Essentials on Forfeiture in Contractual Provisions

The Basics of Forfeiture in a Contractual Provision

In contract law, forfeiture occurs when a party binds itself to certain terms and conditions of a contract, but then does not fulfill its obligations. Forfeiture can take a few different forms. For example, if someone purchases a piece of real estate, but does not complete payments on the home, the vendor has the right to reassume possession of the property. It would be necessary for the vendor to follow whatever contractual obligations are required regarding forfeiture , but so long as they do so properly, he/she may reclaim possession of the property. In some cases, sometimes forfeiture is also unconditional.
Forfeiture has an important place in contract law. When reviewing the stipulations of a contract, a party is bound by much of what is agreed upon. Therefore, in instances where a party does not abide by those agreements, it is in fact violating an obligation, and is liable as such. Forfeiture is part of upholding contractual obligations.

Elements that Constitute a Forfeiture Clause

The imprint of a forfeiture provision in any contract is predictable, and can be summarized as following: whenever a contracting party can gain some advantage by the failure of another contracting party to fulfil its term of the contract, the contract will be enforced according to its terms, thus rendering the offending party unable to take ‘the benefit of its own wrongdoing’. In order to give legal effect to this certainty in contract enforcement, there are specific components which must be present in any forfeiture provision. They are: 1. Clearly stated terms. Forfeiture provisions are strictly enforced, so it is essential that the terms be expressed unambiguously and be bolstered by sufficient evidential facts or standards to demonstrate that the offending conduct is clearly proscribed. 2. Has a reasonable basis. The courts will not enforce unreasonable forfeiture clauses that are outside the bounds of rationality. Therefore, there must be a true correlation between the sanction imposed and the contract breach. Failing to encourage the party to comply with the contract cannot be deemed justified. 3. Where appropriate, should be warranted by the circumstances of the breach. If the contract gives the injured party the right to terminate for any breach then that will suffice. However, if the offender can first remedy their breach the forfeiture provisions can be invoked thereafter, when reasonable.

Types of Forfeiture in the Law of Contract

Parties to a contract can agree to a variety of forfeitures, some of which will apply automatically and others which will not. Automatic forfeitures generally apply when the impact of a breach of contract is immediate. Non-automatic forfeitures arise in situations where the parties agree to treat performance as a condition precedent to further obligations under the contract.
Automatic Forfeiture
Some contracts have automatic forfeitures. For example, in a real estate purchase contract, if the purchaser defaults, then they lose their deposit. Other examples of automatic forfeitures include:
contracts of membership in clubs agreements between financial institutions and their customers rental agreements between landlords and tenants
The rationale for allowing forfeiture clauses coming into play even if they may be grossly disproportionate lies in the fact that some forfeitures represent an appropriate estimate of contractual loss in certain contract contexts.
Non-Automatic Forfeiture
Forfeiture clauses can also be used as conditions of a contract. That is, performance of certain conditions of a contract can be delayed or made contingent on performance of certain conditions. If either party fails to perform the condition, the other can consider the contract terminated and exercise his/her rights in case of breach.
For example, an auto financing agreement can contain a clause stating that full payment for the auto is due when the customer defaults on any payment even if the loan is not yet paid in full. Potential difficulties arise, however, where the liability for damages is not easy to quantify, such as contracts of membership in private clubs. In the absence of an express clause dealing with the issue, in an action arising from a breach of a condition, prompt performance of the conditions set out in the contract is most often required but failure to satisfy a condition will not normally result in a forfeiture unless the parties intended the forfeiture as the primary result.

Legal Theories Behind Forfeiture

The legal consequences of a forfeiture can be significant for all concerned. Both parties should be aware and advised of the nature of those consequences. The most obvious consequence of the forfeiture of a purchaser’s deposit is that the forfeited deposit will be retained by the vendor, without any obligation to pay interest to the purchaser. The vendor, having received a certain amount of funds as a result of forfeiture, is not required to mitigate damages (in the sense of using such funds in an effort to try to minimize any loss suffered as a result of the breach). In fact, the vendor will have received the benefit of the money pursuant to strict legal obligations. The vendor has also been saved from pursuing the most certain pursuit possible: a remedy for breach of one’s contractual obligation to pay money.
One the other side of the coin, if a vendor forfeits the deposit of a purchaser, and something further goes wrong so that the purchaser wishes to hold the vendor accountable, it can be very difficult to enforce one’s rights against a party who no longer has the money, or where the circumstances are such that the deposit is minimal in comparison to the entire amount of the purchase price (as is often the case in the sale of real property).
In some cases, where specific performance is an option, the court may award either the vendor or the purchaser a remedy for its loss, or order a refund of the forfeited deposit. In most cases, however, total forfeiture is upheld because it will represent the most efficient way of compensating the vendor for its loss, short of continuing with the sale.
In a commercial transaction, one of the most important conditions is the requirement of a forfeitable deposit. Without this, the financial loss, or loss of opportunity that a vendor suffers, can be substantial and may lead the court to consider a remedy other than the forfeiture of the deposit. For this reason, the forfeiture of the deposit must be clearly stipulated in the contract. It is important to contract in a way that you will be able to uphold a total forfeiture of the deposit, in order to prevent commercially embedded equity.

Enforcing a Forfeiture Clause

The first and most common method of challenging a forfeiture finds its source in the general powers of the court to make a declaration of rights. A litigant will normally seek a declaration that the relevant clause is unenforceable or void.
Alternatively, the litigant may seek to have the clause declared to be penal or in terrorem in nature and therefore unenforceable. Such circumstances are referred to as res judicata although the appropriate judgment need not itself deal with the validity of the clause as its root lies in the public policy rules that a court will not give effect to a pre-letter of demand clause which provides for the forfeiture of an amount equal to the whole of the debt (where the amount payable is certain) or the clause is calculated to give rise to an obligation to perform an obligation on the part of the debtor which is substantially disproportionate to the prejudice to the creditor resulting from the breach of the contract. In this regard, see the decisions of the Supreme Court of Appeal in Duxbury versus Bock and Others 2002 (4) SA 1079 (SCA).
Further, it has been held that the consequences of the enforcement of such a clause must be out of all proportion to the importance of the object which it is to obtain. Such claims arise mainly in leases (as regard levis et operis and where there is the payment of a penalty for the breach of a resolutory condition (see also the decision in Sappi (Wood) v Afri-Pulp & Paperkor CC 1997 (3) SA 1137 (SCA)).
Reliance may also be placed on conflicting judgments of the various divisions of the High Court.
The next avenue is to argue that the clause ought to be severed from the agreement . This approach is frequently taken by litigants where the clause in question is contained within a number of clauses (often 20 or more clauses) spread throughout the contract.
A litigant may also argue that either the clause itself is separable from the remainder of the contract (that is, the clause may be deleted from the document) or that the remainder of the contract is brought to an end and that the client is entitled to a vindicatio. Of course, the problem with this argument is that where a party can show some evident commercial advantage arising from the preservation of the contract, albeit with the offending clause being removed, the alternative claim is bound to fail (see the decision of the SCA in Pomona Quarries supra at para [62]).
Often the argument that the court should act in contract with the parties’ intention and delete the offending provisions from the contract is met with the submission that the contract is valid and binding and that the entire agreement clause embodied in the contract negates any defence of rectification. A party so opposing must show that the offending clause was a material term of the contract and that it was intended to be a firm and binding undertaking.
A litigant may also argue that the offending clause provisions are capable of rectification.
It has also been held that a servitude which is permissible in terms of a licence agreement is invalid in terms of the Registration of Deeds Act 1937 because it is inconsistent with s 63(1) thereof (i.e. the purpose of the servitude must be definite, certain and lawful).
Alternatively, an argument is frequently raised that the clause ought to be declared by the court to be against public policy. Here, a litigant may seek to rely on the provisions contained specifically in s 3 of the Taariq Motors case (supra).

Drafting a Forfeiture Clause

The best practice for any forfeiture clause is to clearly and accurately describe the conduct or action that constitutes a default. A clause that provides broad authority to terminate or cancel a contract in the event of "default" will more likely than not avoid scrutiny if it neatly defines default and all the parties’ obligations. This also allows the parties to predict with far greater certainty the outcome of a breach of contract litigation. Specificity is often required with respect to the following:
A well-drafted forfeiture clause will often provide precise language for the parties and the court to consider in determining the type of conduct that constitutes a breach of contract. This is especially important in a commercial contract that relies upon payment of penalties, liquidated damages, forfeitures, or other post-breach or contract-termination measures. Commercial contracts should specifically define post-breach damages, the method for calculating the damage amount as well as how the amount of liquidated damages bears any relationship to the real damages that would be incurred.
While no contract is immune from forfeiture challenges, the better the forfeiture clause’s drafting, the better the chances that the challenged clause will remain intact and enforceable.

Recent Developments on Forfeiture Law

Recent trends in forfeiture law have focused on the interplay between forfeiture and the legal limits of liquidated damages and equitable remedies. As forfeiture becomes more commonly used, courts and legislatures are cautioned to consider their role as an alternative to liquidated damages. Forfeiture has garnered scholarly attention in the last decade, but its use remains limited. Forfeiture is most commonly used as a punitive equitable remedy.
In reaching a determination on forfeiture, courts examine the equity of a situation and the parties involved. This has prompted suggestions that forfeiture should be construed narrowly so as to not unduly penalize the parties. In this regard, rules on forfeiture have been liberalized in many states. The Uniform Commercial Code permits forfeiture upon breach of any contractual duty. By contrast, other state statutes allow forfeiture only for breach of a specific contractual duty. States also vary in their rules concerning legislative and judicial forfeitures.
Courts are reluctant to apply forfeiture broadly because the remedy may operate in a harsh or unconscionable manner. Courts tend to reject the forfeiture remedy if it appears that a party would not be able to recover even under a properly drafted liquidated damage clause. Courts also determine that forfeiture is inappropriate when the forfeiture is more than the actual damages suffered by the non-breaching party and is thus penal in nature.
Legislatures have taken action to clarify equitable forfeiture. For example , states have statutorily limited forfeiture by focusing on materiality or good faith breach. Courts are now more willing to enforce forfeiture since courts tend to view forfeiture as the last resort after other remedies have failed. In this context, courts examine the incentive effect of forfeiture on parties to an option contract. Courts may also parcel out the forfeiture remedy so that some of the provisions for forfeiture are permitted. However, courts will not permit forfeiture if it takes the remedy beyond its intended scope.
As a remedy, a court may condition a forfeiture. For example the court may declare a forfeiture and allow the breaching party time to redeem itself or to reinstate the forfeited contract. This approach, however, imposes a new duty to perform on the breaching party, and only applies in limited circumstances.
Courts also evaluate the alternate or substitute remedy available. An example is where a court is faced with a choice between awarding a forfeiture or adopting a liquidated damage provision as the measure of damages.