Oct 24

Highest Court Expands the Right to Demand Reasonable Assurance

This article was published in The New York Law Journal, May 24, 1999

As many litigators can attest, frequently clients call upon them for their counsel to assist in devising a strategy that will place the clients in the best possible light should it become necessary to initiate litigation down the line. Take for example the not uncommon situation where one party to a business transaction begins to suspect that the other party will not be able to fulfill its financial commitments at some future date. Instead of waiting for what may be the inevitable, your client–not wanting to invest any further monies or efforts in the business venture–wants to be assured that the other party has the financial wherewithal to hold up to its end of the bargain and consummate the transaction.

This can become a very delicate situation because a party who suspends its own performance under the premise that the other party may not be able to perform risks having its own suspension of performance be deemed a “breach of contract” by the other party, thereby entitling the other party to recover any damages occurring as a result of any suspension in performance.What precisely to do in these situations–both for the party seeking assurances and the party that is requested to give assurances is not unlike walking a tightrope. However, in light of a recent change in the law expanding the right of one party to a business transaction to request adequate assurances that the other will indeed perform, the advice a New York attorney offers to his or her client will now be somewhat different than before.

Up until now, New York had refrained from expanding its common law to permit a party to demand adequate assurance of performance beyond the Uniform Commercial Code.As many attorneys know, UCC 2-609 permits one party upon “reasonable grounds for insecurity” to “demand adequate assurance of due performance” and permits that party to suspend any performance until such assurances are received. Furthermore, it provides that the other party’s “failure to provide within a reasonable time not exceeding 30 days such assurance of due performance” constitutes a “repudiation of the contract.”

Of course, Article 2 of the UCC applies only to a sale of goods and historically New York courts have balked at expanding the adequate assurance concept to commercial transactions not involving a sale of goods.Accordingly, in the past, absent the actual insolvency of *one party, neither party to a commercial transaction involving the performance of services (and not exclusively the sale of goods) had any right, as a matter of law, to demand adequate assurances and performance.

Recently, New York was invited to consider a change in the common law when the United States Court of Appeals for the Second Circuit presented the New York Court of Appeals with the following novel question:

“Does a party have the right to demand adequate assurance of future performance when reasonable grounds arise to believe that the other party will commit a breach by non-performance of a contract governed by New York law, where the other party is solvent and the contract is not governed by the Uniform Commercial Code?”

To some observers’ surprise, the Court of Appeals answered the question in the affirmative, thereby expanding a party’s right to demand adequate assurance in certain non-UCC transactions.In that case, Norcon Power Partners, LP v. Niagara Mohawk Power Corp., 92 N.Y.2d 458, 682 N.Y.S.2d 604 (Dec. 1, 1998), an independent power producer and Niagara Mohawk, a public utility provider, had entered into an agreement whereby Niagara undertook to purchase electricity generated at Norcon’s Pennsylvania facility. The contract was executed in 1989, was for 25 years and contained a complex pricing formula which was triggered upon certain events.

* At the point of insolvency, New York courts reasoned that it was no longer necessary for the other side to continue performing and, in fact, most commercial agreements provide that the insolvency and/or bankruptcy of one party constitutes a material breach of contract.

– Neal Eiseman, Esq.

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