Limit Exposure with the Uniform Commercial Code

Demanding assurance pursuant to the UCC may save you from sinking on someone else’s ship.

Vessel operations require a large network of companies that come together to keep the entire business chain – including yours – running smoothly. Keeping the lights on and the boats running requires agreements with banks, investors, shipbuilders, component manufacturers, designers, technical specialists, repairmen, suppliers, agents and countless other entities. Many of these agreements involve relationships that have developed over time during differing market conditions.

Unfortunately, a large portion of our industry is dependent on the exploration and production of oil and gas, and the services related to it. As this column is written, the price of crude oil is hovering at just above $30.00 per barrel with a twelve month forecast (depending on who you believe) of $35 per barrel, down from $110 per barrel just over a year ago. As a result of these depressed oil prices, oil and gas exploration has slowed down drastically and producers, when they can, are restricting the production of their wells. There are very few businesses that operate in this environment that have not been impacted one extent or another. As a direct result, many of these symbiotic relationships are beginning to sour and many transactions are being cancelled or defaulted on.

Left in the Lurch?
No one wants to be left in the lurch when an entity that you have an agreement with can no longer perform its obligations. Although you can’t guarantee that another person or entity will honor their commitment, you can use an obscure provision in the Uniform Commercial Code to minimize your exposure by stopping the losses before they fully accrue. 

If you begin to have some concern that a contracting entity may have difficulty performing, or paying you for your performance, you can manage this exposure by sending the other entity a Demand for Assurance pursuant to the Uniform Commercial Code (“UCC”). UCC Section 2-609 provides you with a “Right to Adequate Assurance of Performance.” Although not all states have adopted the Uniform Commercial Code, most have. For the states that have adopted this section of the Code, the requirements for demanding assurance are included in Section 2-609. The statute provides:

1. 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.
2. Between merchants the reasonableness of grounds for insecurity and the adequacy of any assurance offered shall be determined according to commercial standards.
3. Acceptance of any improper delivery or payment does not prejudice the aggrieved party’s right to demand adequate assurance of future performance.
4. 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.

Essentially, if you become concerned that a company that you have an agreement with will be unable to perform its obligations in the future, this provision allows you to demand that they provide you with assurance that they can complete your transaction. If the company cannot provide adequate assurance that they can pay for your services or provide the materials or services agreed to in your contract, you have the right to terminate the contract before the other party defaults. Using this assurance provision proactively can keep you from sustaining additional losses in the event of a default.

The UCC in Action
By means of an example, let’s look at a fuel distributor who provides products to certain customer pursuant to a credit agreement. Although the commercial relationship continues to proceed in a customary fashion, you receive news that one of your customers is having financial trouble and may have trouble paying its bills in the near future. If you are concerned that they may ultimately not be able to pay you for the fuel that they purchase on credit, you can use the adequate assurance provision included in Section 2-609 to demand assurance that they have the ability to pay you for the fuel before you provide additional credit.

If the customer is unable, or unwilling, to provide some reasonable assurance that they can pay you for your fuel, you have the ability to terminate the agreement prior to the customer defaulting on your agreement. 

Any assurance provided by the customer must be commercially reasonable and will depend upon your particular situation. In this example, the customer could provide assurance by providing you financial information or putting up some additional money or collateral as security. The ability to make a demand for assurance works for both sides of an agreement. Additional examples when a demand for assurance could be used include:

• A ship owner demanding assurance from a shipyard that a vessel will be completed;
• Any company that is concerned that another company will be unable to deliver a good or service in the future; or
• Any situation where you are providing goods or services on credit and you have concerns about the customer’s ability to pay.

The UCC Primer
Making a demand for assurance is easy. The demand can be made by sending a simple letter to your customer. Although the letter can take any form, we suggest beginning with a short introductory paragraph identifying the goods and services that are specified in your agreement and a short explanation of why you have concerns about their ability to pay for or provide these goods or services pursuant to the agreement. The second paragraph should state that you have become aware of a certain event, or issue, that constitutes reasonable grounds for insecurity under UCC Section 2-609, or your corresponding state law. The next paragraph should demand that the vendor provide you adequate assurance that they can complete their performance under the agreement. The letter should conclude by stating that, unless you receive the adequate assurance by a certain date, that you will regard the agreement between the parties as being breached by the other party. Although the UCC does not set a time period for responding to a demand for assurance, you should select a commercially reasonable deadline that is less than 30 days away from service of the demand.

Depending upon the circumstances, the adequate assurance could be as simple as a letter explaining a prior delivery problem or as complicated as the provision of financial statements or a credit agreement proving that they will be able to deliver on the agreement. 

In the event that the party does not provide adequate assurance, and you still believe you have a reasonable basis for insecurity, you can then move forward with the termination of the agreement citing the lack of adequate assurance as the reason. This early termination of an agreement will allow you to ‘stop the bleeding’ before a situation goes from bad to worse. Using our fuel example, it is much better to cancel the credit agreement early than to get stuck with an uncollectable credit balance.

Although no one likes being put in a position to write such a letter, in any rapidly deteriorating market, it is important to take these types of precautions to make sure that you are not stuck in a situation where your company incurs significant losses because of another company’s failure to perform.  Courtesy of this UCC provision, you are not required to wait until you suffer significant losses before cancelling the contract. Using this statute, you can try to jump off the other ship before it sinks. You may get a little wet. But, you will continue on to sail another day.

The Author
Mr. DeMarcay is a partner in the law firm of Fowler Rodriguez Valdes-Fauli. His areas of practice include Commercial Litigation, Admiralty, Personal Injury, Transportation, Real Estate, Construction and Corporate Law. Prior to attending law school, Mr. DeMarcay served on the Washington based legislative staff of Congressman Jimmy Hayes. On the WEB: www.frvf-law.com

(As published in the February 2016 edition of Marine News - http://magazines.marinelink.com/Magazines/MaritimeNews)