Breach of Contract Explained: Types and Consequences

What Is a Breach of Contract?

A breach of contract is a violation of any of the agreed-upon terms and conditions of a binding contract. The breach could be anything from a late payment to a more serious violation, such as the failure to deliver a promised asset.

A contract is binding and will hold weight if taken to court. If it can be proved that a contract was breached, the remedy would generally be to give the victim what they were initially promised. A breach of contract is not considered a crime or even a tort, and punitive damages are rarely awarded for failing to perform promised obligations.

Understanding a Breach of Contract

A breach of contract is when one party breaks the terms of an agreement between two or more parties. This includes when an obligation that is stated in the contract is not completed on time—for example, you are late with a rent payment—or when it is not fulfilled at all, such as a tenant vacating their apartment owing six months’ back rent.

Sometimes the process for dealing with a breach of contract is written in the original contract. For example, a contract may state that, in the event of late payment, the offender must pay a $25 fee along with the missed payment. If the consequences for a specific violation are not included in the contract, then the parties involved may settle the situation among themselves, which could lead to a new contract, adjudication, or another type of resolution.

Types of Contract Breaches

One may think of a contract breach as either minor or material.

• Minor breach: A minor breach happens when you don’t receive an item or service by the due date. For example, you bring a suit to your tailor to be custom fit. The tailor promises (an oral contract) that they will deliver the adjusted garment in time for your important presentation but, in fact, they deliver it a day later.
• Material breach: A material breach is when you receive something different from what was stated in the agreement. Say, for example, that your firm contracts with a vendor to deliver 200 copies of a bound manual for an auto industry conference. But when the boxes arrive at the conference site, they contain gardening brochures instead.

Further, a breach of contract generally falls under one of two categories:

• Actual breach: When one party refuses to fully perform the terms of the contract.
• Anticipatory breach: When a party states in advance that they will not be delivering on the terms of the contract.

Legal Issues Concerning a Breach of Contract

A plaintiff, the person who brings a lawsuit to court claiming that there has been a breach of contract, must first establish that a contract existed between the parties. The plaintiff also must demonstrate how the defendant—the one against whom a claim or charge is brought in a court—failed to meet the requirements of the contract.

Is the Contract Valid?

The simplest way to prove that a contract exists is to have a written document that is signed by both parties. It’s also possible to enforce an oral contract, though certain types of agreements still would require a written contract to carry any legal weight. These kinds of contracts include the sale of goods for more than $500, the sale or transfer of land, and contracts that remain in effect for more than one year after the date when the parties sign the agreement.

Courts will review the responsibilities of each party of the contract to determine whether they have fulfilled their obligations. Courts also will examine the contract to see if it contains any modifications that could have triggered the alleged breach. Typically, the plaintiff must notify a defendant that they are in breach of contract before advancing to legal proceedings.

Possible Reasons for the Breach

The court will assess whether or not there was a legal reason for the breach. For example, the defendant might claim that the contract was fraudulent because the plaintiff either misrepresented or concealed material facts.

The defendant could alternatively argue that the contract was signed under duress, adding that the plaintiff compelled them to sign the agreement by applying threats or using physical force. In other cases, there might have been errors made by both the plaintiff and the defendant that contributed to the breach.

How to Avoid a Breach of Contract

To avoid a breach of contract lawsuit, you should check any contract you sign for three things.

1. Clarity: The language of the contract should be clear and precise. If the other party is not a native speaker of the language the contract is in, it may be worthwhile to hire an interpreter to ensure that everyone understands their roles and expectations under the contract.
2. Expectations: You and any other parties signing the contract should understand the expectations it outlines and already know that you are able to fulfill them. Your ability to meet those expectations should not rely on future amendments because those may not happen.
3. Legality: In order to be binding, your contract needs to be legal where it is signed. If you are not sure, work with a lawyer who specializes in contract law before anyone commits to signing.

You can also avoid breach of contract lawsuits by carefully selecting the people or companies that you work with. Take time to research their professional reputations and legal history. If they have previously been involved in breach of contract lawsuits, you may not wish to do business with them.

Damages and Legal Remedies

Generally speaking, the goal of contract law is to ensure that anyone who is wronged is basically left in the same economic position that they would have been in had no breach occurred. A breach of contract is not considered a crime or even a tort, and punitive damages are rarely awarded for failing to perform promised obligations, with payouts limited to the figures listed in the contract.

For example, if you completed a job for which a contract stated you would get paid $50,000, but you only got $20,000, you could be awarded damages of $30,000.

However, the doctrine of reliance damages does offer some exceptions in very specific circumstances. Additional monetary damages may be awarded if it can be proved that a reliance on the contract being fulfilled triggered other connected expenses, such as lifeguard equipment being bought based on the assumption laid out in the contract that a pool would be built.

In such cases, those harmed will be rewarded extra damages only if they did their best to get themselves out of that unfavorable situation—such as, in the example above, by selling the lifeguard equipment.

Economics of a Breach of Contract

Economically, the costs and benefits of upholding a contract or breaching it determine whether either or both parties have an economic incentive to breach the contract. If the net expected cost to a party of breaching a contract is less than the expected cost of fulfilling it, then that party has an economic incentive to breach the contract. Conversely, if the cost of fulfilling the contract is less than the cost of breaking it, it makes sense to respect it.

Furthermore, when the expected cost to each party of following through with a contract is greater than the expected benefit, both parties have an incentive to forgo the transaction in the first place or mutually agree to void the contract. This may occur when relevant market or other conditions change over the course of the contract. 

Example of a Mutually Beneficial Breach of Contract

A farmer agrees in the spring to sell grapes to a winery in the fall, but over the summer, the price of grape jelly rises and the price of wine falls. The winery can no longer afford to take the grapes at the agreed price, and the grape farmer could receive a higher price by selling to a jelly factory. In this case, it may be in the interest of both the farmer and the winery to breach the contract. 

If the parties were to uphold the contract, the farmer would miss out on an opportunity to sell at higher prices and the winemaker would suffer by paying more than it can afford to, given what it would receive for the resulting wine at the new market price. Consumers would also be punished; the change in relative prices for grape jelly and wine signal that consumers want more jelly and less wine. 

Economists recognize that upholding this contract (making more wine and less jelly, contrary to consumer demand) would be economically inefficient for society as a whole. Breaching this contract, therefore, would be in the interests of everyone: the farmer, the winemaker, the jelly maker, and the consumers. 

Societal Effects of Breach of Contract

It could also be the case that a breach of contract is in the interest of society as a whole, even if it may not be favorable to all of the parties in the contract. If the total net cost of breaching a contract to all parties is less than the net cost to all parties of upholding the contract, then it can be economically efficient to breach the contract, even if that results in one (or more) parties to the contract being harmed and left worse off economically.

This is an example of what economists call Kaldor-Hicks Efficiency: If the gains to the winner from breaching the contract outweigh the losses to the loser, then society as a whole can be made better off by breaching the contract.

The Bottom Line

Contracts are specifically designed to be upheld and to give all parties to the agreement peace of mind. However, there are cases when they are breached, and a solution must be found to remedy a failure to perform promised obligations.

While not strictly a crime, a contract is there to be honored—unless all parties agree to renege on it—and it is not particularly easy to wriggle out of one. The punishment for breaching may be already outlined in the contract itself. Alternatively, a resolution might need to be found, which can result in the breacher being forced to abide by its original commitment.