Substantial Performance of Contract Doctrine

What is Substantial Performance?

Substantial performance is a doctrine that relates to the performance obligations of parties to a contract. As with other closely-related doctrines, it is designed to solve problems related to breach. A good place to start is with an understanding of the performance obligations in a contract. When a contracting party agrees to perform under the contract, that party becomes the obligor. The other party becomes the obligee. And as a general rule, the performance obligation of the obligor is absolute. The obligee must receive exactly what was promised. If not, then the obligor has breached the contract. But sometimes a minor deviation from a promise is not a material or substantial breach of the contract . If the deviation is minor, we say that the obligor has substantially performed his part of the bargain. When this is the case, the obligee cannot exercise his right to withhold payment for the promised performance. If the obligor has substantially performed the contract, then he has actually performed the contract; he has done what he contracted to do. And as a general rule, he has the obligation to give back any benefit that he received under the contract. Any resting of the contract needs to noticed. The contract will not be terminated without giving ample notice for the party to cure the breach.

Substantial Performance Criteria

In determining whether a contract has been substantially performed, the courts will consider a number of criteria:
• The nature of the contract: The closer the contract is to a sale, the more likely a high standard is required. In a contract for the sale of goods or real estate, if the goods or real estate have been delivered in accordance with the contract specifications, then the buyer will have breached the contract if it does not make payment when due. In contracts for personal services, a minimal deviation will not be considered a breach. In construction contracts, a material deviation may not amount to a material breach if the contracted-for result is ultimately achieved.
• The purpose of the contract: The courts will tend to find a contract has been substantially performed where nonperformance defeats the purpose of the contract. In cases involving employment contracts, the courts "look at the function of the particular obligation" to determine if nonperformance defeats the purpose of the contract. Courts will consider factors such as the nature of the obligations and the extent to which the employer is prejudiced by nonperformance.
• The extent to which the injured party will be compensated for its damages: When the injured party will receive "substantially all of the benefits" of the contract despite the nonperformance, the breach is not material. Whether the injured party will receive substantially all of the benefits goes to the nature of the injured party’s interest under the contract.
• The extent to which the injured party can be adequately compensated for nonperformance: If damages are an adequate remedy and the injured party can be made whole, nonperformance usually will not be material. On the other hand, if the injured party cannot be made whole through an award of damages, nonperformance will be material.
• The time of the essence clause: A time of the essence clause will be strictly enforced. If you sign a contract containing a time of the essence clause, even though it is not material to the purpose of the contract, you must perform on or before the date set out in the contract. A court will not accept a defendant’s argument that because the contract was substantially performed the failure to perform by the date set out in the contract is not material.
• The likelihood of serious injury to the injured party: A material breach has occurred where a "material part of the thing bargained for is not done." For example, in Amey, Inc. v. Mobil Oil Corp., 515 F. Supp. 1283, 1285 (N.D. Tex. 1981), the breach was material because "a material part of the bargain between [the parties], the obtaining of [government] permits, was not performed."

Substantial Performance in Law

The doctrine of substantial performance recognizes that while the completion of contractual obligations must be precise, and arguably strict, a million minor faults can be overlooked where the purpose of a contract has been achieved. But when an issue arises about one or more minor faults or breaches of contract, will there be any impact on the parties to the contract?
The answer is yes. Substantial performance will affect the legal rights and obligations of the parties. Importantly, the party who makes a claim of breach of contract cannot include claims for compensation in respect of what has not been completed as part of their material breach against the other party.
A useful example of how the substantial performance rule works is to use the example of a building contract. If a house is built, and a well-known brand of ceramic tiles are used when cheaper tiles were required under the terms of the contract, the builder will not be liable in damages to compensate the owner. This is because the purpose of the contract has been achieved.
However, there will be legal implications for the builder. For example, the builder will not be able to sue the owner for their payment. Liability will rest on the owner to pay the builder their money. The owner will not have a valid claim for minor defects against the builder as the owner can only claim damages in a matter where there has been a material breach.
Another important legal implication is that if the non-defaulting party wishes to end the contract, the innocent party must give the party in breach an opportunity to remedy any defective work before termination of the contract can be claimed.

Examples of Substantial Performance

In a case before the United States Court of Appeals, Substantial Performance of a construction contract by the contractor allowed the contractor to recover $293,000 of its claim for over $675,000, even though there was an extension of time to perform the work. The District Court held that under Massachusetts law a general contractor who performs professionally and competently is entitled to recover on his contract if it meets the "substantial performance" standard, even if defective or incomplete.
In another case before the United States Court of Federal Claims, the contractor construct a number of upgrades to a facility for the Department of Veterans Affairs. However, the contractor failed to complete the work within the specified time and received a Notice of Default. The Board of Contract Appeals awarded the contractor $263,000 but denied the claim for $2.5 million in both delay damages and lost profits because the contractor had substantially performed under the contract. The United States Court of Federal Claims disregarded legal issues of waiver and laches and held that the contractor could not recover any lost profits on the project under the doctrine of substantial performance.
In a case before the New York Court of Appeals, the issues were very much similar to the above noted Court of Federal Claims case. The contractor applied for a change order which was granted by the owner, but required that the contractor assume responsibility for delays and additional costs. The contractor, nevertheless, recognized that he had not completed the work in the agreed upon time period and filed a claim. The New York Court of Appeals denied the claim for delay damages reasoning that the contractor had substantially performed under the contract. The Court determined that the contractor should have filed a claim against the owner.
Substantial performance claims are important and should be made whenever it is possible that the contractor has been impeded or delayed in the performance of the contract. It is usually better to file a substantial performance claim which is denied than to simply notify the owner that you have defaulted and failed for to past performance.

Substantial Performance and Full Performance

Substantial performance is a notion that the courts have developed as a way to deal equally with the parties to a contract when one of them does not deliver what they promised. It allows a court to inquire into the extent to which the contract has been performed and, usually in the context of an outright breach by one party, gives the innocent party the opportunity to seek a proportionate remedy.
On the other hand, the common law requires that where a party fails to completely or fully perform their obligations under a contract, that party is in breach. And the result of that is that the innocent party can claim some kind of damages, possibly the costs of obtaining that performance from someone else, or possibly some kind of penalty to be determined at the time by the courts. This kind of situation, on the other hand, creates a lot of benefit for the innocent party who may come out ahead economically as a result and gives rise to the dichotomy of whether or not there was a substantial performance defense.
The test for substantial performance was articulated in the 1896 Supreme Court of Canada case of H.P. Bolster Co. v. MacMillan Company of Canada Ltd. The test is this: "that where a contractor has substantially performed (the contract) there has been a sufficient performance of it to entitle him to recover upon the contract, and that the defect in the performance is merely such as to entitle the employer to some abatement of the price at which the contract was undertaken" . The result is that so long as that party has done enough of the contract, they will be deemed to have performed and because they have performed, they have a right to seek a remedy against the other party to the contract.
While the performance must be sufficient for the parties to go forward, the defendant will be entitled to raise a defense of set-off. So if, for example, you had a plaintiff who was to paint the exterior of a house and the defendant was to pay $1000 and the plaintiff painted only half of the house, the work would be sufficient for the defendant to bring a set-off claim against the plaintiff for the cost of hiring someone else to paint the other half. And by the same token, if a contractor starts off with a contract worth $100,000 but only finishes $80,000 worth of work, the plaintiff would be entitled to withhold the $20,000.
The two terms, substantial performance and complete performance, have been used almost interchangeably in the case law. To say that performance was substantial, however, means that it was not complete, while complete performance speaks for itself.
Whether looking at the full performance of a contract or looking at the substantial performance of a contract, the two are closely linked.

Effects of Substantial Performance on Remedies

The doctrine of substantial performance carries with it a series of remedies depending on the type of contract. But regardless of the type in question, they are all designed to honor the original contract as much as possible.
When a construction contract has been substantially performed, for instance, the contractor may be entitled to the payment of the contract price minus any damages that flow from the contractor’s failure to perform. That means if the contractor lied about the costs of labor or materials and the price was cut to reflect that, they may not get the entire contract price, but they will be compensated for as much of the value of the contract as was delivered.
In cases where no monetary value has been lost through a breach of contract, however, such as with rescission, substantial performance can reduce or eliminate the damages available from the breach, to varying degrees.
It’s important to note that even if a party does not have a legal right to a remedy, this does not mean they do not have an equitable right to it. Courts have discretion to provide equitable remedies at their discretion, and remedy under the doctrine of substantial performance is one of them. With this remedy, the court seeks to do justice among the parties.

Considerations for Corporations

The substantial performance doctrine offers a number of benefits to businesses, but it can also pose significant risk. For example, in construction contracts, liability for delays caused by alleged breach of contract is typically limited to the liquidated damages provision, thereby precluding or limiting the ability of the owners to recover consequential damages." Cd’A, Inc. v. Spokane School Dist. No. 81, 199 P.3d 924, 931 (Idaho 2009). However , the substantial performance doctrine has generally been found not to apply when the damages which are sought as a consequence of the breach are not a proper subject of the liquidated damages provision, such as loss of projected profits or loss of use damages. Id. Because these issues depend in large part on the specific contract language at issue, whether a theory of breach of contract can be maintained and, if so, to what extent, depends in part on how that contract is drafted.