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# 1 George Mason School of Law Contracts II Warranties F.H. Buckley

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1 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu

2 Conditions and Warranties Promises ConditionsWarranties Election Forfeiture DamagesDamages only

Warranties With a warranty a seller assumes a risk as to the product The prior question is whether the risk should be born by the seller or the buyer 3

4 Lets say seller sells a whizbang

5 The whizbang 50% chance of a whiz It might go whiz

6 The whizbang 50% chance of a whiz, 50% of a bang It might go whiz … or it might go bang …

7 The expected monetary value of an accident is p*L Evaluating risk: Expected Values

8 The expected monetary value of an accident is p*L where p is the probability of occurrence And L is the cost of the accident on occurence Evaluating risk: Expected Values

9 So the expected monetary value for an accident with a 50 percent probability of a loss of \$250 is \$125 Evaluating risk: Expected Values

10 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs The Least-Cost Risk Avoider

11 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expected cost of a bang is \$125 The Least-Cost Risk Avoider

12 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expected cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 The Least-Cost Risk Avoider

13 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 Seller is the least-cost risk avoider The Least-Cost Risk Avoider

14 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 How will the parties assign the risk? The Least-Cost Risk Avoider

15 Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 How will the parties assign the risk? Buyer will pay seller to assume the risk The Least-Cost Risk Avoider

16 Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 How will the parties assign the risk? Buyer will pay seller to assume the risk And what will this do to the purchase price? The Least-Cost Risk Avoider

17 Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 How will the parties assign the risk? Buyer will pay seller to assume the risk What is the range of prices between which the parties will bargain? The Least-Cost Risk Avoider

18 Assume that the expect cost of a bang is \$125 Seller (but not Buyer) can eliminate this risk at a cost of \$100 How will the parties assign the risk? Buyer will pay seller to assume the risk Seller will not accept less than \$100 and (risk-neutral) buyer will not pay more than \$125 The Least-Cost Risk Avoider

19 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expected cost of a bang is \$125 Buyer (but not Seller) can eliminate this risk at a cost of \$100 What happens now? Lets flip this Buyer as Least-Cost Risk Avoider

20 Seller sells a whizbang to Buyer for \$1,000, with no warranties as to bangs Assume that the expected cost of a bang is \$125 Buyer (but not Seller) can eliminate this risk at a cost of \$100 Buyer will spend \$100 to eliminate a risk with an EMV of \$125 Lets flip this Buyer as Least-Cost Risk Avoider

21 The parties will seek to assign the risk to the party who can most efficiently eliminate it. The Least-Cost Risk Avoider

22 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem If bargaining is costless, does it matter who bears the risk? The Least-Cost Risk Avoider

23 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem And if bargaining isnt costless? The Least-Cost Risk Avoider

24 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Youre a judge. You have a pretty good idea who the least-cost risk avoider is. The parties have left the question of risk silent in their contract. How do you assign the risk? The Least-Cost Risk Avoider

25 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Mimicking the market The Least-Cost Risk Avoider

26 Same example. But now neither party can eliminate the risk for less than \$125. On whom should the risk fall? Does it matter? A second way of thinking about Least-Cost Risk Avoiders

27 Same example. But now neither party can eliminate the risk for less than \$150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? A second way of thinking about Least-Cost Risk Avoiders

28 Same example. But now neither party can eliminate the risk for less than \$150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? Do risk preferences matter? A second way of thinking about Least-Cost Risk Avoiders

Are you an EMVer? An EMVer always selects the payoff with the highest expected monetary value (p*O) 29

Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (p*O) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of \$2. Would you pay me 50¢ for the ticket? 30

Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of \$2. Would you pay me 50¢ for the ticket? EMV =.5(\$2) = \$1.00 31

Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of \$10,002. Would you pay me \$5,000 for the ticket? 32

Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of \$10,002. Would you pay me \$5,000 for the ticket? EMV =.5(\$10,002) = \$5,001 33

34 Three kinds of people EMVers are risk neutral They always take the gamble with the highest EMV

35 Three kinds of people EMVers are risk neutral Most people are risk averse Theyll pass on some opportunities with a positive EMV

36 Three kinds of people EMVers are risk neutral Most people are risk averse Risk lovers are risk prone They will accept some gambles with a negative EMV

37 Recall what we said about utility Utility is the economists measure of well-being (cf. utilitarianism) Ordinal Utility measures preferences without weighing them (first, second, third are ordinal numbers) Cardinal Utility (Benthams utils) weighs utility (one, two, three are cardinal numbers)

38 Cardinal Utility plotted against EMV Utility \$EMV For EMVers, utility is linear with money

39 Cardinal Utility Utility \$EMV For the risk averse, the marginal utility of money declines (more money generates increasingly smaller increases in utility).

40 Cardinal Utility Utility \$EMV A justification for progressive income taxation?

41 There is a 50 percent probability of a loss of \$250 Same example. But now neither party can eliminate the risk for less than \$125 Would you assume that firms are risk- neutral and consumers risk averse as to a loss of \$250? This suggests a second way of thinking about Least-Cost Risk Avoiders

42 There is a 50 percent probability of a loss of \$250 Same example. But now neither party can eliminate the risk for less than \$125 Would you assume the firms are risk- neutral and consumers risk averse? Would you expect the risk to be born by the wealthier party? This suggests a second way of thinking about Least-Cost Risk Avoiders

43 There is a 50 percent probability of a loss of \$250 Same example. But now neither party can eliminate the risk for less than \$125 On whom should the risk fall? Does it matter? Suppose that seller sells 10,000 whizbangs and buyer buys only one? Does that make a difference? Now--A third way of thinking about Least-Cost Risk Avoiders

Probability distribution for buyer 44 \$EMV 7501,000 \$750 %.5

Probability distribution for seller of 60 whizbangs 45 \$EMV %.5 875

Probability distribution for seller of 10,000 whizbangs 46 \$EMV 875 % 1.0

Probability distribution for seller of 10,000 whizbangs 47 875 % 1.0 All Curves have the same mean value (\$875) but different risk (dispersion from the mean).

Probability distribution for seller of 10,000 whizbangs 48 875 % 1.0 All Curves have the same mean value (\$875) but different risk (dispersion from the mean).

Probability distribution for seller of 10,000 whizbangs 49 \$EMV 875 % 1.0

50 1.Where one party is better able to reduce the risk or the harm (or to value the loss) 2.Assuming risk aversion, where one party is wealthier than the other 3.Assuming risk aversion, where one party is a better insurer because he can diversify the risk Three kinds of Least-Cost Risk Avoiders

51 Where one party is better able to reduce the risk or the harm (or to value the loss) Assuming risk aversion, where one party is wealthier than the other Assuming risk aversion, where one party is a better insurer because he can diversify the risk Where might third party insurance substitute? Three kinds of Least-Cost Risk Avoiders

52 Where might third party insurance substitute? Liability for a faulty transmission? Break-in of a house? Emotional Distress World War III? Three kinds of Least-Cost Risk Avoiders

Sessa v. Riegle Was there a finding that the horse that was sold was defective? 53

Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the later case, buyer took the risk 54

Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the former case, who took the risk? UCC §§ 2-501(1)(a), 2-504 55

Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable Thrombosis might have been a pre- existing latent condition Might the seller be liable for this? 56

Sessa v. Riegle Was this a promise that the horse would be sound after the sale Like a 5 year warranty on a sale of a car? 57

Sessa v. Riegle Was this a promise that the horse would be sound after the sale E.g. 5 year warranty on a sale of a car Was this a promise that the horse was sound at the time of the sale? the horse is sound the horse is a good one you will like him 58

Sessa v. Riegle Why not within UCC §2-313? 59

Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact? Statements of opinion: UCC §2-313(2) Mere puffs 60

Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact Statements of opinion: UCC §2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures 61

Sessa v. Riegle Why not within UCC §2-313 an affirmation of fact Statements of opinion: UCC §2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures Frederickson Distinguish McNair What if soundness was guaranteed 62

Royal Business Machines Copy machine: Was of high quality Frequency of repair was very low Would remain so Will bring buyer substantial profits 63

Royal Business Machines Copy machine: Machines were tested 64

Royal Business Machines Copy machine: Machines will not cause fire 65

Specificity: Searls v. Glasser recession resistant? Keith: sure-footed seaworthiness? 66

67 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu

Flippo Remedy in tort? 68

Flippo Remedy in tort? Remedy in contract? What were the goods? 69

Flippo Remedy in tort? Remedy in contract? Implied warranty of merchantability What were the goods? Cf. Prosser on p. 672 UCC § 2-313B 70

Implied UCC Warranties Merchantabilty: UCC § 2-314 Fitness: UCC § 2-315 71

Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt. 13 72

Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt. 13 Does reliance come into this? 73

Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC § 2-314, cmt. 13 Does reliance come into this? I sell you a car which proves unsuitable for off-terrain driving 74

Fitness: UCC § 2-315 How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance 75

Fitness: UCC § 2-315 How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance Why no warranty in Lewis and Sims at 674? 76

Warranty of Workmanlike Performance Construction and services contracts Could any contractor be thought to resist such a duty? 77

Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average 78

Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) 79

Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) What if it had been proven that seller knew it was a clunker. Morris v. Macks 80

Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC § 2-316(3)(a) What if seller in Pelc had said its in perfect condition or I guarantee its in good shape 81

Exemption Clauses Does an as is clause exclude express warranties? Only if not unreasonable UCC § 2- 316(1) 82

Exemption Clauses What were the warranties in Pelc? Qu. the finding that the representations were not improper? 83

Exemption Clauses What were the warranties in Pelc? Qu. If the representations had been fraudulent? 84

Weisz v. Parke-Bernt Can you spot the fake Van Gogh? 85

Weisz v. Parke-Bernt Why was the exemption clause ignored? 86

Weisz v. Parke-Bernt Just what is a Raoul Dufy?? 87

Weisz v. Parke-Bernt The old fundamental breach doctrine 88

Substantial Performance vs. Perfect Tender Perfect tender required in UCC § 2- 601 Substantial Performance Restatement § 229 (no disproportionate forfeiture unless material event) Restatement § 237 (no uncured material failure 89

Substantial Performance vs. Perfect Tender Perfect tender required in UCC § 2- 601 Substantial Performance Restatement § 229 (no disproportionate forfeiture unless material event) Restatement § 237 (no uncured material failure Materiality defined in § 241 90

Substantial Performance in Jacob & Young 91

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? 92

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? 93

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Could you draft a clause that would have given Kent a right to rescind? 94

What is Reading Pipe? This is Reading Pipe

This is not Reading Pipe

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Would the parties have agreed to such a clause? Why not? 97

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? 98

Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? What is substantial performance for a roof? 99

Haymore v. Levinson 100

Grun Roofing vs. Haymore Personal taste or fancy vs. operative fitness mere taste may be controlling in the former case 101

Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? 102

Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? The substantial performance standard 103

Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of Πs loss? Would perfect tender open the door to opportunism? 104

105 Things looked simple at common law Promises ConditionsWarranties Election Forfeiture DamagesDamages only

Theyre more complicated in the UCC Buyers Remedies 2-601 Perfect Tender required Conforming goods 2-106 106

Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 107

Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Action for price paid 2-711 Incidental Damages 2-711, 2-713 Cover 2-711, 2-712 108

Cure by Seller 2-601 Perfect Tender required Accept2-606Reject 2-602 Cure 2-508Dont cure 109

Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715 110

Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715Revocation of Acceptance 2-608, 2-607 111

Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715Revocation of Acceptance 2-608, 2-607 Cancel 2-711, 2-106(4) Damages 2-711, 2-713 Specific performance? 2-711(2) 112

Sellers Remedies Goods not deliveredGoods delivered Withhold delivery 2-703 Stoppage in transitu 2-705 Damages 2-703, 2-708 113

Sellers Remedies Goods not deliveredGoods delivered Action for the price 2-709 Damages 2-710 114

115 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu

Opportunism and Perfect Tender? The problem of buyer opportunism is addressed by the sellers right to cure 116

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? 117

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% 118

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% The price of oil had fallen by 25% 119

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 When was delivery to take place? 120

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 When was delivery to take place? When was the substitute delivery to occur? 121

Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date: 2-508(1) Cure after: 2-508(2) Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance 122

Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Cure after Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance Must seller know that tender will be non- conforming? Nordstrom on Sales 123

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? 124

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date 125

Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date Cf. proposed 2003 revision 126

Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 127

Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? 2-508(2)

Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods? 2-606 129

Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods? Did buyers revoke acceptance and cancel? 2-608, 2-711 130

Can 2-508 be waived by seller? Qu. Consumer goods where seller specifies goods satisfactory or money refunded I order a shirt on-line, which is torn. Can seller resend? 131

When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets 132

When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets In other cases, weakened cure rights? Zabriskie Chevrolet Might cure rights give sellers misincentive to cheat on terms? 133

134 George Mason School of Law Contracts II Anticipatory Repudiation F.H. Buckley fbuckley@gmu.edu

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