Thelen Reid Brown Raysman & Steiner LLP

New York's highest court, the New York Court of Appeals, created a new common law doctrine that may allow, among other things, a party to certain complex, long-term construction contracts to demand assurance of future performance from another party when reasonable grounds exist to believe that the other party will not perform its obligation under the contract.  If the party from whom adequate assurance is demanded does not provide such assurance within a reasonable time, that party is deemed to have repudiated the contract, and the non-breaching party may take reasonable actions as though repudiation had occurred.

In New York, before the Court of Appeals' decision in Norcon Power Partners, L.P. v. Niagara Mohawk Power Corp. [92 N.Y.2d 458, 682 N.Y.S.2d 664, 705 N.E.2d 656 (1998)], the doctrine of adequate assurance of future performance essentially was a Uniform Commercial Code doctrine, applicable only to contracts for the sale of goods.  In the vast majority of states, the doctrine of adequate assurance of future performance remains limited to the Uniform Commercial Code.  The New York Court of Appeals is the highest and most influential court in the United States to have created a common law doctrine of adequate assurance of future performance, applicable outside of the sale of goods context, and its decision may be followed by courts in other states.

The Facts.  The Norcon case was not a construction case.  In Norcon, Norcon was an independent producer of electricity.  Niagara Mohawk was a provider of electricity to public utilities.  Norcon and Niagara Mohawk entered into a contract under which Niagara Mohawk agreed to purchase electricity from Norcon for 25 years.  The contract contained three different pricing periods.

In the first period, Niagara Mohawk paid Norcon a flat rate per kilowatt-hour for electricity.  In the second period, Niagara Mohawk paid Norcon according to an "avoided cost" rate that was based upon the cost that Niagara Mohawk would have incurred to either generate electricity itself or purchase it from other sources.  The second pricing period also contained a "floor" price, namely, a minimum price that Niagara Mohawk would have to pay Norcon for electricity for the second period even if Niagara Mohawk did not purchase an amount of electricity for the period that equaled the floor price at the avoided cost rate.  An "adjustment account," however, kept track of any difference between the payment actually made by Niagara Mohawk during the second period and what Niagara Mohawk's payment to Norcon would have been if based solely on the avoided cost rate.  That is, if Niagara Mohawk was required to pay the floor price, the adjustment account would keep track of the difference between the floor price and what Niagara Mohawk would have paid to Norcon if its payment was based solely on the avoided cost rate.

Lastly, in the third pricing period, Niagara Mohawk paid Norcon according to the avoided cost rate adjusted to account for any balance existing in the adjustment account.  For example, if the payment actually made by Niagara Mohawk in the second period exceeded what the payment would have been if based solely on the avoided cost rate, the amount paid by Niagara Mohawk in the third period would be reduced to reflect the difference.  Any amount left over in the adjustment account in favor of Niagara Mohawk at the end of the third period would have to be paid to Niagara Mohawk within 30 days of the end of the period.

Within the first few years in the performance of the contract, Niagara Mohawk estimated that it would accrue over $610 million in the adjustment account by the end of the second pricing period.  Concerned that Norcon would neither be able to credit this amount in the third pricing period nor repay it at the end of the third period, Niagara Mohawk wrote Norcon demanding that "Norcon provide adequate assurance to Niagara Mohawk that Norcon will duly perform all of its repayment obligations."  In response, Norcon promptly sued Niagara Mohawk in federal court, asserting that Niagara Mohawk had no contractual right under New York state law to demand adequate assurance of Norcon's future payment performance under the contract.  Niagara Mohawk countered that it could properly invoke such a right.

The United States District Court, Southern District of New York, found in favor of Norcon, reasoning that New York law only recognizes the doctrine of demand for adequate assurance of future performance in two limited circumstances:  (1) when the obligor becomes insolvent or  (2) when the sale of goods under UCC 2-609 is involved.  Since neither circumstance was involved in the case, the District Court was constrained to rule in favor of Norcon.  Niagara Mohawk appealed the District Court's decision to the Second Circuit Court of Appeals, which preliminarily agreed with the District Court but refrained from making a final decision until it could ask New York State's highest court, the New York Court of Appeals, if New York law only recognizes the doctrine of demand for adequate assurance of future performance in the two limited circumstances mentioned above.

The Holding.  The New York Court of Appeals took up the Second Circuit's question.  It found New York until then had refrained from expanding the right to demand adequate assurance of future performance beyond the Uniform Commercial Code but declared that it was time for a "modern pronouncement" governing the kind of contract and dispute between Norcon and Niagara Mohawk.  Accordingly, the Court of Appeals created a new common law analogue to the statutory doctrine of demand for adequate assurance of future performance in UCC 2-609 that would apply outside of the sale of goods context and held that the new doctrine should apply to the type of long-term commercial contract entered into by Norcon and Niagara Mohawk.

The doctrine of demand for adequate assurance of future performance as embodied in UCC 2-609 allows a party to a contract for the sale of goods to demand assurance of future performance from another party when reasonable grounds for insecurity exist.  If the other party does not provide adequate assurance within a reasonable time, that party is deemed to have breached the contract and the non-breaching party may act accordingly.  UCC 2-609 recognizes that "the essential purpose of a contract between commercial [parties] is actual performance... and that a continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain."  (Official Comment 1 to UCC 2-609).

In reaching its decision to create a new common law doctrine of demand for adequate assurance of future
performance, the Court of Appeals seemed most persuaded by the fact that the policies behind UCC 2-609 are not unique to contracts for the sale of goods.  Whether a contract is for the sale of goods or for the performance of services, "the parties to a contract look to actual performance... and a continuing sense of reliance and security that the promised performance will be forthcoming when due, is an important feature of the bargain."  (Restatement [Second] of Contracts § 251, comment a, quoting comment 1 to UCC 2-609).  Accordingly, the Court decided to create a common law analogue to UCC 2-609 because it puts commercial parties in such disputes "at relatively arms length equilibrium in terms of reliability and uniformity of governing legal rubrics."

Applicability to the Construction Industry.  The new common law doctrine of demand for adequate assurance of future performance, however, most likely will not apply to all construction contracts.  The Court of Appeals rejected a "wholesale" application of the adequate assurance doctrine to all contract disputes.  Instead, the Court carefully focused its ruling on the case before it, stating that the new common law doctrine "should apply to the type of long-term commercial contract between corporate entities entered into by Norcon and Niagara Mohawk here, which is complex and not reasonably susceptible of all security features being anticipated, bargained for and incorporated in the original contract."

Only time will tell to what type, if any, of construction contract the new common law doctrine created by the Court of Appeals in Norcon will apply.  Clearly, the greater the complexity, the longer the term, and the less susceptible of incorporated security features the construction contract, the more likely that the new adequate assurance doctrine will apply.  In sum, the New York Court of Appeals' decision in Norcon is a significant development in the world of construction law, for it may portend a new day in which parties to certain long-term construction contracts have the right to demand adequate assurance of future performance when they have reasonable grounds to believe another party may breach the agreement.


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For more information about the issues covered in this report, please contact Richard P. Dyer in our New York office at 212-895-2117 or at rpdyer@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.





©1998 Thelen Reid Brown Raysman & Steiner LLP