What happens when a contract is broken?

Failing to comply with a term of the contract is called a breach of contract. Generally, when you breach a term of the contract, the other party will be entitled to:

• monetary damages; and
• if the breach is serious enough (or if the contact explicitly states so), terminate the contract.

We will save the question of determining whether a breach allows a party to terminate the contract for another article. For now, we will explain what happens in terms of financial compensation after a breach of contract.

How are damages calculated?

The guiding principle when calculating breach of contract damages is the ‘compensation’ principle. You are only ever meant to be compensated for loss that you actually suffered, or will suffer, as a result of the breach – no more. In fact, the law specifically prohibits a party to make a ‘windfall’ from a contract claim (that is, to be put in a better position than if the breach never occurred).

For example, if your timber supplier flaked on you, and you then had to buy timber from a more expensive supplier, you can claim only the extra money it costs you to get the timber. The idea is that the law puts you in the same place you would be in if the breach never took place. You don’t get any extra compensation on the basis that the other party ‘did you wrong’.
There are also various other limitations on how you can recover money for breach of contract, including:

1. Remoteness – certain damages, such as consequential and indirect damages, are not recoverable under breach of contract.
2. The duty to mitigate – the party claiming under breach of contract has a duty to mitigate its damage. It cannot recover damages which it could have reasonably mitigated.
3. Limitation or exclusion clauses – professionally prepared contractsusually contain limitation provisions which state that a party is only liable for so and so damages.
4. Contributory conduct – if you somehow contributed to the contract being breached or to the loss being suffered, your compensation may be reduced.

Remoteness

When claiming for breach of contract, a party can only recover loss which is “reasonably foreseeable”. This a complex legal concept which will be explained in very basic terms here with an example:

• You sell someone a faulty car. The person now needs to pay for a new engine and wait 10 days for the repair.
• The cost of the engine is clearly foreseeable and you will have to pay it. You will also probably have to pay for that person’s transport costs over the next 10 days (taxis etc), because you knew that if he had no car he would have no way of getting around.
• However, let’s say that person was actually a fulltime Uber Black driver. He will now say that the fact the car was faulty means he will miss out on 10 days of wages!
• If that person never actually informed you that he was an Uber driver, this loss of wages will be considered ‘remote’. You could not have reasonably foreseen (on the information provided) that he will suffer this loss if you gave him a faulty car. You will not need to pay it.

What’s the lesson to be learned from this? Always make sure you tell the other party (in writing) about any damages you expect to suffer if they break the contract. Once you give them notice of a subsequent contract, it will not be deemed remote.

Mitigation

When you suffer loss from a breach of contract, you have a duty to try and mitigate your loss – namely, take all reasonable action to try and minimise that loss. For example, if you are a landlord and your tenant breaks the lease and leaves, you have a duty to try and mitigate your loss (lost rent) by getting in a new tenant straight away. You will not be able to simply recover the rest of the rent payment for the duration of the lease.

Mitigation is judged from a ‘reasonable’ perspective – so, a reasonable landlord will be expected to relist the property for rent within a few weeks (possibly allowing some time for the property to be fixed up a bit). However, mitigation does not need to be perfect – a landlord may still be viewed as reasonably mitigating if they accept a tenant paying a little bit less than the original, and they will be entitled to recover the difference. The landlord is also not expected to do anything in its power to mitigate the loss (for example, selling the property) – just what is reasonable and commercial.

Lastly, it sometimes happens that you end up losing even more money trying to mitigate a loss! For example, let’s say you cleaned up the property, and list it up on the market, but no matter what you do, no one will rent it. Well, the law actually says that you are entitled to recover any further loss you suffered in your reasonable attempts to mitigate the loss (key word being ‘reasonable’).[i]

Next time someone breaks a contract, make sure you don’t just sit there and let the loss accumulate. You have to try do something about.

Limitation of liability

• When contracts are prepared professionally by lawyers, they often contain some clauses which limit a person’s liability. This can be done in a number of ways:
• Liability cap – this would mean that a person will only be liable for a maximum amount under this contract, no matter what happens. It’s common for the amount to be equal to the total price of the contract.
• Exclusion clauses – some contracts expressly state that they do not accept liability for certain damages. For example, most mobile phone warranties state that there is no liability for water-damage, and most carparks don’t accept liability for damage to your car whilst it’s parked.
• Time limitations – there are some contracts (especially within supply chains) which give a customer a deadline to bring a claim. The classic example is when a supplier of goods gives its customer 7 days to inspect the goods and make any claim. Similarly, most clothing stores give you 7 or so to return an item.

Always check written contracts for limitation of liability provisions.

Contributory conduct

This is relatively self-explanatory. Your compensation may be reduced to the extent that you were actually complicit in the breach of contract, or in causing the loss. A person breaching a contract will often claim that your conduct somehow caused him or her to breach the conduct. Even more common is for a person to claim that some of the loss you suffered was not solely due to his or her breach, but due to your poor decisions or other conduct. An easy example of contributory conduct is failing to store goods properly or use them according to instructions.

Commercial issues

Often the biggest issue with breach of contract is that there is no actual damage suffered. If your painter shows up four days late, it is very difficult for you to prove to a court that there was real damage suffered by you. This is a commercial issue owing to the compensation principle.

Certain jurisdictions allow damages to be awarded on an ‘exemplary’ (or ‘punitive’) basis for certain conduct. Exemplary damages are damages not awarded to compensate, but to punish the party in breach and ‘make an example’ out of them. Such damages are not contingent on proof of damage, they are simply meant to deter further bad conduct.

US courts are notorious for handing out massive exemplary damages in respect of personal injury claims (eg, a person sues a shopping centre for failing to put a ‘wet floor’ signs and win millions of dollars). This practice has made civil liability lawsuits profitable in America and spawned the concept of ‘ambulance-chasers’. However, exemplary damages are incredibly rare in Australia. They are not available at all in relation to contract claims or negligence claims, which is why suing people is not a profitable activity in Australia. The strict adherence to the ‘compensation principle’ in Australian law means that even if you win a court case, you can only ever break even (and that’s before paying your legal fees).

Conclusion

A breach of contract entitles the aggrieved party to make a claim in damage (and sometimes, terminate the contract). There is a common misconception that suing for breach of contract might yield a high return. However, the principles of compensation, remoteness and mitigation ensure that it is very difficult for a party to actually make money from a claim. In a sense, the only real winners in a court case are the lawyers.