The Statute of Frauds
§2-201: Statute of Frauds:
1. A K for the sale of goods for the price of $500 or more must be evidenced by a
writing. The writing must contain three things:
1. A quantity
2. An indication that a K has been made
3. Signed by the “party to be charged.”
§1-201(39): “Signed” includes any symbol executed or adopted by a party with
present intention to authenticate a writing.
§1-201(46): “Written” or “writing” includes printing, typewriting, or any other
intentional reduction to tangible form.
2. This involves a special situation. Example:
1. Assume that A calls B and places an order for 100 widgets at $10/widget.
Normal business practice would cause B to send an acknowledgement to
A for the $1000 order.
2. Assume further that once A receives B’s acknowledgement, A calls C and
says, “I have a commitment whereby I can buy 100 widgets for $1000.
Can you beat it?” C says, “Ok, I’ll supply them to you for $900,” and in
the normal course of business, C sends A an acknowledgement for the
$900 order. Note: at this point, A has signed nothing, but under 2-201,
both B and C are bound.
3. A continues to go back and forth b/w B and C to extract the lowest price,
and use the writing to his benefit, but never against him.
o
Solution: 2-201(2) changes the law provided all parties are merchants, i.e.,
“between merchants.” It says if B (or C) sends a writing to A that would
bind them under 2-201(1), it will also bind A if A does not object in
writing within 10 days of its receipt.
3. The three situations under 2-201(3) that do not require a writing are:
1. Part payment or part performance, but only for that part paid or for that
part performed, or
2. A party admits in pleading, testimony, or otherwise in court that the K
exists, or
3. Specially manufactured goods not suitable in the ordinary course of
business for resale.
Problem 6:
On Dec 10, Ross, president of Ross Ice Cream, phoned Scott, president of Amundsen Ice Company, and
negotiated the purchase of two tons of ice from Amundsen at $256/ton. As they talked on the phone, Scott
picked up a memo pad enscribed “Amundsen Ice Company From the Desk of the President,” wrote on it “2
tons Ross Co.,” and then scribbled his initials on it. When the parties hung up the phones, Scott placed the
memo on a spindle marked “Orders.” Ross wrote Scott a letter beginning “Dear Bob: this is to confirm our
ice purchase deal . . . ,” which described their transaction completely. Scott received the letter on Dec 14.
On Jan 17, Scott phoned Ross and denied the existence of the contract and detailed in the Ross letter.
Answer these questions:
(a) Does the memo pad note satisfy §2-201(1)?
Yes, it is a writing indicating the contract and signed (initials = signature) by Scott, the party against
whom the enforcement is sought. .
(b) What legal effect did the Dec 14 letter have? Same result if Ross’s letter failed to mention the quantity?
Even if the letter satisfies the SOF, is it conclusive as to the existence and terms of the contract?
It is a written confirmation under §2-201(2) and binds Scott because he didn’t object in writing within 10
days of receipt. If the confirmation didn’t mention quantity, it wouldn’t be effective because it doesn’t
satisfy §2-201(1). No, satisfying the SOF just allows you to go to trial, it doesn’t prove your case.
(c) Did Scott’s denial of the terms contained in Ross’s letter avoid the operation of §2-201(2)? Suppose
Scott had immediately written Ross a letter stating, “You haven’t stated the terms correctly. We only
agreed to sell you 1.5 tons.” Would that letter be sufficient notice of objection?
No, he had to deny in writing. If he wrote a letter it would be a valid objection to the quantity, not the
contract.
(d) If there had been no confirmation letter, suppose Ross files suit and Amundsen responds with a
demurrer, may the trial court judge dismiss on the pleadings? If Scott admits the K formation in a
deposition, would §2-201(3)(b) be satisfied? Does §2-201(3)(b) always require the judge to permit the
matter to go to trial?
No, because there is still the spindle order form initialed by Scott to evidence the formation of a contract,
this should satisfy the SOF. If Scott admits the K, §2-201(3)(b) would be satisfied.
St. Ansgar Mills, Inc. v. Streit
* has bought corn from * for a long time. * usually always stops by each month to pay off
his account and usually forgets to sign and return the written confirmations, but usually
always accepts delivery of the corn from *. * ordered corn, * prepared a written
confirmation, but when * didn’t stop in that month, * delivered it to * the next month. *
then refused delivery. * sued for breach of K. Does the statute of frauds make this oral
contract unenforceable? Under §2-201(2), the SOF is satisfied if a written confirmation
of an oral contract is delivered within a reasonable time. §1-205(1) requires that all
relevant circumstances, including custom and practice of the parties, be considered in
determining what constitutes a reasonable time under §2-201(2). Many factors existed
showing the parties had developed a custom to delay delivery of the confirmation. These
factors make the issue over the reasonableness of the delay in delivering the confirmation
an issue appropriate for the jury. Summary judgment if favor of the defendant is
reversed.
•
§2-201(2) of the Statute of Frauds is at issue here, specifically whether the
confirmation was sent within a reasonable time.
•
The purpose of the section is to put professional buyers and sellers on equal
footing, because once this confirmation is sent, even if it is not signed by the
“receiver, “ it still binds both parties to the contract.
•
“Reasonable time“ is determined by all relevant circumstances, including
custom and practice of the parties, must be considered in determining what
constitutes a reasonable time under §2-201(2). The courts usually leave the
determination of the reasonableness of particular conduct to the jury.
§2A-201: Statute of Frauds:
Same as §2-201, except the amount of the lease must be at least $1000 before a writing is
required, and the writing must describe the leased goods and the lease terms in order to
satisfy the SOF. There is no equivalent of §2-201(2) though.
Problem 7:
The city manager of Thebes, Utah, which is world-famous for its beautiful desert golf course, orally
ordered a huge water tank to be made in the shape of a golf ball on a tee from Tanks of America. The price
was agreed to be $30,000, and the city sent Tanks a down payment check of $3000, signed by the city
comptroller and market “Tank” on the memo line. Tanks of America built the tank and was in the process
of painting “City of Thebes” on the side when a representative of a newly elected city administration called
and said that the new administration considered the K unenforceable.
(a) Does the check satisfy §2-201(1)? Where is the quantity?
By putting “tank” on the memo line, this evidences the existence of a contract. If a quantity isn’t stated, the
court presumes (on checks) that the quantity is one. So this satisfies §2-201(1).
(b) What legal argument can Tanks make based on §2-201(3)(a) and 2-201(3)(c)? Does the City of Thebes
have a good response to the §2-201(3)(c) argument?
Under 2-201(3)(a) the contract is still enforceable because the Tank is a one of a kind specially created for
the buyer and not suitable for others in the ordinary course of seller’s business and the seller has partially
performed already. Under §2-201(3)(c) they could argue that they have accepted payment already,
Thebes can’t really argue that they didn’t give a full payment to get out of §2-201(3)(c) because a court
will usually enforce the contract when one payment is made on the sale of one item.
(c) If the city had promised to sign a written contract but had never gotten around to doing so, can
promissory estoppel or equitable estppel be used to circumvent §2-201?
Yes, the code says unless it is specifically excluded from §2-201.
Problem 8:
Tomorrow, Inc. a computer company, and Systems Unlimited, company specializing in advising other
companies how to maximize their computer operations, entered into a written joint venture K by which
Tomorrow promised to design and sell to Systems software that would enable the latter’s customers to
receive engineering drawings by phone. The parties agreed that their arrangement was “non-exclusive”
(meaning either was allowed to deal with other buyers and sellers of the same product). The K described
the obligations of the parties in some detail and stated that the K would terminate after 2 years unless
renewed. In fact, after working with Tomorrow for only 6 months, Systems decided it could develop its
own software cheaper than buying it from Tomorrow, so it faxed a letter to the latter stating that their K
was at an end. Systems declined to purchase any further software. Tomorrow, which had incurred
substantial startup costs in developing the software for this K, was astounded and promptly filed suit.
Systems sought refuge in the SOF, arguing that the K signed by the parties stated no quantity. Does §2201(1) always require a specific quantity?
The K is not insufficient because it doesn’t state a quantity, §2-201 only says that if it had stated a
quantity, the K wouldn’t be enforceable beyond that quantity. (This applies when the quantity needed is
unknown.)
The Parol Evidence Rule
General rule: Oral or written statements or agreements that are made prior to or
contemporaneous with a written K are not going to be admissible. This rule limits what’s
admissible in court.
§2-202: Parol Evidence Rule:
Terms with respect to which the confirmatory memoranda of the parties agree or which
are otherwise set forth in a writing intended by the parties as a final expression of their
agreement with respect to such terms as are included therein may not be contradicted by
evidence of any prior agreement or of a contemporaneous oral agreement but may be
explained or supplemented
(a) by course of dealing or usage of trade (§1-205) or by course of performance (§2208); and
(b) by evidence of consistent additional terms unless the court finds the writing to
have been intended also as a complete and exclusive statement of the terms of the
agreement (total integration).
o
Official Comment 3: Test to determine if a K has totally integrated:
Would the term have “certainly” been included in the written contract? If
yes, this is a total integration
Problem 9:
Lawyers for Swinging Singles Magazine negotiated for an entire year with Space Age Aircraft to obtain a
K for the construction of a special Swinging Singles airplane. (The plane was to be black and silver, with
the Swinging Singles emblem painted on the tail; it was to contain a living room, a bed chamber, a
swimming pool and hot tubs, and a dance floor.) The resulting 30 page K also contained a merger clause,
stating that all prior negotiations were merged into the written K that contained all the terms of the
agreement. The K was signed by both parties. Does §2-202 bar the introduction of evidence of the
following?
(a) An alleged pre-contract agreement that Space Age would provide free flying lessons to Hi Handsome,
president of Swinging Singles? The K says nothing about this.
This may not have been certainly included in the written contract; therefore, there is not total integration.
So because this evidence doesn’t contradict the K, only supplements the K, the court would allow it in.
(b) An alleged pre-contract agreement that Swinging Singles could use the plane for 2 months, and if they
didn’t like it, they could return it for a full refund?
This would not be allowed under §2-202 because it certainly would have been included in the contract, so
this contract is already totally integrated.
•
To aid in the construction of agreements, the Code looks to the customs of the
industry (usage of trade), the parties “ past contracts with one another (course of
dealing), and the parties“ behavior during the existence of the contract in
question (course of performance) and presumes that these matters are relevant in
fleshing out the express terms of the K.
Columbia Nitrogen Corp. v. Royster Co.
Columbia and Royster executed a K for Royster to sell tons of phosphate each year for 3
years to Columbia. Phosphate prices soon dropped. As a result, Columbia ordered less
10% of the phosphate Royster was to ship in the first year. Columbia refused delivery at
the contract price. Royster sued. Columbia wanted to introduce evidence on usage of the
trade and course of dealings between the parties. Should evidence on the usage of the
trade and course of dealing between the parties be admissible? Yes. §2-202 allows this
evidence to explain or supplement a contract. Therefore a finding of ambiguity is not
necessary for the admission of this type of extrinsic evidence. The test of admissibility is
whether the evidence of course of dealing and trade usage can reasonably be construed as
consistent with the express terms of the agreement. The evidence here sought to establish
that because of changing weather conditions, dealers adjusted prices, quantities, and
delivery schedules to reflect declining market conditions. Columbia also sought to show a
practice of mutual adjustments so prevalent in the industry and prior dealings between the
parties that it formed part of the agreement governing this transaction. Because this
contract is silent about adjusting prices and quantities to reflect a declining market, it is
reasonable to construe this evidence as consistent with express terms of the K. This
evidence should be admitted.
•
The usage of trade and course of dealing should be excluded whenever it cannot be reasonably
construed as consistent with the terms of the contract.
•
The usage of trade and course of dealing can be used to supplement a written K when the offered
evidence of course of dealing and trade usage can be reasonably construed as consistent with the
express terms of the agreement.
•
There were 4 reasons why the evidence offered didn “t contradict the K and should be allowed to
supplement the K here: (1) the K doesn’t expressly state that course of dealing and usage of trade
cannot be used to explain or supplement the written K; (2) the K is silent about adjusting prices
and quantities to reflect a declining market; (3)the words “products supplies” as not the same thing
as “products” or “products purchased under the K”; and (4) the default clause of the K refers only
to the failure of the buyer to pay for delivered phosphate.
•
There are difference between §2-202(a) and§2-202(b) with regard to admissibility. §2-202(a)
allows supplementing a written contract by course of dealing or usage of trade, whereas §2-202(b)
only allows supplementing it by consistent additional terms. Evidence of additional terms aren’t
excluded in (a), only in (b) when there has been total integration of the K.
OFFER AND ACCEPTANCE
2-204: (Formation in General)
1. A contract for sale of goods may be made in any manner sufficient to show
agreement, including conduct by both parties which recognizes the existence of
such a contract.
2. An agreement sufficient to constitute a contract for sale may be found even
though the moment of its making is undetermined.
3. Even though one or more terms are left open a contract for sale does not fail for
indefiniteness if the parties have intended to make a contract and there is a
reasonably certain basis for giving an appropriate remedy.
2-205: (Firm “Merchant” Offer): (5 elements)
An offer by a merchant to buy or sell goods in a signed writing which by its terms gives
assurance that it will be held open is not revocable, for lack of consideration, during the
time stated or if no time is stated for a reasonable time, but in no event may such period
of irrevocability exceed three months; but any such term of assurance on a form supplied
by the offeree must separately signed by the offeror.
2-206: (Offer and Acceptance) (Formation of K)
1. Unless otherwise unambiguously indicated by the language or circumstances
a. an offer to make a contract shall be construed as inviting acceptance in
any manner and by any medium reasonable in the circumstances;
b. an order or other offer to buy goods for prompt or current shipment shall
be construed as inviting acceptance either by a prompt promise to ship or
by the prompt or current shipment of conforming of non-conforming
goods, but such a shipment of non-conforming goods does not constitute
an acceptance if the seller seasonably notifies the buyer that the shipment
is offered only as an accommodation to the buyer.
2. Where the beginning of a requested performance is a reasonable mode of
acceptance an offeror who is not notified of acceptance within a reasonable time
may treat the offer as having lapsed before acceptance.
Problem 10:
Mastervoice TV ordered 20,000 fuses from GE, the order stating “reply by return mail.” Instead of a
formal reply, GE immediately shipped the fuses. When the fuses arrived, they were found to be defective.
Mastervoice, which had to procure substitute goods elsewhere to meet its production schedule, sued GE for
breach of warranty.
a.
At what moment was the K formed?
Formed upon shipment.
b.
Can GE make this defense: “There was never any K since our alleged act of acceptance (the
shipment of defective goods) did not comply with requirements of Mastervoice’s offer (which
contemplated only shipment of good fuses)”?
No, this is not a defense b/c 2-206 says that there can be an acceptance even with nonconforming goods. (If ship non-conforming goods then there is an acceptance, but if ship
green dolls instead of blue dolls this is a counteroffer not an automatic acceptance.) GE
should have sent a note to Mastervoice so there would be no automatic acceptance.
c.
Instead of the above, assume that when GE received the order it discovered that it no longer
manufactured the type of fuses Mastervoice wanted, but that it did carry a very similar type of fuse
that it believed would suit Mastervoice’s needs. The shipping manager for GE was unable to get
through to the relevant people at Mastervoice, so in the end GE shipped the slightly different fuses
along with a cover note saying, “These are similar to the fuses you ordered but may not be right
for you. If they are not suitable, we will gladly take them back without charge.” Is GE now in
breach b/c it shipped non-conforming goods? See 2-206(1)(b)
No, GE is not in breach b/c they sent the letter along with it which constitutes a
counteroffer. This leaves it in Mastervoice’s hands now.
Problem 11:
For years P Dreamer had wanted a Rolls Royce Silver Shadow with burgundy-colored trim. He saw one on
the lot of Posh Motors. After Dreamer had dickered loud and long with Paula Posh, president of Posh
Motors, they finally agreed on a price. Dreamer said he wanted to clear the deal with his wife before
signing anything, so Posh promised she would hold the car for Dreamers until the next day at noon. When
Mr. and Mrs. Dreamer arrived at the dealership the next day, and the car was gone. Posh made a better deal
with another buyer. Do the Dreamers have a good cause of action? See §2-205. Does §1-103 help?
There is no good COA here, b/c a signed writing is missing, a requirement for 2-205
(firm offer rule). 1-103 doesn’t help b/c there is no writing.
B. Battle of the Forms
The battle of the forms is a much litigated problem that arises from 2 sources: (1) the
business practices of either negotiating deals orally and then exchanging printed forms
that no one reads until a dispute arises, or dealing at arms length with non-matching
purchase orders and acknowledgments, and (2) the complexities of §2-207 and its official
comment.
2-207: (Terms in acceptance and confirmation)
1. A definite and seasonable expression of acceptance or a written confirmation
which is sent within a reasonable time operates as an acceptance even though it
states terms additional to or different from those offered or agreed upon, unless
acceptance is expressly made conditional on assent to the additional or different
terms.
2. The additional terms are to be construed as proposals for addition to the contract.
Between merchants such terms become part of the contract unless:
a. the offer expressly limits acceptance to the terms of the offer;
b. they materially alter it; or
c. notification of objection to them has already been given or is given within
a reasonable time after notice of them is received.
3. Conduct by both parties which recognizes the existence of a contract is sufficient
to establish a contract for sale although the writings of the parties do not
otherwise establish a contract. In such case the terms of the particular contract
consist of those terms on which the writings of the parties agree, together with
any supplementary terms incorporated under any other provisions of this Act.
The way §2-207 works:
o
Subsection (1) to §2-207 is meant to reverse the common law rules that an
acceptance that was not the mirror image of the offer was (impliedly) both
a rejection and a counteroffer. Under §2-207(1), an acceptance adding
new terms created a contract based on the original offer, unless the
acceptance very clearly states otherwise. As to what happens to the
additional term, see §2-207(2).
o
If in spite of all logic and business judgment, the parties exchange
documents that cannot be reconciled so as to produce a contract, no
contract results, and either party may, on discovering this mishap, back out
of the deal if that party acts prior to the beginning of performance.
o
If performance has begun (with the parties wrongly believing a contract
exists) subsection (3) of §2-207 regulates the ensuing mess.
o
Always remember you will either use §2-207(2) or §2-207(3), but never
both.
Battle of the Forms Handout (UCC §2-207)
Assume:
•
You have an Offer (O) and a Return Document (RD)
•
The RD has either an additional term or a different term than was contained in the
O.
Additional term: O = ABC, RD = ABCD
Different term: O = ABC, RD = ABD
Question: Does the additional term or the different term make the return document a
counter-offer or an acceptance?
§2-207(1)
1. “definite and seasonable expression of acceptance”
** Answering YES and NO to the following questions…
a. Did the RD change a dickered term? (usually the price, quantity, or something the
parties negotiated)
b. Did the RD change or add a term widely divergent from the Offer?
c. Did the documents fail to agree on a major or critical term?
** See official comment 6 for guidance.
If NO, then go to number 2 below, but first ask: Does it trigger the proviso language?
(Expressly conditional on assent to the [different or additional term]). If NO, then go to
§2-207(2): Acceptance. If YES, then ask was there assent to the proviso clause? Is Yes,
a K exists according to the additional or different term. If No, then go to 2-207(3):
Counteroffer.
If YES, then go to §2-207(3): Counteroffer. (Still addresses the proviso language for
exam purposes- if properly done, you will never end up in both paragraphs 2 and 3.)
§2-207(2): Acceptance
2. Were the exchanges documents between Merchants?
If NO, a K exists. The additional or different term is merely a proposal for an addition to
the K unless the offeror expressly agrees.
If YES, the additional or different term will automatically become part of the K UNLESS
any one of the following 3 is present:
1. The additional or different term “materially alters,” or
2. There was a notice of an objection to the term within a reasonable time, or
3. The offer is limited to its terms.
If find any of the three above, then a K exists but the additional or different terms will not
be part of the contract. (For exam purposes, if find one of the above, still go through all
three).
§2-207(3): Counteroffer
3. Does the conduct of the parties indicate there is a contract?
If NO, then there is no K.
If YES, a K exists. The terms include all the terms on which the writings agree, PLUS
any UCC gap fillers, including but not limited to:
a. §2-308(a) place (seller’s place of business)
b. §2-309 time (reasonable time)
c. §2-305 price term (reasonable price)
d. §2-314 warranty of merchantability
e. §2-315 warranty of fitness for a particular purpose
Problem 12:
The Magic Carpet Co. had a long and profitable business relationship with Alibaba Carpet Manufacturers
of Baghdad, Illinois. 55 times Alibaba had sold carpets to Magic carpet. Each sale was carried out in the
following manner. A partner of magic carpet called Alibaba’s order department and ordered a certain
quantity of carpet at the price listed in the catalogue. After each oral order was made, the credit department
was consulted to determine if Magic was paid up. Then, if the credit was okay, the order department of
Alibaba typed the information from the order on one of its printed acknowledgement forms, each of which
had the following information on its face: The acceptance of your order is subject to all of the terms
and conditions on the face and reverse side hereof, all of which are accepted by buyer; it
supersedes buyer order’s form, if any. It shall become a contract either (a) when signed and
delivered by buyer to seller and accepted in writing by seller, or (b) at seller’s option, when buyer
shall have given to seller specification of assortments, delivery dates, etc…, or when buyer has
received delivery of the whole or any part thereof, or when buyer has otherwise assented to the
terms and conditions hereof. The provisions on the reverse side of the form provided, among other
things, that the seller disclaimed all warranties, express or implied, each form was signed by an employee
of Alibaba and mailed to Magic. Shortly thereafter, the carpet was shipped. Magic always received the
acknowledgement before the carpet. They placed each form on a file, accepted delivery of the carpet and
paid for it promptly. On the 56th sale, the accepted and paid-for carpet proved to be non-conforming.
Magic sued Alibaba for breach of warranty. Alibaba replied that its form disclaimed all warranties.
a.
Was a K formed between Magic Carpet and Alibaba? See 2-207.
Yes, b/c there is definite and seasonable expression of acceptance by Magic Carpet.
b.
Was the disclaimer of warranties part of that contract? See 2-207(2).
No, b/c it is a material alteration to disclaim general warranties (Comment 4 to 2-207).
Although merchants are involved here (define) the term doesn’t become part of the
contract.
Problem 13:
Humpty Dumpty Corp. (HDC) was a company that demolished old buildings to clear sites for new
construction. HDC proposed to sell a large quantity of used bricks to the Kings Horses Company on the
condition that Kings Horses would pick up the bricks and haul them away. The seller made a formal
written offer, stating the quantity (2.5 tons), the price (22,000) and a delivery date of June 15. Kings
Horses accepted, enclosed a check for 22,000, and changed the delivery date to July 20. The president of
HDC calls you and asks if Kings has breached the K if it does not pick up the bricks on June 15. What do
you advise him? See 2-207(3) and official comment 6. See also 2-309.

Changing of the delivery date was a widely divergent or critical term. So there
is no K b/c there was not a seasonable expression of acceptance.

Then go to 2-207(3). Did the parties act if they had a K? Yes. So then all terms
which are not the same are knocked out.

Delivery date is knocked out (b/c the forms didn “t agree) and 2-209 comes in.
Delivery date will then be a reasonable time.
Diamond Fruit Growers, Inc. v. Krack Corp.
Krack manufacturers cooling units that contain steel tubing it purchases from outside suppliers. Metal
Matic is one of Krack’s tubing suppliers. Beginning of each year, Krack sent a blanket purchase order to
MM stating how much tubing would be needed throughout the year. Then as Krack needed tubing they
would send a purchase order over. MM responded to the purchase order by sending an acknowledgement
form over and then shipping the tubing. MM’s acknowledgment form disclaimed all liability for
consequential damages and limited MM’s liability for defects to refund of purchase price or repair of the
tubing. Krack’s forms did not contain these terms. MM’s forms also contained a proviso clause
(acceptance expressly conditional to purchaser’s acceptance of the terms). At one time the 2 companies
talked about the disclaimers but nothing was ever done to change them and Krack continued to accept the
tubing. Krack sold one of its units to Diamond. The unit leaked ammonia, due to a defect in the tubing and
Diamond sued Krack. Krack brought a 3rd party complaint against MM seeking contribution or indemnity.
The court found that MM’s attempt to disclaim all liability with the use of the proviso clause failed b/c
Krack never expressly consented to the new terms. The companies therefore had no K but performed as if
they did and then 2-207(3) came in. 2-207(3) states that only those terms to which the forms agree will
remain intact and all others will be knocked out. Then the UCC’s gap fillers will fill in. So the disclaimers
of liability were knocked out.
•
If the partners discuss the terms of the documents AFTER they exchange forms, does §2-207 still
apply?
Yes, §2-207 still applies.
•
In determining whether the buyer assented to the proviso, what is the underlying principle behind
2-207?
One of the principles underlying §2-207 is neutrality. If possible, the section should be
interpreted so as to give neither party to a K an advantage simply b/c it happened to send
the first or in some cases the last term. (This disposes of the common law Last Shot
Rule.)
•
Have proviso clause. Did they assent? No b/c need to come forward and express your assent,
behavior is not enough to assent to proviso language. So then land in paragraph 3.
•
Is 2-207(3) disadvantageous to either party?
2-207(3) will often work to the disadvantage of the seller b/c he will wish to undertake
less responsibility for the quality of his goods than the Code imposes or else with to limit
his damages liability more narrowly than the Code would.
•
What is MM argument, and why did the court reject it?
MM argued that Krack assented to the disclaimer when it continued to accept the tubing
and pay for it once MM indicated that it was willing to sell tubing only if its warranty
and liability was limited. MM’s argument was outweighed by public policy.
•
How does a seller in MM position protect itself?
Do not act as if there is a K when the buyer disputes a term of the contract. If this
happens don“t ship the goods b/c the disputed disclaimer will be thrown out.
Problem 14:
Would the following clause in the seller’s acknowledgement to the buyer’s order form be a material
alteration under 2-207(2)(b): “Any disputes concerning this contract shall be subject to binding
arbitration”?
Yes, an arbitration clause is treated as a material alteration in most jurisdictions.
Bayway Refining Co. v. OMT
Bayway paid federal excise tax on a petroleum transaction, as the IRS code requires a petroleum dealer to
do in a sale to a buyer who has not produced an exemption under the applicable tax provision. Bayway
seeks to recover from OMT the amount of excise tax ($464,035.12) it paid. The ISSUE: is whether a K
term allocating liability to the buyer for an excise tax is an additional term presumed to have been accepted
(as the seller contend) or (as the buyer contends) a material alteration presumed to have been rejected? The
court agreed with the seller and found that the excise tax paid is an additional term presumed to have been
accepted by the buyer. The court concluded: (1) the party opposing the inclusion of an additional term
under 2-207(2)(b) bears the burden of proving that the term amounts to a material alteration (which OMT
failed to do); (2) the district court properly granted summary judgment in favor of Bayway, b/c the
additional term did not materially alter the K; (3) the district court properly admitted evidence of custom
and practice in the industry despite that fact that it was first proffered in the moving party’s reply papers.
Affirmed (*).
•
Why does this case fall within 2-207(2)?
Know that every time end up in section 2 then a K exists, and just trying to figure out the
terms of the K.
•
Who carries the burden of proving the additional or different term is a material alteration?
The person who is opposing the inclusion of the additional term under 2-207(2).
•
What if neither party introduces evidence of material alteration?
Then the term will be included in the K.
•
What are the two elements if surprise, and how does a party establish that?
A material alteration is one that would “result in surprise or hardship if incorporated
without express awareness by the other party.” (1) Subjective (what the party actually
knew) or (2) Objective (what the party should have known). To carry the burden of
showing surprise, a party must establish that, under the circumstances, it cannot be
presumed that a reasonable merchant would have consented to the additional term.
•
Typically, when do courts find that hardship materially alters a contract?
Typically, courts that have relied on hardship to find that an additional term materially
alters a K have done so when the term is one that creates or allocates an open-ended and
prolonged liability.
•
If cannot find surprise or hardship, then there is no material alteration.
Proviso Clause: (Strictly construed)
"The language 'Subject to the Terms and Conditions' does not satisfy the expressly
conditional requirement of Section 2-207(1). By contrast, language in a response to
an offer reading '[i]f the terms and conditions of this acknowledgement differ in any
way from the terms and conditions of [the offer] the acknowledgement shall be
construed as a counter offer and shall not be effective as an acceptance' does satisfy
the requirements of Section 2-207(1) and amount to a counter offer.
Problem 15:
On April 25, Plastic Furniture Mart sent a purchase order for 100 tables to the Ersatz Manufacturing Co. In
addition to the usual boilerplate language, the purchase order also stated, “BUYER OBJECTS IN
ADVANCE TO ANY TERMS PROPSED BY SELLER THAT DIFFERS IN ANY WAY FROM THE
TERMS OF THIS PURCHASE ORDER.” Ersatz received the order, and on May 3 it sent back its own
acknowledgement form, which disclaimed all warranties and contained this clause: “THIS IS NOT AN
ACCEPTANCE UNLESS BUYER ASSENTS TO ALL CHANGES MADE BY THIS
ACKNOWLEDGEMENT FORM.” Neither party read the details of the other’s form. On May 6, Ersatz
shipped the tables. Is there a contract? See 2-207(3). Did Ersatz make a warranty as to the conditions of
the tables? See 2-314. On May 3, was there a K?

Get to paragraph 3 b/c there is proviso clause. There is a contract under 2207(3) b/c the parties performed as if they had a contract.

There was an implied warranty of merchantability.

No, there was no conduct yet indicating there was a contract.
Leonard Pevar Co. v. Evans Products Co.
•
•
Name three ways a contract may be formed?
o
(1) Oral agreement followed by confirmation
o
(2) Written documents not containing identical terms
o
(3) Conduct establishing the existence of a K.
Does the proviso apply to confirmatory memoranda when the parties have first reached an oral
agreement?
o
•
In what paragraph of 2-207 must you end up if you have an oral agreement followed by a
confirmation memo (which adds a term)?
o
•
A proviso cannot apply to confirmatory memoranda when the parties have first reached
an oral agreement b/c the parties have already entered into an agreement and one party
doesn“t have the power pursuant to 2-207 to terminate it unilaterally.
You must end up in subsection (2) of 2-207 if you have an oral agreement followed by a
confirmation memo (which adds a term)
In what paragraph(s) might a party end up if there is no prior oral agreement, but different
documents are exchanged?
o
•
You must end up in subsection (2) or (3) of 2-207 if there is no prior oral agreement, but
different documents are exchanged.
Can a contract be formed if there is no written or oral agreement between the parties?
o
Yes if you are under subsection (3)
Klocek v. Gateway, Inc.
•
Do you need to have two “forms “ in order to invoke 2-207?
o
•
Who made the offer and who made the purported acceptance?
o
•
No indication of proviso language. (No dickered term) so then go to subsection (2).
Which paragraph determines the outcome of the case?
o
•
Consumer was the offeror and Gateway accepted the offer.
Was there proviso language?
o
•
No don“t need two forms (lots of different scenarios)
§2-207(2)
Was there a K, and if so, did the terms include the arbitration clause?
o
This was not between merchants. The consumer was not a merchant.
o
Gateway argued that the consumer expressly consented b/c kept computer for 5 days.
This court said this is not enough. Not express assent. Have a K. Arbitration clause falls
out.
WARRANTIES
The law of warranty has borrowed its concepts from the legal coffers of tort, contract,
and property. The UCC divides warranties into two basic types: warranties of title and
warranties of quality.
The Warranty of Title
** The warranty of title will not be tested on exam, only warranties of quality will be
tested.
Note that warranty of Title also includes:
1. A warranty that there are no security interests (or liens) on the goods other than
those of which the buyer knows. (2-312(1)(b)).
2. A warranty given by merchant sellers against claims based on patent infringement
or the like. (2-312(3)).
** If the buyer furnishes specifications to the seller (which happens where the goods are
to be specifically manufactured to the buyer’s order), the buyer automatically makes a
warranty to the seller that protects the latter from infringement claims. Section 2-312(3).
This is the only situation under the UCC where the buyer is the warrantor.
Warranties of Quality
A. Express Warranties
An express warranty arises when the seller does something affirmative to create buyer
expectations about the characteristics or performance of the goods. Typically this means
that the seller will make oral or written representations about the products in
advertisements, the verbal sales pitch, or the written K. These representations must have
some substance to them (more than mere puffery) to rise to the dignity of an express
warranty. In the code’s words, they must “relate to the goods” (an obvious requirement)
and become part of the basis of the bargain (a not so obvious requirement). Most courts
have adopted a test suggested by Professor Williston that a statement goes to the basis of
the bargain if its natural tendency is to induce the buyer to purchase (even though that is
not the sole reason). This means that if the statement however made, has any substance
to it so that it might have played some part in the buyer’s decision to buy, the burden is
on the seller to prove that the buyer did not rely. If the seller cannot meet this burden, the
buyer has the benefit of an express warranty.
2-313: (Express Warranties by Affirmation, Promise, Description, Sample)
1. Express warranties by the seller are created as follows:
a. Any affirmation of fact or promise made by the seller to the buyer which
relates to the goods and becomes part of the basis of the bargain
(reliance) creates an express warranty that the goods shall conform to the
affirmation or promise.
b. Any description of the goods which is made part of the basis of the
bargain created an express warranty that the goods shall conform to the
description.
c. Any sample or model which is made part of the basis of the bargain
(reliance) creates an express warranty that the whole of the goods shall
conform to the sample or model.
2. It is not necessary to the creation of an express warranty that the seller use formal
words such as “warrant” or “guarantee” or that he have a specific intention to
make a warranty, but an affirmation merely of the value of the goods or a
statement purporting to be merely the seller“s opinion or commendation of the
goods does not create a warranty. (This is puffing).

Comment 4:
The whole purpose of the law of warranty is to determine what it is that the
seller has in essence agreed to sell.
Problem 19:
a.
The Salesman at the lot of Smiles Pre-owned Vehicles told the woman buying the car that it was
in “A-1 shape.” She bought the car, but it broke down the next day, stranding her in the country.
Was this oral statement mere puffing? Is it an easier case if the seller tells the buyer that the used
car is in “mint condition”?
o
b.
This is mere puffing, whereas “mint condition” is more of an express warranty.
When the farmer looked over the young chickens he was contemplating purchasing from the
poultry company, he complained that they looked pretty scruffy. The salesman explained that that
was b/c they were on half-feed and that when they were placed in full-feed, they would “bloom
out, straighten up, and fly right,” and they would “do a good job in your chicken house.” The
farmer purchased the chickens, and 2 months later they starting dying in droves. The farmer sued,
claiming breach of an express warranty. Is he right? Is this a question of law or of fact for the
jury?

c.
Portia Moot, a 3 year law student, had taken the course in sales, so when she went to buy a used
car, she listened very carefully to the sales pitch. The smarmy salesman was quite friendly, but he
only made 2 statements about the car she bought: “This is a great car!” and “You’re going to love
it!” In fact, the car broke down a great deal, and Portia quickly grew to hate it. Does she have a
COA here?

d.
This is an express warranty. If it this were a gray area and an oral statement
then they jury would decide it, but if it were a written statement then the judge
would decided it as a matter of law.
This is mere puffing b/c this is an opinion.
Assume that the car salesman told Portia that the used car she was contemplating purchasing had
been thoroughly inspected by the car dealership“s crack repair department and was
“mechanically in perfect condition.” However, Portia was suspicious about the reliability of the
car and before she bought it, she took it to her own favorite mechanic for an inspection. She
didn’t buy the car until her mechanic cleared it as fine. When the car broke down a few days later,
she decided to bring suit on the express warranty. What defense will the car dealership raise?

There was no reliance, b/c she didn“t rely on the car dealerships mechanic,
instead she relied on her own mechanic to purchase the car.
Problem 20:
Upon graduation from law school, Andrew Loner hung out his shingle and waited. Mr. and Mrs. Consumer
were his first clients, and they told him the following story. 2 weeks earlier they has visited a wallpaper
store, Paper and Paste and inquired about vinyl wallpaper for their dining room. The salesman told them
that the “finest” wallpaper in the store was Expenso-Paper, a vinyl wallpaper selling at $25 a roll. When he
learned that the Consumers had never before put up wallpaper, the salesman assured them that Expensopaper “goes up easily, can be put on with any paste, and dries immediately.” He said that it “would look
wonderful” and moreover, that Expenso-Paper “was used by Mary Magic,” the famous movie star, in her
dining room. He showed them a sample book, and they picked out a pattern they liked and ordered 10
rolls. When the paper arrived the next week, it proved to be very stiff and hard to work with. It tore easily
and refused to stay flat on the wall (it either bubbled or, due to its heavy weight, fell down on drying). In
addition, it was dyed a darker color than the version of the pattern in the sample book. The final result was
that the Consumers’ dining room looked terrible. To top it off, the Consumers discovered that Mary Magic
did not own a home (she lived in hotels.) Upon complaining to Paper and Paste, the Consumers were told
by the manager that Expenso-Paper needs a special brand of paste, to wit, Expenso-Paper. They were also
told that Expenso-Paper was an inferior brand and that next time they should buy Super Wall, a better
product that the store carried. The Consumers told Loner that they signed the K without reading it and that
the statement about Mary Magic’s dining room was made after they signed the agreement. Loner (and you)
have to answer these questions:
1.
Which of the salesman’s representations amount to express warranties?
a.
Finest?

b.
Goes up easily?

c.
This is an express warranty.
Would look wonderful?

2.
This is an express warranty.
Dries immediately?

e.
This is an express warranty.
Can be put on with any paste?

d.
This is an opinion, more so than an express warranty. (Puffing)
This is an opinion. (Puffing)
Do you see any other express warranties? Is the Mary Magic statement part of the basis of the
bargain, arising as it did after the K was signed? See 2-209(1); Official Comment 7 to 2-313.

Precise time when affirmation is made is not material (comment 7). Some
affirmations after the fact can be considered to become the basis of the bargain,
but courts are skeptical about this. So this did not become part of the basis of
the bargain.
Problem 21:
Balding Paul bought a wig from Hair, Inc. He became annoyed when the wig changed colors slightly from
season to season. He did not do anything about it until one day, while thumbing through a newspaper, he
noticed an ad for Hair, Inc., that claimed that their wigs did not shrink or change color. On checking back,
he discovered that Hair has run an identical ad during the week prior to his purchase of the wig. He sues.
On the witness stand Paul confesses that he never saw the as until a year after his purchase of the wig. Is
this admission fatal on his theory of recovery on a theory of express warranty?

No, b/c the court will look at public policy to help decided that the company can
handle the risk more than the consumer can.
B. Implied Warranties
In many ways implied warranties are the legal opposites of express warranties. An
express warranty is created only where the seller does something affirmative (opens his
mouth and says something, takes out a newspaper ad, displays a sample.) Implied
warranties, on the other hand, are automatically part of the K unless the seller (or the
circumstance) does something affirmative to get rid of them. Implied warranties are
implied as a matter of law; they are sometimes referred to as “children of the law.” Like
express warranties, the seller’s intention to create any implied warranty is completely
irrelevant.
1. Merchantability
The implied warranty of merchantability is not given a precise definition in the code.
The basic idea is that the item must be saleable and conform to the normal expectations
of the parties. Notice that 2-314(2), which you should now read, sets minimum standards
for its meaning.
2-314: (Implied Warranty: Merchantability; Usage of Trade)
1. Unless excluded or modified (Section 2-316), a warranty that the goods shall be
merchantable is implied in a contract for their sale if the seller is a merchant with
respect to goods of that kind. Under this section the serving for value of food or
drink to be consumed either on the premises or elsewhere is a sale.
2. Goods to be merchantable must be at least such as:
a. Goods without objection in the trade under the contract description; and
b. In the case of fungible goods, are of fair average quality within the
description; and
c. Are fit for the ordinary purpose for which such goods are used; and
d. Run, within the variations permitted by the agreement, of even kind;
quality and quantity within each unit and among all units involved; and
e. Are adequately contained, packaged and labeled as the agreement may
require; and
f. Conform to the promise or affirmations of fact made on the container or
label if any.
3. Unless excluded or modified (Section 2-316) other implied warranties may arise
from course of dealing or usage of trade.
The Implied Warranty of Merchantability DOES NOT require reliance.
Shaffer v. Victoria Station, Inc. (Man“s hand injured by broken wine glass at a
restaurant.)
•
How do courts determine whether goods are merchantable under the implied warranty of
merchantability?
o
The court determines this by examining §2-314(2).
•
Was this seller a “merchant with respect to goods of that kind?“
o
•
Does this glass or container that holds liquid being sold at a restaurant constitute a sale of goods?
Why?
o
•
Here the seller is a merchant b/c he was selling wine in a glass, the only way to transport
that item to the customer was in a glass.
There is no other way to transport liquid than to serve it in a glass, so this is a sale.
(Wine can“t be served without an adequate container.)
Does it matter whether the seller also “sold“ the glass or container with the liquid?
o
No, this is immaterial here. The implied warranty of merchantability still applies.
By far the most important segment of §2-314(2) is found in subsection (2)(c): to be
merchantable the goods must be “fit for the ordinary purposes for which such goods are
used.”
Problem 22:
Consider the following:
a.
Are cigarettes that cause lung cancer merchantable if used over a period of years? If the seller’s
advertisements stated that the cigs were “mild,” would that create an express warranty?

b.
Are these fit for their ordinary purpose? If you can prove that the ordinary
purpose is to get some high and to be pleasurable, then it would not be fit for the
ordinary purpose b/c getting cancer is not the ordinary purpose. Courts are
reluctant to say that cig manufactures breach the implied warranty of
merchantability b/c this would open the floodgates for all manufacturers of
similar products.
Officer Krupke, a NY police officer by profession, sold his family car to his next-door neighbor,
Maria, telling her it was a “good car.” In fact, it was falling apart and blew up the first time she
drove it. Has Krupke breached the implied warranty of merchantability? See 2-104(1); Official
Comment 3 to 2-314; 1-203. Should §2-314 be extended so that the warranty is made by all
sellers?

No, he is not a merchant with respect to goods of this kind, so there is no
implied warranty of merchantability.
Problem 23:
Natty Bumpo was driving through upstate NY when a deer ran in front of his car. He swerved to avoid it
and ran into a tree. His major injuries came from his sudden contact with the inside of the driver’s door,
where he smashed up against sharp points on the door handle, the window lever, and an ashtray. Natty
sued the car manufacturer, the Mohican Motor Co., for breach of the warranty of merchantability. His
theory was that the manufacturer should have designed a much safer car. The manufacturer’s defense was
that the car was fit for ordinary purpose and that Natty has misused it. How should this come out?

Natty should win; cars should be created for more than just driving. They
should predict for foreseeable accidents.
Daniell v. Ford Motor Co.
* locked herself inside the truck of her car to attempt suicide and was in there for nine days. * seeks to
recover damages for psychological and physical injuries. * argues various theories of recovery including
breach of implied warranty of merchantability and breach of implied warranty of fitness for a particular
purpose. The court said that the ordinary purpose of an automobile trunk is to transport and store goods.
*’s use of the trunk here was highly extraordinary, so no breach of merchantability. And no reliance so no
express warranty or breach of warranty for particular purpose.
•
Why did *“s express warranty claim fail?
o
•
Why did *“s implied warranty of merchantability claim fail? Is reliance required?
o
•
b/c there was no affirmative action made by the seller that led *“s reliance in purchasing
the car.
It failed b/c the car’s ordinary purpose was to be driven, not to hang out in the trunk.
Therefore, the car was fit for its ordinary purpose. However, under current law, all
automobiles must have inner trunk releases, so now it would be a breach of implied
warranty of merchantability. Reliance is not required for implied warranty of
merchantability.
Why did *“s implied warranty of fitness for a particular purpose claim fail? Is reliance required?
o
This fails b/c need reliance.
2. Fitness for a Particular Purpose
Where the buyer wants to use the goods for something beyond their ordinary purpose, a
warranty of merchantability is not enough. But the buyer may be able to sue for breach
of implied warranty of fitness for a particular purpose if the buyer can satisfy all of the
elements of §2-315.
2-315: Implies Warranty: Fitness for Particular Purpose
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.
Problem 24:
When Christopher Wren finished building a recreation room in his basement, he wanted a heater for it. He
saw an ad for the A-1 Hotblast Heater, which seemed to be what he needed. A good friend of Wren’s
named Inigo Jones ran a nearby appliance store. Wren went there and told Jones that he wanted the heater
for the new room. Jones knew the room well; he had helped build it. When the heater arrived, it worked
perfectly, but it simply did not have the capacity to heat the room. May Wren sue Jones for breach of either
2-314 or 2-315? See Comment 5 to 2-315.
•
Is there a breach of implied warranty of merchantability? No b/c the heater is doing what it is
intended to do (heating) but it is just not heating the whole room. Is there a breach of implied
warranty of fitness for a particular purpose? Yes, b/c the seller knew why the goods were being
purchased and he relied on his friend’s skill. (Although this may go both ways.)
Problem 25:
Harold Thumbs went to the Easy Paint Store and bought a can of green paint, which the store mixed on the
premises from various pigments. Harold used the paint on his dining room walls, but due to a
miscalculation on his part, he ran out when he was half finished. He took the empty paint can back to the
store. He told the clerk that he was only half done with the job and needed another cam, which the clerk
promptly mixed and sold to him. Harold finished the painting and then noticed 2 things: (1) the dried paint
gave off an offensive odor and (2) the paint from the second can did not match the first. What causes of
action does he have?
•
He has an action for a breach of an implied warranty of merchantability b/c the paint smells and it
is not for its ordinary use. There is a breach of implied warranty of fitness for a particular purpose
for the wrong paint color b/c the paint store knew what color he had already purchased and he
relied on them to give him the same color.
Problem 26:
Donald Souse ordered a martini at the Tired Executives Club. When he bit into the olive, he cracked his
new $2000 dentures on a pit. Is there a COA under either 2-314 or 2-315?
•
If you used the reasonable expectation test, there would be no breach of implied warranty of
fitness for a particular purpose b/c olives in martinis are not supposed to be pitted.
Webster v. Blue Ship Tea Room, Inc
Woman ate fish chowder in New England. She swallowed a bone and was injured. She was raised in New
England. The * sued * for breach of implied warranty of fitness for a particular purpose.
•
Was the * a merchant?
o
•
Is the court saying that a natural substance does not breach the warranty or that the *“s
reasonable expectation should have included the bone?
o
•
* was a merchant under 2-104 b/c they were in the business of selling seafood.
The court says that the woman should have had a reasonable expectation that the fish
chowder contained some bones, and b/c she was raised in that area she should have
known it was possible.
Would the result be the same if the * was from South Dakota and was on her first visit to Boston?
o
No, she would not have had a reasonable expectation that bones would have been
contained in the chowder. SD probably has different chowder.
Branch of cases is contaminating food cases: Approach in these cases can be distilled
into several possibilities: foreign natural distinction where some courts hold no liability if
the material in food that injures you is a natural by-product of the food itself (ex. Choke
on chicken bone, no liability in some places b/c bone natural by-product.) Secondforeign natural approach (LA) distinction P must prove negligence is foreign object is a
by-product but the manufacturer is SL if the foreign object is actually a foreign
substance. Third - Adopt consumer expectation test. Ask: What would consumer
expectation be?
Problem 27:
Carry Nation, on the advice of her beautician, Parker Pillsbury, bought a hair due names “Intoxicating
Fragrance” and proceeded to use it in accordance with the instructions on the package. Unfortunately the
product contained the alcohol, to which Ms. Nation was allergic, and she suffered considerable burn
damage to her scalp and ears. When she sued the manufacturer, Harper“s Hair Products, Inc., the basic
defense was that only 0.5 percent of the population had this allergic reaction. Is this a good defense?
•
The implied warranty of merchantability would kick in here b/c this hair dye was to be used for its
“ordinary purpose.” The courts are struggling with whether ordinary purpose means for the
“ordinary purpose without regard for the extraordinary purpose” or the other way?
Warranty Disclaimers and Limitations
Disclaiming Express Warranties:
§2-316: Exclusion or Modification of Warranties:
(a) Words or conduct relevant to the creation of an express warranty and words or
conduct tending to negate or limit warranty shall be construed wherever reasonable as
consistent with each other; but subject to the provisions of this Article on parol or
extrinsic evidence (§2-202) negation or limitation is inoperative to the extent that such
construction is unreasonable.
*The proper way to avoid liability for an express warranty is to not make it in the first
place. Express warranties are created by affirmative seller conduct that create buyer
expectations that the product will comply with the representations made. Once this is
done, the seller must live with the liability assumed.
Bell Sports, Inc. v. Yarusso
Yarusso fell off his dirt bike and landed on his head. As a result of this fall, he became a quadriplegic. He
sued Bell Sports, the manufacturer of the helmet he was wearing at the time, claiming his injuries were the
proximate result of a defect in the helmet’s design.
•
The language under “Warranty“ in the user manual gave rise to the express warranty, it said
that “the primary function of a helmet is to reduce the harmful effects of a blow to the head.“
•
Yarusso“s implied warranty of merchantability claim arose out of his contention that the helmet
was not merchantable because it was sold as an off-road helmet but was designed to function for
“on-road“ use. The court agreed that the helmet was not fit for its ordinary purpose.
•
A seller cannot disclaim an express warranty under §2-316(1) which states that a seller cannot
disclaim that which has already been expressly warranted.
•
Formal words are not needed to create an express warranty. (Don“t need words at all; a sign or
advertisement can be an express warranty.)
•
§2-316(1) protects buyers from the unexpected and unbargained language of disclaimers by
denying effect to such language when inconsistent with language of an express warranty. This is
to hold the seller responsible for its representations and assure that a buyer receives that which he
bargained for.
•
The jury properly found breach of an express warranty.
•
The verdict was inconsistent with the tort claim b/c they weren“t at fault but they breached their
promise.
Problem 28:
When Portia went to buy a new car, she asked the salesman how many miles to the gallon it would get. He
replied that it would get “between 30 and 35 m.p.g. in the city and 40 to 45 on the highway.” Delighted, she
bought the car. The very best the car ever did, even in highway driving, was 27 m.p.g., and Portia was
upset. When she threatened a lawsuit, the dealership pointed out the following three clauses in the contract
she had signed that it relied on to avoid liability. This contract said nothing about miles per gallon of gas. In
your opinion is there any way around these clauses?
(1) “This is the entire contract, and there are no other matters agreed to by the parties that are not contained
herein.”
o
First, must consider the Parol Evidence Rule. This statement does not contradict the
writing (b/c the writing was silent on how many m.p.g. the car would get) so it would be
permitted in to supplement the K.
(2) “There are no other express or implied warranties except those contained herein.”
o
First, look at express warranties. Under 2-316(1) courts are not likely to let you disclaim
express warranties. Second, look at implied warranties. In order to disclaim or limit the
implied warranty of merchantability under 2-316(2) it must mention merchantability and
must be conspicuous. This disclaimer does neither, so it is ineffective as to the implied
warranty of merchantability. In order to disclaim the implied warranty of fitness for a
particular purpose under 2-316(2), the exclusion must be in writing and be conspicuous.
This is in writing but it is not conspicuous (not in bold, doesn’t draw attention to it). This
clause is not enforceable.
(3) “No salesperson has the authority to give express warranties other than those contained herein.”
o
This is not a disclaimer of warranties by itself. This is a statement of agency law. Courts
struggle with this issue and there are inconsistent answers for this issue.
Disclaiming Implied Warranties:
§2-316: Exclusion or Modification of Warranties:
(2) Subject to subsection (3), to exclude or modify the implied warranty of
merchantability or any part of it the language must mention merchantability and in case
of a writing must be conspicuous, and to exclude or modify any implied warranty of
fitness the exclusion must be in writing and conspicuous. Language to exclude all implied
warranties of fitness is sufficient if it states, for example, that “There are no warranties
which extend beyond the description on the face hereof.”
(3) Notwithstanding subsection (2):
(a) unless the circumstances indicate otherwise, all implied warranties are excluded by
expressions like “as is”, “with all faults” or other language which in common
understanding calls the buyer’s attention to the exclusion of warranties and makes plain
that there is no implied warranty; and
(b) when the buyer before entering into the contract has examined the goods or the
sample or model as fully as he desired or has refused to examine the goods there is no
implied warranty with regard to defects which an examination ought in the
circumstances to have revealed to him; and
(c) an implied warranty can also be excluded or modified by course of dealing or
course of performance or usage of trade.
Seller’s recourse
Notice: notice is very very important in the UCC Privity
Cate v. Dover Corp.
Cate purchased three lifts.
•
Who decides whether a disclaimer is conspicuous?
o
•
How is conspicuous defined?
o
•
Objective standard: would a reasonable person have had their attention drawn to that?
(Comment 10 of the Texas UCC)
Does actual knowledge of the disclaimer matter if the disclaimer is NOT conspicuous?
o
•
A term is conspicuous when it is so written that a reasonable person against whom it is to
operate ought to have noticed it. (Bold words, all capital letters, larger words or of
another color, etc )
Is it based on an objective or subjective standard?
o
•
Question of law to be decided by the judge not the jury.
Actual knowledge of the disclaimer does make a difference if the disclaimer is not
conspicuous.
How is actual knowledge determined?
o
This knowledge can result from the buyer“s prior dealings with the seller, or by the
seller specifically bringing the inconspicuous waiver to the buyer“s attention.
•
Who has the burden of proving actual knowledge?
o
•
The seller has the burden of proving the buyer“s actual knowledge of the disclaimer.
Was there actual knowledge here?
o
No, merely providing a buyer a copy of documents containing an inconspicuous
disclaimer does not establish actual knowledge. This is not drawing their attention to the
disclaimer.
Problem 29:
(a) A statement buried in the fine print of a used car purchase agreement states that “There are no express
or implied warranties that are part of this sale.”
(1) Are the implied warranties effectively disclaimed?
o
No, this doesn’t disclaim either the implied warranty of merchantability or the implied
warranty of fitness for a particular purpose. (Make sure do a separate analysis for both of
these on exam)
(2) If the car dealership asks you to redraft this clause so as to comply with the Code, what changes
would you make in the language?
o
Add the special words and make it conspicuous.
(3) What changes would you make in the physical appearance of the clause in the contract? Is it all right
to put the disclaimer in a clause labeled “Warranty?”
o
Change the color, font, the size, etc… Don’t only put it in Bold.
(4) Can the car dealer win the legal dispute by arguing that usage of trade (§1-205) permits the burial of
warranty disclaimers in the fine print?
o
Comment 4 in §1-205 says that it is very difficult to allow you to say that usage of trade
will trump out an established code provision.
(b) The words “as is” are written with soap in large letters across the front windshield of the used car. Is
this effective to disclaim implied warranties? Express warranties? Must the “as is” language be
conspicuous?
o
Implied Warranties: 2-316(3)(a) all implied warranties would be disclaimed by “as is”
language. The express warranties are hardly ever disclaimed.
(c) The car salesman asks the buyer, “Would you like to examine the car?” and the buyer, who is in a hurry
says, “No.” Effective disclaimer?
o
Official comment 8 under §2-2-316 says that it is not sufficient that the goods are
available for examination, there must be a demand by seller to inspect the goods. This
language is probably not considered a demand.
(d) Remember Ted Traveler (Problem 18), who walked into the men’s room of the bus depot and bought an
expensive watch? We decided there was no warranty of title in that transaction. However, a warranty of
quality is a separate question. Are there implied warranties in this sale?
o
No, under §2-316(3)(c) says that implied warranties are excluded by course of dealing or
course of trade.
Problem 30:
Joe College bought a new car from Flash Motors, relying on the seller’s extravagant claims about the car’s
superior qualities. He signed a purchase order on August 1, and the car was delivered two weeks later. In
the glove compartment he found the warranty booklet and on reading it was dismayed to learn that the
actual written warranty was very limited in coverage. Is he bound by the written warranty’s terms? What
argument can he make?
o
This goes to the timing of when drawn to attention of disclaimer. Answer is dependant
on which case the court adopts (Bowdoin orRinaldi).
Bowdoin v. Showell Growers, Inc.
•
When did the buyer receive notice of the disclaimer? Why?
o
•
What is the “basis of the bargain” rule
o
•
No, courts still consistently hold that post-sale disclaimers were ineffective.
Does the conspicuousness of the disclaimer matter here?
o
•
Under the UCC, a manufacturer may disclaim the implied warranties of merchantability
and fitness provided that the disclaimer is in writing and conspicuous, and provided that
the disclaimer is part of the parties’ bargain. If a disclaimer was conspicuous to the
purchaser before the sale, a court will generally hold the disclaimer effective based on the
assumption that the disclaimer formed a part of the basis of the bargain. If however, the
disclaimer was not presented to the purchaser before the sale, the court will hold such a
disclaimer ineffective b/c it did not form a part of the basis of the bargain. The “basis of
the bargain“ rule protects purchasers from unexpected and coercive disclaimers.
Does it matter if the buyer is a sophisticated commercial enterprise?
o
•
The buyer received notice of the disclaimer two weeks after the sale of the spray rig was
purchased; it was included in the instruction manual which was shipped with the spray
rig.
As a general matter, the conspicuousness of post-sale disclaimers are irrelevant.
Is course of dealings relevant here?
o
No, it is irrelevant.
Rinaldi v. Iomega Corp.
•
What is plaintiff“s argument about whether the disclaimer was conspicuous? Defendant“s
argument?
o
* argued that the disclaimer, located in the packaging of the product, could not
realistically be called to the attention of the consumer until after the sale had been
consummated, thus rendering the disclaimer not “conspicuous” as a matter of law and
therefore ineffective. * contends that the conspicuousness requirement has been met
regardless of the location of the disclaimer inside the Zip drive package so long as the
disclaimer is “noticeable and easily readable.”
•
What is the purpose of 2-316?
o
•
What cases did the court rely on in support of its holding?
o
•
Pro CD, Inc., v. Zeidenberg and Hill v. Gateway (These cases say that licenses packaged
within shrink wrap are effective.)
Does this case conflict with the previous case
o
•
The purpose of that section is to “protect a buyer from unexpected and unbargained for
language of disclaimer.“ That purpose is the real backbone in determining if a
disclaimer is conspicuous when looking at factors beyond the mentioning and type set.
Yes, this case conflicts with the previous case. It reaches the exact opposite decision.
This case stands for the principle that as long as type face is larger and it stands out, the
timing of the disclaimer is irrelevant.
If the court had done a 2-207 analysis, would it have reached the same result?
o
This court could have done a §2-207 argument, and this would have probably reached a
different result. This doesn’t change a dickered term, and it doesn’t trigger the proviso
language. We end up in paragraph 2. We have a K and now must determine the terms of
the K. First, is this between merchants? No, so the additional terms are merely a
proposal to the K, and would not become part of the K b/c they weren’t agreed upon.
Limitations on the Warranty:
Sometimes a seller is willing to give a warranty to the buyer, but wants in some way to
limit the scope of the liability that a breach creates. The Code permits such a limitation,
but puts various restrictions on its use.
§2-316: Exclusion or Modification of Warranties:
(4) Remedies for breach of warranty can be limited in accordance with the provisions of
this Article on liquidation or limitation of damages and on contractual modification of
remedy (§2-718 and §2-719). (This means that it is possible to limit the remedy
available to a party.)
§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.
Wilson Trading Corp. v. David Ferguson, Ltd.
•
What did paragraph 2 of the contract do? Paragraph 4?
o
•
When can a clause limiting or modifying a remedy be stricken from the contract?
o
•
It is unnecessary to decided the issue of whether the time limitation is unconscionable 2719(2) provides that the general remedy provisions of the code apply when
“circumstances cause an exclusive or limited remedy to fail of its essential purpose.”
When does an exclusive or limited remedy fail of its essential purpose? Why does that matter?
o
•
It follows that contractual limitations upon remedies are generally enforceable unless
unconscionable.
Was it necessary for the court to determine whether the clause was unconscionable?
o
•
Paragraph 2 of the K says that no claims related to quality or shade of the yarn can be
made after weaving, knitting, or processing the yarn. Paragraph 4 of the K says that no
warranties exist expect those within the actual contract, and the contract disclaims the
implied warranty of fitness.
The official comments say that “where an apparently fair and reasonable clause b/c of
circumstances fails its purpose or operates to deprive either party of the substantial value
of the bargain, it must give way to the general provisions of this Article.“ This matters
b/c paragraph 2 eliminates all remedy for defects not discoverable before knitting and
processing, so 2-719(2) applies.
What happens to the time limitation provision if it fails of its essential purpose?
o
If these factual allegations are established at trial, then the buyer is, in effect, without
remedy. (Go to the gap fillers, for a reasonable time.) The time limitation clause of the
K must give way to the general code rule that a buyer has a reasonable time to notify the
seller of a breach of K after he discovers or should have discovered the defect. §2-207(3).
Problem 31:
On November 1, Jack of Portland, Maine, bought a snowmobile from King Cold Recreationland. Jack used
the snowmobile to get to work during the week in the winter and for fun on the weekends. The contract that
he signed stated that the seller warranted that the vehicle was merchantable, but that, in the event of breach,
“the buyer’s remedy was limited solely to repair or replacement of defective parts.” Moreover, the contract
conspicuously stated that the seller was not responsible for “any consequential damages.” One week after
he received the snowmobile, Jack noticed a strange rumble in the engine. He took the machine back to the
King Cold service department. The machine was returned to him in three days allegedly repaired. These
events repeated themselves three times over the next three weeks. Four weeks after he bought the
snowmobile, Jack was seriously injured when it blew upwhile he was riding. The machine, which cost
$1,200, was destroyed. Jack temporarily lost the use of his left arm, incurred hospital expenses of $2,500,
and lost pay of $1,600. Moreover, when he did return to work, he had to rent a snowmobile for $40 a week
until spring (16 weeks – spring is very late in Maine = $640). In addition, a $350 camera he was carrying
was also destroyed. Jack brought suit against King Cold. King Cold defended on the ground that its liability
was limited to the cost of repair or replacement. Jack argued that the remedy limitation was
“unconscionable” and failed of its “essential purpose.” All the parties pointed to §2-316(4), §2-302, §2719, and §2-715. How should this suit come out?
o
Jack should recover for all losses except the camera under §2-719(3). All other losses are
as a result of the personal bodily injury, so these are recoverable b/c limitations of those
remedies would be per se unconscionable. The loss of the camera is a commercial loss
for a consumer good and therefore is not allowed under §2-719(3). Jack should also
recover the loss of the snowmobile b/c it “failed its essential purpose” under §2-719(2).
§2-302: Question is can you disclaim warranties under section 2-302? Answer is yes. If
trying to argue that a disclaimer is not valid always make a §2-302 argument b/c can
argue that the court should not enforce disclaimer b/c of the unequal bargaining power of
the customer. If can make this argument then the disclaimer would be unconscionable.
Pierce v. Catalina Yachts, Inc.
•
Does the code allow a seller to limit consequential damages?
o
•
When can circumstances cause a limited or exclusive remedy to fail? What happens then, under
the Code?
o
•
Typically, a limited repair/replacement remedy fails of its essential purpose where (1) the
seller is unsuccessful in repairing and replacing the defective part, regardless of good or
bad faith; or (2) there is unreasonable delay in repairing or replacing defective
components.
If a limited remedy fails of its essential purpose, can the buyer always get consequential damages?
o
•
If circumstances cause an exclusive or limited remedy to fail its essential purpose,
remedy may be had as provided in the code. §2-719(2). This rule is to insure that the
buyer has at least minimum adequate remedies.
Give two examples where the limited remedy can fail of its essential purpose
o
•
Yes, unless it is unconscionable under other Article provisions.
§2-719(b) implied promise that when a limited remedy fails, the buyer may claim
consequential damages b/c they are a remedy provided for in the Code.
What is the conflict between 2-719(b) and (c)? How do courts resolve it?
o
Most jurisdictions read these two subsections independently, ruling that when a warranty
fails, a separate provision barring consequential damages will survive under subsection
§2-719(c) as long as the bar itself is not unconscionable.
•
How do courts determine whether the limit on consequential damages is unconscionable?
o
In determining whether an exclusion is unconscionable, courts examine the
circumstances existing when the K was signed, asking whether “there was reason to
conclude that the parties could not competently agree upon the allocation of risk.” Courts
are more likely to find unconscionability when a consumer is involved, when there is a
disparity in bargaining power, and when the consequential damages clause is on a preprinted form; conversely, they are unlikely to find unconscionability when “such a
limitation is freely negotiated b/w sophisticated parties, which will most likely occur in a
commercial setting.”
Defenses in Warranty Actions
Notice:
§2-607(3)(a): Effect of Acceptance; Notice of Breach:
Where a tender has been accepted the buyer must within a reasonable time after he
discovers or should have discovered any breach notify the seller of breach OR be barred
from any remedy.
§2-515: Preserving Evidence of Goods in Dispute:
In furtherance of the adjustment of any claim or dispute
(a) either party on reasonable notification to the other and for the purpose of
ascertaining the facts and preserving evidence has the right to inspect, test and sample
the goods including such of them as may be in the possession or control of the other; and
(b) the parties may agree to a third party inspection or survey to determine the
conformity or condition of the goods and may agree that the findings shall be binding
upon them in any subsequent litigation or adjustment.
§2-508: Cure by Seller:
1. Where any tender or delivery by the seller is rejected because nonconforming and
the time for performance has not yet expired, the seller may seasonably notify the
buyer of his intention to cure and may then within the contract time make a
conforming delivery.
2. Where the buyer rejects a nonconforming tender which the seller had reasonable
grounds to believe would be acceptable with or without money allowance the
seller may if he seasonably notifies the buyer have a further reasonable time to
substitute a conforming tender.
Problem 32:
Pearl, a farmer, exhibited to Dave samples of her apples, but said that the bulk of the apples had less color
and were one fifth smaller in size than the samples. Dave said, “Bring your apples to my warehouse; such
size apples are worth $3 a bushel, and I will pay you that for them.” Pearl agreed to do so. The next day
Pearl delivered 150 bushels of apples to Dave’s warehouse. These apples were not as good, on an average,
as the samples and were one third smaller in size than the samples were. Dave, without inspecting the
apples, delivered them 10 days later to his commission merchant, who the same day sold them on the
market, bringing only $1.50 per bushel. The commission merchant, immediately upon making the sale,
called Dave and informed him of the price brought by the apples. Dave was disgusted and decided to wait
until Pearl billed him for the apples, at which time he would give her a piece of his mind. Sixty days later
Pearl billed Dave in the amount of $450 for the 150 bushels of apples. Dave refused to pay, telling Pearl
that the apples hadn’t measured up to the contract. Pearl sues Dave. Dave contends that Pearl breached an
express warranty under the UCC since a contract of sale by sample was involved. What result?
We are dealing with apples here and they are perishable goods, which makes the
reasonable time a lot shorter than it would be for other goods. Dave did not give Pearl a
reasonable notice within a reasonable period of time so he is barred from making a
claim b/c he remained silent.
Problem 35:
Icarus Airlines ordered 40 new airplanes from the Daedalus Aircraft Company. 20 were to be delivered on
May 8 and the rest on November 10. The first shipment actually came on September 9, but Icarus didn’t
complain. The second came on January 12 of the next year. On January 30 the president of Icarus wrote
Daedalus that “We are very disappointed by your late shipment, which has caused us much expense and
inconvenience.” 3 months later Icarus sued, claiming some $24 million in damages caused by the delayed
deliveries. In its answer Daedalus responded by stating that it had received no notice of the breach as to the
first shipment and that the notice concerning the second shipment was defective because it didn’t announce
Icarus’s intention to claim a breach as a result of the late delivery. At trial, Icarus countered by stating that
no notice is required where, as here, the breach is obvious to the seller. As to the lack of formal notice of
breach in the January letter, Icarus pointed to Official Comment 4 to §2-607 (which tells us that content of
the notice must let the seller know there is trouble with the transaction and should be watched).
(a) As the trial court judge, how would you rule on the notice issues?
The code requires in §2-607(3)(a) the buyer must within a reasonable time notify the
seller of the breach or be barred from any remedy. Icarus did not give notice of the
breach but only gave notice of the facts of the breach, so Icarus is barred from any
remedy.
(b) What if on January 30 Icarus had filed suit against Daedalus rather than waiting 3 months? Would the
notice requirement have been satisfied?
No, a lawsuit is not sufficient notice.
Problem 36:
Alonso invited his good friend Sancho to dinner and served him a pheasant for the meal. The wine specially
uncorked for the meal had been bottled by La Mancha Vineyards. It proved to be laced with poisonous
chemical, but only Sancho drank enough to have a serious reaction: it put him in the hospital for 8 months.
When he was discharged, he hired an attorney and filed suit against La Mancha Vineyards, which defended
on the lack of notice required by §2-607(3)(a). How should this come out? If the person who had been
injured had been Alonso and if he had given notice of breach to the retail seller, Carrasco Liquors, would
that preserve his rights against the manufacturer, La Mancha Vineyards?
Comment 5 says that various beneficiaries can collect for a seller’s breach, the
beneficiary gets a reasonable time to give notice. Alonso purchased the wine from the
seller (who purchased it from La Mancha) and gave it to Sancho. The courts typically
allow Sancho in this situation to get around the notice issue here under Comment 5.
Alonso would still have to give notice. Depends on who talking about. Usually end
users escape notice requirements.
Privity
B/c suits on warranties are K actions, the buyer must establish that there was in fact an in
law a K b/w the 2 parties. This legal connection is called privity. The problem of how
far back up the distribution chain the buyer can go is said to be an issue of vertical
privity. To complicate matters, there is a second type of privity, horizontal privity. This
deals with identifying to whom the retail seller is liable other than the immediate
purchaser.
Manufacturers
Vertical Privity: How far back up the distribution chain can
*
sued?)
the buyer go? (Who can be
Wholesaler
*
*
Distributor
*
Horizontal Privity: To whom is the retail seller liable
other
Retailer
than the immediate purchaser? (Who can sue?)
*
Consumer * Spouse * Child * Third Party
Problem 37:
The Girard Instruments Corporation manufactured a pocket calculator called the Descartes 1000. It bought
the paint used on the machine from the Hamilton Paint Company. Girard sold the calculators to the retailer,
Leibnitz Department Store, which sold a calculator to Sylvester Cayley. He in turn gave it to his wife as a
birthday gift. The Descartes 1000 was a popular gift. Joan Cayley used it all the time, as did the Cayley
children (for homework) and even Mr. Gauss, the mailman, who borrowed it one day to compute the
distance he walked on his route. After this last use, Mr. Gauss went home, where his dog, Diophantus,
eagerly licked his hand and promptly dropped dead of lead poisoning. It turned out that the paint used on
Descartes 1000 had an extraordinarily high lead content. All the Cayleys and Mr. Gauss became ill and, on
recovery, brought suit for their pain and suffering, lost wages, medical expenses, and, in Mr. Gauss’s case,
the value of his dog. Whom should they sue?
o
A: Suit looks like, Sylvester can sue. Joan can sue (member of household reasonably
affected by product). The children can sue assuming meet the same standard as Joan.
Mailman would not be considered a guest and would not meet the reasonable standard.
He cannot recover for his dog. In vertical privity only to the retailer (department store)
o
B: Mailman would be able to sue (foreseeability). Injury to mailman’s dog not be able to
recover (must have bodily injury, not recover for the property damage here. Can go all
the way to the manufacturer under vertical privity.
o
C: Everyone can sue. Even mailman can recover for injuries to dog (property damage).
A Note of Strict Products Liability:
§2-318: Third Party Beneficiaries of Warranties Express or Implied:
Alternative A: A seller’s warranty whether express or implied extends to any natural
person who is in the family or household of his buyer or who is a guest in his home if it is
reasonable to expect that such person may use, consume, or be affected by the goods and
who is injured in person by breach of the warranty. A seller may not exclude or limit the
operation of this section.
Alternative B: A seller’s warranty whether express or implied extends to any natural
person who may reasonably be expected to use, consume, or be affected by the goods and
who is injured in person by breach of the warranty. A seller may not exclude or limit the
operation of this section.
Alternative C: A seller’s warranty whether express or implied extends to any person
who may reasonably be expected to use, consume, or be affected by the goods and who is
injured by breach of the warranty. A seller may not exclude or limit the operation of this
section with respect to injury to the person of an individual to whom the warranty
extends.
•
Comment 3: A includes as beneficiaries the family, household, and guests of the
purchaser. B is designed for states where the case law has already developed
further and for those that desire to expand the beneficiaries. C goes further, in
extending the rule beyond injuries to the person.
•
Alternative A is the most restrictive, Alternative B is in the middle, and
Alternative C is the most liberal on who can sue. (MI follows Alternative C).
•
Courts have generally said that under Alternative A you may sue the retailer, but
it generally doesn“t extend up to the manufacturer. However, you can still sue
manufacturers under express warranties.
•
Use the foreseeability test under Alternative B. You also need bodily injury. You
may go all the way up the chain to the manufacturer with vertical privity (case
law says this.)
•
Alternative C is the most liberal. This includes property damage, not just bodily
injury. Courts allow vertical privity all the way up the chain to the manufacturer.
Hypo:
What is the outcome under each of the alternatives? You are a buyer and purchase a
lawn mower. In mowing the lawn the first time, it tips over and the blade flies out and
hits your child, a household guest, and cuts your fence and flies over to the neighbor’s
yard and injures them. Who can sue.
Alternative A: You can sue, your child can sue (if expected that they were likely
to be affected by the goods. Also prove for the guest that it was reasonable that
they would be affected by the product. Cannot recover for the property damage.
Can go after the retailer (Home Depot). Home Depot is going to bring in the
United Steel.
Alternative B: You can sue; your child and the guest can sue if reasonable they
would be affected by the product. Neighbor can sue if can show that was
foreseeable that they would be affected by product.
Alternative C: Can go all the way up the chain. Can recover the property damage
and everybody can sue.
§402A: Special Liability of Seller of Product for Physical Harm to User or Consumer:
(1) One who sells any product in a defective condition unreasonably dangerous to the
user or consumer or to his property is subject to liability for physical harm thereby caused
to the ultimate user or consumer, or to his property, if
(a) the seller is engaged in the business of selling such a product, and
(b) it is expected to and does reach the user or consumer without substantial change in
the condition in which it is sold.
(2) The rule stated in subsection (1) applies although
(a) the seller has exercised all possible care in the preparation and sale of his product,
and
(b) the user or consumer has not bought the product from or entered into any
contractual relation with the seller.
East River Steamship Corp. v. Transamerica Delaval, Inc.
o
Do products liability actions extend to include protection against property? Whose
property?

o
What is the policy behind awarding damages for products liability? K?

o
People need more protection from dangerous products than is afforded by the
law of warranty. Trying to protect the people. For K: Interest trying to protect
in K law is not the people it is the bargain b/w the parties.
What is lost when only the product is injured? How do you protect against that loss?

o
Yes, a products liability action will include protection against property damage
to another person“s property.
Lose the value of the product when only the product is injured.
What is the purpose of express and implied warranties?

The maintenance of product value and quality is precisely the purpose of express
and implied warranties.
o
Why is the law of warranty well-suited for commercial controversies?

o
B/c the parties may set the terms of their own agreements. The manufacturer
can restrict its liability, within limits, by disclaiming warranties or limiting
remedies. In exchange, the purchaser pays less for the product. Since a
commercial situation generally does not involve large disparities in bargaining
power, we see no reason to intrude into the parties’ allocation of risk.
How do product actions and warranty actions differ with regard to limiting liability?

A warranty action also has a built in limitation on liability, whereas a tort action
could subject the manufacturer to damages of an indefinite amount. The
limitation in a K action comes from the agreement of the parties and the
requirement that consequential damages, such as lost profits, be a foreseeable
result of the breach. In a warranty action where the loss is purely economic, the
limitation derives from the requirements of foreseeability and of privity, which
is still generally enforced for such claims in a commercial setting. In products
action, where there is a duty to the public generally, foreseeability is an
inadequate brake.
Problem 36:
The axle on Python’s new car snapped in two while he was driving at a high rate of speed on the interstate.
Python’s car skidded across the median and ran into a hitchhiker, Thumbs, killing him instantly. As
Thumb’s attorney, decide which is the best cause of action: negligence, §402A, or §2-314?
o
If sue in (K) warranty need privity and notice, and it is harder to get around. In products
don’t need either, so it is easier to sue under. In B jurisdiction can go to the manufacturer
(foreseeability test). In C, stronger alternative. In K also have to worry about the type of
jurisdiction you are in.
Warranties and Article 2A
The warranty rules for the lease of goods found in Article 2A are, with minor variations,
mere carbon copies of the Article 2 rules. There is one major difference, however, which
arises in what Article 2A calls a “finance lease.”
Colonial Pacific Leasing Corp. v. McNatt Datronic Rental Corp.
A finance lease is when a person wants goods for their business. They would go to the supplier for
specifications. The person who will ultimately use the goods is the lessee. (They do not purchase the
goods, but negotiate with the supplier for those goods- the only problem is that they can’t pay for them so
the supplier gets another entity buy those goods and lease them to the other party.) Itex is the supplier. The
Lessee is Quick-Trip (run by the McNatts). Initially, Burnham is the lessor, but they assign that to Colonial
Pacific and Datronic.
o
Which article of the UCC applies and why?

o
In GA, all lease contracts for “goods: including finance leases, are governed by
Article 2A of the UCC.
What is a “Hell or High Water“ clause?

o
What is the relationship between the supplier, finance lessor, and lessee? Describe their
roles.

o
The requirement that the lessee continue to make payments regardless of the
condition of the equipment and that the lessee not assert against the
assignee/lessors defenses assertable against the original lessor is commonly
referred to as a “hell or high water” clause.
A finance lease involves three parties- the lessee/business, the finance lessor,
and the equipment supplier. The lessee/business selects the equipment and
negotiates particularized modification with the equipment supplier. Instead of
purchasing the equipment from the supplier, the lessee/business has a finance
lessor purchase the selected equipment, and then leases the equipment from the
finance lessor.
If the supplier commits fraud in dealing with the lessee, can the lessee sue the finance
lessor? Under what circumstances? Were those circumstances present here?

Only if you can prove an agency relationship existed b/w the two.
Problem 40:
Chemicals decided that the safest way to work with hazardous materials was through the use of an
advanced robot. It persuaded Aurora to design a robot that would meet its needs. To finance the purchase of
the robot, Chemicals of Tomorrow went to Octopus Bank, which bought the robot from Aurora and then
leased it to Chemicals subject to both express and implied warranties, which became important when the
robot ran amuck in one of Chemicals laboratories and caused extensive damage. Answer these questions:
(a) Is this a “finance lease”? What factors do and don’t influence this decision? As the leasing officer for
the bank, what steps would you have recommended to make sure that a court would hold that this lease so
qualified?
o
Yes, this is a finance lease. Generally looking for factors such as: lessor is not involved
in picking the goods, lessee should see everything including warranties as if they were
purchasing the goods.
(b) What name does Article 2A give to Aurora in this situation?
o
They are the supplier. Chemicals is the lessee and Octopus National bank is the lessor.
(c) Does Chemicals have the benefit of whatever warranties Aurora gave Octopus Bank?
o
Yes, this is the purpose of the finance lease.
(d) Is Octopus Bank responsible for breach of the implied warranty of merchantability?
o
No, the implied warranties aren’t extended by the finance lease.
(e) If Octopus Bank’s leasing officer had told Chemicals of Tomorrow’s president, “We have investigated
this robot, and I guarantee you it will cause you no trouble,” must the lessor then respond in a warranty
lawsuit to a claim for damages?
o
Yes, the implied warranties don’t automatically kick in. The lessor can on the other hand
extend express warranties.
(f) The lease between Octopus Bank and Chemicals contained a clause stating that the lessee had to pay the
lessor even if the goods didn’t work, a “hell or high water” clause, so-called because the lessee binds itself
to pay the lessor no matter what happens in connection with the performance of the leased goods. After the
robot ruins the laboratory, must Chemicals nonetheless pay Octopus Bank? Would we reach the same result
if the lessee were a consumer?
o
Different standard for commercial leases and consumer leases b/c a consumer needs more
protection.
Warranties in International Sales
The warranty provisions of the CISG for the international sale of goods are very similar
to the UCC rules. The major difference isn’t one of substance, but one of terminology:
the treaty drafters, wanting to write on a clean slate, eschewed use of the term “warranty”
and all the historical baggage that comes with it. It includes counterparts to all the
warranties: warranty of title, express warranty liability, and implied warranties of
merchantability and/or fitness for a particular purpose.
Terms of the Contract
Filling In The Gaps
In the 19th and early 20th centuries, if the parties left a major term out of the K, the courts
typically found no legally enforceable agreement. Judges declared themselves powerless
to “make a K for the parties.” But now the courts are more willing to save the K by
implying reasonable terms where possible. The courts use §2-304-§2-311, known as the
Gap Fillers for guidance.
§2-305: Open Price Term
The parties if they so intend can conclude a contract for sale even though the price
is not settled. In such a case the price is a reasonable price at time for delivery if
nothing is said as to price; or
the price is left to be agreed by the parties and they fail to agree; or
the price is to be fixed in terms of some agreed market or other standard as
set or recorded by a third person or agency and it is not so set or recorded.
A price to be fixed by the seller or by the buyer means a price for him to fix in
good faith.
When a price left to be fixed otherwise than by agreement of the parties fails to be
fixed through fault of one party the other may at his option treat the contract as
cancelled or himself fix a reasonable price.
(4) Where, however, the parties intend not to be bound unless the price be fixed or
agreed and it is not fixed or agreed there is no contract. In such a case the buyer
must return any goods already received or if unable so to do must pay their
reasonable value at the time of delivery and the seller must return any portion of
the price paid on account.
§2-311: Options and Cooperation Respecting Performance
1. An agreement for sale which is otherwise sufficiently definite (subsection (3) of
Section 2-204) to be a contract is not made invalid by the fact that it leaves
particulars of performance to be specified by one of the parties. Any such
specification must be made in good faith and within limits set by commercial
reasonableness.
2. Unless otherwise agreed specifications relating to assortment of the goods are at
the buyer's option and except as otherwise provided in subsections (1)(c) and (3)
of Section 2-319 specifications or arrangements relating to shipment are at the
seller's option.
3. Where such specification would materially affect the other party's performance
but is not seasonably made or where one party's cooperation is necessary to the
agreed performance of the other but is not seasonably forthcoming, the other party
in addition to all other remedies
is excused for any resulting delay in his own performance; and
may also either proceed to perform in any reasonable manner or after the
time for a material part of his own performance treat the failure to specify
or to cooperate as a breach by failure to deliver or accept the goods.
Problem 43:
Edwin Drake wrote to the Watsons Flat Motor Oil Company and said that he wanted to buy 100 cases of its
motor oil, some cases to be Type A (the expensive oil) and some to be Type B (a cheaper kind). He said he
would let the company know later how much he wanted of each type. The company told him that Type B
was selling for $30 a case, but that since the price of Type A was fluctuating, the sale price would have to
be set by the company at the time of delivery. Drake agreed. The parties signed a written K for the
delivery of 100 cases, types to be specified by Drake one week prior to the delivery date, which was set for
April 8. On April 1, the agent of the oil company called Drake and to ask how much would he take of each
type. Drake said, “April Fool! I’m not taking any,” and hung up the phone. The company calls you, its
attorney, for advice. In the past dealings that it has with Drake, he always has ordered 100 cases and has
taken 50 to 65 percent in Type A and the rest in Type B. The usual price for Type A has been $50 a case,
but due to a Middle East oil situation, the price has now jumped to $125 a case. What should the company
do? See § 2-305, §2-311, §1-205. If this were an international sale of goods under the CISG, what result?
See Article 65.
2-305 tells us that a reasonable price would be set at the time of delivery taking into consideration
the market price.
•
2-311 tells us there must be commercial reasonable. 2-311(2) tells us that it is the buyer’s option
to pick how many of type A and type B are needed. But there prior conduct would come into to
dictate how many of each they would need. Could not say need all of Type A b/c that wouldn’t be
commercially reasonable. If the essential terms of the K are not agreed upon at common law the
courts were reluctant to fill in those terms, but now the courts are more willing.
What if Drake had simply said, “April Fool!” and hung up? Is this a definite repudiation? See §2-610, §2611. What action can the oil company take to clear up Drake“s ambiguous statement? Read §2-609 and
its Official Comment.
•
This is not a definite repudiation b/c it is not clear or specific enough. This matters b/c then the
buyer could ask for assurance.
•
2-609 tells us that you have a right to send a demand letter (in writing) demanding reassurance. If
they do not respond to the letter then this can be treated as a repudiation and you can sue
immediately.
Landrum v. Devenport
o
If both parties agree on a price, but do not put it in their written K, is the agreement
invalidated?

o
If the parties fail to agree on a price at all, can there still be a K? Under what
circumstances?

o
When a writing appears obviously incomplete, as when it is silent on a point
which would normally be expressed, it may be completed by extrinsic proof of
the omitted term.
No, §2-204(3) tells us that even if the price was not agreed upon the agreement
may still constitute a valid and binding contract if both parties intended to be
bound and there is a reasonably certain basis for giving an appropriate remedy.
In such a case the law will imply that a reasonable price was intended §2-305(1).
Which price will control here?

Either market price or the sticker price, but if they didn’t agree on a price then a
reasonable price at the time of delivery. These are questions of fact for the jury
to decide.
Performance of The Contract
§2-301 states that the seller’s basic obligation is “to transfer and deliver” and the buyer’s
is “to pay in accordance with the K.” Thus the seller must tender (offer to deliver)
conforming goods, and the buyer must pay for them.
Installment Sales
In installment K, defined in §2-612(1), substantial performance is still the law. The seller
is entitled to payment even where the tender of goods fails to conform exactly to the K as
long as it “substantially” conforms. Read §2-612.
§2-503: What does the seller’s tender entail? (Manner of Seller's Tender of Delivery)
1. Tender of delivery requires that the seller put and hold conforming goods at the
buyer's disposition and give the buyer any notification reasonably necessary to
enable him to take delivery. The manner, time and place for tender are
determined by the agreement and this Article, and in particular
a. tender must be at a reasonable hour, and if it is of goods they must be kept
available for the period reasonably necessary to enable the buyer to take
possession; but
b. unless otherwise agreed the buyer must furnish facilities reasonably suited
to the receipt of the goods.
2. Where the case is within the next section respecting shipment tender requires that
the seller comply with its provisions.
3. Where the seller is required to deliver at a particular destination tender requires
that he comply with subsection (1) and also in any appropriate case tender
documents as described in subsections (4) and (5) of this section.
4. Where goods are in the possession of a bailee and are to be delivered without
being moved
a. tender requires that the seller either tender a negotiable document of title
covering such goods or procure acknowledgment by the bailee of the
buyer's right to possession of the goods; but
b. tender to the buyer of a non-negotiable document of title or of a record
directing the bailee to deliver is sufficient tender unless the buyer
seasonably objects, and except as otherwise provided in Article 9 receipt
by the bailee of notification of the buyer's rights fixes those rights as
against the bailee and all third persons; but risk of loss of the goods and of
any failure by the bailee to honor the non-negotiable document of title or
to obey the direction remains on the seller until the buyer has had a
reasonable time to present the document or direction, and a refusal by the
bailee to honor the document or to obey the direction defeats the tender.
5. Where the contract requires the seller to deliver documents
a. he must tender all such documents in correct form, except as provided in
this Article with respect to bills of lading in a set (subsection (2) of
Section 2-323); and
b. tender through customary banking channels is sufficient and dishonor of a
draft accompanying or associated with the documents constitutes nonacceptance or rejection.
§2-504: What does the seller“s tender entail? (Shipment by Seller)
•
This section is below in Rejection and Acceptance
§2-106(2): What does conforming mean? (Definitions: Conforming)
Goods or conduct including any part of a performance are "conforming" or conform to
the contract when they are in accordance with the obligations under the contract.
§2-511(2)(3): What means of payment can the buyer use? (Tender of Payment by Buyer;
Payment by Check)
(2.) Tender of payment is sufficient when made by any means or in any manner current in
the ordinary course of business unless the seller demands payment in legal tender and
gives any extension of time reasonably necessary to procure it.
(3.) Subject to the provisions of this Act on the effect of an instrument on an obligation
(Section 3-802), payment by check is conditional and is defeated as between the parties
by dishonor of the check on due presentment.
§2-612: "Installment contract"; Breach
1. An "installment contract" is one which requires or authorizes the delivery of
goods in separate lots to be separately accepted, even though the contract contains
a clause "each delivery is a separate contract" or its equivalent. (Tells us what an
installment K is.)
2. The buyer may reject any installment which is non-conforming if the nonconformity substantially impairs the value of that installment and cannot be cured
or if the non-conformity is a defect in the required documents; but if the nonconformity does not fall within subsection (3) and the seller gives adequate
assurance of its cure the buyer must accept that installment.
3. Whenever non-conformity or default with respect to one or more installments
substantially impairs the value of the whole contract there is a breach of the
whole. But the aggrieved party reinstates the contract if he accepts a nonconforming installment without seasonably notifying of cancellation or if he
brings an action with respect only to past installments or demands performance as
to future installments.
Problem 51:
Travis Galleries developed a market in copies of famous statues. It ordered monthly shipments of the
statues from Ersatz Imports, agreeing to take 12 shipments of 20 statues each over the coming year. The
first month all of the statues arrived upside down in their cartons. The manager of Travis Galleries was
amazed that most had survived the trip in this condition. Only one was broken, and a phone call to Ersatz
Imports resulted in a promise to ship a replacement at once. The next month the statues were again
package upside down, and half of them were broken. Does §2-612 permit rejection for this reason?
Assume that Ersatz replaced the broken statues within a week, but that the next month the shipment
contained no statues at all. Instead, Ersatz had mistakenly shipped Travis poor copies of 20 French
Impressionist paintings. Travis Galleries called you, its attorney. May it reject this shipment? Under what
theory? May it now cancel the remainder of the Ersatz contract?
•
§2-612 doesn“t permit rejection b/c of the broken statues b/c this does not substantially impair
the value of the statues. When half are broken this is a substantial impairment of that shipment,
but this is probably not at this point a substantial impairment to the entire K. Can reject the
shipment when didn’t get any of the right statues, and likely that this substantially impairs the
value of the entire K b/c this is the third time they screwed up out of 12 times. There is no bright
line rule. This would go to the courts.
Cherwell-Ralli, Inc. v. Rytman Grain Co.
o
Can a seller in an installment K terminate a contract without first invoking 2-609?

o
When is a party entitled to adequate assurances?

o
Yes, if the buyer“s conduct is sufficiently egregious. Then such conduct will
in and of itself constitute substantial impairment of the value of the whole
contract and present breach of the contracts as a whole. An aggrieved seller is
expressly permitted. By §2-703(f), upon breach of a K as a whole, to cancel the
remainder of the K “with respect to the whole undelivered balance.” Court
suggests that if there is reasonable doubt about whether the buyer’s default is
substantial, the seller may be well advised to temporize by suspending further
performance until it can ascertain whether the buyer is able to offer adequate
assurance of future payments.
The right to assurance is premised on reasonable ground for insecurity. Whether
a buyer has reasonable grounds to be insecure is a question of fact.
Can a buyer suspend performance if it has already received the agreed goods? In whole
or in part?

A party to a K may not suspend performance of its own for which it has already
received the agreed return.
The Perfect Tender Rule
The substantial performance rule (common law) has never (at least in theory) applied to
single-delivery contracts between merchants. To prevail in a single delivery sale, the
seller must make a perfect tender, one that complied with all of the terms of the K,
and then show that the buyer refused to take the goods. The reason for this higher
standard in single-delivery sales is that in such cases the buyer does not have the same
bargaining position a buyer would have in installment sales (where the seller needs to
keep dealing with the buyer on repeated occasions and therefore must, as a business
matter, keep the buyer happy.) Code’s Perfect Tender Rule is found in §2-601.
§2-601: Buyer's Rights on Improper Delivery (Tender: Single Delivery)
Subject to the provisions of this Article on breach in installment contracts (Section 2-612)
and unless otherwise agreed under the sections on contractual limitations of remedy
(Sections 2-718 and 2-719), if the goods or the tender of delivery fail in any respect to
conform to the contract, the buyer may
a. reject the whole; or
b. accept the whole; or
c. accept any commercial unit or units and reject the rest.
§2-508: Cure by Seller of Improper Tender or Delivery; Replacement
1. Where any tender or delivery by the seller is rejected because non-conforming
AND the time for performance has not yet expired, the seller may seasonably
notify the buyer of his intention to cure and may then within the contract time
make a conforming delivery.
2. Where the buyer rejects a non-conforming tender which the seller had reasonable
grounds to believe would be acceptable with or without money allowance the
seller may if he seasonably notifies the buyer have a further reasonable time to
substitute a conforming tender.
Problem 52:
Stella Speculator, a wealthy investor, signed a K with Swank Motors to buy five new cars. All 5 were to be
delivered on October 1. When the cars arrived, she test drove each of them and then returned 2 of the cars,
saying she would keep the other three. She rejected the 2 cars b/c the audio system did not work in one of
them (she was a great music lover) and the carpeting in the trunk of the other one was ripping. Swank
Motors offered to repair both defects. When Speculator refused to permit the repair, Swank sued. Answer
the following questions:
a.
Does the common law doctrine de minimis non curat lex (“the law does not notice small defects”)
survive §2-601? If so, in spite of the tiny defects, the cars would be conforming. See Official
Comment 2 to §2-106. The Gindy case said “some defects do not justify rejection by the buyer
but can be cured by replacement or repair.”
o
b.
A seller has a right to cure in some circumstances, See §2-508. Is this section of use to Swank
motors?
o
c.
Yes, the doctrine does survive §2-601(some courts says this). Comment 2 to §2-106 says
that cannot reject for tiny defects.
Must first make sure if the goods were delivered within the time for performance. If the
cars were delivered after then Swank Motors right to cure is already up.
Suppose Swank can demonstrate that it is common for car seller to correct small defects. Will
Swank succeed if it argued that such correction is a usage of trade (§1-205) and thus either that
the goods are conforming of that b/c of this usage of trade, the parties have impliedly agreed that a
§2-601 perfect tender is not required? See §§1-102(3), 1-102(4), 1-201(3).
o
This is a valid argument (the court will not throw this out), but they may not agree with it
when they hear it.
Cure
If the seller has not made a perfect tender, and as a result the buyer has rejected the
goods, the seller has the right in some circumstances to cure the defective performance.
The key section is §2-508 (above). Read its Official Comments also.
§2-508: Cure by Seller of Improper Tender or Delivery; Replacement
1. Where any tender or delivery by the seller is rejected because non-conforming
AND the time for performance has not yet expired, the seller may seasonably
notify the buyer of his intention to cure and may then within the contract time
make a conforming delivery.
2. Where the buyer rejects a non-conforming tender which the seller had reasonable
grounds to believe would be acceptable with or without money allowance the
seller may if he seasonably notifies the buyer have a further reasonable time to
substitute a conforming tender.
Problem 53:
On August 8, Francis and Sophie Ferdinand ordered a new car from Princip Motors for $22,000. The car
was scheduled for delivery “no later than September 1” (it had special accessories that had to be installed at
the factory). On August 15, Princip Motors told the Ferdinands that the car was ready, so they picked it
up. Halfway home (3 miles from the dealership), the engine blew up without warning. The Ferdinands
(neither were nor hurt), but the engine was destroyed. On being informed that the Ferdinands wanted their
money back, Princip made the following responses:
a.
Princip offered to take the engine out of a car of the same model and install it in the original
automobile (which was otherwise undamaged).
o
b.
No time problem here and notice was given. What does cure mean? Some courts say
that seller may not have the right to cure if the buyer’s faith is shaken. Courts are not
uniform in what cure actually means. It depends on the facts and circumstances.
Princip refused to refund the money; instead, it claimed a right to give the Ferdinands a new car to
be delivered fresh from the factory on August 20. Does §2-508 require the Ferdinands to accept
either of these cure offers?
o
It can be argued that §2-508 does not require the Ferdinands to accept the cure b/c cure is
not defined in the code.
o
In resolving this problem, it may help you to know about the Shaken Faith Doctrine,
developed in a similar situation by the court in a leading case. Put one way, once a
person’s faith is shaken, a vehicle loses not only its real value but becomes an instrument
whose integrity is substantially impaired and whose operation is fraught with
apprehension. Put another way, “the court should be willing to take judicial notice of
what all modern day consumers “know “ “t hings that do not work well at the start are
not likely to work well in the future unless the original defect is minor in nature.“
Wilson v. Scampoli
•
May a buyer reject goods b/c of a minor defect?
o
•
A buyer may not reject the goods b/c of a minor defect without giving the seller a
reasonable chance to cure the defect.
Does the seller have to replace the goods or may the seller repair them?
o
Minor repairs or reasonable adjustments are frequently the means by which an imperfect
tender may be cured.
•
When is the repair of the goods appropriate?
o
•
When the seller is able to cure the defect without subjecting the buyer to any great
inconvenience, risk or loss. Minor defects are typically repaired.
Is there a cause of action for breach of warranty if the buyer refuses to allow inspection of the
goods and an opportunity to inspect them?
o
No there is no cause of action.
Rejection and Acceptance
When the seller makes a tender of goods, the buyer must choose between two possible
legal responses: rejection (§2-602) and acceptance (§§2-606, 2-607). A buyer cannot do
both since they are mutually exclusive actions. Failure to act results in a technical
acceptance, since rejection must come within a reasonable period of time after delivery of
the goods. Read §2-606. The definition of acceptance is found in §2-606, and its legal
consequences are spelled out in §2-607. Note 2 important things about these sections: (1)
a buyer is entitled to a reasonable trial use period to see if the goods conform (this is
phrased in the code as a “reasonable opportunity to inspect”), and (2) on acceptance, the
burden of proof as to defects shifts to the buyer (§2-607(4)). Prior to acceptance the
seller must prove that a perfect tender was made under §2-601.
§2-602: (Manner and Effect of Rightful Rejection)
1. Rejection of goods must be within a reasonable time after their delivery or
tender. It is ineffective unless the buyer seasonably notifies the seller.
2. Subject to the provisions of the two following sections on rejected goods
(Sections 2-603 and 2-604),
a. after rejection any exercise of ownership by the buyer with respect
to any commercial unit is wrongful as against the seller; and
b. if the buyer has before rejection taken physical possession of goods
in which he does not have a security interest under the provisions
of this Article (subsection (3) of Section 2-711), he is under a duty
after rejection to hold them with reasonable care at the seller's
disposition for a time sufficient to permit the seller to remove
them; but
c. the buyer has no further obligations with regard to goods rightfully
rejected.
3. The seller's rights with respect to goods wrongfully rejected are governed by the
provisions of this Article on seller's remedies in general (Section 2-703).
Note: Rejection must be after reasonable time for delivery or tender. Possession doesn’t
mean acceptance. Rejection will be ineffective unless you give notice to the seller. You
can’t exercise ownership that is wrongful against the seller (merely driving a car isn’t
exercising ownership and it is not wrongful against the seller, but repainting the car
would be.)
§2-606: (What Constitutes Acceptance of Goods)
1. Acceptance of goods occurs when the buyer
a. After a reasonable opportunity to inspect the goods signifies to the
seller that the goods are conforming or that he will take or retain
them in spite of their non-conformity; or
b. Fails to make an effective rejection (subsection (1) of Section 2602), but such acceptance does not occur until the buyer has had a
reasonable opportunity to inspect them; or
c. Does any act inconsistent with the seller’s ownership; but if such
act is wrongful as against the seller it is an acceptance only if
ratified by him.
2. Acceptance of a part of any commercial unit is acceptance of that entire unit.
Note: It is fatal to assume that b/c someone has merely taken possession that they have
accepted the goods. Make sure they have time to inspect the goods. Have acceptance if
(1) signified that the goods conform, (2) take and retain despite their nonconformity or
(3) fail to make a proper rejection.
§2-607: (Effect of Acceptance; Notice of Breach; Burden of Establishing Breach After
Acceptance; Notice of Claim or Litigation to Person Answerable Over)
1. The buyer must pay at the contract rate for any goods accepted. (Once accept
must pay)
2. Acceptance of goods by the buyer precludes rejection of the goods accepted and
if made with knowledge of a non-conformity cannot be revoked because of it
unless the acceptance was on the reasonable assumption that the non-conformity
would be seasonably cured but acceptance does not of itself impair any other
remedy provided by this Article for non-conformity. (Possibly could revoke if
meet requirements but also still have remedies provided in this article.)
3. Where a tender has been accepted
a. the buyer must within a reasonable time after he discovers or should have
discovered any breach notify the seller of breach or be barred from any
remedy; and
b. if the claim is one for infringement or the like (subsection (3) of Section 2312) and the buyer is sued as a result of such a breach he must so notify
the seller within a reasonable time after he receives notice of the litigation
or be barred from any remedy over for liability established by the
litigation.
4. The burden is on the buyer to establish any breach with respect to the goods
accepted.
5. Where the buyer is sued for breach of a warranty or other obligation for which his
seller is answerable over
a. he may give his seller written notice of the litigation. If the notice states
that the seller may come in and defend and that if the seller does not do so
he will be bound in any action against him by his buyer by any
determination of fact common to the two litigations, then unless the seller
after seasonable receipt of the notice does come in and defend he is so
bound.
b. if the claim is one for infringement or the like (subsection (3) of Section 2312) the original seller may demand in writing that his buyer turn over to
him control of the litigation including settlement or else be barred from
any remedy over and if he also agrees to bear all expense and to satisfy
any adverse judgment, then unless the buyer after seasonable receipt of the
demand does turn over control the buyer is so barred.
6. The provisions of subsections (3), (4) and (5) apply to any obligation of a buyer to
hold the seller harmless against infringement or the like (subsection (3) of Section
2-312).
§2-504: (Shipment by Seller)
Where the seller is required or authorized to send the goods to the buyer and the contract
does not require him to deliver them at a particular destination, then unless otherwise
agreed he must
a. put the goods in the possession of such a carrier and make such a contract for their
transportation as may be reasonable having regard to the nature of the goods and
other circumstances of the case; and
b. obtain and promptly deliver or tender in due form any document necessary to
enable the buyer to obtain possession of the goods or otherwise required by the
agreement or by usage of trade; and
c. promptly notify the buyer of the shipment.
Failure to notify the buyer under paragraph (c) or to make a proper contract under
paragraph (a) is a ground for rejection only if material delay or loss ensues.
Problem 54:
Midwestern Seafoods, headquartered in Iowa, ordered 50 live lobsters from Maine Exports, “FOB
Portland.” On September 1, Maine Exports (ME) loaded the lobsters on board an airplane in Portland,
from where they were flown to Boston and then to Des Moines. ME failed to notify Midwestern Seafoods
of the date of the flight until 2 days later, when Midwestern’s purchasing agent called to inquire. He then
made a few calls and located the lobsters in Des Moines, where they had been sitting for a day.
Midwestern signed a receipt and picked the lobsters up. 20 of them were clearly dying (15 due to bad
handling by ME before they were handed over to the airline and 5 due to damage in transit); the other 30
were fine. Midwestern decided, for reasons that are unclear, that it wanted none of the lobsters.
Is the seller’s failure to notify Midwestern of the shipment a ground for rejection? See
§2-504 (above).

Under §2-504 these are grounds for rejection only if it is a material delay. This
is typically a question of fact for the jury.
May Midwestern reject b/c of the 20 defective lobsters? See §§ 2-601, 2-503, 2-509(1),
2-510(1).

§2-510(1) tells us that if they failed to conform to the contract the burden stays
on the seller until it is cured. But under §2-601 they must give seasonable notice
to the seller and a reasonable time to cure the defect.
How quickly must Midwestern act if it wishes to reject? What technical steps is it
required to take? See §2-602, 1-201(26), 1-204.

Reasonable time. Give notice.
Must Midwestern reship the goods to ME if the latter offers to pay the freight? See §2602(2) and its Official Comment 2; §2-603, 2-604.

Midwestern is a merchant buyer. Under §2-603(1) B/c of that they must reship
them if ME offers to pay the freight. Must comply with reasonable instructions
and these are reasonable here.
If Midwestern decides to keep 30 of the lobsters for resale, is this allowed? See §2602(2)(a), 2-606; cf. §§2-601, 2-105(6).

Yes under §2-601, Midwestern can accept part of a commercial unit and reject
the rest.
If Midwestern rejects the goods, must it give its reasons in the notice of rejection? What
penalty is there for not doing so? See §2-605 and its Official Comment 2.

Under §2-605(1) if they reject the goods they do have to give their reasons in
their notice. If they do not put in their notice, then you waive your right to object
to that.
If Midwestern gives a valid notice of rejection within a reasonable period of time after
the lobsters are delivered, what should it then do with the lobsters? See §2-602(2).

Under §2-602(2) (the risk of loss remains on the seller) it says must take care of
those lobsters.
Ramirez v. Autosport
o
If the seller substantially performs the K, may the buyer reject?

o
Yes, the buyer can still reject even when the seller substantially performs under
§2-601.
When do goods conform to the K?

o
How does the UCC mitigate against the harshness of the Perfect Tender Rule?

o
After acceptance, the Code strikes a different balance: the buyer may revoke
acceptance only if the nonconformity substantially impairs the value of the
goods to him. This provision protects the seller from revocation for trivial
defects. It also prevents the buyer from taking undue advantage of the seller by
allowing goods to depreciate and then returning them b/c of asserted minor
defects.
What is the remedy available to a buyer who rejects goods with insubstantial defects and
the seller fails to cure in time?

o
The determination of what constitutes a further reasonable time depends on the
surrounding circumstances, which include the change of position by and the
amount of inconvenience to the buyer. (Official comment 3 to §2-508).
Why is it more difficult to revoke acceptance?

o
The Code achieves that result through its provisions for revocation of
acceptance and cure.
What constitutes a further reasonable time?

o
§2-601 states that goods conform to a K “when they are in accordance with the
obligations under the K.“
The Code provides expressly that when the “buyer rightfully rejects, then with
respect to the goods involved, the buyer may cancel.“ Cancellation occurs
when either party puts an end to the K for breach by the other. B/c a buyer may
reject goods with insubstantial defects; he may also cancel the K if those defects
remain uncured. Rescission is a common law remedy. Under the UCC it is
called Cancellation. Cancellation entitles you to the K price and possibly
consequential damages.
What are some of the differences between the rejection and revocation provisions of the
code?

With rejection you don“t have to take delivery of the goods. Can reject outfront. With revocation you must first accept the goods in order for there to be a
revocation. Timing is another distinction b/w the two. Can reject for minor
defects and can only revoke for substantial impairments. One more distinction:
Burden of proof, once the goods are accepted then buyer has to prove that the
goods are defective. But the seller has the burden of proving that the goods are
conforming.
Problem 55:
Ulysses Sinon ran a dude ranch in Troy, Colorado. He decided to erect a statue of a giant horse near the
entrance to the ranch as a tourist attraction. The horse was specially manufactured by Epeius of Paris and
arrived in six boxes to be assembled by Sinon. When the horse was put together, Sinon was displeased
with the appearance of the tail. The horse has been designed by Epeius, and the scale model Sinon had
seen when he decided to buy the horse had had a different tail. Sinon removed the tail and substituted one
of his own design. He returned the original to Epeius along with a letter of rejection, In the meantime,
Sinon painted the rest of the horse black (in the delivered state it was white) and used it extensively in
advertising for the ranch. The horse failed to attract new business to the ranch. After three months of
display, Sinon took it down and shipped it back to Epeius with a letter of rejection that stated the problem
with the tail made the horse unattractive and unusable. Epeius sues. Did Sinon make a rejection or
acceptance? If the tail did not conform to the model, is that a ground for rejection? See §2-601. If Sinon
had made a technical acceptance, does that fact preclude a suit for breach of warranty? See §2-607(2).
What steps should Sinon take to preserve his legal rights? See §2-607(3)(a). What reasons lie behind the
notice requirement? See §2-508, 2-515.
•
The tail didn“t conform to the model so there is a breach of an express warranty. Can he accept
the body of the horse and reject the tail> (§2-508)…This horse in not a commercial unit, so he
cannot reject the tail and just accept the body of the horse. One commercial unit= the horse. He
painted the horse, which is inconsistent with his ownership, this suggests acceptance. Technical
acceptance doesn’t preclude him from a breach of warranty suit b/c the perfect tender rule doesn’t
discuss remedies. Under §2-607(3) must give the seller reasonable notice of the breach. This
gives the seller the right to cure.
Plateq Corp. Of North Haven v. Machlett Laboratories, Inc.
o
When does acceptance of goods occur?

o
Where does inspection of goods typically take place?

o
Yes, the court determined that the * had accepted the tanks. The trial courts
alternate theory was that the * failed to properly reject.
Can the notice of rejection be general in nature?

o
At the seller“s place of business.
Did acceptance occur here? What was the alternate theory of the trial court?

o
§2-606 says acceptance occurs primarily by signifying its willingness to take
them despite their non-conformities and secondarily by failing to make an
effective rejection.
The notice must be specific in nature. Must give details about what doesn“t
conform.
After acceptance, who has the burden of proving non-conformity?

The buyer has the burden.
Revocation of Acceptance
If the buyer technically accepts, they may still bring a breach of warranty action provided
that a proper §2-607(3)(a) notice was given. If the buyer wins, damages based on §2-714
and §2-715 will be awarded, and the buyer will still have the goods. If the buyer does not
want the goods, but wants the return of the price, that is called revocation of acceptance,
under the UCC. Read §2-608. At common law this was called rescission. May, unlike
at common law, also get consequential damages. To revoke an acceptance, the buyer
must show that the defect “substantially impairs the value” of the goods.
§2-608: Revocation of Acceptance in Whole or in Part
1. The buyer may revoke his acceptance of a lot or commercial unit whose nonconformity substantially impairs its value to him if he has accepted it.
a. on the reasonable assumption that its non-conformity would be cured and
it has not been seasonably cured; or
b. without discovery of such non-conformity if his acceptance was
reasonably induced either by the difficulty of discovery before acceptance
or by the seller’s assurances.
2. Revocation of acceptance must occur within a reasonable time after the buyer
discovers or should have discovered the ground for it and before any substantial
change in condition of the goods which is not caused by their own defects. It is
not effective until the buyer notifies the seller of it.
3. A buyer who so revokes has the same rights and duties with regard to the goods
involved as of he had rejected them.
Note: Mistake often made: can’t reject once accepted. §2-608 tells us that it must
substantially impair the value to the buyer. He must have accepted it (a) on the
assumption that it would be cured and it wasn’t or (b) they were induced by difficulty of
discovery by seller’s assurance. Revocation must be within a reasonable time after
discovered or should have been discovered. There must also be notice.
Rester v. Morrow
o
Did the buyer accept the car? How?

o
When is the buyer entitled to revocation of acceptance?

o
Our law tells a buyer such as Rester that he may revoke only if there is
substantial impairment of the value of the car “to him.“
How long does the seller have to cure the defect? Can this happen perpetually?

o
Yes, he accepted the car when he failed to make an effective rejection after
having had a reasonable opportunity to inspect it.
Reasonable time. No, the law does not allow the seller to postpone revocation in
perpetuity by fixing everything that goes wrong with the automobile.
How is substantial impairment determined?

Substantial impairment is determined by reference to the particular need of the
buyer, even though the seller may have no advance knowledge of those needs
and even though those needs may change after acceptance of the car.
Lemon Laws:
A number of states have enacted the so called Lemon Laws that resolve some of these
disputes we have been exploring when they arise in connection with a consumer’s
purchase of an car.
Problem 56:
The day after Alice Bluegown bought her new car, the right rear fender fell off. May she use §2-608 or
must she give the car dealer a right to cure?
•
Can argue she hasn“t even accepted the car b/c no reasonable time to inspect. Can revoke
acceptance if substantially impairs the value to her. The bumper falling off possibly substantially
impairs the value to her.
Pretend she is sitting in your office expecting an immediate answer; glance at §2-608 and decided. The
next day she took the car back to have the fender repaired; this made her late for work. The dealer fixed it,
and the fender gave her no more trouble. However, the first time it rained all the paint washed off her car.
May she revoke now?
•
Yes, more likely substantial impairment to her.
She took the car back to the dealer when the rain stopped and rode the bus to work (late again). The car
dealer did a nice job repainting the car. 2 weeks later the engine quit on her when she was in the middle
lane of a superhighway at rush hour. The car had to be towed to the car dealer, and Alice missed an
important sales meeting. The car dealer fixed the engine. Now Alice is back in your office. The car’s
trunk will not open. Must she permit them to fix it, or can she revoke?
•
She can revoke. Bring up the Shaken Faith Doctrine.
She has missed enough work to worry about hurting her career. She“s also concerned that the car is going
to keep breaking down right through and past the warranty period. What do you advise? Is §2-609 of use
to her? Is she decided to revoke acceptance and if the court agrees that this is allowed, would it also permit
her to recover for the cost of the rental car used as a substitute transportation while she was attempting to
purchase a new car? If she goes out and buys a new car, can she make the first car dealer pay for it? See
§2-712.
•
The rental car- some courts say yes and some courts say no. Courts won“t allow you to get a
new car b/c it would be a windfall. May be able to deduct the value b/w the two cars.
Problem 57:
Suppose in the last Problem the K b/w the dealer and Bluegown explicitly limits the remedy for breach to
repair or replacement of defective parts. The dealer argues that all defects have been promptly and
successfully repaired and that the remedy of revocation of acceptance is therefore unavailable to
Bluegown. See §2-719(2).
•
Yes, the seller is allowed to limit the remedy, but the buyer can get around this if the remedy fails
its essential purpose.
Problem 58:
Arthur Author ordered an expensive computer (the ION # 740) from ION Business Machines. ION sent
him model # 745, a newer and better version of the machine he had ordered, at the same price. When he
saw the computer, he liked it and wrote them a letter of acceptance, enclosing a check in payment.
However, when he began to use it, he was horrified to learn that the computer was turned on by a hidden
switch under the front panel. Arthur Author’s father had lost a finger when he reached under a machine to
activate it. Arthur has witnessed the accident as a child. Arthur sent a notice of revocation of acceptance to
ION, stating that the #745 brought back childhood memories that kept him from wanting the computer.
Does §2-608 permit him to revoke for this reason? See Official Comment 2. Is §2-508(2) relevant? How
would you advise ION to respond to Arthur Author’s letter?
•
First, must decide if this substantially impairs the value “to him,“ the buyer. Yes, this is a
substantial impairment to him subjectively. Is this really right? Some courts will struggle even
though the comment says “to him,“ but the majority of courts reads its subjectively (like it
says).
Problem 59:
After his car had broken down with the same defect six times Zack Taylor decided to revoke acceptance
and return the car to Fillmore Motors, the dealership that had sold him the vehicle but that had been unable
to repair it. To Zack’s dismay, he discovered that Fillmore Motors had gone bankrupt and was out of
business. Zack is now in your office with this issue: may he revoke acceptance against the manufacturer of
the car (which had covered its product with a limited warranty?) Note that the Magnuson-Moss Warranty
Act might help consumers in this situation. Section 110(d) of the Act allows civil action against the
warrantor that includes both legal and equitable relief.
•
There is a split among jurisdictions.
Problem 61:
Ambiance Hotel decided to acquire 10 horse-drawn carriages to be specially designed to carry its guests
around the tourist areas of the scenic city in which it is located. It had the plans for the carriages
transmitted to Buggies, Inc., a carriage manufacturer, which assured Ambiance that there would be no
problem with the creation of the carriages. Ambiance financed this transaction by having Octopus National
Bank purchase the carriages from Buggies, Inc., and then lease them to Ambiance for a 10-year period.
Assume that this transaction qualifies as a finance lease; See §2A-103(1)(g).
a.
If the carriages are delivered to the hotel and Ambiance rejects them b/c they are the wrong color,
must Ambiance pay the lease amounts to Octopus National Bank? (You may assume that the
finance lease contained a “hell or highwater” clause.) See §2A-407(1), 2A-515.
o
b.
No b/c the clause doesn’t kick in until the goods have been accepted.
If the hotel accepts the carriages, but becomes upset when they constantly break down, can it
revoke its acceptance and refuse to pay the lessor? See §§2A-407, 2A-516 and its Official
Comment, 2A.
o
No b/c most likely still going to have to pay them come hell or highwater.
Risk of Loss: No Breach
General Rules:
The UCC expressly states that that its rules as to who bears the risk of loss have nothing
to do with who has technical title (2-401(1)). The general Code rule on the transfer of the
risk of loss is that, absent contrary agreement (1) where the seller is a merchant, the risk
of loss passes to the buyer on the buyer’s actual receipt of the goods; and (2) where the
seller is not a merchant, risk of loss passes to the buyer when the seller tenders delivery.
See §2-509(3). ROL will always begin with the seller and will at some point transfer to
the buyer. You must determine when this shift takes place. This is important b/c of
insurance.
§2-509: Risk of Loss in the Absence of Breach
1. Where the contract requires or authorizes the seller to ship the goods by
carrier
a. Shipment K: if it does not require him to deliver them at a
particular destination, the risk of loss passes to the buyer when the
goods are duly delivered to the carrier even though the shipment is
under reservation (Section 2-505); but
b. Destination K: if it does require him to deliver them at a particular
destination and the goods are there duly tendered while in the
possession of the carrier, the risk of loss passes to the buyer when
the goods are there duly so tendered as to enable the buyer to take
delivery.
2. Bailment Situation: Where the goods are held by a bailee to be delivered
without being moved, the risk of loss passes to the buyer (depends when
title passes)
a. on his receipt of possession or control of a negotiable
document of title covering the goods; or
b. on acknowledgment by the bailee of the buyer's right to
possession of the goods; or
c. after his receipt of possession or control of a nonnegotiable document of title or other direction to deliver in
a record, as provided in subsection (4)(b) of Section 2-503.
3. Catchall: In any case not within subsection (1) or (2), the risk of loss
passes to the buyer on his receipt of the goods if the seller is a merchant; if
the seller is not a merchant the risk passes to the buyer on tender of
delivery.
4. The provisions of this section are subject to contrary agreement of the
parties and to the provisions of this Article on sale on approval (Section 2327) and on effect of breach on risk of loss (Section 2-510). (Can always
allocate risk of loss by agreement.)

Problem 44:
Comment 3: whether the K involves delivery at the seller“s place
of business or at the situs of the goods, a merchant seller cannot
transfer ROL and it remains upon him until actual receipt by the
buyer, even though full payment has been made and the buyer has
been notified that the goods are at his disposal.
William College (non-merchant buyer) bought a car from Honest John, the friendly car dealer. He paid the
price in full, and Honest John promised delivery on the next Monday. On Monday, the car was ready, and
Honest John phoned College and said, “Take it away.” College said he was busy and that he would pick it
up the next day, to which Honest John agreed. That night the car was stolen from the lot due to no fault of
Honest John, who had taken reasonable precautions against such a thing. Who had the risk of loss? See
§2-509(3) and Official Comment 3. Might Honest John claim he was a bailee so that §2-509(2) applies?
(Risk of loss, no breach- §2-509)
o
Problem 45:
Seller is a merchant so risk of loss passes to buyer when the buyer receives the goods
says §2-509(3). Did the buyer receive the goods? No, the buyer has not received the
goods which means the risk of loss is still on the seller.
t
Janice Junk (non-merchant) decided to hold a garage sale to clean up her home and get some extra cash. In
the course of the sale, which was a huge success, her neighbor, Barbara Bargain, offered Junk $200 for her
piano, and the 2 women shook hands. Junk said to Bargain, “Take it away. It’s yours.” Bargain replied
that she would come get it the next day with four strong friends and a truck. That night Junk’s home
burned to the ground, and the piano was destroyed. Did the risk of loss pass from Junk to Bargain? See
§2-503. If Bargain never picked up the piano and if it was destroyed in a fire 6 months after the sale, what
result? See §2-709(1)(a).
o
Under §2-509(3) for a non-merchant seller the risk of loss will pass to the buyer when the
seller tenders delivery. Under §2-503, the risk of loss will remain with the seller here b/c
it hasn’t been a reasonable time for the risk of loss to pass over to the buyer. When talk
about a piano they will need some time to move it.
o
Clearly 6 months is reasonable time to pick up the piano, but we just don’t know when
the time is where the seller can assume the buyer is never coming to pick up the goods.
§2-503: Manner of Seller's Tender of Delivery
6. Tender of delivery requires that the seller put and hold conforming goods at the
buyer's disposition and give the buyer any notification reasonably necessary to
enable him to take delivery. The manner, time and place for tender are
determined by the agreement and this Article, and in particular
a. tender must be at a reasonable hour, and if it is of goods they must be kept
available for the period reasonably necessary to enable the buyer to take
possession; but
b. unless otherwise agreed the buyer must furnish facilities reasonably suited
to the receipt of the goods.
7. Where the case is within the next section respecting shipment tender requires that
the seller comply with its provisions.
8. Where the seller is required to deliver at a particular destination tender requires
that he comply with subsection (1) and also in any appropriate case tender
documents as described in subsections (4) and (5) of this section.
9. Where goods are in the possession of a bailee and are to be delivered without
being moved
a. tender requires that the seller either tender a negotiable document of title
covering such goods or procure acknowledgment by the bailee of the
buyer's right to possession of the goods; but
b. tender to the buyer of a non-negotiable document of title or of a record
directing the bailee to deliver is sufficient tender unless the buyer
seasonably objects, and except as otherwise provided in Article 9 receipt
by the bailee of notification of the buyer's rights fixes those rights as
against the bailee and all third persons; but risk of loss of the goods and of
any failure by the bailee to honor the non-negotiable document of title or
to obey the direction remains on the seller until the buyer has had a
reasonable time to present the document or direction, and a refusal by the
bailee to honor the document or to obey the direction defeats the tender.
10. Where the contract requires the seller to deliver documents
a. he must tender all such documents in correct form, except as provided in
this Article with respect to bills of lading in a set (subsection (2) of
Section 2-323); and
b. tender through customary banking channels is sufficient and dishonor of a
draft accompanying or associated with the documents constitutes nonacceptance or rejection.
Note:
Section §2-509(3) applies only when §2-509(1) or §2-509(2) does not.
Delivery Terms
•
Shipment Contracts: a sales K where the seller need only get the goods to the
carrier and then the buyer will take on the risk of loss.
•
Destination Contracts: where the parties agree that the goods must be delivered by
the carrier before the risk passes from seller to buyer.
•
Official Comment 5 to §2-503: Article 2 makes a presumption in favor of a
shipment K. When a K is silent on risk of loss, typically this presumption will
come into play.
•
Delivery terms: merchants have created a shorthand method of stating whether
the sale calls for a shipment or a destination K by using abbreviations, such as
(F.O.B.- free on board; F.A.S.- free along side; CIF- cost, insurance, freight; C.
& F.- cost and freight; and ex-ship-off the ship). These are not only delivery
terms but also price terms and inform the buyer that the price quoted includes
freight paid to the point indicated.
1. C.I.F. and C. & F. indicate a shipment K. C.I.F. means the price stated includes
the cost of the item, the insurance premium, and the freight charge. C. & F. is the
same but without the buyer’s agreeing to pay insurance.
2. F.A.S. and Ex-ship are delivery terms used in connection with ships. Read §2319(2) and §2-322, and use them in answering Problem 47 below.
3. F.O.B. can indicate either a shipment or a destination contract. In a K it is always
followed by a named place (like F.O.B. Pittsburgh). The risk of loss passes at the
named place. Thus, if the named place is the seller’s warehouse, the F.O.B. term
calls for a shipment K; if it is the buyer’s store, a destination contract results.
§2-319: F.O.B. and F.A.S. Terms
(1) Unless otherwise agreed the term F.O.B. (which means "free on board") at a
named place, even though used only in connection with the stated price, is a
delivery term under which
a. when the term is F.O.B. the place of shipment, the seller must at
that place ship the goods in the manner provided in this Article
(Section 2-504) and bear the expense and risk of putting them into
the possession of the carrier; or
b. when the term is F.O.B. the place of destination, the seller must at
his own expense and risk transport the goods to that place and
there tender delivery of them in the manner provided in this Article
(Section 2-503);
c. when under either (a) or (b) the term is also F.O.B. vessel, car or
other vehicle, the seller must in addition at his own expense and
risk load the goods on board. If the term is F.O.B. vessel the buyer
must name the vessel and in an appropriate case the seller must
comply with the provisions of this Article on the form of bill of
lading (Section 2-323).
(2) Unless otherwise agreed the term F.A.S. vessel (which means "free
alongside") at a named port, even though used only in connection with the stated
price, is a delivery term under which the seller must
a. at his own expense and risk deliver the goods alongside the vessel
in the manner usual in that port or on a dock designated and
provided by the buyer; and
b. obtain and tender a receipt for the goods in exchange for which the
carrier is under a duty to issue a bill of lading.
Problem 46:
Seller in NYC contracted to sell 80 boxes if clothing to buyer in Savannah, GA. The delivery term was
“$1,800 F.A.S. S.S. Seaworthy, N.Y.C.” Seller delivered the 80 boxes to the dock alongside the S.S.
Seaworthy and received a bill of lading from the ship as a receipt. Before the boxes could be loaded, the
dock collapsed, everything thereon disappeared into the water. Under §2-319(2) must buyer pay the $1,800
anyway? What if the delivery term had been “Ex-ship S.S. Seaworthy, Savannah,“ and the boxes had
been properly unloaded just before the dock collapsed? Would §2-322 make the buyer pay?
•
Under §2-319(2), the requirements were met so the risk of loss shifts over to the buyer.
•
Under §2-322, the requirements are met, so the buyer passes over to the buyer.
Problem 47:
Seller in Detroit, MI contracted to sell and ship 50 automobiles to buyer in Birmingham, AL. Assume
lightning strikes, destroying the vehicles after the carrier has received them but before they are loaded on
board the railroad car that was to take them to Birmingham. Who had the risk of loss if
(a) The K said, “F.O.B. Detroit” See §2-319(1)(a));
o
The risk of loss is going to pass to the buyer after the seller duly delivers them, which
they did here.
(b) The contract said, “F.O.B. railroad cars Detroit” (See §2-319(1)(c)); or
o
The risk of loss is not going to pass until the seller actually loads the goods onto the
carrier, and here they were not, so the ROL is on the seller.
(c) The contract said, “C.I.F. Birmingham” (See §2-320)
o
Not a definitive answer here. The Code is ambiguous, so this would have to be litigated.
Problem 48:
The dispatcher for Perfect Pineapples, Inc. had just finished loading five boxcars of the company’s product
on board the cars of an independent railroad carrier when he received a notice from PPI’s sales department
that the company had agreed to sell one boxcar load to Grocery King Food Stores “F.O.B. seller’s
processing plant.” The dispatcher agreed to divert one of the boxcars to Grocery King, but before he could
do so, a hurricane destroyed all 5 boxcars and their contents. Who bears the risk of loss? See Official
Comment 2 to §2-509.
o
Official Comment 2 to §2-509 tells us that once the goods are afloat the seller must
identify the goods in order for the risk of loss to pass over to the buyer. None of the box
cars were identified so the ROL did not pass to the buyer here.
Cook Specialty Co. v. Schrlock
o
What does the term “F.O.B. place of shipment“ mean? Who bears the risk of loss?

o
The term F.O.B. place of shipment means that “the seller must at that place
ship the goods in the manner provided in this Article (§2-504) and bear the
expense and risk of putting them into the possession of the carrier.“
What does “duly delivered“ mean under §2-509?

o
When is §2-504 satisfied?

o
It is satisfied when where the seller is required or authorized to send the goods
to the buyer and the K does not require him to deliver them at a particular
destination, then unless otherwise agreed the seller puts the goods in possession
of such a carrier and make such a K for their transportation as may be
reasonable having regard to the nature of the goods and other circumstances of
the case.
What is an example of something that constitutes and “unreasonable“ K of
transportation?

o
Goods are not duly delivered unless a K is entered which satisfies the provisions
of §2-504.
It would be unreasonable to send perishables without refrigeration.
Was it an unreasonable K of transportation here?

No, MSI obtained from the carrier a certificate of insurance and did nothing to
impair *“s right to recover for any loss from the carrier. Accidents occur in
transit. The K in this case was “F.O.B.“ seller“s warehouse. * clearly bears
the risk of loss in transit.
Rheinberg-Kellerei GmbH v. Vineyard Wine Co.
o
What happened to the goods in transit? Was it either party“s fault?

o
Which section of the UCC helps determine when the ROL passes to the buyer?

o
§2-509(1)(a). Risk of loss in the absence of breach (1) where the K requires or
authorizes the seller to ship the goods by carrier (a) if it does not require him to
deliver them at a particular destination, the risk of loss passes to the buyer when
the goods are duly delivered to the carrier even though the shipment is under
reservation.
What does duly delivered mean as far as the duties that are owed to the buyer under §2504?

o
The goods were sent on the M.S. Munchen, which was lost in the North
Atlantic. This was neither party“s fault.
Before a seller will be deemed to have “duly delivered“ the goods to the
carrier, however, he must fulfill certain duties owed to the buyer.
What did the seller do wrong here, and what were the consequences?

He failed to promptly notify the buyer that his goods were in transit as is
required in §2-504. Since the * was never notified directly or by the forwarding
of shipping document within the time its interest could have been protected by
insurance or otherwise, * was entitled to reject the shipment pursuant to the term
of §2-504(c).
Problem 49:
The University of Beijing in China ordered video equipment to be shipped from Applied Technology, Inc.,
in San Jose, CA. If nothing is said about the subject, as a matter of international law, will this create a
shipment of a destination contract? See CISG Articles 67 and 69. If the parties had been negotiating for
the purchase of this equipment but had not gotten around to signing the contract until the goods were
already on board an airplane crossing the Pacific Ocean, does the buyer have the risk of loss only from the
moment of the signing of the K or from the delivery of the equipment to the air carrier? See Article 68.
•
Under the CISG, if the parties fail to agree a destination K will result.
•
From the signing of the K.
Problem 50:
Dime-A-Minute Rent-A-Car rented a new sports car to Joseph Armstrong. Due to a snafu at the rental
office, Armstrong did not sign a rental agreement. As he was leaving the rental car lot, the car was struck
by a city bus due to no fault of Armstrong (who was not hurt). The sports car was totaled. Dime-A-Minute
demanded that Armstrong look to his insurance to replace the car. Did he have the risk of loss here? See
§2A-219. If he had signed a rental agreement making him responsible for the car, would that agreement be
valid? See §§1-102(3) and 2A-108.
•
There is a strong presumption the ROL would remain on the lessor in a situation such as this.
•
The question would be is this or is this not unconscionable. This would be litigated.
Note:
In risk of loss, both the UCC and the CISG, presupposes that neither of the parties is in
breach of their agreement at the moment when the risk would normally pass. If this is not
true (for instance, when the seller is in breach b/c the goods do not conform to the
warranties made in the K), §2-509 does NOT apply. The relevant section is §2-510
(§2A-220 for leases and Articles 66 and 70 for the CISG).
Risk of Loss: Breach
The Code’s general rules on risk of loss are found in §2-509, but that section applies only
where neither party has breached the sales K. If a breach has occurred, §2-510 is the
relevant section. Read it.
§2-510: Effect of Breach on Risk of Loss
1. Where a tender or delivery of goods so fails to conform to the contract as to give a
right of rejection the risk of their loss remains on the seller until cure or
acceptance.
2. Where the buyer rightfully revokes acceptance he may to the extent of any
deficiency in his effective insurance coverage treat the risk of loss as having
rested on the seller from the beginning.
3. Where the buyer as to conforming goods already identified to the contract for sale
repudiates or is otherwise in breach before risk of their loss has passed to him, the
seller may to the extent of any deficiency in his effective insurance coverage treat
the risk of loss as resting on the buyer for a commercially reasonable time.
Note: (1) if seller breached the ROL is on the seller until there is cure or acceptance, (2)
if seller breaches and buyer rightfully revokes acceptance then the ROL is on the seller
but only to the extent to any deficiencies in the buyer’s insurance or (3) if buyer breaches
the ROL is on the buyer but only to the extent of any deficiencies in the seller’s
insurance.
Jakowski v. Carole Chevrolet, Inc.
* is a non-merchant and he is the buyer of a car. The * is a merchant and he is the seller.
The car was delivered to the buyer without the undercoating that was promised in the K.
So the seller calls the buyer and tells him he will cure the defect. The car was stolen from
the dealership that night and the seller refused to give the buyer back the purchase price
or deliver another car to him. This lawsuit ensued.
•
Does §2-509(3) or §2-510(1) apply here, and why?
o
•
What are the three questions §2-510(1) requires to be answered?
o
•
No, no particular quantum of non-conformity is required where a single delivery is
contemplated. Need any non-conformity.
Did the buyer accept the car? Why?
o
•
(1) Did the car “so fail to conform“ as to give this buyer a right to reject it? (2) If so,
did the buyer “accept“ the car despite non-conformity, (3) Finally, did the seller cure
the defect prior to the theft of the auto?
Where a single delivery of goods is contemplated, is there any particular quantum of nonconformity needed?
o
•
§2-510(1) applies here b/c there has been a breach of the sales contract by the seller.
The buyer had the right to reject b/c the goods failed to conform to the sales K. No, the
buyer did not accept the non-conforming car. He didn“t have a reasonable opportunity
to inspect the goods. The buyer was precluded from rejecting the car b/c the seller
shortly after delivery, offered to cure the goods to the extent they failed to conform.
Who bears the ROL here? Why?
o
The goods failed to conform, the buyer never accepted and the defect was never cured.
Accordingly, the risk of loss remained on the seller and judgment is granted for the *.
o
Rule: Under §2-510(1) where goods fail to conform to the contract of sale, the risk of loss
remains on the seller until the buyer accepts the goods or until the seller cures the defect.
Problem 62:
The Lamia Museum’s director Mandrake Griffin, ordered three new pieces for the museum: an Egyptian
sphinx, an Old World gargoyle, and an Etruscan statue of a centaur. These objets d’art were purchased
under separate contracts from Empusa Exports of London, England. All were to be shipped “F.A.S. S.S.
Titanic” on or about April 9, on their way to the museum, which was located in NJ. The parties agreed that
NJ law would apply. Prior to April 9, Empusa Exports received a call from Griffin canceling the purchase
of the centaur statue. Empusa protested the cancellation, but agreed to ship the other two pieces. Empusa’s
manager discovered that the sphinx was phony, but kept her mouth shut and shipped it anyway. She also
discovered that the gargoyle’s condition was such that it could not survive the exposure to seal air, so she
decided to send it by air in spit of the K’s F.A.S. Titanic term. This decision proved wise since the Titanic
encountered an obstacle on its sea voyage and foundered, taking the sphinx with it. The gargoyle arrived in
good condition, and Griffin wrote a letter to Empusa accepting the gargoyle and enclosing the museum’s
check. A week later Griffin learned that the gargoyle was not from the “Old World” but instead had been
cast in Hoboken many years ago and had somehow found its way to Europe. He sent Empusa a letter
demanding that the museum’s money be returned and stating that he canceled the sale. Before Empusa
could respond, two things happened: the museum burned to the ground, and the centaur statue was stolen
from Empusa’s warehouse (through no fault of Empusa, which was not negligent in guarding it). Both the
museum and Empusa were fully insured. Answer these questions:
a.
By shipping the other two objects after the museum refused to take the centaur statue, did Empusa
waive its right to sue for the repudiation? See §2-106(4). Would §1-207 have helped Empusa?
What should it have done to use this section?

b.
Which party took the risk of loss on
1.
The centaur?

2.
3.
The buyer breached and the seller is protesting the breach. The buyer is the one
at fault. Under §2-510, insurance becomes important. The ROL is on the buyer
to the extent to any deficiencies in the seller’s insurance, but here the seller and
the buyer are fully insured. There are no deficiencies in sellers insurance (the
sellers insurance will cover everything) so there is nothing for the buyer’s
insurance to cover.
The sphinx?

Seller ships phony sphinx. Under §2-510(1) the ROL is on the seller b/c the
seller did not make a perfect tender (did not conform to the K).
The gargoyle?

c.
Under §2-106(4), the answer is probably not. §1-207 would have helped
Empusa, by shipping the other two and rejecting the other one this is probably
enough.
Under §2-510(2) the buyer rightfully revokes acceptance. The ROL is on the
seller over and above B“s insurance. Buyers insurance is going to cover all of
this.
When Empusa shipped the gargoyle by air instead of by sea could Lamia have treated this as an
imperfect tender and rejected the gargoyle for that reason? See §2-614.

§2-614(1) tells us that where the manner of shipment becomes impracticable
reasonable substitute should be used and must be accepted. They can’t object
and say that you didn’t give a perfect tender b/c it was impracticable to ship it by
sea. This is a bad argument.
d.
The Lamia Museum’s insurance policy with the Pegasus Insurance Company contains two clauses
relevant to §2-510. One provided that on payment of a claim the insurance company was
subrogated to any claim its insured had against any other person. The other stated that the policy
should not be deemed to provide protection for any claim where the risk of loss rested with
another person. What is the effect of these provisions? See Official Comment 3 to §2-510.

Insurance companies cannot get around there obligations by inserting provisions
like these. They are not effective.
Impossibility of Performance
The Code has four provisions designed to straighten out the legal tangles created by those
unexpected events of life that make the performance of a contract impossible or (the UCC
equivalent) commercially impracticable. By creating a new standard of commercial
impracticability, the Code drafters intended to broaden the common law concept of
impossibility. Many commentator believe that the courts have essentially ignored the
drafters’ intentions and treated commercial impracticability as synonymous with common
law impossibility. (§2-613: Goods are identified, §2-614: substitute performance, §2-615:
Goods are not identified, §2-616: Notice provision when use Commercial
Impracticability as defense).
§2-616: Procedure on Notice Claiming Excuse:
1. Where the buyer receives notification of a material or indefinite delay or an
allocation justified under the preceding section he may by written notification to
the seller as to any delivery concerned, and where the prospective deficiency
substantially impairs the value of the whole contract under the provisions of this
Article relating to breach of installment contracts (Section 2-612), then also as to
the whole,
a. terminate and thereby discharge any unexecuted portion of the contract;
or
b. modify the contract by agreeing to take his available quota in substitution.
2. If after receipt of such notification from the seller the buyer fails so to modify the
contract within a reasonable time not exceeding thirty days the contract lapses
with respect to any deliveries affected.
3. The provisions of this section may not be negated by agreement except in so far
as the seller has assumed a greater obligation under the preceding sections.
Problem 63:
V had always wanted a sundial for his garden, and he ordered one for $250 from Horology. The latter had
12 sundials of the type V ordered in its storage room when an earthquake shook the building. All 12 fell
over, and all but three were smashed. The remaining three were slightly damaged. V, on being informed of
the problem, insisted on the right to look over the three remaining sundials and to select one for his
purchase, possibly at a reduced price due to the damage. Horology comes to you. Is §2-613 or §2-615
relevant? Must it let V pick out a sundial, and must if offer to let him purchase at a reduced price, or can it
simply cancel without fear or legal liability? For the test for impossibility of performance in international
sales, see CISG Article 79.

§2-615 would apply here b/c the goods are not yet identified (that this particular
sun dail goes to this particular person).

§2-615 tells us that no it must not let V pick out a sundial, no he can allocate
how he is going to deliver them as long as it is fair and reasonable. He cannot
be arbitrary; he must act in a fair and reasonable manner.
Problem 64:
Suppose the following, using the basic facts of the last Problem. When Horology received V’s order, one of
their salespersons immediately put a red tag on one of the sundials. It said, “Hold for V.” Then the
earthquake occurred, and miraculously only V’s sundial was destroyed. The other 11 sundials, all exactly
like V’s, were undamaged. When V demanded his sundial, Horology pleaded §2-613. Will that section
excuse them?
•
§2-613 only applies when the goods have been identified and they have not been identified here
so this will not excuse Horology. For §2-613 to apply the K language must specify that that the
goods must be identified. It would have to be required.
Arabian Score v. Lasma Arabian Ltd.
* bought a horse from * for a million dollars. He paid a large sum of money for the horse
to be promoted. The horse had 2 foals and then it died. The horse was covered by
insurance, but the insurance company went broke. The * sued the *. The court said it
was practicable to promote a dead horse.
•
How does the court define commercial frustration?
o
•
Does it include impracticability? How do you prove that?
o
•
The court did not limit the doctrine to strict impossibility but included impracticability
caused by extreme or unreasonable difficulty or expense. This is proved by showing that
the supervening frustrating event was not reasonably foreseeable.
What happens when a party assumes the risk of the frustrating event?
o
•
The court defined commercial frustration as circumstances beyond the control of the
parties which render performance of the K impossible and exonerate the part failing to
perform.
The application of commercial frustration doctrine is rejected when the party assumes the
risk of a frustrating event. If the parties to a contract have agreed in express or implied
terms that the risk of loss shall fall upon one or the other of the parties, full effect is given
to such provision.
What were the 3 reasons why the doctrine didn“t apply in this case?
o
The commercial frustration doctrine doesn“t apply in this case b/c (1) Score’s death was
foreseeable, as evidenced by Arabian’s purchase of insurance, and (2) b/c Arabian
assumed the risk of Score might die prematurely, and (3) b/c the party obligated to
perform- Lasma- does not contend that it is unable or unwilling to complete its duty to
promote Score.
Problem 65:
In the mid-1960s, in an effort to boost sales of its nuclear reactors, Westinghouse agreed to sell 27 utility
companies 80 million pounds of uranium over the next 20 years. The average sale price per pound was $10.
When Westinghouse made the sale, it actually owned only 15 million pounds of uranium. By the mid1970s, the price or uranium had risen to $40 a pound. In late 1975, Westinghouse announced that it would
not honor its contract. The utilities sued. Westinghouse argued that the best evidence in the late 1960s and
early 1970 syndicated uranium prices would be stable over the long term. The Corporation claimed that the
price rise was unforeseeable and that the contracts were excused under §2-615 as “commercially
impracticable.” In particular, Westinghouse blamed the 1973 oil embargo and worldwide price fixing for
the “unpredictable” price rises. How should the dispute be resolved? If you could advise Westinghouse on
how to avoid this problem in the future, what would you suggest?
•
This dispute should be resolved in favor of the utilities. The argument that the cost has risen to
high that the K is impracticable is almost always a loser.
Louisiana Power and Light Co. v. Allegheny Ludlum Industries, Inc.
•
When it is appropriate to invoke §2-609?
o
•
Where those circumstances present here?
o
•
Yes, the letter LP & L received from Allegheny requesting “additional compensation“
provided LP & L with a reasonable basis for insecurity as to Allegheny“s performance
under the K.
When a party repudiates the K and performance isn“t yet due, what remedy may be had?
o
•
It is appropriate to invoke §2-609 when reasonable grounds for insecurity with respect to
the performance of either party the other may in writing demand adequate assurance of
due performance.
When either party repudiates the K with respect to a performance not yet due the loss of
which will substantially impair the value of the K to the other, the aggrieved party may…
(b) resort to any remedy for breach (§2-703 or §2-711)…UCC §2-610. An example of a
remedy is for the buyer to obtain a :cover” by purchasing goods in substitution for the
goods due from the seller. A buyer and non-breaching party may then seek to recover
from the seller and breaching party the price of such substituted goods plus incidental and
conqsequential damages.
When may performance be excused because of commercial impracticability?
o
§2-615: Except as far as a seller may have assumed a greater obligation and subject to the
proceeding section on substituted performance: (a) Delay in delivery or non-delivery in
whole or in parts by a seller who complies with paragraphs (b) and (c) is not a breach of
his duty under a K for sale if performance as agreed has been made impracticable by the
occurrence of a contingency the non-occurrence of which was a basic assumption on
which the K was made…
o
•
What are the three conditions that must be met?
o
•
Mere increase in cost alone is not a sufficient excuse for non-performance. It must be an
“extreme and unreasonable“ expense. It must be severe, unreasonable, excessive, etc...
(Footnote 7) Would this put the party out of business?
When is unconscionability an appropriate defense?
o
•
The burden of proof on a claim of commercial impracticability rests with the party
making the claim, in this case the *.
When may lost profits be enough to show commercial impracticability?
o
•
Before performance under a K can be excused b/c of commercial impracticability three
conditions must be met pursuant to §2-615: (1) a contingency must occur, (2)
performance must thereby be made “impracticable,“ and (3) the non-occurrence of the
contingency must have been a basic assumption on which the K was made.
Who bears the burden of proof?
o
•
The rule has also been stated as “excusing delay or non-delivery when the agreed upon
performance has been rendered commercially impracticable by an unforeseen
supervening event not within the contemplation of the parties at the time of the K was
entered into.“
Comment 1 to §2-302 tells is that “The basic test is whether in the light of the general
commercial background and the commercial needs of the particular trade or case, the
clauses involved are so one-sided as to be unconscionable under the circumstances
existing at the time of making the K… The principle is one of the prevention of
oppression and unfair surprise… and not of disturbance of allocation of risks b/c of
superior bargaining power.”
What does good faith mean?
o
Under §1-203, Good-faith is defined as “honesty in fact and the observance of
reasonable commercial standards of fair dealing in the trade.“
Remedies
Seller “s Remedies
The plan of the 2-700s is to describe briefly the seller’s remedies in §2-703 and the
buyer’s in §2-711 and then the flesh out these brief descriptions in the sections
immediately following. All of these remedies sections are to be read in light of the
Code’s guiding remedial principle,
§1-106(1): The remedies provided by this Act shall be liberally administered to the end
that the aggrieved party may be put in as good a position as if the other party had fully
performed but neither consequential or special nor penal damages may be had except as
specifically provided in this Act or by other rule of law.
§ 2-702. Seller's Remedies on Discovery of Buyer's Insolvency.
(1) Where the seller discovers the buyer to be insolvent he may refuse delivery except for
cash including payment for all goods theretofore delivered under the contract, and stop
delivery under this Article (Section 2-705).
(2) Where the seller discovers that the buyer has received goods on credit while
insolvent, the seller may reclaim the goods upon demand made within a reasonable time
after the buyer's receipt of the goods. Except as provided in this subsection, the seller
may not base a right to reclaim goods on the buyer's fraudulent or innocent
misrepresentation of solvency or of intent to pay.
(3) The seller's right to reclaim under subsection (2) is subject to the rights of a buyer in
ordinary course of business or other good -faith purchaser for value under Section 2-403.
Successful reclamation of goods excludes all other remedies with respect to them.
§2-703: Seller’s Remedies in General (Buyer has Breached):
Where the buyer wrongfully rejects or revokes acceptance of goods or fails to made a
payment due on or before delivery or repudiates with respect to a part or the whole, then
with respect to any goods directly affected and, if the breach is of the whole contract (§2612), then also with respect to the whole undelivered balance, the aggrieved seller may
(a) withhold delivery of such goods;
(b) stop delivery by any bailee as hereafter provided (§2-705);
(c) proceed under the next section respecting goods still unidentified to the contract;
(d) resell and recover damages as hereafter provided (§2-706);
(e) recover damages for non-acceptance (§2-708) or in a proper case the price (§2709);
(f) cancel.
Accepted Goods:
The seller’s recovery of damages is measured by §2-709 (Action for the Price) if the
buyer has made a technical acceptance of the goods or if the goods are destroyed within
a commercially reasonable period of time after the risk of loss shifts to the buyer. In
effect, §2-709 is the equivalent of a specific performance remedy for the seller. As
discussed below, if the seller still has possession of the goods (or had the risk of loss at
the time of their destruction), damages are measured by other sections in the 2-700s.
§2-709: Action for the Price: (seller’s remedies for accepted goods)
1. When the buyer fails to pay the price as it becomes due the seller may recover,
together with any incidental damages under the next section, the price:
a. of goods accepted or of conforming goods lost or damaged within a
commercially reasonable time after risk of their loss has passed to the
buyer; and
b. of goods identified to the contract if the seller is unable after reasonable
effort to resell them at a reasonable price or the circumstances reasonably
indicate that such effort will be unavailing.
2. Where the seller sues for the price he must hold for the buyer any goods which
have been identified to the contract and are still in his control except that if resale
becomes possible he may resell them at any time prior to the collection of the
judgment. The net proceeds of any such resale must be credited to the buyer and
payment of the judgment entitles him to any goods not resold.
3. After the buyer has wrongfully rejected or revoked acceptance of the goods or has
failed to make a payment due or has repudiated (§2-610), a seller who is held not
entitled to the price under this section shall nevertheless be awarded damages for
non-acceptance under the preceding section.
Problem 69
B Auto sold a new blue sports car to D on credit. He accepted the car and drove it for a month. He then sent
B Auto a notice of revocation of acceptance and gave as his reason the recent repainting of his garage in a
color that clashed with the blue car. The notice stated that D had parked the car down the block from his
home (away from the clashing garage) and that B Auto should come and get it. D also refused to make any
more car payments. Three days after B Auto received the notice, the car disappeared and has never been
found. May the seller recover the price under §2-709? Who had the risk of loss? Would it make a
difference if D had rejected the goods for the same reason?
o
The goods were accepted here and there was not a proper revocation because you have no
right to revoke because the goods clash with your garage. The seller may recover the
price under §2-709. The buyer has the risk of loss here because he took possession and
did not have the right to revoke. No, either way he needs a commercially reasonable
reason to revoke or reject.
Unaccepted Goods:
When the buyer repudiates before delivery or rejects the goods, the relevant Code section
is
§2-706 if the seller resells the goods to someone else. If no resale occurs, damages are
measured under §2-708. Other relevant sections are cited in the following problems.
§2-706: Seller’s Resale Including Contract for Resale: (Seller resells the goods)
1. Under the conditions stated in Section 2-703 on seller's remedies, the seller may
resell the goods concerned or the undelivered balance thereof. Where the resale is
made in good faith and in a commercially reasonable manner the seller may
recover the difference between the resale price and the contract price together
with any incidental damages allowed under the provisions of this Article (Section
2-710), but less expenses saved in consequence of the buyer's breach.
2. Except as otherwise provided in subsection (3) or unless otherwise agreed resale
may be at public or private sale including sale by way of one or more contracts to
sell or of identification to an existing contract of the seller. Sale may be as a unit
or in parcels and at any time and place and on any terms but every aspect of the
sale including the method, manner, time, place and terms must be commercially
reasonable. The resale must be reasonably identified as referring to the broken
contract, but it is not necessary that the goods be in existence or that any or all of
them have been identified to the contract before the breach.
3. Where the resale is at private sale the seller must give the buyer reasonable
notification of his intention to resell.
4. Where the resale is at public sale
a. only identified goods can be sold except where there is a recognized
market for a public sale of futures in goods of the kind; and
b. it must be made at a usual place or market for public sale if one is
reasonably available and except in the case of goods which are perishable
or threaten to decline in value speedily the seller must give the buyer
reasonable notice of the time and place of the resale; and
c. if the goods are not to be within the view of those attending the sale the
notification of sale must state the place where the goods are located and
provide for their reasonable inspection by prospective bidders; and
d. the seller may buy.
5. purchaser who buys in good faith at a resale takes the goods free of any rights of
the original buyer even though the seller fails to comply with one or more of the
requirements of this section.
6. The seller is not accountable to the buyer for any profit made on any resale. A
person in the position of a seller (Section 2-707) or a buyer who has rightfully
rejected or justifiably revoked acceptance must account for any excess over the
amount of his security interest, as hereinafter defined (subsection (3) of Section 2711).
Note: This section gives us specific requirements for public and private sales, must meet
the requirements to reap the benefits. If the case damages are calculated by K price then
you get the resale price plus incidentals.
§2-708: Seller’s Damages for Non-acceptance or Repudiation: (Seller doesn’t resell the
goods)
1. Subject to subsection (2) and to the provisions of this Article with respect to proof
of market price (Section 2-723), the measure of damages for non-acceptance or
repudiation by the buyer is the difference between the market price at the time and
place for tender and the unpaid contract price together with any incidental
damages provided in this Article (Section 2-710), but less expenses saved in
consequence of the buyer's breach.
2. If the measure of damages provided in subsection (1) is inadequate to put the
seller in as good a position as performance would have done then the measure of
damages is the profit (including reasonable overhead) which the seller would have
made from full performance by the buyer, together with any incidental damages
provided in this Article (Section 2-710), due allowance for costs reasonably
incurred and due credit for payments or proceeds of resale.

Comment 2: This section permits the recovery of lost profits in all
appropriate cases, which would include all standard priced goods.
The normal measure there would be list price minus cost to the
dealer or list price minus manufacturing cost to the manufacturer.
Note: K price-market price plus damages allowed within there. Look to paragraph 2 also
b/c sometimes 1 is not good enough… only applies when 1 is not adequate.
Problem 70:
Lannie was the sole proprietor of Light’s, a lighting fixtures business in Austin, Texas. She contracted to
sell 80 neon light fixtures to Signs, a firm in San Antonio. The price was $1500 “FOB Austin” and the
shipment date was to be March 15. On March 5, Signs phoned Light and told her that the deal was off, but
Lannie refused to agree to a cancellation. She went to her warehouse and picked 80 of the fixtures from her
large stock. Then she posted a notice on the bulletin board near the cash register in her store, stating that 80
of the fixtures would be sold to the person making the best offer. Carl (who was always buying these types
of items) saw the sign and offered Light $1000 for the fixtures. Light sold Carl the goods and took
payment. Now Light comes to you. She tells you that on March 5 the fixtures were selling on the open
market at $800 for 80 and that on March 15 the price for 80 fixtures was $900 in Austin and $800 in San
Antonio. Answer these questions:
(a) Does the UCC permit Light to select goods from the warehouse after the buyer repudiates?
Yes under §2-704(1)(a) because it allows the seller to identify the conforming goods because they were still
in his possession.
(b) Was the resale proper?
No, because requires commercially reasonable notification to the buyer which was not done here, so the
resale was not proper.
(c) If Light’s damages are measured under §2-708(1), what amount may she collect? What amount under
§2-706?
She would get $600 ($1500(contract price) - $900(market price at place of tender)) under §2-708(1),
whereas under §2-706 she would get $500 ($1500(contract price) - $1000(resale price)).
(d) Does Light have the choice between the §2-706 (Resale) computation and the §2-708 (Repudiation)
computation?
o
No, they will get the remedy under §2-706 because they violated the code by not giving
adequate notice to the buyer and the court will not reward them with the higher damage
amount after such a violation.
Problem 71:
Fun sells swimming pools. Its president comes to your law office with this problem. A customer named
Esther ordered one of the standard above-ground pools, retailing for $2000. The pool’s components are
purchased by Fun at a wholesale price of $800 and are assembled into the finished product. The assembly
process costs the seller $400. Swimmer has now repudiated the contract, and Fun wants to sue. The current
market price is $2000 for such a pool. Fun is sure it can find another buyer at that price if it resells the pool.
Does it have damages? How are they measured?
o
Under §2-708(2) they should still get $2000, because they are considered a “lost volume
seller,” they could have sold 2 pools instead of just 1 but for the breach.
The problem with the sellers in Fun’s position (sellers having an unlimited supply of
goods) is that if the law forces them to measure the damages under §2-706 or §2-708(1),
they lose the profit they would have made from the sale to the second customer. A seller
in such a position is called a lost volume seller. The drafters meant for §2-708(2) to
rescue such a seller from this dilemma, but the actual mechanics of the operation of the
section aren’t clear. The problem arises in part from the undefined phrase “profit
(including reasonable overhead),” which contains accounting terms having no fixed legal
meaning.
Teradyne, Inc. v. Teledyne Industries, Inc.
Teledyne is the buyer and Teradyne is the seller. They bought a transistor system for
$98,000. After the K is entered into the system was packaged and prepared for shipment.
The buyer then wanted to cancel. The seller refused to allow cancellation. Then the buyer
turned around and offered instead to buy another system worth only $65,000. The seller
refused to accept the alternative purchase and resold the system to an alternative
purchaser for $98,000. The seller argued that they would have sold two systems if
Teledyne hadn “t breached, so they are a “lost volume seller “ and should still get
damages regardless of cover.
•
Under §2-708(1) the measure of damages is the difference between unpaid contract price and
market price.
•
Under §2-708(2) the measure of damages is the expected profit (including reasonable overhead)
on the broken contract. §2-708(2) only applies if the damages provided by §2-708(1) are
inadequate to put the seller in as good as position as performance would have done. Here no
damages would be recoverable under §2-708(1), this is inadequate.
•
A “l ost volume seller “ is one who had there been no breach by the buyer, could and would have
had the benefit of both the original contract and the resale contract.
•
Lost profit does not include a deduction for reasonable overhead. Damages are to be calculated
pursuant to §2-708(2) and the formula used for determining lost profits under that provision
includes overhead.
•
Wages are not part of overhead and as a “direct cost“ should be deducted from the contract
price.
•
One is not required to mitigate his losses by accepting an arrangement with the repudiator if that is
made conditional on his surrender of his rights under the repudiated contract.
Problem 72:
Milo, sales agent for CCC, negotiated a contract whereby his company was to design and manufacture a
special computer that would regulate the timing of subway trains for the City of Plantation. The price was
$20,000 FOB CCC’s plant in Atlanta. When the computer was half completed, the City of Plantation
underwent a change of administration, and the new city leaders decided to dump the subway renovations.
They phoned CCC and canceled the computer order. Now Milo phones your law office for advice. To help
in your decision, Milo states that as scrap the computer and its components are now worth $5000. Milo has
heard that three other cities have subway systems similar to Plantation’s, and if the computer is finished,
they might by enticed to buy it at a price between $15,000 and $20,000. On the other hand, it will cost
CCC $9000 to complete the computer.
(a) Should CCC stop the manufacture of the computer and sell it for scrap or complete manufacture and
then try to resell it? See §2-704 and Official Comment 2.
o
Under §2-704 Comment 2, the seller can complete manufacture, but not if it would
clearly increase the damages from breach. Here they can complete manufacture if it is
commercially reasonable, we would probably want to know if the other cities are likely to
purchase this computer or not to determine if completion is commercially reasonable.
(b) If CCC completes manufactures and then, after a good faith effort, is unable to find a new buyer for the
computer, can it made Plantation pay for the finished product? See §2-709(1)(b) and Official Comment 1 to
§2-704.
o
If they complete manufacture and can’t resell after a good faith effort to do so, the buyer
will have to pay for the finished product.
The remedies provided for the parties in a lease of goods by Article 2A have been
slavishly copied from the corresponding provisions in Article 2. For the most part this
does no harm, but the Article 2A equivalent to §2-709’s “Action for the Price” has
generated a lot of discord.
Problem 73:
Lawyer Portia decided to rent a computer from Machines and use it in her office. The computer arrived,
and Portia found it most satisfactory, but her struggling practice made it difficult for her to make the lease
payments on time. After she had missed two payments in a row, Machines sent a goon to her office to
repossess the computer. Portia wasn’t there at the time, but her loyal secretary protested mightily when the
good grabbed the machine – at one point blocking the door with her body – but she was shoved aside and
the computer was taken. The lease still had a year to run, with payments of $100 due each month. Machines
sued Portia for $1200.
(a) Was Machines repossession valid? What remedy does Portia have if it was not? See 2A-525.
o
It is only valid if there was no breach of peace, there was a breach of peace here, so
repossession is not valid. Therefore, Portia can seek an action for replevin.
(b) Assuming there was no problem with the repossession, is the lessor required to try to mitigate damages
by re-leasing the machine? See §2a-529.
Possibly depending on the actual language of the contract.
(c) Could the lessor avoid any possible duty to mitigate by so stipulating in the lease agreement? See §1102(3)
No, even if that was entered in the contract, it would not be valid.
Buyer’s Remedies
The general list of the buyer’s remedies is found in §2-711. This section also gives the
buyer a right to cancel and recover the price if the buyer has already paid. In most
circumstances, the buyer has further recoverable damages, as identified in other sections.
All the sections are designed to follow §1-106’s admonition that the Code’s goal is to put
the aggrieved party in as good a position as performance would have. As for which
sections are appropriate in a given case as far as monetary damages are concerned, the
answer depends on whether the buyer has accepted the goods or not.
Note (code sections follow): For accepted goods, no revocation but breach of warranty
where proper notice: §2-714 (calculate based on value of goods warranted-value of goods
accepted + incidental and consequentials, but to determine look at §2-715 to see if
allowed to get those incidentals and consequentials.) Remember that incidentals are not a
subset of consequentials; you cannot recover consequentials if fail to cover and could
have. Also for unaccepted goods §2-711 (seller never delivers goods or buyer rightfully
rejects or revokes) get action for price plus other damages, go to §2-715. Also §2-716
(specific performance, if goods are unique or in other circumstances.) Go to §2-712
when seller breached, buyer doesn’t have goods, buyer can go out and cover… get
difference b/w the cover price and the K price.
§2-711: Buyer's Remedies in General; Buyer's Security Interest in Rejected Goods:
(1) Where the seller fails to make delivery or repudiates or the buyer rightfully rejects or
justifiably revokes acceptance then with respect to any goods involved, and with respect
to the whole if the breach goes to the whole contract (Section 2-612), the buyer may
cancel and whether or not he has done so may in addition to recovering so much of the
price as has been paid
(a) "cover" and have damages under the next section as to all the goods affected
whether or not they have been identified to the contract; or
(b) recover damages for non-delivery as provided in this Article (Section 2-713).
(2) Where the seller fails to deliver or repudiates the buyer may also
(a) if the goods have been identified recover them as provided in this Article (Section
2-502); or
(b) in a proper case obtain specific performance or replevy the goods as provided in
this Article (Section 2-716).
(3) On rightful rejection or justifiable revocation of acceptance a buyer has a security
interest in goods in his possession or control for any payments made on their price and
any expenses reasonably incurred in their inspection, receipt, transportation, care and
custody and may hold such goods and resell them in like manner as an aggrieved seller
(Section 2-706).
Accepted Goods:
If a technical §2-606 acceptance of goods has been made and is not later revoked, the
buyer may still sue for seller’s breach of warranty (or other breach of contract) if a
notice of the defect has been given to the seller within a reasonable time after the defect
should have been discovered; §2-607(3)(a). Damages are then measured by §§2-714 and
2-715.
§2-714: Buyer's Damages for Breach in Regard to Accepted Goods:
(1) Where the buyer has accepted goods and given notification (subsection (3) of §2607) he may recover as damages for any non-conformity of tender the loss resulting in
the ordinary course of events from the seller's breach as determined in any manner which
is reasonable.
(2) The measure of damages for breach of warranty is the difference at the time and
place of acceptance between the value of the goods accepted and the value they would
have had if they had been as warranted, unless special circumstances show proximate
damages of a different amount.
(3) In a proper case any incidental and consequential damages under the next section
may also be recovered. (You cannot get consequential damages if you don’t cover.)
§2-715: Buyer's Incidental and Consequential Damages:
(1) Incidental damages resulting from the seller's breach include expenses reasonably
incurred in inspection, receipt, transportation and care and custody of goods rightfully
rejected, any commercially reasonable charges, expenses or commissions in connection
with effecting cover and any other reasonable expense incident to the delay or other
breach.
(2) Consequential damages resulting from the seller's breach include
(a) any loss resulting from general or particular requirements and needs of which the
seller at the time of contracting had reason to know and which could not reasonably be
prevented by cover or otherwise; and
(b) injury to person or property proximately resulting from any breach of warranty.
•
Comment 1: Subsection (1) is intended to provide reimbursement for the buyer
who incurs reasonable expenses in connection with the handling of rightfully
rejected goods or goods whose acceptance may be justifiably revoked, or in
connection with effecting cover where the breach of the K lies in non-conformity
or non-delivery of the goods. The incidental damages listed aren“t intended to be
exhaustive but are merely illustrative of the typical kinds of incidental damage
•
Comment 2: The “tacit agreement” test for the recovery of consequential
damages is rejected. Although the older rule which made the seller liable for all
consequential damages of which he had reason to know in advance is followed,
the liberality of that rule is modified by refusing to permit recovery unless the
buyer couldn’t reasonably have prevented the loss by cover or otherwise.
•
Comment 4: The burden of proving the extent of loss incurred by way of
consequential damage is on the buyer, but the section on liberal administration or
remedies rejects any doctrine of certainty which requires almost mathematical
precision in the proof of loss. Loss may be determined in any manner which is
reasonable under the circumstances.
Problem 74:
The world famous pianist Cristofori made $50,000 a year giving concerts. Recently he decided to
experiment with some new sounds. He purchased an electric piano for $3,000 from the Silbermann
Electronic Music Company. The purchase was negotiated orally; there was no written contract. Cristofori
practiced day and night to master the new instrument. After three months of arduous practice, he noticed a
strange ringing in his ears. Subsequent medical examination revealed that Cristofori was going deaf. The
cause was a high-pitched whine (above the level of human perception) emanating from the electric piano.
On learning that the piano had done this to him, Cristofori took an axe and chopped the piano into
unrecognizable bits. (This action ended his ability to revoke his acceptance; §§2-608(3), 2-602(2)(b).)
When he calmed down, he brought suit against the piano company for breach of warranty. His damages
were claimed as $1,755,505, based on the following elements: $3,000 was the cost of the piano, $2,000 was
the doctor’s fees, $500 was paid to experts to examine the piano and determine if it was the cause of the ear
problem, $750,000 was lost income for the next 15 years, $1,000,000 was the value of Cristofori’s hearing,
and $5 was for the axe. Sibermann Electronic Music defended by (1) denying that it had warranted the
piano in any way and (2) proving that the whine was harmless to everybody in the world except Cristofori.
(The company proved that the accident occurred to him only because of the bone structure of his skull
coupled with the fact that he had a metal plate installed in his head as a result of an auto accident in his
youth.) Answer these questions:
(a) What warranty, if any, did the Silbermann Company breach? Does the company’s care in manufacturing
the piano or the freakishness of the injury keep the warranty from being breached?
•
There was a warranty of merchantability. This was not breached because the piano was fit for its
ordinary purpose, we don “t look at this person “s special circumstances.
(b) Which, if any, of Cristofori“s damaged are recoverable under §2-714?
•
Damages for any non-conformity. Because he could have resold the piano for the market price he
is only entitled to incidental damages, no consequential damages.
(c) Which, if any, of the items claimed are incidental damages under §2-715(1)?
•
Only the $500 for the payment to the expert.
(d) The §2-715(2)(a) test of consequential damages with its “reason to know“ language is a restatement
of our old friend Hadley v. Baxendale. Is it relevant here?
•
No, because he isn“t entitled to any consequential damages because he didn’t cover.
Problem 75:
Sheila Spin made it to the finals of the USA Yo-Yo Championship, where she was widely thought to be a
cinch to win the $10,000 first prize. The day of the competition she went into the Smalltime Drug Store
owned by her Uncle Mort and told him that she wanted to buy a four-foot nylon yo-yo cord to use in the
competition. Mort sold her one for $1.50 (he put it on her bill) and wished her luck. That she didn’t have.
The cord was defective and broke during her first trick, thus eliminating her from the competition. When
the bill came from the drug store, Sheila refused to pay it. In fact, she filed suit against Mort asking for
$50,000 consequential damages. Every expert witness who testified stated that Sheila’s ability with the yoyo was the greatest in the world. Mort defended on two grounds: (1) merely knowing about the intended
use of the yo-yo in the competition wasn’t enough to impose liability on him unless the parties had agreed
to put this risk on him, and (2) her damages were too speculative. Answer these questions:
(a) Does the UCC permit Sheila to refuse to pay the bill? See §2-717
•
Yes, §2-717 says that Sheila can refuse to pay the bill if the warranty has been breached and notice
is given of the non-conformity. They should write “payment in full“ for it, if they cash the
check, this is acceptance of that payment only.
(b) Are the consequential damages for which Sheila asked too speculative? See Official Comment 4 to §2715.
•
No, this wasn“t too speculative because she was likely to have won this competition according to
all the experts.
(c) Is knowledge of the possible consequential damages alone sufficient to impose liability on a seller? Or
is Mort right in saying that the liability for consequential damages attaches only if the seller has agreed
(expressly or impliedly) to assume the risk? See Official Comment 2 to §2-715.
•
The Uncle“s argument is the “tacit agreement“ test, this has been rejected by a majority of
courts. Therefore, the risk was on him even without his agreement to assume this risk.
Problem 76:
Rambo Trucks sold Hercules Moving Company a large moving van. The contract of sale limited the
buyer’s remedy for breach of warranty to replacement or repair only and clearly disclaimed liability for
consequential damages. The first day on the job, the truck proved incapable of climbing even small hills, so
Hercules Moving Company revoked its acceptance of the truck. It claimed a security interest in the truck
pursuant to §2-711(3) and pending sale stored it at a truck depot, which charged it $50 a day for storage.
Must Rambo Trucks pay the storage charges, or is the company protected by the disclaimer of
consequential damages? See §2-719(3), 2-715(1).
•
Storage costs are incidental damages; therefore, under the UCC this disclaimer doesn“t eliminate
incidental damages, but only consequential damages. Under common law, this disclaimer would
eliminate incidental damages as well because they are a subset of consequential damages.
Unaccepted Goods:
Where the seller never delivers the goods or where the buyer rejects or revokes
acceptance, §2-711 states that the buyer may recover the price and other damages. These
generally include incidental and consequential damages under §2-715. See Official
Comment 1 to that section. In addition, the buyer may seek specific performance or
replevin under §2-716. Read §2-716 and its Official Comment.
As Comment 1 indicates, the drafters intended to “liberalize” the application of the
doctrine of specific performance. Thus, §2-716 provides for the use of specific
performance not only when goods are unique, but also “in other proper circumstances.”
What are “proper circumstances”?
An important buyer remedy is found in §2-712, where the buyer is authorized to cover –
1that is, purchase substitute goods. If a buyer covers properly, the damages are measured
by a comparison of the original contract price and the cost of the cover.
Read §2-712.
§2-716: Buyer’s Right to Specific Performance of Replevin:
(1) Specific performance may be decreed where the goods are unique or in other proper
circumstances.
(2) The decree for specific performance may include such terms and conditions as to
payment of the price, damages, or other relief as the court may deem just.
(3) The buyer has a right of replevin for goods identified to the contract if after
reasonable effort he is unable to effect cover for such goods or the circumstances
reasonably indicate that such effort will be unavailing or if the goods have been shipped
under reservation and satisfaction of the security interest in them has been made or
tendered. In the case of goods bought for personal, family, or household purposes, the
buyer’s right of replevin vests upon acquisition of a special property, even if the seller
hadn’t then repudiated or failed to deliver.
•
Official Comment:
§2-712: "Cover"; Buyer's Procurement of Substitute Goods:
(1) After a breach within the preceding section the buyer may "cover" by making in good
faith and without unreasonable delay any reasonable purchase of or contract to purchase
goods in substitution for those due from the seller.
(2) The buyer may recover from the seller as damages the difference between the cost of
cover and the contract price together with any incidental or consequential damages as
hereinafter defined (§2-715), but less expenses saved in consequence of the seller's
breach.
(3) Failure of the buyer to effect cover within this section does not bar him from any
other remedy.
•
Comment 2:
Problem 77:
Mr. and Mrs. Transient ordered a 2002 Blocklong model mobile home for $8,000 from the Home on
Wheels Sales Corporation, delivery to be made on May 20. The Transients planned on spending an
additional $500 to build a foundational that the Blocklong trailer had to have for maximum utility. Due to
widespread industry strikes, the price of trailers rose dramatically in the early spring, and on May 10 Home
on Wheels informed the Transients that the deal was off. The Transients shopped around and on September
25 bought a 2003 Behemoth model mobile home for $15,000 from another dealer. The Behemoth was
larger than the Blocklong model (it had a basement and a laundry room), but it didn’t require a foundation.
The Transients then brought suit. Home on Wheels defended by offering to show that (a) the Behemoth
was selling for $10,000 up to September 5 when the price rose to $15,000, and (b) the Behemoth always
sells for $2,000 more than the Blocklong since the former is a snazzier trailer. What damages can the
Transients get under §2-712? See Official Comment 2.
•
Under §2-712, they can get the difference between cost of cover and the contract price, so $7000.
However, they saved $500 from cover for not having to build a basement, so now they can only
recover $6500. The fact that the car they covered with always sells for $2000 more means that
they can only recover $4500 because the trailer they received instead was worth $2000 more than
the original.
Hughes Communications Galaxy, Inc. v. United States
There was a service contract here for launch services agreement (LSA). The agreement
was that NASA would launch 10 393 model satellites off NASA shuttles within a specific
amount of time or as many as they could have in that time. A shuttle explodes and
Reagan said no more private use of shuttles. Hughes doesn’t know what to do anymore,
so they launch 3 of the 393 model shuttles off a different spacecraft (not NASA’s). It
didn’t work, so they had to create different satellites to launch off the spacecraft because
the 393 models didn’t work. They sue the US for the cost of cover. NASA argues that
they would have only likely been able to launch 5 of the 10.
•
The general rule in common law breach of contract cases is to award damages sufficient to place
the injured party in as good a position as he would have been had the breaching party fully
performed.
•
While the cover remedy under the UCC doesn“t govern this contract, the UCC provides useful
guidance in applying general contract principles.
•
The substitute goods or services involved in cover need not be identical to those involved in the
contract, but they must be “commercially usable as reasonable substitutes under the
circumstances.“ Whether cover provides a reasonable substitute under the circumstances is a
question of fact. It is a “classic jury issue.“
•
When a buyer of goods covers, the buyer“s remedy for the seller“s breach as to those goods
equals the difference between the cost of the replacement goods and the contract price plus other
losses.
•
The 601 model satellites were reasonable “cover“ for the 393 model satellites because there
was no alternative, they had to develop something else to launch the satellites.
•
NASA did not breach its obligation to use best efforts before the Regan announcement.
•
The lower court properly extended damages to only 5 of the 10 satellites.
•
The amount of damages should not be reduced by any increased pricing to customers as a passthrough.
Technically, a buyer doesn’t have to cover. If a buyer fails to cover in an appropriate
situation, however, consequential damages that could have been avoided are denied. See
§2-715(2)(a). If a buyer decides to cover, the legal effect of the steps taken, as well as
when cover should be effectuated, is measured against a standard of reasonableness in the
given factual situation. Financial inability is an excuse for non-cover. One practical test
by which to gauge the reasonableness of the buyer’s covering actions is to ask if the
buyer would have made the same arrangements if there was no prospect of a successful
suit against the breaching seller. If the buyer doesn’t cover, damages may be measured
under the next section, §2-713, a much criticized provision. Read §2-713.
§2-713: Buyer's Damages for Non-delivery or Repudiation: (No cover)
(1) Subject to the provisions of this Article with respect to proof of market price
(§2-723), the measure of damages for non-delivery or repudiation by the seller is the
difference between the market price at the time when the buyer learned of the breach and
the contract price together with any incidental and consequential damages provided in
this Article (§2-715), but less expenses saved in consequence of the seller's breach.
(2) Market price is to be determined as of the place for tender or, in cases of rejection
after arrival or revocation of acceptance, as of the place of arrival.
•
Comment 5: The present section provides a remedy which is completely
alternative to cover under the preceding section and applies only when and to the
extent that the buyer has not covered.
Problem 78:
The Student Bar Association of the Gilberts Law School decided to hold a mammoth wine- and cheesetasting party for the students, faculty, staff, and alumni. The SBA ordered the wine from Classy Caterers.
They agreed to pay $1,000 for it, the wine to be delivered on March 30, the day of the party. Classy
Caterers ordered the wine from Grapes Vineyards in California, “FOB San Francisco” for $750, but Grapes
Vineyards when bankrupt on March 25. Classy Caterers was able to find identical wine in its own city for
$750, and it bought the wine on March 25 for that amount. On March 25, the price of similar wine in San
Francisco to the site of the party would have been $100. The SBA paid Classy Caterers $1,000 for the
wine. Classy Caterers filed claims for damages in the bankruptcy proceeding of its defaulting supplier.
Compute the damages due Classy for the failure to deliver the wine under §2-712. Now do it under §2-713.
See Official Comment 5 to §2-713.
•
Under §2-712, they could get cover minus contract price, so $0. Under §2-713, they could get
market price when buyer learned of breach minus contract price, less expenses saved, so $50.
Tongish v. Thomas
Tongish (seller) contracts to sell all the sunflower seeds he could grow to Thomas
(buyer). Thomas would sell the seeds to another buyer for the same price, but retain a
handling fee. The market price doubles, so Tongish breaches the contract and sells the
seeds to another buyer for double the price. He then argues that he only owes Thomas
damages equal to what they earned; the handling fees. Thomas argues that he is entitled
to more.
•
§1-106 provides “The remedies provided by this act shall be liberally administered to the end
that the aggrieved party may be put in as good a position as if the other party had fully performed
but neither consequential or special nor penal damages may be had except as specifically provided
in this act or by other rules of law.“ Under this, Thomas would on get the handling fees.
•
§2-713 provides “the measure of damages for nondelivery or repudiation by the seller is the
difference between the market price at the time when the buyer learned of the breach and the
contract price together with any incidental and consequential damages provided in this article, but
less expenses saved as a consequence of the breach.” So under this, Thomas would get much
more.
•
The statutes contain conflicting provisions. §1-106 offers a general guide of how remedies should
be applied, whereas §2-713 specifically describes a damage remedy that gives the buyer certain
damages when the seller breaches a contract for the sale of goods.
•
The cardinal rule of statutory construction, to which all others are subordinate, is that the purpose
and intent of the legislature governs. When there is a conflict between a statute dealing generally
with a subject and another statute dealing specifically with a certain phase of it, the specific statute
controls unless it appears that the legislature intended to made the general act controlling.
•
The court adopts §2-713 because it allows the buyer to collect the difference in the market price
and contract price for damages in a breached contract, so it encourages an efficient market and
discourages breaches such as this.
The damages provisions in the CISG for the international sale of goods are modeled after
the similar provisions of the UCC and should look reassuringly familiar to you. Read
Articles 74 to 78. There are some new words that the treaty has to teach American ears.
One is the concept of “fundamental breach,” an idea that comes from the civil law. Read
Articles 46(2) and 25. Fundamental breach is roughly equivalent to “material breach”
(the opposite of “substantial performance.”) Restatement 2d of Contracts §241 states:
§241: Circumstances Significant in Determining Whether a Failure is Material:
In determining whether a failure to render or to offer performance is material, the
following circumstances are significant:
(a) the extent to which the injured party will be deprived of the benefit which he
reasonably expected;
(b) the extent to which the injured party can be adequately compensated for the part of
that benefit of which he will be deprived;
(c) the extent to which the party failing to perform or to offer to perform will suffer
forfeiture;
(d) the likelihood that the party failing to perform or to offer to perform will cure his
failure, taking account of all the circumstances including any reasonable assurances;
(e) the extent to which the behavior of the party failing to perform or to offer to
perform comports with standards of good faith and fair dealing.
The treaty has a strong presumption in favor of specific performance. See Articles 46 and
62. However, Article 28 doesn’t require specific performance if the court that would be
asked to grant it would not do so if its own law applied. For example, in the US there are
major limits on equitable remedies (there must be no adequate remedy at law – i.e.,
damages; the court must not become involved in undue supervision of the resulting
performance; etc.), and an American court might use these rules to duck an order for
specific performance.
Special Remedies
The 2-700s of the UCC are the basic remedy provisions (though some remedies, such as
rejection and revocation of acceptance, which we covered earlier, are found in other parts
of Article 2). The 2-700s may be further divided into two parts: the seller’s remedies
when the buyer is in breach (§§2-703 through 2-710) and the buyer’s remedies when the
seller is in breach (§§2-711 through 2-717).
Remedies on Insolvency:
When one contracting party becomes insolvent while in possession of goods that have
been identified to the contract, the other may in some circumstances elect to forgo
damages and get the goods themselves. This is called reclamation. The key Code
sections are §2-502 and §2-702; read them. Section §2-702 is very important and much
litigated. Quite often a battle develops between a party (buyer or seller) seeking to
reclaim the goods and either a secured creditor of the party with the goods or a trustee in
bankruptcy. The battle between the secured creditor and the reclaiming party is governed
by meshing Article 2 with Article 9, not always an easy task. If the battle is between the
reclaiming party and the trustee in bankruptcy, a section of the Bankruptcy Reform Act
was designed to protect a seller’s reclamation right from the trustee’s avoiding powers in
most situations where the seller would win under §2-702.
Liquidated Damages:
At common law, if the parties put a liquidated damages clause in their contract, it was
upheld by the courts only if the parties truly intended the figure named to be
compensatory and had made in good faith an attempt to pre-estimate the damages. The
courts have struck the clause and made the aggrieved party prove actual damages if the
courts decided that decided that the parties had intended the liquidated figure to be a
penalty amount to be forfeited in the even of breach.
The Code’s liquidates damages provision is §2-718(1). It makes little change from the
common law rules except that it provides that the validity of the liquidated damages
clause is to be tested, in part, against the actual harm caused by the breach (a criterion of
no importance at common law). Interestingly enough, the liquidated damages provision
in Article 2A no longer refers to actual damages, specifically allows a formula to be used
to compute damages, and drops all reference to the effect of an unreasonably large
liquidated damages clause. Read §2A-504 and its Official Comment.
The Breaching Buyer’s Restitution:
Problem 66:
The zoo officials for the W. Virginia Zoo contracted to buy an elephant from the Delaware Zoo. The terms
of the deal were that the W. Virginia Zoo would deliver a black bear worth $300 as a down payment and
pay $100 a month for 20 months, at the end of which time the Delaware Zoo would deliver the elephant.
The bear was tendered and accepted. The W. Virginia Zoo duly made its $100 payments for 15 months
before it ran out of money and could pay no more. The W. Virginia Zoo comes to you. Can it recover the
$1500 it has paid? The bear? Assuming the bear was and is still worth $300, calculate the amount that the
W. Virginia Zoo is likely to recover in a restitution action.
o
It can recover $1340. The contract price is $2,300 ($2000 cash plus $300 bear). 20% of
that is $460, which is less than $500. So that is subtracted from $1800 (amount actually
paid, which is $1500 cash and $300 bear), so they get $1340.
Anticipatory Repudiation
It is settled that if one party to a contract makes a definite repudiation of the contract
before the date set for performance, the other party can treat the repudiation as a breach
and sue immediately. The common law also permitted the innocent party to ignore the
repudiation and await the performance date to see if the repudiator would retract the
repudiation. As long as the innocent party hadn’t changed position in reliance on the
repudiation (say, by covering), the repudiator was free to retract the repudiation, reinstate
the contract, and perform as originally agreed.
Read §§2-610 and 2-611. These sections don’t define repudiation, which is, of course,
their triggering event. A repudiation must be a definite refusal to perform, mere
equivocation isn’t enough. See Official Comment 1 to §2-610. The equivocating party
can be forced into performance or repudiation by use of the procedure outlined in §2-609
(Right to Adequate Assurance of Performance).
Unfortunately, in the process of drafting the Code’s damages sections, the drafters
became careless when dealing with the time for measuring damages in anticipatory
repudiation situation, and the UCC sections simply don’t fit together.
§2-609: (Right to Adequate Assurance of Performance)
1. A contract for sale imposes an obligation on each party that the other's
expectation of receiving due performance will not be impaired. When
reasonable grounds for insecurity arise with respect to the performance of
either party the other may in writing demand adequate assurance of due
performance and until he receives such assurance may if commercially
reasonable suspend any performance for which he has not already received
the agreed return.
2. Between merchants the reasonableness of grounds for insecurity and the
adequacy of any assurance offered shall be determined according to
commercial standards.
3. Acceptance of any improper delivery or payment does not prejudice the
aggrieved party's right to demand adequate assurance of future
performance.
4. After receipt of a justified demand failure to provide within a reasonable
time not exceeding thirty days such assurance of due performance as is
adequate under the circumstances of the particular case is a repudiation of
the contract.
§2-610: Anticipatory Repudiation:
When either party repudiates the contract with respect to a performance not yet due the
loss of which will substantially impair the value of the contract to the other, the aggrieved
party may
(a) For a commercially reasonable time await performance by the repudiating
party; or
(b) Resort to any remedy for breach (§2-703 or §2-711), even though he has notified
the repudiating party that he would await the latter's performance and has urged
retraction; and
(c) In either case suspend his own performance or proceed in accordance with the
provisions of this Article on the seller's right to identify goods to the contract
notwithstanding breach or to salvage unfinished goods (§2-704).
•
Comment 1: Under the present § when such a repudiation substantially impairs
the value of the K, the aggrieved party may at any time resort to his remedies for
breach, or he may suspend his own performance while he negotiates with, or
awaits performance by, the other party. But if he awaits performance beyond a
commercially reasonable time he cannot recover resulting damages which he
should have avoided.
§2-611: Retraction of Anticipatory Repudiation:
(1) Until the repudiating party's next performance is due he can retract his repudiation
unless the aggrieved party has since the repudiation cancelled or materially changed his
position or otherwise indicated that he considers the repudiation final.
(2) Retraction may be by any method which clearly indicates to the aggrieved party that
the repudiating party intends to perform, but must include any assurance justifiably
demanded under the provisions of this Article (§2-609).
(3) Retraction reinstates the repudiating party's rights under the contract with due excuse
and allowance to the aggrieved party for any delay occasioned by the repudiation.
Problem 78:
The US Army contracted with the Hawaiian Cattle Company for the purchase of 1000 lbs. of beef. Delivery
was set 6 mo. later, on Oct 8, the agreed price to be $5000. Shortly thereafter, the price of beef rose sharply,
and Hawaiian Cattle repudiated the contract on July10, when the price was $6000. The Army’s
procurement officer scrambled around and on July 15 discovered it was possible to cover by buying similar
cattle from Texas at a cost of $7000. Instead, the Army sent Hawaiian Cattle a telegram stating that it didn’t
accept or recognize the repudiation and expected performance on October 8. By October 8 the price had
risen to $8000. The Army decided not to cover at all and instead served the troops beans. As general
counsel for the Army, advise the Army of the amount it can recover from Hawaiian Cattle. Read §2-610,
§2-713, and §2-723(1), Does it help to reconcile these sections to know that the drafters of §2-713 were
thinking of a buyer who learns of the repudiation after the date set for the original performance, not (as in
this Problem) before the due date?
•
Damages would be the difference between the contract price and the market price at the time of
repudiation, even though §2-713 says at the time when buyer learned of the breach. The courts
have said go with the “commercially reasonable“ time. Here the commercially reasonable time
is at the time of the repudiation. 1000k
2-713 only works when theres already a breach--- with ar, you don’t know abou the
breach—it occurred befor a date was set for performance--
The Statute of Limitations
The Code drafters decided that it was important to have a uniform SOL for transactions
in goods, and they chose 4 years “as the most appropriate to modern business practice.
This is within the normal commercial record keeping period.” Official Comment to §2725. Read §2-725, and note that the 4 year period begins to run at the accrual of the
cause of action (the moment a suit could be brought). The parties may reduce the period
by agreement down to one year, but they may reduce the period by agreement down to
one year, but they may not extend it beyond 4. One court has decided that an agreement
so reducing the limitation period need not be conspicuous to be enforced. In most
jurisdictions the SOL is an affirmative defense and is waived if not pleaded and proved.
§2-725: Statute of Limitations
•
Paragraph 2 is the exception to paragraph 1. Paragraph 2 is about when the clock
starts ticking.
1. An action for breach of any contract for sale must be commenced within
four years after the cause of action has accrued. By the original agreement
the parties may reduce the period of limitation to not less than one year but
may not extend it.
2. A cause of action accrues when the breach occurs, regardless of the
aggrieved party's lack of knowledge of the breach. A breach of warranty
occurs when tender of delivery is made, except that where a warranty
explicitly extends to future performance of the goods and discovery of the
breach must await the time of such performance the cause of action
accrues when the breach is or should have been discovered.
3. Where an action commenced within the time limited by subsection (1) is
so terminated as to leave available a remedy by another action for the
same breach such other action may be commenced after the expiration of
the time limited and within six months after the termination of the first
action unless the termination resulted from voluntary discontinuance or
from dismissal for failure or neglect to prosecute.
4. This section does not alter the law on tolling of the statute of limitations
nor does it apply to causes of action which have accrued before this Act
becomes effective.
Poli v. Daimler Chrysler Corp.
•
What code provision covers the statute of limitations? How long is it?
o
•
Generally, when does a cause of action accrue under the code?
o
•
A COA accrues when the breach occurs, regardless of the aggrieved party“s lack of
knowledge of the breach and that a breach of warranty occurs when tender of delivery is
made.
What is the exception?
o
•
The limitations period under the UCC for an action for breach of a sales contract is “4
years after the cause of action has accrued.“ The provision §2-725.
The UCC provides an exception to this general rule if “a warranty explicitly extends to
future performance of the goods and discovery of the breach must await the time of such
performance. If the seller has provided this form of warranty, the cause of action accrues
when the breach is or should have been discovered.
Does the general rule or the exception apply here? Why?
o
The exception applies here. Therefore, we conclude that a claim for breach of this
warranty did not accrue at the time of delivery pf the car but rather when * allegedly
breached its duty to repair the defect.
Problem 80:
Jane bought a new car on April 1, 2002. The written warranty that came with the car read: “The
manufacturer will replace any part found to be defective in the first five years.” Three years and 358 days
after Jane purchased the car, the steering wheel came off in her hands. Luckily she was able to brake in
time, and both she and the car were uninjured. She had the car towed to the dealer’s place that same day.
The dealer kept the car for three months, promising each week that it would be repaired. At the end of that
period, the dealer told her to come and get the car. On the way home the steering wheel again came off in
her hands. This time Jane was not lucky, she was killed. You are the attorney for her estate. Answer these
questions:
(a) When did the COA accrue with regard to the effective steering wheel? With the delivery of the car? On
the 358th day of the fourth year? On the day of the fatal accident?
•
Not with the delivery of the car b/c of the express extension of the SOL. The SOL accrued
somewhere between the 358th day and the day she was killed.
(b) Was the statute tolled during the three months that the car was in the shop?
•
The courts split on this.
(c) If the manufacturer of a vehicle sold it to the dealership, and the dealership then resold the vehicle to a
consumer, would the four-year period on the manufacturer“s implied warranty start running on the date of
delivery to the dealership or on the date of the sale to the ultimate consumer? Would we reach the same
result on an express warranty given by the manufacturer?
•
The implied warranty goes back to the date the manufacturer delivers it to the dealership, but if
looking at express then the courts say the date is the dealership delivers the car to the purchaser.
(d) Should the courts draw a distinction as to when the COA accrues based on whether the injury is to
person or to property? Code sections week 7:
•
Courts have different positions. It depends where you practice.
II. Payment
Negotiability
Introduction:
•
Article 3: Negotiable Instruments (Payment Systems)
•
Article 4: Bank Deposits and Collections
•
Both revised in the 1990“s.
NEGOTIABILITY – SUPER 7: (requirements to have proper form)
A. Writing
B. Signed
C. Unconditional Promise or Order
D. Fixed Amount of Money
E. Courier Without Luggage
F. Payable on Demand or at a Definite Time
G. Payable to Bearer or Order
If meet all requirements for negotiability and negotiation = holder in due course
(super-*)
Types of Negotiable Instruments:
The types of negotiable instruments that Article 3 does cover can be divided into 2 basic
categories:
1. Notes: is a written promise to pay money.

If the note is created by a bank, it is called a certificate of deposit
(or CD for short). §3-104(j).

Promissory notes-promise by one person to pay another person.

Notes are typically 2 party documents.
§3-104(j): Negotiable Instrument:
“Certificate of deposit” means an instrument containing an acknowledgement by
a bank that a sum of money has been received by the bank and a promise by the
bank to repay the sum of money. A certificate of deposit is a note of the bank.
2. Drafts: is a written order by one person (the drawer) to another (the drawee,),
directing the drawee pay money to a third person (the payee.)
o
Typically a three party document.
o
A common example is a check. A draft written on a bank and payable on
demand is a check.
o
If the check is drawn by the bank on itself (the bank is both the drawer and
the drawee), the instrument is called a cashier’s check.
o
If one bank draws a draft on another or makes the draft “payable through”
another bank, the instrument is called a teller’s check.
§3-103(a)(2)(3): Definitions:
2. “Drawee” means a person ordered in a draft to make payment.
3. “Drawer” means a person who signs or is identified in a draft as a person ordering
payment.
§3-104(f)(g)(h): Negotiable Instruments:
f. “Check” means (i) a draft, other than a documentary draft, payable
on demand and drawn on a bank or (ii) a cashier’s check or teller’s
check. An instrument may be a check though it is described on its
face by another term, such as “money order.”
g. “Cashier’s check” means a draft with respect to which the drawer
and drawee are the same bank or braches of the same bank.
h. “Teller’s check” means a draft drawn by a bank (i) on another
bank, or (ii) payable at or through a bank.
§3-103(a)(11): Definitions:
11. “Remitter” means a person who purchases an instrument from its issuer if the
instrument is payable to an identified person other than the purchaser.
Problem 83:
When law student Portia Moot went to buy a used car from a man who sold it through the newspaper, the
seller told her he refused to take her personal check, demanding instead a cashier’s check payable to his
order. Portia went to Octopus National Bank and paid the bank the amount required, and the bank then
issued the cashier’s check, with Portia“s car seller being named as payee. The bank gave the check to
Portia, and she in turn handed it over to the payee. What is the name that the Code gives to Portia in this
situation? See §3-103(a)(11).
•
Portia is considered the remitter by the Code.
Notes:
•
If the drawee on a draft is not a bank, Article 3 still applies, but the instrument no
longer meets the technical definition of a check (which requires that the drawee
be a bank).
•
A negotiable instrument containing a promise to pay money is a note and one
containing an order to pay money is a draft.
§3-104(e): Negotiable Instruments:
e. An instrument is a “note” if it is a promise and is a “draft” if it is
an order. If an instrument falls within the definition of both “note”
and “draft,” a person entitled to enforce the instrument may treat it
as either.
The Negotiability Concept:
If paper is technically negotiable (which refers to its form), it is technically negotiated
(which refers to the transfer process) and reaches the hands of a purchaser for value who
has no knowledge of problems with the transaction giving rise to the paper’s creation
(such a person is called a holder in due course); then the later purchaser becomes the
super-plaintiff and can sue the parties to the instrument who are not (with certain
exceptions) permitted to defend the lawsuit; the *’s simply lose and pay up.
Before the rules of Article 3 apply to an instrument, regardless of whether it is a note or a
draft, the instrument must be technically negotiable within the rigid definitional
requirements of §3-104(a). Every element specified therein must be met, or the
instrument is non-negotiable, and Article 3 does not apply, except by analogy; See §3104(b).
§3-104(a)(b): Negotiable Instruments:
a. Except as provided in subsections (c) and (d), “negotiable instrument”
means an unconditional promise or order to pay a fixed amount of money,
with or without interest or other charges described in the promise or order,
if it:
is payable to bearer or to order at the time it is issued or first comes into
possession of a holder;
is payable on demand or at a definite time; and
does not state any other undertaking or instruction by the person
promising or ordering payment to do any act in addition to the payment of
money, but the promise or order may contain (i) an undertaking or power
to give, maintain, or protect collateral to secure payment, (ii) an
authorization or power to the holder to confess judgment or realize on or
dispose of collateral, or (iii) a waiver of the benefit of any law intended for
the advantage or protection of an obligor.
b. “Instrument” means a negotiable instrument.
A. Writing
A negotiable instrument cannot be oral. The definitions in both promise and order in §3103(a) require a “written” instruction or undertaking. However, there is no requirement
that the writing be on a piece of paper.
B. Signed
Section §3-103(a)’s definitions of both “promise” and “order” require that the instrument
be signed.
Problem 84:
Texas millionaire Howard Chaps signs all of his checks with a small branding iron that prints a fancy X on
the signature line. Are his checks negotiable? See §1-201(39); Official comment 39.
•
Yes, his checks are negotiable. §1-201(39) tells us that as long as the symbol was executed or
adopted by the party with the present intention to authenticate the writing the symbol will be fine.
Problem 85:
Walter Capitalist is the sole proprietor of the Capitalist Company. He signs all of the store’s checks by
writing “Capitalist Company” on the drawer’s line, but the checks are drawn of his personal checking
account at the Octopus National Bank. Can the bank treat the checks as if Walter had signed his own
name? See §3-401(b).
•
Yes b/c §3-104(b) says that a signature may be made (ii) by the use of any name, including a trade
or assumed name, or by a word, mark, or symbol executed or adopted by a person with the present
intention to authenticate a writing.
C. Unconditional Promise or Order
A promissory note must contain an unconditional promise to pay; a draft must contain
an unconditional order to the drawee requiring payment. The rule that the promise or
order be unconditional is obviously a necessity if negotiable paper is to circulate without
question. The Code requires that the promise or order be unconditional, or the paper will
be technically non-negotiable. Nonetheless, certain conditions are permitted in the
instrument without destroying negotiability.
§3-106: Unconditional Promise or Order:
a. Except as provided in this section, for the purposes of Section 3-104(a), a promise
or order is unconditional unless it states (i) an express condition to payment, (ii)
that the promise or order is subject to or governed by another writing, or (iii) that
rights or obligations with respect to the promise or order are stated in another
writing. A reference to another writing does not itself make the promise or order
conditional. (Basically unconditional unless i, ii, or iii applies.)
b. A promise or order is not made conditional (i) by a reference to another writing
for a statement of rights with respect to collateral, prepayment, or acceleration, or
(ii) because payment is limited to resort to a particular fund or source. (If either i,
or ii is involved this doesn’t make it conditional).
c. If a promise or order requires, as a condition to payment, a counter signature by a
person whose specimen signature appears on the promise or order, the condition
does not make the promise or order conditional for the purposes of §3-104(a). If
the person whose specimen signature appears on an instrument fails to
countersign the instrument, the failure to countersign is a defense to the obligation
of the issuer, but the failure does not prevent a transferee of the instrument from
becoming a holder of the instrument. (When need a counter signature.)
d. If a promise or order at the time it is issued or first comes into possession of a
holder contains a statement, required by applicable statutory or administrative
law, to the effect that the rights of a holder or transferee are subject to claims or
defenses that the issuer could assert against the original payee, the promise or
order is not thereby made conditional for the purposes of §3-104(a); but if the
promise or order is an instrument, there cannot be a holder in due course of the
instrument. (Where a particular law that says that rights of holder are subject to
claim or defenses it doesn’t mean instrument is conditional, but at same time you
will not be able to get holder in due course status.)
1. Implied Conditions:
The fact that it is possible to think up things that might happen to destroy the maker’s
liability on the instrument does not destroy negotiability unless the instrument makes
itself expressly conditional as to these matters. Example of negotiable instrument:
“(Date), I have this day rented a theater from Music Hall, Inc., and I promise to pay $800
to the order of Music Hall.” The possibility that the theater may burn down prior to
Joanie’s use of it does not make the note conditional (and therefore non-negotiable); this
condition is only implied. Example of a non-negotiable instrument: if the note had said,
“I promise to pay $800 to the order of Music Hall only if the theater does not burn down
before I use it” b/c this would be subject to an express condition. See above §3-106(a)
(i).
Triffin v. Dillabough
* cashes stolen money orders at Chuckie’s. Chuckie tries to recover money from
American Express and they refuse b/c the money orders were stolen from them. Chuckie
sold the money orders to * and he brought suit against * and American Express. Issue:
Whether the money order are negotiable instruments and if they are whether * has the
rights of a holder in due course who may recover the face value of those money orders
from American Express? Yes. The court used a 4 part test: (A) Requisites to
negotiability- any writing to be a negotiable instrument within this division must: (1) be
signed by the maker or drawer; (2) contain an unconditional promise or order to pay a
sum certain in money and no other promise, order, obligation or power given by the
maker or drawer except as authorized by this division; (3) payable on demand or at a
definite time; and (4) be payable to order or to bearer.
•
American Express claims that a legend it placed on the back of the MOs qualifies an otherwise
unconditional order on the frond directing the drawee to “Pay the Sum of“ a specified amount
“To the Order or“ the payee. The legend provides: “Important: Do Not Cash for Strangers:
This money order will not be paid if it has been altered or stolen or if an endorsement is missing or
forged. Be sure you have effective recourse against your customer.“
•
The majority did not find that this was an express condition. Comment 4 of
§3-104 says that any writing which meets the requirements of subsection (a) and is not excluded
under §3-103 is a negotiable instrument, and all sections of this division apply to it, even though
it may contain additional language beyond that contemplated by this section. Expressing the
drawee’s statutory defenses in a legend with the conditional phrase “This MO will not be paid if . .
.” doesn’t elevate the legend to a condition under §3-104(a) because it is merely a restatement of
the defenses present in the UCC.
•
The dissent argued that the word “if“ is a word of condition and makes the money orders
conditional. “If“ means “on condition that.“ The dissent had the better argument.
2. Consideration Stated
The holder must be able to determine the negotiability of an instrument from within its
own four corners alone. If any referencing outside materials is required the instrument is
non-negotiable.
Problem 84:
Are the following notes negotiable?
b.
“(Date), I promise to pay bearer $500, subject to the contract I signed with Honest John
today, (Signature).” See official comment 1, second paragraph, to §3-106.
o
No, “subject to” destroys negotiability, so common law applies instead of Article 3.
c.
“(Date), I promise to pay bearer 500 as per contract I signed today with Honest John,
(Signature).” §3-117, which says that a separate agreement affects only the parties thereto
and not a subsequent holder in due course.
o
Yes, “as per” merely references the other contract, this doesn’t destroy negotiability.
d.
“(Date), I promise to pay bearer $500 on January 1, 2010. For rights as to prepayment
and acceleration, see the contract signed September 25, 2005, between the maker and the
payee. (Signature).” See §3-106(b)(i).
o
Yes, this is a negotiable instrument even though it references outside references b/c §3106(b)(i) permits reference to a separate writing for information with respect to collateral,
prepayment, and acceleration.
Problem 85:
Whenever it mails out a check, the Adhesion Insurance Company marks it “Void after 90 days.” Is such an
instrument technically negotiable?
o
This is a conditional promise, so No.
Problem 88:
The promissory note contained this clause: “ The collateral for this note is a security interest in the maker’s
art collection; for rights duties on default, see the security agreement signed this day creating the security
interest.” Does this clause destroy the negotiability? See §3-106(b)(i) and its OC 1, 3rd paragraph.
o
This does not destroy its negotiability. The official comment tells us that in some cases it
may be convenient not to include a statement concerning collateral, prepayment, or
acceleration, but rather refer to a security agreement, mortgage or loan agreement for that
accompanying statement. §3-106(b)(i) allows a reference to the appropriate writing for a
statement of these rights.
D. “Fixed Amount of Money”
A document will be non-negotiable if one cannot look at it and readily calculate the
amount that the maker or drawer has promised to pay.
Problem 89:
The promissory note stated that the rate of interest was “2% above the prime rate as of the date of
maturity.” The prime rate is the interest charged by banks to their best customer and can be ascertained by
reference to financial publications. Does the fact that the holder of the note has to consult sources outside
of the instrument in order to calculate the interest due destroy negotiability? See §3-112
o
No, §3-112 tells us that the amount or rate of interest may be stated or described in the
instrument in any manner and may require reference to information not contained in the
instrument.
Note on Page 343:
“I promise to pay 100 bales of cotton to bearer” is a non-negotiable promise; a negotiable
instrument must promise or order payment in money. But what is money? §1-201(24
defines money as the “medium of exchange authorized or adopted by a domestic or
foreign government as a part of its currency.” The official comment to that section stated
that the “test adopted is that of the sanction of government… which recognizes the
circulating medium as part of the official currency of that government.” Remember
money does not only mean US currency.
E. “Courier Without Luggage” Requirement
PA Justice Gibson once said that a negotiable instrument must be a “courier without
luggage.” This means that the instrument must not be burdened with anything other then
the simple and clean unconditional promise or order; it cannot be made to truck around
other legal obligations. If the maker of a note adds any additional promises to it, the note
becomes non-negotiable b/c the prospective holder is then given notice that the note is or
may be conditioned on the performance of the other promise. §3-104(a)(3) contains a
few exceptions.
Problem 90:
Do the following clauses in an otherwise negotiable promissory note destroy negotiability?
a.
“Maker agrees that signing of this note also indicates acceptance of the contact
of sale for which it is given.“

Yes, b/c it carries another obligation.
b.
“Maker agrees and promises that if the holder of this note deems himself
insecure at any time, he may so inform the maker, who will then supply
additional collateral in an amount and kind to be specified by the holder.“

No, under §3-104(a)(3)(i) says you can mention additional collateral.
c.
“Maker agrees to let the holder select and attorney for the maker; at any time
the holder directs, said attorney is hereby given the authority to confess
judgment against the maker in any appropriate court.“

No, under 3-104(a)(3)(ii) allows this.
d.
On the front of a check: “By cashing this check, the payee agrees that the drawer
has made payment in full of the debt drawer owed to payee as a result of the
purchase of a 2002 Ford, made on January 24, 2002.” The revised version of
Article 3 drops any discussion of the effect of this language on negotiability, but
§3-311 regulates the contractual result of such a restriction.

Yes, this is an instruction in addition to the payment of money which isn“t
allowed.
e.
“Maker hereby grants the payee a security interest in the collateral described
below.“

No, under 3-104(a)(3)(i) this doesn“t destroy negotiability.
Woodworth v. The Richmond Indiana Venture
* executed a promissory note to pay part of the deferred portion of *’s investment in the
partnership. The note was assigned to Signet Bank. * defaulted on the note. This action
ensued. Issue: Was the promissory note a negotiable instrument in this case? No. In
order to be negotiable, a promissory note must be signed, unconditional promise to pay a
sum certain in money which is payable on demand or at a definite, stand time. The note
must be payable to order or bearer and contain no other promise, order, obligation, or
power given by the maker except as authorized by §3-104. This promissory note indeed
was a promise but it also contained a forfeiture agreement of the *’s partnership interest.
Nothing in the code authorizes the forfeiture agreement. This leaves the negotiability of
the note in doubt, and where there is doubt, the decision should be against negotiability.
•
What was the clause in question?
o
The promissory note contained the following forfeiture provision: “The
undersigned agrees that, in the event any payment due pursuant to the
terms of this not be not timely made, at the option of the Partnership, the
undersigned shall retroactively lose any interest in the Partnership from
the date hereof and the Partnership shall have no obligation to account for
any payment theretofore made by the undersigned, and that this remedy is
in addition to other remedies afforded by the Partnership Agreement.
•
Why did the plaintiff argue that the clause destroyed negotiability?
•
Did the court agree that the clause destroyed negotiability? Why?
F. “Payable on Demand or at a Definite Time “
A holder of an instrument must be able to tell when it comes due, or the instrument is
non-negotiable; however, there is no requirement that the instrument be dated. An
undated instrument that specifies no time of payment is treated as an instrument payable
on demand by the holder. Read §3-108 and §3-113.
Problem 89:
Do the following clauses in a promissory note destroy negotiability?
a.
“Payable 30 days after sight.”

b.
3-108(b), so No
“Payable in 11 successive monthly installments of $2,414.92 each and in a final payment of
$2,415.03 thereafter. The first installment being payable on the ___ day of ___, 20__, and the
remaining installments on the same date of each month thereafter until paid.“

Yes, blanks left in contemplation refer to 3-108(b), not 3-108(a).
c.
“Payable on November 8, 2010, but the holder may demand payment at any time prior thereto if
he deems himself insecure.Ҥ1-208.

d.
“Payable when the sun comes up tomorrow.“

e.
(No idea when he is going to die, so no definite time.) Date isn“t definite, not
really ascertainable, so yes.
“Payable 100 years from today, but if my rich uncle Al dies before this note is due, it shall
become payable 10 days after distribution of his estate to his heirs.“

i.
Yes, under 3-108(b)(iv), to indefinite time.
“Payable 120 days after my rich uncle Al dies.“ Such notes are called post-obituary notes.

h.
No under 3-108(b)(iv), extension to a further definite time.
“Payable on November 8, 2010, but the maker hereby reserves the option to extend the time of
payment until he can pay without serious financial hardship.“

g.
If undated you wouldn“t know when its due, if dated it“s okay.
“Payable on November 8, 2010, but if my potato crop fails that year, payment shall be extended
until November 8 of the following year.“

f.
Yes, acceleration clause okay if follow definite time or on demand. So its okay
here.
(This is a definite time. Acceleration clauses are allowed.) Second portion will
occur 1st, so this is an acceleration clause which is allowed. So no.
“Payable on my next birthday.“

No.
G. “ Payable to Bearer or to Order“
§3-104(a)(1) of the Code continues the ancient requirement that the maker or drawer use
either bearer or order language (words of negotiability) on an instrument before it is
technically negotiable. §3-104 lays out the requirements and §3-109 explains them in
detail.
§3-109: Payable to Bearer or to Order:
a. A promise or order is payable to bearer if it:
1. states that it is payable to bearer or to the order of bearer or otherwise
indicates that the person in possession of the promise or order is entitled to
payment;
2. does not state a payee; or
3. states that it is payable to or to the order of cash or otherwise indicates that
it is not payable to an identified person.
b. A promise or order that is NOT payable to bearer is payable to order if it is
payable (i) to the order of an identified person or (ii) to an identified person or
order. A promise or order that is payable to order is payable to the identified
person.
c. An instrument payable to bearer may become payable to an identified person if it
is specifically indorsed pursuant to §3-205(a). An instrument payable to an
identified person may become payable to bearer if it is indorsed in (blank)
pursuant to §3-205.
Definitions:
Bearer paper is paper that is payable to the holder of the paper and to a specific person.
This means that privity is going to pass to the next person when the next person actually
physically receives that paper. When create bearer paper, anyone can cash it if they hold
it. This is contrasted with order paper, which is payable to a specified person or to
whomever that person further orders the paper to be paid. Under the revised Article 3, if
you have a check it does not need order or bearer language. This is not the same for
notes, still must have order or bearer language.
Problem 90:
Do the following clauses in a promissory note create bearer paper?
a.
“Pay to John Smith.”
o
b.
“Pay to the order of John Smith or bearer.” See Official comment 2 to §3-109.
o
c.
Yes. §3-109(a)(1).
“Pay to the order of Cash.”
o
e.
Yes, this still means the check is payable to bearer. Bearer trumps order language if both
listed.
“Pay to bearer.”
o
d.
No. This is non-negotiable. This is not order paper b/c this is not paid to the order of
John Smith, so must go to the common law.
Yes. §3-109(a)(3).
“Pay to a Merry Christmas.”
o
Yes, this would be considered bearer paper b/c this is definitely not an identified person.
Comment 2 to §3-109.
Problem 91:
Do the following clauses create order or bearer paper, or do they make the instrument non-negotiable for
failure to create either?
a.
“Pay to the order or (blank).” See §3-115 and OC 2.
o
Bearer paper until filled in, then its order paper.
b.
“Pay to John Doe’s estate.” See §3-110(c)(2)(i).
o
Non-negotiable b/c no order or bearer paper used.
c.
“Pay to the order of the President of the US.” See §3-110(c)(2)(iv).
o
Order paper
d.
The drawer of a check drew a line through the words “the order of” that were printed on
the check prior to the space for the payee’s name. Is the check, as altered, negotiable?
See §3-104(c). If the drawer of a check or the maker of a promissory note wants to
destroy negotiability, what should be done? See §3-104(d). Why would this ever be
desirable?
o
It’s okay. To destroy negotiability they should write “non-negotiable” on it
inconspicuously. Desirable to protect drawer or maker… allows them to use defenses
down the road, even against HDC.
H. Consumer Notes
The Uniform Consumer Credit Code does preserve a consumer’s defenses even if the
instrument is owned by a holder in due course. See pages 350-351.
Negotiation
Some Technical Terms
A. Parties
Those whose names appear on a negotiable instrument are given definite labels, with
specific legal consequences varying according to the label attached. For example, a
promissory note is a two-party instrument. On the other hand, a draft is always a threeparty instrument. With each instrument, each party has a different name and legal
consequence. See vocabulary below.
Vocabulary: (Slide)
(1) Promissory Notes- 2 parties
(a) Maker: person who issues it and promises to pay
(b) Payee: person to whom the note is made payable
(2) Drafts (Checks)- 3 parties
(a) Drawer: creates the draft and orders the drawee to pay
(b) Drawee: person to whom the drawer addresses the order of payment (usually
bank)
(c) Payee: person entitled to payment
B. Negotiability vs. Negotiation
Do NOT confuse these 2 terms. The question, “Is an instrument negotiable?” asks if the
instrument is in the proper form to meet the technical requirements of negotiability found
in §3-104(a). The question, “Has the instrument been negotiated?” asks about the legal
validity of the attempted transfer of the instrument. Thus negotiability refers to form, and
negotiation to transfer.
Transfer and Negotiation
1. Stage 1: Issuance §3-105
2. Stage 2: Transfer(s) §3-203

Every legally significant movement of the paper between issuance
and presentment

§3-203(b) (The shelter rule) Physical transfer of the instrument
vests in the transferee whatever rights the transferor had in the
instrument.

If the physical transfer is done in a way to make the transferee a
Holder, then the transfer is called a Negotiation.
3. Stage 3: Presentment §3-501
How do you negotiate the paper? §3-201
1. Order Paper

Indorsed by the proper person (who thereby becomes the Indorser),
AND

The delivery of the instrument to the transferee (who thereupon
qualifies as a Holder)

Note: An indorsement is a signature placed on an instrument by the
payee or any later transferees.
2. Bearer Paper
1. Needs no indorsement

Delivery of the instrument to the transferee (who thereupon
qualifies as a Holder)
Special and Blank Indorsement
1. Order Paper: when a payee wants to transfer it to another person, the
drawee bank will require the payee’s indorsement. §3-501(b)(2)(iii).
2. Blank Indorsement: when the payee simple signs the back of the
instrument. Legal effect? It converts the paper into bearer paper.
3. Special Indorsement: to preserve the “order” character, the original payee
may specify a new payee by writing “Pay (name.” The new payee
becomes a holder as soon as the instrument is delivered. (Do not need
“pay to the order of” here).
4. Negotiability is not affected by the language written on the instrument
during the course of negotiation.
Problem 92:
David Hansen banked with the Mechanical National Bank (MNB). Hansen owed 50 to Egger and decided
to pay him by writing out a check for $50, using one of the checks MNB furnished him when he opened his
account. He gave the check to Egger, who wrote his name on the back of the check. Egger gave the check
to his wife Cynthia, who took it down to the Cornucopia Grocery (CG) and asked the manger to cash it.
The manager paid Cynthia $50 and then took the check and wrote “Pay to CG” just above Egger’s
signature. When Billy Speed, the Check Collection Services’ messenger, came by, the manager gave the
check to him for delivery to the Octopus National Bank, where the grocery store had an account. Speed
delivered the check to the bank, where the bank’s check processing machine merely stamped the words
“ONB” on the back of the check. ONB then forwarded the check to the MNB.
a.
To which parties should these labels be attached: drawer, drawee, payee, or depository bank?
o
b.
Did the following people qualify as holders: David Hansen, Egger, Cynthia, the manager of CG,
CG, Billy Speed, ONB, and MNB?
o
c.
Yes, depository banks are holders, even if not endorsed, if put in payee’s account (4-205)
What was the legal effect of the language written on the check by the grocery store manager?
o
e.
All holders except: David Hansen, and Mechanical National Bank (drawers and drawees
aren’t holders)
If Egger had failed to indorse the check, but simply deposited it in his account with ONB, would
the bank have been a holder? See §4-205.
o
d.
Drawer: David Hansen; drawee: Mechanical National Bank; payee: William Egger; Dep.
Bank: ONB
It made the bearer paper into order paper (3-205(c)).
Which of the parties are properly called indorsers? See §3-204.
o
William Egger and manager of the Grocery Store and ONB (3-204)
Problem 93:
A check was made payable to “Mary and Donald Colpitts.” Must both payees indorse it in order to
negotiate the instrument? What if the check were payable to “Mary or Donald Colpitts”? Must both
payees indorse now? Finally, what if it simply is payable to “Mary Colpitts, Donald Colpitts” with no
connecting word? Are 2 indorsements needed here? See §3-110(d) and OC 4.
o
Both parties must endorse to negotiate the instrument. Then only one needs to endorse
the instrument when nothing is specified, it’s considered “or.”
Problem 94:
When Portia Moot received her 1st paycheck from the law firm that recently hired her, she was annoyed to
discover that it was made out to “Portia Mort.” When she took the check to her bank to cash it, she
mentioned the problem to the bank clerk, who promptly called you, the bank’s attorney. What steps would
you suggest the bank follow in this situation? See §3-204(d) and its OC 3.
o
Bank should have her endorse the way written on check and the correct way (3-204(d))
In the original version of Article 3, only a holder has the right to sue on an instrument to
enforce payment, but the revised version of §3-301 would allow owners who are nonholders to sue in some circumstances, replacing the original word holder with the more
inclusive person entitled to enforce the instrument. This term generally means a holder,
but it also includes certain parties to whom other sections of the Code give similar rights.
Read §3-301. To qualify as a holder under §1-201(20), a person must meet 2
requirements: (a) possession of the instrument and, for non-bearer instruments, (b) be the
person identified in the instrument (either as a payee or special indorsee). Failure to
establish holder status b/c of defects in negotiation can be legally fatal.
Problem 95:
Desert Paradise, Inc. (DP), initiated a scam in which hundreds of middle-class people signed promissory
notes in order to invest in the supposed development of a retirement community to be built in the
Southwest. Desert Paradise, the payee on all of these notes, sold them in bulk to ONB. Rather than
indorsing its name hundreds of times of each of the notes, DP had its indorsement printed on a separate
sheet of paper, which it then folded into each note, not connecting it and any way other then the fold. DP’s
officials absconded with the money and left the desert untouched. ONB demanded payment from the
makers of the notes, and when they tried to raise defenses of breach of K and fraud, ONB claimed to be a
holder in due course, so as to take free of these defenses. Is ONB even a holder? See §3-204(a) and the
OC 1 (last paragraph). A separate paper used for indorsements is called an allonge, and the last sentence of
§3-204(a) says that it must be affixed to the instrument. What does “affixed” mean? Would a paper clip do
the trick? A staple?
o
ONB is not a holder b/c folding and paper clipping does not mean affixed; stapling is
affixed.
Forgery of the Payee’s Name
o
If an instrument is payable to the order of a named payee, only that payee
can become a holder.
o
That person does not become a holder until the Payee gets possession of
the instrument.
o
Thereafter, no one can qualify as a Holder until the payee indorses the
instrument.
o
Without the payee’s valid indorsement, no later transferees will have taken
by a valid negotiation of the instrument, which remains the payee’s
property.
o
An unauthorized signature (i.e., a forgery or signature by a non-agent) is
Not effective to negotiate the instrument.
o
Following a forgery of the payee’s name, no later transferee (no matter
how innocent, no matter how good the forgery, no matter how far down
the line the taker is, etc.) can qualify as a holder.
Problem 96:
When Laura Lawyer’s briefcase was stolen, it contained her monthly paycheck from the law firm for which
she worked, made payable to her order. She has not indorsed it. The thief who stole the briefcase forged
her name to the back of the check and transferred it to an innocent party, Grocery. When the latter tried to
cash the check at the drawee bank, the bank alerted Laura, and she arrived at the bank immediately. Can
she retrieve the check from the Grocery? See §3-306.
o
Yes, forgery is not effective to negotiate the instrument. (3-306). Cornocopia is not a
holder.
Problem 97:
Assume that on receiving her paycheck, Laura had signed her name to the back of the instrument, which
was then blown out a window and landed at the feet of a criminal, Harry. Harry took the check to the
Grocery and told the manager that he was Lance lawyer, Laura’s father, and asked the manager to cash it
for him. The manager made Harry indorse the instrument (reason: to make Harry contractually liable
thereon (§3-415(a)), so Harry wrote “Lance Lawyer” under Laura’s name. Is the Grocery a holder?
o
Yes, this was bearer paper, so anyone in possession is a holder.
Problem 98:
Assume that Laura wanted to indorse the instrument over to her mother, so on the back she wrote “Pay to
Lilly Lawyer” and then signed her own name. Thus indorsed, the instrument was blown out the window,
and Harry found it. He indorsed “Lilly Lawyer” under Laura’s name and transferred the check to Grocery.
Is the Grocery a holder? See §3-205(a).
o
No, forgery is not effective to negotiate, so Cornocopia is not a holder. Lilly had to
endorse first.
Rule: The rule here is that ay unauthorized indorsement of the payee’s name or any special indorsee’s
name is not a valid negotiation and gives subsequent transferees no legal rights in the instrument no matter
how innocent they are or how far removed from the forgery. The same rule applies to missing indorsments
of the payee of special indorsee; later possessors of the instrument do not qualify as holders. BUT once an
instrument becomes bearer paper, subsequent unauthorized signatures have no effect on the holder status of
later takers, since valid indorsements are not required to negotiate bearer paper (§3-201(b)).
Problem 99:
Laura never had a course in commercial paper, so when she received her paycheck, she simply wrote her
name on the back and mailed the check to her mother. Her mother needed some reason to hold onto the
check for a week before cashing it, so she wrote “Pay to Lilly lawyer” above Laura’s indorsement. Has the
check now become order paper requiring the mother’s indorsement for further negotiation? See §3-205(c)?
o
Yes, under 3-205(c), holder can make bearer paper into order paper.
Holders in Due Course (HDC)
Acquiring Holder in Due Course Status
“Value”:
§3-303: Value and Consideration:
(a) An instrument is issued or transferred for value if:
(1) the instrument is issued or transferred for a promise of performance, to the
extent the promise has been performed;
(2) the transferee acquires a security interest or other lien in the instrument other
than a lien obtained by judicial proceeding;
(3) the instrument is issued or transferred as payment of, or as security for, an
antecedent claim against any person, whether or not the claim is due;
(4) the instrument is issued or transferred in exchange for a negotiable instrument; or
(5) the instrument is issued of transferred in exchange for the incurring of an
irrevocable third party by the person taking the instrument.
(b) “Consideration” means any consideration sufficient to support a simple K. The
drawer or maker of an instrument has a defense if the instrument
•
Comment 1: The distinction between value and consideration in Article 3 is a fine
one. Whether an instrument is taken for value if relevant to the issue whether a
holder is a HDC. If an instrument is not issued for consideration the issuer has a
defense to the obligation to pay the instrument. Outside Article 3, anything that is
consideration is also value, but a different rule applies in Article 3.
Example #1:
X owes Y $1000. The debt isn’t represented by a note Later X issues a note to Y
for the debt. Under subsection (a)(3) X’s note is issued for value. Under
subsection (b) the note is also issued for consideration whether or not, under K
law, Y is deemed to have given consideration for the note.
Example #2:
X issues a check to Y in consideration of Y’s promise to perform services in the
future. Although the executory promise is consideration for issuance of the check
it is value only to the extent the promise is performed. Subsection (a)(1).
Example #3:
X issues a note to Y in consideration of Y’s promise to perform services. If at the
due date of the note Y’s performance isn’t yet due, Y may enforce the note
because it was issues for consideration. But if at the due date of the note, Y’s
performance is due and hasn’t been performed, X has a defense. Subsection (b).
*Check for shelter rule still!
Problem 103:
Zach bought a car for his business from Fillmore, signing a promissory note for $23,000 payable to
Fillmore. Fillmore sold the note to the Pierce Financing Company for $22,800, a $200 discount. The car
fell apart, and Zach refused to pay. Is the finance company (assuming good faith and lack of notice) a HDC
for the $23,000 or $22,800? If Millard Fillmore, the owner of Fillmore, owed his mother $21,000 and gave
her the note with the understanding that the extra $2000 was a Mother’s Day gift, would the mother be a
HDC for the full amount?
The Finance company is a HDC for the $23,000. Millard would be a HDC for only the $21,000
because she gave no value for the other $2000.
Problem 102:
Tom tricked old Mrs. Nodding into writing a check payable to Tom (she thought he was the agent for a
local charity). The check for $1000 was drawn on her bank, First County Bank. Tom took the check to his
bank, Last National Bank, and after indorsing it, put it in his checking account. Last National Bank sent the
check to First County Bank for payment, but by the time it got there Mrs. Nodding had stopped payment so
that the check was dishonored and returned to Last National. Is Last National Bank a HDC? This question
will be important if Tom has skipped town and Last National decides to sue Mrs. Nodding under §3-414.
It depends on whether they have had to give money out of their own pocket. If the bank permitted
Tom to get the money before the check was cleared through the drawee bank, and there is not
$1000 in Tom’s account, the Last National Bank would be a HDC because they would have to pay
out of their pocket.
Falls Church Bank v. Wesley Heights Realty, Inc.
Customer deposited a check for $1400 in his bank account and withdrew $140. Later the
check was dishonored because a stop payment was placed on it. Customer had skipped
town in the interim. So his bank was out $140 of its own money. The bank sued Wesley
as a HDC.
•
The depository bank did acquire a security interest in the deposited check because they allowed
Wesley to withdraw cash off a deposited check. A bank acquires a security interest in items
deposited with it to the extent that the provisional credit given the customer on the item is
withdrawn. §4-208.
•
§3-303(a)(2) says that a security interest proves that value has been given. The depository bank
gave “value“ to the extent that it acquired a security interest in the check. For purposes of
achieving the status of HDC, the depository bank gives value to the extent that it acquires a
security interest in the item in question. §4-209.
•
A bank may be a holder in due course while acting as a collecting agent for its customer.
•
The bank is a HDC as to $140, because that is what they have paid out of their own pocket.
Problem 103:
Same situation as Problem 102 except that when Tom deposits the $1000 check in his account, the account
contains $500. Later that afternoon he withdraws $500. Is the bank a HDC for any amount? See §4-210(b)
(the FIFO rule: First in, First out.) What result if he withdraws $750?
The bank is not a HDC because they have failed to give value themselves; they aren’t out of
pocket anything. However, if he withdrew $750, the bank would be a HDC for the $250.
“Good Faith” and “Notice”
To become a HDC, the owner of the instrument must basically be a bona fide purchase –
that is, the owner must have given value for the instrument in good faith (defined in §1201(19) as “honesty in fact in the conduct or transaction concerned,” but redefined in §3103(a)(4) to include not only “honesty in fact” but also “the observance of reasonable
commercial standards of fair dealing”), thus making the test one that is both subjective
and objective. Comment 4 of §3-103(a)(4) says that ordinary care means observance of
reasonable commercial standards of the relevant businesses prevailing in the area in
which the person is located. The holder must also be without notice that there are
problems with the instrument. If, at the time value is given for the instrument, a person
has notice of a defense the maker of a note has against the payee, the holder cannot be
said to take the note with the good faith expectation that it should be paid in spite of the
defense.
*A revised Article 1 has been proposed. It contains a NEW definition of “good faith.”
Check with your state before taking the bar to see if they have adopted the revised
version of Article 1 and, thus, have a new definition of good faith.
General Investment Corp. v. Angelini
Angelini hired Lustro to do repair work on their home. Their work contract said that no
payment was due until work was completed. Angelini signed a note payable to Lustro
that had a blank space as to when payment was due, this was blank when Angelini signed
it, but later a date was filled in by Lustro. Now Angelini may have to pay on that date
even if the work isn’t finished if the note becomes held by a HDC because they won’t be
able to defend on breach of contract. General Investment, a finance company, purchased
the note from Angelini. Is General Investment a HDC?
•
General Investment Corp. required Lustro to deliver the home improvement contract between
Angelini and Lustro with the note. Thus, General Investment knew that under Lustro“s method
of operation the homeowner“s obligation to commence payments didn“t come into being until
60 days after the home improvements were completed. It had to know by inescapable implication
that “60 days after completion“ were not just words, but meant after completion in a
workmanlike manner.
•
General Investment Corp. should have requested the certificate of completion before paying
Lustro. If they had, they would have learned immediately that the work hadn’t been completed.
Instead they chose to accept the representation in the printed form of endorsement, appearing on
the back of the note and above Lustro’s signature, that the work had been “fully completed” in the
10 days between the contract date and the false date of execution of the note.
•
The Unico court defined Good Faith: The more the holder knows about the underlying transaction,
and particularly the more he controls or participates or becomes involved in it, the less he fits the
role of a good faith purchaser for value; the closer his relationship to the underlying agreement
which is the source of the note, the less need there is for giving him the tension free rights
considered necessary in a fast-moving, credit-extending commercial world.
•
Ordinarily where the note appears to be negotiable in form and regular on its face, the holder is
under no duty to inquire as to possible defenses, such as failure of consideration, unless the
circumstances of which he has knowledge rise to the level that the failure to inquire reveals a
deliberate desire on this part to evade knowledge because of a belief or fear that investigation
would disclose a defense arising from the transaction.
•
By failing to get the actual required information, General Investment acted in bad faith, so that
they cannot obtain HDC status.
Problem 104:
The corporate treasurer of the Business Corporation was having major troubles paying his personal bills, so
finally he decided to embark on a life of crime. He used a corporate check to pay his American Express
bill, making the check out to “Amerex Corp., 770 Broadway, NY, NY 10003” (the actual address of
American Express). On the corporate check requisition form he wrote a phony explanation that this check
represented shipping expenses. This caused no suspicions at Business Corporation and, thus encouraged, he
did it every month for two years. When Business Corporation finally figured out what had happened, it
sued American Express in quasi-contract for all the money it had received in this fashion. American
Express replied that it was a HDC of these checks and, as such, was not amenable to this suit. Business
Corporation pointed to the suspicion circumstances and to UCC §3-302(a) and 3-307 (arguing that the
corporate treasurer was a fiduciary). How should this be resolved?
American Express is a HDC because they have given value up front, expecting to get a payment
back in return. The abbreviation of their name was allowed by the court because several people
actually pay their bills this way with this abbreviation.
Winter & Hirsch, Inc. v. Passarelli
D applied for $10,000 from the mortgage company, Equitable. They agreed to pay back
$16,000. Passarelli signed it. Equitable sold it to Winter and Hirsch. Passarelli’s
defaulted, and Winter and Hirsch claimed that it was a HDC so that they would get their
money.
•
Passarelli“s claimed that this was a usury note. A usurious rate of interest is so great that it is
illegal. Such an amount is made illegal by statute.
•
It is significant that Plaintiff was a co-originator of the note because they were to pay Winter and
Hirsch directly instead of Equitable, and Winter and Hirsch“s name was on the loan application.
As a co-originator, they can“t claim that they are innocent as to the usury note, they had
knowledge all along.
•
The instrument was incomplete because the principal amount was not included. This matters
because if the principal amount had said been small and the pay back amount was high, the
originators would be on notice that the interest rate was usurious.
•
A reasonably prudent businessperson should have raised the question here, they should have
noticed that something was wrong.
•
A person has notice of a claim or defense if the instrument is so incomplete, ears such visible
evidence of forgery or alteration, or is otherwise so irregular as to call into question its validity,
terms or ownership or to create an ambiguity as to the party to pay. A person also has notice of a
fact when from all the facts and circumstances known to him at the time in question he has reason
to know that it exists. They were on notice here, so they do not achieve HDC status.
Problem 107:
Fred wrote a check on Jan 5, 2008, but mistakenly put down 2007 as the year. He saw his error, crossed out
the last digit, and wrote 8 above it. Can anyone become a HDC of this instrument?
Something is only an alteration if it is an unauthorized change. Here he authorized the change, he
did it himself, so this is not considered an alteration and someone can become a HDC.
§3-304: Overdue Instrument:
(a) An instrument payable on demand becomes overdue at the earliest of the following
times:
(1) on the day after the day demand for payment is duly made;
(2) if the instrument is a check, 90 days after its date; or
(3) if the instrument isn’t a check, when the instrument has been outstanding
for a period of time after its date which is unreasonably long under the
circumstances of the particular case in light of the nature of the instrument and
usage of the trade.
(b) With respect to an instrument payable at a definite time the following rules apply:
(1) If the principal is payable in installments and a due date hadn’t been
accelerated, the instrument becomes overdue upon default under the instrument
for nonpayment of an installment, and the instrument remains overdue until the
default is cured.
(2) If the principal is not payable in installments and the due date hasn’t been
accelerated, the instrument becomes overdue on the day after the due date.
(3) If a due date with respect to principal has been accelerated, the instrument
becomes overdue on the day after the accelerated due date.
(c) Unless the due date of principal has been accelerated, an instrument doesn’t become
overdue if there is default in payment of interest but no default in payment of principal.
Problem 108:
Ace Finance Company was the payee on a promissory note signed by John Maker. On its face the note calls
for John to make 12 monthly interest payments before the note matures. Ace sold the note at a discount to
Big Town Bank. If the note has written on it, in big letters, a penciled notation, “Missed Paying First
Installment,” can Big Town Bank ever qualify as a HDC?
Yes. Under §3-304(c), a missed interest payment is not the same as a missed principal payment.
Under §3-304(b), only when principal payments are missed and the holder is put on notice can
they lose HDC status.
Problem 109:
Dan Drawer wrote a check dated April 30 to Dr. Paine, his dentist, for $80, in payment for services
rendered. Dr. Paine was not aware that the check fell to the floor behind his desk, where it lay until the end
of August, when the janitor found it. Dr. Paine then indorsed the check over to his local grocery store on
August 31, and it bounced on Sept 3, when the drawee bank informed the manager of the grocery store that
Dan had stopped payment because the dental work had been done badly. Is the grocery store a HDC?
No, the date was on the check, so the grocery store was clearly on notice that the check was
overdue because more than 90 days had passed since it was issued.
Problem 110:
When Ellen found out that the computer she had purchased didn’t work, she was furious and decided not to
pay the promissory note she was furious and decided not to pay the promissory note she had signed. The
note stated that it was “payable at Busy State Bank” (which in this case means that the bank would pay the
note when presented and then expect reimbursement from the maker.) Harold, the head cashier at the bank,
took Ellen’s phone call and promised not to pay the note when it was presented. Four months went by, and,
on one hectic afternoon, the bank paid the note by accident. Harold said he had forgotten the request not to
pay. The bank now demands payment, claiming to be a HDC. Is it?
No. Problem 108 involves the “forgotten notice doctrine,” which permitted a holder to forget
notice and thus become a HDC if sufficient time passed between the notice and the acquisition of
the instrument. The UCC does seem to retain the “forgotten notice doctrine” under §1-201(25),
but the courts don’t like this doctrine at all.
§3-203: Transfer of Instrument; Rights Acquired by Transfer:
(c) Unless otherwise agreed, if an instrument if transferred for value and the transferee
doesn’t become a holder because of lack of indorsement by the transferor, the transferee
has a specifically enforceable right to the unqualified indorsement of the transferor, but
negotiation of the instrument doesn“t occur until the indorsement is made.
•
Comment 3: Subsection (c) provides that there is no negotiation of the instrument
until the indorsement by the transferor is made. Until that time the transferee
doesn’t become a holder, and if earlier notice of a defense or claim is received,
the transferee doesn’t qualify as a HDC under §3-302.
Problem 109:
Giant bought some machinery from Tractors, and in payment executed a promissory note payable to the
order of Tractors for $2000. Tractors sold the note without indorsement to the Friendly Finance Company
for $1500. The maker of the note refused to pay the note when it matured, stating that the machinery didn’t
operate properly. Friendly decided to sue Giant, and the day before the lawsuit was filed, Friendly’s lawyer
noticed that the note had never been indorsed by Tractors. He had Tractors’ president specially indorse the
note over to Friendly right away, and then the suit was filed. Is Friendly a HDC?
Friendly had notice before the indorsement so they are not a HDC.
Jones v. Approved Bancredit Corp.
Jones wanted to purchase a home. She was presented with several things to sign,
including an affidavit (sworn statement) that said the work was finished, but it hadn’t
actually started. She asked to have an attorney present, but they refused to start until she
signed and kept pressuring her to sign, so she finally signed it upon their coercion. She
signs a mortgage, a note, and the affidavit. The note was sold to Bancredit and they gave
value for the note. The home was destroyed during construction. The construction
company went out of business. Jones didn’t pay for the unfinished home and Bancredit
sued Jones for the value of the note, claiming to be a HDC.
•
The rule of balance involves balancing the needs of the installment-buying community and the
commercial community.
•
The finance company is better able to bear the risk of the contracting party“s insolvency.
•
The divergent line of cases, reflecting an underlying conflict in policy considerations, accords
determinative importance to the maintenance of a free flow of credit. These cases protect the
finance company from purchaser defenses on the ground that this is an overriding consideration in
order to assure easy negotiability of commercial paper and the resultant availability of the rapid
financing methods required by our present-day economy.
•
This court adopts the rule of balance. It should operate in favor of the installment buyer for the
reason that, in their opinion, Bencredit was so involved in the transaction that it may not be treated
as a subsequent purchaser for value. By reason of its sister corporation relationship with the
construction company and the established course of dealing between them, Bancredit was more
nearly an original party to the transaction than a subsequent purchaser of the paper; and, for the
reasons of fairness and balance stated in the foregoing authorities, Bancredit should be denied the
protected status of HDC which would prevent Jones having her day in court on the defenses she
would have otherwise had against the construction company.
Sullivan v. United Dealers Corp.
•
The Sullivans pleaded that the finance company wasn’t a HDC of the note and that the contractor
had constructed the house in an un-workmanlike manner by reason of which they had been
damaged (this is a personal defense); they sought to assert their claim against the contractor as a
defense against the finance company.
•
The Sullivan“s argued that the finance company was not a HDC because they were put on notice
that there might be a defense on the note because of the faulty construction of the dwelling house.
•
“Notice“ means notice at the time of the taking or at the time the instrument is negotiated, and
not notice arising subsequently. The time when value is given for the instrument is decisive. The
moment value is given without notice the status as a HDC generally is definitely and irrevocably
fixed.
•
The Commercial Code provides that to be effective, notice to a purchaser must be received at such
time and in such manner as to give a reasonable opportunity to act on it.
•
The evidence failed to demonstrate any bad faith on the part of the finance company at the time of
the negotiation and transfer of the note to it. All of the evidence demonstrated a complete lack of
notice to the finance company that would justify a finding that it failed to acquire the status of a
HDC.
The Shelter Rule:
It has always been a basic rule of the CL that the unqualified transfer of a chose in action
places the transferee in the transferor’s shoes and gives the transferee all the rights of the
transferor. This rule is codified in §3-203(b), where it is made clear that even HDC rights
can pass to a person not otherwise entitled to them. Because the transferee of a HDC
takes shelter in the status of the transferor, §3-203(b) is called the shelter rule.
§3-203(b): The Shelter Rule:
Transfer of an instrument, whether or not the transfer is a negotiation, vests in the
transferee any right of the transferor to enforce the instrument, including any right as a
HDC, but the transferee cannot acquire rights of a HDC by a transfer, directly or
indirectly, from a HDC if the transferee engaged in fraud or illegality affecting the
instrument.
•
Comment 4: The operation of §3-203 is illustrated by the following example.
Payee, by fraud, induced Maker to issue a note to Payee. The fraud is a defense to
the obligation of Maker to pay the note under §3-305(a)(2).
Example #1:
Payee negotiated the note to X who took as a HDC. After the instrument became
overdue X negotiatied the note to Y who had notice of the fraud. Y succeeds to
X’s rights as a HDC and takes free of Maker’s defense of fraud.
Example #2:
Payee negotiated the note to X who took as a HDC. Payee then repurchased the
note from X. Payee doesn’t succeed to X’s rights as a HDC and is subject to
Maker’s defense of fraud.
Example #3:
Payee negotiated the note to X who took as a HDC. X sold the note to Purchaser
who received possession. The note however, was indorsed to X and X failed to
indorse it. Purchaser is a person entitled to enforce the instrument under §3-301
and succeeds to the rights of X as HDC. Purchaser is not a holder, however under
§3-308 Purchaser will have to prove the transaction with X under which the rights
of X as HDC were acquired.
Example #4:
Payee sold the note to Purchaser who took for value, in good faith and without
notice of the defense of Maker. Purchaser received possession of the note but
Payee neglected to indorse it. Purchaser became a person entitled to enforce the
instrument but didn’t become the holder because of the missing indorsement. If
Purchaser received notice of the defense of Maker before obtaining the
indorsement of Payee, Purchaser cannot become a HDC because at the time
notice was received the note hadn’t been negotiated to Purchaser. If indorsement
by Payee was made after Purchaser received notice, Purchaser had notice of the
defense when it became the holder.
Problem 110:
Happy, the used car salesman, sold Manny a lemon car, taking in payment a promissory note for $2000
made payable to the order of Happy. Happy discounted the note with Alfred, a local licensed money
broker, who paid him $1700 and took the note without knowledge of the underlying transaction. Alfred’s
daughter Jessica had a birthday shortly thereafter, so Alfred indorsed the note in blank and gave it to her as
a present. When the note matured, Manny refused to pay it to Jessica, the car had fallen apart and he felt
that he shouldn’t have to pay for a pile of junk. Is Jessica a HDC?
She is not an actual HDC, but she has the rights of a HDC because Alfred was a HDC.
Problem 111:
If in the above Problem Jessica had thereafter made a gift of the note to her husband, Lorenzo, would
Lorenzo have HDC rights? Does it matter if Lorenzo, prior to the gift, knows of Manny’s problems with
the car? If Manny won’t pay, is Alfred liable to Lorenzo? See §3-305(a)(2) and 3-303.
Lorenzo would also have rights of a HDC under the shelter rule. Mere knowledge of the problems
wouldn’t strip him of his HDC rights. Alfred was a HDC and Lorenzo has rights of a HDC, the
actual HDC will win out.
Problem 112:
After Lorenzo (from the last Problem) acquired the note, he sold it for $1800 to Portia, a local attorney. She
had no notice of problems with the instrument. When she presented it to Manny for payment, he refused to
pay and instead filed for bankruptcy. May she recover from Alfred? See §3-305(b). If she does and prevails
Alfred will reacquire the instrument. Does the shelter rule give him Portia’s HDC rights? Does Alfred
reacquire his original HDC status when he gets the instrument back? Could he sue Jessica or Lorenzo?
She is an actual HDC, so yes. No, he gets his own rights back, not hers.
Reacquisition of an instrument:
On reacquisition a holder is remitted to his former rights as regards all prior parties.
Although the UCC doesn’t expressly state this rule, the idea is implicit throughout the
Code, and it is therefore still the law.
§3-207: Reacquisition:
Reacquisition of an instrument occurs if it is transferred to a former holder, by
negotiation or otherwise. A former holder who reacquires the instrument may cancel
indorsements made after the re-acquirer first became a holder of the instrument. If the
cancellation causes the instrument to be payable to the re-acquirer or to bearer, the reacquirer may negotiate the instrument. An indorser whose indorsement is canceled is
discharged, and the discharge is effective against any subsequent holder.
When a previous holder reacquires the instrument, he or she has the power to strike the
intervening indorsements.
Triffin v. Somerset Valley Bank
Hauser issued their payroll checks through ADP. Someone got hold of these ADP checks
and began passing them fraudulently. The fraudulent checks were written to Triffin.
Triffin demands payment from Hauser as HDC. The checks cleared through Somerset
Bank, that is why they are a party.
•
The checks were negotiable instruments because they were signed and everything appeared to be
valid.
•
§3-302 is our normal HDC definition.
•
§3-203(b) gives the shelter rule. Comment 2 states that “§3-203(b) states that transfer vests in
the transferee any right of the transferor to enforce the instrument “including any right as a HDC.”
If the transferee is not a HDC because the transferor didn’t indorse, the transferee is nevertheless a
person entitled to enforce the instrument under §3-301 if the transferor was a holder at the time of
transfer. Although the transferee is not a holder, under subsection (b) the transferee obtained the
rights of the transferor as holder. Because the transferee’s rights are derivative of the transferor’s
rights, those rights must be proved . . . .“
•
Whether Triffen is an HDC himself matters because if Hauser only has the rights of a HDC he will
lose against an actual HDC if he has to go up against one.
•
§3-308(a) shifts the burden of establishing the validity of the signature to the plaintiff, but only if
the defendant specifically denies the signature’s validity in the pleadings. Comment 1 provides
that a specific denial is required to give the plaintiff notice of the defendant’s claim of forgery or
lack of authority as to the particular signature, and to afford the plaintiff an opportunity to
investigate and obtain evidence . . . In the absence of such specific denial the signature stands
admitted, and is not in issue.. Nothing in this section is intended to prevent amendment of the
pleading in a proper case.
•
Hauser would have had to provide evidence of the invalidity of the signature to satisfy evidentiary
requirements if it plead the checks were forged or not authorized?
•
The reason for the shelter rule: It may seem unfair to give HDC status to non-purchasers and those
who take with notice of defense, but on reflection the unfairness disappears. If the rule were
otherwise, the current holder would simply pass the instrument back up the chain until it reached a
former holder in due course, who would then reacquire that status, sue the instrument’s creator,
and prevail. The shelter rule accomplishes the same result without all these maneuvers and has the
further benefit of promoting commercial confidence in the soundness of the instrument once it has
floated through the hands of multiple purchasers.
Real and Personal Defenses/Claims
Defenses Against a Holder in Due Course:
The obligor mentioned throughout §3-305 is the party to the instrument who is being
sued by the holder of the instrument. Thus, the obligor could be the drawer of the draft,
the maker of the note, or someone who indorsed the instrument. A “defense,” of course,
is the legal excuse the obligor may have to avoid paying the obligation.
Subsection (b) tells us that a HDC takes subject to the defenses listed in subsection (a)(1),
meaning that these defenses, if true, defeat the right of the HDC to enforce the
instrument. Defenses that are good against a HDC are commonly called real defenses, a
label you might wish to write next to §3-305(a)(1). Subsection (b) tells us that a HDC is
not subject to the defenses raised in subsection (a)(2), the so-called personal defenses.
Subsection (b) also states that a HDC holds free of “claims in recoupment” per §3-305(a)
(3), but what does that mean? Recoupment is the legal ability to subtract from any
payment due the amount the person is trying to collect the debt (or that person’s
predecessor) happens to own the debtor. For example, if I owe you $500 pursuant to our
contract, and, as a result of your breach of that same contract, you have caused me $200
worth of damages, my claim in recoupment permits me to subtract those damages and
only pay you $300. A claim in recoupment is so similar to a defense that the original
version of Article 3 seemed to lump it in with the other personal defenses, but the revised
version of Article 3 gives it its own special treatment (leading to the awkward references
throughout to a “defense or claim in recoupment”).
§3-305: Defense in Claims in Recoupment:
(a) Except as stated in subsection (b), the right to enforce the obligation of a party to pay
an instrument is subject to the following:
(1) a defense of the obligor based on (i) infancy of the obligor to the extent it is a
defense to a simple K; (ii) duress, lack of legal capacity, or illegality of the
transaction which, under other law, nullifies the obligation of the obligor; (iii)
fraud that induced the obligor to sign the instrument with neither knowledge nor
reasonable opportunity to learn of its character or its essential terms; or (iv)
discharge of the obligor in insolvency proceedings; (real defenses that will be
upheld against a holder in due course)
(2) a defense of the obligor stated in another section of this Article or a defense of
the obligor that would be available if the person entitled to enforce the instrument
were enforcing a right to payment under a simple contract.
(3) a claim in recoupment of the obligor against the original payee of the
instrument if the claim arose from the transaction that gave rise to the instrument;
but the claim of the obligor may e asserted against a transferee of the instrument
only to reduce the amount owing on the instrument at the time the action is
brought.
(b) The right of a HDC to enforce the obligation of a party to pay the instrument is
subject to defenses of the obligor stated in subsection (a)(1), but isn’t subject to defenses
of the obligor stated in subsection (a)(2) or claims in recoupment stated in subsection (a)
(3) against a person other than the holder.
•
Comment 3: addresses this idea about claims and recoupment (if the buyer has a
warranty claim ) If the HDC is the actual seller of the goods, the seller can’t
hide behind the HDC status to get away with selling bad goods. So, claim in
recoupment is valid against a HDC, even if the seller is a HDC. But if talking
about any other HDC then it is ok (that is going to be a defense) that is not valid
against any other HDC. (last three sentences are important)
Problem 113:
Stephen bought a sailboat from Jack, paying $500 down and signing a $1000 promissory note for the
balance due. Stephen loved everything about the boat except the color, and he promptly repainted it his
favorite color black. Prior to the sale Jack had told Stephen that the boat was constructed so that it wouldn’t
sink even in the roughest weather. This proved to be untrue when the sailboat went down in the first storm
that came along, and it cost Stephen $300 to have it dredged from the bottom and restored. In the
meantime, Jack had given the promissory note to his father as a birthday gift, and his father presented it to
Stephen for payment at maturity. May Stephen assert his damages against the father’s demand for
payment? Same result if the boat never sank, but Jack’s dog bit Stephen on the leg one week after the
delivery of the sailboat, and Stephen incurred $100 in medical bills as a consequence?
Yes, even though he has no value (and is not a HDC) the father has an argument to enforce it
under the shelter rule… He would take shelter under Jack as a HDC. Reason why father cannot
lock this defense in recoupment is b/c the seller who is HDC cannot shield himself from a claim in
recoupment. (2nd part)… this is setoff and Stephen cannot use setoff here. This is not a valid
claim to reduce the amount owed on the note.
Federal Deposit Insurance Corp. v. Culver
Farmer gets into financial arrangement with Culver.
•
What kind of fraud is a “real“ defense, and how do you prove it?
o
•
What does Comment 7 to 3-305 essentially provide?
o
•
The test of the defense here stated is that of excusable ignorance of the contents of the
writing signed. The party must not only have been in ignorance, but must also have had
no reasonable opportunity to obtain knowledge.
What are the three ways to resolve a situation where a person is tricked into signing a note?
Which one did the court adopt?
o
•
Fraud in the factum. 3-305(a)(1)(iii). To the extent that a holder is a HDC he takes the
instrument free from (2) all defenses of any party to the instrument with whom the holder
has not dealt except… (c) such misrepresentation as has induced the party to sign the
instrument with neither knowledge nor reasonable opportunity to obtain knowledge of its
character or its essential terms.
(1) He never intended to execute a bill or note, it cannot be considered his act, and he
should not be held liable thereon any more than if his name had been forged to such an
instrument. (2) It is always a question of fact for the jury whether under the
circumstances the party was guilty of negligence. (3) As a matter of law, one must be
adjudged guilty of such negligence as to render him liable who, possessed of all his
faculties and able to read, signs a bill or note, relying upon the assurance of the reading of
a stranger that it is a different instrument.
Did the defendant have a reasonable opportunity to know of the “character“ of the document?
The essential terms?
o
Yes. The court said that we must conclude that * has failed to show that “excusable
ignorance“ necessary to establish fraud in the factum. We conclude as a matter of law
that the * had a reasonable opportunity to obtain knowledge of the document“s
character before he signed it.
•
Does the defendant have legal recourse against anyone?
o
Problem 114:
When Ronald, newly rich, moved to NYC, he was impressed by the Brooklyn Bridge when he first saw it.
Simon, a con man, told Ronald that he was the owner of the bridge (a lie, of course), and offered to sell it to
him for $2,000,000 (described as a bargain). Ronald paid $20,000 cash as a down payment and signed a
promissory note, payable to Simon, for the rest. Simon negotiated the note to a finance company, which
claimed to be a HDC. When Ronald discovered that Simon lacked title to the bridge, he refused to pay the
note. Does he have a real defense of fraud here?
This is fraud but just not essential fraud, which is required to be good against a HDC. This is
personal defense, and this is not good against a HDC.
Problem 115:
A child prodigy, Thomas, had been playing the piano since he was 3 and making professional tours of the
world since he was 12. He looked much older than he 17 years. He signed a promissory note for $800
payable to the order of Mercy Music Company as payment for a piano, planning a tour with it. The
company was unaware of Thomas’ age. The payee endorsed the note over to Big National Bank for $725.
When the fist payment came due, Thomas refused to pay. He told the bank to come pick up the piano – he
was disaffirming the sale. Who wins?
The kid wins b/c he is an infant and under 3-305(a) this is a real defense which is valid against a HDC.
Problem 116:
Childe, 17, received a check for $1000 from his employer and decided to use it to buy a car from Byron
Auto, a used car dealership. He picked out the car he wanted, indorsed the check in blank, and handed it
over to the salesman. Byron Auto indorsed the check on the back and cashed it at its own bank the
Crusaders National Bank. Before this bank could present the check to the drawee bank, Childe decided to
buy a horse instead of a car, so he returned the car to the dealer and asked for the check back. Informed that
the bank had it, Childe called up the bank and informed it of his rescission of the K. When the bank refused
to return the check to Childe, he filed suit, asking the court to restrain the bank from presenting the check to
the drawee and to order replevin of the check. How should the court rule? It is clear that a HDC takes
subject to the defense of infancy, but does it take subject to a claim to the instrument based on infancy? See
§3-202, §3-305(a) and (b), and §3-306.
Under 3-306, if the bank is HDC, they take free of the claim to the instrument and the child won’t
get the check book. But if the bank isn’t a HDC the bank doesn’t take free of the claim to the
instrument and the childe can get the check book.
Sea Air Support, Inc. v. Herrmann
•
What did the Nevada Statute hold regarding notes drawn for the purpose of gaming?
o
•
The statute provides that all notes drawn for purpose of reimbursing or repaying any
money knowingly lent or advanced for gaming are “utterly void, frustrate, and none
effect.“
Was Sea Air an HDC? Why or why not?
o
Sea Air had at least constructive notice of a defense against collection b/c the check was
payable to a casino, and Sea Air knew the check had been dishonored. Consequently,
Sea Air is not a HDC.
•
If Sea Air had been an HDC, would it have been able to enforce the check then? Now?
o
This would have been a real defense b/c these types of promises are illegal and illegality
that makes something void that makes something a real defense which is valid against a
HDC.
Kedzie & 103rd Currency Exchange, Inc. v. Hodge
•
What is the distinction between void and voidable, and why does it matter under article 3?
o
•
What is the difference between illegality of the transaction and illegality of the instrument? Why
does it matter?
o
•
Vodiable means you can proceed if you want to, but if a transaction is utterly null and
void then you could not precede. Utterly void is a real defense and something that is
vodiable is a personal defense.
Illegality of the transaction is
and illegality of the instrument is
Why did the dissent disagree with the majority?
o
The dissent said that something was missing from section 3-305. 3-305 doesn“t make a
distinction b/w the instrument being void and the transaction being void which the
majority used.
Problem 117:
When she heard her creditors fighting over priorities on her doorstep, Elsie knew that she had no choice but
bankruptcy. Among the debts that she reported to the bankruptcy court was the loan she had taken from
Point National Bank, which was evidenced by a promissory note she had signed. In due course the
bankruptcy proceeding culminated in the judge’s ordering that Elsie be discharged from all her scheduled
debts. Two years later, the promissory note surfaced in the possession of Shadbolt State Bank, which
claimed quite convincingly to be a HDC. Must Elsie pay? See §3-305(a)(1) and (b).
No, under 3-305(a)(1)(4) which says discharge of the obligor in insolvency proceedings. This is a
real defense that would be good against a HDC. Discharging bankruptcy is always a real
defense.
Discharge as a Real Defense:
§3-302(b) says that notice of discharge of a party, other than discharge in an insolvency
proceeding, isn’t notice of a defense under subsection (a), but discharge is effective
against a person who becomes a HDC with notice of the discharge . . . . What dose this
mean? First of all, as the above problem illustrates, discharge in a bankruptcy is always a
real defense, regardless of what the subsequent holder knows or doesn’t know at the time
of acquisition of the instrument. Any other discharge that the Code or common law
creates isn’t effective against a HDC unless that holder, at the time of acquisition, knew
of the discharge, in which case the discharge is, in effect, a real defense and assertable
against the HDC. For example, suppose that there are 4 sureties who have signed their
names as indorsers on a promissory note. The current holder of the note decides to excuse
one of them from future liability, and so draws a line through that surety’s name, thus
discharging that person from all liability. Even a later HDC of the note, seeing the line
drawn through the former surety’s name, would know that that surety is no longer liable
on the note, and therefore could only enforce it against the other obligors.
Problem 118:
Malvolio, a traveling salesman, bought a new car from Valentine Auto, signing a note for $18,000. The
payee discounted the note for $16,000 to the Orsino Finance Company, which notified Malvolio that he
should make all future payments to them. Malvolio immediately sent them a check for the outstanding
balance (he had come into some money when his aunt died). He asked for the note back, but Orsino was
evasive. A week later Malvolio received a note from the Olivia Finance Company saying that his note had
been assigned to them and that he should direct his payments to their office. When Malvolio protested, they
made HDC noises and became quite nasty. Malvolio, worried, comes to you for advice. What should he
do? See §3-501(b)(2); read §3-601 and 3-602. Does Malvolio have remedies outside the Code? Think back
to Contracts.
Personal defense her (discharge by payment). Should have gotten the actual note back b/c if it
gets in the hands of a HDC then the fact that you already paid it is not a real defense against a
HDC and you may have to pay on it again.
A Special Note on Forgery:
An important issue is whether forgery is a real defense under the Code, so that it can be
raised against a HDC, or a personal defense, so that it cannot. The answer to this
question lies in §3-401(a): “A person isn’t liable on an instrument unless (i) the person
signed the instrument . . .” and §3-403(a): “Unless otherwise provided in this Article or
Article 4, an unauthorized signature is ineffective except as the signature of the
unauthorized signer in favor of a person who in good faith pays the instrument or takes it
for value . . . .
Problem 119:
Slick, an expert con man, went into John’s and told John, the owner, that he was Money, the richest man in
town. John was too awed to ask for identification. Slick then picked out several very expensive pieces of
jewelry and signed Money’s name to a promissory note to pay for them. Slick skipped town with the
jewelry. When the note matured, the Tenth National Bank (a HDC to whom John has negotiated the paper)
presented it to Money for payment. May Money refuse to pay a HDC?
Yes. This is not an effective authorized signature under 3-403. Under 3-305(a) there is no party
to pay the instrument b/c this was an unauthorized signature. He never signed the document
himself. So this an effective defense b/c the party never signed the document.
If the forgery is of a name necessary to a valid negotiation, there can be no HDC
following the forgery because no later transferee will qualify as a holder.
Defenses Against a Non-Holder in Due Course:
All claims and both real and personal defenses may be asserted against anyone who
doesn’t qualify as a HDC. The only claim a non-HDC takes free of is a perfected security
interest in non-negotiable instruments, and then only if they are purchased for value in
the ordinary course of business without notice of the security interest. The most common
of personal defenses are want of consideration (no consideration) and failure of
consideration (breach of contract, called a claim in recoupment in the Revision).
§3-306: Claims to an Instrument:
A person taking an instrument, other than a person having rights of a HDC, is subject to a
claim of a property or possessory right in the instrument or its proceeds, including a claim
to rescind a negotiation and to recover the instrument or its proceeds. A person having
rights of a HDC takes free of the claim to the instrument.
Herzog Contracting Corp. v. McGowen Corp.
Herzog bought the assets of a corporation (Tru-Flex) from McGowen and formed a
wholly owned subsidiary of Herzog, (also Tru-Flex), to hold them. Herzog then assigned
the asset purchase agreement to Tru-Flex, which called for 5 annual payments of
$500,000 to be made by Tru-Flex to McGowen. McGowen later issued 2 promissory
notes to Tru-Flex. Herzog claims it loaned McGowen $400,000 and the notes were
McGowen’s promise to repay. McGowen claims that the $400,000 was an advance
payment from Herzog on the asset purchase agreement and it only issued the notes to
avoid paying taxes on the pre-payment. Tru-Flex assigned the promissory notes to
Herzog. Herzog in not a HDC. Herzog sued to recover payment from McGowen. Are
the notes enforceable because they are “clear and unambiguous“ despite the parties
actual intentions?
•
What defenses can be brought against a non-holder?
o
•
How does the Parol Evidence Rule interplay here?
o
•
A holder of a promissory note who is not a HDC takes the note subject to “all defenses
of any party which would be available in an action on a simple contract.“ §3-305(b).
Doesn’t matter is personal defense, real defense, claim and recoupment subject to all
defenses.
The Parol Evidence Rule applies here because McGowen is trying to prove that the
parties didn’t intend to create an enforceable contract, regardless of how unambiguous
the notes are. Both parties agree that whether parol evidence is admissible is governed by
the “special purpose doctrine,” that the delivery of the negotiable instrument was for a
special purpose. (§3-306(c)). Herzog argues that the special purpose doctrine is limited
to conditions precedent, which is not the case here. McGowen argues that a sham case is
within the special purpose doctrine and the court agrees, so the parol evidence is
admissible.
How would this case come out under the current version of the UCC, focusing on 3-105(b), 3305(a)(2), and 3-117 (the first clause of the first sentence)?
o
§3-117 says that the obligation of a party can be modified, but subject to applicable law.
McGowen’s sham-transaction defense would probably be excluded under the parol
evidence rule (§2-202) because it completely contradicts the K.
o
If this defense were raised under the current code, then 3-105(b) tells us this would be
considered a personal defense, which is not good against a holder in due course. 3-305(a)
(2) says that it is an invalid defense if it is a personal defense against a HDC. Then 3-117
says that subject to the parol evidence rule, he would not be able to present this evidence
that it was supposed to be a special purpose. Nothing else would be allowed in.
The Nature of Liability
Once a negotiable instrument is created and enters commerce the parties thereto are
automatically locked into relationships that may lead to legal liability. When a problem
arises in connection with one of these instruments, the knowledgeable attorney (and the
wise student) asks four preliminary questions:
(1) What negotiable instrument labels (drawer, payee, drawee, maker, indorser,
guarantor, accommodation party, acceptor, ect.) do the parties bear?
(2) What causes of action (contractual obligation: 3-412, 3-415, 4-101; Property
(warranty) 3-416. 3-417, 4-207, 4-208; Tort actions (conversion) 3-420; suits “off
the instrument”) are available to each party?
(3) What defenses are possible?
(4) Can liability be passed to someone else?
The Underlying Obligation
The most common lawsuit connected with negotiable instruments, but not created by
Articles 3 and 4, is a suit on the underlying obligation that generated the instrument. If a
corporation mails a dividend check to one of its stockholders and the check is lost in the
mail, the stockholder can sue on the underlying obligation (in the case, the agreement to
pay the dividend) and ignore whatever rights negotiable instruments law would give.
This means that in addition to the negotiable instruments suits described below, a party
may not always bring suit on the underlying obligation. Courts won’t let you double dip;
they will not let you go for both.
Problem 122:
Aunt Fran was unable to pay the annual rent on her hat shop, so she asked the LL, Simon, to accept instead
a promissory note from her to him for the amount of the rent, the note to be due in 3 months in the future.
Simon took the note and immediately discounted it with a local bank. A week later (an before the note
matured), Simon brought suit against Aunt Fran for non-payment of the rent (the underlying obligation
being the lease agreement). Can she defend by saying that the note somehow suspended his right to sue on
the underlying obligation?
Yes. The common law doctrine of merger stated that once an instrument was offered and accepted
in satisfaction of an underlying obligation, the obligation merged with the instrument, and until
the instrument was dishonored the underlying obligation was suspended (unavailable as a cause
of action).
§3-310: Effect of Instrument on Obligation for Which Taken:
(b) Unless otherwise agreed and except as provided in subsection (a), if a note or an
uncertified check is taken for an obligation, the obligation is suspended to the same
extent the obligation would be discharged if an amount of money equal to the amount of
the instrument were taken, and the following rules apply:
(1) In the case of an uncertified check, suspension of the obligation continues
until dishonor of the check or until it is paid or certified. Payment or certification
of the check results in discharge of the obligation to the extent of the amount of
the check.
(2) In the case of a note, suspension of the obligation continues until dishonor of
the note or until it is paid. Payment of the note results in discharge of the
obligations to the extent of the payment.
(3) Except as provided in paragraph (4), if the check or note is dishonored and the
obligee of the obligation for which the instrument was taken is the person entitled
to enforce the instrument, the obligee may enforce either the instrument or the
obligation. In the case of an instrument of a third person which is negotiated to the
obligee by the obligor, discharge of the obligor on the instrument also discharges
the obligation.
Note that under §3-310(b)(1) and (2) the payment of a check or a note discharges the
underlying obligation, but until then that obligation is suspended. Once the instrument is
dishonored, subsection (b)(3) divorced the underlying contract from the instrument and
separate causes of action then exist for both.
Problem 123:
Suppose in the last Problem Aunt Fran had paid her rent by giving a cashier’s check to Simon. The check
was drawn by ONB on itself (the very definition of a cashier’s check – see §3-104(g)). Simon took the
check down to ONB and was dismayed to discover that the bank had failed and was now closed. He
returned to Aunt Fran and demanded the rent money. What should she tell him? See §3-310(a).
Her obligation is gone so she should tell him to take a hike.
Problem 124:
When Aunt Fran told Simon that she was not liable for the rent as long as the note was outstanding, he got
it back from the bank and tore it up. May he now sue her for the rent even though the note has not yet
matured? See §3-604, 3-310(b)(4), 3-309. If the cancellation had been a clerical error, what result?
She is going to argue that she made a mistake. Some courts would allow him to say that this
wasn’t an intentional act.
Ward v. Federal Kemper Insurance Co.
•
Describe the legal relationship between the drawer and drawee of a check, and who “owns “ the
money.
o
•
As between drawer and drawee, the relationship is one of creditor and debtor. The
drawer does not own the funds it has on deposit with the drawee. Its balance on the
drawee“s books represents a debt owed the drawer by the drawee. The funds are owned
by the drawee.
What does conditional payment mean?
•
o
Check must first be presented and then honored or if dishonored then you get the ability
to sue.
o
When the drawer draws a check on the drawee and delivers the check to the payee, the
check ordinarily is regarded as only a conditional payment of the underlying obligation.
The conditions are that the check be presented and honored. Until those conditions are
met, no one is directly liable on the check itself. The underlying obligation represented
by the check is similarly suspended until those conditions are met; 3-802(1)(b). If they
are not met, an action may be maintained either on the check or the obligation.
What does the court mean by “the drawer is secondarily liable“?
o
•
The point is that the drawer is only secondarily liable on the check when he issues it.
Must first meet conditions (presentiment and honor) then if it is dishonored then you can
go after the other person (they would be secondarily liable).
Did the defendant have the right to lawfully cancel the insurance policy? Why or why not?
o
No, Kempar hadn“t presented it and either had it honored or dishonored so it was in a
state of suspension. He hadn’t gotten any value from that. In other words, there is no
problem here. The money wasn’t actually his yet b/c no presentment took place yet.
Kempar’s insurance policy is still in effect b/c he never took that check and presented it
to the bank and got money from it.
Liability on the Instrument
As soon as someone places a signature on a negotiable instrument, an implied
contractual obligation is automatically made promising to pay the instrument when it
matures (unless in the meantime a defense, real or personal, develops). The original
version of Article 3 actually called these obligations “contracts,” but the name was
misleading because the legal responsibility imposed thereby didn’t depend on the
intention of the relevant party. The so-called contract was imposed as a matter of law
whether or not the contracting party understood the fact or extent of liability.
In the Revision these promises are called obligations and not contracts, but the basic
ides is the same. Putting one’s signature on a negotiable instrument in anything other than
an innocuous capacity (“witness” for example) leads to a promise implied in law (actual
intent being irrelevant) to pay the instrument under certain circumstances. This obligation
is sometimes described as liability on the instrument – that is, as a result of signing the
instrument, and the person who could enforce that liability was the current holder of the
instrument.
The basic rule found in §3-401(a) states “[a] person isn’t liable on an instrument unless
(i) the person signed the instrument . . . .” This means that no contractual liability arises
on a negotiable instrument until and unless a signature is placed thereon. Signature is
defined in §1-201(39) and 3-401(b).
§1-201(39): Definition of “Signed”:
“Signed” includes any symbol executed or adopted by a party with present intention to
authenticate a writing.
§3-401: Signature:
(b) A signature may be made (i) manually or by means of a device or machine, and (ii) by
the use of any name, including a trade or assumed name, or by a word, mark, or symbol
executed or adopted by a person with present intention to authenticate a writing.
The Maker’s Obligation:
The maker of a promissory note is absolutely liable on the instrument; a maker’s liability
has no technical implied conditions to it. The same thing is true of a bank that issues a
cashier’s check. This “primary” liability is codified in §3-412 (where both the maker of a
promissory note and the bank issuing a cashier’s check are lumped together as issuers.) If
there is more than one maker, those who sign are presumed to be jointly and severally
liable to the rest of the world (meaning that they can be sued individually or as a group),
but they have a right to contribution from their co-makers if they are forced to pay more
than their share. (If 3 people sign instrument as co-makers, I can go after any of the three
for the entire amount. Then that one can sue the others for contribution. I can also bring
all three of them in.)
§3-412: Obligation of Issuer of Note or Cashier’s Check:
The issuer of a note or cashier’s check or other draft drawn on the drawer is obliged to
pay the instrument (i) according to its terms at the time it was issued or, if not issued, at
the time it first came into possession of a holder or (ii) if the issuer signed an incomplete
instrument, according to its terms when completed, to the extent stated in §3-115 and §3407. The obligation is owed to a person entitled to enforce the instrument or to an
indorser who paid the instrument under §3-415.
Problem 125:
Winkin, Blinkin, and Nod signed the following promissory note:
Oct. 1, 2010
$3000
On or after 6 months from date, we promise to pay to the order of
Grimms National Bank, the sum of three thousand dollars ($3000). We, along
with all sureties and subsequent endorsers, waive all rights to presentment,
notice of dishonor, and protest, and all parties hereto agree to any extension
of time granted by the holder to the makers.
Wilbur Winkin
Barney Blinkin
Harry Nod
Grimms National Bank indorsed the note in blank and discounted it to Anderson Finance Co. When the
note matured, Anderson sued only Winkin, demanding the entire amount. May he defend on the basis that
Anderson should have sued all three of them, since the note contains the words “we promise to pay”? If
Anderson wins, can Winkin sue Blinkin for $2000? $1000? See §3-116.
No, it is perfectly ok to sue one of the three makers. They are jointly and severally liable. Anderson can
sue (according to the agreement that they were equally liable) Winkin for$ 1000. If one is insolvent and
you paid the entire $3000 then you can go after the other one (split amongst 2) for $1500.
The Drawer’s Obligation:
One of the happiest things about the revised version of Article 3 is its de-emphasis of the
technical rules of presentment, notice of dishonor, and protest, all described below. Under
the original version of Article 3 these were complicated matters, but they are now of
much less importance. We will consider them in connection with both the obligation
incurred by the drawer of a draft and that undertaken by an indorser.
The drawer of a draft incurs the obligation specified in §3-414. It is sometimes said that
the drawer’s liability is secondary because the draft must first be presented to the drawee
for payment and dishonored by the drawee before the drawer has a legal obligation to pay
the instrument (unlike the liability of a maker of a note, which is primary since it is not
subject to these conditions precedent). Why should the drawer’s liability be different
from that of a maker? The answer is that, with a draft, it is the understanding of all the
parties that the payee will first attempt to secure payment from the drawee (a
presentment) and only look to the drawer if the drawee refuses to pay (makes a
dishonor). Consider, for example, that if I owe you money and give you a check for the
amount due, common sense tells you that you must first try to collect the check from my
bank. Only if my bank refuses to pay the check can you expect me to make the check
good. Similarly, with a sales draft drawn by the seller on the buyer, the seller is not liable
until the draft is dishonored by the buyer/drawee.
§3-414: Obligation of Drawer:
(a) This section doesn’t apply to cashier’s checks or other drafts drawn on the drawer.
(b) If an unaccepted draft is dishonored, the drawer is obliged to pay the draft (i)
according to its terms at the time it was issued or, (ii) if the drawer signed an incomplete
instrument, according to its terms when completed, to the extent stated in §3-115 and §3407. The obligation is owed to a person entitled to enforce the draft or to an indorser who
paid the draft under §3-415.
(c) If a draft is accepted by a bank, the drawer is discharged, regardless of when or by
whom acceptance was obtained.
(d) If a draft is accepted and the acceptor isn’t a bank, the obligation of the drawer to
pay the draft if the draft is dishonored by the acceptor is the same as the obligation of an
indorser under §3-415(a) and (c).
(e) If a draft states that it is drawn “without recourse” or otherwise disclaims liability of
the drawer to pay the draft, the drawer isn’t liable under subsection (b) to pay the draft
isn’t a check. A disclaimer of the liability stated in subsection (b) isn’t effective if the
draft is a check.
(f) If (i) a check isn’t presented for payment or given to a depository bank for collection
within 30 days after its date, (ii) the drawee suspends payments after expiration of the 30
day period without paying the check, and (iii) because of the suspension of payments, the
drawer is deprived of funds maintained with the drawee to cover payment of the check,
the drawer to the extent deprived of funds may discharge its obligation to pay the check
by assigning to the person entitled to enforce the check the rights of the drawer against
the drawee with respect to the funds.
1. Presentment and Dishonor:
Presentment is the demand for payment made to the maker of the note or, for drafts, to
the drawee. Read §3-501, which defines and describes presentment. Under the NIL the
holder was required to exhibit the instrument at the moment of presentment (NIL 74), but
the Code is more flexible – exhibition is required only if the presentee demands it. Read
§3-501(b)(2), which sets out other rights of the presentee. Dishonor is the refusal of the
presentee to pay. Read §3-502.
§3-501: Presentment:
a. "Presentment" means a demand made by or on behalf of a person entitled to
enforce an instrument (i) to pay the instrument made to the drawee or a party
obliged to pay the instrument or, in the case of a note or accepted draft payable at
a bank, to the bank, or (ii) to accept a draft made to the drawee.
b. The following rules are subject to Article 4, agreement of the parties, and
clearing-house rules and the like:
1. Presentment may be made at the place of payment of the instrument and
must be made at the place of payment if the instrument is payable at a
bank in the United States; may be made by any commercially reasonable
means, including an oral, written, or electronic communication; is
effective when the demand for payment or acceptance is received by the
person to whom presentment is made; and is effective if made to any one
of two or more makers, acceptors, drawees, or other payors.
2. Upon demand of the person to whom presentment is made, the person
making presentment must (i) exhibit the instrument, (ii) give reasonable
identification and, if presentment is made on behalf of another person,
reasonable evidence of authority to do so, and (iii) sign a receipt on the
instrument for any payment made or surrender the instrument if full
payment is made.
3. Without dishonoring the instrument, the party to whom presentment is
made may (i) return the instrument for lack of a necessary indorsement, or
(ii) refuse payment or acceptance for failure of the presentment to comply
with the terms of the instrument, an agreement of the parties, or other
applicable law or rule.
4. The party to whom presentment is made may treat presentment as
occurring on the next business day after the day of presentment if the party
to whom presentment is made has established a cut-off hour not earlier
than 2 p.m. for the receipt and processing of instruments presented for
payment or acceptance and presentment is made after the cut-off hour.
§3-502: Dishonor:
a. Dishonor of a note is governed by the following rules:
1. If the note is payable on demand, the note is dishonored if presentment is
duly made to the maker and the note is not paid on the day of presentment.
2. If the note is not payable on demand and is payable at or through a bank or
the terms of the note require presentment, the note is dishonored if
presentment is duly made and the note is not paid on the day it becomes
payable or the day of presentment, whichever is later.
3. If the note is not payable on demand and paragraph (2) does not apply, the
note is dishonored if it is not paid on the day it becomes payable.
b. Dishonor of an unaccepted draft other than a documentary draft is governed by
the following rules:
1. If a check is duly presented for payment to the payor bank
otherwise than for immediate payment over the counter, the check
is dishonored if the payor bank makes timely return of the check or
sends timely notice of dishonor or nonpayment under Section 4301 or 4-302, or becomes accountable for the amount of the check
under Section 4-302.
2. If a draft is payable on demand and paragraph (1) does not apply,
the draft is dishonored if presentment for payment is duly made to
the drawee and the draft is not paid on the day of presentment.
3. If a draft is payable on a date stated in the draft, the draft is
dishonored if (i) presentment for payment is duly made to the
drawee and payment is not made on the day the draft becomes
payable or the day of presentment, whichever is later, or (ii)
presentment for acceptance is duly made before the day the draft
becomes payable and the draft is not accepted on the day of
presentment.
4. If a draft is payable on elapse of a period of time after sight or
acceptance, the draft is dishonored if presentment for acceptance is
duly made and the draft is not accepted on the day of presentment.
c. Dishonor of an unaccepted documentary draft occurs according to the rules stated
in subsection (b)(2), (3), and (4), except that payment or acceptance may be
delayed without dishonor until no later than the close of the third business day of
the drawee following the day on which payment or acceptance is required by
those paragraphs.
d. Dishonor of an accepted draft is governed by the following rules:
1. If the draft is payable on demand, the draft is dishonored if presentment
for payment is duly made to the acceptor and the draft is not paid on the
day of presentment.
2. If the draft is not payable on demand, the draft is dishonored if
presentment for payment is duly made to the acceptor and payment is not
made on the day it becomes payable or the day of presentment, whichever
is later.
e. In any case in which presentment is otherwise required for dishonor under this
section and presentment is excused under Section 3-504, dishonor occurs without
presentment if the instrument is not duly accepted or paid.
f. If a draft is dishonored because timely acceptance of the draft was not made and
the
person entitled to demand acceptance consents to a late acceptance, from the time
of acceptance the draft is treated as never having been dishonored.
Problem 139:
Grosvenor finally paid off an old debt to Bunthorne by giving him a check drawn on the Patience National
Bank. Bunthorne took the check to the bank and demanded payment. The bank asked him to sign his name
on the back, but Bunthorne refused, saying “I will never put my name on any check Grosvenor has
touched.” If the bank declines to pay the check, has a technical dishonor occurred? See §3-501(b)(3)(i), 3501(b)(2)(iii). This may be important because Grosvenor’s §3-414 obligation is conditional on a dishonor,
and he can no longer be sued on the underlying obligation that is suspended until dishonor by §3-310.
When the check is presented the bank can return the check for failure to sign under §3-501, which
is not a technical dishonor.
Problem 140:
When Grosvenor gave Bunthorne a check to pay off an old debt, Bunthorne negligently lost it behind the
sofa and didn’t find it for 8 months. The bank it was drawn on refused to pay it because it was suspiciously
old (§4-404). Is Grosvenor still liable on this check? See §3-414(f). Would he be if the drawee bank had
folded 5 months after the check was written but before it was presented? If Bunthorne had indorsed the
check the day after it was issued to him and then cashed it at the corner drugstore and the drugstore mislaid
it for 5 months before the drawee bank dishonored it, is Bunthorne still liable to the drugstore? See §3415(e).
Probably yes, but loophole if the drawee bank causes the problem itself. (e) says you are entitled to 2
things as the drawee before you have to pay: presentment and dishonor.
Messing v. Bank of America, N.A.
•
What does a reasonable identification mean?
o
This means no clear definition but signature is a reasonable identification. Reference the
definition of signature.
•
What are the 4 reasons the court gave for why the thumbprint identification was reasonable?
o
•
(1) Thumbprint accepted by drafter of Maryland (2) Not inconvenient b/c ink is invisible
(3) Protects against check fraud and (4) The American bankers association enforces it.
Did the bank dishonor the check, and why does that matter?
o
No.
2. Notice of Dishonor:
Indorsers are also entitled to notice of the dishonor after it occurs (but drawers are
entitled to notice of dishonor only if a non-bank acceptor refuses payment of the draft;
§3-414(d)). Notice of dishonor is defined in §3-503. Note that §3-503(c) requires notice
of dishonor to be given very quickly to be effective.
§3-503: Notice of Dishonor:
The obligation of an indorser stated in Section 3-415(a) and the obligation of a
drawer stated in Section 3-414(d) may not be enforced unless (i) the indorser or
drawer is given notice of dishonor of the instrument complying with this section
or (ii) notice of dishonor is excused under Section 3-504(b).
Notice of dishonor may be given by any person; may be given by any
commercially reasonable means, including an oral, written, or electronic
communication; and is sufficient if it reasonably identifies the instrument and
indicates that the instrument has been dishonored or has not been paid or
accepted. Return of an instrument given to a bank for collection is sufficient
notice of dishonor.
Subject to Section 3-504(c), with respect to an instrument taken for collection by
a collecting bank, notice of dishonor must be given (i) by the bank before
midnight of the next banking day following the banking day on which the bank
receives notice of dishonor of the instrument, or (ii) by any other person within 30
days following the day on which the person receives notice of dishonor. With
respect to any other instrument, notice of dishonor must be given within 30 days
following the day on which dishonor occurs.
3. Protest:
Protest is a technical ritual in which an official, normally a notary public, makes a formal
presentment of a draft to the drawee and, upon dishonor, draws up, signs, and seals an
official statement (called a protest) of what happened. The protest may also mention to
whom notice of dishonor is given. This ritual is no longer required, but is nonetheless
sometimes done because it simplifies proof of these matters.
§3-505: Evidence of Dishonor:
a. The following are admissible as evidence and create a presumption of dishonor
and of any notice of dishonor stated:
a document regular in form as provided in subsection (b) which purports
to be a protest;
a purported stamp or writing of the drawee, payor bank, or presenting
bank on or accompanying the instrument stating that acceptance or
payment has been refused unless reasons for the refusal are stated and the
reasons are not consistent with dishonor;
a book or record of the drawee, payor bank, or collecting bank, kept in the
usual course of business which shows dishonor, even if there is no
evidence of who made the entry.
b. A protest is a certificate of dishonor made by a United States consul or vice
consul, or a notary public or other person authorized to administer oaths by the
law of the place where dishonor occurs. It may be made upon information
satisfactory to that person. The protest must identify the instrument and certify
either that presentment has been made or, if not made, the reason why it was not
made, and that the instrument has been dishonored by nonacceptance or
nonpayment. The protest may also certify that notice of dishonor has been given
to some or all parties.
4. Excuse:
Under some circumstances – spelled out in detail in §3-504 – these technical
requirements (presentment, dishonor, notice of dishonor) can become either temporarily
or completely unnecessary. For the lawyer whose client has failed to take these technical
steps, §3-504 can be a bonanza – the treasure chest from which is pulled the excuse that
saves the case.
These technical rights must in some situations give way to the exigencies of life. In an
early case, Polk v. Spinds, the advent of the Civil War made it “difficult” for the Northern
holder of a promissory note signed by a Tennessee maker to make a presentment to the
maker until the war ended. The Supreme Court of Tennessee held the presentment and
delayed notice of dishonor excused, stating a test that is often quoted: “Obstacles of the
kind which will excuse, need not be of the degree or extent which make travel,
intercourse, presentment, impossible. It is enough if they be of the degree and character
which deter men of ordinary prudence, energy and courage, from encountering them in
prosecution of business, in respect of which they owe an active and earnest duty, and feel
an active and earnest interest.” §3-504(c) talks about when delay in taking one of these
steps is excused (but the step must still be taken), and §3-504(a) and (b) address
themselves to situations in which the step becomes completely unnecessary.
Problem 141:
A promissory note contains a clause stating, “All parties to this note hereby waive all rights to presentment,
notice of dishonor, and protest . . . .” Is a clause like this buried in the fine print on the front side of a note
sufficient to deprive indorsers of their right to notice of dishonor? See §3-504(a)(iv) and (b)(ii).
Yes, that is effective. §3-504 doesn’t say anything about where the waiver must be located. The
waiver would be effective, but negotiability is not destroyed.
Problem 142:
Fortune was walking along the street, his pockets stuffed with money and checks he had won with a
dazzling display of his prowess in the game of stud poker, when he was stopped by a creditor, one Mr.
Holdit. Holdit demanded payment of a long-due $50 obligation, and Fortune was glad to indorse over to
him a check for that amount that Fortune had won from Deuces; Fortune was named as payee on the check.
After giving the check to Holdit, Fortune thought better of the whole transaction so he contacted Deuces,
the drawer, the next day and persuaded him to stop payment on the check. Holdit held onto the check for 6
weeks and then took it to his bank, the Creditors National, and cashed it. Creditors National presented the
check to the drawee bank, which dishonored it whereupon Creditors National reclaimed its money from
Mr. Holdit. Holdit, now very mad, sued Fortune on his indorser’s obligation. Was Fortune discharged by
the delay in presentment? See §3-415(e). Was the presentment delay excused within the meaning of §3504(a)(iv)?
Normally answer if yes, but under these facts the answer is no b/c of his urging to stop payment he
doesn’t have a right to expect that the instrument would be paid in the first place, so this would be
considered a waiver. §3-504(a)(iv). This is an example of excuse.
Makel Textiles, Inc. v. Dolly Originals, Inc.
•
What was Dolly“s defense in not having to pay the promissory notes?
o
•
Why did Makel not have to give Goldberg notice of dishonor and non-payment?
o
•
Dolly claims that there was no presentment and notice of dishonor. They also argued that
these 5 checks were after the two notes and they were supposed to pay off the notes.
Court said no to this argument, b/c the checks only suspended the obligation.
There is no reason to present the note to the president that we already know will be
dishonored b/c the very fact that he wrote the subsequent checks. Him writing the checks
excused Makel from giving him notice of dishonor, this would be futile.
Why were the outcomes different for Kushner and Goldberg?
o
For Kushner, there is no evidence of activity or participation in the affairs of the
corporation so as to excuse presentment or notice of dishonor. Goldberg was involved in
the corporate affairs and he knew that the corporation would not be able to pay their
obligation so the result is different for him. Kushner is not liable but Goldberg would be
liable.
The Indorser’s Obligation:
Once the payee signs the back of the instrument, the payee automatically incurs the
obligation the law imposes on an indorser. In fact, per §3-204(a), anyone who signs an
instrument in an ambiguous capacity is conclusively presumed to assume this liability.
This obligation is described in §3-415, which you should read carefully. Note that unlike
the obligation of a maker, the indorser’s obligation is secondary in that there are certain
technical conditions that must be met before the indorser can be sued on the §3-415
obligation: the instrument must have first been presented to the maker (if it is a note) or
to the drawee (if it is a draft), there must have been a dishonor (by the maker or drawee),
and in certain circumstances §3-503 requires that the indorser be given notice of
dishonor.
These three rights (presentment, dishonor, and notice of dishonor) are discussed ad
nauseam in the §3-500 section of the Code. It is unfortunate, but unavoidable, that we
must explore these sections at some time, but let’s postpone that until after we’ve
established the drawer’s liability on the draft. For now it is sufficient if you remember
that an indorser isn’t liable until the person primarily liable has dishonored the instrument
and the indorser has been so notified.
§3-415: Obligor of Indorser:
a. Subject to subsections (b), (c), and (d) and to Section 3-419(d), if an instrument is
dishonored, an indorser is obliged to pay the amount due on the instrument (i)
according to the terms of the instrument at the time it was indorsed, or (ii) if the
indorser indorsed an incomplete instrument, according to its terms when
completed, to the extent stated in Sections 3-115 and 3-407. The obligation of the
indorser is owed to a person entitled to enforce the instrument or to a subsequent
indorser who paid the instrument under this section.
b. If an indorsement states that it is made "without recourse" or otherwise disclaims
liability of the indorser, the indorser is not liable under subsection (a) to pay the
instrument.
c. If notice of dishonor of an instrument is required by Section 3-503 and notice of
dishonor complying with that section is not given to an indorser, the liability of
the indorser under subsection (a) is discharged.
d. If a draft is accepted by a bank after an indorsement is made, the liability of the
indorser under subsection (a) is discharged.
e. If an indorser of a check is liable under subsection (a) and the check is not
presented for payment, or given to a depositary bank for collection, within 30
days after the day the indorsement was made, the liability of the indorser under
subsection (a) is discharged.
o
Comment 5:
Problem 126:
Billy wrote out a check payable to the order of Snow to pay for some carnival equipment. Snow cashed the
check at Drug Store, indorsing his name on the back. Drug Store then indorsed the check and deposited it in
its account at Jordan State Bank. This bank also indorsed the check and then presented it to the drawee
bank, Rodgers National Bank, which dishonored it because Billy had no money in his account, marking it
NSF. The check was returned to Jordan State Bank. You are the bank’s attorney, and it calls you with three
questions:
1.
Drug Store has suddenly gone out of business and there is no money in its account. Can Jordan
State Bank sue Snow and, if so, on what theory? Read §3-415(a).
Yes, under the indorser obligation.
2.
If Jordan State Bank sues Snow, may he raise his defenses (say, that the Drug Store had failed to
pay him any money when he indorsed it over to them), or is the indorser liability found in §3-415
strict liability?
Not Strict Liability, he may raise such a defense, however, it is a personal defense, so if it is
against a HDC will not be effective.
3.
If the bank does recover from Snow, will he have to pay the whole amount or do the indorsers
divide up the indorsement liability and share it proportionately? See §3-116, 3-205(d).
Will be entitled to the full amount from him. 3-116 allows for Joint and several liability which
allows for contribution but only where indorser signs the agreement with the other indorsers. He
may or may not get contribution depending on how he signed the agreement.
Problem 127:
Charlie Brown wanted to borrow $10,000 from the Peanuts National Bank, but the bank told him that it
wouldn’t loan him the money unless his note was indorsed by four responsible people. Charlie explained
his problem to his friend Lucy, and she signed her name to the back of the instrument. Charlie then took the
note to another friend, Schroeder, who not only signed, but also persuaded his friend Pig Pen to add his
name below Schroeder’s. Finally, Charlie had Peppermint Patty sign her name, at which point he took the
note back to the bank, and it loaned him the money. When the note came due, the bank made a presentment
of it to Charlie and demanded payment. He had used the money in a business venture that, predictably
enough, was a moral but not a financial success, and so he was unable to pay the note (a dishonor). The
Peanuts National Bank gave notice of dishonor to all four indorsers, but demanded payment of Peppermint
Patty alone. She resisted, claiming she was liable at most for only ¼ of the amount ($2,500). See §3-415.
a.
Is she right?
§3-415 tells us that she is not right b/c she is contracted to pay that full amount. As an
indorser she made her self liable to the full amount.
b.
If she pays $10,000, can she sue Pig Pen for the entire amount or only for part? See §3-116, 3205(d).
§3-116 tells us that she is only able to sue for the proportionate amount. This will be
governed by the way in which they signed the agreement.
c.
If she is sued, can she bring the other indorsers into the lawsuit? See §3-119 (explaining the so
called “vouching in” notice.)
§3-119 tells us yes, she can bring the others into the lawsuit.
d.
If Charlie Brown comes back into the chips, can she sue him? On what theory?
Yes, she can sue under the issuer’s liability which is part of the maker’s liability under
§3-412 and an accommodation party under §3-419(e).
Co-Suretyship v. Sub-Suretyship:
The common law presumed, unless the sureties agreed otherwise, that those signing later
in time could get complete reimbursement from those signing prior in time, and this was
called the presumption of sub-suretyship. If the sureties have agreed, expressly or
impliedly, to share the liability, then they are co-sureties and have a right of partial
contribution from each other. Where the parties have made what §3-205(d) calls an
anomalous indorsement (one made by a non-holder – i.e., a surety), §3-116 changes the
common law and now presumes that the parties are co-sureties, and hence must share the
liability among themselves proportionately.
Indorsers are Sureties: (Very important note)
Whether the indorser intends it or not, the imposition of a §3-415 obligation makes the
indorser an unintentional surety for the parties who have signed the instrument prior to
the indorser, and the Code generally gives indorsers all the rights it gives to voluntary
sureties, whom it calls accommodation parties.
Qualified Indorsements:
How can the indorser avoid incurring the §3-415 obligation? The answer is by writing the
words “without recourse” next to his or her name, preferably above it. In this manner the
indorsement (technically called a qualified indorsement) operates to negotiate the
instrument, but doesn’t create any contractual liability. (Example: On a check written
“For deposit only”)
Problem 128:
Melody, a professional pianist, bought a piano from the Ivory Keys Music Company, signing a promissory
note payable to the company for $3000. The day after the piano was delivered, the music company
discounted the note to the Friendly Loan Company for $2700, indorsing the back, “Pay to Friendly Loan
Company, Ivory Keys Music Company (Without Recourse).” The piano fell apart, and Melody refused to
pay the note when it came due. Friendly Finance sued both Melody and the Ivory Keys Music Company.
What is its cause of action against each? What defenses can each defendant raise?
The lawsuit against Melody is based on §3-412 (issuer’s liability) and she could raise the defense of failure
of consideration (personal defense). The lawsuit against music company is based on qualified indorsement
and they can not base liability on the music company b/c it said without recourse (which means will not
incur indorser’s liability. Friendly Finance has no COA against the music company.
Practical Note:
When a lawsuit is settled, the losing side will frequently send the victorious attorney a
check on which the attorney and the attorney’s client are joint payees. This is done to
protect the attorney’s lien and to help the attorney get payment from the client. When the
attorney indorses such a check, the indorsement should be “without recourse.” This
makes it clear that the indorsement is made only to negotiate the check and that the
attorney assumes no §3-415 obligation. There is no reason why the attorney (or the client
for that matter) should make an unqualified indorsement and become, in effect, a surety
for the drawer of the check, already known to be a loser.
The Surety’s Obligation:
In a negotiable instruments setting, suretyship problems come up whenever the maker
must get others to “lend their names” to the maker’s basic obligation. Suretyship matters
can arise even in connection with checks. If you are the payee on a check drawn on Bank
A, just see how easy it is to cash the check at Bank B if you do not have an account
there. Bank B will probably not take the check unless one of its customer-depositors is
willing to sign (become a surety) along with you. To alert potential sureties to the nature
of their understanding, both the FTC and Federal Reserve Board have issued regulations
requiring consumer debts to carry a notice to co-signers.
In any surety setting, there are three basic contracts involved. (1) The underlying
obligation between the principal and the creditor. (2) The promise of the surety to back
up the underlying obligation and see that the creditor loses nothing as a result of
accepting the principal’s promise on the first contract. (3) The promise of the principal to
reimburse the surety if the surety is forced to pay off on the surety’s promise to the
creditor. The K of reimbursement is frequently implied, as where a sister co-signs for her
brother and expects to lose no money from the transaction; when a professional surety’s
liability is obtained, the K of reimbursement will be spelled out in a multi-page, fine print
document.
Surety Chart:
Surety
“Accommodation Party”
K3
Principal (Debtor)
“Accommodated Party”
K2
K1
Creditor (Holder)
“Person entitled to enforce
the instrument.
Problem 129:
Frank Family wanted to move out of his apartment and into his dream house. He hired Quickie Contractor
to build the house on land Family had purchased, requiring Quickie to get a performance and payment bond
guaranteeing that Quickie would do the work and pay its laborer and suppliers. Quickie got Big bank to
issue the bond guaranteeing these matters. Quickie went bankrupt half-way through the job, and Family
called on Big Bank to finish the work. Which of these parties is the surety? Which is the principal?
Which is the creditor? Identify the three contracts.
Big bank is the surety. The principal is Quickie. The creditor is Family. The first K is b/w
Family and Quickie. The second K is b/w Big Bank and Family. The third K is b/w Quickie and
Big Bank.
Note: Sureties have several remedial rights in addition to the right of reimbursement.
These include the rights of exoneration, subrogation, and contribution, and the principle
of structissimi juris.
1. Exoneration
This is an equitable right by which the surety, at maturity, can compel the principal to
perform instead of the surety. That is, by a bill in equity, the surety can prevent the need
for a later suit for reimbursement. The basis for this right is said to be the implied duty
that every principal owes to the surety to perform at the earliest moment and exonerate
the surety from liability.
2. Subrogation
If the surety is forced to pay off the creditor, the surety is subrogated to whatever rights
the creditor had. Put another way, the surety steps into the shoes of the creditor and is
said to take an “equitable assignment” of the creditor’s rights. This may be important is
the creditor possesses rights the surety can take advantage of—for instance, a lien, a
security interest in collateral, a priority in bankruptcy, a power to confess judgment, etc.
In effect, by paying off on the second contract, the surety’s right of subrogation permits
the surety to become a party to the first contract and enforce it as if the surety were the
creditor.
3. Contribution
This is the right of partial reimbursement that co-sureties have against each other for
proportionate shares of the debt. If X, Y, and Z each sign M’s note for $9,000 agreeing
to be co-sureties, the payee may enforce the entire obligation against any one of the three,
and the right of contribution will then permit that one to sue the other two for their
shares.
4. Strictissimi Juris (Common Law)
A surety, particularly an uncompleted surety, is a favorite of the law, so that at common
law the surety’s obligation is to be construed strictissimi juris (of the strictest law), and
thus the surety prevails if possible.
Memorize this common law black letter rule: If the creditor releases the principal
debtor from liability on the first contract or gives the debtor a binding extension of time
in which to pay, the surety is discharged unless (1) the surety consents, or (2) the creditor
informs the principal of the preservation of the surety’s rights against the principal.
Notice that the non-consenting surety is discharged only by binding extension of time.
There is all the (legal) difference in the world between the following 2 hypos.
1. The note comes due, and the principal does not pay it; the creditor waits a
month before suing.
2. The note comes due, and the creditor and principal agree to wait a month
to enforce it, with the principal agreeing to pay an extra month’s worth of
interest.
There are other important rules of suretyship (for instance, a surety’s promise—the
second K—must be in writing to be enforceable under the SOF), but these rules play little
part in negotiable instruments law. Section 3-419(b), for instance, completely does away
with the Statute of Frauds defense as far as negotiable instruments are concerned.
Instead, our study will focus on how the above rules have been varied in the law of
negotiable instruments.
5. The Accommodation Party
The UCC on §3-419 reserves special suretyship rights for those who deliberately lend
their names to an instrument to accommodate another. These sections spell out the
obligation incurred by the Code’s sureties. Section 3-419 applies to an accommodation
party, defined in subsection (a) as a party who “signs the instrument for the purpose of
incurring liability on the instrument without being a direct beneficiary of the value given
for the instrument. Read Official Comment 1 to §3-419. Subsection (b) informs us that
the accommodation party may sign in any capacity (as maker, drawer, acceptor, or
indorser), but is “obligated to pay the instrument in the capacity in which the
accommodation party signs.” This means that the surety (accommodation party) has the
same liability as a maker if the surety signs as a maker, but the surety signing as an
indorser is liable only in that capacity (and has the rights of an indorser: presentment,
notice of dishonor, etc.); in addition, of course, the surety gets both statutory and
common law suretyship rights.
§3-419:
a. If an instrument is issued for value given for the benefit of a party to the
instrument ("accommodated party") and another party to the instrument
("accommodation party") signs the instrument for the purpose of incurring
liability on the instrument without being a direct beneficiary of the value given for
the instrument, the instrument is signed by the accommodation party "for
accommodation."
b. An accommodation party may sign the instrument as maker, drawer, acceptor, or
indorser and, subject to subsection (d), is obliged to pay the instrument in the
capacity in which the accommodation party signs. The obligation of an
accommodation party may be enforced notwithstanding any statute of frauds and
whether or not the accommodation party receives consideration for the
accommodation.
c. A person signing an instrument is presumed to be an accommodation party and
there is notice that the instrument is signed for accommodation if the signature is
an anomalous indorsement or is accompanied by words indicating that the signer
is acting as surety or guarantor with respect to the obligation of another party to
the instrument. Except as provided in Section 3-605, the obligation of an
accommodation party to pay the instrument is not affected by the fact that the
person enforcing the obligation had notice when the instrument was taken by that
person that the accommodation party signed the instrument for accommodation.
d. If the signature of a party to an instrument is accompanied by words indicating
unambiguously that the party is guaranteeing collection rather than payment of
the obligation of another party to the instrument, the signer is obliged to pay the
amount due on the instrument to a person entitled to enforce the instrument only if
(i) execution of judgment against the other party has been returned unsatisfied, (ii)
the other party is insolvent or in an insolvency proceeding, (iii) the other party
cannot be served with process, or (iv) it is otherwise apparent that payment cannot
be obtained from the other party.
e. If the signature of a party to an instrument is accompanied by words indicating
that the party guarantees payment or the signer signs the instrument as an
accommodation party in some other manner that does not unambiguously indicate
an intention to guarantee collection rather than payment, the signer is obliged to
pay the amount due on the instrument to a person entitled to enforce the
instrument in the same circumstances as the accommodated party would be
obliged, without prior resort to the accommodated party by the person entitled to
enforce the instrument.
f. An accommodation party who pays the instrument is entitled to reimbursement
from the accommodated party and is entitled to enforce the instrument against the
accommodated party. In proper circumstances, an accommodation party may
obtain relief that requires the accommodated party to perform its obligations on
the instrument. An accommodated party that pays the instrument has no right of
recourse against, and is not entitled to contribution from, an accommodation
party.
o
Comment 1:
o
Comment 2:
o
Comment 3:
Problem 130:
Consider the following promissory note:
FRONT:
December 23, 2010
I, Mary Maker, promise to pay $4,000 to the order of Paul Payee on
December 25, 2012, with interest at 8% per annum from date.
/s/ George Generous (He is an accommodation maker.)
/s/ Mary Maker
BACK:
Pay to Ace Finance /s/ Paul Payee
Ace Finance, comes to you early in 2013 and tells you that the note is in default, but that it failed to give
notice of dishonor—a right that indorsers have but makers do not—to George Generous.
a.
May Generous establish his status as surety against a holder in due course? See §3-419(c) with its
OC 3, §§3-205, 3-605(h).
The way George signed this note would put everyone who reads this note that he has
signed this as a surety, however, just b/c you have notice is not going to prevent someone
from becoming a HDC.
b.
May Generous defend on the basis that he received no consideration for his undertaking? See §3419(b) and its OC 2.
No, §3-419(b) tells us that it doesn’t matter whether he received consideration. B tells us
that it doesn’t matter.
c.
Is George an accommodation maker or an accommodation indorser? See §§3-116(a), 3-204(a).
He is an accommodation maker. He would have liability as a maker, but he could have
liability as a maker but will have protection as a surety.
Note:
It should be emphasized that Article 3’s rules apply only to accommodation parties who
sign the instrument. If the accommodation party signs a separate suretyship agreement
but not the note itself, common law rules, not the code, govern the result. See OC 3, last
paragraph to §3-419.
A guarantor is a surety who adds words of guaranty to his signature. (“I hereby
guarantee this instrument,” for example), but words of guaranty add nothing to the
suretyship obligation unless the surety has specifically guaranteed collection only, in
which case guarantor is given the extra protections described in §3-419(d). If write on
there that “I hereby guarantee this instrument for collection only” then you will have the
protection of §3-419(d).
Problem 131:
Suppose in the prior problem George Generous has written the word Guarantor after his name. Would Ace
Finance have had to sue Mary Maker first or not? §3-419(d).
No, when he signs as accommodation maker they can go after him without ever having to go after her.
6. Tender Payment
Skip last sentence of c.
§3-603:
a. If tender of payment of an obligation to pay an instrument is made to a person
entitled to enforce the instrument, the effect of tender is governed by principles of
law applicable to tender of payment under a simple contract.
b. If tender of payment of an obligation to pay an instrument is made to a person
entitled to enforce the instrument and the tender is refused, there is discharge, to
the extent of the amount of the tender, of the obligation of an indorser or
accommodation party having a right of recourse with respect to the obligation to
which the tender relates.
c. If tender of payment of an amount due on an instrument is made to a person
entitled to enforce the instrument, the obligation of the obligor to pay interest after
the due date on the amount tendered is discharged. If presentment is required
with respect to an instrument and the obligor is able and ready to pay on the due
date at every place of payment stated in the instrument, the obligor is deemed to
have made tender of payment on the due date to the person entitled to enforce the
instrument.
Problem 133:
When Saul Panzer needed to borrow money, his friend Rex Stout agreed to loan him $10,000 if Saul could
get a co-signor. Saul talked Orrin Cather into signing Saul’s promissory note as co-maker. The note was
payable to the order of Rex Stout, who loaned Saul the $10K and took the note in return for the money.
Rex indorsed the note and sold it as a discount to Archie Goodwin.
a.
On the date the note matured, knowing that Saul Panzer, the maker, was in financial trouble and
wanting to stop the running of interest, Orrin Cather, the co-signor, went to Archie Goodwin, the
current holder, and offered to pay the note, planning to seek reimbursement from Saul. Goodwin
replied, “Let’s give poor Saul a chance to pay it off himself.” A month later Saul went bankrupt,
and Goodwin demanded that Cather pay the initial amount due plus interest for the extra month.
Cather refused, and Goodwin sued, adding a claim for attorney’s fees. To what is he entitled, if
anything? See §3-603(c)’s first sentence.
§3-603(c) tells us that he is still going to be liable for the initial amount due, but he will
not be liable for any additional interest since he tendered payment and was refused.
b.
On the due date Saul went to Goodwin and offered to pay, but Goodwin said, “Look, I know you
need money for your other bill—pay me next month.” A month later Saul went bankrupt. Can
Goodwin now recover from Cather? From Stout, the payee/indorser? See §3-603(b).
§3-603(b) tells us no, he tried to pay, they wouldn’t take his money and both parties
would be discharged b/c they wouldn’t take his tender.
c.
Instead of the above, assume that on the maturity date Orrin Cather went to Goodwin and offered
to pay the debt, to which Goodwin made the same reply. A month later Saul went bankrupt, and
Orrin Cather filed for bankruptcy at the same time. Is Stout, the payee/indorser, liable to
Goodwin?
No, the refusal of Cathers tender discharged Stout’s obligation to pay.
7. Section 3-605—Strictissimi Juris Again
Sureties are the beneficiaries of a number of common law maxims, among them that a
“surety is a favorite of the law” and that “security (collateral) follows the debt.” The
former you must remember to quote to the court should your client be a surety. The latter
refers to the collateral (security) given to the creditor by the principal and means that on
paying off the creditor and thereby acquiring the negotiable instrument (debt), the surety
is also entitled to that collateral.
It follows that the surety has an interest in the creditor’s handling of the collateral. Both
at common law and under §3-605(e), (f), and (g), the non-consenting surety is
discharged, up to the value of the collateral, if the creditor (holder) fails to protect the
collateral and if it is thereby unavailable to pay the debt.
§3-605: (Discharge of Secondary Obligors)
(e) secondary obligor is not discharged under subsection (a)(3), (b), (c), or (d) unless the
person entitled to enforce the instrument knows that the person is a secondary obligor or
has notice under Section 3-419(c) that the instrument was signed for accommodation.
(f) A secondary obligor is not discharged under this section if the secondary obligor
consents to the event or conduct that is the basis of the discharge, or the instrument or a
separate agreement of the party provides for waiver of discharge under this section
specifically or by general language indicating that parties waive defenses based on
suretyship or impairment of collateral. Unless the circumstances indicate otherwise,
consent by the principal obligor to an act that would lead to a discharge under this section
constitutes consent to that act by the secondary obligor if the secondary obligor controls
the principal obligor or deals with the person entitled to enforce the instrument on behalf
of the principal obligor.
(g) A release or extension preserves a secondary obligor's recourse if the terms of the
release or extension provide that the person entitled to enforce the instrument retains the
right to enforce the instrument against the secondary obligor; and the recourse of the
secondary obligor continues as though the release or extension had not been granted.
•
Comment 7:
Problem 134:
When Butch Byrd borrowed $10K from ONB, the bank not only made him get a surety, but also demanded
that the inventory of Butch’s feed store stand as collateral. Butch talked his brother Arnold into signing the
promissory note as a guarantor and signed the necessary papers for the bank to get an Article 9 security
interest in the inventory. Unfortunately, the bank failed to file the Article 9 financing statement in the
correct place, so when Butch had financial difficulties, other creditors prevailed over the bank’s attempt to
claim the inventory. The inventory was worth $6K. What is the effect of the bank’s Article 9 difficulties
on Arnold’s liabilities? §3-605(e) and (g).
The effect was that Arnold is discharged of his liability up to the value of the collateral that is lost.
Problem 135:
George and Martha Washington borrowed 10K from the Mt. Vernon Finance Co, both signing a
promissory note for the amount borrowed. To secure the note, the bank took a mortgage on Martha’s
Vineyard, but failed to file its mortgage in the proper place. Before the note matured, Martha filed for
bankruptcy, and the bankruptcy creditors were able to get the vineyard free and clear of the bank’s
mortgage. Is George discharged in whole or in part by §3-605(e)? By §3-605(f)? If Martha had not filed
for bankruptcy, but the vineyard was still lost when the state seized it b/c she hadn’t paid her taxes, is she
discharged by the bank’s failure to perfect its interest in the vineyard? As to all this, see OC 7 to §3-605.
§3-605(e) doesn’t apply to George, it only applies to an indorser or an accommodation party, he
is a maker. Under §3-605(f) George is discharged in to his extent of his contribution that is
prejudiced by his impairment of that particular collateral. Martha is not discharged b/c she has
not suffered any harm.
** Look to see if your state has adopted amendments to Article 3 and 4 b/c it has changed
the law dramatically.
Problem 136:
When Jack Point borrowed 75K from Yeomen National Bank to start up his carnival business, the bank
made him sign a promissory note in its favor and get a surety. Point talked his good friend Wilfred
Shadbolt into signing as an accommodation maker. Is Shadbolt discharged by any of the following
agreements between Yeomen National and Point?
a.
When the note matured, Point told Yeomen that his business had gone bust and that he was
thinking about filing a bankruptcy petition. Worried that it would get nothing in the bankruptcy
distribution, Yeomen persuaded him to pay all he could, a mere 5K, and then signed an agreement
with Point excusing him from having to pay the rest of the debt. The bank them demanded that
Shadbolt pay the amount still due. Does Shadbolt owe it? §3-605(b). Does the accord and
satisfaction agreement b/w the bank and Point also bind Shadbolt, or may the latter still seek
complete reimbursement from Point? §3-419(e) and OC 3 to §3-605.
Yes, this is different from the common law. He would be liable for the entire 70K
remaining. Yes, he can still seek reimbursement from Point (but this is tough b/c Point is
about to file bankruptcy.
b.
Assume instead that when the note matured Point went to the bank and asked for more time in
which to pay. The bank did this, giving Point an extra 6 months. No one notified Shadbolt of this
extension. At the end of the 6 month period, Point filed for bankruptcy instead of paying the
note. Was Shadbolt discharged by the bank’s actions? Would your answer change depending on
whether or not Point ever had the money to pay the note at any relevant period? §3-605(c) and its
OC 4. Who has the burden of proof on the issues? Could Shadbolt, has he known of the
extension agreement, have ignored it, paid the note, and then sued Point for reimbursement?
Shadbolt would be discharged if he could show some harm by extending that particular
time. The burden would be on him. Yes, it will depend on whether he had the money to
pay the note. If they will allow that, he could sue Point for reimbursement..
c.
Assume instead that when the note was signed the bank also made Point put up 100 shares of
stock as collateral for the debt. Before the note matured Point went to the Bank and asked to have
the stock back, saying he needed to take advantage of a stock split the issuing corporation was
offering. The bank returned the stocks to him, but made him agree to pay a higher rate of interest.
The original not contained a clause by which the surety automatically agreed in advance to any
impairment of the collateral. Has Shadbolt nonetheless been discharged? Who has the burden of
proof here? §3-605(d) and OF 5.
2 issues here: impairment of the collateral and the higher interest rate. The Burden of
proof has shifted, it is on the bank to show that it doesn’t cause him harm otherwise the
higher interest rate will discharge him.
d.
Is there a simple way that the bank could have avoided all these issues ab initio? §3-605(i) and
OC 2.
Yes. Have waiver clauses in agreement and then all these issues become moot.
8. New Notes for Old
§3-310(b)(2):
(b) Unless otherwise agreed and except as provided in subsection (a), if a note or an
uncertified check is taken for an obligation, the obligation is suspended to the same
extent the obligation would be discharged if an amount of money equal to the amount of
the instrument were taken, and the following rules apply:
(2) In the case of a note, suspension of the obligation continues until dishonor of the
note or until it is paid. Payment of the note results in discharge of the obligation to the
extent of the payment.
Problem 137:
(page 472)
In 2009 Rex Lear borrowed 5K from the Kent Lending Corp. and gave them his promissory note due June
8, 2012. Rex had his daughter Cordelia sign as accommodation maker. Early in 2012 Rex defaulted on the
installment payments and in return for mercy by the lending company, he signed a new promissory note
dated January 11, 2012, payable to the company September 25, 2012 for the same amount but with
additional collateral. The Kent Corp. kept the first note as security for the payment of the second. Cordelia
never signed the second note.
(a) Can the payee sue on the first note prior to September 25, 2012?
Under §3-310(b)(2), No that first note is suspended during that particular time.
(b) If Lear does not pay the 2nd note when it matures, can Kent sue on the first note, or has it been paid and
discharged by the second note?
If note 2 is dishonored, then Kent can sue on note 1.
(c) Assume that Cordelia can prove that the failure of the lender to enforce its rights on the 1st note caused
her major damages in that Lear’s financial situation deteriorated drastically b/w January 11 and September
25, 2012, and the collateral became worthless during the same period. Is Cordelia still liable on the first
note?
§3-605(c) tells us that she will be discharged b/c taking that second note worked to an extension
of time b/c she it caused her severe damages.
Problem 138:
Sam was the surety on a promissory note that Marty Make had given to the Dogfish Loan Company along
with a pledge of 100 shares of Titanic Telephone stock to secure the loan for $800. Shortly after receiving
the loan, Marty asked for the stock back, saying that he wanted to sell it and buy other stock that he would
repledge as collateral. Dogfish gave him back the stock, which Marty sold. He used the proceeds to
finance a bad day at the races. A week later Dogfish transferred the note for value to the Hammerhead
Loan Company, a bona fide purchaser. Assume that Sam has been discharged under §3-605(e),
(impairment of the collateral). Is he still liable to Hammerhead?
This is a personal defense, so if Hammerhead is a HDC then Sam is still liable to Hammerhead
unless he had notice of the impairment of the collateral , which we don’t know here.
The Drawee’s Obligation:
Problem 143:
After he brought a successful Truth in Lending action against ONB, attorney Sam Ambulance made the
mistake of continuing to bank at ONB. At a time when his bank balance greatly exceeded that amount,
Sam wrote an alimony check for 3K and gave it to his ex-wife, Sue. B/c similar checks had bounced in the
past, Sue hurriedly walked the check directly into the bank and presented it across the counter. The teller
who took the check alerted the bank’s manager who laughed evilly as he threw it back across the counter at
Sue, informing her that Sam’s business was no longer welcome at ONB and that it refused to pay any more
of his checks, even thought there was money in the account sufficient to meet the check. You are the
attorney who handled Sue’s divorce, so she calls you and asks what she should do. §3-408, 3-401(a), 3414, 4-402.
The drawee, not having signed the draft, is not liable on it. The drawee, having signed nothing,
incurs no contractual obligation (though it may still be liable to the drawer under §4-402.
Note:
So far, when we have mentioned drafts, we have really been talking only about drafts
drawn on banks (checks); the drawee we have been discussing is a bank administering a
checking account. The business community makes much use of the non-bank draft in the
purchase and sale of goods, particularly when the parties are in different cities. Consider
the following hypo.
The seller agrees to ship buyer 10,000 widgets at $20 each, “payment against sight
draft.” This means that the seller will draw a draft on the buyer payable on “sight” (when
the buyer first sees it.) Such a procedure permits the seller to discount the draft with the
seller’s bank, which will indorse the draft over to a collecting bank in the buyer’s city.
The collecting bank will make a formal presentment to the buyer-drawee. The parties
frequently arrange it so that the collecting bank has control over the goods and will turn
them over to the buyer at the moment when the latter pays the draft. Thus, at the moment
of payment, buyer received the goods. No one need trust anyone else.
In the hypo, the seller is the drawer, and the buyer is the drawee. The payee on the draft
could be any number of people—the seller itself, the seller’s bank, or simply “bearer.”
The two banks that transfer the draft will presumably sign it, and as soon as they do so,
they will become indorsers. If the buyer dishonors the draft on presentment, the
collecting bank will send out the required notices of dishonor and then request payment
on the basis of the obligations (indorser and drawer) of the prior parties.
1. The Non-Bank Acceptor
Sometimes in the sale transaction described above, the buyer will ask for time in which to
pay the draft after receiving the goods. In such a case the seller will probably want the
buyer to assume liability on the instrument, so the seller will require the buyer to sign the
instrument when it is presented and this become primarily responsible for its payment.
The drawee who places a signature on a draft is said to have accepted it, and he or she
incurs the obligation of an acceptor. See §3-413. Acceptance is defined in §3-409(a) as
the “drawee’s signed agreement to pay a draft as presented.”
§3-413:
a. The acceptor of a draft is obliged to pay the draft (i) according to its terms at the
time it was accepted, even though the acceptance states that the draft is payable
"as originally drawn" or equivalent terms, (ii) if the acceptance varies the terms of
the draft, according to the terms of the draft as varied, or (iii) if the acceptance is
of a draft that is an incomplete instrument, according to its terms when completed,
to the extent stated in Sections 3-115 and 3-407. The obligation is owed to a
person entitled to enforce the draft or to the drawer or an indorser who paid the
draft under Section 3-414 or 3-415.
b. If the certification of a check or other acceptance of a draft states the amount
certified or accepted, the obligation of the acceptor is that amount. If (i) the
certification or acceptance does not state an amount, (ii) the amount of the
instrument is subsequently raised, and (iii) the instrument is then negotiated to a
holder in due course, the obligation of the acceptor is the amount of the
instrument at the time it was taken by the holder in due course.
§3-409(a):
"Acceptance" means the drawee's signed agreement to pay a draft as presented.
It must be written on the draft and may consist of the drawee's signature alone.
Acceptance may be made at any time and becomes effective when notification
pursuant to instructions is given or the accepted draft is delivered for the purpose
of giving rights on the acceptance to any person.
A draft may be accepted although it has not been signed by the drawer, is
otherwise incomplete, is overdue, or has been dishonored.
If a draft is payable at a fixed period after sight and the acceptor fails to date the
acceptance, the holder may complete the acceptance by supplying a date in good
faith.
"Certified check" means a check accepted by the bank on which it is drawn.
Acceptance may be made as stated in subsection (a) or by a writing on the check
which indicates that the check is certified. The drawee of a check has no
obligation to certify the check, and refusal to certify is not dishonor of the check.
o
Comment 4:
2. Checks
When the draft is a check, so that the drawee is a bank, the same rules apply. The
drawer’s writing of the check does not, absent unusual circumstances, create any
immediate rights in the checking account funds, and the drawee bank has no liability to
the holder of the check until it accepts it. Of course, the drawee bank is bound by the
terns of its checking account agreement with its customer, the drawer. This checking
account agreement is analogous to the K of sale in the non-bank drawee situation
discussed above. But the checking account agreement is a private contract b/w the bank
and its customer and confers no rights on other parties.
§3-408: (DRAWEE NOT LIABLE ON UNACCEPTED DRAFT)
A check or other draft does not of itself operate as an assignment of funds in the hands of
the drawee available for its payment, and the drawee is not liable on the instrument until
the drawee accepts it.
Note:
Section 3-408 does not mean that under no circumstances can the drawee bank become
liable to the holder prior to acceptance. It was the common law rule that by special
agreement the drawer could work an immediate assignment of bank-held funds so as to
give the holder of the check a claim against the drawee bank prior to acceptance.
3. Certification
The drawee bank’s acceptance of a check is called certification. All of the Code sections
on acceptance apply equally to certification. Read §3-409(d), 3-411, and 3-413.
Problem 144:
George Generous gave a check for 5K to the Grapes of Wrath Church as part of the church’s drive to get
money for a planned new building. The church did not want to cash any checks it received until it had at
least 20K worth of pledges. On the other hand, the church didn’t want contributors to be able to back out
and stop payment either, so the church’s lawyer advised the church directors to have all large checks
certified. This, the lawyer knew, would have the effect of making the certifying bank primarily liable on
the check (§3-413(a)). The church treasurer took George’s check down to the drawee bank and asked to
have it certified, a presentment for acceptance. The drawee bank refused, saying that its practice was never
to certify gift checks.
a.
Is that a dishonor so that the church should give George notice of dishonor? See §3-409(d) and
OC 4.
No, that is not a dishonor, so no need to give notice of a dishonor.
b.
What should the church’s lawyer advise it to do now?
Cash a gift check immediately.
c.
If the bank had certified the check but later refused to pay it, could the church sue George on his
drawer’s obligation? See §3-414(c). Same result is George had donated a certified check that the
bank later dishonored? See OC 3 to §3-414.
3-414(c) tells us that they could not sue him on the drawer’s obligation if they accepted
it. They certified it when the accepted it.
F. Signature by an Agent
§3-402(a) generally defers to the common law governing an agent’s signing of a K on
behalf of the principal. Thus, the agent’s authority to sign the principal’s name may be
real (express or implied) or even apparent.
Problem 145:
When tycoon J.B. Biggley wanted to borrow money for a business venture, he had his agent, J. Pierpont
Finch, negotiate the loan from Wicket’s National Bank. When Finch signed the promissory note payable to
the bank, he simply wrote his name as “J. Pierpont Finch, Agent,” and failed to mention the name of his
principal Biggley. Is Biggley bound to this note? See §3-402 and OC 1.
Yes. It doesn’t matter whether he has been identified on the instrument. Undisclosed principals
are bound by the agent’s signature whether clearly identified or not.
Note:
The smart way for an authorized agent to sign the instrument so as to avoid personal
liability is for the agent to be careful to do two things: (1) name the principal and (2)
unambiguously indicate that the agent is signing only in a representative capacity. See
§3-402(b)(1). If the agent does one of these 2 things but not the other, the agent is liable
to a holder in due course taking the instrument without notice that the agent was not
intended to be liable, but otherwise the agent may prove that the original parties did not
intend for the agent to incur liability. OC 2 says that a HDC should be able to resolve
any ambiguity against the agent.
Problem 146:
In the last problem would Finch himself be liable to a HDC? To Wickets National Bank?
Yes, the agent was probably not enough to unambiguously show that he was signing for someone
else. If Wickens wasn’t a HDC, he can defend by arguing that he was not expected or intended to
be liable for this.
Problem 147:
The president of Money Corporation was John Smith. He signed three corporate promissory notes as
follows:
1.
“John Smith.” Money Corporation was not mentioned in the note.
2.
“Money Corporation, John Smith.”
3.
“Money Corporation, John Smith, President.”
In each case is he personally liable to a HDC of the instrument?
He is liable and so is Money if he was authorized to sign for them. (2) This depends on whether
the court says that John has unambiguously signed in an agency capacity. (3) This is clear that
he is an agent of Money, so he is not personally liable.
Problem 148:
Kit Fielding was the corporate president of Francis Racing Stables. The corporate checks had the words
“Francis Racing Stables” printed prominently in the upper left-hand corner of the checks, but when
Fielding went to sign the checks on the drawer’s line, he simply signed his name and did not sign the name
of the company or in any way indicate that he was signing as an agent. If the check is negotiated to a HDC
and then dishonored by the drawee bank, may the HDC successfully impose personal liability on Fielding?
See §3-402(c) and OC 3.
No, so long as the check has the name of the corporation at the top of it, then and only then the
signature on the drawer line (assuming its authorized) wouldn’t impose personal liability.
Other Theories of Liability
In commercial paper law, contractual obligations arise from the voluntary act of putting
one’s signature on a negotiable instrument. But the Code also establishes a host of other
theories imposing liability.
The next chapter explores the legal relationship between a bank and its customer, and, as
we shall see, these parties may sue each other for violations of the rules arising from that
relationship, primarily the “properly payable” rule of §4-401 and the wrongful dishonor
rule of §4-402.