Adequate assurance (or are they looking for more?)

DESPITE sayings such as "What is good for the goose is good for the gander," one might prefer to adopt the philosophy behind the saying, "Shoemaker, stick to your last." In other words, if you want the structure and formalities of litigation, then specify so. But, on the other hand, if you elect arbitration, you have to be satisfied with the informality of a process which endeavours to provide a speedy and economical resolution of disputes and does not always give you the same rules and parameters that are applicable in litigation.

It is understandable that admiralty lawyers practicing litigation as well as arbitration may find it convenient or productive on occasion to apply techniques from one discipline to the other. For example, attorneys have proposed adopting procedures from the CPLR (Civil Practice Law and Rules) or the FRCP (Federal Rules of Court Procedures) in furtherance of the arbitral process. Whereas there is no question that certain rules could indeed be helpful in streamlining the arbitral procedures, they are nevertheless alien to commercial arbitration and as such not readily accepted.

This brings me to another text which has made its way into commercial arbitration, i.e., the UCC (Uniform Commercial Code). This document, however, is more appropriate for the maritime arbitration process as it directly addresses sales, negotiable documents, letters of credit, bulk sales, warehouse receipts, bills of lading and other documents of title.

For example, in a commodity transaction where seller and buyer agree on the grade, price, delivery time and place, which can be compared to the main terms of a charter party, they look to the UCC as something comparable to the details in charter parties. There are a number of reported Society of Maritime Arbitrators (SMA) cases which involve charter party vessel demurrage claims with underlying cargo sales with UCC terms attached.

The UCC section on sales covers, in Paragraph 2-609, the "Right to Adequate Assurance of Performance," and states as follows:

(1) A contract for sale imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired. 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.

(2) Between merchants the reasonableness of grounds for insecurity and the adequacy of any assurance offered shall be determined according to commercial standards.

(3) Acceptance of any improper delivery or payment does not prejudice the aggrieved party's right to demand adequate assurance of future performance.

(4) After receipt of a justified demand failure to provide within a reasonable time not exceeding thirty days such assurance of due performance as is adequate under the circumstances of the particular case is a repudiation of the contract.

The Restatement (Second) of Contracts, in paragraph 251, addresses the condition when a failure to give assurance may be treated as a repudiation. The text states that:

(1) Where reasonable grounds arise to believe that the obligor will commit a breach by non-performance that would of itself give the obligee a claim for damages for total breach under § 243, the obligee may demand adequate assurance of due performance and may, if reasonable, suspend any performance for which he has not already received the agreed exchange until he receives such assurance.

(2) The obligee may treat as a repudiation the obligor's failure to provide within a reasonable time such assurance of due performance as is adequate in the circumstances of the particular case.

Under these provisions, the "insecure" party is granted three rights:

• it is permitted to suspend its own performance
• it can demand adequate assurance that the other party's performance will be forthcoming and
• it may treat the contract as broken if its reasonable grounds for insecurity are not cleared up within a reasonable time.

In the Corey Pride (1993 AMC 2261, 1st Circuit 1993), the court addressed the application of the UCC terms. The case involved the sale and installation of a rebuilt engine on a commercial vessel and was considered maritime in nature and, therefore, governed by federal maritime law. The court held that "the UCC is considered a source for federal admiralty law." This statement is subject to interpretation and could mean that the UCC is not federal admiralty law, but rather state law. However, if the court is called upon to decide an issue which has not previously been dealt with under federal law, but has been covered in the code, the courts may look to the code for guidance with respect to reaching a decision under federal law.

One of the reasons cited by those who advocate the application of this concept is that, in the first instance, the parties can attempt to resolve their problems themselves before proceeding to arbitration or litigation.

There are a few cases in which the concept was argued in arbitration proceedings. In the case of the Opal Star (SMA Award 3650, 1997), owners were asking the panel to issue a declaratory judgment finding that charterers' refusal to furnish two months' security violated the doctrine of adequate assurance, thus entitling owners to treat that refusal as an anticipatory breach of the charter.

These principals were parties to an earlier, virtually identical, long-term time charter for the Opal Sun (a newbuilding sistership to the Opal Star). It appears in that particular case that owners agreed to a temporary hire reduction because of a steep decline in the freight market. Despite these arrangements, charterers still failed to make the reduced hire payment and, therefore, owners withdrew the vessel from service.

Subsequently, owners learned about serious financial difficulties, which, coupled with the continued decline in the freight market, led owners to request fresh assurances from charterers that they were able to perform under the charter. Owners specifically requested that charterers provided a security deposit of two months' hire as evidence of good faith and financial capability. Charterers confirmed their intentions to perform the time charter, but declined to provide the security deposit.

The panel concluded that the events associated with the Opal Sun were sufficient to entitle owners to seek adequate assurances from charterers. The panel declined to conclude that charterers, through their failure to provide the security, repudiated the charter, particularly since the relief was sought in June with delivery scheduled in December. The arbitrators, however, directed charterers' counsel to deposit two months' hire with charterers' counsel and make payment from this account upon right and true delivery of the vessel. If charterers failed to comply, owners would treat the contract as repudiated.

The concept was again raised in the matter of the Forest Link (SMA Award 3745, 2002), which dealt with the vessel's condition and ability to continue performance under a time charter. Charterers had requested that owners unconditionally consent to the termination of the charter or, in the alternative, furnish adequate assurance that they were prepared to carry out the necessary repairs to restore the vessel to a seaworthy condition.

Charterers based their argument upon the fact that in an earlier arbitration for the Forest Enterprise (SMA Award 3743, 2002) involving the same parties, the arbitrators had confirmed charterers' entitlement to cancel a long-term time charter. This contention was no doubt raised because the fact pattern appeared to be similar to the Opal Star/Opal Sun scenario. Owners opposed the request and argued that the doctrine of adequate assurance was intended to apply to prospective performance due under a contract which has not yet come into force. Therefore, it should not find application in circumstances where performance had already been made.

In the case of the Forest Link, the charter had been in existence for four years and had two more years to run. The panel found that once a contract is in force, the only remedies available are those expressed in the governing charter party. Therefore, the concept of adequate assurance had no application to the circumstances of this case, and the panel furthermore held that charterers, based upon the facts of the case, were not entitled to terminate the charter party.
In the course of the arbitration, owners also requested the panel to direct charterers to ensure that they would take the vessel back into charter once all repairs had been carried out to the 24-year-old vessel. The panel declined to address this issue for the same reason. To do otherwise would change the contractual basis on which the parties had agreed and commenced performance of their venture.

Whatever one's feelings about the influx and impact of other statues on arbitration, arbitrators should not reject these aids out of hand, but carefully consider their benefits for the arbitral process.

The benchmark for the arbitrator should be that by invoking these non-charter party/contract concepts, neither party should attain a better position than they had originally bargained for when concluding their contracts. Arbitrators should also remember that, despite the very limited scope, the courts have the power to review awards as well as arbitrator conduct. If one were to err, one might prefer to err on the side of caution.