When is a party relieved from her obligations under a contract?
Parties to a contract have duties or obligations thereunder. There are generally three options to relieve these obligations:
• Perform – An individual is relieved from her duties under a contract once she has fully or substantially performed those duties. The individual is “discharged” from the contract.
• Release from Contract – Either party may be released from a contract by the other party. Alternatively, the person may be released if the contract becomes void.
• Breach – Once a party to a contract breaches that contract, she and the other party no longer have duties to perform. If the contract is enforceable, the other party then has the ability to enforce the contract against the other party by seeking damages.
Performance of the contract and release eliminate a person’s liability under the contract. Breach exposes the breaching party to damages or losses suffered for the breach. None of these options relieve a party form tort liability if her actions with regard to the contract constitute a tort.
• Discussion: Should a party pursue the method of relieve her obligation under a contract that is of greatest advantage to her? Why or why not?
• Practice Question: Katie and Smith enter into a contract. Each has a duty to perform services for the other. Neither party ever takes action to act on the contract. What is the result?
What are “executed contracts” and “executory contracts”?
An executed contract is one in which the parties have performed their duties under the contract. An executory contract is one in which the parties have not yet performed their obligations under the agreement.
• Example: I enter into a contract with you. Before I have fully performed the contract, it is executory. Once performed, the contract is executed.
• Discussion: Why do you think it is necessary in business to characterize contracts are executory versus executed?
What is performance of a contract?
Performance of a contract relieves a person from further duties under the contract. There are three levels of performance:
• Complete Performance – Complete performance by a party means that the contracting party has fulfilled every duty required by the contract. A completely performing party is entitled to a complete performance by the other party.
⁃ Example: I enter into a contract to build a house for Ellen. I build the house and complete all of the material and non-material requirements of the contract.
• Substantial Performance – Substantial performance of a contract means less than complete performance; but, the level of performance is sufficient to avoid a claim of breach of contract. More specifically, it means that a party has performed all material elements of the contract, but there are non-material aspects left uncompleted.
⁃ Note: The other party may be entitled to seek offset or recovery from the substantially performing the party for the aspects of the contract not completed.
⁃ Example: I enter into a contract to build a house for Ellen. I build the house, but fail to paint the interior the color described in the contract. This contract is substantially performed and does not give rise to an action for breach. Ellen may, however, recover or offset the cost of painting the walls when paying me.
• Breach of Contract – Any performance that is not complete or substantial performance is a material breach. This entails performance at a level below what is reasonably acceptable. The materially breaching party cannot sue the other party for performance and is liable for damages to the other party for the breach.
⁃ Example: I enter into a contract to build a house for Ellen. I distracted by another contract and make material errors in laying the foundation. It causes the house not to meet standards and pass inspection by the building inspector. In this case, I have breached the contract by failing to perform a material duty under the agreement.
• Discussion: How do you feel about the concept of substantial performance? Do you believe that failure to perform certain duties under a contract should not constitute a breach? Why or why not?
• Practice Question: Missy enters into a contract to perform auditing functions for ABC Corp. She does reconciliation of many of the accounts, which takes substantial time. She is satisfied that the books are accurate, so she skips performing many of the key tasks required of external auditors. What is the status of Missy’s duties under the contract?
What is performance of a “divisible contract”?
A divisible contract is one that has multiple parts or is divided up into segments. Each segment exists and can be completed independently. That is, each segment has duties that require completion. An installment contract is an example of a divisible contract. Each installment has duties or obligations that must be completed. Performance of one segment does not relieve a party from the obligation to perform the other segments. Further, breach of one segment does not excuse performance of the other segments by the parties.
• Example: I enter into a road construction contract that has three separate and distinct duties of completion. I complete the first phase by constructing a specific stretch of road that entitles me to compensation. I have significant delays in constructing the second stretch of road. I have materially breached this divisible portion of the contract. I still have the duty to complete and be compensated for the third divisible contract.
• Discussion: Do you agree that the breach of any phase of a divisible contract should not constitute breach of the entire contract? Why or why not?
• Practice Question: Clark’s construction company wins the bid to build a large commercial building for the city. The contract is broken into multiple, divisible pieces. Clark completes the first phase consisting of laying the building foundation, which simultaneously working on the second phase. This second phase regards constructing a parking garage beside the building. Clark has some serious difficulties and is unable to complete this phase on schedule. What is Clark’s legal status with regard to the third phase of the contract?
What situations relieve individuals from performing her duties under a contract?
An individual is relieved from her duty to perform a contract in the following scenarios:
• Void Contract – If a contract becomes void, both parties are relieved from their duty of performance.
• Breach by Other Party – If the other party materially breaches the contract, the non-breaching party is relieved from the obligation to further perform the agreement.
• Failure of a Condition – A contract may contain any number of conditions that may materialize (or fail to materialize), which relieve the parties’ obligation to perform under the contract.
• Impossibility, Impracticability, of Frustration of Purpose – Parties to a contract may be relieved from their obligation to perform if performance becomes impossible, commercially impracticable, or the underlying purpose of the contract is frustrated.
• Waiver or Release – A party may, per her own volition, sign a waiver or release relieving the other party’s obligation to perform.
Any of the above situations may release one or both parties from their duties of performance.
• Discussion: Do you agree that the above situations should relieve an individual from her obligations under a contract? Why or why not?
What are “conditions” upon the duty to perform a contract?
Conditions are facts or situations that must materialize (or fail to materialize) for either or both parties to have the duty to perform a contract. Conditions are generally divided as follows:
• Condition Precedent – A condition precedent is where something must take place or a situation must arise prior to or before a party has a duty to perform.
⁃ Example: Eric agrees to sell Fran one of his playoff seat tickets if the Atlanta Braves make it to the playoffs. The obligation to sell Fran a ticket only arises upon the occurrence of a specific event.
• Condition Subsequent – A condition subsequent excuses contractual performance if some future event takes place or situation arises.
⁃ Example: Frank agrees to cut Gina’s grass today if it does not rain. If it rains, Frank is relieved from the obligation to cut the grass. Likewise, Gina is relieved from her duty to pay Frank.
A condition may be expressed between the parties or implied from the nature of the agreement. That is, the parties affirmatively discuss or include the conditions in the agreement or the language or nature of the contract may imply certain conditions on performance. The contract may also contain conditions that must take place concurrently before either party has a duty to perform. This is often the case when the contract requires simultaneous performance. Most point-of-sale purchases involve an implied concurrent condition of performance.
• Example: I give the cashier money and she sells me the groceries. My giving her money is a condition necessary for her to sell me the groceries.
• Discussion: Should conditions precedent and conditions subsequent be treated the same? What is the justification for categorizing each type of condition?
• Practice Question: Harold enters into an agreement to sell his house to Emily. The contract states that Emily is relieved from her obligation to purchase Harold’s house if the home does not receive approval from a licensed home inspector. What type of condition is present in this agreement?
What are the conditions regarding payment, delivery, and tender of performance?
Tendering performance means to offer or attempt to perform the agreement. Often a party’s offer or attempt to perform is sufficient to satisfy the condition of performance and obligate the other party’s performance. That is, a party cannot avoid her obligation under the contract by failing to accept the other party’s tender of performance. One party offering or attempting to perform is a condition to the other party’s obligation to perform. Unless a contract states otherwise, the default rules under the UCC and Restatement place conditions on the delivery of services and the delivery of a product by a party to a contract.
• UCC Condition of Performance – The UCC states the buyer tendering payment to the seller of a good is a condition that must be satisfied before the seller has the duty to deliver the good.
⁃ Example: I offer to purchase an expensive jacket from you. You accept. I must offer to give you the money before you are obligated under the contract to give me the jacket.
• Restatement Condition of Performance – The Restatement, in contrast to the UCC, requires that a service provider must tender performance before the other party has a duty to pay for those services.
⁃ Example: I offer to paint your house for $500. You accept. I must complete my obligation to paint your house before you are obligated to pay me $500. In this case, tendering performance is completing my duty to paint.
In either case, rejecting a party’s tender of performance can constitute a breach of contract if the tender of performance conforms to the requirements of the contract.
• Discussion: Why do you think tending performance as a condition is treated differently under the UCC versus the Restatement?
• Practice Question: Herman offers to purchase machinery for his business from Jamie. The party is silent on who must perform first. Herman asks that Jamie ship the goods to his business location so that he can inspect it. If it meets inspection, he will pay for the machinery. Jamie refuses and asks Herman to pay first. If both parties refuse to perform first, who is likely legally liable for breach of contract?
What are “impossibility”, “impracticability”, and a “supervening frustration of purpose” of a contract?
Impossibility of performance, commercial impracticability, and a supervening frustration may excuse a party’s duty to perform a contract. Further, it will relieve the party from liability for the non-performance.
Impossibility of Performance
A party may be excused from her duty to perform under a contract if performance becomes impossible. Events that make a contract impossible include:
⁃ Illegality of the subject matter;
⁃ Example: I enter into a contract with you to sell you cleaning chemicals. The sale of such chemicals becomes illegal. My duty to perform is excused.
⁃ The subject of the contract (property) is destroyed;
⁃ Example: I enter into a contract to sell you a car. Before I can sell it to you, a branch falls from a large tree and destroys the car. I am excused from my duty to sell an undamaged car.
⁃ One of the parties to the contract dies or becomes physically or mentally disabled;
⁃ Natural forces interrupt the contract;
⁃ Example: A tornado, earthquake, severe storms, flooding, etc., permanently interrupts a party’s ability to perform her contractual obligations.
⁃ Performance would cause substantial risk of physical harm to one party.
⁃ Example: I enter into an agreement to replace the shingles on our house. Upon inspection, the roof of the house appears to be structurally unsound. Replacing the shingles would put me in an unreasonably dangerous situation. I did not anticipate this danger when entering the contract. As such, my duty to perform is relieved.
Impossibility of performance will only excuse a party’s performance if the impossibility is not the fault of the non-performing party. Further, impossibility will not excuse liability for non-performance if the contract expressly contemplated the risk of conditions making performance impossible and specifically placed those risks upon the non-performing party.
⁃ Example: I enter into a contract to sell you a piece of machinery. In the contract, we expressly state that I must repair any malfunction of the machine that occurs prior to sale. The machinery breaks before the sale date. In this situation, the contract anticipates a risk and places it on me. I must repair the machine prior to sale.
⁃ Discussion: What do you think is the justification for allowing the above situations to excuse a person’s duty under a contract? Can you think of any other situations that you believe should excuse a person’s duty?
⁃ Practice Question: Derek agrees to sell Artem sheet rock for a construction job. Derek leaves the sheet rock outside and it rains. The sheet rock is ruined. Artem has to purchase sheet rock from another source at a much higher price. If Artem decides to sue Derek, what will be the likely outcome?
Commercial impracticability arises when performance of a contract by a party has become unfeasibly difficult or costly to perform. The difference between impracticability and impossibility is that impracticability is still physically possible; however, performance will result in a substantial hardship to the performing party. Impracticability will excuse performance where the excused party did not have control over (or was not at fault for) the condition that made performance impracticable. Further, the excused party must not have expressly or impliedly assumed the risk of the duties becoming impracticable. Generally, impracticability is only found in extreme circumstances.
⁃ Example: I enter into an agreement with you to sell goods or perform services. The cost of performing the contract spikes because of a government tax, regulatory hurdles, raw material rates, etc. When entering the contract, we did not contemplate the price of goods or the cost of performing services to go up. If performing the contract would result in a serious financial burden to me, I may be able to get out of the contract by claiming that commercial impracticability excuses my performance.
⁃ Discussion: How do you feel about the doctrine of commercial impracticability? How unforeseeable must the intervening event be to make the contract impracticable? How severe must the damage suffered by the performing party be?
⁃ Practice Question: Tom agrees to sell lobsters to Suzie for resale in her restaurant. Tom sets the price at a specific dollar value per pound. Later, the government imposes a large tax on sales of lobsters. If Tom continues to sell at the contract price, he will go out of business. What are Tom’s options?
Supervening Frustration of Purpose
This is when circumstances arise that fundamentally frustrate a party’s reason or purpose for entering a contract. The doctrine is similar to impracticability, but it does not relate to a party’s hardship; rather it focuses on her expectation and purpose in entering the agreement. For a frustrating circumstance to relieve or excuse an obligation under a contract, the party cannot have assumed the risk of the circumstance (in the contract) or be at fault for the occurrence or the non-occurrence of the event or circumstance. Further, the occurrence or non-occurrence must have been a basic assumption on which the contract was made.
⁃ Example: John signs up for piano playing lessons from Tara. John suffers a horrible accident that causes him to lose dexterity in his hands. This is a frustration of purpose that was unforeseeable and substantially frustrates the purpose of learning to play the piano. As such, John will be excused from performance of the contract. Suffering an economic loss is not a frustration of purpose.
⁃ Discussion: How do you feel about allowing an unforeseen event relieving a person’s duty for performing a contract? How fundamental must the assumption be to the purpose of the contract? To what extent must each party understand this to be the fundamental purpose of the agreement?
⁃ Practice Question: Donald bids for and wins a government contract to construct a dam. The contract is subject to legislative approval. He begins preparing by entering into contracts with Lizzie for the purchase of cement. The cement supplier knows that the cement purchase is in preparation for the dam-building project. The legislator ultimately disapproves the dam project, which causes Donald to lose the contract. What is the possible result?
What is “waiver” or “release” from a contract?
A waiver and a release serve to excuse one or both parties’ duty of performance.
• Waiver – When a party intentionally relinquishes a right to enforce the contract. A waiver is generally employed after a party fails to perform.
⁃ Example: Per our contract, I am supposed to paint your house, but I fail to do so in the allotted time. You grant a waiver excusing my liability for failure to perform.
• Release – When one party is relieved from her promise of performance. A release generally occurs before a contracting party has to perform.
⁃ Example: We sign a contract where you agree to pay me to paint your house by the end of the month. Before my performance is due, I explain that I do not have time to paint your house. You sign a release that frees me of my duty to paint your house.
Waiver and release are often used synonymously to refer to a single document that simultaneously relieves a party from her duty to perform and excuses a non-performance or breach.
• Discussion: What do you think is the justification for categorizing a release and waiver differently? Should the content of a release agreement be treated differently than the content of a waiver?
• Practice Question: Pam enters into a contract with Lia to perform consulting services for her business. Pam has a great deal of work and is too busy to perform the contract. She asks Lia to let her out of the contract. What is Pam asking of Lia?
What is a “breach of contract”?
A party who is not relieved from her duty of performance and fails to perform her obligations under a contract is said to breach the contract. Breach entails a failure to perform material duties in accordance with the agreement. This can include a complete lack of performance, partial performance of the material duties, or performance that fails to meet the demanded standard. A breach by one party relieves the other party’s duty of performance.
• Discussion: Should different types of breach be treated differently? Why or why not?
• Practice Question: Joseph enters into a contract with Eric to build a deck on Eric’s house. Joseph builds a deck that is weak, flimsy, and drastically varies from the design plans. Under what grounds might Joseph allege breach of contract against Eric?
What methods exist for resolving a breach of a contract?
There are several remedies or solutions available for a breach of contract:
• Negotiated Settlement – The parties may work out a satisfactory solution to most breaches of contract is resolved by the parties themselves through voluntary negotiated settlements.
• Arbitration – The parties may agree to submit their dispute to a neutral third party or parties to resolve the dispute.
• Litigation – The parties seek to enforce their contract rights in a court of law.
All of these methods are discussed in greater detail in other chapters of this text.
• Discussion: What are the benefits of pursuing each of the available methods of resolving a breach of contract?
What remedies exist for breach of a contract?
A breach of contract action may result in any number of damages:
• Compensatory Damages – Compensatory damages are court-awarded damages to put the plaintiff in the same position as if the contract had been performed. It includes lost profits on the contract and the cost of substitute performance. A party’s lost profits from the other party’s breach of contract are the expected gains from performance of the contract. This would generally mean the value received minus the costs incurred in performing. This calculation is known as the “expectation damages”.
⁃ Example: You sign a contract to sell me supplies for my business. You back out of the contract and I have to purchase my supplier from another vendor. The cost to me to purchase the supplies from a new vendor is 15% higher than pursuant to our agreement. I have suffered damages of 15% of the contract value. Alternatively, if I backed out of the contract and my duties to purchase your supplies, you would have suffered expectation damages equal to the price of the goods minus your cost of supplying them to me.
• Consequential Damages – These are court-awarded damages arising from unusual losses which the parties knew would result from breach of the contract.
⁃ Example: I order cement from you to complete a large contract. I express to you that I intend to use the cement for the large construction contract and that time of deliver and quality of the goods is of utmost importance. You fail to deliver the cement and I am forced to purchase from another vendor. The cement arrives late and causes delays. I incur substantial penalties under the larger contract. Your breach of contract may have cost me compensatory damages equal to the price difference between our contract and the replacement vendor. The consequential damages, however, are the penalties incurred and any lost business as a result of your breach.
• Liquidated Damages – Liquidated damages are damages specified in the contract in the event of non-performance by either party. Liquidated damages are appropriate where real damages for breach of contract are likely to be uncertain. In such a case, the parties decide to specify in the contract the damages in the event of breach. Courts will enforce these liquidated damage clauses unless they seem to penalize the defendant instead of merely compensating the plaintiff for uncertain losses.
⁃ Example: I sign an agreement to provide you with consulting services. It is difficult to estimate the damage to your business if I fail to adequately perform. In the agreement we indicate that my failure to perform will result in damages of $1,000 to you. This liquidated damages clause is likely enforceable.
• Nominal Damages – Nominal damages include a small amount awarded by the court to the plaintiff for a breach of contract, which causes no financial injury to the plaintiff.
⁃ Note: In a tort action, a court may only award punitive damages if there is some finding of liability of the defendant. The court may not be able to find liability based upon tort theory in the absence of identifiable harm suffered by the plaintiff. If, however, the tort action is accompanied by a contract cause of action for the same conduct, the award of nominal damages for breach of contract may support a finding of punitive damages in the related tort action.
⁃ Example: I enter into a contract to provide you with consulting services. I fail to perform and you hire someone else. In this situation, it is difficult to determine if your business incurred any damages. If you sue me, a court may award nominal damages against me indicating that I was legally wrong in failing to perform my contractual duties. A common nominal damages amount is between $1 – 100.
• Specific Performance – Specific performance is a court-ordered, equitable remedy available when the subject matter of the contract is unique. A court order for specific performance directs a party to perform her duties under the contract. The court will only apply this remedy when the subject matter of the agreement is truly unique and irreplaceable. Specific performance is not available for service obligations.
⁃ Example: You agree to sell me a Picasso painting that you inherited. At the last minute, you back out of the contract. I sue you to force you to sell me the painting. A court may order specific performance of the contract by ordering you to sell me the painting.
• Rescission – Rescission means to undue a contract and return the parties to the position they were in prior to entering the contract. This generally means returning property sold in the condition it was transferred and a return of the purchase price. This remedy is not available for executed services contracts.
• Discussion: How do you feel about the concept of consequential damages? Is it fair to impose that extent of liability on a party if it is not part of the subject matter of the contract? Why or why not?
• Practice Question: Taylor enters into a contract with Winnie to supply her with reinforced steel. Winnie is going to use the steel in the construction of a new manufacturing facility for her business. Winnie backs out of the contract when she realizes that she can get the steel 10% cheaper from a competitor. If Taylor sues Winnie, what are his options for damages?
What is “efficient breach”?
Efficient breach occurs when a party makes a conscious decision to breach a contract after balancing the costs of complying against fulfilling the contractual obligation. This normally arises in situations where a party will incur fewer losses or make more money by breaching the contract than the party would suffer in compensatory or consequential damages if sued.
• Discussion: How do you feel about the concept of efficient breach? Should the decision of whether to breach a contract simply be an economic consideration or is there a moral consideration involved? Should morality or ethics play a role in business transactions? If so, to what extent and why?
• Practice Question: Wendy enters into a contract to sell a piece of equipment to Laura. Before the sale is finalized, Erwin offers to purchase the equipment from Wendy at a much higher price. Wendy evaluates whether to breach the contract with Laura and sell the equipment to Erwin at the higher price. What might Wendy consider in making her decision?