Can The Breach Of A Non Essential Term Of A Contract Give Rise To A Right To Terminate At Common Law?
Originally Published 8th October 2008
Following the recent decision of the High Court in Koompahtoo Local Aboriginal Land Council v Sandpine Pty Ltd  HCA 61, the breach of a non-essential term of an agreement may now give rise to an entitlement to terminate the agreement at common law.
In Koompahtoo, the High Court clarified the circumstances under which an innocent party may terminate an agreement at common law. The High Court held that if the breach of a non-essential term is "sufficiently serious" or "goes to the root of the contract" or causes "substantial loss of benefit" to the innocent party, then a breach of that term will give the innocent party a right to terminate the agreement and may expose the defaulting party to a claim for damages.
The case highlights the importance of expressly setting out in an agreement the circumstances under which the agreement may be terminated. There were no such termination provisions contained in the agreement in the Koompahtoo case and although Koompahtoo's termination was ultimately held to be valid, it took almost four years for the issue to be resolved at considerable cost and inconvenience to the parties.
- Koompahtoo Local Aboriginal Land Council and Sandpine Pty Ltd entered into a joint venture agreement for the commercial rezoning and development of land near Morisset in northern NSW.
- Koompahtoo contributed the land to the joint venture and Sandpine, a property development company, contributed its expertise in development management. Each party had a 50% interest in the joint venture.
- The joint venture was dependent on external borrowings to finance the project.
- Despite incurring costs of more than $2 million, the joint venture failed to obtain approval to have the land rezoned for commercial use. In April 2003, a mortgagee took possession of the land and an administrator was appointed.
- The joint venture agreement imposed certain obligations on Sandpine to manage the finances of the joint venture, to maintain proper books of account and financial records, and to make relevant information available to Koompahtoo so that it could properly assess the financial position of the joint venture on an on-going basis.
- From February to December 2003, the administrator made several attempts to obtain information from Sandpine relating to the financial status of the joint venture and, more specifically, on how the borrowed money had been applied. However, the administrator was unsuccessful on each occasion due to the lack of proper financial records maintained by Sandpine.
- There were no express provisions in the joint venture agreement setting out the circumstances under which the parties could unilaterally terminate the agreement.
- In December 2003, the administrator purported to terminate the joint venture agreement by issuing a letter to Sandpine acknowledging that Sandpine had repudiated the agreement by breaching its obligations under the agreement and confirming that Koompahtoo would not be proceeding with the joint venture.
- Sandpine commenced proceedings in the Supreme Court of New South Wales seeking a declaration that the termination of the joint venture agreement by Koompahtoo was invalid. It also claimed damages for unlawful termination.
The High Court dismissed Sandpine's claim and held that Koompahtoo had validly terminated the joint venture agreement.
The primary issue considered by the High Court was whether or not the breach of a non-essential term in an agreement entitles the innocent party to terminate the agreement at common law.
The majority of the judges held that:
- contractual terms can be classified into 3 categories:
- a 'condition', which is a term agreed between the parties to be essential, a breach of which gives the innocent party a right to terminate the agreement
- a 'warranty', which is a term (or promise) agreed between the parties to be non-essential, a breach of which does not give either party a right to terminate the agreement
- an 'intermediate term', which is a term agreed between the parties to be non-essential, a breach of which may give the innocent party a right to terminate the agreement depending on the seriousness of the breach.
- there are 3 circumstances under which the right to terminate an agreement arises at common law:
- the breach of an 'essential term' of the agreement
- the breach of a 'non essential term' (or an 'intermediate term') of the agreement, which:
- is 'sufficiently serious' to justify termination
- 'goes to the root of the contract' (taking into account the nature of the agreement and the consequences of a breach for either party), or
- deprives the innocent party of 'a substantial part of the benefit for which it contracted' or causes 'a substantial loss of benefit', or
- where one party's conduct shows an unwillingness or an inability to perform its obligations under the agreement (ie repudiation).
- Sandpine's contractual obligations under the agreement were non-essential terms (or 'intermediate terms') and:
- Sandpine had committed 'serious' breaches of these obligations without any representations from Koompahtoo permitting non-performance of the obligations. The judges identified several distinct breaches. For example, there was little documentation to satisfactorily explain large amounts of money charged to the joint venture that Sandpine claimed to be joint venture expenses
- the repeated breaches by Sandpine of its obligations under the agreement went 'to the root of the contract' and deprived Koompahtoo 'of a substantial part of the benefit for which it contracted' by preventing Koompahtoo from assessing the financial position of the joint venture and from making informed decisions about the joint venture
- the breaches were 'sufficiently serious' to justify termination of the joint venture agreement by Koompahtoo without warranting a claim for damages from Sandpine.
The inconvenience and costs experienced by both parties in the Koompahtoo case may have been avoided if appropriate termination clauses had been incorporated into the joint venture agreement.
Accordingly, it is important, when negotiating and drafting an agreement to clearly set out those obligations which, if breached, will entitle the innocent party to unilaterally terminate the agreement. The parties should also set out the specific circumstances under which an agreement may be terminated. For example, the parties may want:
- to be able to terminate an agreement if circumstances change or if certain conditions are not satisfied within a specified time period
- to provide the defaulting party with an opportunity to remedy its default before allowing the innocent party to terminate
- to limit certain breaches as only giving rise to a right to make a claim for damages (as opposed to a right to terminate the agreement).
An innocent party must still carefully consider its position before claiming that the conduct of another party to an agreement entitles it to terminate the agreement. If the purported termination is itself unlawful, it may entitle the other party to terminate the agreement and to claim damages.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.