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 that is the subject of this blog is unique in that it is one where 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 materially breaches, the other party is relieved from rendering further performance and cannot be held liable for damages flowing from any breach that occurred after the first 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 agreement (the “Agreement”) required the Buyer to pay $150,000 within two days of closing, and thereafter, to 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, the Seller promised not to compete with the Buyer and not to solicit the Buyer’s customers.

After closing and the Buyer’s $150,000 initial payment, it made the first monthly installment seven days late. Less than a month later, the Buyer notified the Seller that it would not make any additional payments because of several alleged breaches by the Seller. Buyer claimed that Seller had violated the non-compete and non-solicitation provisions and had failed to deliver its recipes.

Seller then filed a breach of contract lawsuit against Buyer, alleging that Buyer breached its promise to make the monthly payments. Buyer defended by asserting that it had no obligation to pay because Seller committed the first material breach by violating the non-compete and non-solicitation provisions and by failing to deliver the recipes.

The Buyer moved for summary judgment, asking the court to dismiss Seller’s claim on the grounds that Seller had committed the first material breach. The trial court granted the motion, and the Court of Appeals of Tennessee affirmed. Both courts found that Seller’s violations of the non-compete and non-solicitation provisions, along with its failure to tender the recipes, amounted to material breaches.

The first material breach rule arose in two contexts. Buyer relied on it as a defense, and Seller attempted to rely on it in response. Seller argued that Buyer could not invoke the rule because Buyer had committed the first material breach by making its first monthly installment payment seven days late.

The appellate court, like the trial court, found the Buyer’s late payment was not a material breach under the circumstances. In reaching that decision, the court relied on established law that a very short delay in payment is generally not a material breach, nor is a missed installment where it does not interfere with the other party’s ability to perform.

Because this case involved an asset sale where the Seller did not need ongoing money to fulfill its obligations, the late payment did not amount to a material breach. Keep in mind, however, that in other situations—such as a contractor who cannot continue construction without progress payments—failure to make an installment can constitute a material breach.

Tennessee contract lawyers should also remember 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 more on that topic.)