A contract is essentially an exchange of promises between two organisations, so at its most basic, a breach of contract is a broken promise. Broken promises have a similar effect on business relationships as they do on personal relationships, and as such, they should neither be given nor taken lightly.
Damage to Reputation
In a personal context, breaking a promise is a breach of trust. The same applies to business. The old adage, that trust can take years to build, but only a moment to destroy, is very relevant to contractual breach. Though some breaches may be minor, a series of minor breaches can serve to undermine a business relationship like small holes drilled below the waterline of a boat – each not enough to cause major damage on its own, but enough of them will eventually sink the ship. Once trust is lost, the relationship inevitably breaks down, causing termination of contract and a possible claim for damages.
Legal and Insurance Costs
A claim for breach of contract will often require the involvement of lawyers – whether internal or external, and a significant amount of employee and management time in undertaking the due diligence, performing discovery, information-gathering, meetings and negotiations necessary to build or defend a case. Contracts will often have a limitation of liability or liquidated damages clause that acts to cap the amount of damages payable in the event of a breach, and some companies seek to insure against this risk. Claims on such policies will inevitably result in higher premiums.
Higher Cost of Business
A company who acquires a reputation for breaching contracts will find it much harder to do business, as customers and partners will seek to impose ever increasingly onerous terms to mitigate against the risk of breach. In addition, a company burned by bad performance will often seek to insulate itself against the same risk with its new partner, effectively penalising them for the sins of the other.
The impact on employees is a hidden cost. No one wants to work for an organisation that can’t deliver on its promises. Customer facing relationships become antagonistic, support functions find themselves under strain and the morale of the business suffers. Unhappy employees don’t produce a healthy, productive work environment. If an organisation spends all of its time fire fighting problems, little can be done to proactively develop new business.
Breach of contract has serious consequences for any commercial organisation. The key to mitigating the damage is to engage with the other party early, show a willingness to fix the problem, and develop an ongoing program of communication to keep the other party informed of progress.