In a perfect world once a contract is signed, all dealings between the parties would proceed smoothly. There would be no problems with compliance. No contracts would go unfulfilled. The contract would be perfectly discharged. Instead, things go wrong. This chapter will examine how a contract is discharged as well as the rights of the party when a contract is broken or—to use the legal term—breached.

Discharging a contract occurs when a party satisfies an obligation it has under the contract. There are several ways a contract can be discharged. This section will examine those as well as the conditions that must be met before the contract is discharged.

The terms of the contract will outline any conditions—those stipulations or prerequisites contained in a contract, will, or other legal document—that must be satisfied before a contract is discharged. Those conditions fall into two categories:

Concurrent conditions are the normal conditions in a bilateral contract. The parties must each perform an action concurrently.

Normally a contract is discharged when the terms of the contract are satisfied. On occasion, the contract will be discharged when the time allotted by its terms expires. Performance of a contract is generally done by performing an act or tendering payment.

If a time period for performance is outlined in the contract, performance must be made by or on that date. If there is no specified time, performance must be made within a reasonable time. If it’s vital that performance is made in the timeframe specified, time is of the essence. Usually, this is the case when perishable goods or items that have volatile pricing are the subject matter of the contract. If the contract is not completed by the stated time, the nonbreaching party is entitled to damages.

In addition to being timely, performance must be adequate. That means the performance must satisfy the terms of the contract. Problems arise when there is partial performance of the terms—and this usually arises in construction cases. If performance is substantial, the performing party can sue for payment, but the other party can countersue for the unfinished performance. For example, if the owner has to repair defective work, the contractor is liable for that cost. Usually, the damages are cost of completion, but if that is disproportionate, the measure of damages will be the reduction in value of the building from the defective performance.

A party cannot complain about performance when it was according to the contract. So, if there’s a problem with the framing of a home, but the contractor framed it according to the provided plans, the homeowner can’t sue for improper performance. Occasionally, a contract will state that performance must satisfy the other party. If that’s the case, the court will enforce that as long as the dissatisfaction of a party is made in good faith. This personal satisfaction usually occurs when an opinion is involved such as interior design work or for-hire art.

For a bilateral contract to be discharged, both parties must perform their obligations. For a unilateral contract, only one party has to perform. (See Chapter 11 for a review of these and other types of contracts.)

Consumer protection laws have created unilateral methods for a consumer to rescind a contract. For example, homeowners have three days to rescind a mortgage for any reason. If someone purchases an item worth more than $25 through a home-based sale, he or she has three days to rescind.

There are several ways that a contract can be discharged by the agreement of the parties:

External causes can also discharge a contract, usually because the contract has now become impossible. The Restatement of Contracts defines impossibility as “not only strict impossibility, but impracticability because of extreme and unreasonable difficulty, expense, injury or loss involved.”

After Hurricane Katrina swept through New Orleans and part of Mississippi in 2005, thousands of contracts became impossible because the companies no longer had inventory, buildings, and so forth. If the inability to perform had been due to shortages of material, that in and of itself is not sufficient for impossibility unless a specific source for that material was listed in the contract. Without a specifically designated supplier, the law assumes material can be found from another supplier.

If the parties have contracted for a particular item or subject matter and that is destroyed, the contract is discharged for impossibility. For example, if a rice farmer and a buyer contracted for the buyer to purchase the rice from his fields, the contract would be impossible after Hurricane Katrina flooded the fields and destroyed that crop. If, however, the contract was for rice without specification as to what field, the rice farmer would still be obligated to perform the contract since he could obtain the rice to sell from any source.

Similarly, if the subject matter of the contract becomes illegal after the contract is in effect, it is discharged for impossibility. If one party to a personal services contract dies or becomes ill or otherwise incapacitated, the contract is discharged if it called for a specialized service. If a party refuses to perform in a manner that makes the contract impossible, the other party is discharged from performing. For example, if a contractor refuses to provide needed material or payment to a subcontractor, the subcontractor is released from his obligation under the contract. However, the subcontractor may have to show that he or she could not find similar goods from another source.

When determining which party should bear the risk of the contract impossibility, the court will ask two questions:

A developing and related theory to impossibility is commercial impracticability. Under that theory, a contract may be discharged because fulfilling the contract is unreasonable and carries an excessive cost. To prevail, the discharging party must show that something unexpected occurred, the risk of that occurrence was not assigned to one of the parties by contract or custom, and that unexpected event rendered performance of the contract commercially impracticable.

Temporary impossibilities may arise that frustrate the ability to perform a contract for a period of time. Usually these are related to events like the 9/11 terrorist attack or extreme weather. The event is out of the control of the parties and requires a temporary suspension of the contract. Eventually, the parties will be able to honor the contract.

The law will discharge a contract in several situations. If the court discharges claims in bankruptcy, they are discharged regardless of whether the contracting party received full compensation. Statutes of limitations can also bar contract claims if the injured party allows too much time to pass. In addition, the contract may contain a clause that limits how long a party can wait to file suit. Once that time expires, the aggrieved party cannot sue. There may be a similar provision requiring notice of the intent to sue.

Breach is the failure to perform or act in the manner called for by the terms of the contract. While parties do not sign a contract anticipating one of them will breach the contract, the question of how a breach occurs is important.

A breach of contract occurs when a promisor is under an absolute duty to perform and fails to discharge that duty. Sometimes that breach will be anticipatory, occurring when the promisor announces its intent before the duty to perform. The promisee can accept that as a contract breach.

If the breach is minor, the promisee has received the benefit of a substantial portion of the contract despite the promisor’s defective performance. The promisee may be compensated for any costs of the minor breach, but must still complete its portion of the contract. If the breach is major, the promisee did not receive the substantial benefit intended by the contract. In that case, the promisee can treat the contract as discharged and immediately seek remedies for the breach. In certain cases the promisee can treat a minor breach when it’s paired with anticipatory repudiation as a major breach.

Contracts are repudiated when a party to the contract indicates by words or deeds that it has no intention of performing its obligations under the contract. In other words, repudiation is a threatened breach of contract. Anticipatory repudiation occurs when a party who has an obligation to perform under a contract repudiates before the time of performance. Then the injured party has the right to damages for total breach as well as discharges any remaining duty to perform that party has.

Anticipatory repudiation also occurs when one party becomes insecure that the other party will actually perform its portion of the contract. The insecure party can contact the other party demanding assurances. If it does not receive satisfactory assurances, it can consider the contract anticipatorily breached.

To determine which level of breach is involved, courts will examine several factors. They look at the amount of the benefit received by the promisee. The adequacy of damages to substitute for performance will also be considered. Then the courts consider the extent of the promisor’s part performance and the hardship the breach imposes on the promisee. Finally, the courts determine whether any negligent or willful behavior led to the breach as well as the likelihood the breaching party can fully perform the contract.

The breaching party can retract its repudiation if the other party has not changed its position in reliance on that repudiation. Let’s say Acme Inc. is purchasing widgets from Brown & Co. Brown tells Acme it will be unable to fulfill the contract because its supplier for a scarce commodity has gone bankrupt. Acme acknowledges the repudiation but takes no action to mitigate the damage. Before Acme signs a contract with another firm, Brown locates a new supplier and announces it intends to fulfill the original contract. Brown has successfully revoked its repudiation, and Acme must allow Brown to fulfill the contract. If Acme had already signed with another company, Brown would be liable for any damages Acme incurs as a result of the breach.

A party may waive the other party’s breach. There may be business reasons the nonbreaching party will waive the breach. Maybe the promisee has found a source of materials cheaper than the promisor and is happy to allow the promisor to breach. If the promisee later decides to sue the promisor for breach, the question of whether it waived the breach is one of fact for the judge or jury to determine.

Waiver can be expressly stated or it can be inferred from the actions of the party. A contract could state that payment must be on time or the contract is breached, but a payment is late and the promisee says nothing and continues to accept payments. The continuing acceptance of payments constitutes waiver of breach for the late payment. Sometimes a party will be willing to waive breach without waiving its right to damages. In that case, that party should make what’s called a reservation of rights.

Before a promisee can sue for the promisor’s breach, the promisee must show that he or she is willing and able to perform the contract. The only thing stopping the promisee’s performance is the promisor’s breach. Once the promisee makes that showing, the issue of remedies rises to the surface. (See Chapter 14 for a discussion of remedies for breach of contracts that deal with sales of goods.)

If a party has been harmed by the anticipatory repudiation of another party, he or she has three options:

The court will impose quasi-contractual damages if the contract is defective but one party performed and the other party benefited. The courts will attempt to balance the outcome so that neither party receives an undue benefit. Let’s say Bob and Jane enter a contract for Bob to paint Jane’s house. Jane gives Bob a down payment and then decides to hire someone else. Because Bob has not performed any work on Jane’s home, he must reimburse her for the down payment. Otherwise, he is unjustly enriched at Jane’s expense.

Sometimes restitution of money is insufficient to remedy the breach. This often arises in circumstances where the subject matter of the contract is a unique item or land. Because each parcel of land is unique, money may not be a sufficient substitute for performance of the contract. In cases like that, the courts can impose specific performance. In other words, the breaching party must perform the actual terms of the contract because merely suing for damages is not adequate to compensate the aggrieved party.

Monetary damages for breach fall into several categories, as summarized in the following table. Compensatory damages will compensate the injured party for the injuries from the result of the breach. Again, the idea is to place the injured party in the position they would have been in if the contract had been honored by the breaching party. Punitive damages are used by a court to punish the breaching party for its bad acts. Punitive damages are rarely awarded in contract cases. Normally, the contract will not allow the use of punitives, but will limit damages to compensatory or liquidated damages.

Direct damages are those that flow directly from the breach of contract. Direct damages may include incidental damages, which are those extra expenses the injured party had to pay as a consequence of the breach or to mitigate damages. Consequential damages are those that can’t necessarily be anticipated before the breach but flow from special circumstances of the injured party. However, the damages must have been reasonably foreseeable to the parties because of the special circumstances. For example, if a company contracted to have hotels built in Beijing in anticipation of the Olympics, it would be reasonably foreseeable to both parties that the failure of the contractor to have the hotels ready for occupancy in time would result in extra damages to the company.

Nominal damages are token damages. The amount can be as little as $1 and is awarded simply to show the contract was breached. However, the injured party suffered no real harm from the breach. Liquidated damages are agreed to by the parties in the contract. These are often used in construction contracts where a specific amount of damage for delay is hard to ascertain ahead of time, yet the parties want to quantify the damage if there is delay.

Regardless of the damages, the nonbreaching party has an obligation to mitigate—or limit—the damages. This may require the nonbreacher to buy goods from someone else. For example, a landlord will be required to attempt to release an apartment if the tenant moves out prior to the expiration of the lease instead of waiting for the end of the lease. Then any rent received from releasing the apartment will be applied to the rent the former tenant owes. The former tenant will also be required to pay the difference between the new rent and the rent under his or her lease if the new rent is lower. The landlord must receive the full rent amount owed under the terms of the lease, but must take steps to mitigate the harm by renting the apartment if possible and applying that rent to the balance.

The remedies I’ve just discussed are not the only ones available to contract parties. Parties can also consider using the following remedies when a contract is breached:

Contracts can be drafted to remove the mystery from how a breach will be treated as well as the measure of damages. Contracts often have terms that expressly limit damages. For example, if you buy electronic equipment, the damages in the warranty are often limited to repair or replacement.

A contract may also limit damages through a liquidated damages clause. This is often used in construction contracts as well as noncompete covenants. The parties agree that damages in the event of breach are too hard to determine, so they set a specific amount in advance. To be effective, liquidated damages provisions can only be used in situations where it’s difficult or impossible to determine actual damages, and the amount stated must not be excessive.

Contracts may also contain clauses that limit liability. These are called either an exculpatory clause or limitation-of-liability clause. Courts will generally allow parties to allocate the risk between them as they choose. Thus, the clause can leave the risk unbalanced, but courts will rarely enforce a clause that leaves one party free from any liability. Releases signed when participating in risky outdoor events are one example of a limitation-of-liability clause.