Chapter 1. Formation
Assignment 1: The Role and Scope of Codes in Sales Systems
A. Fundamental Aspects of Sales
· Sales “systems” mean all of the people, institutions, laws, and practices that are involved in transfers of ownership for a price.
· Whether a sale involves a corporation buying sophisticated machinery, or a consumer buying a DVD player at Sears, sales systems generally perform 4 functions that facilitate the transfer of ownership from seller to buyer.
1. Sales systems bring buyers and sellers together and enable them to create legally enforceable transfers of ownership.
§ In facilitating the formation function, the systems not only provide legal rules to define when formation occurs but also provide people and institutions that help enable formation to happen at all.
2. Sales systems provide a set of standard terms that govern the transfer of ownership unless the buyer and seller choose to modify the standard terms.
§ For example, the UCC acts as a gap filler.
§ One important caveat is not to confuse the code (UCC) with the sales system itself.
3. Sales systems provide a set of delivery institutions that facilitate the possessory, legal, and symbolic transfer from seller to buyer.
§ For example, the sales system provides a menu of standardized delivery terms that allow parties to select different arrangements with respect to insurance costs, delivery charges, and passage of the risk of loss from seller to buyer.
4. Sales systems enforce agreements to transfer ownership by giving the aggrieved buyer or seller various remedies for breach by the other.
§ These remedies might be non-legal, such as a buyer’s refusal to buy in the future from a seller. Or, these remedies could consist of the various damage formulas provided by the UCC.
· Basically, the four subsystems of a sales system are:(1) formation,(2) terms,(3) performance, and (4) remedies.
· International sales are generally governed by the Convention on Contracts for the International Sale of Goods (CISG).
B. The Real World of Sales
· There seem to be two, only slightly overlapping, worlds out there:(1) the world of business practice, and(2) the world of law.
o In the world of business practice, law is much less significant than reputation and leverage as forces that govern the day-to-day behavior of the actors.
o If there is a long-term relationship at stake, both sides have an incentive to compromise and to avoid the litigation world.
· “People often renegotiate deals that have turned out badly for one or both sides. They recognize a range of excuses much broader than those accepted in most legal systems.”
· There are at least three ways in which sales law has an impact on sales systems:(1) the law of sales will be crucial in those instances where the normal business relationship breaks down and the parties end up in the litigation world.(2) when parties to a sales agreement negotiate informal settlements to disputes, they will probably do so in the “shadow of the law.”(3) legal rules are important in sales systems because they help dictate the terms of the various forms that business people use in conducting transactions within a given sales system.
C. Functions of a Code in Sales Systems
· A code has an important role to play in sales systems, and that is the role of gap-filling.
o Parties to a sales contract cannot think of every contingency in advance.
· As hard as a code drafter might try, no code will successfully fill all of the gaps in all of the contracts that the code is intended to cover. That is where the common law comes in, as a kind of back-up gap-filler.
· If the code and common law conflict, the code usually wins. The common law still acts as a supplement though.
· The common law continues to play at least three roles in law-related sales systems:(1) in cases where Article 2 is merely codifying existing law, the common law can help define terms that the UCC has left undefined.(2) in some UCC sections and Official Comments, the Code drafters make it clear that the UCC provision in question is not intended to affect certain related common-law doctrine. Thus, parties must still look to the common law to define the parameters of that related doctrine.(3) there are a number of common law doctrines that are never referred to explicitly in UCC sections or Comments but that nevertheless continue to operate side-by-side with Code provisions. These include such concepts as mitigation of damages, frustration of purpose for a buyer, and even such related tort theories as intentional interference with contract.
D. Scope of Article 2
· Whatever the governing set of rules for the system, it is important that players in the system know whether they will ultimately be subject to those rules or not.
· Article 2 is the most prevalent set of default rules for sales of goods.
· Article 2 emphasizes the importance of courts enforcing course of performance or course of dealing – that is, the actual practices used by the disputing parties before the relationship broke down – when faced with a sales dispute.
· While there are lots of gap-fillers in Article 2, two of them tend to provide the most common reasons why parties fight about whether or not Article 2 applies to their transaction: the warranty gap-filler and the statute of limitations gap-filler.
o For example, UCC §2-725(1) gives a plaintiff four years to commence an action for breach of a sales contract, but the four years is measured from the time when the cause of action accrued, whether or not the plaintiff was aware of it.
o Many state statutes of limitations for general contract actions, by contrast, do not begin running until the plaintiff actually discover or should have discovered the breach.
· There are at least four ways in which a UCC gap-filler will be superseded:(1) the gap-filler will not apply to a particular term if the contract itself specifies what that term should be.(2) even where the parties’ written contract is silent on a particular matter, the parties’ repeated occasions for performance within that contract may establish an agreement by implication. [“course of performance”](3) where parties’ past dealings with one another have established a particular way that the parties do business with one another, that history may establish by implication certain standard terms between the parties. [“course of dealing”](4) if there is a custom in a particular industry concerning a performance term, that custom will prevail over the UCC gap-filler whenever the two are inconsistent. [“usage of trade”]
· On the issue of scope, Article 2’s provisions are most deficient in their coverage of what are commonly known as “mixed contracts”: those involving a combination of goods and services, or a combination of goods and something other than services.
· Courts have taken two approaches to these mixed contracts.
o Most courts apply some version of a “predominant purpose test,” by which the court decides whether the predominant purpose of the transaction is to sell goods or services.
§ If it is goods, then Article 2 applies to the whole transaction, even the services portion of it.
§ If it is services, then Article 2 does not apply to any part of the transaction, not even the goods portion.
o The other common approach is the “gravamen of the action” test.
§ Under this test, the court determines whether the gravamen of the action (the source of the complaint) is with the goods or the services portion of the transaction.
· Each of the above tests has its problems. For example, it is often quite difficult to distinguish between goods and services.
· The UCC defines “goods” as all things “which are movable at the time of identification to the contract for sale.”
o Goods “must be both existing and identified before any interest in them can pass.”
· Nowhere does it say that a court cannot apply the principles of Article 2 to subjects that are admittedly not within the formal scope of Article 2.
· Many courts have in fact heeded the admonitions of the UCC drafters, who note with favor in at least one Official Comment those courts that “have recognized the policies embodied in an act as applicable in reason to subject-matter which was not expressly included in the language of the act… where reason and policy so required, even where the subject-matter had been intentionally excluded from the act in general.”
· Probably the most significant Article 2 concept for a court to apply by analogy in non-goods transactions is the implied warranty of merchantability.
o In a nutshell, the warranty of merchantability promises the buyer that the goods will be fit for their ordinary purpose.
· Merchants occupy a special place within Article 2. There are special default rules that apply only with respect to merchants. i.e. In many parts of the UCC, those qualifying as merchants are held to higher standards than are other players in the system.
· § 2-104(1) defines “merchant” as “a person who deals in the goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by his employment of an agent or broker or other intermediary who by his occupation holds himself out as having such knowledge or skill.”
· The law of implied warranty in the commercial code is found in §2-315 which states: “Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.”
· Another insta
e is a “full payout lease” (i.e., where the lessee pays an amount equal to or greater than the lessor’s cost of the goods or their fair market value),(c) whether the lessor is a financing agency,(d) whether there is an acceleration clause in the lease,(e) whether the lessor has permission to file a financing statement, and(f) whether the lessee has an option to purchase the goods for a nominal consideration.
· Revised §1-201(37) Test: if the obligations of the lessee under the lease are not subject to termination by the lessee, and if the lease is for the full economic life of the goods (or if the lessee may, without further consideration, acquire all rights in the goods for the full economic life of the goods) then a security interest is created. But if the lessor retains the reversionary interest in the goods, then the transaction is a true lease.
· To determine whether an agreement represents a sale or a lease, the bankruptcy court must look to applicable state law.
· The test for whether the lessee has an option to become the owner of the goods for nominal additional consideration is whether “the option price is so low that the lessee will certainly exercise it and will, in all plausible circumstances, leave no meaningful reversion for the lessor.”
The UCC’s definition of “security interest” properly concedes that “whether a transaction creates a lease or a security interest is determined by the facts of each case.”
UCC §1-201(37) does two useful things:(1) it sets out four different scenarios in which the transaction in question must be considered a disguised sale. This list is not exhaustive.(2) it sets out a number of factors that do not by themselves necessarily create a disguised sale.
The drafters of Article 2A also created special rules for two distinct kinds of leases:(1) the consumer lease, and(2) the finance lease.
With respect to the consumer lease, the drafters did not assume equal bargaining power and therefore created some special protections for the consumer lessee.
The finance lease departs from the paradigm lease transaction in that it involves three parties rather than two, and the putative “lessor” is really no more than a provider of financing to the lessee.
Article 2A includes a number of provisions that reduces the finance lessor’s responsibility for the performance of the leased goods and instead create direct rights for the lessee against the seller, known as the “supplier.”
B. Scope of the CISG
CISG = Convention on Contracts for the International Sales of Goods.
· When two foreign nations are signatories to the CISG, that Treaty governs contracts for the sale of goods between parties whose places of business are in such nations unless the contract contains a choice of law provision to the contrary.
Like Article 2 of the UCC, the CISG is by its terms a default mode that parties may opt out of.
There are at least three key matters included in UCC Article 2 but excluded from the CISG:(1) the CISG does not cover the sale of consumer goods, unless the seller neither knew nor should have known that the goods were being purchased for a consumer purpose.(2) Article 5 says that CISG does not apply to the liability of the seller for death or personal injury caused by the goods sold.(3) the CISG specifically excludes from its coverage issues of whether the sale to the buyer cuts off the property interests of third parties in the goods that were sold.
C. Real Estate
There is no widely adopted uniform code in the real estate system that plays a role comparable to that played by the UCC in the personal property system.
Thus, real estate law is often a function of the geographical idiosyncrasies of particular states or regions of the country.
UCC §2-107 attempts to draw a line between the personal property and real property aspects of sales that in some respects affect both.
Section 2-107(1) says that a contract for the sale of things which are to be removed