November 11, 2007 “Material Breach”
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.
November 11, 2007 at 8:43 am
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.”
November 11, 2007 at 9:19 am
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
November 11, 2007 at 10:44 am
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…
November 11, 2007 at 12:33 pm
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
November 12, 2007 at 12:01 pm
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