In my tireless quest to master all things related to materiality, I recently asked myself what the heck material breach means. I suspect that if you were to ask that question to a random sample of lawyers and business people, you’d mostly get a lot of hemming and hawing.
By extrapolating from my analyses of material and material adverse change (the most recent being the third article in this issue of Deal Lawyers), I came up with the definition of material breach contained in the following provision:
2.3 Termination for Breach. If either party commits a Material Breach of its obligations under this agreement, the other party may terminate this agreement by giving the breaching party at least ten days’ prior notice, except that any such notice will not result in termination if the breaching party cures that breach before the ten-day period elapses. For purposes of this agreement, “Material Breach” means, with respect to a given breach, that a reasonable person in the position of the nonbreaching party would wish to terminate this agreement because of that breach.
What do you think?
I have in mind that this definition would apply only in the context of termination. When it comes to remedies, if you want to incorporate a significance qualifier, you’d probably want it to express a lesser level of significance, so you wouldn’t want to use the word material.
Hmmm… again, I think you’re barking up the wrong tree on this.
“Material” is used as a substitute for “Substantial”, as most folks would like to make sure that you’re not going to terminate an agreement, for example, for being 2 days late in performance of an obligation that doesn’t have a critical time schedule.
In other words, if one party is supposed to create a deliverable by x date, and the other party is supposed to pay by y date, a delay of either obligation by 2-3 days isn’t going to be a material breach, even though it IS a literal one.
On the other hand, if a 3 day slip on the part of the creator of a single deliverable could or does cascade to a 3 week delay on a larger overall project, then it might be considered “material.”
Jeff: Have you read the article I linked to? In it I point out that the word material is ambiguous. Courts construe material to mean, in effect, “of such a nature that knowledge of the item would affect a person’s decision-making process.” But practitioners also use the word to mean simply “significant.”
I suggest that if drafters want to avoid confusion, they should use material to convey only the meaning that courts give it; otherwise, they should use significant or use some other means of expressing significance.
I suspect that your “substantial” is comparable to my significant.” I have no fixed notions regarding whether it would be better to use material or significant for purposes of termination provisions. But if you want to use material, then I remain of the view that your provision should look something like mine. If you want to express a different meaning, use a different word.
Finally, note that my language doesn’t attempt to express the level of breach that would be required to terminate. It simply indicates that you can terminate if a reasonable person in your shoes would terminate. Whatever word you use, the inquiry is going to remain utterly vague.
Ken
Interesting. I think I wasn’t clear enough the first time around (ambiguity doesn’t just happen when writing contracts). :)
The difference I’ve seen attributed to the words “material” and “substantial” are used to connote whether a breach is of a nature that is really important to the purpose of the agreement, versus a breach that is of a certain quantity.
In other words, “material” is used when describing a breach that is of significant import to the terms of the contract. “Substantial” on the other hand is used to describe a breach of a specific amount. When explaining this to the other side, I usually talk in terms of analogy to explain it best.
The one I use here is that if the contract between us is for the provision of apples, and you give me oranges, you may have substantially complied with the agreement. Both are fruits, are relatively round in shape and have a nutritional value. However, they’re materially different. Apples are not identical to oranges. Different colors, different specific nutrients, etc. If I only wanted a roundish fruit, I would’ve simply contracted for a roundish fruit. But since I asked for apples, I want apples.
I do see, however, that “material” could be ambiguous…
Jeff: I don’t think it’s possible to distinguish between material and significant except in terms of degree of significance. It’s useful that the SEC has embraced this distinction, as I mention in my article. Ken
I usually encourage my clients to think through under what circumstances (what types of breach) they would want to terminate, for instance delay in excess of a certain number of days or a defect ratio in excess of some factor. These circumstances are then – non-exclusively – specified as Material Breach. For practical purposes this approach has proven useful in the past.
Martin
Understanding the inherent ambiguity in “material,” and its frequent misuse where some variant of “significant” might be more appropriate, there still exists a general comfort with “material” qualifiers among practitioners. So where another party doesn’t want to explore new verbiage, what is the preferable phrasing in this (understandably perilous) scenario:
“ACME may issue a notice of default to BUSINESS if BUSINESS materially breaches any term of this Agreement…” or
“ACME may issue a notice of default to BUSINESS if BUSINESS breaches any material term of this Agreement…”
The second seems more consistent with the court-imposed meaning, but may wrongly suggest that there are non-material (read: extraneous) provisions in the agreement. We actually just want to guard against default for only a nominal breach rather that a significant (or “material”) one.
There is a general resistance to adding more defined terms to this particular agreement, so implementing your initial suggestion – while legally preferable – will unduly aggravate my client.
Given the suboptimal contextual restraints, is there a way to redeem, or at least mitigate against, the natural limitations of “material” here?
You touch on a distinction that, annoyingly enough, I don’t cover in MSCD. It will appear in the fourth edition.
As regards the notion of practitioners being comfortable with “material” qualifiers, it’s a comfort based on obliviousness.
Note that my analysis of “material” has come a long way in seven years. You might, for example, find of interest my recent post on “material breach.”
Hi Ken,
Did you ever drill down on the ACME distinction drawn above? I’d be curious what you found:)
The question is whether you’re dealing with a material breach of any term or any breach of a material term. The theoretical implications are clear, but I haven’t seen the distinction appear as a factor in litigation.
The Restatement is pretty clear about how to evaluate the whether breach is “material”, and it’s a much higher bar than just “the non-breaching party would want to terminate” (which creates all sorts of perverse incentives):
In determining whether a failure to render or to offer performance is material, the following circumstances are significant:
(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing.
Restatement (Second) of Contracts § 241 (1981)
Thanks. I’ll soon revisit this, and I’ll have to take into account the various definitions out there.
Hi Adam,
Just a simple question here; is it possible to substantially perform a contract and yet in material breach of the same in your view? For example, if a contractor completes the works under a construction contract thereby substantially performing its obligations but only completed it 2 days after the deadline where the contract has the time of the essence clause which indicates that the contractor materially breached the contract.
In such a case, do you think the owner can only recover damages (let us assume that there was no LD for the sake of discussion) or can they refuse to pay all together for the material breach?
Sorry, I’m not equipped to answer that sort of question.
hi – dumb question – is it OK to draft a termination clause for breach without requiring that the breach be “material?” in our standard contracts we don’t require the breach to be material before a party can terminate for a non-cured breach, after notice. I’d rather not argue about whether the breach was material. but maybe I’m missing something….