Right to Adequate Assurance of Performance: Be Clear!

Section 2-609 contemplates a situation where either party to a sales contract has ‘reasonable grounds for insecurity’ regarding the other party’s performance, and the insecure party wants some evidence that the other party is willing and able to perform. Subsection (1) to Section 2-609 states as follows:  

The cases are clear that the determination of whether or not a party’s stated grounds for insecurity are reasonable is a question of fact. In this regard, I want to emphasize a point made repeatedly throughout these posts, and particularly in connection with the discussion of Section 1-302(b) which allows parties to an agreement to set standards for what is or is not ‘reasonable’, provided the standards set are not ‘manifestly unreasonable’.  If standards for ‘reasonableness’ are in fact stated, the inquiry will be limited to: were the called for standards met, and if so, were the standards ‘manifestly unreasonable’? If the standards are not manifestly unreasonable, and proven, inquiry ends. Parties to a contract, can if they choose, create provisions for what ‘reasonably constitutes’ insecurity which would frame the inquiry as stated.

A contract for sale imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired. When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return.

Although there are some cases which state that an oral demand for ‘adequate assurance of due performance’ is sufficient, the majority of cases follow the clear language of the statute which requires that the request for adequate assurances be in writing. Further, the cases are clear that the writing which purportedly seeks adequate assurances actually make it clear in the writing that such a demand is being made.  Mere objections as to performance do not meet the standard of a demand for proper performance which is required to gain the benefit of the provisions of the section. As discussed in the last post regarding Section 2-607(5)(a), the best way to insure that the requirements of a particular provision are complied with is to track the language of the statute.

In Alaska Pacific Trading Company v Eagon Forest Products 85 Wn App 354, 93 P 2d 41 (1997) one of the issues considered by the court was whether the purported demand for assurances was properly stated.  The case involved a sales contract by which ALPAC was to sell 15,000 cubic meters of logs to Eagon.  The lumber was to be shipped from Argentina to Korea.  Between the time of the execution of the contract in April of 1993 and time stated time for shipment, the market price for the lumber dropped significantly. Eagon became tentative about performing under the contract and ultimately, ALPAC came to the conclusion that Eagan was not going to accept the logs, and decided not to ship. In discussing whether or not a proper demand for adequate assurance of performance had been made by ALPAC, the court stated:          

Here, while Ahn [Eagon] had some idea that Kimura and ALPAC were concerned about the status of the contract, he did not understand that ALPAC would withhold performance as a result….If we were to hold that, in every case where a contract becomes less favorable for one party, general discussions between the parties can be considered requests for assurances, we would defeat the purpose of 2-609. That section requires a clear demand so that all parties are aware that, absent assurances, the demanding party will withhold performance. An ambiguous communication is not sufficient.   Eagon at 357

When merchants are involved, the determination of whether or not a particular performance was such as to properly give rise to insecurity will be determined by commercial standards:

          (2) Between merchants the reasonableness of grounds for insecurity and the adequacy of any                 assurance offered shall be determined according to commercial standards.

This is consistent with Article 2 in general and the drafters’ consistent direction to focus on what is going on in the commercial world, not simply the legalese involved.  As stated in comment 2 to Section 2-202:

[This section definitely rejects] the premise that the language used has the meaning attributable to such language by rules of construction existing in law rather than the meaning which arises out of the commercial context in which it was used;

This policy applies throughout Article 2 and, through the expanded definition of good faith, arguably throughout the Code.

         Once a proper demand for adequate assurance of performance has been made, the failure to provide that assurance is a repudiation of the contract:

 After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract.  Section 2-609(4)

Section 2-609 provides parties with a remedial type course of action which is short of litigation, but clearly creates a situation where insecurities about performance are either effectively dealt with through adequate assurances of performance or repudiation occurs as a result of not providing those assurances.  Firms dealing in sales and leases of goods would be well advised to create a template for properly activating and utilizing Section 2-609.  This is in addition to drafting a contract provision which sets standards for ‘reasonable grounds for insecurity.'

Parol Evidence and Article 2

 We have discussed the basic drafting of Article 2 insofar as it relates to the general formation of a contract, noting that the Code has removed many formal restrictions for contract formation which existed in pre Code law.  This is consistent with the overall drafting of Article 2 which reflects the reality of the business world.  Often, there is no finalized contract, but instead a series of writings followed by conduct which recognizes the existence of a contract.  If there is an acceptance in ‘confirmation of an offer’ the rules of Section 2-207 will apply.

In that situation, and even in situations where you have a finalized contract, parties may wish to introduce evidence which assist the court in interpreting the writings in a manner favorable to the proponent of the evidence.  In that situation, Section 2-202 comes into play.  That section reads as follows:

Terms with respect to which the confirmatory memoranda of the parties agree or which are otherwise set forth in a writing intended by the parties as a final expression of their agreement with respect to such terms as are included therein may not be contradicted by evidence of any prior agreement or of a contemporaneous oral agreement but may be explained or supplemented

(a) by course of dealing or usage of trade (Section 1-205) or by course of performance (Section 2-208); and

(b) by evidence of consistent additional terms unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement .

            Section 2-202 once again, underscores the importance of the individual elements of agreement in the ultimate interpretation of the meaning of the contract.  Thus, course of performance, course of dealing, and usage of trade not only create avenues whereby conduct and trade can supply terms of a contract, but also create an avenue by which evidence can be introduced to ‘explain or supplement’ the terms contained in any writings between the parties.  The manner in which this evidence is presented to the court is critical.  If the evidence of course of performance, course of dealing and trade usage is presented to ‘contradict’ the writing, it is not acceptable. If however, such evidence is introduced to ‘explain or supplement the writings’ the evidence is proper.  This is true regardless of whether or not the writings are intended as a ‘final expression’ of the parties’ agreement.

            Section 2-202 was discussed by the Arkansas Court of Appeals in L.F. Brands v Dillard’s 314 SW 3d 736, 2009 and, like most cases which have disc used Section 2-202, reached a decision that was consistent with the statute.  The case involved a breach of contract action brought by L.F. Brands against Dillard’s.  Brands was a supplier of Dillard’s with whom Dillard’s had a long standing relationship.  All transactions between the parties were governed by a document entitled ‘Dillard’s Inc. Purchase Order Terms, Conditions, and Instructions’.  In addition to the terms contained in the purchase orders, undisputed testimony from Brands and Dillard’s employees established that the parties would meet at the beginning of each fashion season to discuss profit margins.  Sales were monitored throughout the course of the season, and allowances would be processed at various times during the year to make adjustments to the margins.  At the end of the year, parties would determine if gross margins had been met.  If not, the parties would negotiate on further allowances to achieve an acceptable resolution.

            Among the provisions contained in the Purchase Order agreement was the following provision:

[L.F. Brands] acknowledges by acceptance and shipment against any Dillard Purchase Order that the terms, conditions and instructions stated herein, in the Purchase Order, [and in two other Dillard's documents] (collectively, the “Agreement”) shall bind [L .F. Brands] and shall constitute the entire agreement between Dillard and [L.F. Brands], which cannot be modified by either party except in a writing executed by both parties, or [another method]; provided, however, that this provision shall not apply to markdown allowance and other credits authorized by [L.F. Brands]․

L.F. Brands went out of business in December of 2003.  In February 2004, Dillard’s deducted markdown allowances and chargeback’s from its account balance.   These markdowns and chargebacks were the basis of Brands’ appeal. 

The trial court denied both parties’ motion for summary judgment determining that the entirety of the parties’ agreement must be determined by looking at both the written documents, as supplemented by the parties’ oral agreements.  The case was submitted to a jury with instructions with the definition of course of dealing, and that course of dealing evidence may be used to give particular meaning to and supplement the terms of the agreement.  The jury found for Dillard’s on the complaint, and further found for Dillard’s on its counterclaim in the amount of $1,265,938.98

            In discussing Brand’s argument that the merger clause in the Purchase Order superceded the prior oral agreements concerning merchandise allowances the Court stated:

This argument sweeps too broadly in this case for the sale of goods governed by Article 2 of the Uniform Commercial Code(UCC) which has a specific provision allowing parol evidence to be introduced even in situations involving fully integrated written agreements.  Under the UCC’s parol evidence rule, a writing intended to the parties’ final expression of their agreement may not be contradicted by evidence of any prior agreement or contemporaneous oral agreement, but it may be supplemented by evidence of the parties’ course of dealing or course of performance. [citing Section 2-202(a).]

The court went on to state:

In such instances, the evidence of a course of dealing that explains or supplements a contract is competent evidence of the parties’ intent and can become a part of a contract.

In affirming the trial court, the court of appeals also noted that, per comment one to Section 2-202, there is no requirement that the contract be ambiguous in order for such evidence to be introduced.

This case underscores a point that has been made repeatedly in previous posts—course of dealing and course of performance, if they exist, are always relevant.  If however, the parties choose to do so, they can include a provision in their contract which excludes evidence of course of dealing, course of performance or usage of trade.  If you are drafting a contract, it is a good practice to examine each of these concepts in the context of your situation, so that any desired adjustments can be made.

Section 2-201(2): Reply or Cry

Once it has been determined that Article 2 governs, the next series of questions concerns the parties’ agreement, and possible contract resulting from that agreement:

What are the terms of the agreement between the parties?

How does the UCC impact the parties’ agreement?

How do supplemental general principles of law impact the parties’ agreement?

This basic analysis is called for by the definitions of contract and agreement, both of which were discussed extensively in earlier posts. By way of quick review, contract is defined under Section 1-201(b)(12) as ‘the total legal obligation that results from the parties agreement as determined by the Uniform Commercial Code as supplemented by any other applicable laws.’  It is quickly apparent that in order to know what the contract is between the parties, it is necessary to determine the contents of the parties’ agreement, for the contract is the legal result of their agreement.

‘Agreement’ is defined as the ‘bargain of the parties in fact, as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade as provided in Section 1-303.’ The importance of course of performance, course of dealing and usage of trade in this analysis is critical, and has been discussed several times in earlier posts.  The essence of their importance lies in the fact that each of these components can supply terms to a contract that may never have been discussed or negotiated.

Once all of the terms are understood, the second element of the definition of contract kicks in: What is the impact of the Uniform  Commercial Code on the parties’ agreement?  The first question is whether the proposed transaction is within the purview of the Uniform Commercial Code. This is the scope question discussed in the last post. The second question which must be asked in this context is: Is the contract enforceable?  That analysis begins with the Article 2 Statute of Frauds contained in Section 2-201.  The basic rule is stated in Section 2-201(1):

Except as otherwise provided in this section a contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker. A writing is not insufficient because it omits or incorrectly states a term agreed upon but the contract is not enforceable under this paragraph beyond the quantity of goods shown in such writing.

Section 2-201(1) is clear and very straightforward.  If the contract has a value of $500 or more, there must be a writing which sufficiently indicates such a contract, and which is signed by the party ‘against whom enforcement is sought.’  Therefore, a purported seller of goods who seeks to hold a particular person liable as a buyer, must have a writing signed by the buyer or by his authorized agent or broker.  Similarly, a buyer seeking to hold a person liable as a seller must have a writing signed by the seller.

            The basic rule of Section 2-201(1) has several exceptions.  The Reply Doctrine of Section 2-201(2) has particular significance for two primary reasons.  First, the downside for not understanding and following the rule of Section 2-201(2) can be devastating to a business.  Second, most businesses are unaware of Section 2-201(2) and hence are in a state of potential major liability.  Section 2-201(2) states as follows:

Between merchants if within a reasonable time a writing in confirmation of the contract and sufficient against the sender is received and the party receiving it has reason to know its contents, it satisfies the requirements of subsection (1) against such party unless written notice of objection to its contents is given within 10 days after it is received.

The best way to illustrate the impact is by way of a simple hypothetical:

Assume that you are a manufacturer of tables that you sell at the wholesale level to retailers for $1,000.

You receive a call from a potential buyer who wants to buy 1000 tables for a motel chain and, given the large order, offers you $650.00 for the tables.

You advise buyer that you have no interest in selling your tables for $650.00 and unless he is willing to pay the full $1,000 you have no interest in further discussions with him.

Several days later, you receive the following email:

            Dear Seller:

Pursuant to our discussion of December 4, 2015 I confirm our contract and agree to purchase 1000 tables from you for $650.00 per table.  I appreciate your recognition of this large order through your discounted price.

Sincerely,

Buyer

You read the email and think to yourself ‘This guy is crazy’ so you delete the email, not knowing that your transaction falls within Section 2-201(2).          

Both parties are merchants, so the first prerequisite of Section 2-201(2) is met.  The writing confirms the contract and is ‘sufficient against the sender’—i.e.—signed by the sender—in this case, the alleged buyer.  Hence the second prerequisite is met.  The third requirement will also be met—i.e.—the person receiving it ‘has reason to know of its contents’ since it was sent to his account via email. 

At this point, unless the seller gives written notice of objection to its contents,  within 10 days of receipt, buyer will have been deemed to have satisfied the requirements of the Statute of Frauds.  This may seem to be a harsh result, but the Code is expressing support for a basic business protocol— answer your business communications in a timely manner.  That is reasonable commercial behavior. If you don’t answer your business communications in a timely manner, and one of those communications confirms a nonexistent contract, you are exposed in a major way.    

This does not mean that the buyer will win in a lawsuit for the 1000 tables at $650.00 per table. However it does mean that one of two things will happen—you will either incur the expense of litigation proving your case, or you will settle.  Both of these can be avoided with a simple one sentence reply denying the existence of the contract.