Fundamental breach: Calling time

Every breach of contract entitles the innocent party to claim damages to compensate it for any losses sustained as a result of the breach. Generally, breach of contract by one party does not entitle the other party to stop performing its obligations under the contract. There are, however, exceptions to this rule:

• Where the contract specifically states (or it can be implied) that breach of a particular contractual term entitles the other party to treat the contract as being at an end
• Where the breach of contract effectively deprives the innocent party of the whole benefit of the contract; in other words, where there is a fundamental breach.

If a fundamental breach occurs, the innocent party can either elect to treat the contract as being at an end and pursue the other party for damages or it can waive the breach and continue with the contract, although its right to seek damages remains.

What happens if you believe that the other party to your contract has committed a fundamental breach by, for example, walking off the site so that you then lock the site gates to prevent them returning, but it transpires that they have not committed any such breach?

You have then committed a fundamental breach yourself.

Vivergo’s action in barring Redhall from the site was itself a fundamental breach and the court found that Redhall was entitled to pursue Vivergo for damages rather than the other way round

Consequently, in practice often both parties will accuse the other of having committed a fundamental breach, so liability for what may turn out to be substantial damages rests on the determination by the court of very fact-specific and often complex issues.

The recent case of Vivergo Fuels Ltd vs Redhall Engineering Solutions Ltd [2013] is a good example of just how tricky these issues can be.

Vivergo contracted with Redhall in 2010 for Redhall to carry out mechanical and piping work at a new bio-fuel plant. Vivergo alleged that Redhall committed a material breach of contract (a ground for termination under the contract) by failing to provide a revised programme and that consequently Redhall was failing to proceed regularly and diligently with the works. Vivergo sought to terminate Redhall’s contract and barred it from the site.

Having reviewed the facts, the court concluded that in the second half of February 2011 Redhall was not proceeding regularly and diligently and that this would allow Vivergo to serve notice under the contract. The court then reviewed all of the letters that Vivergo had sent to Redhall upon which Vivergo was relying as the appropriate notices. The court came to the conclusion that only one of these letters was sufficient notice to Redhall that it was in breach of the contract. However, a breach of this contractual obligation was linked to a notice period within which Redhall had the opportunity to rectify its breach. If Redhall did not remedy its breach within 14 days, Vivergo could serve a second notice terminating Redhall’s employment.

Redhall in fact did manage to rectify its default within the 14 day notice period and consequently Vivergo was not entitled to terminate using the contractual mechanism.

Could Vivergo terminate the contract under common law? The court decided that Redhall’s failure to proceed regularly and diligently with the works did not evidence an intention not to be bound by the terms of the contract or go to the “root of the contract” (a phrase often used when considering whether a breach is fundamental or not).

This is a good example of how parties may agree that breach of an obligation can be fundamental in the context of the contract but that same breach is not fundamental at common law. In this case Redhall’s breach was not fundamental and so Vivergo had no right to terminate the contract. It followed that Vivergo’s action in barring Redhall from the site was itself a fundamental breach and the court found that Redhall was entitled to pursue Vivergo for damages rather than the other way round.

The Vivergo decision is a reminder of what a difficult area this can be. The obvious point to take away is that you should only assume that a fundamental breach has occurred if it is manifestly clear either on facts or from the contractual provisions and even then you must ensure that clear notice is served and that the contractual notice procedure is followed closely. The consequences of getting this wrong are, as this case demonstrates, significant.

Simon Lewis is a partner in the construction and engineering team at Bond Dickinson