Events Impairing Performance: The Code Response

In the previous post we looked at situations where ‘reasonable grounds for insecurity’ concerning the other party’s performance have arisen, as well as action which can be taken in such a situation to ‘demand adequate assurance of performance.’ The first sentence of Section 2-609(1) notes in this regard  ‘A contract for sale imposes an obligation on each party that the other's expectation of receiving due performance will not be impaired.' The impairment contemplated by Section 2-609 is the result of some behavior by one of the contracting parties.

            Section 2-615 also contemplates a situation where performance is not forthcoming; however, in this instance, the non performance is not caused by the behaviors of one of the parties to the transaction.  Rather, the non performance (or partial performance) contemplated by Section 2-615 is the result of some event which makes performance ‘impracticable.'  Section 2-615(1)(a) reads as follows:

Except so far as a seller may have assumed a greater obligation and subject to the preceding section on substituted performance:

(a) Delay in delivery or non-delivery in whole or in part by a seller who complies with paragraphs (b) and (c) is not a breach of his duty under a contract for sale if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.

In order for the event to come within Section 2-615, it must be of such a nature that the non occurrence of that event was ‘a basic assumption on which the contract was made.' 

The other situation contemplated by Section 2-615 is where the party who is unable to perform is precluded from performance by ‘any applicable foreign or domestic governmental regulation.' As noted in the text, it is irrelevant if the regulation is later proved to be invalid.

            There are several things which should be noted in the initial discussion of Section 2-615..  First, Section 2-615 deals with a situation where performance has become ‘impracticable.'  This is not the same thing as ‘impossible.'  As noted in Official Comment 3 to Section 2-615, the word ‘impracticable’ was used ‘to call attention to the commercial character of the criterion chosen by this Article.'  Second, although the section is drafted as pertaining only to the seller, Official Comment 9 states in part that in certain situations ‘the reason of the present section may well apply and entitle the buyer to the exemption.' There is case law which supports that result.  Third, a dramatic price change is not within the purview of Section 2-615.  That stated, there must have been some event that caused the dramatic price change, and that is where the focus should be directed.

In order to avail oneself of Section 2-615(1) the party must comply with Sections 2-615(a)&(b). Section 2-615(b) is activated when the triggering event affects only part of a seller’s capacity to perform and requires an allocation of product by the seller:

Where the causes mentioned in paragraph (a) affect only a part of the seller's capacity to perform, he must allocate production and deliveries among his customers but may at his option include regular customers not then under contract as well as his own requirements in any manner which is fair and reasonable.

Note, upon activation of Section 2-615(1), the seller ‘at his option’ may include ‘regular customers not then under contract’, and may also include its own requirements for further manufacture. 

Any allocation must be done in a ‘fair and reasonable manner.'  Once again, we see an opportunity to draft what is, or is not, an allocation which is fair and reasonable, and if this is done, the inquiry will be limited to: were the called for standards of ‘fair and reasonable’ met; and if so, were these standards not ‘manifestly unreasonable’ per Section 1-302.  As will be demonstrated shortly, this is one of several creative drafting provisions that can pay big dividends in the event of litigation.

            Section 2-615(c) states the final requirement for Section 2-615(a) to be properly utilized:

The seller must notify the buyer seasonably that there will be delay or non-delivery and, when allocation is required under paragraph (b), of the estimated quota thus made available for the buyer.

The procedure required for the notice referred to is contained in Section 2-616(1)(a)(b)(2)(3).*

            The general freedom of contract principle contained in Section 1-302 is explicitly stated in the first sentence of Section 2-615(a) which states in relevant part as follows : Except so far as a seller may have assumed a greater obligation... The ‘greater obligation’ does not need to be stated as guarantee of delivery in a Section 2-615 situation.  The greater obligation can be created through a remedial provision.

             Gold Kist v Stokes 138 Ga. App. 482 (1976), 226 S.E.2d 268 involved an appeal from a summary judgment.  There were a number of evidentiary issues at the trial court which the appellate court required to be heard by a jury.  Another issue raised was the failure of the trial court to include the introductory language of Section 2-615 in its jury instruction as it relates to ‘seller assuming a greater obligation’.  The contract in the Gold Kist case had the following provision:

... [i]f the producer is unable to deliver the quantity contracted for solely because of reasons beyond his control, the measure of damages for failure to deliver is the difference between contract and market price on the day of breach.

In reversing the trial court, the appellate court found that under the noted provision, seller had ‘assumed a greater obligation’ via the damage provision, and that the failure of the jury instruction to include the introductory language of Section 2-615 as it pertained to the assumption of a greater obligation by the seller was error.

            The case graphically illustrates a point made throughout these posts. Proper drafting yields great results.   The remedial provision probably got very little notice by the seller during negotiations or one would assume the seller’s attorney would have objected to the provision.  As a result of inclusion in the contract, the remedial provision effectively overrode the result that would have occurred under Section 2-615.

           

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*(1) Where the buyer receives notification of a material or indefinite delay or an allocation justified under the preceding section he may by written notification to the seller as to any delivery concerned, and where the prospective deficiency substantially impairs the value of the whole contract under the provisions of this Article relating to breach of installment contracts (Section 2-612), then also as to the whole,

(a) terminate and thereby discharge any unexecuted portion of the contract; or

(b) modify the contract by agreeing to take his available quota in substitution.

       (2) If after receipt of such notification from the seller the buyer fails so to modify the contract within a reasonable time not exceeding thirty days the contract lapses with respect to any deliveries affected.

         (3) The provisions of this section may not be negated by agreement except in so far as the seller has assumed a greater obligation under the preceding sections.

Merchants and the Economic Loss Doctrine

This post will conclude the discussion of who is, or may be a merchant under Article 2. The impact of ‘merchant status’ has been discussed in general.  However, there is one point which has not been touched on, which should be.  That involves the impact of the good faith definition under Article 2 for those states that have not enacted the amended definition of good faith in Article 1. The amended definition, if you recall requires ‘honesty in fact and the observance of reasonable commercial standards of fair dealing’,  per Section 1-201(b)(20). This applies to merchants and non merchants alike since the definitions in Article 1 apply to all substantive Articles of the Code per Section 1-102.

There are however, a significant number of states which have not adopted the amended definition of good faith*, but have instead, remained with the earlier definition of good faith which simply requires ‘honesty in fact in the conduct or transaction concerned’.  Under Article 2 however, if a party is classified as a merchant, the good faith definition [Section 1-103(1)(b)] is almost identical to the amended definition under Article 1 and thus, requires the observance of reasonable commercial standards of fair dealing in the trade by the party designated as a merchant.  Thus, the standard of conduct is elevated in the commercial arena.  Conversely, if a party is not designated as a merchant and the state law governing has not adopted the amended the definition of ‘good faith’, the party in question simply needs to demonstrate honesty.  Moreover, there are areas outside the Code which are dramatically impacted by whether or not a party is classified as a merchant under Article 2.

The latter point is dramatically illustrated in the case of Regents of the University of Minnesota v. Chief Industries Inc., 106 F3d 1409 (8^th Cir., 1997).  Among the program offerings at the University of Minnesota was an agricultural program which included the Southwest Research station, which was one of several such agricultural research stations operated by the University.   In 1985, the University decided to purchase a new grain dryer for the Southwest Station. After soliciting bids, the superintendent of the Research Station purchased a drying unit manufactured by a subsidiary of the defendant, Chief Industries.  In August of 1982, a fire damaged the structure to which the unit was attached.  The University brought a cause of action alleging that the electric solenoid valve, designed to stop the flow of fuel to the unit at a certain temperature, failed and was the cause of the fire.  In addition to damages for the allegedly defective grain dryer, the University sought damages to the connected structure.

The controlling statute in the case was Minnesota Section 604.10, which deals with the economic loss doctrine in Minnesota. ** That section states as follows:

Minn. Stat. § 604.10.  Economic loss arising from the sale of goods.

(a)  Economic loss that arises from a sale of goods that is due to damage to tangible property other than the goods sold may be recovered in tort as well as in contract, but economic loss that arises from a sale of goods between parties who are each merchants in goods of the kind is not recoverable in tort; (b) Economic loss that arises from a sale of goods, between merchants, that is not due to damage to tangible property other than the goods sold may not be recovered in tort; (c) The economic loss recoverable in tort under this section does not include economic loss due to damage to the goods themselves; (d) The economic loss recoverable in tort under this section does not include economic loss incurred by a manufacturer of goods arising from damage to the manufactured goods and caused by a component of the goods; and (e) This section shall not be interpreted to bar tort causes of action based upon fraud or fraudulent or intentional misrepresentation or limit remedies for those actions. [Emphasis added].

Hence, if the University of Minnesota was held to be a merchant, it would be barred from recovery for damage to the additional structure by the economic loss doctrine. The district court granted summary judgment against the University concluding that the University was a ‘merchant.'

The Court of Appeals phrased the matter on appeal as follows:

This brings us to this appeal's sole question:  is the University a “merchant in goods of the kind?"   That is, is the University a merchant with respect to grain drying heaters such as the one that allegedly caused the fire at the Southwest station?   If, as the district court concluded, the University is a merchant with respect to grain dryers, then it may not recover in tort under either the statute or [case law].  Regents of the University of Minnesota @ 1411

            In addressing the issue, the court first noted the definition of ‘merchant’ under Section 2-104(1), noting in its analysis two ways in which a party can become a merchant: ***

1.    By dealing in the goods involved;

2.    By way of specialized knowledge of the goods.

After quickly dismissing avenue number one—i.e.—that the University ‘dealt in goods of the kind’ the court turned its attention to attaining merchant status by way of specialized knowledge of the goods.  In addressing that question, and affirming the decision of the district court, the court of appeals stated:

In the present case, the University's knowledge and experience with respect to grain dryers constituted “knowledge or skill peculiar to the practices or goods involved in the transaction.”  Minn.Stat. § 336.2-104(1).

The University had purchased a number of such units over the prior thirty years, and had the advantage of a centralized purchasing department that solicited bids for the purchase.   Before purchasing the unit, the Southwest station's superintendent (who had been responsible for other such purchases) consulted a prominent expert in grain drying, who provided advice on such specifications for the unit as fan size and BTU.

            Creating ‘merchant’ status on the basis of ‘specialized knowledge’ opens the door to finding merchant status in situations outside of the normal professional in business.  While this may not be significant in all cases, it will be in some.  This is yet another example where leverage and vulnerability can be created where the other party never saw it coming.  This creates insecurity and facilitates a good settlement for your client.

*Among those states are: Illinois, Missouri and New York

**If you interested in an excellent article on the Economic Loss Doctrine, please check the following:

            Economic Loss Doctrine In All 50 States - Matthiesen ...

***The court did not mention the third way a party can become a merchant, which is through the ‘employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill’.