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Managing Contractual Relationships in a Turbulent Economy

By John Eustermann
Managing contractual relationships and assessing transaction risks is key to a producer's success in today's renewable fuel/energy environment. Tighter commodity margins and credit markets require the producer to be more proactive with regard to managing contractual performance than in the past. Rather than waiting to find out through the trades that a business of a supplier or off-taker has failed, the producer, as a party to the contract that suffers from waning performance by a counterparty, may be able to avail itself of certain "self-help" provisions of the Uniform Commercial Code.

With respect to a contract for the sale of goods, 2-609 of the UCC states, "When reasonable grounds for insecurity arise with respect to the performance of either party, the other party may in writing demand adequate assurance for due performance ." As between merchants, the reasonableness of grounds for insecurity and the adequacy of any assurance offered is determined according to commercial standards. Essentially, with regard to a producer that finds itself in such a situation with a vendor or customer, it must have a good-faith basis for its "reasonable grounds for insecurity."

From the producer's perspective, for example, if reasonable doubts exist as to a counterparty's (vendor/supplier or off-taker of goods) ability or willingness to pay, the producer may suspend its own performance on the contract in question upon a demand for "adequate assurances." If no such assurances in writing are proffered within 30 days of the producer's demand, the contract at issue may be deemed as repudiated by the counterparty. The producer, at this juncture, may avail itself of certain remedies provided under the UCC, including but not limited to, cessation of further performance, claims for amounts owed and, as applicable, claims for incidental and consequential damages.

What constitutes "reasonable grounds for insecurity" and satisfactory "adequate assurances" are fact sensitive and determined on a case-by-case basis. The terms and conditions of the particular contract in question and a party's performance thereunder should be the first driver of the grounds for insecurity. Insecurity stemming from general industry or market conditions is not sufficient for purposes of availing the self-help remedies of UCC 2-206. Thus, whether from the perspective of the party seeking the adequate assurances or from the perspective of the party responding to a demand for adequate assurances, careful analysis of 1) the contract at issue, 2) the parties' dealings thereunder, and 3) any applicable commercial standards is warranted.

The assurances provided must be adequate under the circumstances of the particular case in question. Responses to a demand stating that a party's performance to date has been stellar or faultless has been held by the courts to be evasive and insufficient. Further, statements that a party intends to pay or perform were likewise found to be inadequate.

Rather, the supplier or off-taker should provide information regarding future performance sufficient enough to establish the likeliness of such performance. As for the party requesting adequate assurances, courts have held that demands resulting from commodity pricing insecurity were made in bad faith where the party seeking assurances had found itself in a financial corner due to an over-leveraged balance sheet.

As with any contractual relationship, the best security comes in the form of contractual performance by all parties. The current political and economic environment, however, can have spillover effects that result in waning contract performance and break downs in communication. Appropriately demanding adequate assurances can open up the lines of communication and bring the parties together to get contractual performance back on track or to allow the parties to make needed modifications to contractual terms and conditions. On the other hand, the failure to communicate and provide the sought-after adequate assurances can result in the parties severing their relationship.

John Eustermann is a partner with Stoel Rives LLP. Reach him at jmeustermann@stoel.com or (208) 387-4218.
 

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