Under Hong Kong law, a breach of contract will generally entitle the innocent party to damages (i.e. the right to receive monetary compensation) but may, if the breach amounts to a repudiation of the contract, give the innocent party the right to bring the contract to an end. In this article, we provide a high level overview of the consequences for a breach of contract, focusing on repudiation of contracts. If you are in a contract and would like more information about whether a breach of contract has occurred, whether the breach constitutes a repudiation of the contract, and what remedies you can pursue for the breach, please contact one of our commercial litigation and alternative dispute resolution (ADR) lawyers.
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A breach of contract arises where one party, known as the defaulting party, fails to perform a term of the contract. The failure may arise from either:
Actual Breach – In an actual breach, without lawful excuse, the defaulting party either does not perform a contractual obligation at all or performs the obligation in a way that falls below the required standard.
Anticipatory Breach – In an anticipatory breach, without lawful excuse, before the time arrives at which the defaulting party is bound to perform a contractual obligation, the defaulting party either disables himself from performing the obligation or by words or conduct evinces an intention to refuse to perform the obligation. Where a breach of contract occurs, the party not in breach, known as the innocent party, is entitled to damages to compensate him for the loss of his bargain and, in some cases, may be entitled to terminate the contract.
A repudiation of the contract refers to the non-performance of contractual obligations that goes to the root or essence of the contract. Repudiation may be either justified or wrongful. Where wrongful, the innocent party may terminate the contract. Not every breach of contract amounts to a repudiation that gives the innocent party a right to bring the contract to an end. Only a repudiatory breach, meaning a breach where the failure of the defaulting party to perform is substantial, gives rise to such a right.
The right to bring a contract to an end as a result of a repudiatory breach should be distinguished from an express contractual right of termination.
In determining whether a non-performance is sufficiently substantial to amount to a repudiation, the court usually considers whether the consequences of the failure to perform are “so serious as to justify the innocent party in bringing the contract to an end” at the time when the innocent party purports to end the contract. For this purpose, the court looks both at the proper interpretation of the contract and the relevant circumstances.
For interpretation purposes, Hong Kong law classifies contract terms into 3 broad categories, namely:
Conditions - Conditions are terms going to the substance or foundation of the matter to which the contract relates. A breach of a condition is considered as a repudiatory breach regardless of its substantiality or level of prejudice done to the innocent party.
Warranties - Warranties are the more trivial terms in a contract. Breach of warranties do not give rise to repudiation. The innocent party is entitled only to claim damages and has no right to elect to terminate the contract.
Innominate terms - Innominate terms are terms of a contract that are capable of being broken either in a trivial manner or in a way undermining the whole contract. Where there is a breach of an innominate term, the court determines whether the breach deprives the innocent party of substantially the whole benefit of the contract that “makes further commercial performance of the contract impossible”
Whether a term is classified as a condition or a warranty depends upon the intention of the contracting parties, as reflected by the construction of the contract and in light of the surrounding circumstances as a whole.
As noted above, a breach of a contract may be an actual breach or an anticipatory breach. Both an actual breach and an anticipatory breach may give rise to a repudiation of the contract. In either case, the “substantial failure to perform” test is equally applicable.
A repudiation of a contract does not automatically bring the contract to an end. Instead, the repudiation gives the innocent party a right to choose whether or not to bring the contract to an end. In the face of a repudiation, the innocent party may refuse to accept the repudiation and affirm the contract, meaning the innocent party may treat the contract as continuing. However, if the innocent party chooses to accept the repudiation, the acceptance will bring the contract to an end, meaning that the parties to the contract will be discharged from further performance of obligations under the contract.
The innocent party must choose between accepting a repudiation of the contract or affirming the contract in a timely manner. Unless and until the innocent party accepts the repudiation, the contract subsists and continues to bind the parties. Where the innocent party fails to accept a repudiation in a timely manner, the law may treat him as having affirmed the contract.
In an anticipatory breach, where the innocent party has not yet elected to accept the repudiation or to affirm the contract, the defaulting party may resume performance. If this happens, the innocent party loses the right to elect to accept the repudiation of the contract.
To accept a repudiation of a contract, the innocent party must unequivocally indicate by his behaviour that he no longer intends to be bound by the contract. Usually, the innocent party will do so by expressly communicating his acceptance of the repudiation to the defaulting party, but he may also do so by an “unequivocal overt act which is inconsistent with the subsistence of the contract”. The court will assess whether the innocent party’s act amounts to an acceptance of repudiation by applying an objective test and see if it is a sufficiently unambiguous act as to constitute an unequivocal notice of the acceptance to the defaulting party.
Conversely, an affirmation of the contract following a repudiatory breach may be expressly communicated to the repudiating party or may be implied from the conduct of the innocent party. However, the conduct of an innocent party may only be regarded as amounting to an affirmation of the contract if the innocent party has knowledge of the facts amounting to the repudiation and has knowledge of its legal right to elect between affirming the contract or accepting the repudiation.
On a repudiation of a contract, the innocent party may sue for damages for any loss it suffered by reason of the repudiation. This is so whether or not it accepts the repudiation. However, where an anticipatory breach is concerned, if the repudiation is not accepted, a right to claim damages will not arise until the date for performance of the obligation breached.
A practical difficulty for any party to a contract is to determine whether a breach of the contract by another party to the contract amounts to a repudiation of the contract. Where a party mistakenly takes the view that a breach by the other party amounts to a repudiation and purports to accept the repudiation, the party may, in fact, be wrongfully repudiating the contract. As a result, it is strongly recommended that a party to a contract seek independent legal advice from lawyers well versed in commercial litigation to provide an objective assessment of whether a repudiatory breach has taken place before accepting a breach as a repudiatory breach.
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