A New Approach to Limitations of Remedies and Damages Under the

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A New Approach to Limitations of
Remedies and Damages Under the
UCC
By Peter C. John
This article reviews the
Illinois Supreme Court’s
decision in Razor v Hyundai
Motor America, which
changed existing Illinois law
by limiting the failure of a
remedy to the remedy rather
than also implicating the
limitation on damages.
M
ost commercial contracts for the sale of goods
entered into between businesses contain some
form of limitation of remedy and/or limitation
of damages. Although these concepts are often
grouped together, they are essentially separate, with separate
limitations and separate defenses. It is important for lawyers to
understand this distinction, because for 36 years Illinois courts
ignored it and held that if a limited remedy fails of its essential
purpose, the limitation of damages also fails.
The law in Illinois has now dramatically changed. This article explains the
practical differences between limitation of remedy and limitation of damage
clauses and analyzes the prior failure to recognize the logical distinction between both clauses. It then looks at the Illinois Supreme Court’s 2006 decision in Razor v Hyundai Motor America,1 which changed existing Illinois law
by limiting the failure of a remedy to the remedy rather than also implicating
the limitation on damages. It is important for practitioners to understand the
basis for this change, which should significantly influence litigation strategy
and results in disputed commercial transactions.
__________
1. 222 Ill 2d 75, 854 NE2d 607 (2006).
______________________________________________________________________________________
Peter C. John <[email protected]>, of Williams, Montgomery & John in
Chicago, is a commercial trial lawyer with almost forty years of experience,
and served for nine years on the Illinois Supreme Court Civil Jury Instruction
Committee. Hong Lee, an associate, provided research support.
1
Background
The main source for contractual limitations under Illinois law is the statutory Uniform Commercial Code (UCC)
section 2-103 et seq, which applies to
the sale of goods only.2 In contract actions controlled by the UCC, the relevant remedy provisions are listed in section 2-703 (Seller’s Remedies in General)
and section 2-711 (Buyer’s Remedies in
General).
Both sections include non-damage
remedies such as withholding delivery
of goods by the seller (section 2-703(a))
or buyer’s rightful rejection (section 2711(1)) or specific performance (section
2-711(2)(b)). The remedies sections also
list many types of traditional damage
claims, e.g., claims for money (sections
2-703(d and e), 2-711(1)(a and b)).
Thus, the UCC includes traditional
damage claims as remedies. We point
this out since it becomes relevant when
we evaluate the UCC limitations, which
treat remedy and damage limitations
separately.
The UCC provision concerning limitation of remedy and damages is UCC
section 2-719, which provides as follows:
2-719. Contractual modification or
limitation of remedy.
(1)Subject to the provisions of subsections (2) and (3) of this Section and of the preceding section on liquidation and
limitation of damages,
(a) the agreement may provide for
remedies in addition to or in substitution for those provided in this Article and may limit or alter the measure
of damages recoverable under this Article, as by limiting the buyer’s remedies to return of the goods and repayment of the price or to repair and replacement of non-conforming goods
or parts; and
(b) resort to a remedy as provided is
optional unless the remedy is expressly
agreed to be exclusive, in which case it
is the sole remedy.
(2)Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as
provided in this Act.
(3)Consequential damages may be
limited or excluded unless the limitation
or exclusion is unconscionable. Limitation of consequential damages for injury
to the person in the case of consumer
goods is prima facie unconscionable but
limitation of damages where the loss is
commercial is not.
The interaction between sections 2719(2) and (3) with respect to limita-
tions of both remedies and damages
is the subject of the Illinois Supreme
Court’s decision in Razor.
Illinois law prior to Razor
automatically fails with the remedies
limitations clause.5
In J. I. Case, the court held that the
defendant’s failure to fix a broken tractor pursuant to a limited warranty of repair rendered that limitation – including
its restriction on consequential damages
under section 2-719(3) – unenforceable:
Until the Illinois Supreme Court decision in Razor, the lower Illinois state
courts that had taken up this issue did
Had [the defendants] reasonably comnot interpret sections 2-719(2) and 2plied with their agreement contained in
719(3) separately with respect to the
the warranty they would be in a position
defense to each limitation, even though
to claim the benefits of their stated limeach defense is recognized as a separate
ited liability and to restrict plaintiff to his
test measured at different time periods.
stated remedy. The limitations of remedy
The section 2-719(2) test is the failure
and of liability are not separable from
of essential purpose of the remedy at the
the obligations of the warranty. Repudiation of the obligations of the warranty
time of performance, while the section
destroy[s] its benefits.6
2-719-(3) test is unconscionability at the
time of contracting.
In the past, Illinois UCC
jurisprudence has held that
if a remedy fails of its
It is important for practitioners
essential purpose under
section 2-719(2), the limito review Razor, which should
tation of damages under
significantly influence litigation
section 2-719(3) also fails
on a benefit of the barstrategy and results in disputed
gain theory.3 Accordingly,
commercial transactions.
Illinois courts treated limitation of damage clauses
under section 2-719(3) as
being dependent on the
limitation of remedies
Nowhere did the court discuss unclauses under section 2-719(2).
conscionability
at the time of contractFor instance, consider the case where
there is a contract for the sale of goods in ing. The court specifically acknowledged
Illinois. This contract contains a remedy that plaintiff did not plead coercive,
limitation clause that provides that the fraudulent, or unconscionable sales tac7
exclusive remedy for a breach in the sale tics. The court only relied on section 2of goods is repair or replacement under 719(2), which states that where an exsection 2-719(2). The contract also con- clusive or limited remedy fails of its estains a clause providing that consequen- sential purpose, remedy may be had as
8
tial damages are unavailable pursuant to provided by the UCC.
One of the remedies available under
section 2-719(3).
Suppose in this instance that a party the UCC is the limitation of consequenrepudiates its repair obligations under a __________
2. 810 ILCS 5/2-103. If the contract involves
limited remedy clause, thereby causing
services, it is not controlled by the UCC, but by Illinois
the remedy to fail in its essential purpose. common law. There are no Illinois cases of which the
Under the reading of section 2-719 set author is aware which have adopted the UCC principles
limitations for services unless the contract
forth in Adams v J. I. Case Co,4 the seller concerning
is predominantly for the sale of goods. See Belleville
may not enforce the benefits of the lim- Toyota, Inc v Toyota Motor Sales, USA, Inc, 199 Ill
2d 325, 352, 770 NE2d 177, 194-95 (2002); And
ited remedy under section 2-719(2).
Zielinski v Miller, 277 Ill App 3d 735, 741, 660 NE2d
In addition, the seller will also lose 1289, 1294 (3d D 1995).
3. Adams v J. I. Case Co, 125 Ill App 2d 388,
any purported limitation on consequen261 NE2d 1, 7-8 (4th D 1970) (“It should
tial damages under section 2-719(3) re- 402-03,
be obvious that they cannot at once repudiate their
gardless of whether the section 2-719(3) obligation under their warranty and assert its provisions
remedy was unconscionable at the time beneficial to them.”); see also Lara v Hyundai Motor
331 Ill App 3d 53, 63, 770 NE2d 721, 729
of contracting. Even though the buyer America,
(2d D 2002).
would still have the remedy of direct
4. J. I. Case (cited in note 3).
5. Id at 402-03, 261 NE2d at 8.
damages if consequential damages re6. Id at 402, 261 NE2d at 7.
mained barred, Illinois courts have held
7. Id.
8. Id at 403, 261 NE2d at 8.
that the limit on consequential damages
2
tial damages. The court’s evaluation may
well have assumed that the provision
that remedy may be had as provided by
the UCC trumps the section 2-719(3)
limitation.9
Earlier Illinois cases followed the
analysis of J. I. Case. In Lara v Hyundai Motor America, the court held that
an issue of fact existed as to whether the
limited remedy of repair and replacement was met.10 However, without any
analysis the Lara court stated that
If the finder of fact concludes that the limited remedy of replacement or repair of
defective parts failed of its essential purpose, the express warranty’s exclusion
of consequential and incidental damages
will have no effect and those damages
will be available to plaintiff pursuant to
the UCC.11
These cases culminated in the Illinois
First District Appellate Court’s decision
in Razor. There, the court again held
without analysis that
[W]here a contract limits a remedy to repair and/or replacement of defective parts
or goods and the remedy failed in its
essential purpose, a provision excluding
incidental and consequential damages will
have no effect and those damages will be
available to the plaintiff pursuant to the
UCC.12
The Razor decision
The Razor case was appealed to the
Illinois Supreme Court, which performed
a thorough analysis of the issue and abrogated J. I. Case and Lara. In Razor,
the Illinois Supreme Court confronted
the holding in J. I. Case over the enforceability of a consequential damages
disclaimer in a limited warranty. The
plaintiff in Razor purchased a new car
from the defendant that eventually broke
down soon after purchase. The plaintiff
initiated an action against the defendant for breach of written warranty and
of implied warranty of merchantability
under the Magnuson-Moss Warranty
Act. He prevailed in arbitration, trial,
and again on appeal.
Before the Illinois Supreme Court,
the defendant argued that the lower
courts had improperly invalidated the
warranty’s limitation on consequential/
incidental damages when they held that
the car’s warranty failed of its essential
purpose under UCC section 2-719(2).
The defendant did not contest the
finding that its warranty had failed of its
essential purpose.13 Rather, it argued that
the lower courts improperly disregarded
ing the buyer’s remedies to return of the
the car warranty’s limitation on congoods and repayment of the price or to
sequential/incidental damages without
repair and replacement of non-conformmaking a separate finding that the limiing goods or parts.
tation was unconscionable under section
And UCC section 2-719(2) provides
2-719(3).
thusly:
In considering this issue, the Illinois
(2) Where circumstances cause an exSupreme Court noted the existence of
clusive or limited remedy to fail of its esthree different schools of thought: (i) the
sential purpose, remedy may be had as
“dependent approach” used in J. I. Case
provided in this Act.
Co, where the enforceability of a consequential damages exclusion was continThe Razor court held that
gent on the survival of a
limitation of remedy; (ii) the
the existence of two different
“independent approach,”
standards in the UCC for
where the enforceability of
a consequential damages
evaluating limitations on
exclusion depended upon
remedies and consequential
a finding that the exclusion is not unconscionable,
damages supported treating
regardless of whether any
them differently.
limitation of remedy survived; and (iii) the “case by
case” approach.
After analyzing the benefits and drawbacks of these three apUCC section 2-719(3) provides as folproaches, the Illinois Supreme Court lows:
opted to follow the majority of other
(3) Consequential damages may be
jurisdictions in adopting the independent
limited or excluded unless the limitation
or exclusion is unconscionable. Limitation
approach.14 The court noted that nothing
of consequential damages for injury to the
in the text or comments to section 2-719
15
person in the case of consumer goods is
supported the dependent approach.
prima facie unconscionable but limitaRather, the court held, the existence of
tion of damages where the loss is comtwo different standards in the UCC for
mercial is not.
evaluating limitations on remedies and
Notice that the drafters of section 2consequential damages (failure of es719 appear to separate remedies from
sential purpose and unconscionability,
damages in (1)(a) by allowing the parties
respectively) supported the independent
to “limit or alter the measure of dam16
approach.
ages recoverable under this Article, as by
The court also found that the depen- limiting the buyer’s remedies to return of
dent approach’s automatic elimination __________
of limitations on consequential damages
9. See also Jones & McKnight Corp v Birdsboro
without considering the good/bad faith Corp, 320 F Supp 39, 43-44 (ND Ill 1970) (applying
of the seller went beyond the contempla- Pennsylvania law) (holding that failure to repair under
exclusive remedy provisions of section 2-719(2) would
tion of the UCC,17 and that adopting the vitiate the purported limitation on damages under
more common independent approach section 2-719(3) and permit recovery of consequential
again without mention of unconscionability
promoted the UCC’s goals of unifor- damages
under section 2-719(3)); Dynamic Recycling v Shred
18
mity.
Pax Corp, 210 Ill App 3d 602, 614-15, 569 NE2d
The Illinois Supreme Court’s decision 570, 577-578 (2d D 1991) (holding that defendant’s
failure to remedy defects in tire shredder precluded
in Razor is consistent with a reasonable enforcement of limitation on damage provision under
section 2-719(3)).
interpretation of UCC section 2-719.
10.Lara at 63, 770 NE2d at 729.
Again, section 2-719 (1)(a) provides as
11.Id, citing 810 ILCS 5/2-719(2).
follows:
12.Razor v Hyundai, 349 Ill App 3d 651, 667, 813
(1) Subject to the provisions of subsections (2) and (3) of this Section and of the
preceding section on liquidation and limitation of damages,
(a) the agreement may provide for
remedies in addition to or in substitution
for those provided in this Article and may
limit or alter the measure of damages recoverable under this Article, as by limit3
NE2d 247, 262 (1st D 2004), citing Lara at 63, 770
NE2d at 729.
13.Razor (SC) at 87, 854 NE2d at 615.
14.Id at 98-99, 854 NE2d at 622.
15.Id at 92, 854 NE2d at 618.
16.Id at 92-93, 854 NE2d at 618-19.
17.Id at 94-95, 854 NE2d at 619-20.
18.Id at 99, 854 NE2d at 622. Lack of uniformity
and predictability, in turn, is what motivated the court
to reject the “case by case” approach. Id at 90-91, 854
NE2d at 617-18.
the goods and repayment of the price or
to repair and replacement of non-conforming goods or parts.” (Emphasis supplied.) These limited remedies do not include damages.
Thus, under section 2-719(1)(a) the
parties can agree to limit the remedies
to non-damage remedies only. Therefore, the issue of limited remedy is dealt
with separately only in section 2-719(2)
whereas section 2-719(3) only deals with
a limitation of damages.
This distinction continues in section 2-719(2) and (3), which provide
defenses to limitations of remedies and
damages. Section 2-719(2) provides that
when a limited remedy fails of its essential purpose, then the limited remedy ends. Section 2-719(3), on the other
hand, deals only with a damage issue
– special, incidental and consequential
damages – stating that if a limitation
of consequential damages is unconscionable, it fails. Thus, the different treatment of defenses in section 2-719(2) and
section 2-719(3) strongly suggests that
each section should be analyzed independently.
There is no express provision in section 2-719, or anywhere else in the UCC
which provides the limitation of consequential damages ends due to the failure of its essential purpose of a limited
remedy under section 2-719(2). Only a
limited remedy under section 2-719(2)
can fail of its essential purpose under
the UCC.
If, for example, the contract contains
a limited “repair or replacement” remedy, but the seller has failed to perform
its repair obligations during the warranty period, a jury would be justified
in finding that the repair or replacement
remedy failed of its essential purpose.19
Accordingly, the failure of essential purpose analyzes the performance of the
limited remedy.
Unconscionability of the damage limi­
tation, on the other hand, is evaluated
from the perspective of the parties’ rela­
tive bargaining position at the time of
contract formation.20 Illinois specifically
recognizes the defense of unconscionability in a breach of contract action.21
Unconscionability can be found on either procedural or substantive grounds,
or a combination of both.22
“Procedural unconscionability consists of some impropriety during the
process of forming the contract depriving a party of a meaningful choice.”23
Substantive unconscionability, on the
other hand, “concerns the actual terms
of the contract and examines the relative
fairness of the obligations assumed.”24
Based on evidence adduced at trial in Razor that the warranty and consequential/
incidental damages exclusion were not
shown to the plaintiff at the time of sale,
the Illinois Supreme Court made the independent determination that exclusion
was procedurally unconscionable under
section 2-719(3) and refused to apply the
exclusion against the plaintiff.25
It is also clear that the analysis for
evaluating defenses to section 2-719(2)
limitation of remedy provisions and section 2-719(3) limitation of consequential
damages are completely different. The
relevant time for analyzing each defense
is different as well.
A limited remedy is allowed unless
it fails of its essential purpose, which is
to provide the limited remedy the buyer
agreed to accept in the commercial negotiations. The failure is judged during
the performance of the limited remedy
by the seller and still leaves the buyer
able to recover based on other remedies,
including direct damages.
By way of contrast, the test for unconscionability focuses on the formation
of the contract based on the requirement
of procedural unconscionability. Its purpose is to prevent a seller from taking
advantage of the buyer in the negotiation
pre-contract process.
In short, a close inspection of the
construction of section 2-719(2) and 2719(3) remedy and damage limitations
finds that they were intended to be evalu­
ated separately as the Illinois Supreme
Court has now held in Razor since each
is a different concept, and each is judged
by different standards both in the elements to determine failure and the time
period to judge failure.
Federal courts started
the change in result
Several federal courts in Illinois had
previously rejected the J. I. Case analysis
of sections 2-719(2) & (3) under Illinois
law. Each court treated sections 2-719(2)
remedies limitation provisions and section 2-719(3) consequential damage
limitation provisions separately.26
In AES Technology Systems, Inc v
Coherent Radiation, the seventh circuit said, “[W]e reject the contention
that failure of the essential purpose of
4
the limited remedy automatically means
that a damage award will include consequential damages.”27 Rather, the AES
court requires an analysis of whether a
section 2-719(3) consequential damages
clause is unconscionable before allowing consequential damages. In ruling
that sections 2-719(2) and (3) should be
analyzed independently, the AES court
emphasized that “[t]he purpose of the
courts in contractual disputes is not to
re-write contracts by ignoring parties’
intent; rather, it is to interpret the existing contract as fairly as possible when all
events did not occur as planned.”28
Other jurisdictions have also recognized this distinction between the defense to a remedy limitation in section 2-719(2) and a damage limitation in
section 2-719(3).
For example, the U.S. District Court
for the District of Connecticut in McKernan v United Technologies Corp, Sikorsky Aircraft Division,29 concluded that
the Connecticut Supreme Court would
hold that the UCC subsection authorizing the exclusion of consequential damages – section 2-719(3) – is independent
from the limited remedy provision, section 2-719(2), and fails only if unconscionable, not when the limited remedy
__________
19.See J. I. Case at 402, 261 NE2d at 7.
20.810 ILCS 5/2-302.
21.See Kinkel v Cingular Wireless LLC, 223 Ill 2d 1,
20, 857 NE2d 250, 263 (2006).
22.Razor (SC) at 99, 854 NE2d at 622; but see
Zobrist v Verizon Wireless, 354 Ill App 3d 1139,
1148, 822 NE2d 531, 541 (5th D 2004) (“‘“The more
substantively oppressive the contract, the less evidence
of procedural unconscionability is required to come to
the conclusion that the term is unconscionable, and
vice versa.”’”) Id, quoting Ting v AT&T, 319 F3d
1126, 1148 (quoting Armendariz v Foundation Health
Psychcare Services, Inc, 24 Cal 4th 83, 114, 6 P3d 669,
690 (2000)).
23.Kinkel at 23, 857 NE2d at 264, quoting Frank’s
Maintenance & Engineering, Inc v C. A. Roberts Co,
86 Ill App 3d 980, 989-90, 408 NE2d 403, 410 (1st D
1980).
24.Kinkel at 28, 857 NE2d at 267, quoting Maxwell
v Fidelity Financial Services, Inc, 184 Ariz 82, 89, 907
P2d 51, 58 (1995).
25.Razor (SC) at 101, 854 NE2d at 623. The dissent
supported the majority’s adoption of the independent
approach. Id at 111, 854 NE2d at 629 (McMorrow
dissenting). However, the dissent took issue with the
majority’s holding on unconscionability on the grounds
that the majority opinion imposed upon manufacturers
an unreasonable requirement to ensure the presentation
of warranties at the time of sale, and would thereby
discourage manufacturers from offering warranties on
their products. Id at 119, 854 NE2d at 633.
26.AES Technology Systems, Inc v Coherent Radiation, 583 F2d 933, 941 (7th Cir 1988).
27.Id.
28.Id. See also, Smith v Navistar Intl Trans Corp,
957 F2d 1439, 1443 (7th Cir 1992); Lefebvre Intergraphics, Inc v Sauden Machine Ltd, 946 F Supp 1358,
1370-71 (ND Ill 1996).
29.717 F Supp 60 (D Conn 1989).
fails in section 2-719(2).30 The court also
recognized that the UCC “tests each by
a different standard” and there are “two
discrete ways of attempting to limit recovery for breach of warranty.”31 Even
back in 1989, when McKernan was
decided, this treatment of the two subsections as independent was described
as “the current trend” and the “better
reasoned approach.”32
The Indiana Supreme Court in Rheem
Mfg Co v Phelps Heating & Air Conditioning, Inc,33 held the exclusion of
consequential damages under section 2719(3) fails only if unconscionable at
the time of contract and is therefore independent of the failure of essential purpose of the limited remedy under section 2-719(2).34 The court provided four
sound reasons why that result is dictated
by the UCC:
1. The drafters of the UCC inserted
distinct legal standards differentiating
section 2-719(2) from section 2-719(3),
and there are also distinctions in who applies the standards – section 2-719(2) a
jury, whereas section 2-719(3) the court.
2. The independent view is consistent
with statutory interpretation to give full
effect to each of the terms. A dependent
view would read section 2-719(3) as unnecessary when there is a failure of essential purpose.
3. The independent view supplies simplicity and clarity by allowing a clearly
expressed agreement to control a transaction, and allows the parties to anticipate the results.
4. The independent view allows the
parties freedom of contract, a goal of
the UCC.35
Conclusion
In Razor, the Illinois Supreme Court
finally conducted its own evaluation of
this significant commercial issue rather
than reciting prior Illinois boilerplate
from the J. I. Case decision. It thus
joined the majority of jurisdictions and
followed the more logical path. ■
__________
30.Id at 72.
31.Id at 70, quoting Chatlos Systems, Inc v NCR
Corp, 635 F2d 1081, 1086 (3d Cir 1980).
32.McKernan, 717 F Supp at 70.
33.746 NE2d 941 (Ind Sup Ct 2001).
34.Id at 947-48.
35.Id at 948-51.
Reprinted from the Illinois Bar Journal,
Vol. 96 #2, February 2008.
Copyright by the Illinois State Bar Association.
www.isba.org
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