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UNIT 7: BREACH OF CONTRACT
Difficulties in providing a notion of breach of contract that is valid across history and different
legal systems it’s really difficult to provide a definition valid across time and space:
Path dependencies are very important to explain traditional legal rules and doctrines.
Many traditional rules and institutions differ in Civil Law and Common Law jurisdictions, even within those belonging to the same legal tradition.
However, the case Law of different jurisdictions uncovers some common patterns about the sort of issues that Courts find relevant for a finding of breach of contract and for the application of the appropriate legal remedies.
Spanish Contract Law provides a broad notion of breach of contract, since any behaviour that: - Departs from the specified behaviour in the contract in any way (time, quality, substance, etc.) Is not specially justified on legal grounds o Constitutes a legally relevant breach of contract o Opens (although not necessarily all of them) legal remedies for breach Traditional general rules for breach of contract in Spain: art.1098 and ff. CC.
The general benchmark (punto de referencia) to determine breach is the contract agreed by the parties themselves, and not external notions, but good faith and fair dealing (trato justo) may increase the obligations and duties of a party (see article 1258 CC).
The complete contract that the parties would have agreed, being by definition pareto-optimal, is the best of benchmarks to analyze breach intentions of the parties at the time of concluding the agreement are the relevant elements to discuss the contract itself.
The main element to discuss breach of contract is the contract (not only the written agreement, also incorporates other duties).
Typically the analysis of breach takes place in objective terms: - Subjective factors generally do not exclude breach, although they may affect remedies - In certain contractual areas, breach of duty and fault are generally required: o Professional contracts (doctors, lawyers, engineers, architects, auditors) o Management contracts: breach requires violation of a duty of care or a duty of loyalty.
Benchmark - - - Correspondence of behaviour undertaken by the debtor with due behaviour under the contract, as appears to be written, and duly (debidamente) interpreted and constructed.
In practice, the discussion about the existence of breach typically starts with a comparison of the actions that were due pursuant (de conformidad) to the contract (as written in the agreement, or as resulting from the task of interpreting and construing the complete contract, or of implying terms as a result of usage (uso) and good faith) and the reality of performance.
At least from a general standpoint (punto de vista), any discrepancy that could be found between the first term of the comparison −the ideal complete contract set− and the second −the real actions and outcomes (resultados)− may give rise to a finding of breach of contract (constatación de incumplimiento del contrato).
Example: Example: Supreme Court Decision May the 19th 1998 (Ar. 3381), J: José Luis Albácar López A contractor requested tiles of two different batches (partidas) from a tile (azulejo) producer. The problem arose when the colour of the two batches were not exactly the same, as it is nearly impossible to obtain the same tone in tiles that are produced in different firings.
Due to the differences in colour and the impossibility of using them in the same floor, the purchaser claimed there was a breach of contract. The Court disagreed: it was the purchaser who requested two different batches of tiles, and that was exactly what it got pursuant (de conformidad) to the contract.
The buyer was a firm in the construction business, so there was no need for the seller to specifically inform that the color of the two batches could be different, and the buyer had also failed to specify that the two batches were intended for the same flooring, when this information may have sent the correct incentives to the other party to disclose (revelar) the consequences of ordering tiles from two different batches.
Since no implied terms or duties should be read, the expressed terms in the particular contract would govern the required set of actions, and therefore no discrepancy was to be found with the actual behaviour of the seller.
- - - Notwithstanding (A pesar de) the fact that the contract should be the benchmark, there is a number of rules and doctrines both in Civil Law and in Common Law, that restrict certain consequences of breach to a sub-set of breaches of contract qualified by certain features.
For instance, termination (rescission) of the contract may be reserved under different legal systems to cases of serious or material breach that deprives (priva) a contracting party of substantial utility to be expected under the contract. This is the case of article 25 CISG: “Article 25 CISG: A breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled (tiene derecho) to expect under the contract, unless the party in breach did not foresee (previsto) and a reasonable person of the same kind in the same circumstances would not have foreseen such a result”.
Some remedies for breach (termination) are only applied in cases of fundamental or material breach. See, for instance, article 49.1.a) CISG: “(1) The buyer may declare the contract avoided: (a) if the failure by the seller to perform any of his obligations under the contract or this Convention amounts to a fundamental breach of contract; […]”.
To summarize: - Breach of contract has a broad definition.
- It includes a heterogeneous group of situations.
- Certain remedies or legal consequences for breach require a second stage analysis that forces to assess (oblige a evaluar) additional features or qualifications than the mere existence of a departure (desviación) from the actions that were specified in the contract.
Traditional classification Consequences of delay in performance: Art. 1101 CC: “Incurren en mora los obligados a entregar o a hacer alguna cosa desde que el acreedor les exija judicial o extrajudicialmente el cumplimiento de su obligación” “Mora” requirements: a) Obligation to transfer a good, to perform a behaviour and to avoid performing a behaviour.
b) Notice by the creditor to the debtor (“intimación”).
- Statement of will that has to be received by the debtor in order to have effects.
- Exceptions (art. 1100.2 CC): i. The contract or the legal system establish otherwise.
ii. Where taking into account the circumstances in which the obligation was created, the date to perform was considered relevant.
iii. Synallagmatic obligations: from the moment the other party performs c) Obligation is due.
d) Delay in performing is not excused by the debtor.
Legal effects of “mora”: a) It does not eliminate the duty to perform the obligation.
b) Debtor shall be responsible for damages caused by the delay (in case of monetary obligations: damages are compensated by paying interests).
c) Debtor shall be held liable (sera responsible) in cases in which the good that had to be transferred is lost or destroyed (“perpetuation obligationis”) (see arts. 1096.3 and 1182 CC) Breach of contract linked o the conduct of one of the parties: - Subjective factors: attribution of breach o Contractual fraud (“dolo contractual”) (including intentional brach of contract in Spanish law) one of the parts intentionally breach the contract. Rellevant because limitations of liability aren’t enforced.
Intentional breach in various legal systems may be considered as almost inherently fundamental or material. In Spanish law, it does not require a fraudulent intent do harm the other party.
The presence of intentional breach may affect the validity of liability waivers (renuncia) or limitations, and may also influence the scope of liability. The fact that the breach is fraudulent implies that the clauses of exoneration of liability are not binding upon (no son vinculantes para) the parties (article 1102 CC).
- Example: in a contract whereby (por el cual) the delivery (la entrega) of a certain good is agreed, the liability of the party who shall perform the delivery is limited to “x” euros for each day of delay in the delivery. Let us also imagine that the party obliged to make the delivery voluntarily delays it. So if the other party can proof that the delay has caused him damage of “x + y”, the limit of “x” which has been mentioned before, shall have no validity.
o Negligence or fault (“culpa o negligencia”): when the defaulting party (parte incumplidora) has not subjected to the preventive measures required in the contracts, in the applicable laws or according to the good faith.
General standard: Article 1104 CC: - “La culpa o negligencia del deudor consiste en la omisión de aquella diligencia que exija la naturaleza de la obligación y corresponda a las circunstancias de las personas, del tiempo y del lugar. Cuando la obligación no exprese la diligencia que ha de prestarse en su cumplimiento, se exigirá la que correspondería a un buen padre de familia”.
In certain contractual areas, breach of duty and fault are generally required: - Professional contracts (doctors, lawyers, engineers, architects, auditors…): negligence standard (lex artis ad hoc / specialized fault) - Management contracts: breach require violation of a duty of care or duty of loyalty.
o Strict liability (“responsabilidad objetiva”): In contract law, the promisor is typically liable for breach, even though the breach was not his or her fault. In other words, contractual liability is strict. For example, a construction company is liable for late completion (ejecución tardía) of a building, regardless of whether the construction company did its best to meet the deadline (para cumplir el plazo).
A legally relevant link exists between the breach and one of the parties. Divergence between reality and the agreement.
- Exceptions: o Force Majeure/“Act of God” o Impracticability/Impossibility/Frustration of purpose o Hardship/Change of circumstances/Rebus sic stantibus State of mind - - Relevant o Dolo o Negligence Not relevant o Strict Liability Defences / Exceptions: Perfectly complete contracts would contain terms that explicitly allocate (asignan/distribuyen) all risks. Explicit allocation (asignación/distribución) of risk requires costly negotiating. The cost of negotiating must be balanced against the benefit from explicit allocation of risk. On balance, the cost of negotiating over remote risks may exceed the benefit. Consequently, efficient contracts have gaps concerning remote risks.
For instance, in some circumstances, physical impossibility of performance excuses nonperformance: - - The estate of a famous portrait painter is not liable if death prevents the artist from completing a contract to paint someone’s picture.
A manufacturer may be excused from fulfilling (cumplir) its contracts to deliver goods because lightning (rayo) ignited (encendió) a fire that destroyed her factory. The burning of the factory is an “act of God” or force majeure.
Breach is excused if performance became illegal before it could occur: a shipping company is excused from its contract to carry civilian cargo in time of war if the government commandeers its ships to carry military cargo.
In other cases, performance is physically possible and economically impractical (inviable): changes of circumstances might make performance extremely burdensome (gravosa/pesada) for one of the parties.
When one of such risks materializes, parties may need to allocate it ex post. Legal systems include several rules or doctrines that may apply to the task of allocating remote risks or unanticipated contingencies (different depending on the country): - Force Majeure/”Act of God”/”Caso fortuito”/Unforeseeable circumstances - Impossibility/Impracticability/Frustration of purpose - Hardship/Change of circumstances/Rebus sic stantibus Contract law and economics advocate the reduction of social waste of resources (reducción de los residuos social de los recursos) and in doing that it uses a theory of efficient risk-bearing.
This idea is mainly used in the field tort (responsabilidad civil) law or accident law but it may also be applied to the allocation of unanticipated risks in contract law.
Starting point: Assumption 1. Transaction costs preclude a bargain (negocio) to allocate a risk among the people who affect it assume that the contracts are incompleted.
Assumption 2. One person can eliminate the risk at lower cost than anyone else or any combination of people. That is, efficiency concerns demand that only one person should take precautions against the risk or contingency this person is the superior risk bearer (portador/poseedor) or the cheapest cost avoider. We may assume that one of the parties of the agreement may reduce this risk at a lower cost than the other party.
SOLUTION Holding the person liable who can eliminate the risk at least cost assigning liability to the party who can bear the risk that performance becomes impossible at least cost.
Factors used in determining the superior risk bearer: 1) People can often take steps (tomar medidas) to decrease (disminuir) the probability that performance becomes impossible or to reduce the losses from breach.
- - An elderly and ailing painter might delay other work in order to complete a portrait as commissioned (por encargo).
The ship’s owner might alert the customer to the need for alternative supplies (suministros) in the event that war causes the government to commandeer (apropiarse) ships.
The factory owner might install a sprinkler system (sistema de riego) to reduce the damage caused by fire.
These considerations suggest that a risk should be assigned to the party who can take precautions to reduce it at least cost.
2) In cases in which no one can take precautions to prevent or minimize risk, someone may spread (distribuir) it. Example: an earthquake (terremoto) may prevent a seller from delivering goods on time: no one can prevent earthquakes, but people can insure against them.
Besides insurance contract, the investors in a factory subject to an earthquake hazard can spread risk (distribuir el riesgo) by having premises (locales) in different locations: risk is cheaper to bear when spread than when concentrated.
These considerations suggest that risk should be assigned to the party who can spread it at least cost, by insurance or other means. In some situations there will be one party that can do something to spread the risk (may have better access to insurance).
Force Majeure / “Act of God” Section 1105 of the Spanish CC “unless established otherwise in the contract, a party shall not be liable for damages arising from an unforeseeable event or from an event that was foreseen (previsto) by the parties at the time of contracting but was nonetheless unavoidable”.
Unless is stablished in the contract, a party shall not be liable for damages arising from an unavoidable event.
Example: Transatlantic Financing Corporation v. United States 363 F.2d 312 (D.C. Cir. 1966): The Plaintiff contracted with the Defendant to ship wheat (trigo) from Texas to Iran. The contract specified the destination, but not the route. The ordinary route would take the Plaintiff through the Suez Canal. However, due to armed conflict, the Suez Canal had been blocked by Egypt. The Plaintiff therefore proceeded along the route around the Cape of Good Hope. The Plaintiff then sued (demandó) to recover the additional costs of taking the longer route.
- Because of the Suez Canal problem, the ship hat to take an alternative route (more costs for the owner of the ship), the plaintiff ask to recover this alternative money.
The Court understood that the owner can claim the force major to avoid paying.
o Exception: Situations of strike are not situations of force major.
Impossibility / Frustration of Purpose Performance becomes physically or legally impossible. In some cases, a contingency that renders performance impossible also frustrates the purpose of contracting by destroying a “basis assumption on which the contract was made”. Because of this impossibility, the causa is destroyed.
Obligations to deliver a good: Art. 1182 CC “Quedará extinguida la obligación que consista en entregar una cosa determinada cuando ésta se perdiere o destruyere sin culpa del deudor y antes de haberse éste constituido en mora”.
Art. 1183 CC “Siempre que la cosa se hubiese perdido en poder del deudor, se presumirá que la pérdida ocurrió por su culpa y no por caso fortuito, salvo prueba en contrario, y sin perjuicio de lo dispuesto en el artículo 1.096”.
Art. 1186 CC “Extinguida la obligación por la pérdida de la cosa, corresponderán al acreedor todas las acciones que el deudor tuviere contra terceros por razón de ésta”.
- A (seller) B (buyer) Buyer pays the price in advance The car is destroyed because of a fire caused by C The contract cannot go on A has the 5.000€, but B has nothing (no car, no money) A has to pay nothing C has to pay B the 5.000€ Obligations to perform a behaviour Artículo 1184 “También quedará liberado el deudor en las obligaciones de hacer cuando la prestación resultare legal o físicamente imposible”.
Example: Coronation cases (Krell v Henry  2 KB 740 and other cases) We now consider a contingency that destroys the contract's purpose. A coronation parade was planned for June 1902, in London, following Edward VII’s marriage to Queen Alexandra. Many owners of property along the parade route leased rooms for the day to people wishing to observe the ceremony. When the king’s illness caused the parade to be postponed, many people refused to pay the rent, and some of the property owners sued to enforce the contracts. Most of the courts held that the contracts were unenforceable because their purpose was destroyed by postponing the ceremony.
Frustration of purpose or impossibility doctrine provides a default rule to allocate losses caused by contingencies that make performance worthless. Such performance is meaningless in relation to the purpose that induced the parties to make the contract.
If a contingency makes performance meaningless (sin sentido), a solution may be to assign liability to the party who could bear the risk at least cost. In the coronation cases: the property owners who rented rooms could completely eliminate their losses caused by postponement of the coronation parade by renting the rooms a second time for the rescheduled (reprogramado) parade.
- Wedding ceremony: many citizens rented some apartments in order to watch the parade of the ceremony.
Ceremony hat to be postpone because the king went ill.
Some of the citizens decide not to pay the apartments The Court accept it in case it is demonstrated that they are there in order to see the parade.
Hardship (dificultades) / Change of circumstances / Rebus sic stantibus This doctrine applies to long-term contracts and those not subject to a term. Something unexpected happened that makes performance one of the parts (e.g.: Change on the price).
In the context of long-term contracts, an unexpected change of circumstances may fundamentally alter the equilibrium of a contract resulting in an excessive burden (carga excesiva) being placed on one of the parties involved in the agreement.
The situation existing at the conclusion of the contract may subsequently have changed so completely that the parties, acting as reasonable persons, would not have made the contract, or would have made it differently, if they had known what was going to happen.
Different legal concepts deal with this problem of changed circumstances: Hardship, clausula rebus sic stantibus, Wegfall der Geschäftsgrundlage, impracticability, prestazione di una delle parti è divenuta eccessivamente onerosa.
The concept of hardship in Common Law systems is usually discussed in the context of hardship clauses, which are frequently introduced into contracts in international trade.
Art. 6.2.2 UNDROIT Principles: “There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished, and (a) the events occur or become known to the disadvantaged party after the conclusion of the contract; (b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract; (c) the events are beyond the control of the disadvantaged party; and (d) the risk of the events was not assumed by the disadvantaged party." Example: Maple Farms Inc. v. City School District of Elmira, 76 Misc. 2d 1080, 352 N.Y.S.2d 784 (Sup. Ct. 1974).
Agreement by a milk supplier, Maple Farms, to supply milk to a public school district for the school year beginning in September 1983.
Due to general inflationary trends in the United States, unanticipated crop failures and an agreement by the United States to sell substantial amounts of grain to the Soviet Union, the price of raw milk increased 23% within six months of the date of contract.
The supplier asked to be relieved (disminuir) of the contract. On the school district’s refusal, the supplier sued (demandó) for declaratory judgment excusing further performance.
The court established three requirements before non-performance is justified on the ground of hardship: (a) A contingency — something unexpected must have occurred.
(b) The risk of unexpected performance must not have been allocated either by agreement or by custom.
(c) Occurrence of the contingency must have rendered performance commercially impracticable.
In the Maple Farms case the court held the supplier to the contract. The court did not agree that the contingencies were totally unexpected given a 10% increase in milk the previous year and the general inflationary trend. As to allocation or risk, the court deemed (considera) the risk of increase in price to be allocated to the supplier. The purpose of the fixed price contract was to guard (protegerse) against price fluctuations and the supplier had not bargained for an exculpatory clause to excuse it from performance in the event of an abnormal increase in milk prices.
- Milk in schools supplier Costs of this supplier increased The supplier decided to finish the contract The other part doesn’t accept this changes Supplier went to the Court to do an excuse (the change of conditions excuse them) - The judge understood that the risk was not really enforceable Example: Aluminum Company of America (ALCOA) v. Essex Group, Inc Aluminum Company of America (ALCOA) (plaintiff) agreed to provide Essex Group, Inc. (Essex) with its long-term needs for aluminum. The price for the aluminum was based upon a formula that would allow a portion of the price to escalate in accordance with the Wholesale Price Index (WPI). The contract provided a maximum price that Essex would pay in the event the WPI caused the price to escalate excessively. After some time, ALCOA’s costs increased substantially and the price provided in accordance with the WPI was not sufficient to cover those costs (about $70 million). ALCOA filed suit, seeking reformation or adjustment of the contract. ALCOA argued that it was entitled to relief under the doctrines of impracticabilityhardship.
Court: granted relief to Alcoa and amended the formula to determine prices in detriment of Essex.
In the case of Spanish law, hardship or rebus sic stantibus doctrine is court-made construction Because of its vagueness and lack of clarity, the doctrine fell out of disfavour in the 19th century in Continental Europe, when liberal theories emphasized freedom of contract and the principle of sanctity of contract (pacta sund servanda).
It was then resurrected in the 20th century as a result of the disruptions caused by the First World War and in Spain the Civil War (1936-1939). See Supreme Court Decisions of December 14th 1940 (RJ 1940\1135) and May the 17th 1941 (RJ 1941\632).
Afterwards, Supreme Court Judgment of May the 17th 1957 (Justice: Francisco Eyré Varela. RJ 1957\2164) described the main elements of the doctrine: (a) Circumstances at the time of performing the contract have extraordinarily changed in comparison with the ones concurring at the time of the contract conclusion; (b) Exorbitant disproportion, beyond all calculations, between the ex post surplus of the contracting parties that results in the collapse of the equilibrium created by the agreement; (c) Change of circumstances is the radical result of unforeseeable events; (d) Parties lack other alternative means to remedy the negative result (requirement included in Supreme Court Decision of June the 6th 1959 (RJ 1959\3026)).
Is the financial and economic crisis an event that meets these requirements? Traditionally, the Spanish Supreme Court held that: “[N]o se infringe el art. 1184 del C. Civil al concurrir culpa del deudor al no prever la existencia de una situación de riesgo que era posible anticipar mentalmente, dado que las fluctuaciones del mercado son cíclicas como la historia económica demuestra”.
Supreme Court Decision of January the 17th 2013 marked a turning point: In this Judgment, the Spanish Supreme Court discusses the foreseeability of the current economic crisis and its consideration as a factor resulting in a change in the circumstances in application of the rebus sic stantibus doctrine.
In 2008, a couple brought a lawsuit against a developer seeking termination of a real estate sales contract with ground on the impossibility to qualify for a mortgage loan and therefore to pay the price.
The developer replied to the lawsuit and also filed a counter-lawsuit (reconvención). In this counter-lawsuit, the developer claimed specific performance (=order to the plaintiffs requesting payment of the remaining debt). The plaintiffs replied to the counter-lawsuit and alleged, inter alia, that the rebus sic stantibus doctrine should apply.
Supreme Court: “[U]na recesión económica como la actual, de efectos profundos y prolongados, puede calificarse, si el contrato se hubiera celebrado antes de la manifestación externa de la crisis, como una alteración extraordinaria de las circunstancias, capaz de originar, siempre que concurran en cada caso concreto otros requisitos (…) una desproporción exorbitante y fuera de todo cálculo entre las prestaciones de las partes” This is mostly left to courts and arbitral tribunals: the assessment is only made on a case-bycase basis. In some cases, the current financial and economic crisis has been the ground used to apply the rebus sic stantibus doctrine and to hold a contract to be terminated or amended by the judges.
Effects of the doctrine application: - Adaptation/renegotiation of contracts: depending on the nature of the hardship, involve a price adaptation in order to distribute the losses between the parties.
- Termination Renegotiation of contracts Hold-up risks Renegotiation is not always possible and a judge has to decide hold-up risk.
Hold-up refers to situations in which a party to a new or an existing contract accedes to a very disadvantageous demand due to the party’s being in a circumstance of substantial need.
Example: James Gandolfini, star of the hit television series, The Sopranos, threatened to stop filming new episodes unless his contract with HBO was renegotiated for a significantly higher amount than the $400,000 per episode that he had been receiving. HBO agreed to an increase, purportedly bringing Gandolfini’s per episode payment to over $800,000.
The hold-up problem is central to the theory of incomplete contracts. It shows how the renegotiation of contracts that may result from incomplete agreements can lead to underinvestment (falta de inversion) of specific assets (activos específicos).
Example: Company A is a supplier of components in a contractual relationship with a manufacturer, Company B. Company A has to decide whether to invest in modifying its plant to adapt it better to the production requirements demanded by Company B.
- The investment is efficient: for instance, by investing 50 u Company A would reduce production costs in 100 u.
- The investment is relation-specific: the adapted plant is only useful for producing components for Company B.
If parties may renegotiate the contract between Company A and Company B: - Company B may hold up by threatening termination of the contract, which would result in Company A losing its investment.
- In order to avoid this loss, Company A would be willing (estaría dispuesto) to accept a reduction of prices paid by Company B. In fact, it would be willing to accept any price>0, because otherwise it would not have any chances to use the plant.
Anticipating this negative outcome, Company A would have no incentives to make efficient specific investments.
Historical example: the Fisher Body – General Motors supply agreement.
- General Motors supply agreement with the Fisher Body.