The Condition/Covenant Conundrum

Colaco v. Cavotec SA, No. G052619 (D4d3 Aug. 10, 2018)

This is a complicated breach of contract case arising from a sale of corporate assets. It addresses an issue of contract law that, while not procedural, is worth at least a mention.


Seller’s duties under the contract required it to forward all post-closing revenue to Buyer. Buyer, in turn, was required to make a final $2 million earnout payment on the transaction. Neither party performed, although seller breached first. So the question is, did Seller’s breach relieve Buyer of its obligation to make the final payment?

This gets into the difference between conditions and covenants. Some contractual terms—conditions—are interdependent. (“If you do A, I’ll do B.”) A material breach of a condition excuses further performance. But others create independent obligations—covenants—that are sufficiently unrelated such that even a material breach of one won't excuse the other. (“You do A; I’ll do B.”) The distinction depends on the language, structure, and intent of the contract. 

That, of course, doesn’t say very much about what the rule really is, particularly when the performance of a contract its complicated. The Court doesn’t offer a whole lot of gloss. Suffice it to say, a simple agreement like the basic sale of a good will often be conditional: If I agree to sell you my car for $50, and I don’t deliver the car, you don’t need to pay me the cash. But as agreements get more complicated, and their obligations more mutual and iterative, it becomes increasingly inequitable to reward a non-breaching party with complete cancellation of any obligation to perform. 

Which is kind of what happened here. The asset sale had closed and the assets (basically a company) changed hands. The non-payment of the revenue was a breach, but it was only for $1.3 million. The earnout wasn’t dependent on that revenue. It was conditioned on hitting certain performance metrics, which were in fact hit. So it would give Buyer a windfall if Seller’s failure to forward the revenue also merited an effective $2 million reduction in purchase price, solely due to an issue in the timing of who breached first. Thus, the contract created covenants, not conditions, and so the trial court should have granted Seller's jnov and offset the unpaid revenue against the earnout.

FWIW, this case touches on several other interesting issues. Such as the interaction between the internal affairs doctrine and contractual choice of law clauses, the effects of offsets on punitive damages, and the relationships between contractual limitations on liability and remedies for torts. Worth a read.

Reversed in part.