Murray, Hogue & Lannis

Be Wary of Contract Drafting That Includes Terms that Conflict with the UCC

A newsletter by Jon Hogue

Imagine that you have been asked to draft a contract for a client who is engaged in the sale of goods. In order to protect the client, you add what you perceive to be traditional contract provisions limiting the buyer's remedies and damages. This drafting may, however, lead to the unintentional outcome of actually exposing your client to the opposite result. A recent court decision illustrates this dilemma, giving superseding deference to the UCC over the contract terms included in the agreement.

In the words of the court, “buyers are more likely to enter into contracts when there is a justified expectation of receiving that for which the buyer has bargained…under the UCC, caveat emptor is dead[.]” In 84 Lumber Company v. Fleeher, a court located in Washington County, PA, has issued a thoughtful opinion that analyzes two clauses: a “limited remedy clause” and an “exclusionary clause” that were contained in an agreement between the parties, a supplier and a contractor. Although both of these clauses would traditionally be applicable and valid by virtue of the freedom to contract, each was found to be not valid in this case by legal principles contained in the UCC.

In this case, the Buyer, for the purpose of completing a construction project for a 3rd party, ordered an amount of wood from the Seller, paying extra to have the goods delivered by a certain date, making time of the essence. Seller failed to deliver the goods on time, thus materially breaching the term of the contract. Buyer, acting reasonably under the circumstances, accepted the nonconforming goods and proceeded to use them to complete the project in order to minimize damages. However, Buyer did sustain damages as a result of the Seller‘s breach, and therefore withheld the estimated damages (labor costs, overtime, etc.) from the remaining balance owed to Seller. This self-service remedy of withholding funds is a remedy allowed by 13 P.a.C.S. § 2717, which reads:

The buyer on notifying the seller of his intention to do so may deduct all or any part of the damages resulting from any breach of the contract from any part of the price still due under the same contract.
The Limited Remedy Clause in the contract between the parties however prevented any setoff, reading as follows:
17. Applicant agrees not to withhold, setoff, deduct or retain payment amounts due 84 on the Account for any alleged claims or charges.
Seller argued that the contract terms were meant to supplant the UCC remedy contained in §2717. Buyer countered that the clause deprived it of the benefit of its bargain, and the contract clause should not be found to be valid. The official comments to § 2719 state “where an apparently fair and reasonable clause because of circumstances operates to deprive either party of the substantial value of the bargain, it must give way to the general remedy provisions of this article” The Court used a 2-step test to determine whether a party has been denied a substantial value of its bargain. “First, the fact finder determines the value of the bargain then, the court decides whether the limited remedy operated to deny the aggrieved party of that for which it has contracted in fact.” The court‘s goal in utilizing this test was ultimately to be concerned with reaching reasonable equity between the parties. “Our courts thus ensure that ‘the very essence of a sales contract‘ is preserved by requiring that ‘at least minimum adequate remedies be available‘ for every material breach”, citing § 2719 comment 1. Finding that under the facts of this transaction, the limited remedies clause denied Buyer the substantial value of its bargain, the clause was stricken from the agreement.

With the Limited Remedies clause stricken from the contract, the contract still contained a straight-forward exclusionary clause that clearly limited they types of damages Buyer could seek, including those Buyer sought to off-set in this matter:

13. In no event shall 84 be liable for liquidated, incidental or consequential damages in connection with building materials or services purchased by Applicant. 84 disclaims any express or implied warranties of merchantability or fitness for a particular purpose on building materials or services purchased by applicant

This clause is a fairly standard one appearing in many contracts. However, it also may conflict in a given factual setting with the UCC that sets forth that where a limitation of remedy fails “of its essential purpose, remedy may be had as provided in this title.” In the 84 Lumber case, the damages suffered by Buyer were in fact of the type described in this clause, consequential or incidental damages flowing from the late arrival of their shipment. These types of damages are usually permitted to be contractually excluded, as the Seller argued. However, in this case, the exclusionary clause was found not to have been valid under the circumstances. The controlling statute is 13 Pa.C.S. § 2719, that provides in part:

b) Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this title
c) Consequential damages may be limited or excluded unless the limitation or exclusion is unconscionable. Limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable but limitation of damages where the loss is commercial is not.

The initial legal question the Court asked about these two sections was whether they operated independently of one another (the “independent” approach) or whether one is dependent on the other (the “dependent” approach). There is no continuity among jurisdictions in deciding which approach to take. The Court held that the exclusionary clause contained in the contract is trumped by the failure of the limited remedy clause, taking the “dependent” approach adopted by the majority of jurisdictions which have reviewed this issue. “When a limited remedy fails of its essential purpose or otherwise operates to deprive the buyer of the substantial value of its bargain, subsection (b) makes all UCC remedies available to the buyer, []regardless of contrary contract terms”. The exclusionary clause in this case caused the limited remedy to fail of its essential purpose, and, consequently, Buyer was afforded all UCC remedies and was not bound by the exclusionary clause that the contract contained. (The Court also critiqued the minority “independent” approach, and in doing so invokes our partner, Dr. John E. Murray. “Professor Murray, the foremost living expert on Article 2, suggests amending the code so as to excise this interpretation altogether. He would have an exclusionary clause, where a limited remedy has failed of its essential purpose, be deemed prima facie unconscionable. 84 Lumber citing Murray, The Revision of Article 2: Romancing the Prism, Wm. & Mary L. Rev. 1447 (1994)…at 1505.)

In adopting the dependent approach, it is significant that the Court found its approach accordance with the legislature‘s intent to “simplify, clarify, and modernize the law governing commercial transactions.” 13 Pa.C.S. §1102…” The dependent approach produces clear and predictable results derived from the UCC general remedial provisions. Liberal administration of the UCC remedies encourages modern commercial transactions, because buyers are more likely to enter into contracts when there is a justified expectation of receiving that for which the buyer has bargained. The remedial provisions of the UCC are authored to afford aggrieved buyers just that. Under the UCC, caveat emptor is dead; the dependent approach keeps it so.” This case highlights the careful thought that must be given in drafting agreements to which the UCC applies, which agreements attempt to limit remedies and damages. Central to drafting is the need to review with one‘s client the precise factual setting in order to best understand factually how proposed contract terms might impact the buyer‘s ability to respond if there is a contract breach by the seller. Then drafting counsel is in a position to advise one‘s client about the possible consequences as to what might occur if the contract terms are called into question and seek alternative contract language to protect the client. It still may be best to seek the limitations contained in this contract as the terms might discourage a buyer from acting as Buyer did in this case. In any event, careful consultation with one‘s client will at a very minimum ensure that the unintended result in this case does not catch a client by surprise. Cite: 84 Lumber Company vs. Feeher, No.2005-867 (Washington County, PA 2007) (O‘Dell-Seneca, P.J.)

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