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Anticipatory Breach

When a contract is not fulfilled and an entitlement to legal remedy occurs

What is an Anticipatory Breach?

An anticipatory breach is when a contract is not fulfilled, and an entitlement to legal remedy occurs. Repudiation occurs when the promisor refuses, or explicitly states, that they will not honor their contractual obligations before the predetermined contractual end date. It can be exercised when the promisee provided consideration in terms of payment, and the promisor party failed to perform contractual obligations.

 

Anticipatory Breach

 

What can a Promisee Do in the Case of an Anticipatory Breach?

 

1. Cancellation

The promisee can opt to cancel the contract upon the promisor’s explicit statement of failure to perform. The promissee is likely to opt for cancellation of the contract if the promisor failed to perform upon contractual obligations due to common operational reasons.

For example, consider a clothes manufacturing firm that entered into a contract to deliver clothes to a local retailer. If the manufacturing firm runs out of materials and is unable to produce the goods to be delivered to the retailer, the manufacturing firm will communicate that they cannot perform the contractual obligation.

The retailer can elect to cancel the contract and get their consideration refunded. The retailer can also choose, at this point, to begin legal action before the contractual delivery date against the promisee.

 

2. Legal Action

If a promisor explicitly states to the promisee that they cannot deliver upon the terms of the contract, the promisee can proceed with legal action against the promisor before the contractual delivery date.

If the promisee claims anticipatory breach, they are obliged to do everything in their power to mitigate damages from the promisor’s failure to perform. The promisee can seek compensatory damages for the promisor’s breach of contract.

For example, consider a small firm that obtained debt financing from a venture capital firm. Say that the small firm fails to pay out the debt obligation by the contractual end date and communicates to the venture capital firm that they cannot fulfill their contractual obligation.

The venture capital firm then must do everything to decrease the damages owed, such as ending a revolving credit line for the small firm. Thereafter, the venture capital firm can begin legal action before the contractual end date and sue for compensatory damages. Failure to honor the contract grants the promisee immediate rights to damages.

 

3. No Reaction

The promisee can elect to do nothing once the promisor states that it will be impossible to perform contractual obligations. The promisee is more likely to do nothing if they have a strong relationship with the promisor.

For example, consider a contract between a wheat supplier and a food manufacturer for the delivery of wheat. A drought occurs, and the supplier is unable to produce wheat and therefore, cannot deliver any wheat to the food manufacturer.

The wheat supplier will communicate to the manufacturer that they cannot deliver the contractually obligated amount of wheat. If the food manufacturer keeps a strong relationship with the supplier, they will elect to do nothing and take the loss to maintain the relationship.

 

Controversial Application of Anticipatory Breach?

An anticipatory breach is commonly applied in the case of bilateral contracts. A bilateral contract is where two parties agree to fulfill their contractual obligations by a predetermined date. It is relatively easy to identify the performance obligations of the promisee and promisor; therefore, it is simple to calculate fair compensatory damages.

Unilateral contracts create complexity in the calculation of compensatory damages, and therefore, an anticipatory breach is rarely applied to unilateral contracts. An added level of abstraction exists because performance obligations are often contingent.

For example, consider a purchaser of disability insurance that promises an annuity payment of $100 monthly for as long as he remains alive and disabled. A court rendered that the purchaser was disabled, and therefore, was obliged to the monthly payments.

The insurance company appealed, stating that if the purchaser recovers from the disability, they will cease payments and will be legally allowed to recover damages. Ambiguity arises because the burden of proof should lie with the plaintiff rather than the defendant, and in such a scenario, relies on the defendant remaining disabled.

It implies that no continuing judgment can be made by the courts because it will only hold true if the defendant is disabled. The contingencies associated with a unilateral contract generally render anticipatory breach inapplicable.

 

Related Readings

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

  • Definitive Purchase Agreement
  • Void Contract
  • Letter of Intent (LOI)
  • Addendum

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!