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Confronting a Potentially Breaching Seller
Practical Law Legal Update w-001-0059 (Approx. 10 pages)
Confronting a Potentially Breaching Seller
by Practical Law Commercial Transactions
| Published on 08 Dec 2015 • USA (National/Federal) |
An update that discusses some of a buyer's options when confronting a seller that will potentially breach its performance obligations, including by failing to deliver goods, delivering non-conforming goods, or not honoring its warranties after delivery and acceptance of the goods.
Buyers and sellers enter into sale of goods contracts with the good faith expectation that each party will meet its obligations. Nevertheless, the parties should be prepared to address potential problems that arise during the performance of the finalized agreement. This update outlines various issues that an aggrieved buyer must consider when a seller threatens breach of its performance, including:
- How a seller could breach its performance obligations (see Seller's Potential Breach of Performance Obligations).
- A review of the buyer's potential contractual rights and remedies (see Contractual Rights and Remedies).
- Whether the buyer can accommodate the seller by granting a waiver (see Accommodating a Seller Through Amendment or Waiver).
- Whether the threatened breach constitutes a potential anticipatory repudiation that triggers the aggrieved buyer's right to demand adequate assurances (see Demanding Adequate Assurances and Terminating Under Anticipatory Repudiation).
For information on issues that a seller must consider when confronting a buyer who threatens payment breach, see Legal Update, Confronting a Potentially Breaching Buyer.
Seller's Potential Breach of Performance Obligations
A seller can breach its performance obligations by:
- Failure to deliver. Under the UCC, the seller must tender goods in the manner, time, and place specified in the purchase contract. The buyer should review the contract’s delivery terms to determine its rights and remedies for late or non-delivery of goods. The buyer should also determine whether the contract contains a time of the essence provision, which allows the buyer to terminate the contract and collect damages if the seller is late in delivering the goods. For more information about delivery provisions, see Practice Note, Delivery of Goods. For sample delivery provisions, see Standard Clauses, General Contract Clauses: Delivery Provisions. For more information about time of the essence, see Practice Note, Time of the Essence in Commercial Contracts. For a sample time of the essence provision, see Standard Clause, General Contract Clauses: Time of the Essence.
- Delivery of non-conforming goods. The seller must deliver goods that conform to the contract's specifications, the quantities ordered by the buyer, and the specific delivery schedule at the specified location. The buyer should review the contract’s provisions to determine its rights and remedies if the seller delivers non-conforming goods. For more information on the buyer's rights to accept, reject, and revoke its acceptance, see Practice Note, Acceptance of Goods.
- Warranty, course of dealing, and usage of trade issues. The buyer may have express and implied warranty rights that arise from the language of the contract, the party's existing relationship and past and current conduct, and the routine practices associated with the related industry. The buyer should review any express warranties and any disclaimers of warranties contained in the contract, any conduct or communications between the parties, and industry practices that may differ from the contract’s warranty provisions. For more information on buyer's warranties rights, see Practice Notes, UCC Article 2 Express Warranties and UCC Article 2 Implied Warranties. For more information on course of dealings and usage of trade issues, see Practice Note, UCC Article 2 Implied Warranties: Course of Performance and Usage of Trade.
Contractual Rights and Remedies
The buyer should review the sales contract to determine available contractual rights and remedies for breach of performance:
- Setoff. The buyer typically negotiates setoff rights because the buyer is usually obligated to pay the larger amount under the agreement. The buyer should determine whether it can setoff its payment obligations against the amount of its potential claim against the seller. For a sample setoff provision, see Standard Clause, General Contract Clauses: Setoff. For a sample provision that restricts the right of setoff, see Standard Clause, General Contract Clauses: No Set Off. For more information about setoff, see Practice Note, Setoff and Commercial Contracts.
- Payment Terms. The buyer should review the contract's payment terms, including whether the payment terms permit the buyer to withhold disputed amounts without the imposition of any late payment interest or penalties. For more information on drafting and negotiating payment terms, see Standard Clauses, General Contract Clauses: Payment Terms.
- Indemnification. The buyer should review the contract's indemnification provision to determine whether it can seek indemnification for third-party claims (for example, claims of the buyer’s downstream customers), as well as direct claims, including a direct claim for breach of performance obligations and for attorneys' fees that may not be available under the Uniform Commercial Code (UCC) or the common law. For more information about drafting and negotiating indemnification provisions, see Practice Note, Indemnification Clauses in Commercial Contracts. For a sample indemnification provision, see Standard Clauses, General Contract Clauses: Indemnification.
- Obligation to Negotiate. In addition to reviewing the contract's choice of law and choice of forum provisions, the buyer should review the contract to determine whether it contains any provisions that obligate the parties to resolve disputes through multi-tiered negotiation. For more information, see Standard Clauses, General Contract Clauses: Alternative Dispute Resolution (Multi-tiered). For more information about choice of law and choice of forum issues, see Practice Note, Choice of Law and Choice of Forum: Key Issues.
- Termination Rights. The buyer should determine what rights it may have to terminate the contract and the consequences of termination. For more information about drafting and negotiating termination clauses, see Standard Clauses, General Contract Clauses: Term and Termination. For a sample termination notice, see Standard Document, Notice of Termination for Cause.
- Cumulative versus Exclusive Remedies. The buyer should review the contract to determine whether it can pursue cumulative remedies in addition to any contractual remedies. The buyer should also determine whether the contract’s contractual remedies such as the remedies set out in the indemnification provision and the product warranties are, in fact, exclusive. If any contractual remedy does not specifically state that it is the aggrieved buyer’s exclusive remedy for the specified breach, then the aggrieved buyer can potentially pursue cumulative remedies even after obtaining its contractual remedy. For more information about cumulative versus exclusive remedies, see Standard Clause, General Contract Clauses: Cumulative Remedies (with Exclusive Remedies Carve-out).
The buyer must also consider the impact of any defenses the seller may raise to non-performance, for example, the buyer's failure to:
- Timely pay for the goods.
- Mitigate damages. Before the buyer can recover damages, it must show that it tried to reduce the scope and amount of its damages even if the seller is solely at fault for the buyer’s damages, for example, by acting in good faith and with commercially reasonable efforts to procure substitute goods if the seller has delivered non-conforming goods. For more information see Practice Note, Mitigation of Contract Damages in Sale of Goods Contracts: Buyer's Obligation to Mitigate.
Accommodating a Buyer Through Amendment or Waiver
Buyers almost always consider practical and business considerations together with their legal rights when determining the best response to a potential breach. For example, a buyer may want to preserve a long-standing relationship with the potentially breaching seller. If so, the buyer may choose to negotiate an accommodation for the seller by either:
- Permanently amending the terms of the contract to extend the delivery date or grant some other accommodation.
- Making a one-time dispensation and waiving or partially waiving the defect in performance.
Most commercial contracts include one or more provisions that address the means by which the contracting parties may:
- Amend or modify the agreement.
- Waive or otherwise consent to either or both parties' noncompliance.
The buyer should review the sales contract and determine the documentation required to either amend the contract or grant a waiver.
For more information on drafting and negotiating an amendment clause, see Standard Clause, General Contract Clauses: Amendments. For a sample stand-alone amendment agreement, see Standard Document, Amendment Agreement. For more information on drafting and negotiating a waiver provision, see Standard Clauses, General Contract Clauses: Waivers. For a sample form of waiver, see Standard Document, Waiver.
Demanding Adequate Assurances and Terminating Under Anticipatory Repudiation
Through anticipatory repudiation, both buyers and sellers can treat a counterparty’s words or actions that disavow the agreement as a present breach of contract despite the fact that the counterparty’s performance obligations are not yet mature. To create an actionable anticipatory repudiation, the repudiating party must have performed an overt act or dispatched a communication that both:
- Substantially impairs the value of the contract to the aggrieved party (see Practice Note, Anticipatory Repudiation and Adequate Assurances of Future Performance: Substantial Impairment Requirement).
- Does either of the following:
- renders performance reasonably impossible; or
- clearly demonstrates an intent not to perform or continue to perform when performance is due under the contract.
(UCC § 2-609.)
Often times it is not clear whether a repudiating seller's actions or status will satisfy these requirements, which may compound the buyer’s insecurity about the seller’s ability to perform. A buyer insecure about a seller's ability to perform can make a demand for adequate assurances of performance to the buyer.
There are a number of important factors for a buyer to consider before dispatching its demand for adequate assurances, including:
- How insecure must the buyer be before it can demand adequate assurances from the seller? Whether reasonable grounds exist is a fact-specific determination based on a number of factors, including:
- commercial standards of reasonableness;
- whether the allegedly repudiating seller made a modification demand, for example, a refusal to deliver the goods unless the buyer agrees to more favorable pricing or payment terms;
- facts extrinsic to the contract and relationship but that bear on a party’s ability to meet its obligations (for example, a seller losing its relationship with its distributor, impairing its ability to deliver the goods timely);
- whether the aggrieved buyer has made a prior breach of contract; and
- whether the aggrieved buyer has acted in good faith.
- What are the consequences of a seller not providing adequate assurances of its ability to perform its obligations? A buyer that does not receive adequate assurances from the seller must consider the likely impact of exercising its rights, including the same options as other types of aggrieved parties under anticipatory repudiation, but should elect an option of either:
- treating the contract as having been breached and resorting to available remedies under the UCC;
- ignoring the repudiation and waiting for performance; or
- urging a retraction of the repudiation.
For an overview on anticipatory repudiation and adequate assurances of future performance, see Practice Note, Anticipatory Repudiation and Adequate Assurances of Future Performance. For a sample letter from a buyer to a seller demanding adequate assurances of performance, see Standard Document, Letter from Buyer Demanding Adequate Assurances from Seller. For a sample letter from a seller responding to a buyer's demand for adequate assurances, see Standard Document, Letter from Seller Responding to Buyer's Demand for Adequate Assurances.