Excluding Lost Profits and Consequential Damages Under UCC 2-719: Too Much of a Good Thing?

Whittlestone, Inc. v. Handi-Craft Company 2008 WL 4963053 (USDC, N. D. Ca. Nov. 19, 2008)

Buyers and sellers often limit the damages recoverable for breach contract in sale of goods cases. Under UCC 2-709(3) such limitations are enforceable, with exceptions for unconscionability. If the exclusionary language is too broadly written, it could be interpreted to preclude direct liability on the contract, not merely consequential damages.

Seller Whittlestone entered a 20 year contract to supply Handi-Craft with products. Buyer Handi-Craft was required to purchase a minimum amount each year. Buyer terminated the contract early. Seller filed suit, claiming the termination was a breach of contract. Buyer asked for damages under the contract, including the value of the lost minimum amount of sales over the remaining term of the contract.

Oops. Buyer's and seller's contract provided that in the event of "termination due to a material breach," "neither party shall be liable to the other for compensation, reimbursement, or damages because of the loss of anticipated sales...." The court enforced this literally against seller, finding that seller could not sue for direct lost sales to the breaching buyer. The court struck the language in the complaint damages for "the lost value of the twenty year contract..., lost profits, consequential damages."

This result is not within the typical spirit of consequential damage limitations, which are generally intended to eliminate liability for lost sales to third parties, not lost direct contract sales between the parties. On the other hand, because of the long term, the parties may have specifically contemplated this when the agreement was drafted.

Moral of the story: be careful about a limitation on "lost sales" that is so broad you don't have any direct damages left under the contract.

Sun-Dried Tomatoes, Anyone? Seller Recovery on Buyer Breach: Damages Based on A Lost-Volume Seller Theory UCC 2-702(2)

Culinary Farms, Inc. v. Mooney, 2008 WL 4889621 (Cal. App 3 Distr. Nov. 13, 2008) (Not Officially Published- Non Citable)

This case concerned the appropriate measure of damages where a buyer failed to complete the purchase of sun-dried tomatoes. Although the seller was able to recover possession and resell the tomatoes, it claimed damages as a “lost-volume seller” under Section 2708(2) of the Commercial Code.

A lost-volume seller is one who can establish that the buyer’s breach meant a lost sale that was not recouped by a resale of the product to another buyer, because the seller would have sold product to the other buyer in any event. Under these circumstances, the seller is allowed to recover its lost profits under Commercial Code Section 2708(2), because the seller would not otherwise be able to recover the economic damages suffered when the buyer refused to purchase.

In this case the defaulting buyer asserted that although the seller may have been a lost-volume seller for dried tomatoes generally, the particular product at issue was California sun-dried tomatoes, and the seller was not a lost-volume seller of this type of tomatoes. This was a good theory, and may have worked, but unfortunately for the seller, the facts got in the way. The court found that the breaching seller had not actually proved its contention, and in fact cited the defendant’s own deposition testimony against the defendant.

Unsecured Creditor's Levy on Deposit Account Defeats Prior Secured Creditor--UCC 9-332(b)

In a reported case of first impression under California law, the California Court of Appeal, First District, Division 5 ruled that an unsecured creditor's garnishment or levy on funds in a deposit account will defeat the prior secured creditor. Orix Financial Services, Inc. v. Kovacs, 83 Cal. Rptr. 3d 900, 08 Cal. Daily Op. Serv. 12,845 (Sept. 30, 2008).

The debtor defaulted on $1.5 million in secured debt held by Orix. Kovacs independently obtained a judgment against the same debtor for about $150,000. Kovacs was an unsecured creditor. In traditional analysis of creditors' priorities, Orix's claim was superior to Kovaks. However, Kovacs obtained a writ of execution and levied on the debtor's deposit accounts. The deposit account holders paid the funds to Kovacs. The prior secured creditor Orix sued the unsecured creditor Kovacs for unjust enrichment and imposition of a constructive trust.

The court of appeal ruled that the unsecured creditor was entitled to keep the money as a "transferee" under California's version of UCC 9-332(b) (California Comm. Code 9332(b)), which states:
"A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party."

The term "transferee" is not defined. However, considering the underlying commercial policy favoring certainty in routine deposit account transactions--most of which involve transfers to unsecured creditors--the court ruled that the levying creditor should fall within the definition of "transferee" within UCC 9-332(b).

UCC Warranty Limitations--New Article in Orange County Lawyer Magazine

Our blogger Gregory E. Robinson published an article in the October 2008 edition of Orange County Lawyer Magazine, the official publication of the Orange County [California] Bar Association. "Beyond the Battle of the Forms--UCC Warranty Limitations: 'How to Make 'Em and How To Break 'Em," Vol. 50, N0. 10, Orange County Lawyer, page 18 (October 2008). The article discussed common situations in which express and implied warranties arise (UCC Sections 2-213, 2-314, 2-315). Sellers' exclusions and limitations of warranties are also considered (UCC 2-306) along with buyers' strategies to defeat these restrictions. Buyers' strategies include omission of these limits or exclusions from the contract (Section 2-207), subsequent dealings between the parties giving rise to new obligations, and failure of an essential purpose. (UCC 2-719). We have added a link to the article. Copies can be ordered from the Orange County Bar Association website, http://www.ocbar.org/ or from Robinson & Robinson, LLP.

Implied and Express Warranty Claims: Duck Feet Have No Class

The Central District of California recently denied class certification in a lawsuit alleging breach of express warranty and implied warrant of merchantability. Gable v. Land Rover of North America, 2008 WL 4441960 (C. D. Cal. Sept. 29, 2008)--not reported in F. Supp. 2d. Plaintiff claimed that Land Rovers sold in Michigan in 2005 and 2006 had a defective "toe-out" condition in the rear tires, causing the vehicles to be "duck-footed." The court found that many different circumstances can cause duck-footed misalignments. Without "individual inquiry" there was no way to determine whether the duck-footedness was caused by the manufacturer or driver. The court also noted that plaintiff had not shown that even a majority of the class vehicles experienced the defect. These two factors caused the judge, Andrew J. Guilford, to rule that the plaintiff had "no class." The opinion noted that courts often split over the issue of class certification involving defects that can be caused by the manufacturer or owner. (See Sammuel-Bassett v. Kia Motors America, Inc., 212 F.R.D. 271, 282 (E.D. Pa. 2002) [class certification granted in premature brake wear case]; Kia Motors America Corp. v. Yvonne Butler, No. 3D05-11455 (Florida Third District Court of Appeals, 2008) [class certification denied in case involving the exact same claims.]) Maybe the Ninth Circuit will have to determine whether duck feet have no class.

Statute of Limitations—Student Loans—6 years under Section 3-118

When enforcing or defending an action on a promissory note, remember that the UCC may specify a longer statue of limitations. A student borrower tried to block enforcement of her student loans by asserting the basic 4-year statute of limitations for breach of written contracts (California Code of Civil Procedure Section 337)*. She appealed the judgment against her and lost. In an unpublished decision, the California Court of Appeal, Section District (Los Angeles) found that the 6-year statute of limitations of Ca. Comm. Code Section 3118 (UCC 3-118) applied. The promissory notes were considered “negotiable instruments” covered by the longer statute of limitations. Under Section 3-106, reference to the “disclosure statement” in the notes did not make them “conditional” and therefore non-negotiable. Education Resources Institute v. Yokoyama, 2008 WL 3906834 (Aug. 26, 2008).

(*with thanks to Anonymous for correcting our mistaken reference to the Civil Code.)

Arbitration Wars and the UCC – Unconscionability and Limits on the Arbitrator’s Powers

A recent California appeals court decision highlighted some interesting issues concerning the interplay between arbitration and the Uniform Commercial Code.

The case is J.C. Gury Company v. Nippon Carbide Insurance (USA) Inc. (2007) 152 Cal. App. 4th 1300, 62 Cal. Rptr. 118. Here, a manufacturer brought an arbitration proceeding against its supplier (Nippon Carbide). Apparently the manufacturer had encountered problems with the supplier's product after the supplier moved its production operations from Japan to China. The contract contained an arbitration agreement. The arbitration clause provided that the arbitrator would not have the power to change, modify or alter any expressed term of the contract. The contract also contained a fairly standard limited warranty and a limited remedy providing that the buyer's sole recourse was the replacement of the defective product.

In the arbitration proceeding the buyer sought consequential damages greatly in excess of the replacement costs, and attacked the warranty and remedy limitations as unconscionable. The arbitrator concluded that the exclusion of consequential damages would be unconscionable, based upon the lengthy course of dealing between the parties, the absence of any discussion concerning a warranty disclaimer or damage limitation and Nippon Carbide's superior bargaining position.

Nippon Carbide sought to overturn the arbitration award based on a claim that it was in excess of the arbitrator's powers. Its argument was founded on the contract clause prohibiting the arbitrator from varying the terms of the contract.

The court ruled against the manufacturer, noting that Nippon Carbide had never raised this issue with the arbitrator. By failing to raise a claim of limited powers with the arbitrator, Nippon Carbide had waived its right. In so doing it unequivocally submitted the issue of unconscionably to the arbitrator, and could not thereafter complain about the result.

The obvious moral of the story: it is imperative to raise all issues directly concerning the arbitrator's powers at the actual hearing.

But the case raises some other interesting issues. For example, was the manufacturer best served by an arbitration clause in this commercial context? Would it have done better if it had been able to bring its claim before a court, especially a federal court sitting in diversity jurisdiction? In that context would it have obtained a more favorable forum for consideration of the concept of unconscionability?

A second interesting issue: the court stated, with virtually no analysis, that an arbitrator's determination of “unconscionability” would in fact violate the arbitration agreement’s prohibition on the arbitrator modifying or altering the contract. This implies or suggests that the parties are free to indirectly waive the unconscionability protections of the Uniform Commercial Code by their use of an arbitration clause of the type found here. Did the court fully intend this result? Under the analysis suggested by this court, a party using an arbitration agreement could be free to impose contractual terms that would otherwise be oppressive, burdensome and unconscionable under the standards of the Uniform Commercial Code.

When your Mercedes-Benz C320 lurches, smells and clanks, check your “implied warranty” under Sections 2-314 and 2-315

An interesting appellate case upheld a jury verdict in favor of a woman who bought a new Mercedez-Benz C320. Isip v. Mercedes-Benz USA, LLC, (Sept. 12, 2007; Review Denied Nov. 28, 2007) 155 Cal. App. 4th 19.

The buyer’s new car soon car began to issue headache-inducing smells, lurch like a slingshot when shifting gears, hesitate and pull when slowing down, besides tugging, clanking, leaking and emitting white smoke. Nobody seemed to be able to fix it even though the car could be driven.

The buyer claimed breach of the implied warranty of merchantability applicable to consumer goods under the Federal Magnuson-Moss Warranty Act and California Song-Beverly Consumer Warranty Act. The jury found for the buyer after being instructed that to meet the implied warranty of merchantability, the car must be “in a safe condition and substantially free of defects.” Pp. 23, 25-26. Mercedez-Benz USA argued that the verdict should be reversed because the proper test of merchantability was the lower standard of whether the car was “unfit for ordinary transportation.” P. 25.

The court relied on the Uniform Commercial Code Sections to uphold the jury instructions. UCC Section 2-314 (Ca. Commercial Code 2314) provides that goods must be “merchantable” and “fit for the ordinary purpose” for which they are intended. UCC Section 2-315 (Ca. Commercial Code 2315) establishes an implied statutory warranty of fitness for a particular purpose. The court held that the “core test of merchantability” is “fitness for the ordinary purpose for which goods are used.”

Mere transportation from point A to point B did not meet the warranty of merchantability. The court rejected the lower “fitness for ordinary transportation” language. The buyer did not have to settle for a vehicle that “smells, lurches, clanks, and emits white smoke over an extended period of time.” P. 27. Especially when the buyer paid more than $46,000 for the car!

Judges Are Not Like Pigs: UCC 2-725 allows short 1-year statute of limitations for breach of warranty claim

What is the statute of limitations for breach of warranty claims? Under UCC 2-725 (1), the default limitations period is the later of four years from the breach, or one year from discovery. The parties can subsitute a shorter limitations period (at least in non-consumer settings).

California's version of UCC 2-725 (Ca. Comm. Code Section 2275(1)) provides a four year statute, but the statute accrues when the breach occurs regardless of knowledge of the breach. Ca. Comm. Code Section 2275(1), (2). This period can be shortened to one year by agreement of the parties (not restricted to non-consumer cases).

In a recently released unpublished opinion, Mendelson v. Country Coach, Inc., (Nov. 19, 2007) (U.S. D. Dt., Central Dist. of Ca., No. EDCV 06-00572-SGL (OPx), 2007 WL 4811927) the court came down on the side of the manufacturer of a motor home. Although the claim was to "enforce a warranty" under California's Magnuson-Moss Warranty Act, the court applied UCC 2-725 (California's version, Ca. Comm Code Section 2725). The court enforced a contract term that required "any action to enforce this express or any implied warranty" to one year of the "expiration of the warranty." The purchaser complained that the statute should have been tolled, or equitably estopped, while some forty attempts to repair the vehicle were undertaken. The court denied this argument, since the purchaser's evidence did not clearly establish that these involved the same or related problems. Judge Stephen G. Larson declined the purchaser's suggestion that he review the service record in evidence: "judges are not like pigs, hunting for truffles buried in the record" --quoting Albrechtsen v. Board of Regents of University of Wisconsin System, (7th Cir. 2002) 309 F. 3d 433, 476.

Interestingly, the opinion does not discuss a potential discrepancy between the one year limitations period contemplated by Section 2275(1) and the contract terms in the case. Section 2275 states the parties may reduce the limitations period to "not less than one year," presumably "after the cause of action has accrued." The Country Coach contract tied the one-year claims period to the "expiration of the warranty." The opinion appears to assume that, a breach of the warranty, if it occurs at all, would occur before the expiration of the warranty period. If the repair is unsuccessfully undertaken outside he warranty period, for a defect that first became apparent within the warranty period, one might argue that the breach ocurrred when the repair failed, and that the one-year period for a claim should accrue then. Under these circumstances, the contractual limitation of the period to one year from the expiration of the warranty might be unenforceable under California's Section 2275, as being less than one year from the date the breach accrued.

Take away for the manufacturer: make sure the contract includes a one-year limit on claims for breach of warranty.

Take away for the purchaser: (1) file a claim sooner, rather than later!; and (2) make sure you present a detailed explanation of all events that have any bearing on the occurrence of the breach, tolling while repairs of the same or related defect are underway, and any equitable estoppel, because "judges are not like pigs" and they don't want to root around in the record looking for evidence that may save your case.

UCC § 4A-505. Zengen is a Zinger! Recovering money taken with an unauthorized payment instruction.

UCC § 4A-505 requires a bank customer to “notify the bank of the customer’s objection” within one year.

Suppose your company employee forges the CEO’s name and faxes the bank payment instructions directing the bank to transfer funds into the employee’s own account. You want the bank to credit back the funds. Is it enough to tell the bank that the transfer was “fraudulent and unauthorized” like one defrauded bank customer did? In Zengen, Inc. v. Comerica Bank, 2007 WL 4424947 (Dec. 19, 2007), the court came down in favor of the bank and said, “NO.” The customer also should have informed the bank that it “objected” to the bank’s conduct in processing the transfer and should have specifically asked for the money to be transferred back into its account. The customer should also have notified the bank that it erred in following the established security procedures.

In other words, it is not enough to complain; you must ask for what you want. Don’t just notify the bank of the loss; ask for the money back or submit a claim. Since a bank is not necessarily liable for fraudulent or unauthorized funds transfers unless it fails to follow established security procedures, UCC § 4A-202(b), the court found that mere notification of a fraudulent or unauthorized transaction would not necessarily imply a claim against the bank.

Zenger is a Zinger for the customer. Most cases will not involve this situation because if a customer goes to the trouble of notifying the bank about an unauthorized funds transfer, the customer will also ask for the money to be credited back into the account.

The case was decided (in an unreported and uncitable decision) by the California Court of Appeal on remand from the California Supreme Court’s earlier decision in Zengen, Inc. v. Comerica Bank, (2007), 41 al. 4th 239, 59 Cal. Rptr. 3d 240. The case involved California’s UCC equivalent, California Commercial Code Section 11505.