First Material Breach by Seller Causes it to Lose Breach of Contract Case

I have written at least a couple of blogs about the first material breach rule and how it works (and doesn’t work) in Tennessee.  Nevertheless, here is another blog on that subject which discusses a very recent breach of contract case handed down by the Court of Appeals of Tennessee.  Since the first material breach rule is very often applicable in commercial litigation, it is hard to give it too much attention, analysis, review and thought.  Also, the case which is the subject of this blog is unique in that it is one in which the defense was used successfully.

The first material breach rule, to review, holds that a party cannot recover damages for a breach of contract if it committed the first material breach of the contract. Once a party to a contract materially breaches it, the other party to it is relived from rendering further performance and cannot be held liable for damages flowing from any breach by it which occurred after the other party’s prior material breach.

The case involved an asset purchase agreement whereby the Seller agreed to sell the assets of a meal preparation business to the Buyer, which was also in the same business. The purchase price was $310,000. The asset purchase agreement (the “Agreement”) required that the Buyer pay $150,000 within two days of the closing, and, thereafter, that it pay monthly installments of $11,333 before the last day of each month.

The Agreement also required the Seller to tender to the Buyer its recipes for meals and snacks. Moreover, in the Agreement, the Seller made promises not to compete with Buyer and not to solicit customers of Buyer.

After the closing and the Buyer’s payment of the $150,000 initial payment, it made the first monthly installment payment seven days late. Less than one month later, the Buyer notified Seller that it would not make any additional payments because of several instances of breach by the Seller. Buyer alleged that Seller had breached the non-compete and non-solicitation provisions of the Agreement and that it had breached the Agreement by not delivering its recipes.

Seller, thereafter, filed a breach of contract lawsuit against the Buyer alleging that it had breached its promise to make the monthly payments. Buyer defended by asserting that it had no obligation to pay Seller and that Seller could not recover damages because it had committed the first material breach of the contract by violating the non-compete and non-solicitation terms of the Agreement and by not delivering its recipes to Buyer.

The Buyer moved for summary judgment asking that the Seller’s breach of contract claim be dismissed on the grounds that the Seller had committed the first material breach. The trial court granted that motion and its decision was affirmed by the Court of Appeals of Tennessee. Both courts found that the violations of the non-compete and non-solicitation terms by Seller were material breaches as was Seller’s failure to tender its written recipes to the Buyer.

The first material breach rule arose in two contexts in the case. Not only did the Buyer rely on it, as described above, but also, in defending the Buyer’s motion for summary judgment, the Seller relied on it. The Seller argued that Buyer could not rely on the first material breach rule because the Buyer had committed the first material breach by making the first monthly installment payment seven days late.

The appellate court, like the trial court, found the Buyer’s late payment, under the circumstances, was not a material breach.  In reaching that decision, it relied on the established law that, generally, a very short delay in payment is not a material breach, nor is a failure to make an installment payment where it does not interfere with the unpaid party’s ability to render its performance.  Since the case involved an asset sale whereby the Seller did not need ongoing money to fulfill its promises to Buyer, the case fit into the later category (as well as into the former).  Keep in mind that, in some cases, a failure to make an installment payment or progress payment can amount to a material breach. A classic example of such a situation is one where a contractor in a construction contract cannot continue to build without cash flow to fund labor and materials.

Tennessee contract lawyers should also keep in mind what I have pointed out in previous blogs about the efficacy of the first material breach rule: Even if there was a first material breach, it can be waived. See my blog of July 15, 2014, for a discussion of that topic.



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