CHAPTER 3 Identification and Analysis of Contracts with a Troubled Supplier

JurisdictionUnited States

CHAPTER 3 Identification and Analysis of Contracts with a Troubled Supplier

A. Article 2 of the Uniform Commercial Code Governs All Transactions Involving the Domestic Sale of Goods

1. Identification and Analysis of Typical Contract Documents

One of the first tasks of a vendor or customer of a troubled supplier and its counsel is to collect and analyze all documents evidencing the contract or contracts for the purchase and sale of the subject goods. These documents include requests for quotations, purchase orders and invoices, and any amendments of those pieces of paper. Sometimes, correspondence exchanged among the parties will effectively modify the contract terms. These documents are almost always prepared on preprinted forms that contain detailed terms and conditions printed on the reverse side of the form or on a separate sheet. Sometimes, certain basic terms in the parties' docu-ments conflict. In these situations, the conflict must be resolved by examining § 2-207 of the Uniform Commercial Code (UCC) or other applicable law. After these documents have been collected and reviewed, legal counsel to the vendor or customer of the troubled supplier should interview the persons employed by the client that were primarily responsible for maintaining the business relationship with the troubled supplier. Counsel conducting these interviews should address any ambiguities, conflicts or omissions in the contract documents and obtain factual background concerning the parties' business relationship.

2. General Rules of Contract Formation and Construction

a. Article 2 of the Uniform Commercial Code

Article 2 of the UCC establishes uniform provisions governing the sale of goods. Article 2 also covers contract formation, contract terms, contract enforcement and warranties. It is important to note that Article 2 is not identical in each state. When adopting the UCC, certain states altered the UCC's model version by removing or adding certain provisions. Therefore, any analysis should begin with applicable state statutory and case law to ensure accuracy. However, since the focus herein is not on a particular state, Article 2 of the UCC will be analyzed.

b. The Sale of Goods

At its most basic level, Article 2 applies to the sale of goods.20 Goods are defined as "all things that are movable at the time of identification to a contract for sale" including future goods and specially manufactured goods.21Article 2 further provides that "[g]oods must be both existing and identified before any interest in them may pass."22 Goods that are neither existing nor identifiable are considered "future goods," and any "purported present sale of future goods or of any interest therein operates as a contract to sell."23 Contracts that involve the provision for sale of both goods and services will be considered contracts for the sale of goods, and the UCC will apply if the predominant purpose is the sale of goods.24

When just-in-time delivery is utilized, as in the case of automotive industry, many contracts will be for the sale of future specially manufactured goods.25 Therefore, specially manufactured goods for future delivery fall within the purview of Article 2. Accordingly, interest in specially manufactured goods will not pass to the buyer until the goods are identifiable. Such goods may be sold in bulk, lots or commercial units.26

c. Know Your Contract Rights

When negotiating with any vendor, it is imperative that parties clearly understand their contract rights to ensure receipt of the expected benefit of the bargain and to retain the protections afforded under Article 2.27 The following points will assist purchasers in dealing with vendors.

• Purchasers should add terms and conditions at the time of contract formation that may be useful if the contract is challenged or breached at a later date, such as a reasonable liquidated damages provision and arbitration clause.28
• Purchasers should inspect documents received from a seller and be able to identify whether or not the seller added additional terms/deleted terms that may change the original offer or exclude certain warranties.
• Troubled parties may alter form contracts by adding or deleting terms. Therefore, purchasers should never rely on common practice or previous contracts because the terms may not be the same. All contracts should be carefully reviewed to ensure that the terms are the same as previously agreed upon.
• The parties to a contract, particularly in the manufacturing sector, should carefully review purchase orders and invoices to determine whether general terms and conditions have been incorporated by reference.

These changes or exclusions are unwelcome surprises at a later date if the relationship between the parties is not very cordial. Since long-term supply agreements, purchase orders and invoices regularly cover extended periods of time (sometimes for the entire life of a part or commodity), it is important to carefully review subsequent purchase orders and other correspondence to ensure that the other party is not seeking to modify the original agreement. It is, of course, much easier to control the terms of the deal during formation rather than attempt to "clarify" the deal terms later through litigation.

d. Contract Formation

At its most basic level, a contract is an agreement.29 Its genesis, however, is not that simple. There must first be an offer, usually in the form of a supply agreement or purchase order that invites a reasonable acceptance by the other party.30 There must be an acceptance, which may be by words, act, or conduct that demonstrates the intention of the parties to have an agreement. For example, a response such as the "prompt or current shipment" of parts from a seller is an offer that invites acceptance by the seller. The seller can either promise to ship the parts or promptly ship the parts. In most instances, the seller will promise to ship by a certain date. If acceptance is not made in a reasonable timeframe, the offeror may treat the offer as having lapsed. In the age of electronic communication, it is important to note that an offer and/or an acceptance may be by electronic means.31 It is important to note that courts often attempt to find evidence of the parties' intent to create a contract.

i. Important Definitions

Certain definitions are important when entering into any contract for the sale of goods:

• "'Contract for sale' includes both a present sale of goods and a contract to sell goods at a future time."32
• "A 'sale' consists in the passing of title from the seller to the buyer for a price[.]"33
• "A 'present sale' means a sale which is accomplished by the making of the contract."34
• "Goods or conduct including any part of a performance are 'conforming' or conform to the contract when they are in accordance with the obligations under the contract."35
• "'Merchant' means a person who deals in goods of the kind or otherwise holds itself out by occupation as having knowledge or skill peculiar to the practices or goods involved in the transaction or to which the knowledge or skill may be attributed by the person's employment of an agent or broker or other intermediary that holds itself out by occupation as having the knowledge or skill."36
• "'Termination' occurs when either party pursuant to a power created by agreement or law puts an end to the contract otherwise than for its breach. On 'termination' all obligations which are still executory on both sides are discharged but any right based on prior breach or performance survives."37
• "'Cancellation' occurs when either party puts an end to the contract for breach by the other and its effect is the same as that of 'termination' except that the canceling party also retains any remedy for breach of the whole contract or any unperformed balance."38

ii. Nonconforming Goods

If the supplier does not have or cannot produce goods that conform to the offer, a supplier may ship nonconforming goods.39 The shipment of non-conforming goods is not an acceptance by the buyer if the supplier "reasonably notifies the buyer that the shipment is offered only as an accommodation to the buyer."40 The buyer must show that the goods are both nonconform-ing and that the nonconformity substantially impairs the value of the goods shipped to the buyer.41

Where the buyer has justifiably revoked acceptance of the nonconforming goods, the buyer's remedies include cancellation of the contract and recovering any amount of the previously paid purchase price, as well as seeking cover for the damages between the contract price and the damages incurred in covering for the nonconforming goods.

A buyer should be aware that it can refuse nonconforming goods, which may happen when the seller is in distress and trying to raise capital by jettisoning its inventory.

iii. Terms Added to the Contract

A written acceptance can incorporate additional terms that are different from the original offer.42 The additional terms may not materially alter the contract unless expressly consented to by the parties.43 In other words, an acceptance does not have to be the mirror image of the offer. For example, a seller may respond to a purchase order by sending the buyer a writing that changes the original shipment terms, warranties, and/or credit terms.

• Purchasers must be alert to changes and their potential impact, especially with the long-term nature of many contracts and the numerous documents being exchanged.44
• Purchasers must also be alert as to their conduct, which can alter the agreements.45

e. The Statute of Frauds

All contracts for the sale of goods in the amount of $500 or more must be in writing, contain all material terms, and be signed by the party upon which enforcement is sought.46 The underlying purpose of the Statute of Frauds is to protect parties to the contract from legal actions based on alleged terms that were not originally part of the contract. In other words, the Statute of Frauds protects parties...

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