How to protect yourself and your business if you are owed money on a contract

In the aftermath of the coronavirus pandemic, uncertainty has become the new norm. In this ‘next normal’ it is important to be proactive and protect yourself from more future uncertainty. This article explores ways to protect yourself and your business if you are owed money under a contract.

Do your Due Diligence

Before you sign a contract, do your due diligence. Making sure you are entering into contracts with reputable businesses with positive track records can save you and your wallet a lot of pain later. This is the easiest, simplest way to protect yourself from potential contract fallout.

When Things Go Wrong

In the event of an unanticipated event, like COVID-19, you may find yourself in an agreement with someone who will not be able to perform their part of the deal, despite your due diligence.

What then?

There are two ways to protect your interests: first, a principle known as anticipatory repudiation or anticipatory breach, and second, making a demand for adequate assurance of performance

Option 1: Anticipatory Breach

A contract principle known as anticipatory repudiation or anticipatory breach may provide you some protection in the midst of contractual uncertainty.

If someone you’ve contracted with lets you know that they will not be able to hold up their end of the deal, or if they unilaterally do something that would make it impossible for them to perform, you can hold their actions as a breach of contract, even though the actual, tangible breach (i.e. their failure to pay) has not yet occurred. This gives you some lead time to address a breach before it actually occurs and causes your business harm.

“If a party to an obligation gives notice to another, before the latter is in default, that he will not perform the same upon his part, and does not retract such notice before the time at which performance upon his part is due, such other party is entitled to enforce the obligation without previously performing or offering to perform any conditions upon his part in favor of the former party.”

California Civil Code Section 1440. “While an actual breach of contract cannot occur until the time for performance has arrived, an anticipatory repudiation of the contract, or anticipatory breach, occurs before performance is due under the contract and results in a total breach.” County of Solano v. Vallejo Redevelopment Agency, 75 Cal.App.4th 1262, 1275-76 (1999) (citing Gold Min. & Water Co. v. Swinerton, 23 Cal.2d 19, 29 (1943)). “A party anticipatorily breaches a contract expressly by unequivocally refusing to perform, or impliedly by conduct ‘where the promisor puts it out of his power to perform so as to so as to make substantial performance of his promise impossible.’” County of Solano, 75 Cal.App.4th at 1276 (citing Taylor v. Johnston, 15 Cal.3d 130, 137 (1975)).

Option 2: Demand for Adequate Assurance

Upon making a demand for assurances, a party with reasonable grounds for insecurity may suspend his own performance so long as it is commercially reasonable to do so.

The failure to respond with reasonable assurances constitutes a repudiation by the non-responding party.

California Commercial Code Section 2609.

This means that where you reasonably, under the circumstances, ask for assurances, the other party must give you some sort of reassurance, or their failure to do so in and of itself constitutes an anticipatory breach.

If anticipatory repudiation cannot be established but there are reasonable grounds for insecurity, the insecure party may make a demand for adequate assurance of performance. In re Pacific Gas and Electric Co., 271 B.R. 626 (N.D. Cal. 2002); Cal. Com. Code § 2609 (“When reasonable grounds for insecurity arise with respect to the performance of either party the other may in writing demand adequate assurance of due performance and until he receives such assurance may if commercially reasonable suspend any performance for which he has not already received the agreed return.”).

If for some reason, even though the party hasn’t anticipatorily breached, you have reason to worry that they might breach, you may ask the other party to give you some sort of guarantee or promise that they still plan on performing. Upon making a demand for assurances, a party with reasonable grounds for insecurity may suspend his own performance so long as it is commercially reasonable to do so.

How a demand for adequate assurance can lead to anticipatory breach

The failure to respond with reasonable assurances constitutes a repudiation by the non-responding party. Cal. Com. Code § 2609. This can occur where the other party does not respond to the demand for assurances in a reasonable time or does not respond in a way that provides reasonable assurances. This means that where you reasonably, under the circumstances, ask for assurances, the other party must give you some sort of reassurance, or their failure to do so in and of itself constitutes an anticipatory breach.

A Pitfall to Avoid: Ispo Facto clauses

You may have seen contracts with ipso facto clauses in them – this is a provision that makes the bankruptcy of one party a triggering event for the other party to terminate the contract. An ipso facto clause might say something like:

This Agreement shall terminate without notice, (i) upon the institution by or against either party of insolvency, receivership or bankruptcy proceedings or any other proceedings for the settlement of either party’s debts, (ii) upon either party making an assignment for the benefit of creditors, or (iii) upon either party’s dissolution or ceasing to do business.

Depending on the clause, different events surrounding bankruptcy might trigger the termination, but the same basic idea remains regardless of the exact form the clause takes: if the other company files bankruptcy, you can get out of the contract. This might seem like a great way to protect yourself in case the other party goes into bankruptcy. However, ipso facto clauses are generally unenforceable and invalid under the federal Bankruptcy Code. This means that even if your contract includes a provision allowing you to terminate in the case that the other party files bankruptcy, a court would not enforce that clause. See 11 U.S.C. §§ 365, 541. While there are a few exceptions to that rule, the exceptions are few and far between. So unless you fall into a couple slim categories, a termination on bankruptcy clause will not do you much good.

Putting it all together

Where does this all get you practically?

Upon an anticipatory breach your business has three options:

    1.     Cancel the contract and terminate all rights and obligations under it,
    2.     Bring an action for damages or specific performance of the contract, or
    3.     Ignore the repudiation and continue under the contract.

If you are trying to protect your business from a loss that seems inevitable, anticipatory breach may help you cut your losses by terminating a contract without it being a breach on your part, allowing you to seek a more beneficial business relationship elsewhere.