Parties rarely enter a contract with the expectation that things will go wrong. They may consider it unpalatable or unnecessary to deal with the negative consequences of a contractual breach, but failing to give this area careful consideration could cause significant problems if things go wrong. The benefits of planning for the eventuality include clarity, mitigating risk, and the opportunity to put things right.
Although the law, in principle, is fairly settled on what constitutes a contractual breach, it won’t be specific to the goods or services provided under the contract. Setting out the consequences of breaching specific obligations serves two purposes: (a) it adds clarity to the contract – the interpretation of what goes to the root of the contract is decided by the parties rather than by a judge, who can only guess at their intentions; and (b) it drives the correct behaviour and sets expectations, by highlighting which part of the contract is most important to the respective parties.
For example, late payment, or failure to pay by a customer is a fundamental breach which would give the supplier a right to terminate. However, the supplier may wish to allow some contractual leeway, such as imposing late payment interest on outstanding amounts, a set-off right against anything the supplier owes the customer, or giving the customer a period or time to cure the breach before electing to terminate.
B. Mitigating risk
Remedies play a crucial role in mitigating risk and limiting liability under a contract. By using tools such as a liquidated damages clause – which makes a genuine pre-estimate of loss and provides for a settlement payment (or credit) for breach – parties will know, ahead of time, the cost of breaching their obligations, whilst at the same time allowing the contract to continue. Otherwise, the assessment of damages, and what damages can be claimed in lieu of termination, can be a time-consuming and uncertain proposition.
Likewise, a clause that puts an overall cap on liability ensures that parties can understand their maximum exposure and plan accordingly. Other remedies allow the contract to continue by providing alternatives to termination – such as a step-in right which allows the customer to appoint another supplier until the original supplier is a position to continue providing service, or a parent company guarantee that ensures that a parent company will be liable to pay if its subsidiary is unable to.
C. Dispute resolution
Termination of a contract should be a last resort. However, without remedies for breach explicitly stated in the contract, termination may be the only option available to the parties. Dispute resolution clauses – which provide a clear path of escalation up the management ladder allow the parties to explore commercial alternatives to termination, and also ensure that issues don’t go “legal” too quickly.
If this escalation fails, the parties may resort to binding mediation or arbitration as an alternative, although, in practice these processes can be almost as expensive as litigation. In addition, there are certain instances – like a breach of confidentiality or intellectual property rights – that may require a party to take immediate action to protect its interests.
Leaving remedies for breach of contract for the courts to determine creates uncertainty, unnecessary risk and significant cost. Agreeing remedies means that the parties have much more control over these factors and can agree mechanisms that allow the relationship to continue beyond the breach.