United States: Late Is Never Better! Timeline To Protect Your Contract In A Market Downturn

Monitoring Your Contracts

Managing financial risk demands close attention to your contracts during a market downturn. Your level of exposure depends upon market conditions, your counterparty's capital structure (and cash cushion), your counterparty's position in its corporate structure and the nature of your contract and remedies. Timing is everything—the value of a contract may be preserved by prompt action before and during a counterparty's bankruptcy.

Response to Financial Distress (Before Bankruptcy)

Right to Demand Adequate Assurance. Uniform Commercial Code (UCC) §2-609 grants you the right to demand adequate assurance of your counterparty's future performance in connection with the sale of goods.

  • What triggers the right to demand adequate assurance? Many contracts identify specific grounds, such as a material drop in stock price, a downward trend or a negative outlook by a rating agency, a restatement of prior financial statements or a default under a debt instrument. Other contracts are silent on the subject. If, for example, your counterparty is giving discounts for cash payment, you hear rumors of covenant defaults, or a "market player" has suspended trading activity, you may have reasonable grounds to demand adequate assurance.
  • Contractual terms. A contract may specify when performance may be suspended and define what constitutes "adequate assurance" (i.e., prepayment or issuance of a letter of credit). A pre-bankruptcy demand for adequate assurance is key. "Adequate assurance" of future performance established pre-bankruptcy will be enforced in bankruptcy. For contracts not involving the sale of goods, contractual provisions for adequate assurance are essential because no implied right to adequate assurance would be available under the UCC. Similarly, consider whether you may exercise a right to terminate, as a contract terminated prior to bankruptcy will not be revived.

Letter of Credit. A letter of credit offers powerful protection both before and during bankruptcy. Bankruptcy will not prevent a draw on a letter of credit issued by a third party on behalf of your counterparty. However, there is a preferential transfer risk if the letter of credit is received within 90 days (one year for insiders) before your counterparty's bankruptcy filing—another reason to request adequate assurance at the first sign of distress.

Contractual Obligations. In bankruptcy, creditors are paid according to priority. A bare contractual obligation is typically an unsecured claim. To increase your likelihood of payment, negotiate holdbacks, third-party escrows, guaranties, bonds, letters of credit and setoff rights. Consider obtaining a valuation or solvency opinion before entering into a transaction with a distressed counterparty. To reduce exposure for future litigation claims, ensure that you make payments to the correct entity and allocate the purchase price to the proper affiliates in a transaction. Be wary of "triangular setoffs" or netting across multiple affiliates or contracts without a master netting agreement.

Reclamation. Under the UCC, you have a right to reclaim goods from an insolvent buyer within ten days of receipt. If you suspect that your counterparty is insolvent, act promptly, track your goods and submit a timely demand.

Immediate Action After Bankruptcy Filing

"Automatic Stay." Most actions against a debtor are immediately and automatically stayed upon the filing of a bankruptcy petition. The automatic stay prevents you from suspending performance under a contract or terminating a contract—and "ipso facto" provisions that allow termination in bankruptcy are generally not enforceable. Creditors are typically barred from creating or enforcing liens against property of the bankruptcy estate. In limited cases, your contract may qualify for an exception to the automatic stay applicable to certain financial contracts (such as forward contracts and swap agreements) and contracts to make loans or financial accommodations to the debtor.

"Critical Vendor" Status. If your service or commodity is critical to your counterparty, it is likely that your contract will be assumed and your claim paid in full, in time (often more than a year). If there is no other practical or legal solution, courts may allow "critical vendor"payments on an emergency basis early in the bankruptcy if a debtor risks losing going concern value that is greater than the payment.

Reclamation and Administrative Claims for Value of Goods. If your counterparty files for bankruptcy, your right of reclamation is extended to 45 days. Time is of the essence. Once the goods are resold, used or cannot be identified, your right is inferior to a lender with a lien on the goods. You may also be entitled to an administrative claim for the value of goods received by the debtor within 20 days before a bankruptcy filing, but the claim is usually inferior to a post-petition lender.

Liens. You may benefit from contractual or statutory liens on your counterparty's assets. For example, if you are in possession of your counterparty's product, you should hold it and immediately ask the court to allow you to offset or receive adequate protection. Beware, as possessory liens typically secure only amounts currently owing, not damages for rejection of the contract.

Protecting Your Contract in Bankruptcy

Assumptio n or Rejection. The debtor has two options for treatment of executory contracts—assumption or rejection. Rejection of a contract creates a claim for damages, which are unsecured claims. To assume a contract, the debtor must cure existing defaults. If the debtor seeks to assume and assign your contract to a third party, you may demand proof of that party's ability to perform. Know the status of your contract, catalog the monetary and non-monetary defaults and be prepared to assert your rights.

Setoff. Setoff exists under common law and is also allowed in bankruptcy. However, in bankruptcy, setoff applies only to debts owed by the same parties (i.e., legal entities) in the same capacity (both pre-petition/both post-petition). Never turn over funds if you may have a right of setoff against the debtor. But likewise, never offset debtor funds without seeking court approval.

Protected Financial Contracts. Financial contracts are protected from the effect of the automatic stay and fraudulent transfer and preference attack (except for actual fraud). A financial contract carries with it a right to liquidate, terminate, accelerate or offset under a master netting agreement.


Monitor your counterparty's financial outlook and know your rights. Understanding your contractual rights, security and remedies will allow you to move quickly if your counterparty becomes distressed or files for bankruptcy. The Financial Restructuring group at Andrews Kurth provides seasoned advice to a wide array of clients investing in, or facing, distressed situations. We have extensive experience representing clients in complex restructurings and all aspects of corporate reorganizations and distressed investing, including debtors and issuers, official and ad hoc committees of creditors and stockholders, investors, brokers/dealers and traders of debt and equity in both financial and strategic investments, secured lenders, contract counterparties, litigation trustees, and buyers and sellers of businesses and assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.