Supply Chain Survival Series: What is Breach of Contract (Article #12)
In previous articles, we’ve discussed how contracts are formed and what options may be available to you when it appears that your counterpart won’t perform its contractual obligations. Assuming your counterpart has failed to perform, this article focuses on what constitutes a breach of contract, and whether that breach suspends your performance obligations. The key question for common law contracts is whether the breach was material. Relatedly, in an installment contract governed by the UCC, the question is whether the breach substantially impaired the value of the whole contract.
What is a Breach of Contract?
A breach of contract is a violation of any term or condition of the agreement. It could be a failure to perform an obligation, such as failing to deliver goods or payment; it could be performing an act prohibited by the contract, such as disclosing confidential information; or it could be performing below a required standard of care. Although parties are expected to perform the terms of their agreements in full, not all breaches have the same consequences. In common law contracts, the remedies of the non-breaching party depend, in large part, on whether the breach was material.
Material and Non-Material Breaches
A material breach is a substantial failure to perform. It disrupts the primary purpose of the agreement, and therefore also suspends the non-breaching party’s obligation to perform. It may also entitle the non-breaching party to damages. A non-material breach is less serious—a violation of a term that is part of, but not central to, the agreement. A non-material breach may entitle the non-breaching party to damages, but, critically, does not suspend the non-breaching party’s obligation to perform. Material and non-material breaches are common law concepts that the UCC does not address. What is considered material will be a fact-specific inquiry and may vary from court to court.
Consider a contract between a painter and a homeowner (which would be outside of the UCC’s scope). The contract states that the painter will paint the exterior of the house within one week from the date the parties enter the contract. One week passes and the painter has only finished 25% of the job. The painter violated an express term of the contract, but was his breach material? What if he completes the rest of the job only one day late? Or what if the painter completed the job on time, but the homeowner had agreed to pay him in cash and instead mailed a check? Would the homeowner’s breach be considered material? As stated above, these are fact-specific inquiries and could be treated differently by different courts. As such, you should consult your attorneys when faced with any breach of contract to determine what remedies may be available to you.
Breaches of Installment Contracts
A similar concept to the distinction between material and non-material breaches applies to installment contracts, but the UCC expressly governs what parties to an installment contract may do when goods do not conform. Under the UCC, an installment contract is one which requires or authorizes the delivery of goods in separate lots to be separately accepted, even if the contract contains a clause that “each delivery is a separate contract” or similar language.1 The UCC provides a few important rules—largely centered around whether the defect “substantially impairs” the installment or entire contract (similar to a common law material breach):
- A buyer has the right to reject a non-conforming installment of goods if the non-conformity substantially impairs the value of that installment and cannot be cured.2
- When a non-conformity substantially impairs the value of that installment, BUT does not substantially impair the value of the whole contract, and the seller gives adequate assurance of its cure, the buyer must accept that installment.3
- Whenever a non-conformity or default associated with one or more installments substantially impairs the value of the whole contract the entire contract is breached.4
These rules show that parties have different rights when a defect substantially impairs the value of the defective installment versus the value of the whole contract. Assume, for example, you recently signed a contract on behalf of ABC Corp. with XYZ Corp. under which XYZ Corp. agreed to deliver five shipments of widgets to ABC Corp. Each delivery will contain one million widgets and will be made on the last day of the month. ABC Corp. needs ten days to incorporate the widgets it receives from XYZ Corp. into its own products, which it delivers to a third party by the fifteenth of every month. Assume every widget delivered to ABC Corp. in the second installment is defective. ABC Corp. notices immediately and knows it cannot incorporate the widgets into its products. The defect substantially impairs the value of the second installment, but what if XYZ Corp. promises to deliver conforming widgets by the second of the next month? ABC Corp. only needs ten days to incorporate the widgets, and so it can still timely meet its obligations to the third party. Does XYZ Corp. have the right to cure the installment? The language of UCC § 2-612(2) only provides the buyer a right to reject an installment if it cannot be cured. So, the seller likely would be permitted to cure if it gives adequate assurance that it will do so.
Alternatively assume the second installment of widgets is defective and XYZ Corp. admits it will not have the ability to cure it for months due to supply chain backups, and it will also be unable to timely deliver the remaining installments. This scenario likely substantially impairs the value of the entire contract such that the entire contract has been breached.
If you have any specific questions on this article, please contact your Quarles attorney:
- Brandon Krajewski: (414) 277-5783 / brandon.krajewski@quarles.com
- Patrick Taylor: (414) 277-5523 / patrick.taylor@quarles.com
- Lauren Zenk: 414-277-5242 / lauren.zenk@quarles.com
END NOTES
1 UCC § 2-612(1).
2 UCC § 2-612(2).