Restructuring

Contributed by Sara Coelho
In a previous installment, we wrote about the state law doctrine of adequate assurance, which sometimes gives contract counterparties who have reasonable grounds for insecurity the right to demand adequate assurance of future performance.  The Bankruptcy Code imported this doctrine, at least to an extent, in sections 365(b) and (f), governing circumstances when adequate assurance must be provided upon assumption, or assumption and assignment of a contract.  This bankruptcy application, however, seems narrower than the doctrine’s application in state law, raising questions about to extent to which the doctrines may overlap and differ.  The previous installment outlined generally the right to adequate assurance and the policy behind the doctrine.  This installment treats the common law applications of the right and the related doctrine of anticipatory breach, which give rise to similar considerations.  A final post will consider whether and how these rights can be exercised against a counterparty in bankruptcy.
New York law illustrates that state common law on the doctrine of adequate assurance can be quite muddled on the question of which contracts benefit from this right.  In the sale of goods context, the Uniform Commercial Code allows parties to demand adequate assurance of performance when cause for insecurity arises, but some jurisdictions limit the kinds of contracts to which the right applies.  For example, New York did not recognize a right to demand assurance outside the sale of goods or insolvency context before Norcon, in which New York’s Court of Appeals tentatively recognized a common law right to demand assurance, at least for some complex, long-term, commercial contracts.  Some lower courts in New York have interpreted the decision as applying the right only to contracts “analogous” to contracts for the sale of goods, while others reject such a restriction, noting that the Norcon court did not restrict its holding in this way.  Other courts have applied the doctrine more widely, and the Restatement (Second) of Contracts § 251 provides for a right to demand adequate assurance “without regard to the subject matter of the contract.”  As with the UCC, the Restatement’s rule is premised on the notion that “reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain,” a principle that the Restatement says “is closely related to the duty of good faith and fair dealing in the performance of the contract.”
In some situations where state law does not provide a right to demand assurance, the law on anticipatory breach may, indirectly, provide a similar right, or, in some circumstances, obligation to request assurance.  After an anticipatory breach (generally a clear repudiation of the contract by one party), the non-repudiating party is entitled to treat the contract as completely breached, withhold performance and sue for damages.  A less than equivocal repudiation puts a counterparty in a bind:  should it risk performing itself, or assert the anticipatory breach?  To make the rights even murkier, in New York, performing after an anticipatory breach can be an election to continue the contract, which precludes exercising rights to terminate as a result of the anticipatory breach.
Even where state law provides no right to demand assurance, the failure to ask for it may bear on whether a contract is repudiated.  It may be hard for a court to believe that a repudiation was sufficiently unequivocal, or that it was understood as a repudiation at all, if the actions in question didn’t inspire the non-repudiating party to seek some kind of assurance that performance is intended.  One court has stated that, even in the absence of a right to do so, the “fact or not of a demand for adequate assurance is relevant to the common law inquiry” regarding whether an anticipatory repudiation occurred.  It quoted a commentator who argued that “[t]he nature of communication between the parties should be a major factor in the court’s evaluation of their claims for compensation.  Failure of a party to seek cure or assurances gives rise to an inference that that party did not regard the disruption as a real threat to the contract relationship.”  Indeed, one reason the Norcon court gave for allowing wider recognition to the doctrine of adequate assurance was that assurance demands “may even provide an incentive and tool for parties to resolve their own differences . . . . Open, serious renegotiation of dramatic developments and changes in unusual contractual expectations and qualifying circumstances would occur because of and with an eye to the [adequate assurance] doctrine’s application.”
Note, however, that a refusal to tender performance unless the counterparty fails to satisfy an extra-contractual demand can itself be an anticipatory repudiation of the contract.  Therefore, a party seeking assurances following repudiation, but without a right to condition its own performance on those assurances being provided, would be wise to be very careful not to seek assurance in a form that imposes performance burdens different from the contract, or to imply that its performance is conditioned on adequate assurance being provided.  This may limit the party to seeking a verbal assurance of performance, which in many cases will be a futile or meaningless exercise.  Moreover, repudiation generally cannot be inferred by silence or a refusal to act, and, therefore, the refusal to answer a request for adequate assurance may not, in jurisdictions where there is no right to condition performance on providing assurance, establish a clear anticipatory breach.
Given these difficulties, it’s not surprising that courts and commentators have pressed for a doctrine that allows contract counterparties facing a likely breach some method for attempting to obtain clarity.  Unfortunately, exercising an adequate assurance right simply replaces the chief uncertainty inherent in asserting anticipatory breach with a similar one.  Instead of worrying about whether the contract is repudiated, one has to worry if the assurance demanded is justified by the circumstances.  It does however entitle a non-repudiating party to one more exchange with its counterparty, which sometimes will help reveal intentions.