This is a question that has frequently come up in my experience negotiating commercial contracts as in-house counsel. Fundamentally, when we use this phrase in a contract, we are trying to exclude “technical” kinds of breaches that nobody should reasonably care about, while including the severest breaches that anyone would care about. But there is definitely a middle ground between the two extremes where “materiality” is not so clear.
In the US, contract law is a state law issue, so the concept of “materiality” (and pretty much every other contract interpretation issue) differs from state to state. The Restatement (Second) of the Law of Contracts, an attempt to draft a unified set of rules based on US state laws, explains the concept of “material breach” as follows:
§ 241. Circumstances Significant in Determining Whether a Failure Is Material
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.
The seminal New York law case on the issue, Hadden v. Consol. Edison Co., 34 N.Y.2d 88, 96 (1974), says something similar using different words:
There is no simple test for determining whether substantial performance has been rendered and several factors must be considered, including the ratio of the performance already rendered to that unperformed, the quantitative character of the default, the degree to which the purpose behind the contract has been frustrated, the willfulness of the default, and the extent to which the aggrieved party has already received the substantial benefit of the promised performance.
The lack of a simple test means that materiality of a breach will often be in the “eye of the beholder.” Sometimes this is satisfactory to the parties, but where a clearer standard is desired, the options might include:
- Defining specific breaches as categorically “material” (such as failure to deliver or failure to pay). This requires very careful forethought to ensure that nothing is left out of the list.
- Defining a breach as “material” if it causes damages to the other party that exceed a specific dollar amount. The main downside to this strategy is that some breaches, such as breaches of confidentiality or non-compete obligations, may be difficult to quantify.
- Contract drafting guru Ken Adams has suggested defining “material breach” as a breach because of which a reasonable person in the position of the non-breaching party would wish to terminate the agreement. This is arguably no less ambiguous, but is at least an easier standard to understand and argue about.