July 5, 2023 – Jonathon D. Nelson, General Counsel for Dedicated Financial GBC
In the event that one party to a contract materially breaches that contract, the non-breaching party is usually relieved of their obligations under that contract. Simply stated, the non-breaching party does not have to honor their contractual obligations post-material breach.
Most commercial creditors utilize standard contracts that are designed to protect them from class action lawsuits and otherwise minimize liability. Once a merchant defaults under a standard contract, certain sections of that contract may hamstring the creditor’s ability to swiftly and efficiently collect the debt that is owed to them.
For example, a creditor’s standard contract may contain a section requiring the parties to that contract to arbitrate any and all disputes between them. While that section may help the creditor avoid a jury trial, it will make it more expensive and time-consuming to collect a debt, as arbitrating claims and confirming an arbitration award to convert it to a monetary judgment typically takes longer than commencing a civil lawsuit and prosecuting claims to a monetary judgment. Since a creditor is already owed a debt, they may be reluctant to spend additional sums in an effort to collect the debt through arbitration, sometimes asking why they would throw good money after bad.
In most States, case law regarding material breach of contract will allow commercial creditors to have their cake and eat it, too. In other words, commercial creditors may have a path to compel payment of a debt, without having to first pay an arm and a leg in attorneys’ fees and court costs. It should be noted that a material breach of contract is not a technical breach of one part of a contract, but rather a breach of a portion of the contract that is material to the transaction, such as a failure to timely make payment pursuant to the terms of promissory note when time is of the essence.
Minnesota case law states that a material breach is “[a] breach of contract that is significant enough to permit the aggrieved party to elect to treat the breach as total (rather than partial), thus excusing that party from further performance and affording it the right to sue for damages.” Quoting BOB Acres, LLC v. Schumacher Farms, LLC, 797 N.W.2d 723, 728-29 (Minn. Ct. App. 2011)(Quoting Black’s Law Dictionary 214 (9th ed.2009)). The Minnesota Supreme Court explained that a breach is material when “one of the primary purposes” of a contract is violated. See Steller v. Thomas, 45 N.W.2d 537, 542, 544 (Minn. 1950).
Other States have rendered similar holdings. See e.g., Brown v. Grimes, 192 Cal. App. 4th 265, 277 (2011); Callanan v. Keeseville, Ausable Chasm & Lake Champlain R.R. Co., 92 N.E. 747 (NY Ct. App. 1910); Covelli Family, L.P. v. ABG5, L.L.C., 977 So. 2d 749, 752 (Fla. 4th DCA 2008); Israel ex rel. Dundee-Landwehr Ltd. P’ship v. Nat’l Can. Corp., 658 N.E.2d 1184, 1190 (IL Ct. App. 1995). Much like Minnesota, those States have also held that trivial noncompliance and minor failings do not constitute material breaches. See Wolfram P’ship v. Lasalle Nat’l Bank, 765 N.E.2d 1012, 1025 (IL Ct. App. 2001); Covelli Family, 977 So. 2d at 752; Callanan, 92 N.E. at 752; Superior Motels, Inc. v. Rinn Motor Hotels, Inc., 195 Cal. App. 3d 1032, 1051 (1987).
Oftentimes, whether a breach of contract is material is a factual question. Cloverdale Foods of Minn., Inc. v. Pioneer Snacks, 580 N.W.2d 46, 49 (Minn. App. 1998); Brown, 192 Cal. App. 4th at 278; Covelli Family, 977 So. 2d at 752; Israel, 658 N.E.2d at 1190; cf., Cont’l Ins. Co. v. RLI Ins. Co., 161 A.D.2d 385, 387 (1st Dep’t 1990) (materiality of a breach is a matter of law for the court to decide where the evidence concerning the materiality is clear and substantially uncontradicted). Generally speaking, that means pursuing a material breach of contract argument will lead to a trial, absent a default judgment, settlement, or well-reasoned motion for summary judgment.
Courts across the country have applied material breach of contract case law to many different types of contracts and fact patterns. The Minnesota Court of Appeals discussed material breach of contract in the context of commercial real estate transactions, and the Minnesota Supreme Court analyzed a timber-cutting contract. BOB Acres, LLC, supra.; Cloverdale, supra.; Steller, supra. California’s appellate courts have considered whether a fee-sharing agreement between lawyers was materially breached, in addition to a commercial lease. Brown, supra.; Superior Motels, supra.
The courts in New York have examined fact patterns involving alleged material breaches of railroad reconstruction and raisin reinsurance contracts. Callanan, supra.; Cont’l Ins. Co., supra. A Florida appellate court reviewed a possible material breach of a commercial lease in the aftermath of hurricanes Frances and Jeanne. Covelli Family, supra. Illinois’ 1st District Court of Appeals heard cases involving material breach arguments concerning a commercial lease and a construction loan agreement. Wolfram, supra.; Israel, supra.
In the above-referenced cases, the respective courts held that a material breach occurred in five cases, that there was not sufficient evidence to affirm or reverse a trial court’s finding of a material breach in three cases, and in the remaining two cases, that there was no material breach of contract. While useful, the “odds” of a holding of material breach of contract should not be calculated based on this article.
Instead, a commercial creditor should look to the specific set of facts underlying a dispute with a merchant, in addition to the contract governing the relationship, to make an educated guess as to whether a merchant materially breached that contract. If that commercial creditor purchased future receivables from a merchant, and the merchant promised to timely remit portions of those receivables, it is more likely than not that the creditor will be relieved of its obligations under the contract if the merchant does not make timely remittances and does not communicate with the creditor. Likewise, a commercial creditor that leases equipment to a merchant will very likely be entitled to relief if that merchant fails to timely pay rent.