Tuesday, March 30, 2010

A discourse on materiality and conditions

When is the term of a contract "material"? When is the failure to perform a promise "material"? When is the performance of a condition "material"?

When the parties intended it to be material.

But what is the definition of "material"? West's Encyclopedia of American Law states that something is material if it "is sufficiently significant to influence an individual into acting in a certain way, such as entering into a contract." In securities law, in determining whether a company has complied with the requirement that it disclose all material facts pertaining to the public offering of any security (for example, stock or bonds), "a fact will be deemed 'material' if there is a substantial likelihood that a reasonable investor would consider the fact to be important in deciding whether to invest in the company."
Thus, in making a determination of materiality [in connection with a decision to offer securities for sale to the public], company officials must place themselves in the shoes of a hypothetical reasonable investor and ask themselves, "What matters would I want brought to my attention to assist me in making an informed investment decision"?
Comment a to the Restatement (2d) if Contracts § 241, which addresses "Circumstances Significant In Determining Whether A Failure Is Material," states that
[A] standard of materiality that is necessarily imprecise and flexible. . . . It is to be applied in the light of the facts of each case in such a way as to further the purpose of securing for each party his expectation of an exchange of performances. This Section therefore states circumstances, not rules, which are to be considered in determining whether a particular failure is material. 
So, in order to determine whether a term {or the failure of the term} is material, you need to determine in light of the facts of the particular situation you are considering whether the parties entered into the contract with an understanding that that the term was a significant reason they entered into the contract. The circumstances set forth in Section 241 should of course be considered. Note, however, the emphasis in Comment a that § 241's list is a list of "circumstances, not rules." Note too that it states that while you should consider those circumstances, there is no suggestion (nor should you infer one) that other things should not be considered. You should consider in each case any facts that persuade you regarding what the parties considered significant reasons for entering into the contract. Or, in other words, you should consider the purposes of the parties in entering into the contract and agreeing to what they agreed to.

The circumstances § 241 states you should consider in determining whether the failure to perform a contractual obligation are the following, which I will comment on in order:

(a) the extent to which the injured party will be deprived of the benefit which he reasonably expected

It seems pretty self evident that the greater the difference is between what the promisee reasonably expected to get the more likely the difference is material. But the hard part is figuring out what the promisee reasonably expected to get. Did the buyer in Beachcomber Coins v. Boskett reasonably expect to get a coin that was genuine, or did he reasonably expect to get a coin that probably was genuine but that inherently carried the risk of forgery? Did the banker in Sherwood v. Walker get what 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

If the loss suffered as a result of the promisor's failure to perform can easily be remedied, then the promisee is getting substantially what he expected. That's not to say he isn't entitled to recover from the promisor the cost of remedying the failure, but it is to say that the failure wouldn't be material.

(c) the extent to which the party failing to perform or to offer to perform will suffer forfeiture;

Comment d to Section 241 explains:
[A] failure is less likely to be regarded as material if it occurs late, after substantial preparation or performance, and more likely to be regarded as material if it occurs early, before such reliance. For the same reason the failure is more likely to be regarded as material if such preparation or performance as has taken place can be returned to and salvaged by the party failing to perform or tender, and less likely to be regarded as material if it cannot. 
The loss the builder in Jacobs & Young v. Kent would have suffered had the court found for the owner no doubt is a further reason for the court's finding that the contract's specification of pipe manufactured by the Reading Pipe Company was not a material term. It certainly is not the only reason for reaching that conclusion, but the fact the house was completed and the pipe would have been worthless if removed is further reason for finding the court's conclusion to be sound.

(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.
This factor relates to anticipatory breach and repudiation -- if the promisor has breached but the promisee believes there is still a reasonable likelihood the promisor will perform in a manner that would make his breach non-material, the breach is not yet material. Thus, Illustration 5 to Section 241 explains:
A contracts to sell and B to buy land for $25,000. B is to make a $5,000 down payment and pay the balance in four annual installments of $5,000 each. A is to proceed immediately to have abstracts of title prepared showing a marketable title and to deliver them prior to the time for payment of the first annual installment. Without explanation, A fails to have abstracts prepared for delivery prior to the time for payment of the first annual installment. B refuses to pay that installment. Under the circumstances stated in Subsections (a)-(d), the failure of performance is material and A has no claim against B. B has a claim against A for damages for partial breach based on the delay if A cures his failure and a claim for damages for total breach if he does not

 (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 more your breach is evidence of being bad or of being sleazy, the more likely it is a court will find your breach to be material.

None of these factors easily explains why Dove's presence at Rose Acre Farm every single Monday through Friday for ten weeks was material to Rust, but does anyone seriously doubt that Dove's failure to be there for 4% of that time constituted a significant departure from Rust's purposes and expectations in entering into the contract? How do we know that 100% compliance was material to Rust? Because the evidence showed that Rust regularly asked for and received in exchange for significant reward the same sort perfect compliance with absolute standards of a sort rare in other workplaces. In short, we know (or are at least convinced) that the essence of the contract was perfect attendance and nothing less for 5 weeks in exchange for $5000.

It is important to note too that the absence of evidence that something is significant to the promisee can be very persuasive in determining that something was not material. If there appeared any reason at all that the banker in Sherwood v. Walker had wanted (a) Rose of Alberone in particular or  (2) a cow that was likely barren but possibly fertile, it would be much easier to find for the banker. But in fact, based on what we know, there's no reason to believe he wanted anything but $70 worth of living beef. Similarly, there's no reason we know of other than the contract language itself in Jacobs & Young v. Kent for us to believe that the homeowner cared on whit whether the pipe was manufactured by Reading or Cohoes as long as it was of a certain quality.

In addition, if there's a good explanation for the promisee to want to escape his obligation and little reason to believe the breach he is insisting was material really was of such great importance to him, it is easier to believe the breach was not material. The homeowner in Jacobs & Young v. Kent was doing a common thing: stiffing the contractor for the last payment based on whatever departure from the contract's terms he could find. Once a job is complete, the contractor loses the leverage he has earlier of walking off the job if the owner is not paying him.

Similarly, I would bet that in Oppenheimer & Co. v Oppenheim, Appel, Dixon & Co., 86 N.Y.2d 685, 690 (1990),  the subtenant found a less expensive space after he had signed the lease that provided that he would not have to perform unless the landlord provided written consent to the sublessee's planned renovations. .

The fact that the sublessee in Oppenheim was allowed to walk away from the lease despite getting oral consent emphasizes two other points. The language of the contract is of course another piece of evidence regarding what the parties intended their contract to be. And if you write a term in conditional language, the court is far more likely to let the obligee walk away from the contract if the condition is not satisfied than if the contract is not written in conditional language. But don't forget, a condition is something you determine the parties intended to be a condition. The court in Oppenheim even went so far as to state that the use of terms such as "if," "unless" and "until" constitute "unmistakable language of condition." 86 N.Y.2d at 690 (emphasis added). But it was especially easy for the court to refuse to look behind the conditional language in Oppenheim because the disputants were sophisticated commercial parties represented by high priced, sophisticated lawyers, and the lease was long, detailed, and negotiated between parties of equal bargaining power at arms' length. The court seems almost to be opining that if people like that, and especially the lawyers, write that the sublessee's obligations under the sublease are discharged if it does not get written consent from the landlord for the requested renovations,  the court will take them at their word.

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