In a reciprocal contract, non-performance or malperformance by one party relieves the other party from the obligation to perform his part of the bargain.
The consequences of undertaking reciprocal contractual obligations.
Contracts (legally binding agreements) are the lifeblood of commerce. It is, moreover, a fundamental principle of our law that a contract, once entered into, must be honoured.
That is to say, each party to the contract must do what he has undertaken to do.
If the contract is not honoured, the law provides various remedies to the innocent party.
Many of those remedies - for example, a claim for damages (monetary compensation) for breach of contract - involve litigation, which is expensive and can take a long time to reach a conclusion.
However, there is an important common law remedy that an innocent party to a contractual dispute can, in some circumstances, invoke without resorting to litigation.
This remedy is available in respect of contracts that involve reciprocal obligations.
An example of a reciprocal contract would be where I sell you a widget. The legal consequence is that I have an obligation to deliver the widget to you and you have a concomitant obligation to pay me the agreed purchase price.
Unless we agree otherwise, the law requires performance and counter-performance to take place simultaneously. In other words, at the same time as I hand over the widget to you, you must pay me the price, and vice versa.
From this it follows that, unless and until you deliver the widget to me, I am under no legal obligation to pay you the price. In other words, without resorting to litigation, I can simply withhold the contract price. Conversely, unless and until I tender payment of the price, you are under no obligation to deliver the widget to me.
Partial or defective performance of reciprocal contracts
The difficulty in applying these principles arises where one party to a reciprocal contract makes partial performance or defective performance. What is then the obligation of the other party? Can the latter accept the partial or defective performance but refuse to pay any part of the contract price on the basis that the agreed performance has not been made?
These issues recently came before the Supreme Court of Appeal in Smith v van den Heever 2011 (3) SA 140 (SCA).
In this case, Agrichicks (Pty) Ltd, a company that supplied day-old chicks and chicken feed, entered into a contract with Smith, a contracted chicken farmer.
The agreement was that Agrichicks would supply day-old chicks to Smith, plus the necessary chicken feed. Smith would rear the chickens on his farm until they were 45 days old, at which stage Agrichicks would collect the live chickens, weigh them, slaughter them, and market them as processed broilers. Smith would pay Agrichicks for supplying the day-old chicks and chicken feed, and Agrichicks would pay Smith on a per kilogram basis for the mature chickens they collected from him.
This process would operate in cycles, and each cycle would be accounted for individually, with Smith being debited for the cost of the day-old chicks and chicken feed supplied to him, and credited with the per kilogram value of the mature chickens that Agrichicks collected from him at the end of the cycle. Naturally, there was a mortality rate, and the number of chicks supplied to Smith at the beginning of the cycle would be greater than the number of mature chickens that Agrichicks would collect from him at the end of the cycle. This mortality rate would reduce the net amount that Smith would earn under the contract, and in a bad cycle Smith might end up owing Agrichicks more than they owed him.
Each cycle would commence with Agrichicks' delivery of day-old chicks to Smith and end with the delivery to Smith of the next batch of chicks 56 days later. In the eleven days that intervened between Agrichicks collecting the chicks after 45 days and supplying a new batch after 56 days, Smith would prepare his chicken hatches for the next batch.
In terms of the agreement, each cycle had to be accounted for separately. As noted above, Smith was to be credited with a per kilogram agreed value of the mature chickens collected by Agrichicks at the end of the cycle and Smith would be debited with the acquisition cost of the chicks and the cost of chicken feed supplied by Agrichicks in that cycle.
The contract provided that if there was a debit amount owing by Smith at the end of a particular cycle, that debit would be carried forward for two more cycles, and would then become payable by Smith.
The contract between Agrichicks and Smith commenced on 15 June 1999 and was to continue for a period of five years. Unfortunately, Agrichicks almost immediately experienced financial difficulties and the company was eventually liquidated on 14 August 2002.
Agrichicks became unable to perform its obligations
The problems arose in the last two cycles before Agrichicks went into liquidation in 2002, namely the May cycle and the August cycle in that year.
At the end of the May cycle, Smith owed Agrichicks some R87 000 for his loss on that cycle. Ordinarily, in terms of the contract, that loss could have been carried forward for two further cycles and Smith would then be obliged to pay the amount due.
However, in the course of the next cycle - the August cycle - Agrichicks defaulted on its obligations, since it was unable to deliver the promised chicken feed to Smith for that cycle because of its impending insolvency.
When the company went into liquidation, the liquidator of Agrichicks sued Smith for some R470 000 in respect of the amount owing in terms of the contract. Agrichicks averred -as it had to - that it had performed all of its obligations under its agreement with Smith.
The failure of performance in the two cycles in May and August 2002
In the last (ie August) cycle of the contract before the company went into liquidation, Agrichicks did not collect the mature chickens from Smith at the end of the cycle, and instead informed him that they were abandoning that batch of chickens and that he was free to destroy them or dispose of them. Smith, at his own cost, then had to buy in the remainder of the necessary chicken feed (which, in terms of the contract, should have been supplied by Agrichicks) and he then sold the chickens to third parties.
A dispute then arose between the liquidators of Agrichicks and Smith as to what amount, if any, Smith owed the company in terms of the contract for the day-old chicks and chicken feed that had been supplied to him.
Smith averred that he did not owe the company anything because Agrichicks had failed to perform their reciprocal obligations in the August cycle of the contract, namely the obligation to provide chicken feed and the obligation to collect the mature chickens from him at the end of the cycle.
We see here a classic example of a breakdown of an on-going reciprocal contract in which one party - in this case Agrichicks - had only partially performed its obligations..
On the other hand Smith had had the benefit of the chicks that Agrichicks had supplied to him in the August cycle - which he had, in effect, received gratis since he had not made any payment to Agrichicks for that cycle - and which he had now sold directly to third parties and pocketed the money.
This contractual dispute was first heard in the High Court which found in favour of Agrichicks and ordered Smith to pay the company the full outstanding contracted amount in respect of the supply of day-old chicks and chicken feed.
The Supreme Court of Appeal rules on the reciprocal contract
On further appeal, the Supreme Court of Appeal took a very different view.
The court held that the amount of R87 000 due by Smith to Agrichicks in respect of the May cycle could not be carried forward as envisaged in the agreement because in the next cycle (the August cycle) Agrichicks had defaulted on its obligations to supply chicken feed to Smith and take delivery from him of the mature chickens.
Consequently, said the court, because Agrichicks had not performed all its contractual obligations in the August cycle, the principles of contract law in relation to reciprocal obligations precluded that company from demanding that Smith pay the debit amount that had arisen in the May cycle, which was to become payable two cycles later.
The Supreme Court of Appeal ruled that it was immaterial that Smith's obligation to pay for the day-old chicks in respect of the May cycle had arisen before Agrichicks defaulted on its obligations in the August cycle. Agrichicks' defaulting on its obligations in the August cycle meant that, as matter of contract law, the company was not entitled to demand payment from Smith in respect of the debt he had incurred in the May cycle, but which was only payable two cycles later.
In short, Agrichicks' failure to fully perform its contractual obligations precluded it from demanding any counter-performance from Smith.
It was of course true that Smith had received the benefit of the day-old chicks that Agrichicks had supplied to him in the August cycle. But the court said that Agrichicks had failed to prove what the value of those chicks was, and Agrichicks therefore had no claim against Smith in this regard.
The moral of the story
A contract involving reciprocal obligations is a double-edged sword for both parties. If one party does not perform his obligations, or does not perform them properly, the other party is entitled to withhold his performance.
These rules apply only to true "reciprocal contracts", as defined in contract law, and it can be a matter of some complexity to determine whether a particular contract falls into this category.
If the parties wish to modify these common law rules, such that non-performance in one phase of an on-going reciprocal contract does not relieve the other party from performance in another phase of that same contract, then this needs to be spelled out in the contract itself.