CHAPTER 19

FORMATION AND TERMS OF SALES CONTRACTS

I. OBJECTIVES:

In chapters 8‑18, the student studied the common law rules that govern the creation and performance of contracts generally. This chapter, and the three that follow, build on that discussion and focus on the law codified in Article 2 of the Code that governs the sale of goods. The focus in this chapter is on the rules that govern the formation of sales contracts and the key terms provided by the Code. After reading the chapter and attending class, a student should:

A. Appreciate the fundamental changes made in contract law by Article 2 of the Code, understand the purposes of such changes.

B. Recognize when a transaction is covered by the Code.

C. Understand the concept of title and know when a person may pass greater title than he possesses.

D. Know who has the risk of loss, especially as determined by the delivery terms of the contract.

E. Recognize when a party to a contract has an insurable interest.

F. Know who has title, risk of loss, and other rights and duties when goods are sold‑on‑approval, sale‑or‑return, or consignment.

II. ANSWER TO INTRODUCTORY PROBLEM

A. The first question following the hypothetical that appears at the beginning of the chapter asks whether an enforceable contract can be formed electronically. Under the federal Electronic Signatures in Global and National Commerce Act (the “E-sign act”), which preempts conflicting state law (such as the Article 2 requirement for a “signed writing” as one means of satisfying the statute of frauds), parties may use electronic authentications in lieu of “signed writings.” Moreover, in the relatively few states that have adopted the Uniform Electronic Transactions Act (UETA) online communications can satisfy the Section 2-201 statute of frauds requirement. See Cyberlaw in Action: Electronic Writings and the Statute of Frauds (page 415).

B. The second question asks whether the buyer or the seller of the bicycle had the risk of loss when it was damaged during shipment. Where the seller has not agreed to deliver the goods to the buyer, the general rule is that the seller retains the risk of loss until it has placed the goods in the hands of the carrier. If a Trek employee was loading the box on the carrier’s truck, then Trek would still have the risk of loss. If the bicycle was already in the hands of the carrier, then, Paul would have the risk of loss and must pursue the carrier to recover for the damage done to the bicycle. Another issue that might arise is whether the Trek properly prepared the bicycle for shipping, i.e. used reasonable packaging material or whether the packaging left the bicycle particularly vulnerable to damage during shipment,; in the later case, the risk of loss might have remained with Trek.

C. The third question asks whether the owner of a bicycle that had been entrusted to a bicycle shop for repairs and was then sold by mistake to another customer could recover the bicycle from the customer. Under 2-403(3) where goods are entrusted to a merchant who deals in goods of that kind, the merchant has the power to transfer all rights of the entruster to a buyer in the ordinary course of business. Thus, in this case Paul would not be able to recover the bicycle from Melissa and her boyfriend; rather Paul would have to pursue an action for conversion against the bicycle shop.

III. SUGGESTIONS FOR LECTURE PREPARATION:

A. Introduction

1. Purpose of Article 2 of the Code. Set the stage for the discussion of the law of sales by pointing out that Article 2 is a legislative amendment of the common law of contracts. Note that the primary purpose of Article 2 is to eliminate the technical requirements of contract law that created results not consistent with the reasonable expectations of the parties to a commercial transaction.

2. Coverage of Article 2. Explain when Article 2 applies to a commercial transaction, noting that when Article 2 does not apply, the law of contracts does apply. Ask the students whether Article 2 or contract law applies to each of the following transactions:

a. Sale of a house. (Contract law)

b. Sale of 1,000 books by a publisher to a bookstore. (Article 2)

c. Sale of a book from a consumer to a consumer. (Article 2)

d. Retaining an accountant to provide tax counseling. (Contract law)

e. Problem Case #1. (Contract law).

Baxter v. Maurice’s Auto Repair and Towing Service, Inc. (page 411). Where the owner of an automobile had a rebuilt engine installed in the car by an auto repair shop, the contract was deemed to be a “mixed contract” for the sale of goods and services. The court applied both a “labeling” test (assessing whether the invoice provided for the sale or goods or for the provision of repair services) and the “predominant factor” test to see whether the UCC or contract law would apply to the transaction. The court concluded that under both tests the transaction should be deemed a sale of services with the auto parts a necessary incidental to that service.

Points for discussion. Should the court have considered the relative cost of the “repair services” and the “rebuilt engine” in determining whether this transaction should be considered one for the sale of goods?

3. Note that some of the Code provisions apply only to merchants or to transactions between merchants and that many of the provisions incorporate the concepts of good faith and commercially reasonable behavior.

4. Formation of Contracts. Review the rules concerning offer and acceptance of sales contracts (and the Code rules) which were discussed in Chapters 10 and 11 concerning formation.

5. Review initially the rules concerning offer and acceptance of sales. Note that a contract for the sale of goods is created despite the omission of other terms if the subject matter and the quantity are specified. In this regard you should point out that even the quantity may be somewhat uncertain, if the contract is a requirements or output contract. Other omitted terms, it should be noted will be supplied by reference to Code conventions. Explain the purpose of such a flexible law: to ensure that the parties are not disappointed when they have a reasonable expectation that a binding commitment exists.

Indiana-American Water Co., Inc. v. Town of Seelyville (page 415). The court first held that the contract between the water company and the town should be viewed as an exclusive requirements contract as opposed to an illusory contract calling for the sale of indefinite quantities of water. Then the court held it was not bad faith for the buyer to take advantage of the fact it might reduce its requirements through exploitation of its own water resources which it had acquired prior to entering the requirements contract.

Points for discussion: Would the result have been different if the town had acquired the well-field after it had entered into the requirements contract? Note that there was a upper limit on the amount the water company might be required to sell to the town. How should that factor into what is deemed to be “bad faith” on the part of the town?

C. Title

1. Explain in lay language what is meant by title. One way to explain title is to say the person with title has the power to obtain all rights with respect to the property.

2. When Title Passes. Explain when title passes, the historical importance of that determination, and the decreased importance of when title passes under present law.

State of Connecticut v. Cardwell (page 419). Where the contracts for the sale of tickets to various events being held in the state of Connecticut were made by a seller from its office in Massachusetts and the contracts did not call for the seller to deliver the goods to a particular destination or to bear the risk of loss until the goods were delivered, the contracts were deemed to be “shipment” contracts. Accordingly, the “sale” occurred in Massachusetts and did not violate a Connecticut law against ticket scalping.

Points for discussion: What changes in the facts would create a “destination” contract?

Example for Discussion: Cyberlaw in Action: Buying Beer on the Internet (page 418).

Additional Example: Problem Case #2.

D. Title and Third Parties.

First, state the general rule that a person can convey no greater title than that held by him or the person for whom he is acting. Next list the exceptions to the general rule. Ask the students who has title in the following situations:

1. Ted steals a television from Valerie. Ted sells the TV to Robert's Used TV Sales, which buys in good faith. Robert's sells the TV to Caren, who is a buyer in the ordinary course of business. (Valerie).

2. Mark takes his stereo to Stan's Stereo Store for repair work. Stan's negligently puts the stereo on its display floor, where Calvin, a buyer in the ordinary course of business, purchases the stereo. (Calvin)

3. Same as #2, except that Stan's sells the stereo to Helen's Hi‑Fi Store. (Mark).

Discuss the difference between a void and a voidable title.

Alsafi Oriental Rugs v. American Loan Co. (p. 420). Where an individual, through fraudulent representations, convinced a rug dealer to give her possession of some oriental rugs "on consignment," the individual had voidable title to the rugs and the power to transfer good title to a good faith purchaser for value.

Points for Discussion: Is this an equitable result? Who was in the best position to avoid the harm in this case?

Additional Examples: Problem Cases #3 and #4.

Ethics in Action: Perils of Entrusting Goods (page 423): This question raises the issue of whether the storeowner should go beyond that which he or she is legally required to do (i.e. to pay the original owner/entruster the value of the ring that was converted by selling it) in light of the special value it had to the entruster; for example, would you offer the buyer extra compensation or a special deal on an alternative if he would return it? For the buyer it raises the question of whether he should surrender his legal right to keep the ring in light of the circumstances of the sale and the special meaning it has for the entruster.

E. Risk of Loss

1. Explain the importance of risk of loss and point out that risk of loss does not always pass from the seller to the buyer when title passes. You should carefully define the various terms of shipment, and state when risk of loss passes pursuant to each term of shipment. The student should understand under what circumstances (1) a ‘shipment’ contract and (2) a ‘destination’ contract are created, when the risk of loss shifts in each type of contract, and what the rationale is for shifting the risk at that point. The student should also understand when the risk of loss shifts in a situation where the goods are being held by a bailee and where the delivery takes place without moving the goods.

Windows, Inc. v. Jordan Panel Systems Corp. (page 423). Where the contract for custom-built windows did not require the seller to deliver the windows to the buyer, the seller completed its obligation with respect to the windows when it delivered the windows to the carrier that was to take them to the buyer. Accordingly, the buyer had the risk of loss during transit, and when the goods were damaged during that time, the buyer’s recourse was against the carrier.

Points for Discussion: Ask the students why the law prefers shipment contracts over destination contracts. What should the parties have done if they wanted to create a destination contract? Ask the students when title to the windows passed in this case. Ask them who had an insurable interest in the windows during shipment.

2. Insurable interest should be explained. It should be noted that both the buyer and the seller can have an insurable interest at the same time.

3. You may want to ask when title passes, when risk of loss passes, and when the buyer has an insurable interest in each of the following situations. This exercise will aid student understanding of these three concepts.

a. Problem Case #5.

b. Problem Case #6.

c. Problem Case #7.

4. The Global Business Environment: Risk of Loss in International Sales (page 427): Note the four categories of widely used international shipping terms that are set forth in the “INCOTERMS” document published by the International Chamber of Commerce. Emphasize that these terms are commonly used by parties engaged in international sales of goods and incorporated into contracts that otherwise are governed by the Convention on Contracts for International Sale of Goods (CISG).

F. Sales on Trial

1. Develop the differences between a sale on approval, a sale on return and a consignment as to (1) how they originate, (2) where risk of loss lies between the seller and the buyer and (3) what the relative rights of the buyer, seller and creditors of the buyer are. Discuss what the seller needs to do to protect his rights under each type of sales arrangement.

Regarding consignments you should note the seller's need to file a financing statement and to post notice of the consignment to protect its title in the goods.

In Re Auclair (page 428). Where guns were delivered to the Auclairs on consignment for purpose of resale, the guns were subject to the claims of the Auclairs' creditors. None of the exceptions provided in section 2-326 of the Code were applicable: (1) Alabama has no sign law; (2) the Auclairs were not known to their creditors to be generally in the business of selling goods of others; and (3) Jackson and King had not complied with the Article 9 provisions for public filing of their security interest.

Points for Discussion: Why should the Auclairs' creditors have a better right to the guns than Jackson and King? What policy considerations are involved in this legal choice? What should Jackson and King have done to protect themselves?