Does an attacker with breath weapon have to be next to a figure with shadow cloak ability for the breath weapon to damage the figure? More specifically, if a figure in an encounter is in a tree which grants shadow cloak how does breath weapon effect him?

Unless the attacker, hero or monster is adjacent to the target who is in a tree, the attack will be an automatic miss. This includes breath, blast and bolt attacks.

Thanks. For some reason, my players convinced me that breath ignores shadowcloak. They have a mage with breath weapon that has been nerfing my guys. Now lt encounters should be more even.

Not technically a miss; the figure with Shadowcloak is just unaffected. The attack can still affect other targets under the template.