Bus 311 Business Law
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CHAPTER 7: Formation and Modification of the Sales Contract
CHAPTER 8: Performance of the Sales Contract and Risk of Loss
CHAPTER 9: Warranties and Remedies for Breach
CHAPTER 10: Commercial Paper
Unit III The Uniform Commercial Code
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O ne of the drawbacks of our federalist system of government is that there can be signifi- cant differences in the law from state to state and between the states and the federal government. In general, differences in state laws present only minor inconveniences
to individuals and businesses that need to be aware of these differences when conducting business across state lines. There are, however, some areas in the law that are of particular importance to business and in which even small variations in the law from one state to another can have a very negative effect. Because of this, the National Conference of Commissioners on Uniform State Laws (NCCUSL) drafted the Uniform Commercial Code (UCC) in an attempt to unify state laws affecting commerce into a single code that all states could adopt to make interstate commerce easier and more efficient. As a result of this concerted effort by some of this country’s leading legal experts, the UCC was enacted in whole or in part with only small changes by the legislatures of all states. While the UCC represents a significant effort toward a uniform national law, it should be remembered that there will still be variations from state to state, as different courts interpret the provisions of the statute.
The articles of the UCC are as follows:
Article 1 General Provisions
Article 2 Sales
Article 2A Leases
Article 3 Commercial Paper
Article 4 Bank Deposits and Collections
Article 5 Letters of Credit
Article 6 Bulk Transfers
Article 7 Warehouse Receipts, Bills of Lading, and Other Documents of Title
Article 8 Investment Securities
Article 9 Secured Transactions; Sale of Accounts and Chattel Paper
A complete treatment of the UCC is not possible here (the full text of the UCC is nearly 1,000 pages), but in this unit we will explore the most notable provisions of Articles 2 and 3 (Sales and Commercial Paper) that together make up the single most important statute in the field of business law.
In Unit 2, we examined the basic elements of the law of contracts and explored its appli- cation in a wide variety of business contexts. In the first three chapters of this unit, we will examine significant statutory modifications to the common law of contracts brought about by Article 2 of the Uniform Commercial Code with respect to contracts for the sale of goods. In Chapter 10, we will explore the law of commercial paper under the Uniform Commercial Code.
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Chapter Overview
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7 Learning Objectives
After studying this chapter, you will be able to:
1. Define the concept of goods and be able to give examples of goods and non-goods.
2. Distinguish the common law rule on firm offers and the UCC rule with regard to merchants.
3. Explain how the UCC treats additional terms in an acceptance and distinguish the effect of such terms under the UCC and under common law.
4. Describe the concept of unconscionability and its effect on a contract.
5. Explain how the UCC rule for modifica- tion of a contract differs from the com- mon law rule.
6. Describe when sales of goods contracts must be in writing, and when oral con- tracts are enforceable.
7. Explain the parol evidence rule.
Formation and Modification of the Sales Contract
Chapter Overview 7.1 Offer and Acceptance of the Sales Contract • Merchant’s Firm Offers (§ 2-205) • Method of Acceptance (§ 2-206) • Additional Terms in Acceptance (§ 2-207) • Auction Sales (§ 2-328) • Defenses to Contract Formation • Unconscionable Contracts (§ 2-302)
7.2 Statute of Frauds (§ 2-201)
7.3 Modification of the Sales Contract • Voluntary Modification (§ 2-209)
7.4 Modification by Operation of Law • Casualty to Identified Goods (§ 2-613) • Substituted Performance (§ 2-614) • Unforeseen Circumstances, or Excuse by Failure of
Presupposed Conditions (§ 2-615)
7.5 The Parol Evidence Rule (§ 2-202) • Course of Dealing (§ 1-205(1)) • Usage of Trade (§ 1-205(2)) • Course of Performance (Practical Construction)
(§ 2-208) • Interpretation of Sales Contract
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CHAPTER 7Introduction
Article 2 of the UCC applies to contracts involving the sale of goods. Goods are tan-gible movable (portable) objects that can be owned. This definition excludes many types of subject matter that is subject to personal ownership, such as real estate, fixtures (things permanently attached to land), and intangible property, such as patents, copyrights, and commercial paper. The category of goods includes such things as a pen, a car, a pair of shoes, a dog, a boat, a cheeseburger, and a jet airplane. Contracts for such items will fall under UCC rules.
Example 7.1. Sarah contracts to sell Ben a laptop computer, a fur coat, a thoroughbred racehorse, and a house. The contract for the house will be governed by the common law; the other items will be under the UCC.
To determine whether a specific item is classified as goods, simply determine whether it is movable tangible personal property. A mobile home that rests on wheels or a temporary foundation, for example, is goods, since it is tangible personal property and movable; how- ever if it is attached to real estate on a permanent foundation, then it no longer is goods because it is no longer movable; instead, it becomes real estate. Likewise,
a wild deer standing on a person’s land is not goods, but it becomes so once it is legally shot or trapped and captured (wild animals are not owned by anyone until they are law- fully captured or killed, and the hunter or trapper takes possession of them).
It may seem to the student reading this chapter that the UCC vastly complicates the rules of contracts! But in fact, the rules are designed to reflect the practicalities involved in how people do business, and attempt to achieve outcomes that are more typical of the parties’ understanding than the common law might find.
Goods take many forms.
George Doyle & Ciaran Griffin/Stockbyte/iStockphoto/Thinkstock
7.6 Chapter Summary • Focus on Ethics • Case Study: Kahn Lucas Lancaster, Inc. v.
Lark International Ltd. • Case Study: Cook Grains, Inc., v. Fallis • Critical Thinking Questions • Hypothetical Case Problems • Key Terms
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CHAPTER 7Section 7.1 Offer and Acceptance of the Sales Contract
7.1 Offer and Acceptance of the Sales Contract
Article 2 modifies the common law rules affecting contract formation, firm offers made by merchants, the valid methods for accepting an offer, and the effect of some acceptances that contain additional terms. It may be helpful to remember that the offer could be either to buy or to sell goods, and that a merchant can be either an offeror or offeree, depending upon who initiates the con- tract. Also, don’t forget that UCC Article 2 applies to all sales of goods contracts, whether
In the Media: Is a Kosher Meal More Goods or Services?
Fallsview Glatt Kosher Caterers is a New York catering business that specializes in offering kosher services at select hotels during Jewish holidays. Think of it as a Yom Kippur away from home. In 2004, Falls- view was hired by Willie Rosenfeld to provided catering services for him and 15 members of his family at Kutcher’s Country Club, in the Catskill Mountains of New York. The contract price was $24,050, but it was a contract Rosenfeld never actually signed.
On the day of the event, Rosenfeld and his family failed to show (and without notification to Fallsview), and then, as might be expected, also failed to pay. The catering company filed a breach of contract suit, to which Rosenfeld responded by seeking dismissal on the grounds that the suit was barred by New York’s statute of frauds for goods contracts.
Rosenfeld’s theory was that the contract was, essentially, for the sale of food, which constitutes “goods.” Therefore, because the contract price was for at least $500 and because he hadn’t signed it, it was unenforceable under Section 2-101 of New York’s UCC. Furthermore, Rosenfeld argued that the hotel accommodations and entertainment that accompanied the serving of the kosher food were simply “inci- dental” services and not the primary reason for the contract.
The court ruled against Rosenfeld, applying the “predominant pur- pose” test, and concluded that “‘essence’ of the family and commu- nal ‘experience’ is defined primarily by ‘services’ and not by ‘goods.’” Since the UCC’s statute of frauds didn’t apply, the common law contract doctrines did, and Rosenfeld’s lack of signature didn’t make the agreement unenforceable.
The UCC’s Article 2 only applies to a sale of “goods.” The predominant factor test deals with a contract that includes both goods and services by putting a seesaw scale under the purpose or objective of the contract and weighing which side is heavier: the goods aspect or the services aspect. If the goods side is heavier, so to speak, then the whole contract is governed by Article 2. If not, then the contract is governed by common law contract doctrines.
Sources: Fallsview Glatt Kosher Caterers, Inc. v. Rosenfeld, 794 N.Y.S.2d 790 (NY 2005); http://lawprofessors.typepad.com/ contractsprof_blog/food_and_drink/
The predominant purpose test helps to determine whether a contract is governed by Article 2 of the UCC or by common law contract doctrines. The courts ruled that Rosenfeld’s contract was defined by services and not governed by the UCC, therefore making the agreement enforceable.
FOOD AND DRINK PHOTOS/Food and Drink/SuperStock
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CHAPTER 7Section 7.1 Offer and Acceptance of the Sales Contract
merchants are involved or not, but there are some rules such as the firm offer under Sec- tion 2-209 that only apply to a merchant (although the offeree can be a non-merchant) and other sections such as the additional terms exception under UCC Section 2-207 that applies only if both parties are merchants.
Merchant’s Firm Offers (§ 2-205) The common law rule regarding firm offers (an offer that states it will be open for a period of time) is that they are revocable unless the firm offer is supported by consideration (in which case it is an option, or a contract to keep an offer open). The UCC changes this rule when firm offers are made by merchants. Section 2-205 of the UCC makes a promise by a merchant, in a signed writing, that gives assurance that the offer will be held open, irrevocable for the stated period or, if no specific period is stated, for a reasonable time. However, the time period cannot exceed three months; if the offer says it’s open for six months, the UCC automatically shrinks the time period down to three months.
Example 7.2. The president of Alpha Inc. writes a letter to Jemal, stating that Alpha will sell Jemal “15 office desks at $700 per unit. Offer to remain open for 30 days,” signed Stephen Wright, President, Alpha Inc. Because desks are portable, tangible objects, and Alpha Inc. is in the business of sell- ing such items, and the offer was made in a signed writing, it is a firm offer that must stay open for the 30-day period. It does not matter that Jemal has given no consideration.
Example 7.3. The president of Beta Inc. writes a letter to Ahmad, offering to sell him Beta’s factory for $100,000, adding that the offer is good for 14 days, and signing it “Jose Cruz, President.” Because the factory is real estate, this is not a firm offer, and it may be revoked at any time.
For purposes of the UCC, a merchant is one who regularly deals in goods of the kind involved in the contract, or someone for whom the transaction is occurring in the course of business.
Example 7.4. Rahim, a used car salesman, offers to sell Dana a 2005 Lincoln Navigator for $6,500. Dana tells Rahim that she is interested in the vehicle but needs some time to think about it. Rahim then verbally promises her that he will keep the offer open for 48 hours at the stated price. The follow- ing day, Megan offers Rahim $7,000 for the vehicle. If Rahim sells the car to Megan, will Dana have any legal recourse?
In the above example, Rahim’s promise to hold the offer open is not binding, even though he is a merchant with regard to the car (he regularly sells automobiles), because it was not contained in a signed writing and was not otherwise supported by consideration. If Rahim had written down the promise to sell Dana the car within 48 hours for $6,500 and then signed or initialed the document, he would have been bound to honor the terms of the promise and Dana could have sued him for breach of contract. Keep in mind, however,
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CHAPTER 7Section 7.1 Offer and Acceptance of the Sales Contract
that signed firm offers that are not made by merchants are still not binding under the UCC unless supported by additional consideration.
Method of Acceptance (§ 2-206) In general, an offer may be accepted by any reasonable means unless the method of acceptance is specifically limited in the offer, or the circumstances dictate acceptance in a specific manner. If an offer is to buy goods, it can be accepted by the shipment of conforming (accept- able) or nonconforming (unacceptable) goods, or by a promise to ship the goods.
Example 7.5. Talisa orders an Inspire model laptop from Delta Corp. Delta accepts by sending her an e-mail confirmation.
Example 7.6. Talisa makes the same offer, but this time, without replying, Delta ships the laptop.
Example 7.7. Talisa makes the same offer, and since they have run out of the Inspire model, Delta ships the Imagine model laptop to Talisa.
All of the above constitute Delta’s acceptance of Talisa’s offer, and in all three situations a contract is formed. But in the last example, because Delta shipped the wrong item, it is considered by the UCC to be a simultaneous acceptance and breach of the contract, and Talisa can hold Delta liable for shipping the wrong thing.
How can Delta avoid a breach, while trying to accommodate Talisa’s order? The UCC states that if the seller indicates the nonconforming goods are offered merely as an accom- modation, the seller is making a counter offer rather than an acceptance.
Example 7.8. Talisa makes the offer to buy the Inspire. Delta sends her an Imagine, along with a written note that says they are sorry they are out of the Inspire, but will sell her the newer model, the Imagine, for the same price. Delta is making a counteroffer. If Talisa keeps the computer, she will have accepted this offer. If she sends it back, she will have rejected it and there will be no contract.
Additional Terms in Acceptance (§ 2-207) At common law, an acceptance that contains additional terms beyond those of the offer is deemed to be a counteroffer that effectively revokes the original offer. The UCC changes the common law with regard to sales contracts, effectively doing away with the mirror image rule requiring that an acceptance exactly mirror the terms of the offer. Under the UCC, an acceptance with additional terms is valid unless the acceptance is made conditional on the
UCC § 2-207 deals with the battle of the forms!
iStockphoto/Thinkstock
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CHAPTER 7Section 7.1 Offer and Acceptance of the Sales Contract
seller accepting the new terms. In general, the new terms are simply ignored and do not become a part of the contract.
Example 7.9. Seller offers to sell her boat to buyer for $5,000 in a signed writing. Buyer replies in a signed writing that reads, “I accept and want you to include a boat trailer.” The contract is binding, and buyer must pay $5,000 for the boat. The additional terms as to the boat trailer are ignored. But if buyer replies: “I accept, provided you include a boat trailer” there is no contract, since the acceptance was conditioned on the seller including a boat trailer as part of the deal and is, effectively, a counteroffer.
The last example points to the need for great care in the language used in contracts. The buyer in the first example might well have intended to make his acceptance conditional on the seller throwing in the boat trailer, but that is not what he said, and the courts will construe the language in a contract in accordance to its strict meaning. Hence, the dif- ference between “I want you to” and “I expect you to” is crucial, since the latter clearly conditions the acceptance of the seller consenting to the additional contract term, while the former merely states a desire by the buyer that the seller accept the new contract term.
When both parties are in a sales contract, additional terms become part of the contract unless:
• they materially change the contract, or • the offer was limited to its terms, or • the offeror objects within a reasonable time after receiving the acceptance con-
taining the new terms.
Let’s consider some examples.
Example 7.10. Lancer Inc. offers to sell 500 deluxe light bulbs to Banner Discount Stores at $2 per bulb. Banner responds that it accepts, as long as the shipping is UPS and Banner does not have to pay the charge. This is actually a counteroffer, because of the “as long as” language.
Example 7.11. Lancer makes the same offer. This time, Banner responds, “We accept. Ship UPS and you pay the charge.” The cost of shipping is $5. They have a contract, and Lancer will pay the shipping, because the ship- ping charge is so minimal it would not constitute a material change.
Example 7.12. Lancer makes the same offer, and Banner makes the same response. But this time the cost of shipping is $95. They have a contract, but Banner’s extra term is not part of the deal, since it would be a significant cost and thus a material change.
Example 7.13. Lancer makes the same offer, except it includes language saying “The terms of this offer may not be superseded.” Banner accepts, adding the UPS shipping term, and shipping charges would not be a mate- rial change to the burden of the seller. They have a contract, but Lancer does not need to ship UPS and Banner may have to pay the charge.
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CHAPTER 7Section 7.1 Offer and Acceptance of the Sales Contract
Example 7.14. Lancer makes the same offer, and Banner makes their usual acceptance. The cost of shipping is not a material change, but Lancer doesn’t like UPS, and is giving all their business to FedEx these days. Lancer informs Banner that they will ship FedEx. They have a contract, and Banner’s term is not part of it, since Lancer objected within a reason- able time.
If the offeree attempts to add different, rather than additional terms, the UCC provides that the contradictory terms cancel each other out.
Example 7.15. Alpha offers to sell 1,000 widgets to Beta, with a 30-day war- ranty. Beta accepts, with a 60-day warranty. There is a contract.
What, then, is the term of the warranty? What if once Beta has the widgets, some of them break 40 days later? Remember, neither party’s time period applies. The UCC would con- sider what a typical, reasonable warranty is for the type of goods involved, and put that term in to fill the gap.
This may all seem very convoluted, but what the UCC is attempting to do is establish rules that will govern the contract when the parties clearly have agreed on the essential matters (type of goods, price, etc.) but do not agree on all the possible contract terms. Often these situations arise because of what is known as the “battle of the forms.” What happens is that an order for goods is placed using the buyer’s standard, preprinted form, and all the buyer has done is fill in the sections that describe the goods. The seller accepts the order using seller’s own invoice, which has its own multiple paragraphs of small print. The forms don’t match when it comes to some of the terms. Many times, the seller and buyer may not even realize the forms are in conflict (many people don’t read the small print) until a particular controversy arises, for example, over the length of the warranty period.
Auction Sales (§ 2-328) Article 2 of the UCC also clarifies the common law regarding acceptance in auction sales, which are completed when the auctioneer’s hammer falls. In an auction contract, a bidder makes the offer, which is then accepted by the auctioneer when he announces the item sold. An auction without reserve is one in which the auctioneer agrees to take the highest bid, and gives up the right to withdraw an item if he believes the bidding to be too low. But if sales at auc- tion are specified to be with reserve, the seller reserves the right to withdraw any item offered for sale at auction at any time before accepting a bid.
At an auction, the auctioneer is soliciting offers, and the bidder makes the offer.
PR Newswire/Associated Press
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CHAPTER 7Section 7.2 Statute of Frauds (§ 2-201)
Defenses to Contract Formation The normal defenses to a breach of contract action available under the common law of contracts are also available when a sales contract is involved, unless they are specifically modified by the UCC. Therefore, if a contract for the sale of goods fails because of lack of a valid offer and acceptance, consideration, legality, capacity, or lack of genuine assent, the failure may be raised as a defense if one party sues the other to enforce the agreement. In other words, if you were sued for breach of contract in this situation, your “defense” is that a contract was never formed. In addition to the common law defenses to a breach of contract, the Code details which sales contracts need to be in writing and precludes the enforcement of unconscionable contracts, which we detail next.
Unconscionable Contracts (§ 2-302) If a court finds any provision in a contract to be unconscionable as of the time that the contract was entered into, it can refuse to enforce the contract, or strike out the uncon- scionable clause, or reform the contract by modifying the unconscionable clause so as to prevent an unconscionable result. An unconscionable bargain is one that is grossly unfair to one party, and typically involves a situation where the parties do not have equal bar- gaining power. Although at common law unconscionability is also a defense to a breach of contract, the courts have generally interpreted the UCC more liberally in defining what constitutes an unconscionable contract. As a result, it is likelier for a court to find an inher- ently unfair contract for the sale of goods to be unconscionable than an equally unfair contract not involving the sale of goods.
Example 7.16. Sofia, a 65-year-old Ukrainian cleaning lady who does not speak or read English well, goes to Banner Discount Store to buy a new television. She is looking at a 17-inch screen model that costs $150 on sale when Jason, a slick-talking salesman, gets her in his clutches. Jason persuades her to buy a 36-inch TV with lots of special features on an installment plan, stressing that she’ll be paying only $55 a month, but not mentioning that the price is $1,000 plus interest. If Sofia later realizes she really shouldn’t be spending this kind of money on a TV, she may be able to void the contract due to unconscionability.
Example 7.17. Sofia also buys a house at an inflated price. She is less likely to be able to get out of this contract, even if the terms seem just as unfair as the TV contract.
7.2 Statute of Frauds (§ 2-201)
The statute of frauds states that contracts for the sale of goods for a price of $500 or more are not enforceable unless they are evidenced by a signed writing. This is done to protect both buyer and seller from entering into potentially damaging contracts too easily or perhaps even under false pretenses. For purposes of the statute of frauds, the writing must make it clear that a contract existed. It need not contain all of the terms of the agreement, although the parties would be wise to include as much detail as possible, so as to avoid misunderstandings later. However, a writing that states the quantity and
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CHAPTER 7Section 7.2 Statute of Frauds (§ 2-201)
description of goods will be sufficient, even though it leaves out important terms such as price, shipment, and quality of the goods to be sold, as long as these terms can be reason- ably established.
There are four situations in which oral contracts for the sale of goods for $500 or more will be enforceable despite the statute of frauds. The exceptions to the statute of frauds requirement of a writing involve:
1. specially manufactured goods; 2. admissions in pleadings as to the existence of an oral contract; 3. partially performed contracts; and, 4. between two merchants, the confirming memo exception.
Let’s take a look at each of these more closely.
An oral contract involving specially manufactured goods that are not suitable for sale in the normal course of business is enforceable once substantial steps have been taken by the seller toward performance of the contract. This is to protect the seller from incurring undue costs and burden without compensation.
Example 7.18. On the telephone, Issa orders 125 polo shirts for her work force from Quality Clothes, at a price of $20 per shirt. The shirts are to be embroidered with Issa’s logo. Quality has done 50 shirts when Issa tries to cancel the order. The contract is binding without a written document.
The second exception concerns admissions in pleadings. If a party to an oral contract for goods worth $500 or more admits to entering into an oral contract in pleadings or in testimony in open court, the contract will be enforceable to the extent that it is admitted.
Example 7.19. Buyer orally agrees to buy ten paintings from seller at $10,000 each, but subsequently changes his mind. When he is sued by the seller for breach of contract, he testifies in open court that he had agreed to buy two of the paintings for $10,000, but that he doesn’t have to because the contract was an oral one. Buyer is now obligated to buy the paint- ings, because of his admission, but only the two that he has admitted buying in his testimony.
This exception leads to a lot of people in Buyer’s situation instead testifying that they have no memory of agreeing to anything like that, thus avoiding the exception and possible perjury charges for lying under oath.
Master baker Buddy Valastro of the TLC show Cake Boss shows off a cake that would definitely qualify as specially manufactured goods.
Sean M. Fitzgerald/Associated Press
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CHAPTER 7Section 7.3 Modification of the Sales Contract
The third exception concerns partially performed contracts. A buyer’s acceptance of goods ordered under an oral contract is binding, but only as to the goods actually accepted by the buyer.
Example 7.20. Buyer orders by telephone from seller five Oriental rugs at a price of $2,000 each. When the first rug arrives, he accepts it and informs the seller that he will be sending her a check for $2,000, but that he does not wish to receive the remaining four rugs. With respect to the rug that he accepted, he must pay the contract price of $2,000. But with regard to the remaining four undelivered rugs in the oral contract, he need not accept their delivery unless the contract was evidenced by a signed writing.
The fourth exception only applies if both parties are merchants. The UCC states that if the parties make an oral contract, and then one sends the other a confirming memorandum sufficient in its terms (in other words, something in writing that contains the material terms of the agreement) and the other receives the memo, knowing what it is, and does not object within ten days, the oral contract is enforceable. This sounds complicated, but in practice the rule is simply dealing with things such as telephone orders followed up by an invoice.
Example 7.21. Buyer orders by telephone $1,000 worth of sugar. Seller accepts the order in the same phone call. Seller then sends Buyer an invoice that states the terms of the agreement. Buyer receives it and does not object within ten days. Seller then ships the sugar, and Buyer now claims there is no enforceable agreement. Seller will counter with the confirming memo exception, and the contract is enforceable.
7.3 Modification of the Sales Contract
Another important change to the common law of contracts made by the UCC is in the area of contract modifications. At common law, such modifications are gen-erally invalid unless they are supported by additional consideration, such as an additional payment. The UCC, however, liberalizes the validity of voluntary modifica- tions to sales contracts.
Voluntary Modification (§ 2-209) Under the UCC, voluntary modifications to a sales contract are valid and binding, as long as they are sought and given in good faith, even absent additional consideration.
Example 7.22. Buyer agrees to buy all the gasoline she needs for her fleet of taxicabs from seller for $3.10 per gallon for a period of two years at a time when the average price of gasoline is $3.00 per gallon. After the first year of this requirements contract, a regional conflict breaks out in the Middle East and the price of gasoline jumps by 33 percent to an average cost of $4.00 per gallon. The seller then asks buyer to pay $4.00 per gallon of gas until the situation stabilizes, and buyer agrees. Even though buyer is not obligated to pay the increase under the contract, once she agrees to do so,
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CHAPTER 7Section 7.4 Modification by Operation of Law
In addition to the ability of parties to voluntarily modify sales contracts without additional consideration, there are some circumstances under which a sales contract is modified by operation of law.
Casualty to Identified Goods (§ 2-613) The destruction of goods identified in the contract that occurs without the fault of the buyer or seller will result in a modification of the sales contract by operation of law. If the destruction to identified goods is total, the contract is voided and both parties are excused from having to perform. If the destruction or damage is only partial, the buyer has the option of treating the contract as voided or accepting the goods with a reduction in price to allow for the damage. (The measure of the price reduction that can be taken would be measured by the market price of the damaged goods.) If the buyer elects to accept the damaged goods at a reduced price, he will not be able to seek any additional damages from the seller.
Example 7.23. Tomas agrees to buy Tiffany’s computer for $1,000. Before she can ship it to him, it is damaged in a fire when her house is struck by light- ning. If the computer is destroyed, the contract is voided and performance
7.4 Modification by Operation of Law
she will be bound by the new terms of their modified agreement, even though under the common law of contracts the agreement to pay the $.90 per gallon increase would not have been binding, since it is not supported by consideration.
Keep in mind that the buyer in the last example is under no obligation to agree to the modification of the sales contract suggested by the seller; she can demand that the seller live up to their original contract under which she paid a small premium over the cost of gasoline at the time of entering into the contract in exchange for a guaranteed fixed price for a full two years. The seller will have to honor the contract, unless he can claim com- mercial impracticability or impossibility of performance as we previously discussed, nei- ther of which would be likely here since a change in mar- ket price was foreseeable at the time that the contract was formed, and gasoline is still available for delivery under the facts given. If the buyer does agree to the new terms, however, she will be bound by them. Thus the parties to the contract, whether buyer or seller, should be careful what changes they agree to!
If a modification is made to a contract that needs to be in writing in order to be enforceable under the statute of frauds, then the modification must also be in writing. If the sales contract need not be in writing to be enforceable (e.g., in a contract for the sale of goods for $499.99 or less), then an oral modification would be binding.
If the buyer has an agreement to buy all her gasoline needs for the upcoming year from Mobil at $3.53 per gallon, the parties have made a requirements contract.
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CHAPTER 7Section 7.4 Modification by Operation of Law
by both parties is excused. If the computer suffers some smoke damage but is still functional, Tomas will have the option of voiding the contract or buying the computer at a reduced price (the market price of the damaged computer).
Substituted Performance (§ 2-614) When the agreed-upon method of delivery becomes either commercially impracticable or impossible, seller must offer and buyer accept a commercially reasonable substitute, if one is available. In other words, the mere unavailability of the carrier that both parties agreed would be used will not void a contract or give rise to a breach of contract action if an alternative carrier is available. Under such circumstances, the contract will be modified as a matter of law to allow for the alternate carrier to be used.
Example 7.24. Consumer orders a laser printer for $699 from ACME Mail Order Company and asks that it be shipped by UPS second-day air. If UPS is unavailable at the time that delivery is due through no fault of the seller (e.g., a labor dispute), then the seller must use a commercially reasonable alternative, such as next-day service from the U.S. Postal Service. As long as the price is reasonably similar, the consumer will not be able to object.
Unforeseen Circumstances, or Excuse by Failure of Presupposed Conditions (§ 2-615) If a seller is unable to deliver in whole or in part as promised due to unforeseen cir- cumstances beyond his control, then the seller is excused from performing, as long as he renders whatever performance is practicable under the circumstances, including part performance. If part performance is possible, the seller must allocate his production and delivery among his customers in a fair and reasonable manner. Where delayed delivery, nondelivery, or partial delivery are to be made due to unforeseen circumstances beyond the seller’s control, the seller must notify all affected customers in a timely fashion.
Example 7.25. Buyer, the owner of a factory in Georgia that produces alligator-skin shoes, handbags, and accessories for worldwide distribution, agrees to purchase 1,000 alligator skins per year for the next five years from seller, who owns and operates an alliga- tor farm in Florida. After the first year of the contract, seller’s alli- gator farm becomes infected with a previously unknown disease that affects alligators in the region and kills half of his reptilian stock before an effective treatment can be found. As a result, seller can’t ship the full 1,000 skins to buyer
Alligators, whether dead or alive, are goods under the UCC.
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CHAPTER 7Section 7.5 The Parol Evidence Rule (§ 2-202)
for that year. The seller’s obligation will be discharged if he ships as many skins as he can produce to all of his customers on a fair, prorated basis for that year.
7.5 The Parol Evidence Rule (§ 2-202)
Parol evidence is external oral or written evidence that is not part of a contract. The parol evidence rule states that once parties set down the terms of their agreement in writing, no extrinsic or parol evidence of anything occurring prior to, or contempo- raneously with, the writing may be used to contradict the terms of the written agreement unless fraud, duress, or mistake are alleged.
Example 7.26. Buyer and Seller have a written contract for ten minivans for Buyer’s company fleet. Buyer claims that when they were negotiating, it was agreed that Seller would install GPS units at no extra charge. Even if Seller did agree, the parol evidence rule prevents Buyer from raising the issue in court because it was not in the written contract, and thus Buyer is stuck with whatever the written contract provides.
The basic purpose of the rule is to protect the integrity of written contracts and to prevent fraud by making it difficult to attack the validity of written terms through extraneous evi- dence that is not part of the written contract.
The parol evidence rule applies to con- tracts for the sale of goods under Sec- tion 2-202 of the UCC with, as is often the case under the code, some modifi- cation of the common law rule. Under Section 2-202, terms included in a con- firmatory memoranda of the contract or otherwise set down in writing as a final expression of the parties’ agreement cannot be contradicted by evidence of any prior agreement or of a contempo- raneous oral agreement. In this regard, the code agrees exactly with the com- mon law parol evidence rule. However, Section 2-202 goes on to state that a written agreement may be explained or supplemented by parol evidence as to the following:
1. course of dealing; 2. usage of trade; 3. course of performance; and 4. consistent additional terms (unless the court finds the writing to have been
intended as an exclusive statement of the terms of the agreement).
Evidence of statements made during negotiations before or during the making of a written contract cannot be introduced as evidence to contradict anything in the document.
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CHAPTER 7Section 7.5 The Parol Evidence Rule (§ 2-202)
Course of Dealing (§ 1-205(1)) Course of dealing is previous conduct by the parties that establishes a common basis of understanding for interpreting specific contract provisions and the conduct of the parties. When parties do business over a period of time, a mutual understanding can develop as to interpreting contractual provisions that may not be specifically stated in a contract. The UCC recognizes the importance of past conduct in interpreting the intent of the parties expressed in a written contract.
Example 7.27. Buyer places an order for fifty 42” HD LCD television sets from seller. Nothing is stated as to method of payment or delivery. Normally, this would entitle seller to cash payment on delivery, and would allow her to ship via any commercially reasonable means. But if the buyer and seller have been doing business for years and seller has always shipped via UPS 2nd day air and accepted payment from buyer 30 days from delivery, buyer could present parol evidence as to the course of dealing between the parties to help interpret the contract (e.g., to show that seller was expected to ship via UPS 2nd day air and to be paid on a net-30 basis).
Usage of Trade (§ 1-205(2)) The UCC defines usage of trade as “any practice or method of dealing having such regu- larity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question.” Evidence as to usage of trade can be introduced to show that there was a reasonable expectation that performance under a given agreement would conform to the expected norm.
Example 7.28. Shawon, who owns an apartment building, contracts for 30 air conditioning units with Joe’s Heating and Cooling Company. The con- tract doesn’t specify whether drainage hoses are included. When Shawon discovers the units were delivered without the hoses, he may present evi- dence that it is customary in the rental trade that hoses are included in the quoted price.
Course of Performance (Practical Construction) (§ 2-208) In a contract for the sale of goods that requires repeated performance over a period of time, the actual performance tendered and accepted is relevant to explaining the terms of a contract.
Example 7.29. Noxxe Oil agrees to supply Gus’s Gas Station with 1,000 gallons of gasoline per week for one year at the current market price. For the first ten months, Noxxe ships 400 gallons of 87 octane unleaded regular gasoline, 400 gallons of 89 octane regular-plus gasoline, and 200 gallons of 93 octane premium gasoline per week. Gus accepts the gas and promptly pays for it without complaint. In the eleventh month of the contract, Gus informs Noxxe that he wants it to ship 800 gallons per week of 87 octane regular and 200 gallons of 92 octane premium gas, since his customers are not buying the 89 octane regular-plus gasoline. Even though the agreement between Noxxe and Gus does not state the grades of gas to be purchased
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or the percentages of each grade, the course of performance between the parties would be relevant to show that gas was to be shipped in the same grades and quantities of each grade throughout the contract term.
Interpretation of Sales Contract UCC Section 2-208(2) states that course of dealing, usage of trade, course of performance, and express terms of a contract should be construed as consistent with each other when- ever it is reasonable to do so. When a clear conflict occurs, express terms in a contract con- trol course of performance, course of performance controls course of dealing, and course of dealing controls usage of trade. This sets up the following hierarchy of contract con- struction with regard to determining the agreement between the parties:
1. Written contract provisions (most important and always control, absent a clear conflict in the contract);
2. Course of performance of the parties with regard to the contract in question; 3. Course of dealing between the parties with regard to previous contracts; 4. Usage of trade.
In the last example of Noxxe Oil and Gus’s Gas Station, there is ambiguity in the contract, and hence a conflict, since there is no express provision as to what grades of gasoline are to be purchased in what amounts. The course of performance of this contract has Gus accepting Noxxe’s shipments for ten months, including 400 gallons of 89 octane gasoline. In construing the intent of the parties, this will be the most significant fact. Previous con- tracts between the parties (course of dealing) or the usage of trade would be of secondary importance. If, for example, Gus could show that usage of trade in the gasoline retailing business allows a gas station to order whatever grades of gas it wants, Gus might still be bound to Noxxe’s interpretation of the contract as requiring him to accept all three grades of gasoline under the course of performance of this contract over the previous ten monthly deliveries.
7.6 Chapter Summary
Although many of the legal rules for a sale of goods contract under the UCC are similar to those of the common law, it is important to be aware of the differences. The basic requirements of offer, acceptance, consideration, capacity, and legality are the same. But in such matters as the rules for firm offers, differing or additional terms in the acceptance, and modifications of sales of goods contracts, the UCC rules are excep- tions to the general rule of the common law. The UCC also provides more detail in such matters as a seller’s acceptance of a buyer’s offer by shipment of goods. The UCC covers the topics of contracts in writing under the statute of frauds and the availability of parol evidence with additional clarifications applicable to goods contracts, such as the specially manufactured goods exception that may allow an oral contract over $500 to be enforced.
Although sometimes the UCC rules seem vastly more complicated, they are intended to reflect the way people actually do business, and in practice can help simplify transactions. As so often in the law, the UCC gives the parties a great deal of flexibility to decide on the terms of their bargain. But when the parties don’t provide for common terms, the UCC is ready to step in and plug the gap.
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Focus on Ethics
Ace Heating and Cooling sells air conditioners. One unit, the Freezy, has a fair market value of $300. During a heat wave, Ace sells three Freezys for $1,000 to the following:
• Breanna, single mom with poor credit, who can’t afford to pay cash for an AC unit. Breanna signs a contract to pay $1,000 on a credit plan, with an additional $500 in interest and financing fees.
• Barry Bigshot, investment banker, who knows the price is way too high but who is far too important to waste his time driving around town trying to get a better deal.
• Glamour Café, a fancy restaurant with an upscale clientele, whose AC went out in the middle of the lunch rush. The manager is desperate to get the place cooled down before people like Barry Bigshot come in for the evening happy hour.
• Shady Rest Nursing Home, a business with a narrow profit margin. The manager isn’t happy about the price, but old people are very vulnerable to heat, and she’s afraid that her patients’ health could be compromised by any delay in getting AC.
Questions for Discussion
1. Under UCC 2-302, who has the best chance of getting out of the contract due to unconscionability?
2. The symbol for justice features a woman wearing a blindfold, to illustrate that the law should be applied the same way regardless of who the parties are. Does the UCC rule seem to contra- dict this? Which approach do you think is more ethical?
3. Note that both Glamour and Shady Rest are businesses, and courts rarely find that contracts between two businesses are unconscionable. The rationale is that a business is a sophisticated entity, familiar with transactions and able to protect themselves. Do you think Glamour and Shady Rest are in a comparable position with regard to this contract?
4. Section 2-302 leaves a goodly amount of discretion to the courts in deciding whether a con- tract term is grossly unfair and whether the parties had such disproportionate ability to bar- gain that the contract should be found unconscionable. Do you think this is a good approach? Would it be better if the law were more specific?
Case Study: Kahn Lucas Lancaster, Inc. v. Lark International Ltd.
1997 WL 458785 (S.D.N.Y. 1997)
Facts: Lark is a Hong Kong corporation that acts as a purchasing agent for businesses seeking to buy and import clothing manufactured in Asia. Kahn Lucas is a New York corporation, with its principal place of business in New York City engaged in the children’s clothing business, primarily in reselling imported clothing to major retailers. Kahn sent purchase orders for clothing to Lark that contained an arbitra- tion clause. Lark did not sign the orders, but neither did Lark make any objection. Lark helped Kahn fill the orders with producers in the Philippines. Lark was to be paid a commission on the sale. When the clothing turned out to be defective, Kahn refused to pay. Kahn also demanded that the dispute be settled by arbitration. (continued)
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Case Study: Kahn Lucas Lancaster, Inc. v. Lark International Ltd. (continued)
Lark raised two defenses: (1) it was not the actual seller of the goods and thus not responsible for their quality, and (2) the arbitration clause would not in any case be binding, as it was not accepted by Lark.
Issue: Did Lark accept Kahn’s offer and form a contract on Kahn’s terms?
Discussion: The court found that Lark had subcontracted for the goods and thus was in the position of being the seller. Under UCC Section 2-306, “an offer to make a contract shall be construed as inviting acceptance in any manner” and “an order or other offer to buy goods for prompt or current shipment shall be construed as inviting acceptance either by a prompt promise to ship or by the prompt or cur- rent shipment of conforming or non-conforming goods.”
Holding: Lark and Kahn have a contract, which includes the arbitration clause. The parties were ordered to arbitration.
Questions for Discussion
1. Go through the facts and separate what was the offer, the acceptance, and the consideration. 2. Would the case have come out differently under the common law? 3. How could Lark have better protected its interests?
Case Study: Cook Grains, Inc., v. Fallis
395 S.W.2d 555 (Ark. 1965)
Facts: Fallis, a farmer, and Horton, an agent of Cook Grains, Inc. (Grains) made an agreement for Fallis to sell and deliver to Grains 5,000 bushels of soybeans at $2.54 per bushel. The company sent Fallis a written contract signed by Grains, but Fallis neither signed the contract nor returned it. When Fallis failed to deliver soybeans, Grains sued him for breach of contract and damages in the sum of $1,287.50. Fallis admitted that the sale of soybeans was discussed but argued no agreement was reached. He also argued that the lawsuit was barred by the statute of frauds. The trial court ruled in favor of Fallis, and Grains appealed. Grains argued that there was an exception to the statute of frauds: according to the UCC, as between merchants, a merchant is liable on a written contract— whether he signs it or not—if the merchant does not give within ten days of receiving the contract a written notice that he rejects it. Grains argued that Fallis is a merchant and, therefore, liable under the contract.
Issues: Is a farmer a merchant within the meaning of the UCC? Was the contract enforceable?
Discussion: The appellate court examined the definition of a “merchant” in the UCC—“a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction . . .” However, there is no evidence that Fallis has such knowledge or skills—he is a farmer “and nothing else.” After analyzing the definition of a “farmer” from previous cases, the court found that a farmer is “one devoted to the tillage of the soil” and “a man who cultivates a considerable tract of land.” The court did not find any cases where the word “farmer” could be interpreted as “merchant.” The court stated that, if the state (continued)
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Critical Thinking Questions
1. What was the last sales contract you made? Were you the offeror or offeree? How was the offer made? How was it accepted?
2. How about the last one involving a written agreement?
Hypothetical Case Problems
Case 1. Jane makes a mail-order purchase for 20 pounds of jelly beans from Candy World at $5.00 per pound. Upon receipt of the order, Candy World ships the jelly beans.
A. Is this a contract for the sale of goods? B. If Candy World ships 10 pounds of jelly beans at $5.00 per pound, what
will Jane’s rights be under the contract? C. If Candy World ships 20 pounds of gummy bears instead of jelly beans,
will it be in breach of contract? D. If Candy World ships 20 pounds of gummy bears with a note saying
“Sorry no, jelly beans, but here are some lovely gummy bears in case they will do” to Jane, will it have breached the contract?
Case Study: Cook Grains, Inc., v. Fallis (continued)
legislators intended that the word “merchant” should include farmers, “no doubt clear and explicit language would have been used in the statute.” There is nothing in the statute that indicates that a farmer should be considered a merchant when he is mostly acting in his capacity as a farmer and involved in the commerce only when he tries to sell the produce that he raised. The court also found that a “merchant” mostly means a “trader”—one who buys and sells—and does not include a farmer who sells what he makes. The court concluded that, in construing a statute, “its words must be given their plain and ordinary meaning.” Therefore, Fallis is not a merchant within the meaning of the UCC, and the alleged contract is barred by the statute of frauds.
Holding: The judgment of the trial court is affirmed.
Questions for Discussion
1. What made this contract unenforceable if it was actually written down and signed by a repre- sentative of Grains and in the possession of Fallis, who didn’t deny its existence?
2. Why did the appellate court have to analyze the meaning of the words “merchant” and “farmer”?
3. Why did the court conclude that Fallis was not a merchant within the meaning of the UCC, even though he sold his crops for a living? [In 1991, the Colorado Court of Appeals was faced with the same issue and cited this case. But it reached the opposite conclusion, deciding that in today’s world, farmers are more than just planters of crops and should be considered mer- chants under the UCC. Colorado-Kansas Grain Co. v. Reifschneider, 817 P.2d 637.]
4. What do you think Grains should have done differently to ensure that Fallis would be bound by the contract?
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Case 2. Frank offers to sell his car to Carmen for $4,000 in a letter he sends her. She replies with a letter of her own that states: “I accept. Wash it before you deliver it.”
A. Will a valid contract be formed? B. Will Frank have to wash the car before delivering it? C. If Carmen replied in her letter “I accept, provided you wash the car before
delivering it,” would a contract be formed? Explain.
Case 3. Hank, a 7’6” basketball player, verbally asks Xena, a seamstress, to make him a tuxedo. She agrees and tells him that it will cost $1,200. She takes his mea- surements and tells him that the tux will be ready in ten days. No writing is executed by the parties.
A. If Hank changes his mind the following day and calls Xena to cancel the contract, will he be in breach of contract if Xena has not yet begun work on the project? Explain.
B. If Hank calls to cancel after Xena has already ordered the material from her supplier but has done nothing else to complete the contract, can he cancel without penalty? Why?
C. If Hank cancels after the material is ordered and Xena has cut it into the required pattern to create the suit, will Hank be able to cancel the contract without penalty?
Case 4. Noxxe Oil enters into a binding agreement to provide 10,000 gallons of regular gasoline to Norma’s Gas City for a year at a fixed price of $3.00 per gallon. A month into the contract, armed conflict once again erupts in the Persian Gulf and the price of crude oil increases by 50 percent over a short period of time. Noxxe Oil, which can still find all the oil it needs on the spot market but at a much higher price than originally anticipated, asks Norma if she would be willing to agree to a temporary $1.00 per gallon increase to help defray part of its increased costs. Norma agrees to the temporary increase and begins paying the higher price immediately.
A. If Norma changes her mind a month later, can she enforce the original agreement?
B. Would your answer be the same if this were not a contract for the sale of goods (e.g., a service contract or a contract to purchase real estate)? Why?
C. If Norma refuses to accept the higher price, will Noxxe be able to force her to do so?
Case 5. Joan agrees to sell her business product inventory to Kari for $250,000. When the parties set down the terms of the agreement in a signed writing, the amount is mistakenly written as $25,000. Neither party notices the mistake at the time that the contract is signed.
A. If Kari wants to enforce the contract as written, will Joan be able to pres- ent parol evidence to explain that a mistake was made?
B. If Joan purposely writes down $350,000 as the consideration to be paid for her business inventory on the written agreement and gets Kari to sign it, can Kari present parol evidence to prove the price agreed to was $250,000? Why?
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admission When a party admits in plead- ings, in testimony, or otherwise under oath pursuant to a legal proceeding that a promise was made.
confirming memorandum A written document that contains the material terms of an agreement, generally sent after an oral agreement was made.
goods Tangible, movable objects that can be owned.
merchant A person who regularly deals in good of the type involved in the contract.
statute of frauds A law that specifies that certain types of contracts must be in writing.
unconscionable contract An agreement with grossly unfair terms that usually involves a situation where the parties do not have equal bargaining power. An unconscionable contract can be voided at the court’s discretion.
C. Would your answer be the same if Joan held a gun to Kari’s head as she signed the contract?
D. If Kari claims that at the time the contract was signed Joan orally agreed that she would have the inventory packaged at Joan’s expense, can Kari present witnesses’ testimony to this effect?
Key Terms
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