Some time ago I posted about minding the gaps that can happen where the world of common law contracts meets Article 2 of the Uniform Commercial Code (“UCC”). I see the same issues repeating in my work recently so it is time to revisit this topic.
The interface between common law contracts and Article 2 “Sale of Goods” contracts under the UCC continues to surprise the unsuspecting. Sometimes at great expense. This is particularly important in the construction industry where hundreds of UCC transactions happen every day as contractors and subcontractors buy the materials and equipment they need.
Building construction requires thousands of physical parts and pieces and each component is “movable” when the contractor buys it. Because they are moveable these parts and pieces are legally defined as “goods,” which puts them in the ambit of Article 2 of the UCC.
Article 2 of the UCC is a set of contract rules designed to expedite the sale of goods. Article 2, UCC contracts can be formed in any manner sufficient to show agreement on a few essential terms which often means minimal or no formal documentation. This minimally documented contract formation is in contrast to the common law “mirror image” rules, where forming a contract requires a “mirror image” agreement on all the material terms. When a contractor and a supplier communicate over the sale of a product, they often have conflicting terms in mind but fail to express them either in writing, verbally, or in email. The parties still want to buy and sell the product and have usually done enough to show they intended to make a deal. The UCC treats that “deal” as an enforceable contract even though it is in many respects “incomplete.”
This incomplete language in a contract can lead to trouble. What happens if there is a dispute about the goods later? Occasionally, the express terms of a “deal” do not line up with expectations. These “gaps” are points along a fault line where, for example, the “deal” does not include terms from the general contract on important issues such as time of delivery or a product warranty. Even though there is a “gap” between the two sets of expectations, the UCC recognizes the skeletal deal as the enforceable contract. This can obviously happen a hundred times a day over purchases large and small.
To deal with the missing pieces, the UCC provides a set of standardized default terms called “gap fillers” which provide an answer for many of the inconsistencies in the buy/sell contract for goods. However, the gap filler provided by the UCC may not be what either side originally thought they had agreed to and may force a seller or buyer to assume some major and costly risks. Similarly, the UCC permits disclaimers of warranty and limitations of remedy that differ from most common law contracts.
My original post identified three gap examples: time for delivery; who bears the risk of loss or damage in transit; and limitations and disclaimers of warranty. There are more but sometimes a real-world example is the best way to make the point about the potential impact of the UCC.
Consider the 2003 Texas case of Wade and Sons, Inc v American Standard d/b/a The Trane Company, 127 S.W.3d 814 (Tex. App. 2003). In that case, the project ran six months late. The general contractor fired the mechanical subcontractor. The mechanical subcontractor sued The Trane Company claiming damages for breach of contract and late delivery of air conditioning equipment plus the subcontractor’s cost to fabricate and install certain piping which was supposed to come on the units.
The subcontractor became frustrated with Trane’s efforts to address the problem as the subcontractor perceived it. The subcontractor resorted to self-help and took it upon itself to fabricate and install the piping packages on more than 150 units already in finished space. It then back charged Trane $74,000 claiming that Trane had breached its contract.
The facts raised a number of UCC issues which point out the importance of being aware of how common law and UCC contracts differ. One “gap” issue was the time of delivery. Was the delivery late? Trane had submitted its proposal form for the equipment in March. The subcontractor submitted its purchase order at the end of April expecting delivery in June. However, the Trane terms of sale on the proposal said that the order would not be accepted until Trane approved the subcontractor’s credit. Credit was not approved until the end of July.
The Trane units were manufactured and ready to ship in August, but without the piping packages. Trane tried to expedite by shipping the units without the piping packages and hiring a third party to fabricate and install the packages in the field. The subcontractor decided this was not fast enough and prepared the piping on its own. The subcontractor then withheld payment to Trane and Trane filed a mechanic lien.
When the subcontractor asserted its back charge, Trane responded that it had included its standard terms of sale with its March proposal according to its standard practice. The terms of sale required approved credit before the order was accepted.
When the subcontractor placed its purchase order, it said it was ordering units “as specifically detailed in the proposal dated 3/10/98 and in accordance with the plans, specifications and all other related documents. . .” By using the magic words “plans and specifications” the subcontractor may have felt it was binding Trane to the subcontractor’s terms. The Court disagreed. By incorporating the proposal into the purchase order the subcontractor had instead bound itself to the terms in the first form; the Trane proposal. This is where the requirement for approved credit came from. Credit approval took until July and cost the subcontractor critical months of production and delivery time.
Trane’s terms of sale made full use of the opportunities provided by the UCC. The Court did not find the delivery to be late. The units were delivered within a reasonable time under the circumstances since Trane had not actually accepted the order until July. Further, the Court focused on the disclaimer language in Trane’s terms disclaiming any warranty until the units were paid for. In any event, the court found Trane had disclaimed any liability for consequential damages for the cost of installing the piping. The disclaimer term was another UCC provision in operation to the surprise of the subcontractor.
In the end, the attempt at self-help by back charging Trane backfired. Instead of sticking Trane with the subcontractor’s costs of $74,000, the subcontractor back charge was not allowed and ended up paying Trane the lien balance of $58,000 for the units plus additional damages of $10,000, plus $30,000 for Trane’s attorney fees.
What you don’t know about the UCC can bite you. Resorting to self-help in the form of back charges to suppliers can be legally unsound and expensive. Pay careful attention to those UCC Article 2 contracts for construction materials. The smooth operation of most sale of goods transactions proves that Article 2 is highly functional, nevertheless, it may not align with a contractor’s expectations, so it pays to mind the gaps.