The Uniform Commercial Code and the Construction Industry
The Uniform Commercial Code (U.C.C.) is a set of rules governing specific business transactions and commercial instruments. These transactions include the sale of goods, negotiable instruments, bulk transfers, letters of credit, and some credit transactions involving security interests. For the construction industry, the U.C.C. applies to the purchase of equipment and materials installed or incorporated into the project, normally through purchase orders. Contractors and subcontractors need to recognize that while a purchase order is a type of contract, the U.C.C. alters many of the traditional legal concepts and principles that apply to contract formation, as well as the parties’ rights and remedies under a purchase order contract. Consequently, a contractor’s or subcontractor’s personnel responsible for purchasing materials and equipment for a project and the administration of the resulting purchase order agreements need to understand these critical differences in order to avoid the unintended assumption of risk.
The U.C.C. was developed to create uniformity among state laws governing commercial matters because commercial transactions often involve parties in different states. Forty-nine states, the District of Columbia, and the Virgin Islands have fully adopted the U.C.C. with only minor variations, resulting in considerable uniformity. The sole exception is Louisiana, which has not adopted the uniform version of U.C.C. Article 2 but has revised the Louisiana Civil Code Law of Sales to parallel U.C.C. Article 2.1 The U.C.C. is codified by the states through their respective statutes.2
Article 2 of the U.C.C. governs the sale of “goods.” The provisions of Article 2 are very relevant to the construction industry and govern transactions or disputes relating to the sale of materials or equipment. Article 2 defines “goods” as “all things (including specially manufactured goods like turbines for power plants) which are movable at the time of identification to the contract for sale.”3
While U.C.C. Article 2 broadly defines goods, the U.C.C. is inapplicable to many construction contracts because the U.C.C. does not cover contracts that are predominantly for labor or services. Construction contracts involve a mixture of goods and services, which are commonly known as “hybrid” contracts even though the end result is typically an improvement to real property (structure, utility line, highway, etc.). In some cases, determining U.C.C. applicability can be difficult.
For hybrid contracts, there are several approaches for determining whether the U.C.C. applies. Most courts adhere to the predominant purpose rule. That is, if the contract’s predominant purpose is the sale of goods, with labor or other services incidentally involved, then the U.C.C. will apply.4 However, if the predominant purpose is providing a service, the U.C.C. will not apply. Some courts apply the U.C.C. to the portion of the hybrid contract pertaining to the sale of goods but not to the rest of the contract.5
Even under the predominant purpose rule, no clear test is available for determining U.C.C. applicability because of the difficulty in identifying a contract’s predominant purpose. However, rules of thumb can provide guidance: The U.C.C. is more likely to apply to a hybrid construction contract that does not require the performance of significant labor or services at the jobsite. The U.C.C. is also more likely to apply where the hybrid contract is a purchase order rather than a subcontract. Conversely, the U.C.C. is less likely to apply to a prime contract with an owner, which courts usually find to be a contract primarily for services.
Article 2 of the U.C.C. contains relatively detailed provisions governing contract formation, as well as the parties’ rights and remedies during and after performance. The basic intent of many of these U.C.C. provisions is to fill the “gaps” in a contract, when the agreement between the buyer and seller is silent on the topic. Contractors and subcontractors need to be aware of the U.C.C.’s gap filling provisions in order to appreciate the significance of the terms found in many standard form purchase orders and the effect of the deletion or omission of one of these terms and conditions on their rights and remedies. Buyers and sellers may alter most U.C.C. provisions and obligations by agreement, except where specifically limited. In addition, other U.C.C. sections expressly authorize parties to “contract out” of that section.
Some obligations cannot be limited or disclaimed even by agreement. These unwaivable obligations include the implied duties to act in good faith, with diligence, due care, and in a reasonable manner. The parties may, however, agree to the standards by which performance of these obligations will be measured.
The traditional, common law rules of contract formation provide that a contract is formed when there is an offer and an acceptance of that offer. Under those traditional rules, an offer is rejected unless the acceptance is its “mirror image.” For example, if the response to an offer includes terms that add to or differ from the terms in the original offer, then the response is considered to be a rejection of the original offer and instead a counteroffer based on the additional or different terms. If the parties proceed to perform, a contract is formed that includes the terms of the counteroffer.
Article 2 ignores the traditional, common law rules and brings the process of contract formation for the sale of goods into line with the perceived realities of business practices. The basic principles governing the formation of a contract for the sale of goods are outlined next.
A. Agreement on All Terms and Conditions Is Not Required
Under Article 2, a contract is formed when the parties, through their words or conduct, manifest a sufficient intent to form a contract.6 An acceptance is not required to be a “mirror image” of the offer.7 Instead, an acceptance may contain different or additional terms, so long as it is coupled with a definite expression of acceptance or a written confirmation sent within a reasonable time, unless the acceptance is expressly made conditional upon the original offeror’s acceptance of the additional terms.8 Additional terms are treated as proposals for additions to the contract.9 These additional terms become part of the contract unless the offeror expressly limited acceptance to its original terms, the additional terms materially alter the contract, or the offeror objects to the additional terms within a reasonable time.10 Finally, the parties’ conduct may be sufficient to establish a contract despite unresolved items in the written offer and acceptance.11 Complete agreement on all terms is not required. In the absence of complete agreement, the contract will consist of the terms on which the parties agreed (price, time, method of shipment, place of delivery, etc.) along with the implied terms provided under other provisions of Article 2.
B. Methods of Acceptance
Unless the parties have indicated otherwise, an offer to contract for goods is construed as “inviting acceptance in any manner and by any medium reasonable in the circumstances.”12 For example, an offer to purchase goods for prompt shipment may be accepted by a promise to ship or by prompt shipment of the goods.13 If nonconforming goods are shipped, however, this will create a breach of the contract unless the seller notified the buyer that the goods were being sent as an accommodation. While beginning a requested performance is a reasonable method of acceptance, “an offeror who is not notified of acceptance within a reasonable time may treat the offer as having lapsed before acceptance.”14
C. Requirement for a Written Contract
Contracts for the sale of goods with a value of more than $500 are unenforceable unless there is “some writing that is sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought.”15 This rule has several exceptions and can be satisfied in several ways. For example, the requirement of a written document may be satisfied where one party sends a written confirmation of the contract to the other party within a reasonable time, and the receiving party has reason to know of the contents of the confirmation, but fails to give written notice of objection to its contents within 10 days after receipt.16 The writing requirement does not apply when:
- The goods are specially manufactured for the buyer, and the seller has started manufacturing or procuring the goods;
- The opposing party admits the existence of the contract; or
- The buyer has received and accepted the goods or made payment that the seller has accepted.17
The best way to ensure compliance with the requirement for a written agreement is to have a written contract signed by both parties. A written contract may not be customary or practical, such as where one is ordering supplies or materials by telephone or e-mail.18 If there is no written contract, either party may renege if none of the exceptions apply. If a contract that is required to be in writing is later modified, the modification must also be in writing.19
D. Withdrawal of an Offer
In another departure from the common law, the U.C.C. allows a buyer or seller to hold an offer open even if the other party does not pay to keep it open.20 A written offer to buy or sell goods that gives assurances that the offer will be held open is irrevocable for the stated period or, if no period is stated, for a reasonable period not exceeding three months.21
E. Filling Gaps in Essential Contract Terms
Ideally, parties to a contract for the sale of goods will agree in writing to all essential contract terms after careful negotiations where terms are openly presented and discussed. However, the U.C.C. recognizes that a contract may be formed without such negotiations and that gaps in the contract may result. To resolve problems arising from such gaps, the U.C.C. provides that a contract will not be unenforceable because of indefiniteness, merely because the parties left one or more terms open, if the parties intended to make a contract and a reasonably certain basis for an appropriate remedy exists.22
Under the U.C.C., the quantity of goods bought and sold is usually the only essential contract term.23 Except in the case of “requirements” or “output” contracts,24 if the quantity of goods is missing, the courts will not fill in the “gap” by implying a “reasonable” quantity of goods.25 If the parties agree on quantity, however, a court will enforce a contract even if they have to imply a reasonable price.26 Likewise, if the delivery date is missing, courts will imply a reasonable date based on the circumstances.27
The U.C.C. provides a comprehensive scheme for allocating risk of loss between the parties while the goods are in transit or storage. This provides greater certainty and enables the party that bears the risk of loss to arrange for appropriate insurance.
Where neither party is in breach of contract, the risk of loss is allocated in one of three ways:
- If shipment is by a carrier, risk of loss passes to the buyer upon delivery to the carrier, unless the contract requires delivery at a particular destination, in which case the risk of loss passes to the buyer when the carrier tenders delivery at that destination.28
- If a third party is to hold the goods in a bailment, the risk of loss passes on tender of documents of title or when the bailee acknowledges the buyer’s right to possession. Thus, the risk of loss may pass to the buyer for construction materials that are stored off-site in a warehouse over which the buyer has no control.29
- In all cases not covered by (1) and (2) above, the risk of loss passes to the buyer upon receipt of the goods if the seller is a merchant, or on tender of delivery if the seller is not a merchant. For example, where a supplier ships in its own trucks, the risk of loss passes to the buyer upon the buyer’s receipt of the goods.30
A contract that specifies “F.O.B. [free on board] place of shipment,” also known as a “shipment” contract, places the risk of loss on the seller until the goods are placed in the possession of a common carrier.31 In addition, a contract that specifies “F.O.B. place of destination,” also known as a “destination” contract, places the risk of loss on the seller until the delivery of the goods is tendered at the named destination.32 The U.C.C. allows any of these provisions to be changed by agreement of the parties.33
A. Inspection of Goods
When goods are tendered, delivered, or identified in the contract, the U.C.C. gives the buyer the “right before payment and acceptance to inspect the goods at any reasonable time and place and in any reasonable manner.”34 If the seller is required or allowed to send the goods to the buyer, the inspection may occur after the goods arrive.35 The parties may agree to modify the time, place, or even the right of inspection by inserting appropriate terms in the contract.36
Inspection and payment are linked under the U.C.C., although the parties may agree otherwise by contract. Where the buyer is to pay on or after delivery of the goods, the buyer has the right to inspect before payment.37 Absent an opportunity to inspect, the buyer has no obligation to pay. However, the buyer may lose the right of inspection by agreement or by conduct showing waiver.
The buyer may contract away its right of inspection by agreeing to cash on delivery (C.O.D.) payment terms or other similar terms.38 C.O.D. effectively requires payment before delivery, which precludes inspection prior to purchase.39 Where the contract requires payment before inspection, payment does not necessarily constitute acceptance or defeat the buyer’s right to a later inspection and assertion of its rights and remedies.40 Denial of the right of inspection is a breach of contract. Consequently, if the U.C.C.-governed contract does not allow the seller to ship C.O.D., the seller breaches the contract by shipping C.O.D. because this denies the buyer its right to inspect.
The buyer may waive the right of inspection by unreasonably delaying inspection.41 Whether an inspection delay is reasonable or so unreasonable as to amount to a waiver depends on the facts and circumstances of the transaction. The buyer must also give notice of any defect within a reasonable time after inspection, or it will likewise waive any remedy.42
The right of inspection includes the right to test the goods, which may include tests that must destroy a small amount of the goods. Use of the goods for destructive or nondestructive testing does not constitute acceptance of the goods as long as the testing is necessary and reasonable. The buyer bears the expenses of inspection and testing, but the buyer may recover those expenses from the seller if the buyer rejects the goods due to nonconformance.43
B. Rejection of Goods
If the goods or the seller’s manner of tendering their delivery do not conform to the contract, then the buyer may accept or reject the goods or any part of them.44 If the buyer rejects some or all of the goods, the buyer must do so within a reasonable time and give notice to the seller.45 If the buyer fails to notify the seller of the reason for rejection, the buyer cannot rely on that reason to justify rejection if the seller could have cured the defect after reasonable notice.46 After a buyer rejects goods in its possession, a buyer must hold them with reasonable care for a sufficient time to permit the seller to remove them.47
C. Acceptance and Notice of Breach
A buyer accepts the goods by failing to make an effective rejection, by knowingly taking nonconforming goods following a reasonable opportunity to inspect the goods, or by engaging in any act that is inconsistent with the seller’s ownership.48 For example, a buyer may accept construction materials by using them to perform work because such use is inconsistent with the seller’s continued ownership of those materials.
The buyer must pay for all accepted goods.49 This may seem obvious because in the absence of problems with quantity, quality, or timeliness, the buyer usually pays for the goods in the ordinary course of business. Where the buyer contends that there are problems with the goods but it fails to give the seller notice or otherwise protect its interests, the buyer still may have to pay for the goods because it may be deemed to have accepted them.50 Also, the buyer cannot sit idly by while defective goods are being used. The buyer is required to give the seller notice of any breach within a reasonable time to preserve its remedies.51 Failure to give notice of breach bars any remedy.52 For the notice to be “reasonable,” the buyer must provide notice within sufficient time to afford the seller a chance to remedy the breach and minimize the resulting damages.53 Finally, in general, the notice only needs to convey the essential facts of the nonconformity.54
D. Seller’s Right to Cure
The U.C.C.’s “perfect tender rule” provides that, with a few exceptions, a buyer can reject the goods if the goods or the tender do not conform to the contract in any way.55 The rule does not require a material breach of contract. The seller does, however, have several rights to cure where it has failed to deliver a perfect tender.
Where a buyer has rejected goods because of defects and the time for performance has not expired, the seller may give reasonable notice of its intention to cure and make a conforming delivery within the contracted time.56 The seller normally has no time to cure beyond the original contract performance time. If, however, the buyer rejects a tender of goods that the seller reasonably believed would be acceptable, the seller, upon reasonable notification to the buyer, will have “further reasonable time to substitute a conforming tender.”57 A reasonable belief that the tender would be acceptable can come from trade practices between the parties or ignorance as to the defect on the part of the seller.
E. Revocation of Acceptance in Whole or in Part
The buyer may revoke its acceptance of a lot or commercial unit whose non-conformity substantially impairs its value to the buyer in two situations.58 First, if the buyer accepted on the reasonable assumption that the non-conformity would be cured, but the non-conformity was not seasonably cured; and second, if the non-conformity was not discovered and the buyer’s acceptance was “reasonably induced either by the difficulty of discovery before acceptance or by the seller’s assurances.”59 A buyer’s revocation of acceptance “must occur within a reasonable time after the buyer discovers or should have discovered the grounds for it and before any substantial change in the condition of the goods.”60 A change in the condition of the goods must only be a result of the goods’ own defects in order for revocation of acceptance to be valid.61 In addition, revocation of acceptance is not effective until the buyer notifies the seller of such revocation.62
Several remedies are available to a buyer after proper revocation of acceptance.63 A buyer can cancel the order and, regardless of whether the buyer chooses to cancel, the buyer can recoup as much of the purchase price as has been paid.64 A buyer may “cover” and recover the difference between the cost of the substituted goods and the contract price.65 If a buyer does not cover, then, in addition to the purchase price paid, the buyer may recover the difference between the market price and the contract price.66 Provable incidental and consequential damages are also recoverable.67
The U.C.C. identifies four types of warranties to protect buyers of goods.
- The warranty of title and against infringement warrants that the title to goods conveyed is good and their transfer is rightful. The seller also warrants that the goods “shall be delivered free from any security interest or other lien or encumbrance of which the buyer at the time of contracting has no knowledge.”68
- An express warranty which is made by the seller. An express warranty is created by “any affirmation of fact or promise made by the seller to the buyer which relates to the goods and becomes part of the basis of the bargain,” “any description of the goods which is made part of the basis of the bargain,” or “any sample or model which is made part of the basis of the bargain.”69 The seller is not required to use the word “warranty” or “guarantee” to create an express warranty.70
- The implied warranty of merchantability is the warranty that the goods will be fit for ordinary use.71 Unless excluded or modified by the parties, “a warranty that the goods will be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind.”72 Most purchase order forms used by sellers, as well as construction contracts that might be governed by the U.C.C., expressly exclude this warranty.
- The implied warranty of fitness is the warranty that the goods will be fit for their particular purpose.73 This warranty is also part of a contract, whether or not it is written in the contract, but only where the seller has or should have knowledge of the buyer’s specific purpose and the buyer relies on the seller’s skill or judgment in selecting suitable goods.74 In that situation, the seller warrants that the goods are suitable for meeting such purpose.75 Again, most purchase order forms used by sellers, as well as construction contracts that might be governed by the U.C.C., expressly exclude this warranty.
A. Warranty Disclaimers
The U.C.C. includes rules governing a seller’s attempt to limit or disclaim warranty coverage.76 Generally, a seller’s disclaimer language must conform to the wording suggested by the U.C.C.. For example, the U.C.C. states that “[l]anguage to exclude all implied warranties of fitness is sufficient if it states, for example, that ‘There are no warranties which extend beyond the description on the face hereof.’”77 Notwithstanding this, the U.C.C. allows all implied warranties to be excluded by expressions such as “as is,” “with all faults,” or other language that would commonly put the buyer on notice to warranties being excluded and plainly shows that no implied warranty exists.78 Case law has also upheld warranty disclaimers which stated that “there is no implied warranty of merchantability or any other implied warranty that extends beyond the express warranty included in this contract.”79 The law addressing this subject has developed to the point that sellers have little trouble including enforceable disclaimer provisions in their contracts.80
B. Limitations on Remedies
Since warranties are easily disclaimed, contractual limitations on remedies for breaches such as delivery delays or delivery of nonconforming goods and materials are often more important to buyers.81 Sellers often seek to limit their exposure to buyers by limiting the buyers’ damages or substituting an alternative remedy. For example, a seller may seek to limit the buyer’s remedy to a return of the goods and repayment of the purchase price, or to repair and replacement of the defective goods.82 To be effective in barring consequential damages—that is, business losses other than those incurred to obtain conforming goods—the seller must provide that the alternative remedy is exclusive of all other remedies. If the alternative remedy is not expressly exclusive, then the stated remedy will merely be one of many forms of relief.83 A U.C.C. disclaimer may not be effective to eliminate tort liability—such as for negligence or strict liability in tort—although a seller may obtain a waiver of tort claims through a properly drafted contract provision.