Contractual right to terminate – determining whether there has been a material breach

RiverRock European Capital Partners LLP v Harnack [2022] EWHC 3270 (Comm)

The question

What factors will a court consider when determining whether a breach is “material” in the context of contract termination?

The key takeaway

A termination right which is triggered by a “material breach” will only be effective if the breach has a serious effect on the benefit the innocent party would otherwise derive from performance of the contract. The court will consider the character of the breach, the breaching party’s explanation for the breach and the consequences of the breach in the context of the agreement.

The background

RiverRock brought proceedings in the High Court claiming its entitlement to certain payments on termination of a consultancy agreement and other allied agreements, made with Deutsche Real Estate Asset Management Limited (DREAM).

RiverRock had, under the consultancy agreement, appointed DREAM as its FCA Appointed Representative for the purpose of providing FCA-regulated activities in connection with an investment fund. Mr Harnack and Mr Mörsdorf (H and M) were responsible for the day-to-day operation and management of the fund.

From its launch in around 2016, the fund encountered problems raising and sourcing investments. DREAM was obliged to file a confirmation statement with Companies House in July 2017. This had not been done which resulted in DREAM being struck off and dissolved in November 2017. Consequently, RiverRock terminated the consultancy agreement and brought a claim against H and M.

RiverRock claimed that the striking off of DREAM from the Register of Companies, and its dissolution had put DREAM in breach of various terms of the agreements giving rise to a right to terminate the consultancy agreement. The four broad categories of breach were: material breach of the agreements, breaches of FCA rules, acting in such a way as to bring the parties and the fund into disrepute and breach of implied terms.

A key issue for the High Court was whether any of the breaches said to result from the striking off and dissolution of DREAM were material.

The decision

The court dismissed RiverRock’s claim.

The court acknowledged that the concept of a “material” breach is not easy to define – whether there was a material breach is often dependent on the context and may be dictated by the consequences that flow from a finding that it had occurred. The court also equated words like “substantial”, “more than trivial, but not repudiatory” and “a serious matter” with “material”. Factors to consider on materiality included the actual breaches, the consequence of the breaches to the innocent party, the guilty party’s explanation for the breaches and the breaches in the context of the agreement between the parties continuing or coming to an end.

Applying this to the facts, the court reasoned that the consultancy agreement was expected to continue for some time and, if terminated, might result in the waste of years of work by H and M. In these circumstances, while a repudiatory breach was not required, there had to have been a substantial breach involving serious consequences for the innocent party.

The judge held that there was no such breach citing the following reasons, among others:

• The breaches were the result of a mistake. One of the defendants had moved house and therefore did not receive the notification that they needed to file their confirmation statement.
• The breaches were readily capable of remedy. DREAM could have been restored to the register in a very short period and with little difficulty allowing the arrangements between the parties to continue.
• On the facts, RiverRock were not concerned by the dissolution of DREAM and used the breach as a means of justifying the termination of the agreements. It was apparent from email correspondence and oral evidence that the fund was underperforming and RiverRock sought its end before the dissolution was known to it.
• The breach caused no loss to the fund or its investors or any complaints or claims against RiverRock.
• The FCA took no action against RiverRock as a result of the breaches and it suffered no penalty.

RiverRock failed to identify any other practical consequences arising from the dissolution. 

Why is this important?

Contractual termination which is triggered by a material breach will be effective only if the breach has a serious effect on the benefit the innocent party would otherwise derive from performance of the contract. If the agreement is to continue for a long time and the offending party has invested a lot into the agreement, the breach will need to be more significant to justify termination.

Any practical tips?

Courts are likely to find material breach arguments unattractive where it is clear that the apparently injured party is simply using the clause to prematurely exit the agreement.

There is no definition of “material” in case law – each case turns on its facts. If an express provision giving a party or the parties the right to terminate for material breach is included in the contract, at the drafting stage consider what substantial breaches may arise that may seriously impact the innocent party (ignoring those that may result from mistake or a lack of understanding). The parties should then consider specifying that certain breaches or breaches of certain clauses will always be material.

Those drafting contracts should also keep in mind that contractual material breach should largely be treated as separate to and not the same as the common law right to terminate for repudiatory breach. Not all material breaches will be considered to be repudiatory.

The courts have been prepared to accept a right to terminate for any breach and for specific contracts this might be a better option than a provision for termination in the event of a “material breach”.

Spring 2023