'Materially' rethinking termination clauses

Posted by Kaela Snibson

In many technology and outsourcing agreements, the right to terminate is triggered when a party is in 'material breach' of the contract.  But what does this actually mean?  More specifically,  what degree of non-compliance in this context satisfies the 'materiality' requirement?

• Any breach of a main obligation, no matter how minor?
• A failure to comply with 2 out of 250 of the technical specifications?
• A once-off delay in delivery?

Considering that deliverables under these contracts must often comply with complex and technical specifications – making 100% compliance difficult, if not practically impossible – particular thought should be given to the drafting of termination clauses.

The recent NSW Court of Appeal decision of Lucas Stuart Pty Ltd v Hemmes Hermitage Pty Ltd [2010] NSWCA 283 highlights this.  The facts of the case were as follows:

• Lucas Stuart Pty Ltd (the applicant) was contracted by Hemmes Hermitage Pty Ltd (the respondent) to construct ‘The Ivy’, an iconic restaurant and function centre in Sydney.
• The respondent issued a Notice under the contract alleging the applicant had 'not materially complied' with its contractual obligations due to various defects in the works. The Notice also provided a reasonable time frame for the applicant to correct the defects.
• The applicant failed to comply with the terms of the Notice and the respondent (as it was entitled to) called on undertakings it had provided as security for performance.
• The applicant sought an injunction to restrain the respondent from calling on the undertakings, alleging that there was a serious question to be tried in relation to whether or not the existence of defects constituted material non-compliance with its obligations, as the Notice stated.

The Court held that failing to comply with a material or main obligation under a contract does not automatically amount to material non-compliance (rejecting the finding of the lower court that it did).  What is required, in the Court's view, is a material failure to comply with obligations, with those obligations being looked at as a whole.

The lesson? Avoid ambiguity, and ensure the intentions of all parties are accurately reflected by:

• defining 'material breach' with reference to breach of specific clauses.
• making it clear when breach of a term should not be considered material.
• clearly stating the severity of breach required, for example, any breach (no matter how minor), repeated breach (with 'repeated' defined) or unremedied breach (with a clear time frame for remedy).

Partner: Oliver Barrett