How to Handle Contractual Disputes

Date: July 26, 2016

In our last post we addressed the basics of how to form a binding contract. Now we will address common contractual disputes. Yet it is worth emphasizing that many contractual disputes can be avoided if the parties take the time to work out essential details ahead of time. Once again, it is highly advisable to work with legal counsel when negotiating major contracts, and or to have an attorney work with you in preparing a form contract that you may use with your customers. Such steps may minimize your risks and ensure that you are in the best possible position should a dispute arise. 

Common problems with contract performance

The NFIB Small Business Legal Center receives dozens of calls each year from business owners struggling with contractual disputes. The most common issue is non-payment. But we also hear from business owners who are dissatisfied with the way things are going under an existing contract. We’ll address each of these common concerns—outlining the basics of what you should know about contractual breaches.

But just to put things in perspective, most contractual disputes occur in the “performance stage.” In other words, one party is unhappy either because the other isn’t paying or because they are unsatisfied with the services they are receiving. Or perhaps they find that they’ve agreed to pay fees or to accept other burdensome terms that they did not fully understand at the time they entered into the agreement.  So what are your options in such a scenario? 

One option is to begrudgingly continue with the contract. And of course, you can always choose to do business with someone else in the future, or you may insist on better terms next time. But another option is to try to renegotiate the contract. While this is not always a viable option, there are times when both sides are willing to come back to the negotiating table. In some cases the parties may even agree to the “rescission” of a contract (i.e., an act to dissolve a contract).
 
Are There Grounds to Rescind the Contract?

As discussed in our previous post, a contract requires a “meeting of the minds” as to key terms of an agreement. So in some special cases there may be grounds to ask a court to for rescission of a contract. For example, one might be wise to talk to legal counsel about their options if they believe they were fraudulently induced into signing the contract based on false representations. 
But contracts are generally presumed binding and parties are assumed to be aware of all terms in a written contract. Moreover, courts will not usually allow extrinsic evidence that the parties meant for the contract to include terms that were not included in a written agreement. For more discussion on this point, check out our guidance for dealing with credit card processors.

Know Your Rights: Start by Reading the Contract

With that said, it is always prudent to go back and read your contract as a first step whenever you have a potential dispute on your hands. In some cases the contract may specify that the agreement may be rescinded under certain circumstances. So this might give you an out. 

But perhaps you simply want the other party to carry out their side of the bargain. Or maybe you seek to dispute some charge that the party is insisting you must pay, or some other aspect of your relationship. In these cases, your rights are governed almost always governed by the contract. So you must look to see exactly what terms you agreed upon. If the terms are ambiguous it may be necessary to get a lawyer involved; however, in other cases a quick review of key provisions should answer your questions as to your obligations and rights.

What to Do When Someone Threatens to Breach the Contract

Major problems can arise if one party is threatening to walk away from the contract. Or perhaps they may proceed with providing certain services, but are threatening to repudiate other responsibilities under the agreement or refusing to satisfy certain conditions. For that matter, innumerable problems might arise—from your contractor using a lower grade material than you wanted, to simply performing shoddy work. Or maybe your landlord is trying to tell you that you cannot use part of the property that you have leased.
In these cases, you may be able to resolve matters through negotiation. Of course another option—if things are serious—may be to ask an attorney to write a letter. To be sure, a strongly written letter from an attorney can go a long way toward bringing people to their senses, or the negotiating table. Of course that may also add unnecessary strain if you trying to maintain a friendly working relationship. Yet that is not to say that you should shy away from consulting legal counsel behind the scenes as disputes arise. On the contrary, it is important to consult with legal counsel early for reasons that we will explain. 

And of course, in some cases it may be acceptable to overlook issues for the sake of maintaining a healthy relationship—although it is probably always a good idea to have open communication about your mutual expectations. For example, suppose that you’ve contracted to have “top-rate” produce delivered every other morning at 5AM. Perhaps the company with whom you have contracted occasionally delivers less than stellar produce, or is a bit late in these deliveries. In these cases you might reasonably seek negotiate a discount, and or you might simply remind them of their obligations. 

But supposing that this becomes a continued pattern, you might have to take a more serious tone. One options is to seek a formal “assurance,” that the other party will live up to its contractual obligation to deliver “top-rate” produce on the previously agreed upon schedule. The idea is that the party seeking an “assurance” is (theoretically) allowed to stop performance of his or her end of the bargain—unless and until the allegedly breaching (or soon to be breaching) party provides adequate assurances that the contract will be performed as originally contemplated. 

However, this is not to be done lightly. You are only justified in withholding performance of a contract if you have an objectively reasonable ground for believing that the other party intends to breach the contract. And the risk is that a court might hold that you are in the wrong—which would make you the breaching party. But of course, it is generally advisable to consult with an attorney before taking such action.

[We offer further guidance in this post on dealing with delinquent debtors. When someone is late on their bills, this is a good time to consider seeking an assurance that they will satisfy their end of the deal. It may be wise to stop working if someone is refusing to pay on schedule.]  

Can I Breach my Contract?

Yes – It is usually possible to breach a contract. But it is rarely advisable. There will almost always be a cost for doing so—including reputational costs. For one, the other party may be entitled to damages at law. To be sure, when you enter into a binding contract, you are entitled to the value of your bargain. Thus while it may be efficient (and even rationale) to breach a contract under certain conditions, you may very well end up having to pay something to the other party. 

Of course the prospect of paying money damages will almost always counsel against breaching a contract because it will eat away from whatever cost-savings you are hoping to achieve by walking away from your original agreement. And that is to say nothing of the exorbitant costs that you may have to pay in legal fees if litigation ensues. For that matter, you may also be on the hook to pay their attorney’s fees in such a case. (Conversely, an effective way to discourage breach of contract is to include contractual terms requiring a breaching party to cover attorney’s fees as may be necessary to collect on payments or to force performance). 

Moreover, in some cases, a court might still require you to perform your side of the bargain. This is remedy is available in cases where monetary damages will not suffice to make a contracting party whole. For example, suppose that Jack offers to sell a commercial facility to Diane, which she needs for a planned expansion of her business. If Jack backs out of the deal, she might have to find another seller and might end up paying more. Accordingly, she might thereafter seek to have Jack pay the difference (i.e., monetary damages). But in this case she might instead ask the Court to order Jack to sell the property as they had agreed (i.e., “specific performance”) because it may be that there are no similar properties available on the market in their community. 

What if the Other Party Breaches?

Negotiations and Settlement: Depending on the circumstances, it may be reasonable to allow a minor breach—especially where you want to preserve a long-term relationship. In those cases it may be best simply to make clear your future expectations, and or to warn that you will not tolerate breaches in the future. More often, in these cases the dispute can be resolved through negotiations. 
To be sure, the vast majority of contractual disputes resolve in settlement of some sort. And for many reasons it is often best to try to find a compromise. As noted above, you might accept a shipment of less than perfect produce if the other party agrees to give you a discount for that delivery. But especially with high dollar controversies, it may be necessary to work out a more formal agreement to resolve disputes. 

Since a settlement is in itself a contract, it is generally advisable to work with legal counsel. And, once again, it is important to realize that tensions ratchet up when you begin threatening litigation. But that may be necessary in certain cases. Once again, a well written letter from an attorney can go a long way in resolving a dispute in many cases. But if that fails, it may be time to either consider working with a mediator, or bringing a lawsuit.

Bringing Legal Action: You are within your rights to sue over a material breach.  But litigation should be an option of last-resort. Indeed, lawsuits are expensive and the parties to the suit will almost never leave on good terms. So before filing suit, you should consider: 1) The amount of money in controversy relative to the cost of litigation; 2) your ongoing business relationships, 3) what you ultimately hope to accomplish, and 4) whether your contract includes provisions concerning potential payment of attorneys’ fees in cases of breach, or otherwise. You should absolutely consult an attorney. But at the end of the day, you must make a judgment call as to whether it is worth pursuing a lawsuit—bearing in mind that most lawsuits end in settlement.

You should also remember that lawsuits can be long and drawn-out affairs. So when consulting with an attorney, you should seek candid advice about “best potential outcomes.” And remember, there is usually a risk. An honest attorney will almost always speak in terms of probable outcomes (i.e., this is a strong or weak case). 

Are the Alternatives?

Once again, it is always possible to negotiate a settlement. And one way to do this is to agree to binding arbitration—wherein both parties agree to have a mutually selected arbitrator decide the case instead of a judge. This approach can potentially save a lot of money because arbitration proceedings are much more efficient than traditional lawsuits. Moreover, this may be a much faster way to resolve the controversy.

You may also want to consider including provisions in future contracts requiring binding arbitration for these same reasons. But bear in mind, if you agree to binding arbitration, you will not be able to go to court unless both parties agree to waive the arbitration provision. Only in extraordinary cases will courts invalidate arbitration agreements between commercial parties. However, some states (e.g., California) are more prone to invalidate arbitration agreements between employers and employees. And it is worth repeating: It is always best to work with counsel if you are considering arbitration as an option.

Do I Have Any Duties to the Breaching Party?

While you are within your legal rights to seek enforcement of a contract, it is important to bear in mind that you generally have a duty to mitigate your damages. This means that you need to find a way to lower or offset the amount of damages you are seeking to recover from the other party. For example, suppose you have entered into a commercial lease with a tenant who is now seeking to break the lease. Technically the tenant is on the hook to cover the agreed upon rent through the entire term of the agreement; however, your duty to mitigate damages requires that you actively seek out another tenant. Thus you might minimize damages by finding someone else to take over the lease. The tenant will owe you something, but his or her liability is capped once you find a replacement tenant.

To further illustrate the duty to mitigate, let’s consider the case of Jack and Diane. They have previously agreed to a contract under which Diane will sell 1,000 units of cement to Jack at $5.00 per unit. But, let’s assume that in the course of performing the contract, Diane’s costs go up because a raw component that she needs for making cement becomes extremely expensive. 

At this point, Diane may decide that she can no longer supply Jack with cement at $5.00 per unit. Diane might choose to breach the contract and stop supplying cement. Diane had already supplied jack with 750 units of cement, so Jack only needs 250 more. He needs these remaining shipments in order to complete a football stadium that he is under contract to build for the City. After all, he could potentially be sued for breach of contract if he doesn’t complete that project on time. 

In this case, Jack should aim to mitigate his damages. Jack is going to need to seek a substitute contract for the remaining 250 units of cement. He must make a reasonable effort to find another cement supplier. He might enter into negotiations with Jerry at Grayful Bed Cement Co. They may ultimately agree upon a contract in which the Grayful Bed will supply Jack with 250 units of cement at $8.00 per unit. 

But of course, Jack has suffered damages as a result of Diane’s breach. He ended up having to pay $750 more to complete his project than he would have had to under the original agreement. He was forced to pay $3.00 more per unit (for 250 units) than he had originally bargained for. Accordingly, Jack may pursue a claim for $750 in damages in a suit against Diane, and pursue any other remedies that he may be entitled to under the contract.

Time is of the Essence

Remember that the clock is ticking. If you have an active dispute, it is better to consult legal counsel early. Otherwise, you may prejudice your case. To be sure, every state sets out different timelines for when a lawsuit must be brought. For example, many jurisdictions have a two year statute of limitations for the collection of a debt—usually running from the payment was last received.
 
Overview

It is always best to try to resolve contractual disputes through negotiations if at all possible. Always go back and review the original agreement. And always consult a trust attorney about your legal options. 

*This article does not provide legal advice. Employers are advised to retain counsel from a trusted attorney with experience in employment law.  
 

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