Fundamental breach and avoidance (termination)

Delivery of what, where? Generally, a seller is bound to deliver the goods, to hand over any documents relating to the goods, and to transfer the property in the goods, as required by the sales contract (CISG Article 30). In the absence of a contractual arrangement as to when, where and how the seller must perform these obligations, the Vienna Convention supplements the contract (CISG Article 31, 32 and 33).

If the seller must hand over documents related to the goods – such as transportation documents, import clearances, certificates of origin or quality, or manuals – the sales contract should provide for when, where and in what form the documents must be delivered (CISG Article 34).

The goods. In order for the seller to deliver “the goods”, in cases involving specific goods, clearly the seller must deliver exactly those goods identified in the contract. If the seller handed over a sample or model, the goods must possess the qualities of the sample or model. In cases involving unidentified goods, the seller must deliver goods that generally conform to the description agreed to in the contract.

For example, if the contract demands delivery of corn, the seller has not “delivered” if it provides grain. However, the “goods” are considered as “delivered” even if they are non-conforming. For example, handing over to the carrier the requisite amount of no. 3 grade corn when no. 2 grade was called for, or handing over to the carrier five tons when ten tons were called for, would constitute delivery of “the goods”. Of course, even though “the goods” had been “delivered”, the buyer would be able to exercise any rights it might have because of the seller’s breach of contract.

‘Breach’ or ‘fundamental breach’? The third part of the Vienna Convention deals with the obligations of the parties to the contract. Obligations of the seller include delivering goods in conformity with the quantity and quality stipulated in the contract, together with related documents, and transferring the property of the goods. If a seller delivers goods that may be considered fit for the general purpose for which they are normally used, but that do not meet the specificities of the contract, the seller is in breach.

The same applies if the goods are delivered after the agreed delivery date, or if the seller fails to meet another obligation. Normally, such a breach of contract leads to a reduction of the purchase price, the buyer’s entitlement to compensation of damages or another remedy (including specific performance – CISG Article 28 and 46). Remedies may be cumulated to the extent they do not exclude each other by their very nature (CISG Article 45 and 61 par. 2).

In certain cases, a breach is fundamental:

Article 25 CISG
A breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result.

Avoidance (termination). In case of fundamental breach, the aggrieved party may avoid (terminate) the sales contract (CISG Article 49 and 64). If a breach is not fundamental, the right to avoid the contract is dependent on whether the goods were delivered at all (if not, the terminating party must first fix a deadline allowing delivery). If the goods were delivered, the right to avoid the contract lapses after a reasonable period of time. Exactly when a reasonable period of time is considered to have lapsed, depends on whether the breach amounted to a delay in delivery or not: specific criteria apply as to the knowledge (or imputed knowledge) of the terminating party and (see CISG Article 49).

Case law. In many cases, the issue boils down to the question of whether a breach of contract is fundamental. To a large extent, this depends on whether or not any delivered goods were in conformity with the sales contract and fit for their purpose, and whether any non-conformity was discovered and notified in a timely manner (see section (d)).

Unilex, an initiative of Prof. M.J. Bonell (Rome, Italy), is a collection of hundreds of court decisions and arbitral awards based on the Vienna Convention.[1] The following cases are particularly illustrative for questions related to fundamental breach (CISG Article 35, whether or not leading to avoidance pursuant to Article 49):

Case: cadmium-contaminated mussels[2]
A Swiss seller and a German buyer concluded a contract for the sale of New Zealand mussels. The buyer refused to pay the purchase price after the mussels were declared ‘not completely safe’ because of the quantity of cadmium they contained: significantly greater than the advised cadmium levels published by the German Federal Health Department. The buyer notified the seller and requested it to take back the mussels. Six or eight weeks after the delivery, the buyer complained about defects of the packaging. The seller commenced an action claiming payment and interest. At first instance the Court decided in favour of the seller. The buyer’s subsequent appeals were unsuccessful.
The Court held that the buyer had to pay the purchase price. It was not entitled to declare the contract avoided under CISG Articles 25 and 49(1)(a) since the seller did not commit a fundamental breach. The Court confirmed the findings of the lower courts, according to which the mussels were conforming to the contract since they were fit for the purposes for which goods of the same description would ordinarily be used (CISG Article 35(2)(a)). The Court did find that the fact that the mussels contained a greater quantity of cadmium than the advised cadmium levels could well affect the merchantability of the goods, provided that the corresponding public law requirements were relevant.
However, like the lower courts, the Supreme Court excluded that the seller can generally be expected to observe special regulatory food quality requirements of the buyer’s state; it could only be expected to do so: (1) where the same requirements also exist in the seller’s country; (2) where the buyer draws the seller’s attention to their existence; (3) or, possibly, where the seller knows or should know of those requirements due to “special circumstances”, such as (i) when the seller has a branch in the buyer’s country, (ii) when the parties are in a longstanding business relationship, (iii) when the seller regularly exports to the buyer’s country, or (iv) when the seller advertises its own products in the buyer’s country.
The Court equally confirmed that the buyer was not entitled to avoid the contract because of non-conformity of the packaging (CISG Article 35(2)(c)). The decisive fact in this respect was that the buyer did not give notice of non-conformity of the packaging in due time (notice was given approximately two months after delivery).

Case: underperforming packaging machine[3]
A Swiss seller and a Spanish buyer concluded a contract for the sale of a packaging machine. The seller undertook to install the machine and prepare its operation at the buyer’s factory. A dispute arose between the parties regarding the required performance level of the machine. The buyer asserted that an output of 180 vials per minute had been agreed but the seller contended that this was neither possible nor agreed. On several occasions thereafter, the seller unsuccessfully attempted to increase the performance level. After two years, the buyer declared the contract terminated and claimed restitution of the purchase price plus damages. The seller counterclaimed for the outstanding purchase price along with damages. The seller lost the case in all three instances up to the Swiss Federal Supreme Court.
The Supreme Court stated that the actual performance of the machine delivered by the seller was well below the performance required under the contract. Therefore, the buyer was substantially deprived of what it had been entitled to expect under the contract according to CISG art. 25 and had the right to avoid the contract pursuant to CISG art. 49(1)(a).
As to the seller’s allegation that the buyer had forfeited its right to terminate the contract pursuant to the Vienna Convention, the Supreme Court emphasised a “reasonable” period of time as required by CISG art. 49(2)(b) must be determined in accordance with the circumstances of the case (inter alia, nature of the goods and lack of conformity, conduct of the seller subsequent to buyer’s notice of non-conformity), as well as the purpose of the provision.
In this case, the buyer had properly notified the lack of conformity pursuant to CISG art. 39(1), since it had done so immediately after the machine had been installed and the first test runs had been conducted. Furthermore, the relevant period of time for declaring the contract avoided had commenced only at a late stage, after the seller had eventually proposed an amicable settlement for a target performance level that would still be well below the performance required by the contract and the buyer became aware of the fundamental breach by the seller. Since the buyer declared the contract avoided approximately one month after the settlement proposal, it acted within a reasonable time.
Regarding the seller’s contention that the buyer had lost its right to declare termination of the contract due to its use of the machine (CISG art. 82(1)), the Swiss Supreme Court held that such provision applies only if the condition of the goods have been changing in such manner that it is unreasonable to expect the seller to redeem the goods. This was apparently not the case.

Case: defective pressure cookers[4]
A Portuguese seller and a French buyer concluded a contract for the sale of a stock of pressure cookers to be distributed in a French chain of supermarkets. After delivery, some of the cookers showed a defect that made their use dangerous.        The first instance Court held the contract terminated and condemned the seller to pay damages. Also, it ordered that all items were to be withdrawn from the market. The seller appealed, putting forward that termination should have been limited to those cookers which were defective (identification was possible by their serial number).
The Court rejected the seller’s claim. The number of the defective pressure cookers amounted almost to a third of the total number. Therefore, the seller’s breach of contract (according to CISG art. 35) was ‘fundamental’ under CISG art. 49, taking into account the nature of the goods and the need of security in their use.
Although the seller had stated that the defective items had a differing serial number permitting to limit the scope of a product recall, this did not result from the invoices, referencing to the same number. The seller did not provide for another way to identify the defective items. Partial termination was therefore not admissible.

Analogy with Unidroit Principles. The Unidroit Principles’ Article 7.3.1 uses the same concept of fundamental breach as CISG Article 25, but the Unidroit Principles calls it ‘fundamental non-performance’. Although the Unidroit Principles only apply in connection with the termination of a contract – and not also a claim for specific performance or other remedy – the criteria applied are the same, except that the Unidroit Principles are more specific about the circumstances that may be relevant to determine if a breach is ‘fundamental’:

SECTION 3: TERMINATION
Article 7.3.1 (Right to terminate the contract)
(1)      A party may terminate the contract where the failure of the other party to perform an obligation under the contract amounts to a fundamental non-performance.
(2)      In determining whether a failure to perform an obligation amounts to a funda­mental non-performance regard shall be had, in particular, to whether:
(a)      the non-performance substantially deprives the aggrieved party of what it was entitled to expect under the contract unless the other party did not foresee and could not reasonably have foreseen such result;
(b)      strict compliance with the obligation which has not been performed is of essence under the contract;
(c)      the non-performance is intentional or reckless;
(d)      the non-performance gives the aggrieved party reason to believe that it cannot rely on the other party’s future performance;
(e)      the non-performing party will suffer disproportionate loss as a result of the preparation or performance if the contract is terminated.

One illustrative arbitral award illustrates how the Unidroit Principles must be applied to determine whether a breach of contract is fundamental:

Case: exclusive supply of Mexican squash and cucumbers[5]
Defendant, a Mexican grower, and Claimant, a U.S. distributor, entered into a one year exclusive supply agreement according to which Defendant undertook to produce specific quantities of squash and cucumbers and to supply them to Claimant on an exclusive basis. Claimant had to distribute the goods on the Californian market against a commission. Due to a series of extraordinarily heavy rainstorms and flooding caused by the meteorological phenomenon known as El Niño, a complete harvest of crops was destroyed.
Claimant brought an action before the Centro de Arbitraje de México arguing that Defendant had breached the contract by not providing the agreed goods and by violating the exclusivity clause. The arbitral tribunal rejected the Defendant’s defence based on force majeure and hardship. It also established that the exclusivity clause was breached at least in one instance.
Concerning the request for termination, the Arbitral Tribunal pointed out that according to Unidroit Principles Article 7.3.1 par. (1), the non-performance by Defendant was fundamental since at least three of the criteria laid down in Article 7.3.1 (2) were met: first, Defendant’s failure to deliver the vegetables deprived Claimant of the goods it was entitled to expect under the contract; second, the Defendant’s violation of the exclusivity clause was intentional; and, third, these two circumstances were enough to give Claimant reason to believe that it could not rely on Defendant’s future performance.

[1]           See: http://www.unilex.info/dynasite.cfm?dssid=2376&dsmid=13356&x=35

[2]           German Bundesgerichthof 8 March 1995 VIII ZR 159/94 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=108

[3]           Swiss tribunal federal, 18 May 2009, 4A_68/2009 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=1460

[4]           Paris Cour d’Appel, 4 June 2004, 2002/18702 (Unilex): http://www.unilex.info/case.cfm?pid=1&do=case&id=984.

[5]           Arbitral Award (Centro de Arbitraje de México), 30 November 2006 (Unilex): http://www.unilex.info/case.cfm?id=1149

Terms of Use

I hereby accept (or reconfirm my acceptance of) Weagree’ Terms of use, in which:

Terms of Use

I hereby accept (or reconfirm my acceptance of) Weagree’ Terms of use, in which: