It is common sense that if someone breaches a contract, you should be able to terminate that contract. However, in practice, the process of terminating a contract can be more complicated than you would think, and if you do not do it properly it can backfire. This article will discuss the key issues to consider if you want to terminate a contract due to breach. 

What Is a Breach of a Contract?

Contracts are legally binding agreements which set out two or more parties’ respective rights and obligations. If one of the parties fails to fulfil its promises in line with the provisions of the agreement or they default on the agreement entirely, then a “breach” of that contract occurs.

Does a Breach Mean I Can Terminate the Contract?

A breach doesn’t always mean that you can terminate the contract. You will need to consider the:

  • nature of the term that was breached; and
  • seriousness of the breach of the contractual obligations.

You will also need to be mindful of any procedural requirements in the contract itself.

The right to elect to terminate a contract arises if there is:

  • a breach of an essential term;
  • a sufficiently serious breach of a non-essential term; or
  • if either party repudiates the contract. 

What Is an ‘Essential’ Term?

Most contracts contain dozens, or even hundreds of terms. Each of these terms can be divided into three types:

  • essential terms (also known as “conditions”): an essential term is a term of such fundamental importance that you would not have entered into the contract in the first place if the other party had not promised to perform that term;
  • minor or non-essential terms (also known as “warranties”): in the context of classification of terms, a warranty is a term that is less important than a condition, and its inclusion (or exclusion) would not be considered a dealbreaker during the negotiating process; and
  • intermediate terms: you cannot neatly categorise all terms. Many will sit in between essential and non-essential.

The category of term is important in the context of breach of contract, because if you can establish that the other party has breached an essential term, then you will be entitled to terminate the contract (subject to any procedural requirements in the contract). You will also be entitled to sue for damages (ie, compensation).

In contrast, a breach of a minor or intermediate term will not usually provide a basis for termination. Rather, it will be the basis for suing for damages only.

What Is a ‘Serious’ Breach?

Whether there has been a serious (or ‘material’) breach is a question of fact. A material breach will generally be a substantial failure to meet a promise, rather than a matter of little consequence. A series of minor breaches could potentially add up to a material breach. 

If a breach of an intermediate term is sufficiently serious, it may provide a basis for termination (subject to any procedural requirements in the contract). 

When Is a Contract ‘Repudiated’?

Repudiation is a separate category that goes beyond a breach of a contract. If you demonstrate (by way of action or statements) that you are no longer willing or able to perform your current or future obligations under a contract, then you will ‘repudiate’ that contract.

If someone repudiates a contract, the other party may elect to terminate the contract (subject to any procedural requirements in the contract).

Procedural Requirements

Even if you identify grounds to terminate, you will still need to comply with any termination clause in the contract. A termination clause will usually set out certain procedural requirements for a party seeking to terminate, including: 

  • written notice; 
  • a notice period before termination; and
  • providing the other party an opportunity to rectify the breach.

The contract may also set out a dispute resolution procedure that you should engage in prior to taking action such as terminating. 

What if I Am Not Sure Whether I Can Terminate?

In reality, it is not always 100% clear whether a term is essential, or whether a breach is sufficiently serious to allow for termination. These questions can get even more difficult if the underlying factual scenario is subject to a dispute. The Courts exist to resolve this kind of question, but going to Court can be very drawn out and expensive.

If you are considering terminating on the basis of a breach, it is important that you seek legal advice before doing so. If you terminate a contract without a proper basis (or without following the prescribed termination procedure), the other party may argue that your purported termination is, in itself, a repudiation of the contract. This, in turn, can open you up to claim for damages.

The reason many contracts contain a termination procedure is to avoid a messy situation whereby there is a dispute over whether or not the termination was correct. At a minimum, the procedure will allow you to air your grievances, and give the other party an opportunity to respond, before pulling the trigger on termination.

Key Takeaways

You need to tread carefully if you are considering terminating a contract due to breach. Not all breaches give you the right to terminate, and there are many factors that will need to be taken into account. If you don’t do it properly, your termination is effectively repudiation, which exposes you to a damages claim yourself. If you have any questions about terminating a contract, contact LegalVision’s New Zealand contract lawyers on 0800 005 570 or fill out the form on this page.

FAQs

What a breach of contract?

Contracts are legally binding agreements which set out two or more parties’ respective rights and obligations. If one of the parties fails to fulfil its promises in line with the provisions of the agreement, then a “breach” of that contract occurs.

Does a breach mean I can terminate the contract?

The right to terminate a contract will only arise if there is a breach of an essential term, a sufficiently serious breach of a non-essential term or if either party repudiates the contract. 

When is a contract ‘repudiated’?

If you demonstrate (by way of action or statements) that you are no longer willing or able to perform your current or future obligations under a contract, then you will ‘repudiate’ that contract.

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