What is a breach of contract? How can it impact business?
Siemens Enterprise Communications, Inc. (formerly Siemens AG) is a German conglomerate and one of the largest corporations in the world. In May 1999, the company lost $5 million to a lawsuit filed against it by another Software company Affinitec. The latter claimed that Siemens had breached most of its contract conditions. Siemens, instead of honoring its contract, filed a counter case against Affinitec, but lost that case as well. Justice prevailed.
In a much lesser known and a more recent case back in 2015, a US-based rock quarry operator Bruening Rock Products, Inc., ordered four trucks from Hawkeye International Trucks. The trucks had to have a gross vehicle weight rating of 74,000 pounds so that Bruening could haul rock from its underground mines. Both the parties drew up a contract, mentioning requirements and fulfillment conditions quite clearly. However, Hawkeye’s trucks failed to perform as per the requirement, the wheel rims of some trucks had cracked, and the rims also malfunctioned – a factor that Hawkey had ignored at the time of contract drafting. Bruening, unable to bear the losses, filed a complaint against Hawkeye, who eventually had to pay an amount of $1,167,904.85 to Bruening for breach of contract.
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Breaching a contract is expensive. Regardless of the company’s size, loss of money is one of the many costs incurred in the event of a breach. It directly impacts the finances, operations, goods/service delivery, and goodwill of a company.
What is a breach of contract?
In general, it is easy to understand breach of a contract: two companies enter a written contract that details each of their responsibilities or actions. When either of the parties fails to fulfill what was promised in the contract, a breach of contract happens.
A breach of contract usually involves any one or more of the following conditions –
- The action promised in the contract was not performed as per the terms of the agreement
- The action promised was not performed within the specified period
- Action was not performed at all
When the damaged party seeks compensation for the losses incurred due to the breach, it is vital that –
- The contract must be valid (written agreement signed by both parties)
- Incorporates relevant legal elements to be enforceable in a court of law
- A clear explanation of how the other party breached the terms/conditions
- A notification is sent to the other party who breached the contract, granting the latter to fulfill it before the lawsuit is filed
Do oral contracts stand in court?
While a court of law enforces both oral and written contracts, it is often challenging to establish the validity of an oral contract. Many times, there are no witnesses to a verbal contract or any proof of contract. As a result, in case of a breach, it becomes hard to establish the cost of compensation.
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Impact of contract breaches on business
Effect on production and delivery of goods/services
A breach of contract automatically means that something which was promised earlier was not fulfilled. In a standard business operation, many parties and departments are involved within a process pipeline. When a vendor fails to deliver raw material, the production gets affected, incurring losses of labor or machine costs. When a company that promised to deliver a certain amount of goods or services fails to deliver, it directly affects the business of its client. While delivery failure a few times in a year can be compensated in some ways, permanent inability and lack of compensation for the same results in the breach of contracts leading to disruption of production or services.
The most visible effect of a breach is the way it affects and escalates costs. This is particularly massive in the case of real estate or large contractual infrastructure projects where one minor breach may result in huge losses. A metro rail project in a metropolitan city in India was delayed for several years since one of the parties in charge of approvals failed to provide them on time. It resulted in exorbitant losses to the company hired for construction. A vital factor in that particular case was the failure of one of the parties to locate the right contract terms at the right time and take action.
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An important aspect of efficient contract management is the fulfillment of legal compliances. When a contract is not honored, it often creates legal challenges. In the case of government projects, a company delivering services may be sued for non-compliance due to failure to honor the contract. In other cases, the contracting company may file a lawsuit against the vendor who breached the contract. While most businesses, who are aware of the legal consequences, may not breach a contract deliberately. More often than not, a breach is the result of either negligence or inefficient management of contracts.
Breach of contract is preventable
Most companies will not put themselves deliberately through a lawsuit. That means most of them do not wish to dishonor a contract. Breaches usually happen due to a poor contract management system, a factor that is completely preventable. Here’s how to minimize breaches in the future –
Aim for a unified contract management solution
When all contracts are in one place through a unified system that also provides easy access to contracts at any time, it is possible to foresee non-delivery or non-compliance of terms.
A unified system also has an automated notification system reminding respective parties to take relevant and timely actions. Most breaches are prevented when both parties know what is expected of them and when.
A good contract management solution is one that integrates AI capabilities in terms of analysis, predictions, and future insights. This leads to information-driven contract decisions, further preventing future breaches.
Rev[AI]: Extract contract metadata and intelligently capture terms and conditions, asset information, customer and supplier information, perform auto-discovery of SaaS subscriptions, and so much more.
In a world of automated, digitized services, it is not wise to lose or dishonor contracts simply due to lack of management. Today, there are intelligent contract management solutions that minimize and in some cases absolutely prevent contract breaches.