Say you made a contract to sell a couple of computers. There was a decent margin over your wholesale cost but now, abruptly, they are in short supply and costly. You can get them in time for delivery, but at a much higher wholesale. How do you get out of the contract?
You can delay delivery until the wholesale price comes down, and tick off your customer, but what else can you do?
You are likely not going to get away without a scratch, but maybe I can suggest a soft landing. Let’s look first at way with no scratch.
First, make sure there is a contract. If the deal was for both sides to complete what each promised within a year from when the deal was made, it does not need to be in writing to be valid. Still, if the deal extended over a year and was not in writing, then just do not do what you promised to. In the eyes of the law, there was no valid contract. Do not discuss what the deal was in writing, including emails or exotic stuff like tweets. This is tricky, and if the other side comes after you—demand letters or lawsuits—get a lawyer.
Next, to be valid a contract must be specific enough that both sides know what they are promising, and always be an exchange of promises. So a mere “I promise to pay Charlie one hundred dollars on 1/1/2013” is not a contract and not enforceable—there is no exchange.
What if the unexpected happens? Suppose the wholesale price went up suddenly. This will not get the seller out of the contract. The very purpose of a contract is to shift risk, usually in trade for money or a promise. You took on this very risk, in trade for a promise to buy from you at a given price. You lost that bet. Now what?
You can go ahead with the deal and lose money but maybe keep a customer. You can tell the customer you will not be able to deliver and they should look elsewhere. If they have not paid you anything yet, then you will owe them the extra amount they will have to pay when buying elsewhere. You may know a source that bought stock anticipating the price run-up, and is still selling at a low retail price. Direct them to that store and it will limit your risk. Make sure you can prove the other store is selling cheaper than you can now deliver.
“The painting I agreed to sell you has been destroyed by an unexpected fire; I cannot deliver it to you.” This may fall into “unexpected impossibility of performance.”
Because risk transfer is exactly what people pay for in agreeing to buy with future delivery, this is a narrow doorway. The bad event must really be unexpected, and go to the core of the deal, and the written or oral deal did not anticipate the risk of this.
A builder claimed impossible performance when the building he was constructing for an owner burned up when almost done and within a few days of the agreed completion date. The court said it was not impossible to rebuild, just difficult and expensive. (I think the court believed the builder should have carried fire insurance.) Really difficult or expensive is not “impossible.” This is why lawyers spend a lot of time when drawing up contracts dreaming up what-ifs about hard or impossible performance and who should carry the risk, , i.e. who should carry insurance.
Another hypothetical. You agree to pay $500 in installments for an ad in a magazine or telephone book. You pay some of it and then decide it is not producing and stop paying. If it is a phone book then the ad is already printed and you have little way out. Eventually they might sue, but maybe not, it is too small to sue. If the contract was written, they probably have 3 years from the day the first missed payment was due (the date of breach) … unless the word “Seal” appears on your signature line. Then it is 12 years—lawyer magic :-).
If the ad is in a periodical, tell them you want to stop the ad and will no longer pay. You owe them for the ads already run, at the rate they charge each for fewer ads, but not the whole $500. However, you owe the gross profit on the rest of the contract.
So, what about breaking a medium or long-term deal in the middle? Always give written, provable notice that you are breaking the deal. This way they are bound to seek “substitute performance,” another potato farmer to sell potatoes, etc. It can keep down what you will pay in damages.
When you get the usual letter from a collector or counsel, read it really carefully. Most collectors and lawyers are innumerate. They did not go over the accounting to see if it is right—they just passed on what their client sent them. It is often wrong or internally inconsistent, and your accountant or number-happy S.O. can help you find the issues. This gives you the chance to tell them they will have a devil of a time proving damages in court, and will they settle for fast cash for 75% off? This is business, not religious school.
Any principles here? Yes. When you need to get out of the deal, set up doubt in the outcome for the other party. This will lower the amount of damages they thinks they can get. Offer a deal that will be tempting. And keep in mind that the measure of damages when you fail to deliver is not what the innocent party was going to pay or receive.
If the seller breaks the deal, the buyer can get back what it cost her to buy elsewhere, plus the extra costs of finding and making that substitute deal.
If the buyer breaks the deal then the seller can get the “contract price” but less when he saved by not having to deliver. In effect, this is the likely gross profit.
“If you insist I deliver the computer to you at the agreed price I do not know when I can get it, because the market is so tight right now. It might be there are no more of that model available wholesale, and other dealers will not sell to me as a dealer. You would better off going to Bottom of the Barrel Computers over on High Street. I will give you back your deposit and extra for your trouble.
Quick caution. What we have been discussing usually does not apply to real estate deals or deals for purchase of securities, with their own rules. Anything I said here is general advice, and no proxy for specific advice from a competent lawyer.
© 2011-2012 Philip L. Marcus