The National Association of Dealer Counsel's Newsletter - Defender: What's the Rush? An Analysis of a Time of the Essence Clause in a Buy-Sell Agreement
This article examines the meaning and consequences of a time of the essence clause in a buy-sell agreement for an automobile dealership. The intent of the article is not to make recommendations or dispense legal advice—which require knowledge of the facts and circumstances of a particular transaction and the parties to the transaction--but rather to underscore the need for careful analysis before accepting or demanding a time of the essence clause on behalf of a client.
The Law of Substantial Performance
Before analyzing a time of the essence clause in the context of an asset purchase agreement for a dealership, a simple illustration will be illuminating. Consider a contract governing a teenage child’s allowance and the chores she has to perform to earn it. One such chore is to take out the garbage on Tuesday evening each week, as trash collection by the town occurs on Wednesday morning. On a recent Tuesday night, the teenager was cramming for a calculus test and forgot to take out the garbage. However, the next morning, she arose 15 minutes earlier than normal and pulled out the garbage cans on Wednesday in time for the collection. Mission accomplished but is she entitled to her allowance?
Most people would agree that she did, indeed, earn her allowance, as the ultimate goal—to dispose of the trash on Wednesday morning through the customary collection process—was achieved. This conclusion recognizes the realities that people are imperfect, contracts are not always formulated with precision, and absolute adherence to the terms of a contract typically is not necessary for the other party to realize the benefit of its bargain. In other words, substantial performance is all that is normally required for a party to comply with its obligations under a contract.
Contract law in many states adopts the theory of substantial performance. For example, in Green Tree Servicing, LLC v. Milam, a Florida court examined relevant precedent, concluding that “[i]n Florida, a party's adherence to contractual conditions precedent is evaluated for substantial compliance or substantial performance.” 177 So. 3d 7, 13 (Fla. Dist. Ct. App. 2015). Likewise, in Winfield Mut. Hous. Corp. v. Middlesex Concrete Prods. & Excavating Corp., 39 N.J. Super. 92, 97 (App. Div. 1956), a New Jersey appeals court found that where there is substantial performance of a building contract, even though attended by minor shortcomings, “the contract price may be recovered, less a fair allowance to the owner to make good the defects.” A similar conclusion was reached in the New York case of Khiterer v. Bell, 800 N.Y.S.2d 348 (Civ. Ct. 2005), where the court acknowledged that the substantial performance doctrine allows the contractor to recover or retain the contract price for the work, with a deduction for the cost of completion or correction to contract requirements.
Similarly, Connecticut courts have acknowledged that “‘[t]he general rule with respect to compliance with contract terms . . . is not one of strict compliance, but substantial compliance.’” Pack 2000, Inc. v. Cushman, 89 A.3d 869, 878 (Conn. 2014). The Pack 2000, Inc. court noted that “[t]he doctrine of substantial compliance is closely intertwined with the doctrine of substantial performance” and further explained that “[t[he doctrine of substantial performance shields contracting parties from the harsh effects of being held to the letter of their agreements.” 89 A.3d at 878; see also State Coll. Manor, Ltd. v. Commonwealth, Dep't of Pub. Welfare, 498 A.2d 996, 998 (Pa. Commw. Ct. 1985) (the court acknowledged the doctrine of substantial performance as “the protection and relief of those who have faithfully and honestly endeavored to perform their contract in all material and substantial particulars, so that their right to compensation would not be forfeited by reason of merely technical, inadvertent or unimportant omissions or defects”).
Thus, performing substantially in accordance with the terms of a contract will often suffice.
Consequences of Time of the Essence Clause
Returning to our hypothetical, consider the contrary view, which is that the teenager did not perform her chore in a timely fashion as a result of which she forfeited her right to an allowance that week. Wagging a disapproving finger at their daughter, the parents maintained that she was obligated to pull out the garbage Tuesday night, she failed to do so, and she therefore gets no allowance. The daughter pleads her case, explaining that the garbage was taken out and collected on time and that Tuesday night performance is a sensible safety net but not an essential element of the contract; she performed substantially as she was required to do. The parents hold firm and withhold the daughter’s allowance. This result strikes us as punitive and offends our sense of fair play.
Counterpoised to the illustration involving the teenager and the inconsequential delay in her performance is the family that makes a 8:00 p.m. dinner reservation at a favorite restaurant. When the father calls to make the reservation, the hostess reminds him that the kitchen closes promptly at 9:00 p.m., so the last seating is at 8:00 p.m. The hostess therefore suggests a 7:30 p.m. reservation in an abundance of caution, but the father is adamant about keeping the reservation at 8:00 p.m. Unanticipated delays cause the family to arrive at the restaurant at 8:25 p.m. that evening. While sympathetic to the family’s plight, the hostess refuses to seat them as doing so would require keeping the entire kitchen staff and wait staff on for an extra half hour, a cost and inconvenience the restaurant owner is not prepared to absorb.
In this illustration, we understand the position taken by the restaurant in strictly enforcing the time element of the reservation “contract.” The 8:00 p.m. deadline was not simply a “nice to have” condition but a critical component of the parties’ agreement. The failure to abide by that term was significant and justified the restaurant in disavowing the reservation. Time was of the essence of the parties’ agreement.
Example of Time of the Essence Clause
While the precise language used to make one or more parties’ performance time of the essence will vary from contract to contract and may also depend upon the dictates of the state law governing the contract, a sample clause is as follows:
Time is of the essence with respect to all dates and time periods set forth or referred to in this agreement.
It is also worth noting that a contract may make only certain events or deadlines time of the essence, the most frequent event being the closing date for a transaction.
Legal Effect of Making Time of the Essence
A time of the essence clause transforms the customary rule of substantial performance into one of strict or absolute performance, insofar as contractual time periods or dates are concerned. Any non-compliance with the temporal requirements of a contract in which time is of the essence constitutes a material breach giving rise to remedies for the non-breaching party, which may include the right to terminate.
New Jersey courts have noted that the commercial law governing the sale of goods leaves it to the parties to agree on time requirements; in the absence of an agreement the law will imply a provision in the contract requiring delivery within a reasonable time. Koolvent Aluminum Awning Co. of N. J. v. Sperling, 16 N.J. Super. 444, 446 (App. Div. 1951); see N.J.S.A. 12A:2-309(1). The court in Koolvent Aluminum noted that if time was of the essence then the breach was material and plaintiff had a right to cancel. 16 N.J. Super. at 446; see also Kahle v. Amtorg Trading Corporation, 93 F.Supp. 405, 407 (D.N.J. 1950). Likewise, in Sublime, Inc. v. Boardman's Inc., the Florida court of appeals discussed precedent in which performance by a time or date certain was an essential and vital part of the bargain, rendering late performance, such as payment of a debt due, a material breach. 849 So. 2d 470, 471 (Fla. Dist. Ct. App. 2003). In Morrell v. Broadbent, a Pennsylvania court explained that failure to pay money on a particular day is not such material departure from the terms of a contract as to justify a rescission by the other party, unless the parties have expressly agreed that time should be treated as of the essence of the contract. Where this situation exists, the courts will ordinarily accept the agreement as made and refuse to decree performance in the event of failure to make payment within the stipulated time. 291 Pa. 503, 506, 140 A. 500, 501 (1928).
Time of the Essence in a Buy-Sell Agreement
There are circumstances in which time is of the essence under a buy-sell agreement for an auto dealership. From a seller’s standpoint, closing before the effective date of a change in the tax laws may underlie a time of the essence closing date. Similarly, a seller who is out of trust and is under a forbearance agreement with its lender may be living on borrowed time, impelling a prompt closing. Another example of a critical time deadline under an asset purchase agreement is the expiration of the due diligence period, as the conduct of due diligence poses a risk that employees will learn of the impending sale and because purchasers typically have a walkaway right during the due diligence period. From the perspective of a buyer that is a fund, the window in which the fund is authorized to make investments may be closing, so the fund has to consummate the transaction by a date certain or lose its ability to do so. Under all of these circumstances, a time of the essence clause is justified by a business imperative.
In contrast, consider some of the other deadlines and time periods for performance under a buy-sell agreement. Oftentimes, schedules to an asset purchase agreement must be delivered by a seller within 10 days after the effective date of the agreement. If the asset purchase agreement affords the purchaser a due diligence period of 60 days—during which the purchaser may terminate and receive back its deposit for any or no reason—should the delivery of the schedules 13 days after the effective date constitute a material breach of the agreement? Likewise, if the outside closing date is fixed as the date that is 30 days after factory approval has been obtained, should a buyer or seller have the right to terminate because the approval of a third-party landlord is not obtained until 33 days after factory approval? Other dates or deadlines for performance often designated in an asset purchase agreement concern obtaining factory approval, valuing spare parts inventory, and generating a list of used vehicles for consideration by the purchaser, strict adherence to any of which may not be an essential element of the transaction.
The takeaway from this article is that a time of the essence clause in a buy-sell agreement for an automobile dealership should not be blithely demanded or accepted. It must be carefully considered in light of the totality of the circumstances involving your client, whether you represent the buyer or the seller. If the decision is made to include a time of the essence clause in the agreement, practitioners should analyze how its effects may be mitigated in circumstances where the time for performance is not mission critical. The goal should be adequately addressing business imperatives without providing either side with an unintended escape hatch.
Reprinted with permission from the November/December 2022 issue of the NADC Defender. © 2022 National Association of Dealer Counsel. Further duplication without permission is prohibited. All rights reserved.