Documents of Title: Shipment Under Reservation

The sale of goods often involves the commercial movement of goods by carrier and sometimes the subsequent storage of those goods.  Article 7 of the UCC- Documents of Title- governs the shipment of storage of goods under the Uniform Commercial Code.  At the outset, it must be pointed out that shipments of interstate transactions are governed by the Federal Bill of Lading Act 49 U.S.C.801 et. seq., and the storage of agricultural commodities may be governed by the United States Warehouse Act 7 U.S.C. 241.

A major distinction between these two acts is that the FBLA is a mandatory act, governing shipments in interstate commerce, while the USWA is a voluntary licensing statute in which a warehouse can apply for approval by the Secretary of Agriculture. 

The purpose of the posts relating to the movement and storage of goods will be confined the Uniform Commercial Code; however, given the statistic provided by the Farm Bureau Agency that 47% of all warehouse space in the United States falls within its purview, anyone involved in matters involving the storage of commodities should definitely investigate the applicability of the USWA to a particular transaction.  With respect to other goods which may be stored, Article 7 will control.

The following is an excerpt from The Uniform Commercial Code Made Easy and is designed as a general introduction to bills of lading including the delivery of goods under a bill of lading.  Special emphasis is given to the concept of a ‘shipment under reservation’ which is governed by Section 2-505.

V.    DELIVERY OF GOODS

(A)  Bill of Lading

(B)  Person Entitled to Take Possession of Goods;

          Person Entitled Under the Document.

(A) Bill of Lading[1]

When the carrier receives the boats it will issue  a document known as a bill of lading.   This document will acknowledge the carrier’s possession of the boats, and in addition will contain a contract for delivery of the boats. In such a situation, the carrier is called a bailee.[2] The person from whom the carrier receives the goods is called the consignor,[3] here, Royal. Since the contract calls for delivery to the order of Royal, Royal would also be the consignee.[4]

                                                 Form of Document of Title

A document of title can take one of two forms. It can be negotiable or non negotiable. Section 7-104 specifies when a document is negotiable or non-negotiable:

• (a)  Except as otherwise provided in subsection (c) a  document of title is negotiable if by its terms the goods are to be delivered to bearer or to the order of a named person;

(b)  A document of title other than one described in subsection (a) is non-negotiable.

(c)  A document of title is non-negotiable if, at the time it is issued, the document has a conspicuous legend, however expressed, that it is non-negotiable.

In the instant situation, the goods are to be delivered to the order of a named person, Royal. Thus, the form of the bill of lading falls squarely within Section 7-104(a). As is obvious from the quoted definition, whether or not a bill of lading [or any document of title] is negotiable or non-negotiable is simply a matter of form. To the extent that the bill of lading does not have the proper form, it is non-negotiable.[5] The distinction between negotiable and non-negotiable documents pervades all of Article 7. In fact, the last sentence to the first paragraph of the comments to Section 7-104 states as follows:

The distinction between negotiable and non-negotiable documents in this section makes the most important sub-classification employed in this article....

There are many reasons under Article 7 as to why this is so; it is, however, beyond the scope of this memorandum to discuss all of these. In the instant situation, the question for our purposes is: how does procurement of a negotiable bill of lading to the order of Royal reserve a security interest in Royal?  That is, how does Royal’s procurement of a negotiable bill of lading to its order secure payment or performance of an obligation, per Section 1-201(b)(35). The simple straightforward answer is that the carrier would be required to deliver the boats only to Royal, inasmuch as Royal would be the holder of the negotiable document (bill of lading),  and delivery to anyone else would be unlawful. Again, some further analysis is required to illustrate how this works under Article 7.

(B) Person Entitled to Possession of the Goods; Person Entitled under the Document

The first relevant section in dealing with this question is Section 7-403(a) which reads in pertinent part as follows:

The bailee shall deliver the goods to a person entitled under the document of title if the person complies with subsections (b) [dealing with bailee’s lien] and (c) [surrender or notation of deliveries on document of title]....

As previously noted, the bailee in the instant situation would be the carrier, who, per Section 7-403(a) noted above, must deliver to a “person entitled under a document,” which is defined under Section 7-102(a)(9) ) as follows:

Person entitled under the document means the holder, in the case of a negotiable document of title, or the person to which delivery of the goods is to be made by the terms of, or pursuant to written instructions in a record under, a nonnegotiable document of title.

As indicated, since a negotiable bill would be used here, the “person entitled under the document” would be the holder of that document. Holder is defined under Section 1-201(b)(21)(B) as ‘the person in possession of a negotiable tangible document of title if the goods are deliverable to bearer or to the order of the person in possession’. Thus, as long as Royal maintains possession of the negotiable document of title issued to its order, Royal is the person entitled under the document as the holder of the negotiable document. Should the carrier deliver to anyone other than the holder, it would be an improper delivery for which the carrier would be liable.  The carrier knows this and will only deliver to Royal or the subsequent holder of the document. Royal doesn’t want the boats; it simply wants to maintain possession of the bill of lading until it gets paid.

The next series of posts will roughly track the statutory provisions discussed in the memorandum above as it relates to bills of lading.  Warehouse receipts will be covered thereafter.  

 

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          [1] “Bill of Lading” means a document evidencing the receipt of goods for shipment issued by a person engaged in the business of transporting or forwarding goods.... Section 1-201(b)(6).

A bill of lading is a document of title under Section 1-201(b)(16). That section states as follows:

“Document of title” includes dock warrant, dock receipt, warehouse receipt or order for the delivery of goods, and also any other document which in the regular course of business or financing is treated as adequately evidencing that the person or possession of it is entitled to receive, hold and dispose of the document and the goods it covers. To be a document of title a document must purport to be issued by or addressed to a bailee and purport to cover goods in the bailee’s possession which are either identified or are fungible portions of an identified mass.

The use of documents in commercial transactions is extremely important and will be discussed in some detail in this book. For now it should simply be borne in mind that in many situations the document is treated as the equivalent of the goods it covers and that transfer of the document or rights thereunder will generally be equivalent to a transfer of the goods so covered.

[2] “Bailee” means the person who by … bill of lading or other document of title acknowledges possession of goods and contracts to deliver them. Section 7-102(a)(1).

[3] “Consignor” means the person named in a bill as the person from whom the goods have been received for shipment. Section 7-102(a)(4).

[4] “Consignee” means the person named in a bill to whom or to whose order the bill promises delivery. Section 7-102(a)(3).

[5] Section 7-104(c) previously quoted, states as follows:

(c) A document of title is nonnegotiable if, at the time it is issued, the document has a conspicuous legend, however expressed, that it is nonnegotiable.

This provision is contained in the newest amendments to Article 7 and is absent under Section 7-104. The amendment is logical insofar as it indicates a clear intent of the issuer, and presumably the consignor, that the document be treated as nonnegotiable. The importance of negotiability will be seen shortly in Doug’s memorandum.

Section 2-607(5)(a): Attorneys’ Fees as Consequential Damages

As noted in previous posts, the designation of a party as a merchant activates a number of special provisions under Article 2.  Among the most important is the warranty of merchantability under Section 2-314.  Subsection (1) to Section 2-314 states as follows:

Unless excluded or modified (Section 2-316), a warranty that the goods shall be merchantable is implied in the contract for their sale if the seller is a merchant with respect to goods of that kind.  Section 2-341(1)

What is or is not merchantable is set forth in Section 2-314(2):

            Goods to be merchantable must be at least such as

(a) pass without objection in the trade under the contract description; and

(b) in the case of fungible goods, are of fair average quality within the description;     and

(c) are fit for the ordinary purposes for which such goods are used; and

(d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and

(e) are adequately contained, packaged, and labeled as the agreement may require; and

(f) conform to the promise or affirmations of fact made on the container or label if any.

Sales of goods often involve several levels of distribution.  Initially, the sale of raw materials to be used in the manufacture of finished goods; sales from the wholesale to the retail level, and the sale to the retail customer. The warranty of  merchantability will be given at each stage provided the seller is a merchant.  Most of the time, the goods will meet the requisite standard of merchantability; sometimes they will not.  Very often this will occur in a situation involving a middleman who purchases goods for resale.  When the goods sold are not merchantable, and the middleman is sued for breach of warranty, specific rules kick in which the middleman should be aware of if he or she is to minimize exposure. 

Section 2-607(5)(a) contains rules of particular significance when goods are resold by a middleman to a third party.  That section states as follows:

Section 2-607(5)(a) states as follows:

Where the buyer is sued for breach of a warranty or other obligation for which his seller is answerable over

(a)  he may give his seller written notice of the litigation. If the notice states that the seller may come in and defend and that if the seller does not do so he will be bound in any action against him by his buyer by any determination of fact common to the two litigations, then unless the seller after seasonable receipt of the notice does come in and defend he is so bound.

This section enables the middleman who is being sued for the allegedly defective product to put his seller on notice of the litigation and provide him with the opportunity to defend against the litigation.  The failure of the original seller to do so will result in his being ‘bound in any action against him by his buyer by any determination of fact common to the two litigations.’

            As has been stated throughout these posts, it is highly recommended that the actual language of the statute be tracked in this type of situation.  ‘Coming close’ can result in litigation costs that could have been avoided.  In this regard however, and in connection with Section 2-607(5)(a), it must be noted that this section is permissive in nature, and that if a party does not strictly comply with Section 2-607(5)(a), she or he may still maintain a cause of action against her/his buyer for the breach of warranty.

This follows from the language of Section 2-607(5)(a) which states that the buyer ‘may give his seller written notice of the litigation.’  It is clearly permissive.  This question was thoroughly discussed by the Michigan Court of Appeals in Old Kent Bank v Kal Kustom Enterprises, which has impact in all states by reason of the uniformity provision of Section 1-103(1)(b).  See e.g. of In re Hispanic American Television Co., Inc., 113 B.R. 453 (Bankr.N.D.Ill.1990). 

The court in Old Kent discussed the permissive nature of Section 2-607(5)(a) as follows:

The language of M.C.L. § 440.2607(5)(a) is clear and unambiguous.   The statute's plain language reflects its discretionary nature.   Again, the statute states that where a buyer is sued for breach of warranty or other obligation for which his seller is liable, he “may give his seller written notice of the litigation.”

The court went on to state:

Further emphasizing the permissive nature of subsection 2607(5)(a) is the fact that a review of other subsections set forth in M.C.L. § 440.2607(5) indicates that the Legislature intentionally made some portions of the statute mandatory, and others permissive.   Subsections 2607(3)(a) and 2607(3)(b) contain the mandatory “must” in terms of notice.⁵  If the Legislature intended subsection 2607(5)(a) to be mandatory, it would have used similar mandatory language.

            I have been involved in cases where the original seller refuses to come into defend and in some situations completely ignores the notice sent.  This leaves the middleman in a very bad situation, for the original seller is the party best equipped to defend the product he sold.  As a result of this reality, at least one court has awarded attorney’s fees to the middleman who gave proper notice.  The starting point for this analysis is Section 2-714, which deals with buyer’s damages for accepted goods where seller has breached.  That section states as follows:

(1) Where the buyer has accepted goods and given notification (subsection (3) of Section 2-607) he may recover as damages for any non-conformity of tender the loss resulting in the ordinary course of events from the seller's breach as determined in any manner which is reasonable.

(2) The measure of damages for breach of warranty is the difference at the time and place of acceptance between the value of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount.

(3)In a proper case any incidental and consequential damages under the next section may also be recovered.

As noted in Section 2-714(3), in a ‘proper case’ incidental and consequential damages may be recovered under Section 2-715:

(2) Consequential damages resulting from the seller's breach include

(a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and

(b) injury to person or property proximately resulting from any breach of warranty.  

            In addressing the question of attorney’s fees, it must be noted that the attorney’s fees recoverable under Section 2-715(2)(a) are of a different nature than those claimed in a traditional contract litigation.  Attorney’s fees incurred in connection with a litigation in which a non breaching party is, in effect, forced to defend a claim from his buyer for defective goods sold by the original seller, are of a whole different nature.

            The precise issue was discussed by the United States District Court Acushnet Co. v. G.I. Joe’s, Inc., 2006 WL 2729555 (D. Or. Sept. 22, 2006). The case involved a breach of infringement warranty governed by Section 2-312(3) of the UCC.  Acushnet is the sole manufacturer of Titleist golf balls.  G.I. Joe’s purchased what it thought were Titleist balls from Cam Golf. They were in fact fakes.  Acushnet investigated further and learned that other fake Titleist balls were being sold by G.I. Joe’s elsewhere.

            Acushnet sued G.I. Joe’s, who in turn joined Cam Golf, Inc., the latter for breach of the warranty of infringement.  Acushnet and G.I. Joe’s settled with G.I. Joe’s paying $25,000 and incurring $19,300 in attorney’s fees. G.I. Joe sought recovery of both amounts in its action against Cam Golf.   The latter argued that attorneys’ fees were not recoverable, citing supposed authority for that proposition.  G.I. Joe responded:

G.I. Joe’s contends that Cam Golf has confused the issue of recovering attorney’s fees in prosecuting a lawsuit against the seller of goods with attorney’s fees incurred in defending a claim brought against the buyer by a third party. [at page 5]

 In addressing the matter, the court noted the permissive nature of Section 2-607(5)(a) and concluded that attorney’s fees were recoverable under Section 2-715(2)(a),  the Court quoted from Raymond v. Feldman 124 Ore. App 543, 546 (1993) as follows:

The general rule is that attorney’s fees are not recoverable in a breach of contract action unless authorized by statute or the agreement.  However  an exception to the general rule is when a party’s breach of contract involves the non breaching party in litigation with a third party  In such a case the non breaching party may be entitled to recover its litigation costs resulting from the separate action. [at page 6; Emphasis the Court’s]

These consequential damages are recoverable under the language of Section 2-715(2)(a), and the general policy of Section 1-305 which seeks to make non breaching parties whole, and has a special exception for awarding attorney’s fees when permitted under ‘other applicable rules of law’. The rule allowing attorney’s fees in defense of third party products is one of those exceptions. 

I suggest that parties who may be involved in situations in which Section 2-607(5)(a) create a document tracking the language of that section so that effective notice can be given in any situation in which it is required.

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’.

Banks, Merchants & Article 2

As discussed in the previous post, the characterization of a party as a merchant or non merchant has great significance under Article 2.  This brings us to a point where the cases add a unique flavor to an otherwise very clear definition.  These cases also illustrate the positive results that creativity can bring to the table.  Very early in these posts, the importance of utilizing the mandates of Section 1-103 in presenting creative arguments was emphasized. By way of review, and in the context of the case to be discussed, Section 1-103 directs the court to ‘liberally construe and apply the code’ and to do so in a manner which promotes the underlying purposes and policies of the Code:

(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.

As you view these creative applications of the definition of ‘merchant’, it is useful to see how many of these purposes and policies support the broad interpretation adopted by the courts. 

            The first case for consideration is National Microsales v. Chase Manhattan Bank  761 F. Supp. 304 (S.D.N.Y. 1991)   The facts are briefly as follows:

National Microsales Corporation was engaged in the business of buying and selling computer output microfilming equipment. Chase Manhattan entered into negotiations with National Microsales Corporation to sell some of its used Computer Output Microfilming equipment to NMC for resale. When Chase subsequently sold the equipment to a third party, NMC filed suit alleging breach of contract.

Chase moved for summary judgment dismissing NMC's complaint on the basis of the Statute of Frauds, alleging that the purported contract in question was over $500 and there was no writing as required by Section 2-201(1).

National Microsales Corporation also moved for summary judgment claiming the contract in question was covered by the ‘merchant exception’ contained in Section 2-201(2).  As you may recall, that section applies only to transactions ‘between merchants’; hence, for that section to apply, the court would have to conclude that the bank was a ‘merchant’ under Article 2.

In presenting its case, NMC noted that Chase sold $6.5 million worth of used COM equipment from 1987-1989, and further that there were established policies and procedures of Chase which had been adopted for the purchasing new equipment as well as other ‘fixed surplus assets’.

Chase's response was that it never purchased goods for resale and that Chase has no specialized knowledge concerning the goods which it buys for its own use. There was also testimony that Chase had no familiarity with the market for the equipment which it purchased, and that when it disposed of surplus goods, it generally sold them to resellers, rather than end users, and usually sold the equipment for less than fair market value.

The court found that Chase was in fact a ‘merchant for purposes of the UCC’.  As support, the court quoted the definition of ‘merchant in Section 2-104 and Official Comment 2 to Section 2-104 which states:

The special provisions as to merchants appear only in this Article and they are of three kinds. Sections 2-201(2), 2-205, 2-207 and 2-209 dealing with the statute of frauds, firm offers, confirmatory memoranda, and modification rest on normal business practices which are or ought to be typical of and familiar to any person in business. For purposes of these sections almost every person in business would, therefore, be deemed to be a "merchant" under the language "who . . . by his occupation holds himself out as having knowledge or skill peculiar to the practices . . . involved in the transaction . . ." since the practices involved in the transaction are non-specialized business practices such as answering mail.

In applying the definition of merchant and comment 2 above, the court stated: 

This comment implies that Chase's familiarity with the goods it purchases and sells is sufficient to establish that it is a merchant for the purposes of § 2-201… For Statute of Frauds purposes, the scope and extent of Chase's activities qualify it for merchant status under the UCC.  National Microsales at 307

            The extent of the Court’s holding on the merchant matter is unclear.  On the one hand, the court seems to attempt to limit is holding on the merchant question to the Statute of Frauds provision.  If that were the case however, the Court could have easily so stated without any discussion of ‘Chase’s familiarity with the goods it purchases and sells’.  The limited reading would be found in the fact that responding to mail is something everyone in business should do as clearly stated in the comment.  In mentioning the goods and familiarity of practices with those goods, the Court can easily be interpreted to be saying more.

            There are huge implications from holding that the bank is a ‘merchant with respect to goods of the kind’ for at this point, the warranty of merchantability kicks in, as well as a host of other merchant provisions, some of which have been stated in the last post.  There is a large potential exposure to the bank if it is classified as a ‘merchant under Article 2’, which can create great leverage in litigation.