What is Breach of Covenant?
Breach of Covenant means when parties directly involved in a contract failed to comply with the promises made in the agreement (called as a covenant). In this case, the defaulting party that breached the agreement can be sued for compensation against the damages done.
Example of Breach of Covenant
Mr. Anderson is a person working in the sensible Research & Development team of an FMCG company. They entered into a non-compete agreement where Mr. Anderson agrees with the term and conditions involved in the employment agreement where it was clearly mentioned that if the employee voluntarily leaves the work and wishes to join another FMCG company, then he has to wait for at least three years before joining the company and leaving the current company.
In case Mr. Anderson leaves the current company voluntarily and joined another FMCG company within three years, the employer can sue Mr. Anderson as per the agreement as ‘Breach of Covenant.’ In the given case, the employer can ask the court or judiciary for the injunction or restriction against Mr. Anderson, and the defendant has to comply with the same. Hence this clause helps to keep the sensitive information regarding the applicant’s business from leaking out through the defendant. So, it is always included in a contract entered to protect the rights and interests of both the parties from any severe damage that could arise in case of a breach.
Types
#1 – Breach of Affirmative Covenant
It is a type where the agreement mentioned in the contract obliged a party to perform some act for the completion of the contract’s considerations. For example, in case of a sale agreement, the seller may ask the buyer party to make some payment upon receiving the material and other part payment after some period, and the buyer party fails to do so accordingly may qualify as a breach of covenant.
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#2 – Breach of Restrictive Covenant
It is a type where the agreement mentioned in the contract restricts a party to perform some act as per the contract entered. For example, the example of Mr. Anderson mentioned above, where the employer restricts Mr. Anderson to join another FMCG company within three years of leaving his company. This type of covenant qualifies as a restrictive covenant, and breach of the same is termed as breach of a restrictive covenant.
Waiver
In the case of Breach of Covenant, the aggrieved party may consider the same as default and sue the other party, or both the party can come into a consensus and may agree upon a waiver unconditional or with some conditions. The waiver could be adopted in case the damage is not severe to the aggrieved party upon the breach by the defaulting party.
The unconditional waiver is the option where there is no remuneration or compensation, or other terms are imposed upon the defaulting party. It is due to non-severe damage to the aggrieved party.
A waiver with conditions could be opted as an option by the aggrieved party in the case upon the breach of covenant by the defaulting party, the aggrieved party has incurred some damage but not severe. The aggrieved party agreed to waive its right to go to court if the defaulting party agrees on some conditions like payment of penalty money agreed on, or the compensation for the collateral that was mentioned in the contract, etc.
Importance
- Having control over the borrowing power of the borrower to ensure the financial health and stability of the borrower and helping the creditor by ensuring the possible recovery of the borrowed amount within the time frame;
- Protecting the secrecy and sensible information of the aggrieved party and ensuring the safety of the possible damage that could be done to the aggrieved party.
- Ensuring the compensation in case of damage to the aggrieved party and enforceability in the court helps to maintain the lawful completion and enforceability of the contract agreement. Etc.
Consequences of Breach of Covenant
The court can order one of the following –
- Remedy for Damages of Aggrieved Party: In case the damages could be pay-out in money consideration, and the damage could be mounted into the money, the court may order for payment to the aggrieved party for some amount by the defaulting party.
- The Injunction to Prevent Continuing Breach: In case the damage could not amount into money or the damage occurs could only be pay-out in the high sum of money, the court may order an injunction to stop the continuing breach of the covenant and the defaulting party has to perform his part of the deal as per the covenant to make the covenant normal and the breach to be ceased.
Conclusion
It helps the aggrieved party as well as provide the control to ensure the interest of the creditor parties such as in the case of bank borrowing covenant, which provides the borrowing in the prescribed ratio of debt and equity and in the case of a breach; the bank can restrict any more credit to be taken by the debtor party which helps the creditor to take a record of the financial health and stability of the debtor party.
Recommended Article
This article has been a guide to What is Breach of Covenant and its Meaning. Here we discuss the two types of covenant breach (Affirmative & Restrictive) along with examples, importance, and consequences. You can learn more about from the following articles –
