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Despite occasional glimmers of hope, the economic news remains grim. Unemployment remains high, consumer spending is down dramatically, and many businesses are struggling to merely survive. It's nasty out there and nobody expects a quick recovery. So what can a business that is contractually obligated to extend credit to a financially distressed company do to enhance the likelihood of payment?

Article 2 of the Uniform Commercial Code ("UCC")-the part of the UCC dealing with transactions in goods-contains a number of remedies that a business can utilize when selling goods to a buyer who is financially distressed but still operating outside of bankruptcy. These remedies are premised on the notion that the essential purpose of a commercial contract for the sale of goods is actual performance of the contract, not merely a promise to perform coupled with the right to win a lawsuit for breach of contract in the future. Or, to put it another way, a seller who is a party to a contract granting a buyer credit terms is entitled to exactly what was bargained for: timely payment for the goods sold.

If our company sells goods to a buyer that is or may become insolvent, what rights do we have?

A buyer should not be able to impair your expectation of receiving timely payment of the purchase price for the goods you sold. Therefore the UCC provides a number of remedies to sellers who discover or even suspect that a customer has become insolvent. Under such circumstances, if you, as a seller of goods, are contractually obligated to extend credit to your customer, you have the right to:

• demand adequate assurance of future performance;
• stop the shipment of goods in transit when the buyer is insolvent or in default of its payment obligations to you;
• refuse delivery to an insolvent buyer except for cash including payment for all goods previously delivered under the contract;
• seek the reclamation or recovery of goods that you have sold to an insolvent buyer.

Each of these remedies has certain requirements and risks. Accordingly, you should consult with an experienced creditors' rights attorney before taking any of these actions.

ADEQUATE ASSURANCE OF FUTURE PERFORMANCE

If the buyer is neither insolvent or in default of payment, but you, the seller, are unsure about the buyer's ability to perform under the contract, you can demand that the buyer provide you with adequate assurance of future performance. Pending receipt of adequate assurance and if commercially reasonable, you can suspend your performance under the contract, including conditioning shipment of goods to the financially distressed buyer on cash-in-advance or cash-on-delivery payment terms.

Demand for Adequate Assurance of Future Performance. Section 2-609 of the Uniform Commercial Code provides that, when a party to a sales contract has reasonable grounds to be insecure about the other party's ability to perform its obligations under the contract, the insecure party can demand, in writing that the other party provide adequate assurance of its ability to perform under the contract. The other party must respond to the demand with adequate assurance of its ability to perform within 30 days. In the meantime, the insecure party can suspend its own performance under the contract (such as switching from credit to cash terms) until it receives such assurance as long as its suspension of performance is commercially reasonable. If the other party does not respond or does not provide adequate assurance of its ability to perform under the contract in a timely manner, the insecure party can treat the contract as repudiated and sue for breach of contract.

In determining whether you should demand adequate assurance of performance, you, as the seller, should first review the terms of your contract with the buyer to determine whether (a) your right to demand adequate assurance has been waived; (b) the contract specifies the grounds for the insecurity that might trigger your right to seek adequate assurance; (c) the contract specifies the assurances the buyer could offer. Additionally, under the statute:

• You must be "reasonably" insecure to invoke this remedy. Sellers have been determined to be "reasonably" insecure where there has been (a) news about a buyer that makes the seller suspicious that the buyer may be insolvent, (b) the buyer has made a sudden increase in requests for credits; or (c) the buyer has become past due on its obligations to the seller or other creditors.
• The buyer's assurances need only establish-to a reasonable merchant-a likelihood of the buyer's ability to perform under the contract. Mere unsubstantiated assurance of a buyer's ability to pay for goods, or obtain financing or other third-party support is not enough. On the other hand, providing a letter of credit in the seller's favor or providing financial information, including cash flow projections and financial statements, or proof of availability of credit under the buyer's lending arrangements, have been held sufficient.
• You are only entitled to reasonable assurance of the buyer's ability to perform under the contract and you cannot use the demand for adequate assurance as a way of rewriting the contract on more favorable terms.
• If you act without reasonable grounds for uncertainty or improperly reject assurances offered by the buyer, you could be in breach of the contract and subject to damage claims.

STOPPING DELIVERY OF GOODS IN TRANSIT

If the buyer is insolvent or in default of its payment obligations to you, you may stop delivery of goods that are in transit or in the possession of a common carrier, warehouse or other third-party bailee. (UCC Section 2-705). The right to stop delivery of goods in transit is extinguished when:

• the buyer receives the goods;
• a bailee, other than a carrier, acknowledges that it is holding the goods for the buyer;
• a carrier transporting the goods acknowledges to the buyer that it is holding the goods for the buyer by either reshipping them according to the buyer's instructions or holding them as the buyer's warehouseman; and
• The buyer has received a negotiable document of title for the goods.

If you invoke this remedy, you should send the carrier, warehouse, or third-party bailee a written demand to stop delivery of goods in transit. Additionally, you should be aware that you will be responsible for all charges and damages that the carrier, warehouse, or third-party bailee incurs in connection with honoring your instructions to stop delivery.

REQUIRING PAYMENT IN ADVANCE OR ON DELIVERY

You can refuse to deliver goods to an insolvent buyer on any other than cash terms (UCC Section 2-702(1). This remedy allows you to stop delivery of goods in your possession, change the terms of the contract from credit to cash, and condition further deliveries of goods on cash-in-advance or cash-on-delivery payments if you discover that the buyer is insolvent.

RECLAMATION OF GOODS SOLD TO AN INSOLVENT BUYER

Finally, Section 2-702(2) of the Uniform Commercial Code gives you the right to reclaim goods that an insolvent buyer has received where: (1) the buyer has received the goods; (2) the goods were sold to the buyer in the ordinary course of business; (3) the buyer had possession of the goods at the time of the demand; and (4) the buyer was insolvent when it received the goods. Under the UCC, a reclamation demand applies only to goods the buyer receives within 10 days of the date the reclamation demand is made.

The reclamation demand must be in writing, must specify that you are asserting your "right of reclamation" under applicable state law, and must be sufficiently detailed to permit the debtor to identify the goods being reclaimed, i.e., delivery dates, invoice dates and invoice numbers should be specified and copies of invoices attached. As long as you make the reclamation demand in a commercially reasonable manner, it is effective upon dispatch. To avoid any disputes over the date of the demand, you should consider sending the reclamation demand to the buyer by facsimile and also by overnight delivery or certified mail.

Additionally, in order for the reclamation demand to be valid, you will have to demonstrate that the debtor was in possession of the goods at the time you made the reclamation demand. Because the validity of your reclamation demand may not be addressed until long after the demand is made, you should try to confirm the amount of the goods in a debtor's possession as of the date of the demand either by a prompt, on-site inspection of the buyer's facilities or a written acknowledgment by the buyer.

If you assert your right to reclamation in a timely fashion, you generally are entitled to recover possession of the goods. Your reclamation rights are, however, subject to the rights and interests of third parties. Thus, the existence of a secured creditor with a security interest in the buyer's inventory could render your reclamation claim ineffective. Similarly, if the goods were no longer identifiable at the time you made the reclamation demand-the goods had been commingled with or incorporated into another product by the buyer-the reclamation demand may determined to be invalid.

SURVIVAL STRATEGIES

Whether or not your business survives these difficult economic times may very well depend on your diligence and your willingness to take advantage of the remedies outlined above, so:

• Be Proactive: Monitor your accounts. Watch for increased delays in payment or for unusually large orders. Be on the alert for news about or events concerning your customers and their financial condition.
• Review the terms of the contracts with your financially distressed customers to determine if you have waived or limited your rights to invoke these remedies.
• Remember, your actions must be consistent with your statutory obligations to act in good faith and in a commercially reasonable manner.
• Consult with a creditor's rights attorney before invoking any of these remedies.
• Finally, remember, the rules change if the financially distressed customer files for bankruptcy. For what to do when a financially distressed customer has filed for bankruptcy, click here to review my prior Client Advisory on that topic.

If you have any questions or concerns about this or other creditors' rights issues, you should consult with an attorney who is familiar with Creditors' Rights and Bankruptcy law. The Creditors' Rights and Bankruptcy attorneys at Walter & Haverfield will be pleased to help.