HOW MUCH DOES CONTRACT BREACHES COST BUSINESSES AND HOW DO COMPANY MINIMIZE THEIR LOSSES?

INTRODUCTION

Before any big or small companies think of initiating their business, how small or big is that opposite party with whom the company is thinking of initiating their business? What they actually rely upon is an agreement that is enforceable by law, which we call in legal terms a ‘contract.’ Contracts formulate the backbone of commercial relationships. They provide predictability, trust, and enforceability, elements indispensable for the smooth functioning of business. Well, it’s not ascertained that even a sophisticated legal document drafted by a legal expert outlining the terms and conditions of that contract alongside the roles and responsibilities of parties who have entered into such an agreement would go all the way rightly till the terms are executed for which the agreement was entered into by both the parties. When

TYPES OF BREACHES

In the Indian Contract Act, 1872, however, it is not expressly defined as to what is “breach of contract,” but what is typically comprehended is “failure to perform a contractual obligation without lawful excuse.” The breach may occur by non-participation, defective performance, or anticipatory repudiation.

Before moving further, some forms of breaches have been identified, which are properly explained as provided as follows:

1. ACTUAL BREACH: It occurs when one party fails to perform their obligation on the due date or during performance, when it mattered the most.

2. ANTICIPATORY BREACH (§39 ICA, 1872): when a party refuses to perform or disables himself from performing the promise in its entirety before the due date, the other party may either terminate the contract immediately or wait till the due date. An example of this would be ‘if A agrees to deliver 500 units of material to B on 1st December but informs B on 1st November that he will not deliver the same, it constitutes the anticipatory breach of contract.’

In the case of Hochster v. De La Tour, the plaintiff, a courier, was informed on the very first day that his services were not required, which stands as anticipatory breach, entitling him to sue immediately.

In the case of Frost v. Knight, the defendant promised marriage after his father's death but repudiated the contract earlier. The plaintiff was allowed to sue before the father’s death.

3. MATERIAL BREACH: A material breach is the serious violation that goes to the root of the contract, defeating its primary purpose.

In the case of Poussard v. Spiers & Pond, failure of an opera singer to perform at singing night was held to be a material breach that deeply affected the roots of the contract.

4. MINOR BREACH: A minor breach occurs when the contract has substantially been performed; however, there are some minor defects or delays not central to the purpose of the agreement.

In the case of Boone v. Eyre, the court held that minor breaches do not defeat the contract purpose but only entitle the aggrieved party to fair and proper damages, not rescission.

COMMON REASONS BEHIND BREACH OF CONTRACTS

1. NON-PERFORMANCE OR DELAY IN PERFORMANCE: the most common type of breach when the party that ought to perform such a role has failed to fulfill such an obligation, which has caused such a breach within the stipulated time limit.

2. DEFECTIVE OR INCOMPLETE PERFORMANCE: when the party that ought to have performed such obligations as outlined in the agreement has not performed the same with the same level of quality, quantity, or specifications that were outlined & expected from the execution of such agreement.

3. FINANCIAL INABILITY OR INSOLVENCY: Businesses often breach contracts due to lack of funds, bankruptcy, or cash flow issues. Now what the innocent party is supposed to do is to file for claims during the insolvency proceedings to recover the losses as incurred.

4. MISREPRESENTATION OR FRAUDULENT CONTRACT: when one party enters into an agreement with an intent to deceive or having a misrepresented identity.

5. FAILURE TO COMMUNICATE OR MISUNDERSTANDING OF TERMS: It is all likely to happen due to ambiguity, poor contract drafting, or lack of clarity in contractual terms, which often leads to big loopholes in the drafting and gives the other party the ability to misuse that loophole in order to do a favored interpretation on their behalf to exploit the benefit.

6. EXTERNAL FACTORS SUCH AS ‘FORCE MAJEURE CLAUSE’: such a clause involves circumstances relating to natural disasters, pandemics, wars, or government restrictions that may make performance impossible. For example, a very recent replica of the same would be the ‘Covid-19’ lockdown, which caused businesses to default on supply or service contracts. So, if the same is being covered under the ‘force majeure clause,’ parties will be entitled to excuse themselves from the liability.

7. CHANGE IN LAW OR REGULATORY RESTRICTIONS: New govt. policies and changes in regulations make the contract impractical and illegal, which causes businesses unexpected losses.

8. NEGLIGENCE OR LACK OF DUE DILIGENCE: It's not that if the other party has caused a breach, the non-breaching party will keep looking on and watch for the entire business to collapse and claim for damages; rather, it's taking reasonable steps to ensure that losses could be minimized as much as possible.

9. UNANTICIPATED BUSINESS CIRCUMSTANCES: Sometimes market collapse, shortage of material, or supply chain disruption occurs, which can prevent contract performance.

10. INTENTIONAL BREACH FOR GAINING ECONOMIC ADVANTAGES: sometimes a party may deliberately breach the terms of the contract if performing the contract will be less profitable compared to alternative opportunities. Such deliberative acts even invite compensatory or punitive consequences in certain jurisdictions.

HOW COMPANIES MITIGATE THEIR RISK AFTER CONTRACT IS BREACHED

1. IMMEDIATE ASSESSMENT AND DAMAGE CONTROL: After the contract has been breached, the first and foremost step to be taken into consideration is to determine to what extent the breach of contract has affected the business of the company, typically by identifying the nature of the breach that has been caused and whether the breach caused is a minor breach (non-material) or a fundamental breach (material). Therefore, it’s the responsibility of the legal and management team of the company so appointed to evaluate which contractual obligations have been vitiated and who is the breaching party of that agreement, what losses the company has faced, and whether or not the breach can still be remedied.

2. ADR METHODOLOGIES: Most of the companies after a breach of contract has been made prefer going to pursue the remedies available within the ambit of the ADR clause present in their agreement rather than going for an endless litigation battle, as ADR is the most effective way of reaching a mutual settlement, helps in keeping the trade secrets of the company confidential, and prevents confidential information from being exposed to the public domain, saving time and legal expenses. Eventually, the most common form of recourse available to a company after a contract has been vitiated by the breaching party is nothing but availing the ADR clause available in the agreement that both companies have entered into.

3. ENFORCING THE REMEDIES AVAILABLE IN THE CONTRACT: even if the settlement between the parties to the agreement fails, companies usually rely upon the contractual remedies available in the well-drafted contracts, which are explicitly stated and contain remedy clauses such as liquidated damages, penalty clauses, or termination of rights clauses. Enforcing these contractual remedies thereby allows the company to recover pre determined compensation for losses incurred. Let’s say, for example, in a supply of services contract, which usually contains a remedy clause, which ensures that the non-breaching party of the contract can claim compensation without having to prove actual damages in court or the appropriate forum in whose jurisdiction the current agreement falls.

4. RECOURSE TO LEGAL REMEDIES: Where the breach of contract is severe or willful, companies, after exhausting all their contractual remedies (depending upon the terms & conditions of the contract), may initiate the legal proceedings to enforce their rights under contract law. This could include seeking specific performance (which means that the non-breaching party will compel the breaching party to perform in order to fulfill their obligation under the agreement), seeking an injunction (which is to prevent further harm), or claiming damages (monetary compensation for loss incurred).

5. STRENGTHENING CONTRACT LIFESTYLE MANAGEMENT: Post the breach of contract, the companies shall improvise their company framework policy and also conduct a risk review to examine and identify the contractual weaknesses that allowed the breach to occur. Then, after going through the same, they adopt stricter drafting practices for future contracts, such as clearer performance obligations, better-defined timelines, preferred mode of dispute resolution clauses that have been clearly drafted, and force majeure clauses. They are also opened to enhance their due diligence process on counterparties before entering into new agreements to ensure their reliability and performance capacity.

CONCLUSION

Therefore, the following are the methods properly laid down as to how breach of contracts occurs and in what ways the same may be mitigated.