As of this post, we have covered most of Article1 and
Article 3, and close to half of Article 2.
I am very pleased with the growing views on the blog, and have received
some encouraging emails from readers. As
I stated when the blog first opened, the primary goal is to teach the basic
meaning of the text of the UCC. Periodically, as in the last post, I find a
case which requires discussion, but even in that context, the primary focus is
on the meaning of the text and how it fits in the overall flow of the UCC.
As a law
professor, I felt it important to begin each class with a review, and
periodically, and I feel the same need as to the blog, not just for the
readers, but for myself as well. With
the large number of new readers, and a lot of substantive text behind us, I
wanted to do a brief review of Article 1 and its impact on the UCC. This is
done in the hope that whenever you may encounter a UCC transaction at the
drafting, litigation, or intermediate stage, you will be certain to process the
transaction through Article1 in addition to the substantive Articles activated.
I believe that Article 1 is the most important Article
under the Uniform Commercial Code for two primary reasons. First, Article 1 applies to all transactions under the Code per
Section 1-102. Therefore, regardless of where you are in the Code, Article
1 has impact, and the impact can be dramatic. The substantive Articles deal with the subject matter
with the purview of each Article, however, the content of these Articles only
presents part of the story, for in order to truly understand the meaning of any
of the substantive provisions of the UCC, it is essential to have a thorough
understanding of Article 1.
Second, Article 1 contains some of
the most powerful and impactful provisions of the Code, provisions which bring
light and special meaning to the language of a contract; create remarkable
drafting opportunities; and contain the fundamental policies upon which the UCC
is drafted:
(a) The Uniform Commercial Code must be liberally
construed and applied to promote its underlying purposes and policies,
which are: (1) to simplify, clarify, and modernize the law governing commercial
transactions; (2) to permit the continued expansion of commercial practices
through custom, usage, and agreement of the parties; and (3) to make uniform the law among the
various jurisdictions. [Emphasis Added]
As stated in Section 1-103(a)(1)(2)(3), the drafters of the Code direct that the UCC
be ‘liberally construed and applied’ to promote these policies. An attorney who
lines up legal arguments with an appropriate policy, coupled with the
directives for liberal construction and application, has a great advantage in
guiding the court to the desired result.
In addition to the stated policies,
Section 1-103 contains one of the most powerful and important provisions of the
Uniform Commercial Code:
Unless displaced by the particular provisions of the Uniform Commercial Code, the principles of law and equity, including the
law merchant and the law relative to capacity to contract,
principal and agent, estoppel, fraud, misrepresentation, duress, coercion,
mistake, bankruptcy, and other validating or invalidating cause supplement its
provisions. Section 1-103(b)
The
net effect of Section 1-103(b) is to incorporate all ‘principles of law and
equity’ which exist, ‘unless displaced by the particular provisions of the
Uniform Commercial Code.' So, if the
Code doesn’t knock it out via a ‘particular provision’ the whole body of law
involved will supplement the Uniform Commercial Code provisions. It doesn’t get more powerful than that.
A simple review of the supplemental principals of law
stated illustrates the massive content available to attorneys who are involved
in UCC transactions. The general law of
contracts, agency, estoppel, misrepresentation and fraud often are often intertwined
in commercial transactions.
Understanding the applicability of any of these supplemental principles,
and how to creatively utilize them gives an enormous advantage to someone so
armed.
The impact of Article 1 is dramatically illustrated in
the case of In Re Invenux, Inc., 298 B.R. 442, 51 UCC Rep Serv
2d (Bkrtcy. D. Colo. 2003). The trustee in bankruptcy was
attacking the validity of a security agreement on the grounds that it did not
adequately describe collateral as required by Section 9-203 The security
agreement in question was very detailed in its composition, but did not include
stock that was purportedly to be included.
Defendant’s position was that the contract—i.e.—the security agreement,
was reformed between the original debtor and the secured party and therefore,
stock was incorporated into the security agreement.
The question before the court was very significant for
two reasons. First, if the court did not
find a reformation, the security agreement would have been invalid and the security
interest unenforceable. Second, if the
court found a reformation, as it did, the result would in effect be concluding
that the supplemental principles contained in Section 1-103(b) can override the
substantive provisions of another Article.
Considering the incredibly broad scope of Section 1-103(b), the
implications are enormous. In re
Inveneux is not an aberration as regards the impact of Section 1-103(b)
on the substantive articles of the Code, but illustrative of the powerful
impact that section can have under the UCC.
I review Section 1-103(b) in connection with every
case I review under the Code.
Regrettably, a very large number of commercial transactions involve
fraud and misrepresentation. It may also
be that under the law of a particular substantive Article a result may appear
to be inequitable. Section 1-103(b) supplements the totality of the Code with
the law of equity. Even if one does not
win on such a theory, it forces the opposition to respond and creates doubt.
Another reason Article 1 is so
important is that it contains critical definitions which are applicable
throughout the Code. There are two
definitions which are so important and powerful under the Code that they must
be highlighted. These are the
definitions of ‘contract’ and ‘agreement.’
To get a full picture of the concept
of contracts under the UCC, one must move beyond the instinctive reactions that
most of us have when we hear the word ‘contracts’ in connection with the Code,
namely, Sales contracts. The application
of the word contract under the UCC embodies much more. It is not an
exaggeration to say that it is the most important definition in the Code,
certainly from an operative standpoint.
Breach of contract is the essence of all lawsuits under the UCC. So in viewing the UCC and the word
‘contract,' one should envision the concept as one which permeates the
UCC. By way of illustration, contracts
exist under the Code between: buyers and sellers [Article 2]; lessors and
lessees [Article 2A]; makers and payees [Article3]; banks and customers [Article
4]; applicant and issuer [Article 5]; issuer and bailor [Article 7] debtor and
secured party [Article 9].
The foregoing contractual
relationships are illustrative, not by any means exclusive. In an earlier post, I suggested the benefits
of a systematic approach to all UCC problems.
This creates a consistency of methodology, and the brain will adjust
accordingly. Once the facts are
thoroughly understood and diagrammed, I suggest a very detailed analysis of
contract and agreement. As you will see shortly, the elements of agreement
dramatically impact the bottom line meaning of the contract. Once the analysis
of ‘contract’ and ‘agreement’ are in place, Section 103(b) should be reviewed.
“Contract means… the total legal obligation that results from
the parties' agreement as determined by the Uniform Commercial Code as
supplemented by any other applicable laws."
It is clear from the foregoing definition, that in order to
determine the elements of a particular contract, one must first ascertain the
parties’ agreement, defined
as follows:
“Agreement” means
the bargain of the parties in fact as found in their language or inferred from
other circumstances, including course of performance, course of dealing or usage of trade as provided in
Section 1-303. Section 1-201(b)(3)
The language of the parties may be explicit, but what it is
fascinating, is that what might appear to be very clear and precise language,
or no language, can be literally transformed by the application of course of
performance, course of dealing or usage of trade. Each is discussed in Section
1-303(a)(b)(c) respectively.
Course of performance
requires, among other things, a contract with multiple occasions for
performance and course of dealing requires previous transactions between the
parties. Neither may be present in any
given situation. Amidst this uncertainty
there is one thing that can almost always be counted on to supply valuable
information to any agreement under the Uniform Commercial Code: Trade Usage. Commercial transactions take place
within the context of an existing industry, 99 plus per cent of the time. Within that industry, there is a
manner of business so customary and fundamental to the industry, that it
becomes part of the agreement between the parties, regardless of whether or not
it is even discussed.
Trade usage is defined
under Section 1-303(a) as follows:
A "usage of trade" is any practice or method of dealing
having such regularity of observance in a place, vocation, or trade as to
justify an expectation that it will be observed with respect to the transaction
in question….
The impact that trade
usage can have in a case is dramatically illustrated in the case of In Re: Cotton Yard Antitrust Litigation, 505 F.3d 274 (4th Cir.,
2007). At issue was whether or
not plaintiff purchasers of cotton and poly-cotton yarn were required to submit
their antitrust case to arbitration via an arbitration provision which,
according to defendants, was part of the contract as a result of the regular
and customary use of arbitration in the textile industry as a means of
resolving disputes.
At issue on appeal was
whether the district court’s ruling which excluded
arbitration for the antitrust claim was correct. The court of
Appeals reversed the District Court on the arbitration ruling. After discussing case law which
recognized arbitration as the standard manner of resolving disputes in the
industry, the court held that the arbitration provision was automatically part
of the contract between the parties as a result of arbitration being a trade
usage in the textile industry. This
was true regardless of the fact that it was never formally agreed to by the
purchasers. The court
further found that a party’s knowledge of a trade usage, or lack thereof, is
irrelevant, a result which is clearly consistent with the text of the statute.
There are over
86,000 trade associations in the United States, each with its own rules and
general codes of conduct. I recently
consulted on a case which had a trade association of six members, but
nevertheless had clear cut rules on what was supposed to happen in the event
goods supplied by members of the association turned out to be defective. While these rules may not always be
controlling, they are always relevant.
Another very important
provision under Article 1 is Section 1-302, the Code’s freedom of contract
provision. Subsection (a) allows parties to change the ‘effect’ of provisions
under the UCC, while subsection (b)
states that ‘the obligations of good faith, diligence, reasonableness and care
may not be disclaimed.' However, the
section goes on to state ‘The parties, by agreement, may determine the
standards by which the performance of those obligations is to be measured if
those standards are not manifestly unreasonable.'
By setting standards for the
performance of the items noted, the parties dramatically change the inquiry
should the matter end up in litigation.
In a case where no standards are set, the court and/or jury will
determine whether or not a particular standard has been met. If standards are
set, the inquiry is substantially different.
In this instance, the inquiry is: Were the standards met? Are the standards set ‘manifestly
unreasonable?' If met, and not manifestly unreasonable, they will hold up. The latter scenario gives the parties much
greater control as to the outcome in court.
One of the stated
underlying policies of the UCC is ‘uniformity of law among the various
jurisdictions’ Section 1-103(a)(3). The
provision has been interpreted by many courts to include decisions from other
states in a local jurisdiction.
Therefore, an attorney has the case decisions of 50 states as part of
his or her arsenal. Many attorneys
simply do not know about Section 1-103(a)(3) and are a corresponding
disadvantage in working with the Uniform Commercial Code.
Another critically
important provision under Article 1 is Section 1-304 which states:
Every contract or duty within the Uniform Commercial Code imposes
an obligation of good faith in its performance and enforcement.
Good faith is defined as:
…honesty in fact and the observance of reasonable commercial
standards of fair dealing.
Breach of the duty of good faith can have serious
consequences. Although the comments to Section 1-304 state that no independent
cause of action can be brought for a breach of the duty of good faith, there is
case law to the contrary. In fact, in
the case of In First Nat. Bank in Libby v. Twombly,
213 Mont. 66, 689 P.2d 1226 (Mont. 1984), the court stated:
"When the duty to exercise good faith is imposed by law
rather than the contract itself… the
breach of that duty is tortious. Therefore, punitive damages are
recoverable if the Bank's conduct is sufficiently culpable." First National Bank in Libby at 1230.
Any
litigant who can persuade the court to entertain a claim for punitive damages
has enormous leverage.
It is important to note that while
the definition of ‘good faith’ quoted above is adopted in the majority of
jurisdictions, it has not been adopted in all of them. For example, New York,
Illinois and Missouri have not adopted the amended definition of good faith.
The minority definition of good faith is ‘honesty in fact in the conduct or
transaction’ concerned. There is no
requirement for commercial reasonableness, itself a matter of interesting
interpretation. As the comments to
Section 1-304 state, the conduct being reviewed is not the commercial
reasonableness of the actual conduct in the transaction, but the commercial
‘fairness’ of the conduct.
In this regard, it is important to
remember Section 1-301 which allows parties to transaction under the UCC to
choose the law of any state as long as that state has a ‘reasonable relation’
to the transaction in question.
Individuals involved in multistate transactions should always check the
law of the other jurisdiction prior to any drafting so that the law most
favorable to the client can be drafted into the contract. Although the Uniform Commercial Code is
designed to be ‘uniform,' it is processed through each state legislature before
adoption. Often changes are made and
sometimes they are significant. In
addition, the Code gives various alternatives to the states to adopt. Section 2-318 dealing with third party
beneficiaries of warranties offers a dramatic example and potential impact of
the differences between the provisions which may be enacted in a particular
states.
The forgoing sections are
illustrative of the impact that Article 1 can have under the Uniform Commercial
Code. Most of the provisions of Article
1 are covered in earlier posts for any readers who want to review the
same. The critical point however, is
that if you are involved in UCC transactions—whether at the drafting stage, or
litigation—it is essential to have a solid working knowledge of Article 1. This will give you an enormous advantage in
all dealings which you encounter under the UCC.
Article 1; supplementary principles of law' reformation of contract; description of collateral; good faith; freedom of contract; trade usage; course of dealing; course of performance; punitive damages; customer banking relationship.