The COVID-19 pandemic is causing the suspension or termination of many contracts. At the heart of the problem lies the uncertainty resulting from the recent restrictions on the shipment of goods (ie by closing airports, ports and/or borders), the novel sanitary policies and the lockdown measures. These are only some examples of the new obstacles that are impacting companies’ abilities to perform under contracts.
In this context, companies in the US facing uncertainty can resort to tools like the doctrine of adequate assurance to help them avoid waiting until there is a breach of contract and preserve the existing business relationships. But this solution is not only available in the US. As explained below, Argentina and Brazil also provide for similar remedies to deal with contractual performance uncertainty.
The US perspective
In the US, a company that reasonably believes that its counterparty will not be able to perform its obligations can demand that such counterparty provides adequate assurance of its ability to perform, pursuant to Section 2-609 of the Uniform Commercial Code (UCC).[i] And until said assurance is provided, this company may suspend performance of the contract.[ii] And if the assurance is not provided within a reasonable time (ie not exceeding 30 days) the contract can be deemed terminated.[iii]
Of course, what constitutes 'reasonable' grounds for insecurity will depend heavily on the facts in question.[iv] But generally speaking, US courts have held that the delivery of defective goods[v] or a delay in the delivery of goods[vi] are reasonable grounds for a buyer to feel insecure about a seller’s performance. And from the seller’s perspective, a buyer’s failure to take delivery,[vii] make a payment[viii] or their history of non-payment[ix] – even in separate and legally distinct contracts[x] – have been considered reasonable grounds for the seller to feel insecure about the buyer’s performance. However, general concerns regarding the seller’s ability or willingness to supply goods[xi] or the buyer’s failure to secure financing[xii] have not been considered reasonable grounds for insecurity.
Moreover, the actual facts of the case will also determine what constitutes an 'adequate' assurance of performance. Excuses for failing to perform, with no remedial action, have not been deemed adequate.[xiii] Similarly, US courts have found that a distributor’s vague reference to a 'revolving credit facility' in a letter was inadequate when the distributor never sent any documentation to substantiate the purported lending agreement.[xiv] As a result, the party demanding adequate assurance of performance must be cautious when analyzing whether the assurance given is adequate. Because if it terminates the contract but a court later finds that the assurance provided was indeed adequate, its termination will be considered a contractual breach.
Finally, the terms of the demand for adequate assurance must be clear, which will also depend on the actual facts of the case. For example, US courts have found that the following terms were not 'clear': a cancellation notice by a buyer refusing to accept defective goods;[xv] a letter by a buyer expressing its intention to discuss all aspects of the contract;[xvi] and a demand for accelerated payment for the first shipment of goods when payment was not yet due.[xvii]
The Argentine approach
Argentine law provides for a similar solution for companies facing contractual performance uncertainty: the 'tutela preventiva'. Pursuant to Article 1032 of the Argentine Civil and Commercial Code, whenever a party’s rights are under serious threat of harm due to the counterparty’s inability to perform the contract or its potential insolvency, such party may suspend the contract until the counterparty performs or offers adequate assurance of performance.
Unlike the US approach, under Argentine law 'reasonable' grounds of insecurity are not enough. To demand adequate assurance, a party must show 'serious threat of harm' to its rights. Given that this provision is relatively new, it remains to be seen how it will be interpreted in cases where a breach is likely but it does not yet represent a serious threat of harm; for example, when performance is guaranteed (through a bond or security), and a party would still be interested in demanding assurance.[xviii]
The Brazilian solution
Brazilian law offers a similar solution through the remedy called 'exceção de inseguridade'. Under Article 477 of the Brazilian Civil Code (BCC), a party may suspend contractual performance if its counterparty has been financially affected as a result of a supervening fact, which affects, or sheds doubt on, the counterparty’s ability to perform.[xix] The demanding party must demonstrate that its counterparty’s solvency has been sufficiently affected, so as to make the performance of the contract (at least) doubtful.[xx] Additionally, Article 495 of the BCC allows a seller of goods to suspend its performance if the buyer becomes insolvent[xxi] until the buyer provides adequate assurance of performance.
Although there’s not much jurisprudence on the interpretation of these provisions, Brazilian courts have found that the late payment of an installment in a contract of periodical supply affects the trust between the parties and therefore constitutes a reasonable ground of uncertainty.[xxii] And Brazilian scholars believe that Article 477 also applies to situations where a party’s behavior denotes a high likelihood of non-performance under the contract.[xxiii]
The US doctrine of adequate assurance might be a useful tool for parties facing uncertainties of performance and wishing to preserve the business relationship in place, especially in the context of the COVID-19 pandemic. The legal tools in Argentina and Brazil could also be useful, albeit that they lack extensive jurisprudence. In fact, one may conceive the lack of precedents as a sign that these tools have been used effectively to preserve business relationships, avoiding litigation or arbitration.
In cases of uncertainty, a party demanding adequate assurances should:
- clearly establish the grounds for insecurity pursuant to the applicable law;
- make sure these grounds are reasonable in light of the contractual and factual background; and
- act in good faith, in accordance with the applicable commercial standards.
[i] UCC, Section 2-609 (1). Although the UCC is limited to contracts for the sale of goods, several states have acknowledged the application of the doctrine of adequate assurance to contracts not regulated by the UCC. The provision has been recognized by the Second Restatement of Contracts, Section 251, being part of the general principles of U.S. common law. Notwithstanding, State courts have different interpretations of the application of the doctrine in contracts not regulated by the UCC. For example, the Supreme Court of New York has rejected the application of the doctrine to long-term construction loan agreements. See Bank of New York v River Terrace Assocs., LLC, 23 A.D.3d 308, 804 N.Y.S.2d 728 (2005).
[ii] UCC, Section 2-609 (1).
[iii] UCC, Section 2-609 (3).
[iv] US courts will apply commercial standards if both parties are merchants. UCC, Section 2-609 (2); Universal Builders Corp. v United Methodist Convalescent Homes of Connecticut, Inc., 7 Conn. App. 318, 508 A.2d 819 (1986). According to Section 2-104 (1)(3), a merchant “means a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill”.
[v] AMF, Inc. v McDonald’s Corp., 536 F.2d 1167, 1170 (7th Cir. 1976); LNS Inv. Co. v Phillips 66 Co., 731 F. Supp. 1484 (D. Kan. 1990).
[vi] Universal Builders Corp. v United Methodist Convalescent Homes of Connecticut, Inc., 7 Conn. App. 318, 508 A.2d 819 (1986).
[vii] In re Humboldt Fir, Inc., 426 F. Supp. 292, 297–98 (N.D. Cal. 1977); USX Corp. v Union Pac. Res. Co., 753 S.W.2d 845 (Tex. App. 1988).
[viii] In re Amica, Inc. (1992, BC ND Ill) 135 BR 534, 17 UCCRS2d 11; Kunian v Development Corp. of America (1973) 165 Conn 300, 334 A2d 427; Continental Can Co. v Poultry Processing, Inc. (1986, DC Me) 649 F Supp 570, 3 UCCRS2d 31.
[ix] Toppert v Bunge Corp., 60 Ill. App. 3d 607, 377 N.E.2d 324 (1978).
[x] Hornell Brewing Co. v. Spry, 664 N.Y.S.2d 698 (N.Y. Sup. Ct. 1997).
[xi] In re Coast Trading Co., Inc., 26 B.R. 737 (Bankr. D. Or. 1982); Universal Res. Corp. v Panhandle E. Pipe Line Co., 813 F.2d 77, 79 (5th Cir. 1987).
[xii] Pittsburgh-Des Moines Steel Co. v Brookhaven Manor Water Co., 532 F.2d 572 (7th Cir. 1976).
[xiii] LNS Inv. Co. v. Phillips 66 Co., 731 F. Supp. 1484, 1488 (D. Kan. 1990).
[xiv] Hornell Brewing Co. v. Spry, 664 N.Y.S.2d 698 (N.Y. Sup. Ct. 1997).
[xv] Quaker Alloy Casting Co. v. Gulfco Indus., Inc., 686 F. Supp. 1319 (N.D. Ill. 1988).
[xvi] Penberthy Electromelt Int'l Inc. v. U.S. Gypsum Co., 38 Wash. App. 514, 518, 686 P.2d 1138, 1141 (1984).
[xvii] Nat'l Ropes, Inc. v. Nat'l Diving Serv., Inc., 513 F.2d 53 (5th Cir. 1975).
[xviii] L Fernández, “Coronavirus y tutela preventiva en los contratos. Artículo 1032 del Código Civil y Comercial”, La Ley, Vol 17, 2020, p 5.
[xix] C Peluso, Código civil comentado: doutrina e jurisprudência. Barueri [SP]: Manole, 2018, pp 516-517.
[xx] Ibid, p 517.
[xxi] In order for Article 495 BCC to apply, the buyer does not necessarily need to be in bankruptcy proceedings – he can just be considered insolvent in practice. G Tepedino, Código Civil Interpretado conforme a Constituição da República, Vol. II. Rio de Janeiro: Renovar, 2012, p 156.
[xxiii] “Enunciado No 438 da V Jornada de Direito Civil CJF/STJ”, noting that the “exceção de inseguridade” found in Article 477 may be raised against the party whose behavior poses a clear risk to the performance of the contract.