Termination of a Contract & Damages
– the basis on which a contract can be terminated
– the different types of damages and how they’re awarded
– the basics of dispute resolution and international law
A contract can be made for a:
• Definite term: the parties have designated the passage of time as the event that triggers the end of the legal relationship under the contract;
• Indefinite term: the parties have not designated the specific time in which the contract will be ended. Usually a notice from one party to the other indicates the end of the contract; and
• Perpetual duration: when the contract has no designated event that ends the contractual relationship. Neither party possesses the right or the power to end it.
A contract expires when each party has performed its duties under the contract.
NOTE: “Performance” means “substantial performance”, not necessarily performance to the very last detail. To determine whether the essential parts of the contract have been performed, it is necessary to look at the main provisions agreed; if these have not been achieved, the cost of completing the work can be subtracted from the agreed-upon price of the contract.
If one party fails in a material way to perform, the other party has no obligation on the contract and it may have a prior termination by breach:
• Anticipatory breach: occurs when a party manifests an intent not to perform its obligation under the contract, before performance is due.
• Actual breach occurs when a party fails to perform when actual performance is due.
The most common way is by rescission (the revocation, cancellation, or repeal of a law, order, or agreement). It can be:
• Mutual rescission: when the parties agree to cancel or annul the contract and to return any consideration they received.
• Unilateral rescission: where one party was subjected to fraud or duress, and thus seeks to put itself in the position it occupied before the contract was entered into.
In a breach of contract claim, the plaintiff must prove the following:
• The existence of a contract
• The breach of contract
• The injury or damage suffered by him/her
When a breach of contract claim is proved, the most common remedy granted by courts is the award of damages.
Damages refer to the compensation due to the non-breaching party of a contract to recover any financial loss or injury causedby the breach of the contract.
1) Compensatory Damages (or “actual damages”)
They are imposed when there has been a material breach of the contract that has caused measurable damages to the injured party. The amount awarded is intended to cover the loss to the injured party.
2) Punitive Damages
They are imposed upon the breaching party in order to deter or punish him/her, rather than to compensate the injured party. They are rarely awarded for breach of contract and they arise more often in tort cases.
There are three limitations on the award of damages:
1) Reasonable certainty of harm: it aims at eliminating speculative losses. Damages must be established by evidence that shows a reasonable degree of certainty.
2) Foreseeability of harm: damages are not recoverable for loss that the party in breach did not have reason to foresee as a probable result of the breach when the contract was made. It may not be considered lost profits in damages.
3) Avoidability of harm (duty to mitigate): the non-breaching party is obligated to mitigate, or minimize, the amount of damages to a reasonable extent. Damages cannot be recovered for losses that could have been reasonably avoided or substantially ameliorated after the breach occurred.
If the breaching party knew or had reason to know that losses would result from the breach, “consequential damages” are also allowed as part of the compensatory damages. In this case, indirect damages can include injury and lost profits if foreseeability and certainty are met.
Liquidated damages are well recognized in both civil and common law countries as a mechanism for determining in advance what the damages will be if a contract is breached. However, if the amount is unreasonable, meaning it is considered a penalty for breach, liquidated damages are not enforceable.
Additionally, liquidation damages are only appropriate when they apply to a breach that is uncertain in nature. If there is a way to calculate the damage done by the breach, that amount should be used.
Focuses on the injured party and it is forward-looking. It aims at putting the injured party in the same (monetary) position that he/she would have been in had the contract been fully performed. The measure is the wealth of the injured party if promise had been performed.
Also focuses on the injured party, but it is backward-looking. Damages are awarded based on putting the injured party in as good a position as he/she was prior to the promise. It does so by reimbursing him/her for the loss caused by reliance on the contract.
Focuses on the breaching party and it is backward-looking. It is applicable when there is an unjust enrichment of the breaching party and it aims at putting him/her back in the position he/she was prior to the promise. The party in breach must return any benefits obtained from the injured party.
In the area of dispute resolution, arbitration as opposed to the use of courts is normally preferred due to the following reasons:
• Cost: the arbitration cost is generally lower than going to court;
• Flexibility: the arbitration process has greater flexibility since there is no standard rules and the parties themselves can lead the process;
• Language: the parties may choose freely and agreed the language in which to lead the arbitration, which can not be limited to the national languages of those involved;
• Neutrality: while national judges may be biased or may be lack of competence, the arbitrator is an independent expert appointed by the parties and specialized in the subject matter of litigation; and
• Enforceability of arbitral awards: The final award of an arbitral tribunal, which is a binding decision, is a directly enforceable decision both nationally and internationally.
To avoid uncertain and unpredictability, most international contracts include provisions for the applicable law. The primary sources of law for developing international commercial agreements include:
• treaties and executive orders;
• legislation and government regulations;
• court made law and arbitral decisions;
• general principles of international law; and
• customary international law.
These differences affect not only the kinds of contracts that are enforceable under each system, but also the steps of creating a contractual agreement and the damage available upon its breach.
1) Content of a contract and freedom to contract
The common law system is not primarily based on codes and statutes and thus, from the contract law perspective, there are few provisions implied into a contract. The parties have an extensive freedom of contract and it is important to set out in detail all the terms governing their relationship under the contract.
When it comes to common law contracts, almost everything is permitted that is not expressly prohibited by law. As a consequence, contracts tend to be longer than one in a civil law country.
Civil law systems typically have extensive standard rules and the parties have less freedom of contract because there are a number of provisions implied into a contract. It is not necessary to set out all the terms governing the contract because inadequacies or ambiguities can be remedied or resolved by operation of law. This will often result in a contract being shorter than one in a common law country.
In order to have a binding contract in a civil law jurisdiction, there must be:
• an offer
• an acceptance
• an intention to be bound
In common law jurisdictions, there is one additional element – consideration. A contract has no binding effect unless supported by consideration. This is a typical common law concept under contract law.
Although both common and civil law have a similar classification of contracts, unilateral and bilateral contracts are different in those systems. The common law focuses on “consideration” of the parties and the civil law instead focuses on the parties’ “obligations” to each other.
In the common law system, if considerations in both directions are to be moved after the contract, it is called a bilateral contract. In the civil law system, a bilateral contract is one in which both parties are bound to fulfil obligations reciprocally towards each other.
Under the common law, only onerous promises are enforceable, since gratuitous promises lack consideration. However, under the civil law, it would be possible for a party to be obligated to deliver on the promise of a gift or action.
Under the common law system, “specific performance” is an equitable remedy reserved for only the most extraordinary circumstances, such as the transfer of unique property. Common law courts rarely order it but instead they award monetary damages calculated based on either the injured party’s reasonable expectation of reward or restitution of their loss.
Simultaneously, the common law system will also require the injured party to mitigate damages, thereby encouraging economic efficiency through the completion of the envisioned transaction.
On the other hand, the civil law system desires to enforce the parties’ voluntarily enacted obligations. Therefore, specific performance is a statutory remedy that the civil law courts are expected to turn to first. It may be replaced by monetary damages only in cases where specific performance is either unfeasible or inadmissible.