4 Sales Formation & Terms Product Liability Performance of Sales Contracts Remedies for Breach of Sales Contracts McGraw-Hill/Irwin Business Law, 13/e © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

19 C H A P T E R Formation & Terms “Merchants have no country. The mere spot they stand on does not constitute so strong an attachment as that from which they draw their gains.” Thomas Jefferson, U.S. president and merchant, in a letter to Horatio G. Spafford (March 17, 1814)

Learning Objectives Definitions of basic terminology Terms (details) of sales contracts The nature of “title” Title & third parties Risk of loss Sales on trial, approval, or consignment 19 - 4

The UCC and Sale of Goods The Uniform Commercial Code (UCC or Code) govern most commercial transactions within the United States Under UCC Article 2, a sale of goods involves the transfer of ownership to tangible personal property in exchange for money, other goods, or the performance of services Does not specifically apply to trade in services 19 - 5

International Sale of Goods The United Nations Convention on Contracts for the International Sale of Goods (1980) provides rules governing risk of loss in sale of goods contracts The International Chamber of Commerce published a list of common international shipping terms known as INCOTERMS 19 - 6

If a Dispute Arises… If there is a dispute concerning a sales transaction, a party to the dispute must determine (a) the basis for the dispute, (b) the applicable law, (c) and how to respond to the dispute (negotiate or litigate). Example: Baxter v. Maurice’s Auto Repair and Towing Service, Inc., in which a buyer tried to obtain satisfaction from the seller, but ultimately decided to litigate. UCC Article 2 did not apply. 19 - 7

Choice of Law The UCC Article 2 does not explicitly apply to sale of services, but goods only. While some courts will apply UCC Article 2 rules to a transaction in which sales and services are mixed, most seem to avoid application of UCC Article 2 to mixed goods and services. Therefore, when faced with a sales transaction dispute, a person must identify the subject matter (services, goods, or a mixture) in order to determine the applicable law. This chart is Figure 1 on page 461 of the text. In Baxter v. Maurice’s Auto Repair and Towing Service, Inc., the court looked at the services and goods provided by the “Seller” (Maurice’s Auto Repair) and concluded: “The preponderance of the testimony at trial clearly indicated that the transaction between the parties was for the repair of Baxter’s automobile. Viewed in its entirety, this court holds that the transaction cannot be characterized in part or in its underlying nature as one for the sale of goods.” 19 - 8

Article 2 A Leasing large goods, such as manufacturing or agricultural equipment, is common UCC Article 2A applies to a lease of goods The District of Columbia and all states except Louisiana have adopted UCC Article 2A Only Louisiana (which has a civil law system rather than a common law system) did not adopt UCC Article 2A. 19 - 9

Title to Goods Title (evidence of legal ownership) to goods cannot pass from seller to buyer until goods are identified to the contract [UCC 2–401(1)] Parties may agree when title passes If no agreement, title to goods passes to buyer when seller completes obligations of delivery Passage of title determines who bears risk of loss if goods damaged during shipment 19 - 10

Title to Goods Fundamental rule: buyer cannot receive better title to goods than seller had If seller was thief, buyer does not obtain good title 19 - 11

Title to Goods: Exception to Rule Under UCC 2-403(1), a seller who has a voidable title may pass good title to a good faith purchaser for value Voidable title: gained by fraudulent means Good faith means “honesty in fact in the conduct or transaction concerned” [UCC 1–201(19)] See Alsafi Oriental Rugs v. American Loan Company For example, a person would have voidable title if s/he obtained goods by impersonating another person, paying for goods with bad check, or obtained goods without paying agreed purchase price when it was agreed that the transaction was to be a cash sale. Under the Code, good faith means “honesty in fact in the conduct or transaction concerned” [1–201(19)] and a buyer has given value if he has given any consideration sufficient to support a simple contract [1–201(44)] 19 - 12

Alsafi Oriental Rugs v. American Loan Company Facts: Bradley told owner of Alsafi Oriental Rugs that she was an interior decorator interested in selling his rugs to one of her customers Alsafi allowed her three rugs on consignment, but Bradley was working for another rug dealer, Salaam, who was defrauding Bradley and others by getting them to unwittingly steal for him Salaam pawned rugs at American Loan Company Alsafi learned the rugs were at the pawnshop and sued to recover possession Salaam’s scam was creative. A friend of Bradley’s introduced her to Salaam, who advised Bradley and her friend that he was the owner of an oriental rug store that had recently closed but he was attempting to reopen it. He offered to teach them how to become decorators and told them that when his store reopened they could operate out of the store. Salaam advised them that until he got his store restocked, he wanted them to “check out” rugs on approval from other rug dealers in town. As they had no experience with oriental rugs, Salaam instructed them what rugs to look for. He then instructed them to go to rug dealers in Memphis and advise them that they were interior decorators with customers that wanted to purchase oriental rugs. After Bradley obtained possession of three rugs from Alsafi, she turned them over to Salaam, who in turn took them to a pawnshop operated by the American Loan Company. There Salaam pawned the rugs and filled out the paperwork. Salaam failed to redeem the rugs. Following the default, the pawnshop gave the appropriate notice that it intended to dispose of them. In April 1991, Alsafi learned that his rugs were at the pawnshop. After visiting the pawnshop and identifying the three rugs as his, he brought suit to recover possession of them. 19 - 13

Alsafi Oriental Rugs v. American Loan Company Procedural History and Legal Reasoning: Trial court found for Alsafi and ALC appealed Issue: was ALC a good faith purchaser for value? Applicable law: UCC 2–403(1) Alsafi himself characterized transfer of possession to Bradley as a voluntary consignment Bradley, as purchaser, could pass title to Salaam, who passed title to ALC, a good faith purchaser for value Judgment reversed in favor of pawnshop (ALC) The trial court held that the rugs had been stolen from Alsafi and awarded him possession of them. The pawnshop appealed. Appellate court: “Section 2–403(1) empowers a purchaser with a voidable title to confer good title upon a good faith purchaser for value where the goods were procured through fraud punishable as larcenous under the criminal law. The disdistinction between theft and fraud in this context is found in the statutory definitions of “delivery” and “purchase.” Delivery concerns a voluntary transfer of possession (1–201[14]), and purchase refers to a voluntary transaction creating an interest in property (1–201[32]). As one commentator has pointed out, “a thief who wrongfully takes goods is not a purchaser . . . but a swindler who fraudulently induces the victim to voluntarily deliver them is a purchaser.” 19 - 14

Title to Goods: Exception to Rule A buyer in ordinary course is a person who gains good title because s/he (a) in good faith and without knowledge that the sale to him is in violation of the ownership rights of a third party, (b) buys goods in the ordinary course of business of a person selling goods of that kind (other than a pawnbroker) [UCC 1–201(9)] 19 - 15

Title to Goods: Exception to Rule If goods are entrusted to a merchant who deals in goods of that kind, the merchant may transfer all rights of the entruster to a buyer in the ordinary course of business [UCC 2– 403(2)] But a merchant-seller cannot pass good title to stolen goods even if buyer is a buyer in the ordinary course of business Example: Sutton v. Snider 19 - 16

Test Your Knowledge True=A, False = B UCC Article 2 governs most sale of goods transactions in the United States Tom agrees to mow Katy’s lawn during the summer. Katy failed to pay Tom as agreed. The provisions of UCC Article 2 apply to Tom and Katy’s contract. INCOTERMS were developed by the United Nations to determine title to goods True. False. Tom and Katy’s contract relate to services and not goods, thus the applicable law is a specific statute or common law. False. First, INCOTERMS were developed by the International Chamber of Commerce. Second, INCOTERMS are a published list of standardized terms for international shipping to assist in determining risk of loss. 19 - 17

Test Your Knowledge Multiple Choice Ike’s Bikes sells motorcycles. Sam’s Used Cars & Cycles (Sam’s) sold Ike a used motorcycle. Ike believes the bike belonged to Sam’s since Sam’s produced papers that looked official. Sam’s had stolen the bike from Ted. Ike may: (a) sell the bike since he was a buyer in the ordinary course of business and has good title (b) not sell the bike since it was stolen (c) sell the bike to any customer, but Ted may sue Ike for damages and will win since Ted is the rightful owner of the bike The correct answer is (a). Ike is a buyer in ordinary course of business and gained good title because he bought the bike from Sam’s (a) in good faith and without knowledge that the sale to him is in violation of the ownership rights of a third party, and (b) bought goods in the ordinary course of business of a person selling goods of that kind [UCC 1–201(9)]. 19 - 18

Details of Sales Contracts Interpreting a sales contract is easier with common rules of interpretation: Trade practices refers to using words common in a particular industry Example: “case” has a different meanings for different industries If price was omitted, UCC 2-305 fills the gap by providing the term: reasonable price at the time for delivery 19 - 19

Details of Sales Contracts An outputs contract is an agreement in which buyer purchases all the production of seller Example: chicken farmer agrees to sell only to Chicken Co. all chickens produced A requirements contract is an agreement in which seller must provide all requirements of the buyer Example: Textiles Inc. must provide all fabric required by T-Shirts LLC for production 19 - 20

Details of Sales Contracts Under the exclusive dealing contract provision of UCC 2-306(2), sellers have an obligation to use their best efforts to supply the goods to the buyer and the buyers are obligated to use their best efforts to promote their sale If no time for performance is specified, a reasonable time is implied 19 - 21

Details of Sales Contracts For contracts requiring successive performances over an indefinite period of time, UCC 2-309 provides that either party can terminate the contract upon giving reasonable notice Standardized shipping terms are customarily used in sales contracts to aid in determining which party bears the risk of loss 19 - 22

Risk of Loss in Shipping Common law placed risk of loss on the party who had technical title at the time of loss UCC provides specific rules: Contracting parties, subject to the rule of good faith, may specify who bears risk of loss in the agreement [UCC 2–509(4)] If contract requires seller to ship goods by carrier but does not require delivery to a specific destination, risk passes to buyer when seller delivers goods to carrier [UCC 2–509(1)(a)] 19 - 23

Common Shipping Terms FOB (free on board) point of origin: Seller must deliver goods free of expense and at seller’s risk (including loading on board) to the place designated [2-319(1)] FAS (free alongside ship): Seller must deliver goods alongside the vessel at the port at seller’s own risk and expense [2–319(2)] 19 - 24

Common Shipping Terms CIF (cost, insurance, and freight): price of goods includes seller’s cost and risk to load, ship, and insure goods [2–320] C & F: same as CIF, except seller not obligated to insure [2–320] 19 - 25

Common Shipping Terms Shipment contract: seller must place goods in possession of a carrier and contract for transportation as is reasonable for the nature of goods and other circumstances [2–504(a)] Unless parties specify shipment method, contract is generally construed as a shipment contract 19 - 26

Windows, Inc. v. Jordan Panel Systems Corp. Shipment contract example: “All windows to be shipped properly crated/packaged/boxed suitable for cross-country motor freight transit and delivered to New York City.” Contract placed risk of loss on buyer once seller had packed and placed goods with carrier 19 - 27

Common Shipping Terms Destination contract: seller bears risk and expense of delivery to particular destination [2–509(1)(b)] Common terms of destination contract: FOB destination [2–319(1)(b)]: seller bears expense and risk of delivering goods to that destination Ex-ship [2-322]: seller bears expense and risk until goods unloaded from ship No arrival, no sale [2-324]: seller bears expense and risk during shipment, but if goods fail to arrive, seller has no further liability to buyer 19 - 28

Sales on Trial Common commercial practice is for seller of goods to entrust possession of goods to buyer to either give buyer an opportunity to decide whether or not to buy or to try to resell them to a third person Sale on approval, a sale or return, or a consignment Risk of loss depends on terms of entrusting Cautionary tale: Alsafi Oriental Rugs In a sale on approval, goods are delivered to buyer with an understanding that buyer may use or test them for purpose of determining whether buyer wishes to buy the goods [2–326(1)(a)]. Neither the risk of loss nor title to the goods passes to buyer until he accepts the goods. In a sale or return, goods are delivered to buyer for resale with understanding that buyer has the right to return them [2–326(1)(b)]. Under a sale or return, title and risk of loss are with buyer. While the goods are in buyer’s possession, they are subject to claims of his creditors [2–326 and 2– 327]. If the merchant to whom goods are consigned maintains a place of business dealing in goods of that kind under a name other than that of the person consigning the goods, then consignor must take certain steps to protect his interest in the goods or they will be subject to claims of merchant’s creditors. The risk taken by a consignor who does not take appropriate steps to protect his interest is illustrated in, In re Corvette Collection of Boston, Inc. 19 - 29

Test Your Knowledge True=A, False = B An outputs contract is an agreement in which buyer purchases all the production of seller CIF (cost, insurance, and freight) means buyer covers risk to load, ship, and insure goods FOB (free on board) Port of Miami means that seller must deliver goods to the Port of Miami at seller’s risk and expense, including loading goods on board True. False. CIF (cost, insurance, and freight) means that the price of goods includes seller’s cost and risk to load, ship, and insure goods 19 - 30

Test Your Knowledge True=A, False = B Shipment contract means that buyer must arrange for carrier to pick up and transport goods FAS (free alongside ship) means that seller must deliver goods alongside the vessel at the port at seller’s own risk and expense A consignment is not a sale, but an entrusting in which the consignor bears the risk of loss False. Shipment contract: seller must place goods in possession of a carrier and contract for transportation as is reasonable for the nature of goods and other circumstances False. FAS (free alongside ship) means that seller must deliver goods alongside the vessel at the port at seller’s own risk and expense True. 19 - 31

Test Your Knowledge Multiple Choice Pacific Paper Co. (Pacific) and BoxCo had a contract in which Pacific must provide all cardboard for BoxCo’s box production. This type of contract is known as a(n): (a) outputs contract (b) destination contract (c) supply contract (d) requirements contract (e) none of the above The correct answer is (d). 19 - 32

Test Your Knowledge Multiple Choice Choi ordered 100 crystal vases from Kristal in New York. The contract stated the goods were to be delivered “FOB Choi’s, 111 Main, Cityville, TX.” The truck overturned en route and the vases were destroyed. Choi must: (a) pay Kristal the contract price and order again since Choi contracted for the risk of loss (b) notify Kristal to resend the order since Kristal contracted for the expense and risk of delivering to the destination The correct answer is (b). FOB destination [2–319(1)(b)]: seller bears expense and risk of delivering goods to that destination. 19 - 33

Thought Questions Jefferson said, “Merchants have no country.” Did globalization begin in his time? Do you agree with Jefferson? Opportunity to discuss globalization and the impact of multinational sales contracts on society. 19 - 34