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.'

A Case for Setting Standards

            In our discussion of Article 1, it was noted that the Uniform Commercial Code embodies freedom of contract as an underlying principle.  Section 1-302 is a codification of this basic principle. Section 1-302(1a) states as follows:

(a)  Except as otherwise provided in subsection (b) or elsewhere in [the Uniform Commercial Code], the effect of provisions of [the Uniform Commercial Code] may be varied by agreement.

The limits of the abilities of the parties regarding freedom of contract, as well as some of the specific freedoms granted are noted in section 1-302(b)

(b) The obligations of good faith, diligence, reasonableness, and care prescribed by [the Uniform Commercial Code] may not be disclaimed by agreement. The parties, by agreement, may determine the standards by which the performance of those obligations is to be measured if those standards are not manifestly unreasonable.

            It is my belief that parties should set standards for good faith, diligence, reasonableness and care whenever contracts are being drafted. Setting these standards removes the question from the jury or the court as to the actual legal question and restricts inquiry to the question of whether or not the fact standards set by the parties have been met and whether or not the standards set are manifestly unreasonable.  An excellent example of the importance of setting standards can be found under Article 7 in connection with the storage of goods.

Section 7-204 deals with the duties of a warehouse to exercise care with respect to goods it has stored.  Subsection (a) to Section 7-204 states as follows:

A warehouse is liable for damages for loss of or injury to the goods caused by its failure to exercise care with regard to the goods that a reasonably careful person would exercise under similar circumstances. However, unless otherwise agreed, the warehouse is not liable for damages that could not have been avoided by the exercise of that care.

It is seen that the warehouse must exercise the level of care which a ‘reasonably careful person’ would exercise under similar circumstances.  This of course, is a standard and used frequently in many areas of law. 

            What is or is not consistent with the standard enunciated however, can be dramatically different than what one might reasonably believe would meet that standard.  This is illustrated in United States Borax and Chemical Company v. Blackhawk Warehousing and Leasing Company 586 S.W. 2d 248 (Ark. CA, 1979). Borax involved the storage of goods consisting of agricultural chemicals owned by U.S. Borax pursuant to a warehousing agreement between the parties. In early 1977 goods belonging to Borax were stolen from Blackhawk. The goods in question consisted of 288 five gallon cans of a product known as Cobex.  The court described the burglary as follows:

The burglars entered the building by ripping open one of the side panels. Then chemicals which had been stored next to the wall were pulled outside to allow entry into the building. After entry a padlock and chain were cut to allow a door to be opened. A forklift truck was "hot wired" since it was locked. Then it was used by burglars to move a sailboat blocking the path to appellant's stored chemicals. Other chemicals in the way were shoved aside, and the cans of appellant's stored chemicals were taken from the premises. The loss sustained by the plaintiff amounted to $23,658.28 and suit was brought for that amount.  at 833-834

Defendant was granted a directed verdict by the trial court, and Borax appealed, stating that defendant was negligent in not providing the following specific security measures:

(a) In failing to provide watchmen inside the facility;

(b) In failing to have any burglar alarms or similar systems installed in the warehouse;

(c) In failing to provide roving patrols outside of the building;

(d) In failing to place palletized storage directly against the inside wall at the point of access as was done against other walls to prohibit any attempt to enter from the outside;

(e) In failing to provide other adequate security measures which would have prevented the break-in and subsequent loss to the plaintiff;

(f) In failing to be put on notice that extra security measures were needed after a previous break-in occurred at the warehouse approximately 7 months before the loss was sustained by the plaintiff. at 836

            The court discussed the security procedures in effect in the context of general negligence standards.  In quoting Arkansas case law, the court states the question as follows:

The failure to do something which a person of ordinary prudence would do under the circumstances, or the doing of something that a person of ordinary prudence would not do under the circumstances.  at 836-837

The court  reversed the trial court’s decision concluding that the question of reasonable care should have gone to the jury. 

            As a result of the agreement between the parties, the determination of reasonable care was placed in the hands of the court.  This worked out favorably for Borax, but the warehouse could have avoided the whole problem by simply stating the security measures being taken; selecting standards which are not ‘manifestly unreasonable; and then proving that those standards were met.  I am not an expert in warehouse security procedures, but it is clear that the burglary in question required considerable effort to succeed.  It may be that the suggestions made by Borax have merit, but it may also be that Blackhawk had adequate security in place.  If Blackhawk had properly drafted the warehouse receipt, the problem could have been avoided.

            The same rationale applies to every written contract.  Parties who set the standards of conduct to govern their transaction eliminate the problems which Blackhawk Leasing had to deal with in the Borax case.  In presenting this approach to the other party, it should be emphasized that everyone benefits from the certainty of setting standards.