Breach of Contract: Definition, Example and Related Terms
What is a Breach of Contract ?
For example, imagine that you run a lemonade stand, and you make a deal with your friend to buy sugar from them. You both agree that they will deliver the sugar to you every Monday. But then, one Monday, they don't bring you the sugar. That's a breach of contract.
In business, this can happen in many ways. Maybe a company agrees to deliver 100 computers by a certain date, but they only deliver 75. Or maybe a company promises to pay for a service, but then they don't pay. When this happens, the side that did not keep their promise can be taken to court and made to pay for the damage they caused. This is important in business because contracts help make sure everyone does what they agreed to do.
Consequences for Breach of Contract
The consquences of a Breach of Contract can range from mild to severe, and may include:
- Damages - Financial compensation is the most common remedy. This may cover direct losses and, in some cases, additional damages for consequential losses.
- Specific Performance - The court may order the breaching party to fulfill their part of the agreement
- Cancellation and Restitution - The non-breaching party may be allowed to cancel the contract, with both parties returning any benefits they received.
- Reformation - The contract can be rewritten to better reflect the intentions of the parties.
Different types of contract Breaches
There are a number of different types of contract breaches you should be aware of:
- Material Breach A material breach (also known as a fundamental breach) is a violation of the contract that strikes at the heart of the agreement, significantly harming the injured party and their ability to receive the benefits of the contract. The legal definition may vary slightly by jurisdiction, but generally, a breach is considered material when it involves
(a) failure to perform a task that is central to the contract's purpose
(b) A breach that results in substantial damages to the non-breaching party
(c) A breach where the outcome is such that the non-breaching party does not receive what they were explicitly or implicitly promised in the terms of the contract
See our Material Breach definition for more information.
- Immaterial Breach An immaterial breach, sometimes referred to as a minor breach, is a deviation from the terms of the contract that does not significantly affect the contract's overall purpose and outcome. The non-breaching party generally cannot terminate the contract based on an immaterial breach, but they may be able to seek compensation for any losses incurred. An immaterial breach:
(a) Does not fundamentally destroy the value of the contract for the non-breaching party. (b) Is often more technical or administrative in nature. (c) Might involve a delay or minor defect that does not thwart the contract's main intent.
Good examples of immaterial breaches can be minor delays on delivery, minor defects on a project, a reporting error or very low-stakes finanical discrepancies like an invoice with a few dollars or euros difference.
See our Immaterial Breach definition for more information.
- Anticipatory Breach Occurs when one party expressly indicates that they will not perform their contractual obligations. The other party may immediately claim a breach before the actual time of performance.
How can a contract be structured to mitigate the risks of a breach?
- Clear Terms and Conditions The contract should clearly define the obligations, rights, and responsibilities of all parties involved. It should detail the scope of work, delivery, timelines, payment schedules, quality standards and any other expectations.
- Risk Allocation Clauses Include clauses that address potential risks such as force majeure, which can protect parties from liabilities caused by unforseen circumstances.
- Performance Incentives and Penalties Implementing incentives for performance above and beyond the contract terms, as well as penalties for non-compliance or delays, can motivate adherence to the contract.
- Dispute Resolution Provisions Clearly outline the steps to follow in the event of a dispute, including any requirements for notices and the timeframes for responding to allegations of a breach.
- Termination Clauses Define the conditions under which the contract can be terminated by either party and what compensation, if any, is due upon termination.
- Limitation of Liability Limit the amount one party has to pay the other under the contract, which can include caps on liability and exclusions for certain types of damages.
- Insurance Requirements Require parties to carry insurance policies that can provide sufficient financial protection in the case of a breach.
What other Preventative Measures can be put in place to help avoid breaches of contract?
- Scheduled Assessments Establishing regular intervals (monthly, quarterly etc.) for evaluating the performance of all parties involved.
- Performance Metrics Using clear, quantifiable metrics to assess whether parties are upholding their end of the contract.
- Corrective Actions Identifying any deviations from the terms early and taking corrective action before they escalate in to material breaches.
- Clear Contract Terms Ensuring that the contract clearly defines the obligations, deliverables and timelines for all parties.
- Regular Audits Conducting internal reviews of processes and performances related to contracts as well as 3rd party auidits.
- Incentives for Performance Establishig bonuses or other incentives for early or exemplary performance.
- Project & Contract Management software Assigning and tracking tasks to ensure that deliverables are completed on schedule. Milestone tracking to monitor key dates and deadlines.
What are the steps to take when a breach of contract is identified?
- Review the Contract Examine the contract to understand the specific terms and verify if a breach has occurred.
- Document the Breach Record all instances of non-compliance, including dates, actions or inactions, and how these constitute a breach of contract.
- Notification Notify the breaching party in writing of the breach, referencing the specific contract clauses that have been violated. Allow the breaching party the opportunity to cure the breach if applicable.
- Attempt to Resolve Engage with the breaching party to seek an informal resolution, possibly through negotiation or mediation, to maintain a business relationship.
- Enforce Rights If informal resolution fails, enforce your rights under the contract, which may include seeking damages, specific performance, or other remedies as outlined in the contract.
- Legal Action As a last resort, consider taking legal action. This would typically involve lawyers and, eventually, court proceedings unless resolved through alternative dispute resolution methods.
How can alternative dispute resolution (ADR) be used to resolve contract dispurtes outside of court?
- Negotiation The parties come together to discuss the issue and find a mutually acceptable solution without outside assistance.
- Mediation A neutral third-party mediator assists the parties in reaching a voluntary, negotiated resolution. The mediator does not decide the case but helps to facilitate a discussion that can lead to a settlement.
- Arbitration An arbitrator (or a panel) hears the evidence and arguments of both parties and makes a decision, which can be binding or non-binding based on the terms of the arbitration agreement.
- Conciliation Similar to mediation, but the conciliator may actively advise the parties and suggest solutions to the dispute.
- Mini-Trials A mini-trial allows both parties to present their case in a simplified form before senior management from both sides, often with a neutral advisor present. After the mini-trial, management attempts to negotiate a settlement based on what they have heard.
Scenario Description A company promises to deliver 100 computers by a certain date but only delivers 75. This is a breach of contract because the company did not do what they promised. They agreed to deliver 100 computers but didn't. The company that was supposed to receive the computers can now take them to court and ask for compensation for the 25 computers they didn't receive. A business agrees to pay for a service but then doesn't pay. This is also a breach of contract. The business that was supposed to get paid can take the other business to court and ask for the money they are owed. They could also ask for additional money to cover the cost of taking them to court.