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.