In Magic Carpet Ride LLC v. Rugger Investment Group, L.L.C. (Oct. 25, 2019),a California Court of Appeal addressed the question whether untimely performance under a contract containing a time-is-of-the-essence clause always constitutes a material breach. Although this case involves the purchase and sale of an airplane, the principles discussed in the opinion could apply to an asset or stock purchase agreement.
In September 2015, Rugger Investment Group, L.L.C. (seller) entered into a contract to sell an airplane for $610,000 to a buyer (first an individual and then, under an amendment, Magic Carpet Ride LLC). The seller was obligated to transfer the aircraft on the closing date free of liens, but because a lien had been filed against the aircraft and not released, the seller was not able to deliver clear title.
The purchase and sale agreement was amended to provide that $90,000 of the purchase price would be retained in escrow for 90 days. If the seller obtained a lien release within the 90-day period, the amount held back would be released to the seller on the 90th day. On the other hand, if the seller failed to obtain the lien release within the 90-day period, the entire $90,000 hold-back would be released to the buyer. The transaction closed. The seller conveyed to the buyer title to the aircraft by a bill of sale, and the buyer accepted the aircraft and took possession.
The seller spent $38,000 to get a lien release and, as required by the agreement, deposited a lien release instrument into escrow, but the deposit was made eight days after the expiration of the specified 90-day period. The buyer sued for $90,000, alleging breach of contract.
The seller argued that it substantially performed because its delay of only eight days in depositing the lien release instrument into escrow was immaterial. The buyer argued that the delay was a material breach because the contract made time of the essence. The relevant provision read as follows: “time shall be of the essence for all events contemplated hereunder.”
The trial court granted the buyer judgment for $90,000.
The appellate court reversed, holding that the time-is-of-the-essence provision in the contract did not automatically make the seller’s untimely performance a material breach because there was a triable issue whether the buyer substantially performed its obligation.
In determining substantial performance of an obligation under a contract, which is a question of fact, the court must find that there was “no wilful [sic] departure from the terms of the contract” and that the breach is “such as may be easily remedied or compensated” so that the other party gets the benefit of his bargain.
The appellate court found that the seller did not willfully depart from the terms of the contract but instead diligently sought to obtain the lien release. And the buyer ultimately received the substance of what it contracted for, an aircraft free of liens. It’s just that the lien release instrument was eight days late. The buyer presented no evidence of damages caused by the eight-day delay
The traditional rule on the legal effect of a time-is-of-the-essence clause in a contract has been that a failure to perform within the time specified would be a material breach. But the traditional rule has been tempered so that making time of the essence in a contract does not always make late performance a material breach. The court noted that the case law tempering the traditional rule concerned contracts for the purchase and sale of real property, but it saw no reason why the rule should be different for a contract for the purchase and sale of an airplane. Quoting Corbin on Contracts, the court said:
An express provision can make time of the essence. In this respect there is no limit upon our freedom of contract, as long as no part performance has taken place. If the enforcement of an express provision causes an excessive penalty or an unjust forfeiture, equity will prevent enforcement ….
The court noted that if strict compliance were required, the seller would lose not only the $90,000 hold-back, in effect a price reduction, but it would also not receive any compensation for the $38,000 it paid to get the lien release. The buyer would receive an aircraft free of liens and a $90,000 reduction in price.
In the court’s view, the agreement contemplated the buyer would either get the aircraft free of liens or a $90,000 price reduction but not both. The court concluded that there was a triable issue whether the seller faced a risk of unjust forfeiture and whether the buyer would receive a windfall if strict compliance were required. The judgment was reversed and remanded.
In this case, the transaction closing had already occurred. At the time of the breach by the seller, the buyer already had title to the aircraft as well as use and possession of it. The buyer had received substantially all that it had bargained for, and it presented no evidence that the eight-delay caused any damage. This case therefore does not address untimely performance by a seller prior to closing.
This e-bulletin was prepared by Richard Burt, who practices law in San Jose, California. Mr. Burt is a member of the Corporations Committee of the Business Law Section of the California Lawyers Association.