Adequate Assurance Letters in Times of Supply Chain Instability:  The Importance of Clarity and Consistency

Wednesday, December 30, 2020

As 2020 draws to a close, multiple industries face instability in their supply chains.  The causes vary, ranging from COVID-induced labor shortages, to surging demands for steel and other raw materials, with shortages of supply, to logistical and capacity constraints in the transportation sectors, to widespread financial distress. The result is that buyers frequently face uncertainty regarding the timely and continued supply of needed goods, and sellers frequently face uncertainty regarding receiving payment for goods delivered.

One tool that is available to both buyers and sellers in situations involving such uncertainty is a demand for adequate assurance under the Uniform Commercial Code.  But effective use of this tool, and responding to a demand received, requires careful consideration of the nuances of the law, thoughtful use of language, and consistency in the message communicated.  Failure to understand the law and carefully plan and execute strategy with experienced counsel can have severe consequences.  A recent case from the Seventh Circuit illustrates many of the issues involved and highlights the risks.

Adequate Assurance Under UCC § 2-609

Under Section 2-609 of the Uniform Commercial Code (the “UCC”), a party that has reasonable grounds for insecurity about the other party’s performance does not need to wait until an actual breach occurs but may request “adequate assurance” that the other will perform.  If the other party then fails to provide timely and adequate assurance of its continued performance, the concerned party may treat the contract as repudiated – or breached – and, in turn, may avail itself of the rights and remedies afforded to it under the UCC and the parties’ contract, including immediately seeking cover.  This can be extremely important in time-sensitive situations, where waiting for a breach to occur and then suing for damages can leave a party without an adequate remedy.  As comment 1 to UCC § 2-609 explains, “[t]he section rests on the recognition of the fact that the essential purpose of a [commercial] contract . . . is actual performance and [parties] do not bargain merely for a promise, or for a promise plus the right to win a lawsuit[,]” as “a continuing sense of reliance and security that the promised performance will be forthcoming when due[] is an important feature of the bargain.” 

In furtherance of this point, UCC § 2-609 does not contain bright-line thresholds as to when grounds for insecurity reasonably exist, or as to whether any assurance offered is adequate.  Rather, these concepts are governed by commercial reasonableness under the facts and circumstances at issue in a particular transaction.  Accordingly, parties must be deliberate, clear, consistent, and reasonable in their conduct and communications.

Clear and Consistent Communications are Critical in the Adequate Assurance Context

A.  The Facts of BRC Rubber & Plastics v. Continental Carbon

The recent case of BRC Rubber & Plastics, Inc. v. Continental Carbon Company, 981 F.3d 618 (7th Cir. 2020), illustrates the value that a carefully planned and executed adequate assurance letter can offer for a party and highlights the severity of consequences a party may face by failing to respond with clarity and consistency.

In the BRC Rubber case, BRC manufactured rubber products and purchased one of its key raw materials – carbon black – from Continental.  The parties entered into a five-year contract which established prices for carbon black and specified certain quantities for purchase.  Two years into the contract term, the market for carbon black tightened, and Continental demanded price increases.  BRC insisted on the contractual prices, and the parties failed to resolve their disagreement despite several subsequent communications. 

Eventually, Continental missed a shipment to BRC and failed to provide clarity as to whether and when it would perform under the contract going forward, thus causing BRC concern regarding its ability to satisfy its obligations to its customers.  BRC located an alternate supplier who could promptly ship adequate quantities of the needed carbon black, but at a higher price.

Soon after, BRC sent Continental a demand for adequate assurance, citing Continental’s missed shipments and demand for a price increase as the grounds for BRC’s insecurity.  Continental provided conflicting responses over the next two weeks, with Continental’s attorney sending one letter promising that the contract would be honored, but with Continental’s business people continuing to demand price increases and making equivocal statements regarding continued supply. Ultimately, BRC terminated the parties’ contract, “covered” by buying carbon black from an alternate source at higher prices for the remainder of the five-year contract term, and sued Continental for the price difference.

B.  The BRC Rubber Court’s Relevant Conclusions

While the BRC Rubber case involved numerous issues and numerous earlier trial court and appellate court rulings, the Seventh Circuit’s November 25, 2020 decision focused mainly on the adequacy and effect of Continental’s responses to BRC’s adequate assurance demand.  Ultimately, the court found that Continental did not provide adequate assurance of its future performance under the parties’ contract for numerous reasons. 

First, the court found that Continental’s lawyer’s formal response to BRC’s UCC § 2-609 letter did not suffice as adequate assurance, considering Continental’s subsequent conflicting actions and communications.  The court held that, “Continental's actions and statements after its lawyer's assurance of May 20 were repeated delinquencies that must be viewed as cumulative.  . . . [Thus], if a supposedly adequate assurance is given but then immediately undermined, the insecure party . . . need [not] . . . start the § 2-609 process all over again.”  Id.

Ultimately, the Court concluded that Continental’s conduct substantially impaired the value of the whole contract, and Continental’s failure to provide adequate assurance under the circumstances amounted to a repudiation of the parties’ agreement.  As such, Continental became liable for the increased costs BRC incurred to obtain cover goods, measured by the difference between the prices charged by the substitute supplier and the original prices BRC would have paid under the contract with Continental.  This was the case even though Continental offered to supply BRC again at lower prices than those being charged by BRC’s new supplier after BRC terminated the contract and entered into a new contract with the other supplier.  The court found Continental’s offer to be too little too late, upholding the district court’s finding that, BRC was “not required to trust its fate to Continental any longer” after Continental had failed to provide commercially reasonable adequate assurance.  Id. at 634.

Takeaways

As the BRC Rubber Court most recently confirmed, adequate assurance demands can have great significance to the parties’ respective rights and obligations, and so too can a party’s response to such demands.  Moreover, parties should not assume that only the formal letter and response themselves will constitute the relevant record considered by a court in the event of litigation.  Courts will instead consider the totality of the circumstances when applying the standard of commercial reasonableness under UCC § 2-609. 

Accordingly, parties on both sides of a potentially compromised supply relationship should remain mindful of several key points if they find themselves in a position of having to send or respond to an adequate assurance demand under UCC § 2-609.

  1. In disputed contract situations, organizations should carefully control all communications with the counter party through a central source, preferably counsel, and should ensure that all communications and actions are deliberate and consistent. Failure to follow this protocol and understand the nuances of the law creates great risk, including in the form of terminated contracts and liability for significant damages.    
  2. After a party repudiates a contract, either expressly or by failing to respond properly to an adequate assurance demand, the counter party is entitled to pursue its rights and remedies immediately, and it may be impossible for the repudiator to change its mind or course. As the BRC Rubber Court affirmed, a party is not required to trust its fate going forward to the same party that already repudiated its obligations. 
  3. A buyer making an adequate assurance demand should consider its ability to obtain alternate sources of supply, even at higher costs. Adequate assurance contests frequently result in prompt cessation of supply.  It may be possible to obtain injunctive relief, but a buyer with an alternate source ready to supply can avoid potential disruption and, with careful use of adequate assurance letters and other tools under the UCC, seek cover damages from the seller.  

For further information, please contact the authors of this Alert or your Butzel Long attorney.

David J. DeVine
313.225.7088
devine@butzel.com

Daniel Rustmann
313.225.7067
rustmann@butzel.com

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