06 January 2015

Dealing With a Troubled Customer Relationship? Get Adequate Assurance of Future Performance

Extended credit terms have become a more commonplace means of obtaining a competitive advantage in the marketplace. Although you may need to agree to these extended terms in order to get the business, this can often be a scary proposition. In these situations, the circumstances can arise where, although the customer is still paying within terms (and therefore is not in breach of its obligations), all external signs indicate that it is going to have trouble satisfying even its short-term obligations as time goes on.

What can be done when a customer is paying timely, but you are seeing concerning signs, such as abnormal or inconsistent payment experiences, consistent downgrades in its credit rating, or rumors of bankruptcy or financial struggles? Are you stuck providing this customer extended credit terms until it breaches its agreement by filing bankruptcy, potentially leaving you holding the bag on a substantial receivable that could cripple your business? Not necessarily. In situations where there are reasonable grounds for insecurity concerning a customer’s ability to timely satisfy its payment obligations, the Uniform Commercial Code (UCC) can often provide a seller of goods some relief.

Section 2-609 of the UCC, which applies to all sales of goods, provides that “[w]hen reasonable grounds for insecurity arise with respect to the performance of either party (to a contract for sale of goods) the other may in writing demand adequate assurance of due performance.” One form of adequate assurance of future performance is a letter of credit or other security that ensures prompt payment; other types of assurance may also be used, depending on the situation. If it’s commercially reasonable, you, the seller, may also suspend performance or demand cash-on-delivery or cash-in-advance payment terms while awaiting that adequate assurance. Most often, the ability to shift to cash-on-delivery or cash-in-advance payment terms can provide immediate risk relief. However, if the other party does not provide adequate assurance within a reasonable time, the contracts can be considered repudiated.

This is a very strong and useful tool for creditors. The time and expense of demanding adequate assurance often pays for itself. Proactive suppliers can significantly reduce or eliminate their exposure in many cases. However, because of the UCC’s general requirement that all actions (even adequate assurance demands) be commercially reasonable, you should always consult with an attorney prior to taking any action.

If you have concerns about a customer’s ability to pay, or would like further information regarding making an adequate assurance demand, please contact the author or your Miller Johnson business attorney.