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Most businesses have experienced a breach of contract, either as the party in breach or the party at the receiving end of a breach. Maybe you have entered into a contract with a supplier who is late in delivering the goods. Maybe the accounts receivables team of a supplier has followed you up on an unpaid invoice. These examples are likely to be a breach of contract between the two relevant businesses (ie. the parties to the contract). So how do we know when we are in breach of contract, what does it mean, and what can the innocent party (sometimes called the ‘aggrieved party’) do about it? 

How Do I Know When a Breach of Contract Has Occurred? 

A breach of contract is another way of saying someone has broken a commercial promise or agreement. To determine whether there has been a breach of contract, go through the following steps.

1. Look Closely at the Contract

The first step to determine if there has been a breach of contract is to carefully review the contract terms. This may seem obvious, but sometimes the terms are not exactly as the parties may have thought. This is because, in practice, parties frequently sign contracts without thorough review. 

Hopefully, you have a written contract that sets out what promises each party has made. This will define what each of you agreed to do. Ideally, it will set this out expressly (ie. it will say it clearly on the page). However, there are also certain obligations that can be implied into a contract to fill in gaps.  

The laws around implying terms can be a bit overwhelming. Essentially, however, you can imply an unspoken term if it is clear that both parties should reasonably understand that the contract contains that term. Relevant questions in determining this include whether: 

  1. the term is reasonable and equitable;
  2. the term is necessary to give business efficacy to the contract; 
  3. it “goes without saying” or it is “obvious” that the term is part of the contract; and
  4. the term is capable of clear expression (if it is not, or if it contradicts terms that are expressed, it is unlikely to be an implied term).

A common example of an implied term is where there is no express time stated for the delivery of goods or services. In this case, the obligation is that the delivery is within a ‘reasonable’ time.

2. Determine Whether a Party Breached a Term

By now you should know what the contract requires. Now, consider whether what happened (or did not happen) amounts to a breach of the term in question.

For express terms, this should be fairly straightforward. 

For example, if the contract says that payment is to be made on the 20th of the month, there is a breach if it is not paid on that date. If the contract is for the delivery of 25 units of product and only 20 are delivered, this is a breach of contract. 

The key here is to be very specific. Carefully consider the words in your contract when setting out the breach and ensure there is alignment between these words and what has happened. 

Example of a breach of contract:

Term: Clause 2.1 The buyer shall make payment within 20 days of receiving the goods. 

Event: The buyer received the goods on 1 March 2020 and on 30 March 2020 had still not made payment. 

Breach: The buyer did not make payment within 20 days of receipt of the goods and has therefore breached Clause 2.1. 

Take care to review other clauses in the contract – it is not uncommon for some obligations to intersect.

For example, another term in this contract may say that Clause 2.1 is subject to the goods being of satisfactory quality. Accordingly, if they were not, there was no breach. 

What Happens After a Breach? 

The first step to understanding the consequences and remedies for a breach is to check the contract itself. It is not uncommon for contracts to dictate or limit what parties’ rights are upon breach. 

Leaving aside what the contract says (and how it might limit the rights arising after a breach), however, the most important legal consequences of a breach include:

  • entitlement for damages; and
  • cancellation of the contract.

Entitlement for Damages

In general, the person who has suffered the breach (known as the ‘aggrieved party’) is entitled to recover compensation from the breaching party to put in in the position it would have been in had the contract been properly performed (with some limitations). 

This often means compensation for loss caused by the breach, but can also mean compensation for costs such as lost profits, opportunity costs and paying for (potentially more expensive) replacement goods or services. 

For example, if a party is late in paying for goods, depending on the circumstances, it might be liable in court for for costs such as: 

  • time value of the money at a reasonable interest rate; 
  • administrative costs of recovering the funds; and
  • the cost of the supplier purchasing commodities at a higher rate because it did not have the cashflow to buy them at a lower rate when it otherwise could have.

Likewise, if a party is late in delivering goods, it could be liable for costs such as the: 

  • costs of hiring replacement goods for a period (if the goods were to be used for a particular purpose, like an event);
  • costs to the aggrieved party of late delivery to their own customers (if they are a distributor, for example); and
  • lost profit from a contract that fell through because of the time sensitivity (where this risk was known to the supplier).  

Cancellation of the Contract

If the breach of contract is particularly serious, it may give the aggrieved party a right to cancel the contract

To have this right, the breach must meet one of the following criteria: 

  • the term is expressly or impliedly agreed to be an ‘essential term’ in the contract (in some contracts, this can be indicated by the words ‘of the essence’ in relation to a term); or 
  • the effect of the breach ‘substantially’ alters the benefit or burden under the contract for the cancelling party. 

Cancellation brings the contract to an end, meaning that no party has to perform anything it has yet to do (or is entitled to anything further). It does not affect the right to any damages. 

Before you cancel any contract, you should be sure that you have the right to do so. If you try to cancel without the right to do so, this can give the other party a right to cancel. 

Key Takeaways 

A breach of contract is effectively the commercial equivalent of a broken promise. It has legal consequences, usually resulting in the right of the other party to financial compensation for the loss of the bargain. When entering into contracts, it is crucial that you: 

  • carefully review and understand what the contract requires; 
  • measure performance against those precise requirements to monitor potential breaches; 
  • understand the consequences of potential breaches; and
  • get advice if you are unsure of the consequences of a breach (especially if you are planning to cancel a contract).

If you have questions regarding your contracts, or how to best draft your contracts to fit your risk appetite, contact LegalVision’s New Zealand contract lawyers 0800 005 570 or complete the form on this page.

FAQs

What Is a Breach of Contract?

A breach of contract is effectively the commercial equivalent of a broken promise. It has legal consequences, usually resulting in the right of the other party to financial compensation for the loss of the bargain. 

What Are Express and Implied Terms?

Express terms in a contract are set out clearly on the page. Implied terms are not. However, if it is clear that the contract should be reasonably understood to contain a certain unspoken term, then that term may be implied.

Am I Entitled to Damages for a Breach of Contract?

In general, the person who has suffered a breach of contract is entitled to recover compensation from the breaching party (with some limitations). This often means compensation for loss caused by the breach, but can also mean compensation for costs such as lost profits, opportunity costs and paying for (potentially more expensive) replacement goods or services. 

Can I Cancel a Contract for a Breach of Contract?

If the breach of contract is particularly serious, it may give you a right to cancel the contract. Before you cancel any contract, however, you should be sure that you have the right to do so. If you try to cancel without the right to do so, this can give the other party a right to cancel. 

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