Wednesday, June 29, 2016

No Price?—No Problem

The Article 2 policy, to facilitate the deal, is nowhere more evident than Section 2-305, for that section allows a contract to be formed regardless of whether or not the parties have agreed on a price. This is a radical departure from Pre-Code law. This rule is contained in the first sentence of Section 2-305 which states as follows:
‘The parties if they so intend can conclude a contract for sale even though the price is not settled….’
On it's face, this would seem to conflict with Section 2-204(3) which also facilitates the formation of a contract where the parties intend to form a contract, provided there is a ‘reasonably certain basis for giving an appropriate remedy.'  Price is definitely essential in providing an ‘appropriate remedy.' This is provided in the open price situation as follows:
In such a case the price is a reasonable price at the time for delivery if
(a) nothing is said as to price; or
(b) the price is left to be agreed by the parties and they fail to agree; or
(c) 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 so set or recorded.
            There are a couple of things to be noted in Section 2-305(1).  First, there must be requisite intent by both parties to the contract for the open price term to be valid.  Second, it is important to remember the full import of the definition of ‘agreement’ when trying to ascertain whether the parties ‘agreed’ to an open price term.  Such an agreement can arise by way of course of performance, course of dealing and usage of trade.
            There are situations where the parties agree that a seller or buyer must set a price.  In such a situation, the price must be fixed in good faith.
(2) A price to be fixed by the seller or by the buyer means a price for him to fix in good faith.
Once again, we see the concept of good faith figuring into the equation. If the parties are merchants, this requires ‘honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade.'  Remember that this definition, unlike the definition of ‘good faith’ in Article 1 ties ‘reasonable commercial standards of fair dealing’ to whatever trade is involved.
            One might have difficulty imagining an ongoing business practice of entering into open price contracts.  However, when viewed in the context of a fluctuating market, an open price term makes perfect sense.  The petroleum industry offers an excellent example of an industry that has an ongoing practice of open pricing.  Litigation within that industry demonstrates some points raised in earlier posts.  For example, is the good faith standard based upon a subjective analysis or an objective analysis.  In fact, in Mathis v. Exxon Corp., 302 F.3d 448, 454-57 (5th Cir.2002), the Fifth Circuit interpreted Texas law on the question to involve both subjective and objective standard.
            Mathis involved a claim by Exxon dealers in Texas which was predicated on alleged bad faith pricing by Exxon regarding the cost of gasoline to its dealers. The dealers alleged that Exxon was attempting to drive them out of business by overcharging for the gasoline which the dealers were required to purchase under their agreement with Exxon. Under the terms of the agreement, Exxon was permitted to set the price for the gasoline to be purchased by the Exxon dealers. The court noted:
Texas law, which tracks the Uniform Commercial Code, implies a good faith component in any contract with an open price term.   Specifically,
[t]he parties if they so intend can conclude a contract for sale even though the price is not settled. In such a case the price is a reasonable price at the time of delivery. A price to be fixed by the seller or by the buyer means a price for him to fix in good faith.
Exxon contended that its pricing was proper inasmuch the price charged was within the range of its competitors pricing and therefore established the ‘commercial reasonableness’ requirement of good faith. The dealers’ contention was that even if the price set was within the range stated by Exxon, good faith required more. In essence, the dealers stated that if the ultimate purpose of Exxon was to drive the franchises out of business, this would violate the ‘honesty in fact’ portion of the good faith requirement.
            The Court discussed comment 3 to Section 2-305 in great detail, noting that in a ‘normal’ case the type of standard pricing used by Exxon would have satisfied the good faith requirement.  However, the court went on to state that a lack of subjective good faith, such as the one alleged by the dealers, would take the pricing of Exxon into the realm of bad faith.  Accordingly, the judgment of the district court in favor of the dealers was affirmed.
            In Tom-Lin Enterprises, Inc. v. Sunoco, Inc. (R&M), 349 F.3d 277 (6th Cir. 2003) the court concluded that Ohio law required the analysis of the question of good faith to be limited to the objective standard:
Thus, under Ohio law, to show that a merchant-seller lacks good faith in fixing a price pursuant to a contract with an open price term, it must be shown that the price was not fixed in a commercially reasonable manner and, moreover, that the pricing was commercially unjustifiable. These are two distinct issues, and both involve an objective analysis of the merchant-seller's conduct. at 280 [Emphasis the Court’s]
The Tom-Lin case is brought to your attention for several reasons.  First, to illustrate the differences between the interpretation of the good faith requirement under Section 2-305; second to remind you of the importance of understanding key UCC provisions of any state in which your client might be doing business.  To the extent the transactions involve multiple jurisdictions, a party can draft the law of the favorable jurisdiction to control, provided the requisite contact with the chosen state exists.  As the Mathis and Tom-Lin cases indicate, the differences can have a dramatic impact on the outcome.

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