Damages are the main remedy in actions for breach of contract. **Damages:** A common law remedy intended to restore the party who has suffered loss to the same position they would have been in if the contract had been performed. The two tests applied to a claim for damages relate to remoteness of damage and measure of damages. In a claim for damages, two issues are considered: remoteness and measure of damages. ### 3.1 Remoteness of Damage The first issue is remoteness of damage. Here, the courts consider how far down the sequence of cause and effect the consequences of breach should be traced before they should be ignored. ### 3.1.1 The Rule in Hadley v Baxendale 1854 Under the rule in Hadley v Baxendale 1854 damages may only be awarded in respect of loss as follows. * The loss must arise naturally from the breach. * The loss must arise in a manner which the parties may reasonably be supposed to have contemplated, in making the contract, as the probable result of the breach of it. * A loss outside the natural course of events will only be compensated if the exceptional circumstances are within the defendant's knowledge when they made the contract. The defendant is liable only if they knew of the special circumstances from which the abnormal consequence of breach could arise, Victoria Laundry (Windsor) v Newman Industries 1949 and The Heron II 1969. If the type of loss caused is not too remote the defendant may be liable for serious consequences, H Parsons (Livestock) v Uttley Ingham 1978. ### 3.2 Measure of Damages The second issue is the measure of damages. Here the court must decide how much money to award in respect of the breach and its relevant consequences. ### 3.2.1 Expectation Interest As a general rule, the amount awarded as damages is what is needed to put the claimant in the position they would have achieved if the contract had been performed. This is sometimes referred to as protecting the expectation interest of the claimant. ### 3.2.2 Reliance Interest A claimant may alternatively seek to have their reliance interest protected; this refers to the position they would have been in had they not relied on the contract. This compensates for wasted expenditure. The onus is on the defendant to show that the expenditure would not have been recovered if the contract had been performed, C & P Haulage v Middleton 1983. If a contract is speculative, it may be unclear what profit might result, Anglia Television Ltd v Reed 1972. ### 3.2.3 Financial Loss The general principle of damages is to compensate for actual financial loss, Thompson Ltd v Robinson (Gunmakers) Ltd 1955 and Charter v Sullivan 1957. ### 3.2.4 Market Price Rule The measure of damages for breaches of contract for the sale of goods is usually made in relation to the market price of the goods. Where a seller fails to sell the goods, the buyer can go into the market and purchase equivalent goods instead. The seller would have to compensate the buyer for any additional cost the buyer incurred over the contract cost. The situation is reversed when the buyer fails to purchase the goods. The seller can sell the goods on the open market and recover any loss of income incurred by having to sell the goods at a lower price than what they contracted to. ### 3.2.5 Non-financial Loss In some cases, damages have been recovered for mental distress where that is the main result of the breach. It is uncertain how far the courts will develop this concept, Jarvis v Swans Tours 1973 and Alexander v Rolls Royce Motor Cars Ltd 1995. ### 3.2.6 Cost of Cure Where there has been a breach and the claimant is seeking to be put in the position they would have been in if the contract had been performed, by seeking a sum of money to 'cure' the defect which constituted the breach, they may be denied the cost of cure if it is wholly disproportionate to the breach, Ruxley Electronics and Construction Ltd v Forsyth 1995. ### 3.2.7 Mitigation of Loss In assessing the amount of damages it is assumed that the claimant will take any reasonable steps to reduce or mitigate their loss, Payzu Ltd v Saunders 1919. The burden of proof is on the defendant to show that the claimant failed to take a reasonable opportunity of mitigation. The injured party is not required to take discreditable or risky measures to reduce their loss since these are not 'reasonable', Pilkington v Wood 1953. ## 4 Liquidated Damages and Penalty Clauses Contracts may include terms relating to how damages should be calculated, or penalties due on breach of contract. These are known as liquidated damages and penalty clauses. Each is treated differently in law. ### 4.1 Liquidated Damages To avoid later complicated calculations of loss, or disputes over damages payable, the parties may include up-front in their contract a formula (liquidated damages) for determining the damages payable for breach, Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd 1915 and Azimut-Benetti SpA v Darrell Marcus Healey 2010. Liquidated damage clauses are considered onerous terms that must be highlighted in the contract. **Liquidated damages:** These can be defined as 'a fixed or ascertainable sum agreed by the parties at the time of contracting, payable in the event of a breach, for example, an amount payable per day for failure to complete a building. If they are a genuine attempt to pre-estimate the likely loss, the court will enforce payment.' ### 4.2 Penalty Clauses **Penalty clauses:** A contractual clause that provides that a specific sum of money is payable in the event of a breach of contract. A contractual term designed as a penalty clause to discourage breach is void and not enforceable, Ford Motor Co (England) Ltd v Armstrong 1915 and Bridge v Campbell Discount Co 1962. Relief from penalty clauses is an example of the influence of equity in the law of contract, and has most frequently been seen in consumer credit cases. ### 4.2.1 Penalty Clause Tests In Cavendish Square Holding BV v Talal El Makdessi 2015 a test of whether a clause is a penalty or not was developed. This test states that clauses creating obligation to pay a party more in damages than their actual losses will only be enforceable providing it is in proportion to the primary obligation under the contract. Another view is that if the sum does not protect the legitimate interest of the innocent party and is excessive, then it is a penalty clause and therefore unenforceable, ParkingEye Limited v Beavis 2015. **Activity 1: Liquidated damages** A court will never enforce a liquidated damages clause, as any attempt to discourage breach is void. * True * False ## 5 Other Common Law Remedies As well as damages, two other remedies for breach of contract are available under the common law. ### 5.1 Action for the Price If the breach of contract arises out of one party's failure to pay the contractually agreed price due under the contract, the creditor should bring a personal action against the debtor to recover that sum. ### 5.1.1 Considerations Action for the price is a fairly straightforward procedure but is subject to two specific limitations. * In a contract for the sale of goods, action for the price may only be brought if property has passed to the buyer, unless the price has been agreed to be payable on a specific date. * The injured party may recover an agreed sum due at the time of an anticipatory breach. However, sums which become due after the anticipatory breach may not be recovered unless they affirm the contract. ### 5.2 Quantum Meruit **Quantum meruit:** The phrase quantum meruit literally means 'how much it is worth'. It is a measure of the value of contractual work which has been performed. The aim of such an award is to restore the claimant to the position they would have been in if the contract had never been made, and is therefore known as a restitutory award. Quantum meruit is likely to be sought where one party has already performed part of their obligations and the other party then repudiates the contract, De Bernardy v Harding 1853. ### 5.2.1 Considerations In most cases, a quantum meruit claim is needed because the other party has unjustifiably prevented performance. Because it is restitutory, a quantum meruit award is usually for a smaller amount than an award of damages. However, where only nominal damages would be awarded (say because the claimant would not have been able to perform the contract anyway) a quantum meruit claim would still be available and would yield a higher amount. ## 6 Equitable Remedies In addition to the common law, the law of equity may provide the injured party with a remedy for breach of contract. They are not automatic remedies and will only be granted at the discretion of the court. ### 6.1 Specific Performance **Specific performance:** A court order for a party to perform an obligation. It is an equitable remedy awarded at the discretion of the court when damages would not be an adequate remedy. Its principal use is in contracts for the sale of land but may also be used to compel a sale of shares or debentures. It will never be used in the case of employment or other contracts involving personal services. ### 6.1.1 Considerations An order will be made for specific performance of a contract for the sale of land since the claimant may need the land for a particular purpose and would not be adequately compensated by damages for the loss of their bargain. The order will not be made if it would require performance over a period of time and the court could not ensure that the defendant did comply fully with the order. Therefore, specific performance is not ordered for contracts of employment or personal service nor, usually, for building contracts. ### 6.2 Injunction **Injunctions:** A discretionary court order and an equitable remedy, requiring the defendant to observe a negative restriction of a contract. ### 6.2.1 Considerations The scope of injunctions is limited to enforcement of contract terms which are in substance negative restraints. They would not be made merely to restrain the defendant from acts inconsistent with their positive obligations. An injunction may be made to enforce a contract of personal service for which an order of specific performance would be refused, Warner Bros Pictures Inc v Nelson 1937. ### 6.2.2 Mareva or 'Freezing' Injunctions The Mareva injunction is named from the case of Mareva Compania Naviera SA v International Bulkcarriers SA 1975, but has been given statutory effect. If the claimant can convince the court that they have a good case and that there is a danger of the defendant's assets being exported or dissipated, they may be awarded an injunction which restricts the defendant's dealing with the assets. ### 6.3 Rescission Strictly speaking the equitable right to rescind an agreement is not a remedy for breach of contract - it is a right which exists in certain circumstances, such as where a contract is voidable. Rescinding a contract means that it is cancelled or rejected and the parties are restored to their pre-contract condition. ### 6.3.1 Considerations Four conditions must be met for a contract to be rescinded. * It must be possible for each party to be returned to the pre-contract condition (restitutio in integrum). * An innocent third party who has acquired rights in the subject matter of the contract will prevent the original transaction being rescinded. * The right to rescission must be exercised within a reasonable time of it arising. * Where a person affirms a contract expressly or by conduct it may not then be rescinded. **Exam focus point** Questions may ask whether a particular remedy, say specific performance, is appropriate in any given situation.