What is Breach of Contract: Three Steps to Mitigate Risk
What is a breach of contract?
A breach of contract occurs when a party to a contract violates the agreement’s terms or conditions. Breach does not necessarily make the entire agreement null and void. Parties to the contract can seek different types of remedies in court in order to mitigate losses stemming from the breach, including damages (monetary compensation) and equitable remedies such as specific performance (forcing the breaching party to follow through on its obligations). Even when both parties breach a contract, the agreement may still be enforceable. In some of these cases, each party can actually make a claim against the other.
There is always a risk that the other party will fail to deliver on its promises. However, it's possible to navigate and hopefully decrease that risk by systematizing contract review, creation, and monitoring. Here are explanations of each key type of breach, and three steps that legal and business leaders can take to prevent or prepare for them.
Four main types of breach of contract
Contractual breaches are generally classified as either material or minor, and either actual or anticipatory.
1. Material breach of contract
A material breach is one that is so severe that it defeats the purpose of having created a binding agreement in the first place. This occurs when the breaching party completely fails to fulfill its obligations, leaving the other party with a substantially different outcome than the contract specified. This failure can include the inability to perform within specified time limits. A material breach of contract releases the other party from any further obligations under the contract. It also permits the other party to recover damages, or financial compensation tied to the impact of the breaching party’s failure to deliver.
2. Minor breach of contract
A minor breach, also known as a partial or immaterial breach, is when the breaching party fails to fulfill some part of the contract without compromising the entire agreement. The non-breaching party may pursue damages if it proves that it suffered a financial loss because of the breach, but it is not excused from its own contractual obligations.
3. Actual breach of contract
An actual breach, also called a fundamental breach, happens when the breaching party has refused to fulfill its side of the contract by the due date, or it hasn’t performed its duties correctly. In this case, the non-breaching party may recover either compensatory damages for direct financial losses stemming from the breach, or consequential damages for indirect losses that are outside the terms of the contract but still a result of the contractual breach.
4. Anticipatory breach of contract
An anticipatory breach, also known as a constructive breach, is special in that the breach has not yet occurred. It happens when one of the parties explicitly communicates that it will be unable to fulfill its obligations under the contract. An anticipatory breach can also occur when the non-breaching party determines that the other party, based on its failure to perform, does not intend or will not be able to deliver under the terms of the contract. Following such a determination, the non-breaching party could immediately terminate the contract and sue for damages, rather than wait until after the breach occurred.
Three steps to mitigate the risk of breaches
There is no guaranteed way to prevent a breach when entering a contract. Even the lengthiest agreements and most meticulously crafted clauses can still end up at the center of a contract case in court. Nonetheless, businesses can take concrete action to address this risk before entering (or renewing) a commercial relationship. Here are three steps for legal and business leaders to keep in mind:
1. Create a contract tailored to the deal at hand
Drafting the ideal agreement for a particular business arrangement entails thinking through all of the ways in which the deal is likely to fall through. While there’s a degree of speculation involved in this process, businesses with a history of contracts don’t have to start from scratch.
By reviewing legacy contracts and deals, teams can analyze vendor or partner performance to see what worked and what didn’t, and leverage that knowledge as they craft new agreements going forward. No matter how long a relevant contract existed or terminated prior to the present negotiations, a central contract management system with easy-to-use search functionality can help lawyers and contract managers to quickly find it and decide which parts to use or avoid in the new deal.
2. Ensure that the parties agree on their own and each other’s obligations
Not all of the individual employees or agents who will actually do the work governed by a contract are party to the negotiations. It is therefore essential that everyone at the table agrees on their own side’s obligations and those of the party on the other side of the table. If the people negotiating the agreement aren’t on the same page, it’s impossible to expect the rest of their colleagues to be aligned.
A thoroughly written contract can help to promote common understanding of the parties’ obligations. In addition, basing the negotiations on one version-controlled document stored in a central location helps to avoid scenarios in which conflicting drafts of the contract are stored in different locations, potentially leading to confusion about what everyone has actually agreed to do.
3. Track each party’s performance against the contract
With the contract in place, it is important for contract managers to monitor ongoing performance in order to ensure that each party — both the counterparty, and their own business — is delivering on the terms of the agreement. Proactively tracking performance can help teams to spot potential issues before they arise, and take action to avert an actual breach or a costly lawsuit over an anticipatory breach.
Each of these steps requires an intelligent, reliable contract management system.
Lawyers and contract managers benefit from having smart, centralized contract databases where they can quickly retrieve and analyze all of the business’s past and current contracts and related documents, and draft new agreements leveraging the best examples from their contract portfolios.
Ready to learn how Evisort’s Contract Intelligence Platform can help you efficiently review, create, and track contracts? Schedule a demo today!
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