CONTRACTS UNDER THE UNIFORM COMMERCIAL CODE THE MODERN LAW OF SALES MAY BE SUMMARIZED IN ONE BRIEF STATEMENT: LET THE SELLER BEWARE!

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1 CONTRACTS UNDER THE UNIFORM COMMERCIAL CODE THE MODERN LAW OF SALES MAY BE SUMMARIZED IN ONE BRIEF STATEMENT: LET THE SELLER BEWARE! Uniform Commercial Code All 50 states have adopted some portions of the Uniform Commercial Code (``UCC"), which sets forth the basic guidelines for certain commercial transactions. Article 2 of the UCC establishes rules governing the formation, performance, and enforcement of contracts concerning the purchase and sale of goods. Under the UCC, a contract will be found to exist if the parties, through their conduct, act as though they are contractually bound -- e.g., by shipping and receiving the goods. This ``contract by conduct" may exist even if the forms exchanged do not evidence an agreement on terms. The Seller in such a situation may find that he is bound by provisions he probably never even considered or discussed with the Buyer. If parties to a transaction do not commit their understanding to writing, or if they engage in a battle of forms with neither party assenting in writing to the terms in the form sent by the other, the law will imply a contract with terms that are very much to the advantage of the Buyer and the disadvantage of the Seller including: 1. 4 year warranties 2. Implied warranties of fitness for a particular purpose and merchantability 3. Recovery of consequential damages (lost profits) in the event of a breach of warranty or contract 4. No Force Majeure The point is that a Seller must exercise a degree of prudence in concluding a sales transaction, especially since its obligations are far more complex than those of the Buyer, whose principal obligation is merely to pay the price. Before you relegate formal documentation of an agreement to the level of a handshake or otherwise minimize the importance of the paperwork, you should have an understanding of the consequences. Your understanding the law of commercial transactions could save your business thousands of dollars annually. 1 1 Note that the advantages to the Buyer under the UCC are distinct from what the parties negotiate. In other words, both parties must take care to insure that the contract accurately reflects their respective understandings that have come through the negotiation process. Wise sellers will often use their own contracts to mitigate against the implication of terms under the UCC. 1

2 The Battle of the Forms The exchange of purchase orders and sales acknowledgment forms often creates just such a ``contract by conduct" and is referred to as the ``battle of the forms." This legal ``battle" is too often lost because a selling business has inadvertently been committed to the Buyer's terms (or, alternatively, the default rules supplied by the UCC) while at the same time assuming that the provisions of its own sales order form govern. The rules governing the ``battle of forms" support the admonition: LET THE SELLER BEWARE. At the same time, a buyer can suffer equally from failure to object to terms proposed in the seller s contract, or other writings that might be viewed as part of the contract. A typical ``battle of the forms" occurs when the Buyer submits a purchase order, be it written or electronic. Since the Buyer will have lawyers of its own, the purchase order will typically state that the purchase order is the offer to buy and is ``expressly subject to the terms and conditions on the reverse side hereof." On the other side of the purchase order are probably some 20 odd terms and conditions. Many sellers respond with a sales order acknowledgment which contains seller s business terms and conditions. Both Seller and the Buyer retain one another's forms but neither indicates in writing its acceptance of the other's terms. The goods are shipped and (hopefully) accepted. Eighteen months later defects in the goods appear. Seller contends that the warranty in its sales acknowledgment controls. The Buyer contends that the actual warranty is contained in the Buyer's purchase order form. The two questions which arise are: 1. Is there a contract? 2. If so, what are its terms? In other words, what are the parties respective obligations? Contract by Conduct The UCC recognizes the existence of the contract: ``Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract." 2

3 The Terms of the Contract The next and more important question is what are the terms of the contract? The UCC answers this as follows: "In such case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of [the UCC]." Thus, there is a contract. Not on the Seller s terms. Not on the Buyer's terms. But on the terms common to their respective forms plus such additional terms as the UCC may imply. What terms are common to the forms? Most likely, only the description of the goods and the price are identified. In any event, Seller s warranty terms do not apply. Nor do the Buyer's. If there is a warranty, it is by virtue of the warranties supplied by the UCC. The same is true of patent indemnification, damages for breach of contract or breach of warranties, force majeure, etc. While it may be true that in 99 cases out of 100, even if there is not a contract on the terms set forth in either party's form, no one ever knows the difference. The parties go through with the deal, Seller is paid the purchase price, and the Buyer is completely satisfied with the quality and performance of the goods. Even if there is a problem, it is solved informally without the involvement by attorneys. However, it is that one case in 100 where an informal adjustment cannot be made which may result in substantial losses to your business, losses which are not covered by insurance but which come directly off the ``bottom line." It is not even necessary that any such claims go before a court: one party s threat to enforce its rights to substantial consequential damages under the UCC would seriously undermine the other s ability to negotiate a fair and reasonable settlement of any claims by the threatening party. In other words, either party can put its business ``over a barrel" with very little effort. The Moral of the Battle The moral of the battle of the forms is that for your business's protection, a basic agreement between the parties as to the major provisions--such as those governing warranty protection and damages in the event of breach--should be negotiated at the outset and a written agreement executed before the commencement of any work contemplated by the parties. Winning the Battle of the Forms No amount of legal draftsmanship that can assure winning the battle of the 3

4 forms. The only way to be sure that terms and conditions acceptable to your business are included in the agreement is to negotiate those terms and get those terms in writing signed by both parties. At the very least, those fundamental terms of the contract, such as warranty, damages, patent indemnification, etc., should be negotiated and agreed upon. The Unknown Terms Buyer has negotiated a great price. Seller has cajoled that purchase order out of the purchasing agent. Has Seller won? Buyer? Do you know what you've agreed to? Have you read the ``fine print" or ``boilerplate" on the back of the purchase order, confirmatory memorandum or invoice? Well, take out your magnifying glass and try it. You may be horrified to see what it is you have agreed to. If that isn't bad enough, the UCC will also supply several critical terms, such as: 1. Warranties. A. Express Warranties. The contract will include any representation or promise made with regard to the goods, whether those promises were made orally or in writing. No special language is needed to create an express warranty i.e., portions of a ``sales pitch" or presentation may very well be held to create an express warranty which will bind the Seller. At the same time Seller s transactional documents may operate to disclaim any warranties whatsoever. B. Implied Warranties. Warranties of merchantability, fitness for a particular purpose and other implied warranties are part of the contract. The warranty of merchantability will include warranties that the goods: (a) pass without objection in the trade, (b) are of fair average quality, (c) are fit for ordinary purposes. (d) are of even kind, quality and quantity, (e) are adequately contained, packaged and labeled, and (f) conform to any promises or affirmations of fact. Warranties for a particular purpose arise when the Seller knows the purpose for which the Buyer is purchasing the goods and that the Buyer is relying on the Seller's skill and knowledge with regard to the goods. The goods are warranted as fit for such purpose. Salesmen for the Seller can create warranties of fitness for a particular purpose, if for instance, they know what the end-use of the product will be. Other implied warranties may arise from course of dealing or usage in the trade. There are good reasons for excluding implied warranties: (1) Contractual certainty is desirable. (2) The contents of implied warranties are not well-defined. Limited remedies i.e., repair or replacement for breach of an express warranty, has no application to breach of an implied warranty. Thus, Buyer wants to take advantages of the code implications and Seller, in its documentation, will endeavor to avoid any implication that 4

5 Buyer is relying upon its skill or judgment to furnish suitable goods. Implied warranties can have serious product liability implications to Seller. C. Remedies. The UCC provides that a warranty may be enforced for 4 years, and allows for broad remedies for the Buyer including recovery of the purchase price, and damages in what could be substantial amounts. (See also the discussion on consequential damages). 2. Consequential Damages/Lost Profits The UCC allows a Buyer to recover damages for any breach of the contract by Seller. Consequential damages could include such losses as lost profits on resales, both present and future, loss of revenues, costs involved in system shutdowns, costs of retrieval and reinstallation, purchase of replacement products, damage to property, injury to persons, etc. The type and amount of such damages may be limited only by the Buyer's imagination and the conscience of a court or jury. At the same time, Seller may recover its consequential damages for any breach by Buyer. Consequential damages could include lost revenue and profits, loss of business opportunity, cessation of business damages, interference with business contracts, unfair competition, and more. In both cases, these damages could easily amount to 5, 6 or 7 times the total mount of the sale, if not more! 3. Delays in /Delivery Under the UCC, failure to make timely delivery is a breach of contract except in very limited circumstances. The UCC excuses timely performance by the Seller only upon ``the occurrence of a contingency the nonoccurrence of which was a basic assumption on which the contract was made." This provision has been strictly construed and would most likely not include difficulties in obtaining materials, delays by suppliers, strikes, etc., and may or may not even include so-called ``acts of god" under certain circumstances. These questions are frequent subjects of litigation. 4. Patent Indemnification The UCC implies a warranty against infringement of any kind anywhere in the world, and allows remedies, including recovery of the purchase price, damages including lost profits, etc. Missing in Action You should also note that the UCC will not provide some very basic terms: 5

6 1. Interest In absence of an agreement, the UCC does not allow a party to recover interest. 2. Confidentiality The UCC does not protect a party from misappropriation or wrongful disclosure of confidential information. 3. Entire Agreement One party often reads into contract -- even written contracts -- more than what the other party intended. They listen to and rely on sales presentations, representations as to scope of work and/or other comments that were never intended to bind the party. The cases are legion in which a Buyer or Seller has claimed misrepresentation, malfeasance, or breach outside of the written contract. The UCC will not protect either party from such a claim. Conclusion That purchase order Buyer has just accepted or the confirmatory memo or invoice the Seller has accepted exposes both parties to the risks outlined above. Risks that could, in a year, 2 or even 4 or 5 years down the road, cost a business substantial amounts of money. The old line that ``we've been doing business like this for years" just won't wash when your business gets its first multi-million dollar claim for lost profits or is foreclosed from pursuing certain remedies because of shoddy documentation. Painful as it may sound and as agonizing as negotiations on written agreements may be at times, in the long run negotiating these agreements will protect your business. 6