75 Contractual default

Contractual default

Default is failure to fulfil an obligation. In the life of every contract, it is rare that all things go according to plan or as foreseen. As a consequence, when preparing a contract, not only the foreseeable risks should be addressed, but preparation must also be made for certain unforeseeable risks.

1.  Related to the performance of the contract: Foreseeable operational risks are all related to the performance of the contract. In general, such risks should be clearly understood and appropriate solutions should be developed. For example, the risk of non-conforming goods being provided can be addressed by specifying how repair, replacement or price reduction can be made. The risk of non-payment can be addressed by the timing and method of payment.

For each relevant case, the following can be drafted into the terms of the contract:

a.  Define the non-performance situation(s) leading to a breach of contract.

b.  Define what should be done to correct the situation(s).

c.  Define communication links and means between parties.

d.  Define ultimate steps in case of enduring breach of contracts.

2.  Related to contracting companies: These risks are foreseeable structural risks. Here, particularly with new companies — but also in the context of volatility in management and ownership of companies with which business may have been done in the past — substantial changes can occur. This might cause concerns as to the ability of the other party to perform under the contract.

As compared to operational risks, structural risks relate more to the financial and managerial health of the supplier. The following are some of the possible situations and consequences that can be drafted into the contract where the supplier:

a.  Changes ownership over a certain percentage of voting rights.

b.  Makes a legal transfer of the ownership of the company.

c.  Initiates the process of placing the company under receivership or liquidation.

d.  Commences any proceeding relating to itself under bankruptcy, insolvency, dissolution or liquidation or similar law or proceeding.

e.  Is declared bankrupt or insolvent.

f.  Is the object of any of the above-mentioned petitions or proceedings commenced by others.

g.  Assigns the contract to another party.

3.  Related to the surrounding environment: These risks are those that are generally related to the environment. To some extent, these risks can be foreseen and addressed. However, it is the unforeseen risks that may cause the most difficulties. Thus, some means must be created to address these too.

A contract has a binding character. However, when circumstances arise that lead to a fundamental alteration of the equilibrium of the contract, this may create an exceptional situation known as hardship. The issues to be addressed and drafted in are the circumstances where:

a.  The cost of a party’s performance increases significantly.

b.  The value of the performance that a party receives has diminished.
There are, however, certain key requirements:

a.  The events occur or become known to the disadvantaged party after the conclusion of the contract.

b.  The disadvantaged party could not reasonably have taken the events into account at the time of the conclusion of the contract.

c.  The events are beyond the control of the disadvantaged party.

d.  The risks of the events were not assumed by the disadvantaged party.

It is to be noted that the hardship is relevant only to performance not yet rendered, and so it cannot be used to excuse past performance.

The clause should also indicate that the party that considers itself in hardship must give notice to the other party without undue delay. This notice should be required to specify the grounds on which it is based, and should also include a request for renegotiation. It should be stressed that the request for renegotiation does not in itself entitle the disadvantaged party to withhold performance. Thus, performance is expected to be continued unless there is a reservation in the contract for certain extraordinary circumstances.

In the event that the parties do not reach an agreement within a reasonable time, they can state that either party may resort to a court or arbitral tribunal. If the court (or arbitral tribunal) finds hardship, it may, if reasonable, terminate the contract at a date or on terms to be fixed. Alternatively, it may adapt the contract with a view to restoring the equilibrium.


BLC 304/05 Procurement Management Copyright © 2009 by Wawasan Open University. All Rights Reserved.


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