Breach of Contract Consequences & Penalties

  • Breaking, or breaching a contract is a serious action that can be costly both financially and relationally to both parties. 
  • As one might expect, consequences of breaking a contract occur when one party or another, or both, does not keep one or more of the agreed-upon terms of the contract. 
  • One of the most common ways damage occurs is via monetary damages associated with a contract breach, but there are other consequences that should be considered as well when determining next steps and resolving a contract dispute. 
  • Litigation to remediate losses can be costly to both parties. It is essential to know the consequences of breaking a contract before you pursue a lawsuit or consider breaking a contract yourself.

What Is a Breach of Contract?

A breach of contract occurs when either one or both parties fail to fulfill their part of a contract. 

Not all violations are equal. There can be either a partial breach, where only some of the terms are not met, or a complete breach, where the entire agreement is not upheld. 

There are also different types of breaches, where material breaches go to the core of the agreement while an immaterial breach does not affect the contract's primary purpose.

What Are 4 Types of Contract Breaches?

There are 4 main types of contract breaches:

  1. Material breaches: These are serious because it means the offending party did not perform the duties outlined in the contract. The other party to the agreement can sue and seek damages in court. Material breaches can also be minor breaches, which are less impactful and easier to negotiate or mitigate outside of court.
  2. Fundamental breaches: These are breaches that allow the afflicted party to halt contract performance and sue for damages.
  3. Anticipatory breaches: These happen when the complainant can prove that the other party behaved in a way that showed they were not going to fulfill the duties outlined in the contract.
  4. Partial contract breaches or immaterial breaches: These happen when one party fails to uphold one of the terms of a contract, but the term is negligible and doesn't cause the whole contract to fail.

To take a breach to court, you must prove the following:

  • A contract exists.
  • The contract was broken.
  • You lost money.
  • The violating party was responsible.

Litigation is costly and time-consuming. There are plenty of contract disputes but not all lead to a lawsuit. 

Regardless of the type of breach that occurs, legal counsel should be consulted to determine your next legal step according to what happened.

What Happens After a Contract (in General) Is Breached?

After a contract is breached and litigation initiated, the courts often try to fix the situation by making the damaged party whole. Sometimes, however, the damage amount is hard to compute. 

There are less expensive ways to mitigate a breach other than court. 

ThreeTwo alternate dispute methods include the following out-of-court options (you may include in your contract):

  1. Negotiation
  2. Mediation
  3. Binding arbitration

Negotiation is an informal process that occurs between the two parties where the goal is to come to a new agreement about the work, what will be delivered, and the timelines. Sometimes, though, the work product is so substandard or outside the possibility of being delivered that the next level is needed.

Mediation is a process by which both parties agree to engage in conversation with one another with an unbiased third party present. This third party could be hired by one party, often the non-breaching party, or could be court-ordered before the court agrees to hear and spend time on the case.

Arbitration is a more formal process than mediation, where the third party arbitrator hears both sides of an argument and makes a determination that is legally binding on both parties. Unlike a court order, the arbitrator is unable to impose sanctions or penalties, but the determination is legally binding and will stand up in court.

The final step to resolving a breach of contract is to take it to court, where a judge will hear both sides and make a determination.

How Does a Breach of Contract Impact a Small Business?

Breaches of contract in business can affect any size business, but they are especially hard felt for small businesses.

This is for a few reasons:

  1. Small businesses have smaller budgets and margins within which to make mistakes. Losing that money and still not having anything to show for it can be a death blow to a small business.
  2. Small businesses need to move faster than their larger competitors in order to compete. If a contract is breached and the work is not up to quality standards, the small business loses their velocity advantage for a period of time.
  3. Small businesses usually do not have in-house legal counsel, and so litigation can be extra costly as well as distracting and a waste of time.

Because of these reasons, small businesses are especially at risk when contracts are breached.

What Can Happen if You Breach a Sales Contract

When a sales contract is breached, it can come with harsh consequences that can happen to either party — the buyer or the seller. 

The Uniform Commercial Code establishes laws regarding commercial business transactions. According to this code, a seller-induced breach occurs when the product does not perform as described or the seller did not deliver the product per the agreement. If a product did not perform as expected or did not arrive timely, the buyer may have some recourse.

Not all late delivery counts as a breach of contract, however. Even when you receive something late, ask the following questions:

  • Did the breach cause you significant unanticipated loss?
  • Was the breach within the breaching party's control?
  • Did the breaching party act fair and in good faith?
  • Can you receive compensation for the breach, according to their terms of service?
  • Is the breaching party known for handling situations where there is a breach?

A buyer can sue if the seller fails to live up to obligations, with the amount of restitution depending on the amount of loss. Many times, an arbitration clause is included in the contract to minimize litigation costs, or define who will pay legal fees, for both parties. In that case, the seller and the buyer must follow the arbitrator's recommendation.

Remedies for a Breach of Contract

Under the law, once a contract is breached, the guilty party must remedy the breach. The primary solutions are damages, specific performance, or contract cancellation and restitution.

  • Compensatory damages: The goal with compensatory damages is to make the non-breaching party whole as if the breach never happened.
  • Punitive damages: Though rare, punitive damages can be awarded when the breaching party acted egregiously. The non-breaching party receives a payment beyond the damaging amount.
  • Nominal damages: When the non-breaching party did not suffer a monetary loss, the court or the arbitrator may award nominal damages as a token award.
  • Liquidated damages: There are situations where both parties outline costs in the contract. This is known as liquidated damages. The damage amount must be a reasonable estimate of actual damages.

It is always advisable to try to remedy contract disputes without court involvement, since litigation can be costly. We also highly recommend using a lawyer to look over contracts before they are signed to avoid misinterpretation by you or the other party that results in unneeded court and legal costs. Doing so can prevent you from sending a contract that lacks a termination clause or other important pieces that only a lawyer will recognize.

Need Help With A Breached Contract?

If you need help with reviewing a possible breached contract, you can post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.