If you are starting or buying a small business, you should know something about contracts. A contract is an agreement between two or more parties which creates an obligation to do or not to do a specific thing. A contract is formed when one party offers to do something, the second party accepts the offer, and something of value is given which supports the promises that were made. For example, if your company offers to buy equipment from a seller for $10,000 and the seller accepts your offer, there is a contract for the sale of equipment.

Chances are that you will enter into several different kinds of contracts in your business, including:

  • An agreement to purchase the business
  • Leases for real and personal property
  • Agreements to purchase anything
  • Agreements between parties to take certain actions if the promises made are supported by something of value, which is called consideration
  • Sales to customers
  • Agreements to employ people for a certain amount of time

If you buy a business, you assume the obligations of the outstanding contracts of the business.

Each party to a contract is responsible for fulfilling the terms of the contract. The failure to perform the obligations of a contract is called a breach of contract.


Nonperformance is the failure to fulfill your obligations under a contract. A breach of contract is always a nonperformance of duty, but not every nonperformance of duty is a breach of contract. You do not have to perform your promises under a contract until performance is due. For example, if you agree to pay the seller of equipment on delivery of the equipment, you do not have to pay the seller until the equipment is delivered. You will not be in breach of the agreement until the equipment is delivered and you then fail to pay the seller.

Certain situations may lead to impossibility of performance, which means an unexpected circumstance has made it impossible to fulfill the contract. For example, if your business has a contract with a freelance Web designer to create your company’s Web site and the designer dies, then the designer cannot create the Web site. This would terminate your contract by impossibility of performance.

Breach of Implied Duty

When a contract is made, legal duties may be created that the parties did not expressly or specifically state in the contract. Some duties are implied through the act of making the contract, such as the implied duties to not hinder performance of the contract, or not to repudiate (reject) the contract.

Breach of Contract

Breach of a contract may terminate the obligations of the contract. A breach occurs when either one or both parties to a contract have failed to perform an obligation as expected under the contract. A breach may occur when a party:

  • Refuses to perform the contract
  • Does something that the contract prohibits
  • Prevents the other party from performing its obligations

Not all breaches of contract end up in court. The law distinguishes between different types of breaches of contract.

A material breach of contract gives rise to a cause of action in court. A material breach is a serious one; it is a breach that goes to the heart of the contract. The injured party can seek damages–a money payment adequate to cover economic losses resulting from the breach of contract. For example, suppose your company hires a violinist to play at a company-hosted event, but the violinist shows up at the party without his violin. The violinist has materially breached the contract to perform if he cannot play.

A total breach of contact by the first party will usually terminate the second party’s duty to perform any further on his part, but it does not always do so. The promises of the two parties may have been independent promises, or the breach by the first party may occur after he has already done everything he has to do before the second party must proceed.

If the court decides that the first party’s breach is a total breach, the second party can regard the first party’s performance as at an end and can sue for compensation for all of his injury, past, present, and future. If the first party’s breach is not sufficiently material and important for this, the breach is called a partial breach or immaterial breach.

An immaterial breach of contract is a trivial breach of contract and does not kill the contract. For example, assume a service contract for a heating system under which the service person agrees to inspect the system each month on Thursday. Contrary to the contract, the service person makes inspections on Mondays. This act is a technical breach of the contract, but it is immaterial, unless for some reason the inspections needed to be done on Thursday as opposed to any other day.

Anticipatory Breach

Parties can agree to take certain actions at specified times as part of a contract. Each party has an obligation to take the action at the time specified and to refrain from repudiating his promise before performance is due. An anticipatory breach of contract occurs when one party decides before his performance is due that he will not take the action that he promised and he communicates his decision to the second party. The second party can sue the first party for anticipatory breach of contract before the time for performance has arrived.

Questions for Your Attorney

  • How is a contract formed?
  • What does nonperformance mean?
  • Can I be held responsible for breach of contract if I prevent the other party from performing his agreement?