March  9, 2001



Bulletin #44: "We Paid For This?" Contractors and the UCC (Part II)

In the last Contracts Bulletin, ZZZ Sheet Metal had decided to use a new equipment vendor on a large job. The vendor had by far the lowest bid price, and reassured ZZZ that it could meet the project schedule. The subcontractor’s project manager issued a purchase order for the large quantity of equipment required, and the supplier sent back an order confirmation on its own form (with lots of small print on the back).

Managing the project proved to be a huge challenge for ZZZ’s already over-worked staff. When the equipment from the supplier arrived, the counts and equipment numbers were quickly checked, and the still-crated equipment was stored in the subcontractor’s warehouse. To take advantage of a discount for prompt payment, ZZZ paid the invoice within a few days after receipt of the equipment. Weeks later, when the equipment was uncrated at the site, the subcontractor realized that it had a major problem. Control panels were missing, some of the equipment appeared to be used, and some showed signs of significant damage. Even some of the obviously new equipment did not operate.

In response to the subcontractor’s angry complaints, the supplier trotted out its attorney who mumbled about the “Code,” “acceptance,” and “timely rejection.” He also pointed to language on the back of the supplier’s order confirmation form stating:

“All sales are final unless notice of defects or nonconforming items is provided by the Customer to the Supplier within five (5) days of delivery. The Supplier disclaims all express and implied warranties, and the Customer agrees to look solely to the manufacturer of any defective item.”

The attorney called the situation “unfortunate,” and stated that the supplier’s “hands were tied.” The ZZZ project manager left the supplier’s office angry, frustrated and empty-handed. The use by the supplier’s attorney of the term “rejection” seemed particularly appropriate. The project manager and the ZZZ attorney were about to become very well acquainted.

It had not occurred to the project manager (or to ZZZ management) that the Uniform Commercial Code could have a direct impact on the subcontractor’s business. As ZZZ management presented the facts to the firm’s attorney, they were surprised at how frequently he responded with: “well that’s a UCC issue.” The attorney explained that the Uniform Commercial Code is a set of substantially identical laws adopted throughout the states to provide consistency in the handling of commercial transactions. The UCC covers everything from negotiable instruments (Articles 3 and 4), to letters of credit (Article 5), the storage of goods (Article 7), and the creation of security interests in personal property (Article 9). However, of greatest significance to the contractor would be Article 2, concerning sales and purchases of “goods.”

The ZZZ attorney explained that, viewed from a legal standpoint, the contractor’s operation was actually multiple businesses. The contractor was a provider of construction services. In that capacity, it was subject to the laws, codes and ordinances applicable to construction contracting, as well as the related case law. However, it was also a purchaser and seller of equipment and materials. In that capacity, the UCC might very well take precedence relative to the seller and buyer of the items. The attorney noted that, since the typical construction project involved a high quantity of services along with the sale and installation of equipment, it was most likely that standard construction law would govern. However, the circumstances of ZZZ and its supplier were clearly within the scope of the UCC.

The attorney then stated that, if the UCC applies to a particular situation, a lot of the contractor’s assumptions about its legal rights and obligations might be wrong. For example, the contractor may assume that it has substantial flexibility in getting back to a supplier on whether equipment is acceptable. That is not true. The UCC requires the buyer to reject goods within a “reasonable time” after delivery and to notify the seller of rejection. The concept of “reasonable time” is tied to the buyer’s having a “reasonable opportunity to inspect the goods.” Having such an opportunity, the buyer must then act promptly to protect its right to reject non-conforming items. Even after rejection, the buyer is under a duty to hold the equipment “with reasonable care” to permit the seller to recover the items. Unless the buyer exercises its rejection rights in a timely and proper manner, it is deemed to have accepted the goods.

The attorney noted that ZZZ had checked the equipment counts when delivery had occurred, and had stored the equipment without performing even a minimal inspection. This was clearly a mistake. He recited that, once acceptance occurs, the buyer’s options narrow considerably. It must rely upon its ability to “revoke” the acceptance, and that right applies only if the nonconformity substantially impairs the value of the product to the buyer and (i) the buyer reasonably assumed that the non-conformity would be cured; or (ii) did not discover the non-conformity due to the difficulty of discovery before acceptance or due to seller assurances. The buyer must revoke within a reasonable time after the buyer discovers or should have discovered the grounds for it. The attorney noted once again the importance of time under the UCC.

In the case of ZZZ, there was obviously going to be an issue concerning its ability to discover the defects. Had ZZZ performed even a minimal inspection of the equipment when it was delivered, some of the damage and other problems would have been obvious. The initial discoveries would presumably have led to a more detailed inspection and would have permitted the subcontractor to take aggressive action relative to the supplier. It might even have been justified in rejecting the entire delivery and canceling the contract. However, under the circumstances, the attorney ruled out an argument concerning rejection and also indicated that arguing revocation would be an uphill battle.

There would still be arguments regarding breach of contract (the equipment specifications referred to delivery of “new equipment”) and breach of warranty, but the attorney was disappointed that the “quickest and cleanest” remedies were gone.

As to the troubling language in the order confirmation form, the attorney referred to something called the “battle of the forms.” He informed the subcontractor that it was a “real issue” whether the supplier’s “all sales are final” language would prevail and that there were court cases all over the map on inconsistent contract terms. He was fairly confident that the firm could overcome the disclaimer of warranties’ language since it was so thoroughly inconsistent with what ZZZ was seeking in its bid proposal. He also informed the project manager that the problem could have been easily prevented by including appropriate language in the purchase order form or by promptly responding to the form and telling the supplier that the order would be cancelled unless the supplier removed the offensive language.

ZZZ clearly wanted to have no further dealings with the supplier. The president of the company recommended that the entire shipment of equipment be sent back to the supplier and the contract cancelled. The attorney advised against this indicating that under the UCC it was likely that the contractor would be required to retain the goods that had been accepted, and that its remedies would be limited to the non-conforming goods. It was gut wrenching for the subcontractor to conceive installing any of the supplier’s equipment into the project. For several years, the project manager had a recurring dream in which a fire inspector was walking through the burned-out hulk of the shopping mall, and ultimately pointing to a melted ZZZ-installed fan motor as the source of the blaze. While reviewing all the details of the UCC is beyond the scope of this Contracts Bulletin, there are some fundamental principles that each contractor should keep in mind:

1. If a project predominantly involves the purchase or sale of goods, you are in the realm of the UCC.

2. If the UCC applies, time is of the essence in addressing the acceptance or rejection of goods. Careful inspection upon receipt of goods is extremely important.

3. The contractor should review its purchase orders in an effort to “inoculate” its purchasing transactions against battle of the forms’ issues. A few well-placed sentences can dramatically reduce the risk of disputes over conflicting contract terms.

4. The UCC specifies remedies that are often different and more restrictive than those available under common law. For example, the typical UCC statute of limitations is four years, whereas most states have a six-year breach of contract statute. Consult with your attorney as soon as a potential claim arises so that you do not lose your rights by failing to act promptly.

 

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