Businesses may be agreeing to terms and conditions they cannot fulfill without even realizing it.
By Patrick W. Kelly
Company A needs 500 crates. Company B sells crates. Company A sends a purchase order to Company B for 500 crates. Company B sends Company A an invoice for the cost of the 500 crates. Yet neither the purchase order nor the invoice addresses the timing of the payment, the shipping date or the quality of the crates.
Business moves fast. Deals are made quickly. Sometimes notes hastily written on a dinner napkin suffice to memorialize the deal. Other times, purchase orders, order acknowledgments and invoices evidence the parties’ agreement. But sometimes, these deals fail to capture important terms and conditions. What happens then?
When the deal concerns businesses transacting for the sale of goods, there are rules governing such instances. Each state has a set of rules that govern such transactions and, where necessary, fill in gaps in the parties’ contract. It is important to know how those rules may affect parties’ transactions. This is an overview of the Uniform Commercial Code (the “UCC”), its impact on commercial contracts, and several clauses to consider expressly addressing in commercial contracts.
The Rules Governing Commercial Transactions
The UCC governs commercial transactions in the United States. The UCC, however, is a model code, so it does not have legal effect in a state unless its provisions are enacted by the individual state legislatures as statutes. Currently, the UCC (at least in some part) has been enacted in all 50 states, the District of Columbia, Puerto Rico and the Virgin Islands.
Article 2 of the UCC governs commercial transactions for the sale of goods between merchants. See U.C.C. § 2-102. The UCC defines “merchants” as “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 or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill.” U.C.C. § 2-104. Thus, those individuals whose job it is to sell goods are typically governed by that state’s commercial code (modeled after the UCC).
The UCC recognizes that businesses may enter into deals without always agreeing to every term. Nevertheless, the businesses intended to enter into the agreement. The UCC provides rules for interpreting such agreements. See, e.g., U.C.C. § 2-204(3). And in the event terms are missing or contradictory, the UCC provides the rules to interpret the contract.
Below are examples of terms that, if not agreed upon by the parties or intentionally left for later, may be controlled by the UCC:
+ Price – The UCC provides the remedy when the parties have not settled on a price. In instances where nothing is said as to price; or the price is left to be agreed by the parties and they fail to agree; or the price is to be fixed in terms of some agreed market or other standard as set or recorded by a third person or agency and it is not set or recorded; the contract’s price is the reasonable price at the time of delivery. U.C.C. § 2-305.
+ Delivery – The UCC provides that unless otherwise agreed, all goods must be tendered in a single delivery — not piecemeal — and payment is due only on such tender. U.C.C. § 2-307.
+ Timing – If the timing of delivery of the goods is not agreed upon or not provided, the UCC dictates that the goods be delivered within a reasonable time. U.C.C. § 2-309.
+ Warranties – If the agreement between the merchants is silent, the UCC also adds warranties to the goods. Under Section 2-312, the UCC warrants that the “title conveyed shall be good and its transfer rightful” and “the goods shall be delivered free from any security or other lien or encumbrance.” Under Section 2-314, the UCC creates implied warranties that the goods are merchantable, meaning they, among other things, “pass without objection in the trade under the contract description,” “are fit for the ordinary purposes for which such goods are used,” and “run, within the variations permitted by agreement, of even kind, quality and quantity within each unit and among all units involved.” U.C.C. § 2-314(2)(a), (c), and (d). If the seller at the time of contracting knows that the goods are meant for a particular purpose and that the buyer is relying on the seller’s skill to select suitable goods, Section 2-315 warrants that the goods selected will be fit for that purpose.
Thus, merchants to a contract must be careful not to default to certain terms simply by leaving them out of a contract. By doing so, the seller may “agree” to sell its product at a “reasonable” price, which happens to be too low for the seller to make profit; or may “agree” to deliver its product at a “reasonable” time, which happens to be one that the seller cannot actually meet. It is important to know and understand how the UCC (that state-adopted commercial code) impacts sales transactions. Businesses may be agreeing to terms they cannot fulfill without even realizing it.
The UCC also affects sales transactions in which two businesses (that qualify as merchants) exchange competing acknowledgments of the agreement (such as a purchase order and invoice) that have differing terms. For example, the buyer may request a shipment of crates, submitting a purchase order containing several terms and conditions, including the quantity and price of the crates.
The seller responds by sending an invoice for payment in which the quantity and price on the invoice matches the purchase order. But the seller also includes its own terms and conditions, some of which vary from those included in the buyer’s purchase order and some of which are additional.
Under traditional contract law, no agreement is made – the acceptance did not match the offer and thus did not form a contract. But the UCC recognizes that the merchants intended to make an agreement and thus treats them as having done so.
Section 2-207 provides guidelines for whether the additional terms are part of the contract. It states that between merchants, “additional terms become part of the contract unless: (a) the offer expressly limits acceptance to the terms of the offer; (b) they materially alter it; or (c) notification of the objection to them has already been given or is given within a reasonable time after notice of them is received.” Thus, the merchants cannot ignore the terms and conditions that come along with an invoice – they may be bound by them.
Uncertainty Leads to Disputes
The UCC is helpful in filling in contractual terms that may have been missing or reconciling additional terms, but it does not terminate uncertainty. The UCC generally adds default language relying on what is reasonable.
Agreeing to a reasonable price or a reasonable delivery date (e.g., U.C.C. §§ 2-305, 2-309) leads to disputes as to what is reasonable. Disputes often lead to disintegrated business relationships and, at times, costly litigation. Litigation concerning what is reasonable is generally fact intensive, which increases the likelihood of prolonged litigation.
Moreover, even though Section 2-207 provides guidelines for dealing with additional terms to a commercial contract, it does not take out the uncertainty. Parties to the contract will still likely argue whether the additional terms contradict already established terms or simply clarify or supplement the already established terms.
It is this uncertainty that leads to disputes. Again, that uncertainty can be resolved through litigation, but because of the uncertainty, predicting success through litigation is more difficult, making the litigation riskier and generally more costly. Thus, it is best to understand how the UCC affects contracting and plan accordingly.
+ Be Proactive – Include the terms and conditions you want in your purchase orders and/or invoices. Limit the other side’s acceptance to the terms offered in your purchase order or invoice.
+ Read – Read the terms and conditions included in the purchase order and invoices sent to you. Understand what is in them and what is not.
+ Speak up – If the terms and conditions offered are unacceptable, promptly notify the other party in writing of your rejection of those terms and conditions.
Terms to Consider
While the UCC provides contract-fillers when necessary, it also defers to the parties’ express terms in the contract. Businesses should analyze which terms and conditions they should incorporate in their commercial contracts. Below are a few terms and conditions that businesses should consider.
+ Venue and Jurisdiction – You may want to include a term selecting the county and state where any legal action will take place in the event a dispute arises. This term gains more significance in contracts between parties from different states. Including a venue and jurisdiction selection of your choice will prevent the possibility of litigating the dispute in an inconvenient location.
+ Governing Law – Similarly, you likely want to include a term selecting the state law that will govern the contract. Here, you want to select the state law that you are most familiar with or is most favorable to you.
+ Attorneys’ Fees – Costs are an important consideration when deciding whether to initiate a lawsuit. Thus, you may want to shift those costs to the losing party by including a term that entitles the prevailing party in any lawsuit concerning the contract to its attorneys’ fees and costs. Now, if you are the party that is more likely to breach the contract, you may not want to include such a clause. But if you are likely to perform on the contract, you likely want this clause, so that there is a potential to recover the fees spent enforcing the contract.
+ Limitation of Liability – You may also want to consider limiting your liability in the event you do breach the contract. Limitation of liability clauses set the maximum exposure that you will face if you are found liable for breaching the contract. Including these clauses caps your liability and therefore also provides more certainty when you are facing litigation.
+ Exclusion of Warranties – As stated above, the UCC attaches warranties to goods sold by merchants. But you can expressly waive or disclaim any warranties, including implied warranties. Thus, if you do not want to be bound by the UCC’s warranty provisions, you should specifically disclaim them.
It is important to understand the terms and conditions expressly included in a contract, but equally important to understand the terms that are added into the contract by operation of law. Written offers and written acceptance can provide certainty by not only controlling the terms and conditions expressly included in the contract, but also limiting the impact the UCC may have on the contract.
Patrick Kelly is a partner in the Los Angeles office of Snell & Wilmer. His practice is concentrated on business and commercial litigation, with an emphasis on contract disputes and claims relating to corporate, franchise and partnership disputes. Visit www.swlaw.com for more information.