(1) A party may terminate the contract where the failure of the other party to perform an obligation under the contract amounts to a fundamental non-performance.
(2) In determining whether a failure to perform an obligation amounts to a fundamental non-performance regard shall be had, in particular, to whether
(a) the non-performance substantially deprives the aggrieved party of what it was entitled to expect under the contract unless the other party did not foresee and could not reasonably have foreseen such result;
(b) strict compliance with the obligation which has not been performed is of essence under the contract;
(c) the non-performance is intentional or reckless;
(d) the non-performance gives the aggrieved party reason to believe that it cannot rely on the other party’s future performance;
(e) the non-performing party will suffer disproportionate loss as a result of the preparation or performance if the contract is terminated.
(3) In the case of delay the aggrieved party may also terminate the contract if the other party fails to perform before the time allowed it under Article 7.1.5 has expired.
1. Termination even if non-performance is excused
The rules set out in this Section are intended to apply both to cases where the non-performing party is liable for the non-performance and to those where the non-performance is excused so that the aggrieved party can claim neither specific performance nor damages for non-performance.
1. A, a company located in country X, buys wine from B in country Y. The Government of country X subsequently imposes an embargo upon the import of agricultural products from country Y. Although the impediment cannot be attributed to A, B may terminate the contract.
2. Right to terminate the contract dependent on fundamental non-performance
Whether in a case of non-performance by one party the other party should have the right to terminate the contract depends upon the weighing of a number of considerations. On the one hand, performance may be so late or so defective that the aggrieved party cannot use it for its intended purpose, or the behaviour of the non-performing party may in other respects be such that the aggrieved party should be permitted to terminate the contract.
On the other hand, termination will often cause serious detriment to the non-performing party whose expenses in preparing and tendering performance may not be recovered.
For these reasons paragraph (1) of this Article provides that an aggrieved party may terminate the contract only if the non-performance of the other party is “fundamental”, i.e. material and not merely of minor importance. See also Articles 7.3.3. and 7.3.4.
3. Circumstances of significance in determining whether non-performance is fundamental
Paragraph (2) of this Article lists a number of circumstances which are relevant to the determination of whether, in a given case, failure to perform an obligation amounts to fundamental non-performance.
a. Non-performance substantially depriving the other party of its expectations
The first factor referred to in paragraph (2)(a) is that the non-performance is so fundamental that the aggrieved party is substantially deprived of what it was entitled to expect at the time of the conclusion of the contract.
2. On 1 May A contracts to deliver standard software before 15 May to B who has requested speedy delivery. If A tenders delivery on 15 June, B may refuse delivery and terminate the contract.
The aggrieved party cannot terminate the contract if the non-performing party can show that it did not foresee, and could not reasonably have foreseen, that the non-performance was fundamental for the other party.
3. A undertakes to remove waste from B’s site within thirty days without specifying the exact date of commencement. B fails to inform A that B has hired excavators at high cost to begin work on the site on 2 January. B cannot terminate its contract with A on the ground that A had not cleared the site on 2 January.
b. Strict performance of contract of essence
Paragraph (2)(b) looks not at the actual gravity of the non-performance but at the nature of the contractual obligation for which strict performance might be of essence. Such obligations of strict performance are not uncommon in commercial contracts. For example, in contracts for the sale of commodities the time of delivery is normally considered to be of the essence, and in a documentary credit transaction the documents tendered must conform strictly to the terms of the credit.
c. Intentional non-performance
Paragraph (2)(c) deals with the situation where the non-performance is intentional or reckless. It may, however, be contrary to good faith (see Article 1.7) to terminate a contract if the non-performance, even though committed intentionally, is insignificant.
d. No reliance on future performance
Under paragraph (2)(d) the fact that non-performance gives the aggrieved party reason to believe that it cannot rely on the other party’s future performance is of significance. If a party is to make its performance in instalments, and it is clear that a defect found in one of the earlier performances will be repeated in all performances, the aggrieved party may terminate the contract even if the defects in the early instalment would not of themselves justify termination.
Sometimes an intentional breach may show that a party cannot be trusted.
4. A, the agent of B, who is entitled to reimbursement for expenses, submits false vouchers to B. Although the amounts claimed are insignificant, B may treat A’s behaviour as a funda¬mental non-performance and terminate the agency contract.
e. Disproportionate loss
Paragraph (2)(e) deals with situations in which a party who fails to perform has relied on the contract and has prepared or tendered performance. In these cases regard is to be had to the extent to which that party suffers disproportionate loss if the non-performance is treated as fundamental. Non-performance is less likely to be treated as fundamental if it occurs late, after the preparation of performance, than if it occurs early before such preparation. Whether a performance tendered or rendered can be of any benefit to the non-performing party if it is refused or has to be returned to that party is also of relevance.
5. On 1 May A undertakes to deliver software which is to be produced specifically for B. It is agreed that delivery shall be made before 31 December. A tenders delivery on 31 January, at which time B still needs the software, which A cannot sell to other users. B may claim damages from A, but cannot terminate the contract.
4. Termination after Nachfrist
Paragraph (3) makes reference to Article 7.1.5, paragraph (3) of which provides that the aggrieved party may use the Nachfrist procedure to terminate a contract which may not otherwise be terminated in case of delay (see Comment 2 on Article 7.1.5).
(1) The right of a party to terminate the contract is exercised by notice to the other party.
(2) If performance has been offered late or otherwise does not conform to the contract the aggrieved party will lose its right to terminate the contract unless it gives notice to the other party within a reasonable time after it has or ought to have become aware of the offer or of the non-conforming performance.
1. The requirement of notice
Paragraph (1) of this Article reaffirms the principle that the right of a party to terminate the contract is exercised by notice to the other party. The notice requirement will permit the non-performing party to avoid any loss due to uncertainty as to whether the aggrieved party will accept the performance. At the same time it prevents the aggrieved party from speculating on a rise or fall in the value of the performance to the detriment of the non-performing party.
2. Performance overdue
When performance is due but has not been made, the aggrieved party’s course of action will depend upon its wishes and knowledge.
It may be the case that the aggrieved party does not know whether the other party intends to perform, and either no longer wants the performance or is undecided. In this case the aggrieved party may wait and see whether performance is ultimately tendered and make up its mind if and when this happens (paragraph (2)). Alternatively, it may still want the other party to perform, in which case it must seek performance within a reasonable time after it has or ought to have become aware of the non-performance (see Article 7.2.2(e)).
This Article does not deal with the situation where the non-performing party asks the aggrieved party whether it will accept late performance. Nor does it deal with the situation where the aggrieved party learns from another source that the non-performing party intends nevertheless to perform the contract. In such cases good faith and fair dealing (see Article 1.7) may require that the aggrieved party inform the other party if it does not wish to accept the late performance. If it does not do so, it may be held liable in damages.
3. “Reasonable time”
An aggrieved party who intends to terminate the contract must give notice to the other party within a reasonable time after it becomes or ought to have become aware of the non-performance (paragraph (2)).
What is “reasonable” depends upon the circumstances. In situations where the aggrieved party may easily obtain a substitute performance and may thus speculate on a rise or fall in the price, notice must be given without delay. When it must make enquiries as to whether it can obtain substitute performance from other sources the reasonable period of time will be longer.
4. Notice must be received
The notice to be given by the aggrieved party becomes effective when the non-performing party receives it (see Article 1.10).
Where prior to the date for performance by one of the parties it is clear that there will be a fundamental non-performance by that party, the other party may terminate the contract.
This Article establishes the principle that a non-performance which is to be expected is to be equated with a non-performance which occurred at the time when performance fell due. It is a requirement that it be clear that there will be non-performance; a suspicion, even a well-founded one, is not sufficient. Furthermore, it is necessary that the non-performance be fundamental and that the party who is to receive performance give notice of termination.
An example of anticipatory non-performance is the case where one party declares that it will not perform the contract; however, the circumstances also may indicate that there will be a fundamental non-performance.
A promises to deliver oil to B by M/S Paul at the terminal in country X on 3 February. On 25 January M/S Paul is still 2,000 kilometres from the terminal. At the speed it is making it will not arrive on 3 February, but at the earliest on 8 February. As time is of the essence, a substantial delay is to be expected, and B may terminate the contract before 3 February.
A party who reasonably believes that there will be a fundamental non-performance by the other party may demand adequate assurance of due performance and may meanwhile withhold its own performance. Where this assurance is not provided within a reasonable time the party demanding it may terminate the contract.
1. Reasonable expectation of fundamental non-performance
This Article protects the interest of a party who has reason to believe that the other will be unable or unwilling to perform the contract at the due date but who cannot invoke Article 7.3.3 since there is still a possibility that the other party will or can perform. In the absence of the rule laid down in this Article the former party would often be in a dilemma. If it were to wait until the due date of performance, and this did not take place, it might incur loss. If, on the other hand, it were to terminate the contract, and it then became apparent that the contract would have been performed by the other party, its action will amount to non-performance of the contract, and it will be liable in damages.
2. Right to withhold performance pending adequate assurance of performance
Consequently this Article enables a party who reasonably believes that there will be a fundamental non-performance by the other party to demand an assurance of performance from the other party and in the meantime to withhold its own performance. What constitutes an adequate assurance will depend upon the circumstances. In some cases the other party’s declaration that it will perform will suffice, while in others a request for security or for a guarantee from a third person may be justified.
A, a boatbuilder with only one berth, promises to build a yacht for B to be delivered on 1 May, and no later. Soon afterwards, B learns from C that A has promised to build a yacht for C during the same period. B is entitled to ask A for an adequate assurance that the yacht will be delivered on time and A will then have to give B a satisfactory explanation of how it intends to perform its contract with B.
3. Termination of the contract
If adequate assurance of due performance is not given the other party may terminate the contract.
(1) Termination of the contract releases both parties from their obligation to effect and to receive future performance.
(2) Termination does not preclude a claim for damages for non-performance.
(3) Termination does not affect any provision in the contract for the settlement of disputes or any other term of the contract which is to operate even after termination.
1. Termination extinguishes future obligations
Paragraph (1) of this Article states the general rule that termination has effects for the future in that it releases both parties from their duty to effect and to receive future performance.
2. Claim for damages not affected
The fact that, by virtue of termination, the contract is brought to an end, does not deprive the aggrieved party of its right to claim damages for non-performance in accordance with the rules laid down in Section 4 of this Chapter.
1. A sells B specified production machinery. After B has begun to operate the machinery serious defects in it lead to a shutdown of B’s assembly plant. B declares the contract terminated but may still claim damages (see Article 7.3.5(2)).
3. Contract provisions not affected by termination
Notwithstanding the general rule laid down in paragraph (1), there may be provisions in the contract which survive its termination. This is the case in particular with provisions relating to dispute settlement but there may be others which by their very nature are intended to operate even after termination.
2. The facts are the same as in Illustration 1, except that A discloses to B confidential information which is necessary for the production and which B agrees not to divulge for as long as it does not become public knowledge. The contract further contains a clause referring disputes to the courts of A’s country. Even after termination of the contract by B, B remains under a duty not to divulge the confidential information, and any dispute relating to the contract and its effects are to be settled by the courts of A’s country (see Article 7.3.5(3)).
(1) On termination of a contract to be performed at one time either party may claim restitution of whatever it has supplied under the contract, provided that such party concurrently makes restitution of whatever it has received under the contract.
(2) If restitution in kind is not possible or appropriate, an allowance has to be made in money whenever reasonable.
(3) The recipient of the performance does not have to make an allowance in money if the impossibility to make restitution in kind is attributable to the other party.
(4) Compensation may be claimed for expenses reasonably required to preserve or maintain the performance received.
1. Contracts to be performed at one time
This Article refers only to contracts to be performed at one time. A different regime applies to contracts under which the characteristic performance is to be made over a period of time (see Article 7.3.7). The most common example of a contract to be performed at one time is an ordinary contract of sale where the entire object of the sale has to be transferred at one particular moment. This Article however refers also to, e.g. construction contracts in which the contractor is under an obligation to produce the entire work to be accepted by the customer at one particular time. A turnkey contract provides an important example.
Under a commercial contract one party will usually have to pay money for the performance received. That obligation is not the one that is characteristic of the contract. Thus, a contract of sale where the purchase price has to be paid in instalments, will fall under this Article provided that the seller’s performance is to be made at one time.
2. Right of parties to restitution on termination
Paragraph (1) of this Article gives each party a right to claim the return of whatever the party has supplied under the contract provided that that party concurrently makes restitution of whatever it has received.
1. In the process of a takeover of a company, controlling shareholder A agrees to sell and transfer to B shares for GBP 1,000,000. B only pays GBP 600,000 after the shares have been transferred and A therefore terminates the contract. A can claim back the shares. At the same time, A has to return the GBP 600,000 received from B.
This rule also applies when the aggrieved party has made a bad bargain. If, in the case mentioned in Illustration 1, the real market value of the shares is GBP 1,200,000, A may still require the return of the shares.
This Article also applies to the situation where the aggrieved party has supplied money in exchange for property, services, or other performances which the party has not received or which are defective.
2. Art dealer A sells a Constable painting to art dealer B for EUR 600,000. B only pays EUR 200,000 for the painting, and A therefore terminates the contract. Subsequently it turns out that the painting is not a Constable but a copy. On termination of the contract, B can reclaim the purchase price and must return the painting to A.
As regards the costs involved in making restitution, Article 6.1.11 applies.
3. Restitution in kind not possible or appropriate
Restitution must normally be made in kind. There are, however, instances where instead of restitution in kind, an allowance in money has to be made. This is the case first of all where restitution in kind is not possible. The allowance will normally amount to the value of the performance received.
3. Company A, which has contracted to excavate company B’s site, leaves it after only part of the work has been done. B, which then terminates the contract, will have to pay A a sum in compensation for the work done, measured by the value that work has for B. At the same time B will have a claim against A for whatever damages B may have suffered as a result of A’s breach of contract (see Article 7.3.5 (2)).
4. Company A charters a ship for a company cruise for its employees which is to take them up the Australian Coral Reef. Half-way the cruise ship breaks down and cannot continue the cruise. A terminates the contract with B, the owner of the business organising the cruise, and decides to fly its employees home. If A had already paid the price A can now claim it back. At the same time, A owes B an allowance amounting to the value of the cruise so far. In addition, A can claim damages for the loss suffered as a result of B’s non-performance (see Article 7.3.5 (2)).
An allowance is further envisaged by paragraph (2) of this Article whenever restitution in kind would not be appropriate. This is so in particular when returning the performance in kind would cause unreasonable effort or expense. The standard, in that respect, is the same as under Article 7.2.2(b).
5. A, an artist, sells 200 silver-plated rings to dealer B. B fails to pay for the rings and A thereupon terminates the contract. It turns out that B has, in the meantime, attempted to ship the rings to his business premises. However, the boat on which they had been stored has sunk. Although it would be possible, at great expense, to rescue the rings from the wrecked ship, this cannot be expected of B. B has to pay a reasonable sum to A, measured by the value of the rings.
The purpose of specifying that an allowance has to be made in money “whenever reasonable” is to make it clear that an allowance only has to be made if, and to the extent that, the performance has conferred a benefit on its recipient. That is not the case, for example, where the defect which gives the recipient of the performance a right to terminate has only become apparent in the course of processing the object of that performance.
6. Company A hires company B to develop a specialised software to improve its existing internal communication system. Once B has developed and installed the software, the software does not perform the functions it was intended to. A can terminate the contract and re-claim the price paid, but since the installed system has no value for A, it would not be reasonable to expect A to pay B an allowance for the installed software.
4. The allocation of risk
The rule contained in paragraph (2) implies an allocation of risk: it imposes a liability on the recipient of the performance to make good the value of that performance if it is unable to make restitution in kind. The rule in paragraph (2) applies even if the recipient was responsible for the deterioration or destruction of what it had received. Such allocation of the risk of deterioration or destruction is justified, in particular, because the risk should lie with the person in control of the performance. On the contrary, there is no liability to make good the value where the deterioration or destruction is attributable to the other party: either because it was due to the other party’s fault, or because it was due to a defect inherent in the performance. Hence the rule in paragraph (3).
7. Manufacturer A sells and delivers a luxury car to company B. The car has defective brakes. Due to this defect it crashes into another car and is totally destroyed. Since the car was unfit to be used for its intended purpose, B can terminate the contract and reclaim the purchase price. B does not have to make an allowance for not being able to return the car.
The recipient’s liability to make good the value of the performance received is not excluded in cases where the deterioration or destruction would also have occurred had the performance not been rendered.
8. Manufacturer A sells and delivers a car to company B. After delivery has taken place, the car is totally destroyed by a hurricane flooding the properties of both A and B. B terminates the contract because of a defect attaching to the car. B can reclaim the purchase price but, at the same time, has to make an allowance for the value of the car prior to its destruction.
The question of the recipient’s liability to pay the value of the performance only arises in cases where the deterioration or destruction occurs before termination of the contract. If what has been performed deteriorates or is destroyed after termination of the contract, the normal rules on non-performance apply, as after termination the recipient of the performance is under a duty to return what the recipient has received. Any non-performance of that duty gives the other party a right to claim damages according to Article 7.4.1, unless the non-performance is excused under Article 7.1.7.
9. Company A sells and delivers to company B a limousine with a leaking roof. Since the limousine is unfit to be used for its intended purpose, B can terminate the contract. As a result, B can reclaim the purchase price but is under a duty to return the limousine. Before B can return the car it is totally destroyed by a thunderstorm. A cannot claim damages because B is excused under Article 7.1.7.
5. Compensation for expenses
The recipient of a performance may have incurred expenses for the preservation or maintenance of the object of the performance. It is reasonable to allow the recipient to claim compensation for these expenses where the contract has been terminated and where, therefore, the parties have to return what they have received.
10. Company A has sold and delivered a race horse to company B. Some time later it becomes apparent that the horse is not, as A had promised, a descendant of a particular stallion. B terminates the contract. B can claim compensation for the costs incurred in feeding and caring for the horse.
This rule applies only to reasonable expenses. What is reasonable depends on the circumstances of the case. In Illustration 10 it would matter whether the horse had been sold as a race horse or as an ordinary farm horse.
Compensation cannot be claimed for other expenses linked to the performance received, even if they are reasonable.
11. Company A has sold and delivered a software package to company B. B then discovers that the software is lacking a certain functionality it was supposed to have. B therefore asks software expert C to check whether that functionality can still be implemented. Since that turns out not to be possible, B terminates the contract. B cannot recover the fee paid to C as expenses under paragraph (4) from A.
The Principles do not take a position concerning benefits that have been derived from the performance, or interest that has been earned. In commercial practice it will often be difficult to establish the value of the benefits received by the parties as a result of the performance. Furthermore, often both parties will have received such benefits.
7. Rights of third persons not affected
In common with other Articles of the Principles, this Article deals with the relationship between the parties and not with any rights on the goods concerned that third persons may have acquired. Whether, for instance, an obligee of the buyer, the buyer’s receivers in bankruptcy, or a purchaser in good faith may oppose the restitution of goods sold is to be determined by the applicable law.
(1) On termination of a contract to be performed over a period of time restitution can only be claimed for the period after termination has taken effect, provided the contract is divisible.
(2) As far as restitution has to be made, the provisions of Article 7.3.6 apply.
1. Contracts to be performed over a period of time
Contracts to be performed over a period of time are at least as commercially important as contracts to be performed at one time, such as contracts of sale where the object of the sale has to be transferred at one particular moment. These contracts include leases (e.g. equipment leases), contracts involving distributorship, out-sourcing, franchising, licensing and commercial agency, as well as service contracts in general. This Article also covers contracts of sale where the goods have to be delivered in instalments. Performances under such contracts can have been made over a long period of time before the contract is terminated, and it may thus be inconvenient to unravel these performances. Furthermore, termination is a remedy with prospective effect only. Restitution can, therefore, only be claimed in respect of the period after termination.
1. A contracts to service company B’s computer hardware and software for a period of five years. After three years of regular service A is obliged by illness to discontinue the services and the contract is terminated. B, who has paid A for the fourth year, can claim restitution of the advance payment for that year but not for the money paid for the three years of regular service.
Since contracts are terminated only for the future, any outstanding payments for past performances can still be claimed. This Article does not prevent a claim for damages being brought.
2. Company A leases equipment to company B for three years at a rental of EUR 10,000 a month. B pays punctually for the first two months but then fails to make any further payments despite repeated requests by A. After a lapse of five months A terminates the lease. A is entitled to retain the EUR 20,000 already received (see Article 7.3.7 (1)) and to recover the EUR 50,000 accrued due (on the basis of the contract of lease which is terminated only for the future), together with whatever damages for breach it has sustained (see Article 7.3.5 (2)).
3. A, a hospital, engages B to carry out cleaning services for the hospital, the contract to run for three years. After a year B informs A that it cannot continue with the cleaning services unless the price is doubled. A refuses to agree and B ceases to provide the service. On terminating the contract A can recover damages for any additional expense it incurs in hiring another cleaning firm (see Article 7.4.1 in conjunction with Article 7.3.5 (2)), while B is entitled to retain the payments it has received for services already provided (see Article 7.3.7 (1)).
The rule that restitution can only be claimed for the period after termination has taken effect does not apply if the contract is indivisible.
4. A undertakes to paint ten pictures depicting one and the same historical event for B’s festival hall. After delivering and having been paid for five paintings, A abandons the work. In view of the fact that the decoration of the hall is supposed to consist of ten paintings to be painted by the same painter and showing different aspects of one historical event, B can claim the return of the advances paid to A and must return the five paintings to A.
This Article is a special rule which, for contracts to be performed over a period of time, excludes restitution for performances made in the past. To the extent that there is restitution under this Article, it is governed by the provisions under Article 7.3.6.