The First Material Breach Rule in Tennessee

The “first material breach” rule has become an almost knee jerk response as a defense in breach of contract cases. Under that rule, a party who commits a material breach of a contract cannot recover damages from the other party for the other party’s later material breach of the same contract.

There are exceptions to the first material breach rule.  First, if the party who committed the first material breach cures its breach, then the first material breach rule cannot be used against that party.  Second, one party cannot use the first material breach rule against the other party where the facts show that the party waived the other party’s material breach.

In White v. Empire Express (Tenn. Ct. App. 2012), the defendant in a breach of contract case attempted to rely on the first material breach rule, but was unsuccessful because of waiver.  In that case, the plaintiff entered into a lease-purchase agreement for a truck.  The lease-purchase agreement required the plaintiff to make monthly payments for the 48 month term of the lease.  After the 48 month term ended, the plaintiff was entitled to buy the truck by paying its residual value.  Under the agreement, when the plaintiff paid the residual value, he was entitled to the title to the truck.

The lease-purchase agreement in the Empire Express case contained a paragraph itemizing events and occurrences which would amount to a default by the plaintiff, including, not surprisingly, failure of the plaintiff to make monthly payments or the plaintiff filing a bankruptcy petition.  During the 48 month term, the plaintiff did fail to make payments and also filed a bankruptcy.  The defendant, however, never chose to terminate the lease-purchase agreement.

After the end of the 48 month term, the plaintiff exercised the option to buy the truck. Although the plaintiff did not have the lump sum necessary to pay the residual value, the defendant allowed him to make monthly payments towards the residual value.   The plaintiff made payments on the residual value of the truck for over a year.

After the plaintiff made the final payment towards the residual value of the truck, the defendant refused to give him title and repossessed the truck. The plaintiff filed a breach of contract case against the defendant. The defendant asserted the first material breach rule and claimed that it did not have any liability to the plaintiff because he had first materially breached the lease-purchase agreement by failing to make the payments as required and by filing bankruptcy.

The court in the Empire Express case ruled that the defendant could not avail itself of the first material breach rule because it had waived the breaches of the plaintiff on which it sought to rely.  How so? Because the defendant could have terminated the lease-purchase agreement during the 48 month lease term because of the plaintiff’s breaches, but did not.  Instead, it allowed plaintiff, after that 48 month term, to exercise his right to buy the truck, and, to boot, accepted payments towards the residual value.

Bear in mind that there is a difference between waiving another party’s breach by accepting payments from them, as the defendant in Empire Express did, and situations in which payments are accepted on the basis of some representation of the party who is in breach that it will cure its breach or attempt to do so.  For example, in 94th Aero Squad of Memphis, Inc. v. Memphis-Shelby County Airport Authority (Tenn. Ct. App. 2004), the defendant successfully used the first material breach rule even where it continued to accept payments from the plaintiff after the plaintiff had breached the contract.

What was the difference between the Aero Express case and the Empire Express case?  In Aero Express, the defendant was found to have accepted payments from the plaintiff based on the plaintiff’s representations that it was taking steps to cure its breaches and to otherwise assist the defendant in lessening the effects of its breach.

The first material breach rule, in my experience, is often used by defendants who never had an issue with the plaintiff’s contract performance until the plaintiff filed suit. For that reason, Tennessee lawyers who handle breach of contract cases should be familiar with the holdings in the above cases and ready “to smoke out” the first material breach defense.

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