Only A Material Breach Of Contract Can Support A Party’s Non-Performance Or Claim For Rescission

• Posted on: Jan 13 2017

A breach of contract comes in two primary varieties: a material breach and a minor breach.  The former is substantial, goes to the very heart of the agreement and prevents the contract from being performed. When a material breach occurs, the non-breaching party can cease performing under the agreement and sue to collect the damages caused by the breach.  The latter, also known as a partial breach, occurs when a party fails to complete a less important part of a contract. Importantly, the contract can still be completed. Thus, the non-breaching party remains obligated to complete his/her performance under the agreement, but has the right to sue for damages.

In deciding whether a breach is material, courts often look to the Restatement (Second) of Contracts, as well as to other court decisions that arose from contract disputes. In New York, “courts generally consider the extent to which the non-breaching party will be prejudiced or damaged by lack of full performance.” Awards.com v. Kinko’s, Inc., No. 603105/03, 2006 WL 6544391, at *5 (Sup. Ct. N.Y. Cnty. 2006) (quoting Callanan v. Powers, 199 N.Y. 268, 284 [1910], aff’d as modified, 42 A.D.3d 178 (3d Dept. 2007)).  This determination is not as easy as it seems.

The Restatement (Second) of Contracts provides a list of circumstances that help determine whether a breach is material – that is, whether the non-breaching party is prejudiced by the breach.  These circumstances include: “(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).  These factors are discussed below.

The extent to which the injured party will be deprived of the benefit which he reasonably expected:

An example of this factor can be seen from the Volkswagen emissions scandal. Volkswagen marketed and sold its turbocharged direct injection (“TDI”) diesel engines as “clean diesel” vehicles. Purchasers of these vehicles believed that they were buying vehicles that met or exceeded emissions requirements in the United States. However, Volkswagen intentionally programmed its TDI diesel engines to activate emissions controls only during laboratory emissions testing. Thus, the vehicles were not environmentally clean as represented. For millions of environmentally conscious consumers, the purpose of buying the TDI diesel engine vehicles was denied – that is, they were deprived of the clean diesel vehicles they agreed to buy.

The extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived:

If the breach can be corrected with reasonable effort or expense, while keeping the contract in effect, it is less likely to be a material breach. Consider the Volkswagen TDI diesel engine example. Volkswagen did not have the technology to make the TDI diesel engine clean. Because the manufacturer could not fix the problem, a court would consider Volkswagen to have breached the contract in a material way.

The extent to which the party failing to perform or to offer to perform will suffer forfeiture:

This factor looks at the amount or degree of performance by the breaching party to fulfill his/her end of the bargain? In the Volkswagen example, the company failed to deliver at inception. It did not expend the time and resources needed to deliver a clean diesel engine vehicle. Under that circumstance, the breach is material.

There are other more common, everyday examples of this factor.  For instance, consider the homeowner who hires a contractor to replace his roof with modern tiling. About sixty percent of the way into the job, the homeowner discovers that the contractor is not using the modern tile as agreed upon, though the material used is considered to be comparable. If the homeowner declares a breach of contract, the contractor will have lost a significant amount of time and money than if the breach was declared before the job commenced. If most of the contractual obligations have been completed, the homeowner would be less likely to claim a material breach of contract.

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:

This factor considers whether breaching party can and will correct the problem. The more likely the breaching party can and will fix the problem, the less likely the breach will be deemed to be material. In the Volkswagen case, the technology for “clean diesel” engines did not exist.  Thus, there was no likelihood that Volkswagen could fix the emissions problem.

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:

If the breach was intentional or resulted from bad faith or unfair dealing, a court is more likely to presume a material breach of contract. In the Volkswagen case, the facts showed that in order to deceive the buying public and government regulators about compliance with emissions standards, Volkswagen intentionally programmed its TDI diesel engines to activate emissions controls only during laboratory emissions testing. These controls were automatically turned off once the emissions testing concluded.

The extent to which the Contract Defines A Material Breach:

Often, the parties to a contract will include provisions in their agreement stating that certain events will constitute a material breach of the agreement. For example, a clause may state that certain activities, such as a failure to make payments, a failure to maintain insurance, or a failure to achieve certain sales goals, will constitute a material breach under the contract. Notably, because a delay in performance and/or payment may not be material, parties often include a “time is of the essence” clause, to signify that a delay will be considered a material breach of the agreement.

Matter of Buffalo Schools Renovation Program:

On December 8, 2016, the Supreme Court, Commercial Division, in Erie County issued a decision in the Matter of Buffalo Schools Renovation Program, 2016 NY Slip Op. 51846(U), in which it dismissed a breach of contract and rescission claim because the breach alleged was not material.

Facts:

Buffalo Schools arose out the renovation of 48 schools for the City of Buffalo City School District (“District”), formerly known as the Buffalo Schools Renovation Program (the “Program”).

The general framework of the Program was governed by a Comprehensive Program Packaging and Development Services Provider Agreement, signed by the City of Buffalo Joint Schools Construction Board (“JSCB”) and LPCiminelli, Inc. (“LPC”) in 2002 (“PPDSA”). JSCB acted as the District’s agent in implementing and overseeing the Program. LPC served as the “Program Provider”.

Pursuant to the PPDSA, the Program was implemented over five (5) phases; each phase was governed by separate phase agreements (the “Phase Agreements”). The Phase Agreements set out the delivery model for the phase and the specific schools to be renovated pursuant to that delivery model.

While substantially all of the Program was financed with state funds (not the District’s or the City of Buffalo’s), the District, the JSCB, and the bond insurers and underwriters insisted that LPC agree to commit to fixed-priced construction agreements for each phase of the renovations, pursuant to which LPC assumed virtually all of the risk of cost overruns and time delays. The Phase Agreements required that amounts due LPC were to be determined by the Program’s architects, based upon the percentage of completion of the stipulated sum, not the actual cost of construction and administration.

For more than a decade (and five phases of the Program) the JSCB approved and paid 265 of LPC’s Program payment requisitions, without reservation — until late 2014. At that time (and at the behest of certain members of the District’s Board of Education), the JSCB failed to process certain of LPC’s payment requisitions for completed portions of the Program, totaling in excess of $3.1 million (the “Disputed Payment Requisitions”), and the District insisted that it — not the JSCB, was solely responsible for considering them. For the first time, the JSCB and the District demanded that LPC produce documentation of, inter alia, LPC’s Program-related overhead and administration costs, construction expenses and profit (the “Disputed Information”).

The Motion Court’s Rulings:

The District filed a complaint against LPC on January 29, 2016, alleging, among other things, breach of contract. On February 17, 2016, LPC filed a verified petition and complaint against the District and the JSCB, alleging, among other things, the failure to act on the Disputed Payment Requisitions. Each side moved to dismiss the complaints pursuant to CPLR § 3211; the District and the JSCB also moved to dismiss pursuant to Section 3813 of the New York Education Law, and by way of cross-motion to direct LPC to preserve any documentation related to the construction program at issue.

The Court (by decision rendered on the record on August 15, 2016) disposed of some, but not all aspects of the motions. Instead, it invited further submissions on the remaining issues that were the subject of the Court’s decision.

The Court found that LPC did not breach any provision of the PPDSA. Nevertheless, the Court addressed the allegation that the breach (i.e., the failure to provide certain documentation required under the PPDSA) was material and, therefore, permitted the District and the JSCB to cease performing under the contract.  The Court found that, “even if accepted as true,” LPC’s failure “to provide required information” was not material “as a matter of law and, in any event, [could not] justify the District’s refusal to pay LPC for the work approved and accepted.”

The Court explained that:

Only a material breach of contract gives rise to a cause of action or a right to rescind. A material breach is generally regarded as a breach which substantially defeats the purpose of an agreement in such a fundamental way as to defeat the object of the parties in making the contract, and otherwise occurs where a party fails to perform a substantial part of the agreement performance of which was the initial inducement for entering the agreement. For a breach to be material, it must go to the root of the agreement between the parties.

A party to a contract will not be excused from paying for the other party’s services absent such material breach. In determining whether a breach is material, courts generally consider the extent to which the non-breaching party will be prejudiced or damaged by lack of full performance. Whether a breach is material is a question of law to be decided by the Court.

* * *

Here, any alleged breach by LPC’s purported failure to provide certain information was not material. The purpose of the Program and its contracts was to renovate forty-eight (48) District schools for a stipulated sum. That purpose was fully accomplished. The District does not dispute this. It accepted the work, occupied the buildings, and received the certifications of the Architects of Record, who signed off on the outstanding payment applications. For twelve (12) years, the District never claimed that LPC failed to provide it with regular reports or required information. The District’s claim, raised at Program completion, does not go to the “root” of the contracts; it was not so substantial that it defeated the object of the parties in making the contracts; and, equally important, the provision of information was never an inducement for the District to enter into the contracts at issue. The District wanted schools renovated, at a fixed priced, and that is what it received. Under a fixed-price contract, the actual cost to the design-builder is irrelevant and immaterial. The provision that the District relies most heavily on – PPDSA § 11.05 – predates the entry of the Phase Agreements, meaning it had even less materiality once the fixed-price model was agreed on.

(Internal quotations and citations omitted).

Takeaway:

Buffalo Schools stands as a reminder that parties to an agreement that want to cease performing because of an alleged breach better be sure that the breach goes to the root of the agreement such that performance cannot be made. Otherwise, that party is exposing itself to a claim of breach of contract that may in fact be material.

Tagged with: Business Litigation, Commercial Litigation, Complex Litigation