United States: Material Breach And The Consequences Of Being Wrong

It's not uncommon for parties to a construction contract to exchange heated letters accusing each other of material breach of their contract. Determining whether a breach occurred is easy compared to determining whether that breach was material.

A breach is a failure to perform an express or implied obligation under a contract. Whether that breach is material turns on the facts and circumstance surrounding the formation of the contract and is often a matter of degree. For instance, a seller would breach a contract to sell a 1964 metallic mint green Buick Skylark convertible with Michelin Model XGV tires, size 75-R-14 to a buyer if the seller delivered a 1964 metallic mint green Buick Skylark convertible with Uniroyal size 75-R-14 tires because the seller did not provide the specified tires. Would this be a material breach? Not likely because a material breach goes to the essence of the deal, which in this case would be the sale of a vintage automobile.

Changing the facts slightly can make material an otherwise immaterial breach. Take the same sale, but add that the sale was of a car that had been used in the filming of the movie "My Cousin Vinny." The seller delivers the exact same type of car used in the film, but it is later determined that the car had not in fact been used in the movie. This would most likely be a material breach because the essence of the sales contract was the sale of the car used in the movie "My Cousin Vinny."

Damages are recoverable regardless of whether the breach is material. But in addition to recovering damages, a material breach gives the non-breaching party the option to either stop their performance and terminate the contract or continue to perform the contract.1

The option to stop performance and terminate for material breach should not be exercised casually.  If the breach is determined to not be material, then the terminating party will itself be in material breach for stopping their performance and wrongfully terminating the contract, even if the right was exercised in good faith.2

In addition, terminations are considered forfeitures of the breaching party's contract rights. 3 "Forfeitures are not favored, and are subject to a very strict construction."4  As a result, the benefit of doubt as to whether a breach is material goes to the non-terminating party.

Unfortunately, the case law does not provide clear guidance to determine when a breach is material or substantial enough to excuse further performance and terminate.   The courts in Georgia hold that a breach is material when it is "so substantial and fundamental as to defeat the object of the contract," and "to trigger the right to [terminate], the act failed to be performed must go to the root of the contract.  A breach which is incidental and subordinate to the main purpose of the contract does not warrant termination."5

It follows that "[t]he law in Georgia is that a substantial or material breach by one party excuses subsequent performance by the other party. However, a breach which is incidental and subordinate to the main purpose of the contract, and which may be compensated in damages, does not warrant ... termination, nor does a mere breach of contract not so substantial and fundamental as to defeat the object of the parties in making the agreement."6

Courts sometimes consider a list of five circumstances to aid it in determining whether a failure to perform is material: (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 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.7

Two additional factors may be considered in determining when a party's further performance is excused due to the other party's material breach: (1) the extent to which it reasonably appears to the injured party that delay may prevent or hinder him in making reasonable substitute arrangements; and (2) the extent to which the agreement provides for performance without delay, but a material failure to perform or to offer to perform on a stated day does not of itself discharge the other party's remaining duties unless the circumstances, including the language of the agreement, indicate that performance or an offer to perform by that day is important.8

The case of Mustang Pipeline v. Driver Pipeline9 illustrates how the determination of whether a breach is material can drastically affect the outcome of a case.  In this case, Mustang subcontracted with Driver to install 100 miles of pipe in 98 days.  The subcontract made time an essential term, included welding specifications for working in the rain, and required that "... sufficient forces and equipment be furnished at all times to adequately perform work with ample margin for emergencies and unexpected events, to carry on the work at a sufficient rate of progress to ensure completion within the time specified in the contract."

The progress of the work was impacted by extensive rains, resulting in Driver only installing 15 miles of pipe in the first 58 days of the schedule.  Driver shut down its work, requested a time extension, and proposed a new schedule when the weather improved. Mustang terminated the subcontract, hired a replacement subcontractor, and sued Driver for delay. Driver countersued for wrongful termination.

The jury awarded Mustang $2.1 million for Driver's delay, and it awarded Driver $2.5 million for wrongful termination.  The trial court affirmed the $2.5 million award to Driver, but it overturned the $2.1 million award to Mustang because it determined that the Driver was not in material breach when Mustang terminated the subcontract.  In other words, the trial court determined that Mustang's termination was a material breach that excused Driver from completing its work within the 98 day schedule.

The Texas Court of Appeals affirmed the trial court's decision, holding that the jury's award to both Mustang and Driver could be interpreted as the jury determining that Driver's breach of the time requirements of the subcontract was not material.

The Texas Supreme Court reversed the $2.5 million award to Driver, and it reinstated the $2.1 million award to Mustang, holding that time was an essential term of the subcontract and that Driver's delay was a material breach, as a matter of law, because "[a]t the point at which Mustang terminated the contract, there was virtually no chance that Driver would be able to cure its breach and complete the construction on time."

Parties are free to define in their contracts what constitutes a breach sufficient to warrant termination and excuse further performance.  These clauses often contain ambiguous standards that require caution.

For example, the Georgia Court of Appeals in Hope Electric Enter. Inc.v. Schindler Elevator Corp.10 held that the term "repeatedly" in a provision that authorized a prime contractor to terminate "[i]f the Subcontractor repeatedly fail[ed] or neglect[ed] to carry out [its] Work in accordance with the Subcontract Documents..." was too ambiguous for a court to determine, as a matter of law, whether the contractor was justified in terminating a subcontractor for allegedly having repeated safety violations.

MARTA, the owner of the project, had directed the prime contractor to remove the subcontractor from the project because its president, who was not authorized to be on site, had crossed live train tracks, coupled with the subcontractor's previous citations for leaving an electrical closet door open, and removing a breaker from a panel without the owner present.  The prime contractor immediately terminated the subcontractor, taking the position that it would have been futile to allow the subcontractor to cure these violations without the owner's permission for the subcontractor to access the project sites.

The trial court held that evidence of the three to four violations was sufficient to establish a repeated failure to performance in accordance with the subcontract.  The Court of Appeals reversed, holding that a jury must determine what the parties intended when they used the term "repeatedly" in the termination provision.  The Court explained that "the Subcontract contains no reference point to determine what constitutes a repeated violation or failure to perform and there is no indication of how many occurrences there must be before the contractor is authorized to terminate the Subcontract pursuant to this provision.  And the Subcontract is uncertain concerning what, if any considerations beyond mere number of violations are relevant to make this determination."  The Court of Appeals further explained that it was not clear whether the alleged safety violations had been properly documented and whether the subcontractor was given his contractual opportunity to cure.

In sum, parties should exercise caution in terminating a contract for "material breach," whether they are relying upon the common law meaning of the term "material breach," or a contract definition.  If the terminating party is wrong, then the termination will be a material breach excusing the other party from its continued performance and entitling it to damages.

Footnotes

1  Forsyth County. v. Waterscape Services., LLC, 303 Ga. App. 623, 633, 694 S.E.2d 102, 111-12 (2010); Vidalia Outdoor Prods., Inc. v. Higgins, 305 Ga. App. 836, 701 S.E.2d 217, 219 (2010).

2  Mustang Pipeline Co. v. Driver Pipeline Co., 134 S.W.3d 195, 196 (Tex. 2004).

Powell v. Mars Oil Co., 214 Ga. 710, 107 S.E.2d 208 (1959).

4  Id.

5 Waterscape Services, 303 Ga. App. at 633.

6  Id.

7 Restatement (2nd) of Contracts § 241 (1981).

8 Id. at § 242.

9 134 S.W.3d 195.

10 752 S.E.2d 5 (Ga. Ct. App. 2013)

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