Why A “Binding” Contract Doesn’t Really Bind the Parties

The virus hit me like a ton of bricks. I could barely eat or get out of bed for two days, and my string quartet had a big performance.

This wasn’t a professional engagement; we were one of several groups on the program, so the audience probably wouldn’t have cared if I had backed out. However, the three other people in the quartet had worked for months toward this moment. Not wanting to disappoint them, I rallied, took medicine to mask my symptoms as much as possible, and dragged myself to the performance.

I don’t know if it was the cold medicine I had taken or pressure on my inner ear from the virus, but I lost my equilibrium and fell while walking on stage. Like a good violinist, I held on tightly to my violin and lifted it into the air so it wouldn’t be harmed. But as a result, I wasn’t able to break my fall -- I fell hard, taking the full impact on my hip.

I didn’t break any bones, thankfully, but I was shaken – to say the least. Once again, it wouldn’t have been unreasonable for me to back out – but the idea didn’t cross my mind. Some might think I was crazy for even attempting to perform when I was ill and banged up. I don’t attribute my decision to proceed to determination or grit. Rather, in my mind, the price of withdrawing was too high. Backing out would mean that the others in my quartet would be hurt by missing the performance – and they didn’t deserve that. So, without hesitation, I nodded to the others that I was ready to start.

Reflecting on this experience made me think about a discussion I recently had with a non-attorney. They said they were astonished to learn that businesses sometimes intentionally breach contracts – that it’s a business decision to pay the price of a breach rather than continue performing.

That made me realize that maybe we shouldn’t use the term “binding” to refer to contracts. Many people think that a binding contract guarantees results, that both parties are obligated to perform the contract as written. They believe that if someone signs a contract to buy a house, subject to any contingencies, they must buy the house. Or if a contractor agrees to renovate their house, they must complete the job.

But a contract isn’t a guarantee. This article discusses the real purpose of contracts and why, while a “binding” contract imposes legal obligations on the parties, it doesn’t guarantee that the parties will perform as agreed.

Contracts Outline Expectations

Contracts are comprised of mutual promises. Most contracts also state the factual representations on which the parties are basing those promises. And most contracts state what happens if a representation isn’t accurate or a party doesn’t perform as promised.

For example, in a house purchase contract, the seller may represent that they own the house and can sell it, that they aren’t aware of any major flaws, such as structural or environmental problems, and that the house isn’t leased to anyone else. The buyer, in turn, may represent that it has been pre-approved for a mortgage loan.

The house purchase contract will also include promises. The buyer will agree to submit a formal loan application and close on the purchase within an agreed-upon time after signing the contract. The seller will agree to allow the buyer to conduct inspections and won’t sell or lease the property to someone else.

The contract will require the buyer to post a deposit equal to a portion of the purchase price, which typically will be nonrefundable, with a few limitations outlined in the contract. Most contracts provide that if the buyer breaches, the seller keeps the deposit as “liquidated damages.” In short, the deposit is the price the buyer must pay to cancel the deposit without additional consequences.

Many sellers don’t think about the deposit amount – they’re focused on the purchase price. But because the deposit is the price the buyer must pay to cancel, it can determine the likelihood that the closing will actually occur as promised. If the deposit is low, the buyer is less likely to go through with the purchase than if they stand to lose a significant sum if they back out.

Other contracts include deposits. For instance, a home renovation contract typically requires the homeowner to pay around 30 percent of the total cost as a deposit. A jeweler might require a nonrefundable deposit when ordering a custom engagement ring. Generally, these deposits are best thought of as a pre-negotiated price for a breach.

Contract Damages Usually Aren’t Punishments

The good news for contracting parties is that even if their contracts don’t have deposits, liquidated damages, or other provisions about compensating the innocent party in the event of a breach, the law usually will fill in that gap. But contract damages under the law aren’t designed as punishments, so if the parties want a punishment for bad behavior, they need to negotiate it.

The idea that contract damages aren’t punishments often surprises people. We’re taught from a young age to keep our promises and be “good to our word.” Breaching a contract can be seen as “immoral,” so intuitively, it makes sense that there should be a punishment for breaching a contract.

But contracts aren’t moral obligations; they are business obligations. Parties to business arrangements may suffer harm from a breach of contract, but the harm is usually measurable in dollars. In our examples, the home improvement contractor may have incurred the expense of purchasing and hiring subcontractors. The real estate seller may have turned down other offers to sell the property.

Rarely, a contract will be such that the performance is so unique that it isn’t compensable with money. Real estate is a common example. Since each parcel of real estate is unique, a buyer (but not a seller) frequently can pursue “specific performance” – a court order requiring the seller to sell the property as set forth in the contract.

But most of the time, contract damages are designed to compensate non-breaching parties for the economic losses they suffer as a result of the breach. The general goal of contract damages is to put the non-breaching party in the economic position it would have been in if the contract hadn’t been breached.

For example, if a contractor doesn’t complete a home renovation, the homeowners’ damages would be the cost of completing the renovation, which might be more or less than the contract price. If the homeowner cancels the contract, the damages would be the profit the contractor expected plus the expenses the contractor incurred performing the contract – again, not the full contract price.

Incentives Matter

Because contract damages can be uncertain, parties often try to define remedies in advance. When doing so, it’s necessary to balance provisions that incentivize the parties to perform the contract and the need to adequately compensate each party if the other breaches. When negotiating terms, it’s important to consider both the internal incentives in the contract and the external ones outside of the contract. And context can change external incentives.

In a real estate purchase contract, internal incentives are generally addressed through a nonrefundable deposit for the buyer. However, parties typically also have external incentives. An understanding of external incentives helps determine which internal incentives are necessary to encourage performance.

For example, a prospective homebuyer moving into an area may need a place to live in a particular school district before school starts. A commercial real estate investor may be pressed for time to accomplish a Section 1031 exchange or have spent hundreds of thousands of dollars investing in due diligence, loan application, and other expenses, from which they won’t benefit if they breach. In those instances, a lower internal incentive (i.e., deposit) might be sufficient.

Similarly, sellers might have external incentives, such as a mortgage that matures in a few months. And with real estate, the possibility of a costly specific performance lawsuit provides a significant incentive. With my quartet performance, there weren’t many internal incentives for me to perform. A performer will usually lose some of the benefit of their hard work if they back out, but those often aren’t compelling compared to virus symptoms. With the quartet, the external incentive was the impact on the other quartet members.

However, external incentives frequently have a subjective element. For me, the external incentive of not wanting to disappoint the other quartet members was significant, but that might not be the case for someone else. A party negotiating a contract needs not only to understand what the external incentives are but also to seek to determine the importance the other party attaches to them.

The Better Way to Approach Contracts

Contracting parties shouldn’t view contracts as guarantees. Rather, contracts focus on goals, incentives, and most importantly, risk. Contracts sometimes assign a fixed value (i.e., liquidated damages) to the risk of breach. Other times, the contract might cap the cost of a breach. But it’s critical that parties carefully evaluate their financial exposure and the other party’s incentives when negotiating the contract. Sometimes, the legal measure of damages will be sufficient, but other times, it won’t. When it won’t, the contract should outline a fair measure of damages.

Unfortunately, parties tend to hyperfocus on the core deal terms such as the purchase price, closing date, or scope of work. They might pay attention to the amount of the deposit, but beyond that, they consider the damages and remedies sections boilerplate.

But as with my quartet performance, life happens, people get sick or injured. Inflation or rising interest rates can make home purchases unaffordable. Supply shortages can make it simply too expensive for a contractor to complete a renovation.

Our quartet assumed everyone would show up for the performance – and that’s what happens most of the time. While it wasn’t completely unforeseeable that one member of the quartet might get sick, the illness plus a fall when walking on stage wasn’t at all likely. While our quartet didn’t have a ready-made backup plan, contracting parties should do better by evaluating the likely risks and planning for the possibility that the contract might not be as “binding” as they hope.

© 2026 by Elizabeth A. Whitman

Any references to clients and their legal situations have been modified to protect client confidentiality.

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