United KingdomApril 21 2023
Whether a breach of contract is ‘material’ (or ‘substantial’ – in this context, the terms are generally interchangeable) can be difficult to ascertain. But the answer can have a major impact on the consequences flowing from such a breach. The issue crops up often in commercial disputes. In this briefing, Walker Morris’ Commercial Dispute Resolution experts Gwendoline Davies and Kieran Craddock, and Commercial specialist Ryan Doodson, explain how the approach adopted by the courts can offer practical assistance for contract negotiators and commercial parties.
Breach of contract: Back to basics
The basic, common law position [1] is that a contract can only be terminated if the actions of a breaching party go right to the core of the contract and substantially deprive the innocent party of the benefit the contract was intended to confer. (Such a breach is also known as a repudiation, or a repudiatory breach.)
To allow termination, as opposed to just financial compensation, for breaches which are less drastic than repudiatory breaches, but that nevertheless still have a significant impact, parties often agree express terms providing for termination in the event of a material breach of contract. But what constitutes a ‘material’ breach?
Breach of contract and materiality: Key principles
There is no universal legal definition for material breach of contract. Meaning will therefore be a question of interpretation, on a case by case basis. Over time, the courts have adopted a varied approach to interpreting materiality:
- In National Power Plc v United Gas Co Ltd (1998), the court held that a material breach of contract was a breach that has a serious effect on the benefit that the innocent party would have otherwise derived from the contract.
- In Dalkia Utilities Services Plc v Celtech International Ltd (2006), the High Court ruled that failing to make three consecutive monthly payments constituted a material breach of Celtech’s obligations, as the combined total was “neither trivial nor minimal”. (It was relevant, in that case, that Celtech was on the brink of insolvency.)
- In Crosstown Music Company 1, LLC v Rive Droite Music Ltd(2009) the court considered that the concept of materiality, as opposed to triviality, has to be measured in the context in which the question arises – that is, the total factual matrix, covering the terms of the contract and the circ*mstances of the case.
- In Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust (2013) LJ Jackson stated the phrase ‘material breach’ “connotes a breach of contract which is more than trivial, but need not be repudiatory…. Having regard to the context of this provision, I think that ‘material breach’ means a breach which is substantial. The breach must be a serious matter, rather than a matter of little consequence”.
- Along similar lines, in Mears Ltd v Costplan Services (South East) Ltd (2018), material breach was held to be somewhere between not trivial and sufficiently serious to be repudiatory.
- In the recent case of Stobart v Esken (2022), it was held that there had been no material breach because the sorts of breaches committed could have been put right in the future [2].
- The same principle was applied in the recent case of RiverRock European Capital Partners LLP v Harnack (2022). (Dissolution of a company was found not to constitute a material breach of contract since the company could be restored to the register.)
Ascertaining materiality: The correct approach
So, in light of the court’s varied approach and the significant subsisting uncertainty, how can a contract negotiator or contracting party determine whether a breach of contract is material?
If there’s no express contractual definition for ‘material’ breach of contract, the following factors should be taken into account:
- the nature of the contract and all relevant contractual terms
- the full factual matrix, including the commercial circ*mstances and circ*mstances surrounding the breach
- the parties
- the parties’ conduct, including their reaction to the breach
- the actions constituting breach
- commercial/factual consequences of the breach and impact on the innocent party
- potential consequences on the respective parties if the breach were found to be material
- whether the breach can be remedied in future.
Breach of contract and materiality: What practical advice arises for negotiating/drafting contracts?
For all practical purposes, the courts have a considerable degree of discretion when deciding whether or not a breach of contract is material.
One option to minimise the uncertainty that accompanies that level of discretion is to try to eradicate ambiguity, by expressly defining within the agreement what constitutes a material breach of contract.
Parties can achieve this by including wording to establish a scope of any triggering breach (material or otherwise) and/or by setting out specific circ*mstances which would give rise to a material breach.
A common approach is for the parties to identify any specific contractual obligations that are, in the parties’ opinion, so significant that any breach would have important consequences and should, therefore, give rise to the ability for the innocent party to terminate. Such obligations will vary from contract to contract, depending upon the context, the parties and the particular subject matter of the contract. For example, in a contract containing service levels, the parties – or at least the party seeking to enforce the service levels – may wish to specify that certain failures to achieve the service levels will amount to material breach of contract. Similarly, in a distribution agreement where the distributor is prohibited from distributing into certain territories, the supplier may wish to define breach of this key obligation as material.
Where parties identify specific scenarios in this way, it may be prudent to expressly clarify that the defined list is not exhaustive and is without limitation, but this will be a question of individual preference. This tactic should provide the option for a party to argue that a breach not specifically called out may still be designated material by the party seeking to terminate. However, drafting-in this ‘wiggle room’ does still leave some uncertainty and some scope for dispute.
