What amounts to a material breach of contract?

In the case of RiverRock European Capital Partners LLP v Harnack [2022] EQHC 3270 (Comm), the High Court held that, while certain events might have constituted breaches of contract, none were material which entitled the innocent party to terminate the contract.

Background

The claimant, RiverRock European Capital Partners LLP (‘RiverRock’), appointed a UK company, Deutsche Real Estate Asset Management Limited (‘DREAM’) to act as its consultant and appointed representative in connection with one of its investment funds on 29 June 2016. The two defendants, Mr Harnack and Mr Moersdorf, worked for DREAM and were subject to various obligations under the agreements including payment of certain financial obligations of DREAM in the event the agreements were terminated.

Due to difficulties in sourcing investors and securing investment opportunities for the fund, RiverRock considered changing the fund’s management and began to discuss this with third parties. RiverRock anticipated that this may cause a dispute with DREAM and that they would need contractual grounds for any termination.

Around the same time, the defendants omitted to file a confirmation statement for DREAM with Companies House. Consequently, the Registrar of Companies struck the company off the register in November 2017. Their failure to file the confirmation statement was an oversight as the defendants had not received the correspondence from Companies House in time to avoid the company being dissolved, due to changes in their residence. In fact, they only became aware that DREAM had been dissolved when RiverRock informed them in passing at a meeting on 1 March 2018. Shortly after, RiverRock described the situation as ‘very troublesome’ and notified the FCA given that DREAM was the appointed representative of the fund. The defendants applied to restore DREAM to the register six days later, on 7 March 2018. Nevertheless, RiverRock insisted that the defendants were in breach of contract and gave notice terminating the DREAM agreements with immediate effect on 9 March 2018; they also demanded repayment of fees under the agreements from the defendants.

Material breach?

RiverRock argued that it had an express contractual right to immediately terminate the agreements without liability if ‘DREAM or [the defendants] [committed] a material … breach’ of the agreements. RiverRock identified various breaches of contract committed by the defendants resulting from the dissolution of DREAM and argued that some of these breaches were material.

The Court stated that the concept of a material breach is not easy to define. The meaning is dependent on context and dictated by reference to the consequences which would flow from finding that it has occurred. Where the consequences of a material breach are significant, eg, termination of a contract that had required significant time and resources, then defining a breach as material would require it to be a substantial breach, rather than something of little consequence.

In order to assess materiality, the court considered:

1. the actual breach;
2. the consequences of the breach for the innocent party;
3. the breaching party’s explanation for the breach;
4. the breach and its significance or otherwise in the context of the parties’ agreement; and
5. the consequences for the parties of determining that the breach was not material versus finding that it was.

Whilst the Court held that the defendants were in breach of the agreements, it was not convinced that there had been a material breach or that other breaches of contract entitled RiverRock to terminate the agreements. It found that the dissolution was due to an oversight and was capable of remedy. The restoration of the company had, in fact, already been processed. There were no serious consequences to this breach. RiverRock was not actually concerned by the dissolution, but rather took advantage of it by continuing with their plan to replace the defendants as fund managers. The court therefore found that RiverRock had not been entitled to terminate the agreements as the breach was not material and accordingly it was not entitled to the sums it sought from the defendants.

Conclusion

This decision demonstrates that whether a breach amounts to a material breach is ultimately a fact-sensitive exercise. Before seeking to terminate a contract by asserting a material breach, parties should think carefully about how a breach can be shown to be material (in terms of context and impact) and whether an explanation should be sought from the counterparty. Without a valid basis for asserting the breach and the materiality, the asserting party risks its own exposure, eg, for wrongful termination and / or breach of its own obligations.

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