This Document Contains Chapters 25 to 26 Chapter 25 SALES REMEDIES Remedies of the Seller [25-1] Withhold Delivery of the Goods [25-1a] Stop Delivery of the Goods [25-1b] Identify Goods to the Contract [25-1c] Resell the Goods and Recover Damages [25-1d] Recover Damages for Nonacceptance or Repudiation [25-1e] Recover the Price [25-1f] Recover Incidental Damages [25-1g] Cancel the Contract [25-1h] Reclaim the Goods upon the Buyer’s Insolvency [25-1i] Remedies of the Buyer [25-2] Cancel the Contract [25-2a] Recover Payments Made [25-2b] Cover [25-2c] Recover Damages for Nondelivery or Repudiation [25-2d] Recover Identified Goods on the Seller’s Insolvency [25-2e] Sue for Replevin [25-2f] Sue for Specific Performance [25-2g] Enforce a Security Interest in the Goods [25-2h] Recover Damages for Breach in Regard to Accepted Goods [25-2i] Recover Incidental Damages [25-2j] Recover Consequential Damages [25-2k] Contractual Provisions Affecting Remedies [25-3] Liquidation or Limitation of Damages [25-3a] Modification or Limitation of Remedy by Agreement [25-3b] Statute of Limitations [25-3c] Cases in This Chapter Kenco Homes, Inc. v. Williams. Bigelow-Sanford, Inc. v. Gunny Corp. Midwest Hatchery v. Doorenbos Poultry Coastal Leasing Corporation v. T-Bar S Corporation Chapter Outcomes After reading and studying this chapter, the student should be able to: • Identify and explain the goods-oriented remedies of the seller and the buyer. • Identify and explain the obligation-oriented remedies of the seller and the buyer. • Identify and explain the money-oriented damages of the seller and the buyer. • Identify and explain the “specific performance” remedies of the seller and the buyer. • Describe the basic types of contractual provisions affecting remedies and the limitations that the Uniform Commercial Code imposes upon those provisions. TEACHING NOTES At any stage of a contract for the sale of goods, either party may breach or repudiate the contract; the seller may deliver defective goods, too few (or too many) goods, the wrong goods, or no goods; the buyer may refuse to accept conforming goods or fail to pay for conforming goods. Breach may occur when the goods are in the possession of the seller, in the possession of a bailee of the buyer, in transit to the buyer, or in the possession of the buyer. Remedies, therefore, need to address both the type of breach of contract and the location of the goods. Consequently, the Code provides separate and distinct remedies for the seller and for the buyer, each specifically keyed to the type of breach and the situation of the goods. In all events, the purpose of the Code is to put the aggrieved party in a position as good as the one he would have been in, had the other party fully performed, and therefore provides that its remedies be administered liberally. The purpose of remedies under the Code is compensation; therefore, punitive damages are generally not available. CISG — Damages for breach of contract consist of the loss, including loss of profit; may not exceed the loss which the party in breach foresaw or should have foreseen as a possible consequence of the breach. The aggrieved party must take reasonable measure to mitigate the loss; if he fails to do so, the party in breach may claim a reduction in damages. *** Chapter Outcome (part 1)*** Identify and explain the goods-oriented remedies of the seller. Identify and explain the obligation-oriented remedies of the seller. Identify and explain the money-oriented damages of the seller. Identify and explain the “specific performance” remedies of the seller. 25-1 REMEDIES OF THE SELLER The buyer’s breach may consist of any of the following acts: • wrongfully rejecting the goods • wrongfully revoking acceptance of the goods • failing to make a payment due on or before delivery • repudiating (indicating an intention not to perform) the contract in whole or in part The first three and the ninth of the remedies described below are goods-oriented — that is, they relate to the seller’s exercising control over the goods. The fourth through seventh remedies are money-oriented because they provide the seller with the opportunity to recover monetary damages. The eighth remedy is obligation-oriented because it allows the seller to avoid his obligation under the contract. NOTE: A summary of these remedies of the seller may be found in Figure 25-1. CISG — If buyer fails to perform, seller may require buyer to pay the price or may fix an additional period of time in which buyer must perform. Unless buyer informs seller that he will not perform during this time, seller may not resort to any remedy for breach. If the breach is fundamental or if buyer fails to perform, seller may avoid contract and has the right to damages. 25-1a Withhold Delivery of the Goods A breach by the buyer will permit the seller to withhold the goods. In an installment contract a buyer’s breach as to any separate delivery which impairs the value of the entire contract will permit the seller to withhold the rest. 25-1b Stop Delivery of the Goods A seller may stop goods in transit if the buyer is insolvent or repudiates the contract. This right is terminated if a) the buyer receives the goods, b) a bailee of the goods (not a common carrier) informs the buyer that the goods are being held on the buyer’s behalf, c) the carrier acknowledges to the buyer that he holds the goods for the buyer by reshipment or as warehouser, or d) a negotiable document of title is transferred to the buyer. 25-1c Identify Goods to the Contract Upon buyer’s breach seller may identify goods to the contract. Any unfinished goods may be either (1) completed and identified to the contract or (2) not completed and sold as scrap. 25-1d Resell the Goods and Recover Damages A proper resale of goods made in good faith and in a commercially reasonable manner will permit the seller to recover from the buyer the difference between the resale price and the contract price plus incidental damages less expenses saved. Resale may be public or private; seller must give the buyer notification of private sale. Only identified goods may be sold in public sales “except where there is a recognized market for a public sale of future goods of the kind involved.” Public sales are to be conducted in the usual place, and the buyer must receive reasonable notice unless the goods are perishable and will lose value rapidly. CISG — if contract is avoided and seller has resold goods in a reasonable manner and time, he may recover difference between contract price and resale price, plus consequential damages. 25-1e Recover Damages for Nonacceptance or Repudiation As an alternative to selling the goods the seller may recover as damages the difference between the market price at the time and place of tender and the unpaid contract price. Incidental damages are also available minus any expenses saved. Lost profits plus reasonable overhead may be recovered if the previous recovery formula will not put the seller in as good a position as performance would have. CISG — if the contract is avoided and seller has not resold goods, he may recover difference between contract price and the current price at the time of the avoidance and at the place where delivery of goods should have been made, plus consequential damages. CASE 25-1 KENCO HOMES, INC. v. WILLIAMS Court of Appeals of Washington, Division Two, 1999 94Wn.App.219, 972 P.2d 125 http://scholar.google.com/scholar_case?case=2280470166169778873&q=972+p.2d+125&hl=en&as_sdt=2,34 Morgan, J. Kenco Homes, Inc., sued Dale E. Williams and Debi A. Williams, husband and wife, for breaching a contract to purchase a mobile home. After a bench trial, the trial court ruled primarily for Williams. Kenco appealed, claiming the trial court used an incorrect measure of damages. We reverse. Kenco buys mobile homes from the factory and sells them to the public. Sometimes, it contracts to sell a home that the factory has not yet built. It has “a virtually unlimited supply of product,” * * * On September 27, 1994, Kenco and Williams signed a written contract whereby Kenco agreed to sell, and Williams agreed to buy, a mobile home that Kenco had not yet ordered from the factory. The contract called for a price of $39,400, with $500 down. The contract contained two conditions pertinent here. According to the first, the contract would be enforceable only if Williams could obtain financing. According to the second, the contract would be enforceable only if Williams later approved a bid for site improvements. Financing was to cover the cost of the mobile home and the cost of the land on which the mobile home would be placed. The contract provided for damages. It stated, “I [Williams] understand that you [Kenco] shall have all the rights of a seller upon breach of contract under the Uniform Commercial Code, except the right to seek and collect ‘liquidated damages’ under Section 2–718.” The contract provided for reasonable attorney’s fees. * * * In early October, Williams accepted Kenco’s bid for site improvements. As a result, the parties (a) formed a second contract and (b) fulfilled the first contract’s site-improvement-approval condition. Also in early October, Williams received preliminary approval on the needed financing. On or about October 12, Williams gave Kenco a $600 check so Kenco could order an appraisal of the land on which the mobile home would be located. Before Kenco could act, however, Williams stopped payment on the check and repudiated the entire transaction. His reason * * * was that he “had found a better deal elsewhere.” When Williams repudiated, Kenco had not yet ordered the mobile home from the factory. After Williams repudiated, Kenco simply did not place the order. As a result, Kenco’s only out-of pocket expense was a minor amount of office overhead. On November 1, 1994, Kenco sued Williams for lost profits. After a bench trial, the superior court found that Williams had breached the contract; that Kenco was entitled to damages; and that Kenco had lost profits in the amount of $11,133 ($6,720 on the mobile home, and $4,413 on the site improvements). The court further found, however, that Kenco would be adequately compensated by retaining Williams’ $500 down payment; that Williams was the prevailing party; and that Williams should receive reasonable attorney’s fees in the amount of $1,800. Because Kenco had already received its $500, the court entered an $1,800 judgment for Williams, and Kenco filed this appeal. In this court, Williams does not contest the trial court’s finding that he breached the contract. Thus, the only issues are (1) whether the superior court used the correct measure of damages, and (2) whether the superior court properly awarded attorneys’ fees to Williams. I Under the Uniform Commercial Code (UCC), a non-breaching seller may recover “damages for non-acceptance” from a breaching buyer. [UCC §2–703(e)] The measure of such damages is as follows: (1) * * * 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 ([UCC §] 2–710), but less expenses saved inconsequence 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 ([UCC §] 2–710), due allowance for costs reasonably incurred and due credit for payments or proceeds of resale. [UCC §] 2–708. * * * [T]he statute’s purpose is to put the nonbreaching seller in the position that he or she would have occupied if the breaching buyer had fully performed (or, in alternative terms, to give the nonbreaching seller the benefit of his or her bargain). [UCC §] 1–106(1). A party claiming damages under subsection (2) bears the burden of showing that an award of damages under subsection (1) would be inadequate. [Citation.] In general, the adequacy of damages under subsection (1) depends on whether the nonbreaching seller has a readily available market on which he or she can resell the goods that the breaching buyer should have taken. [Citation.] When a buyer breaches before either side has begun to perform, the amount needed to give the seller the benefit of his or her bargain is the difference between the contract price and the seller’s expected cost of performance. Using market price, this difference can, in turn, be subdivided into two smaller differences: (a) the difference between the contract price and the market price, and (b) the difference between the market price and the seller’s expected cost of performance. So long as a nonbreaching seller can reasonably resell the breached goods on the open market, he or she can recover the difference between contract price and market price by invoking subsection (1), and the difference between market price and his or her expected cost of performance by reselling the breached goods on the open market. Thus, he or she is made whole by subsection (1), and subsection (1) damages should be deemed “adequate.” But if a nonbreaching seller cannot reasonably resell the breached goods on the open market, he or she cannot recover, merely by invoking subsection (1), the difference between market price and his or her expected cost of performance. Hence, he or she is not made whole by subsection (1); subsection (1) damages are “inadequate to put the seller in as good a position as performance would have done;” and subsection (2) comes into play. The cases illustrate at least three specific situations in which a nonbreaching seller cannot reasonably resell on the open market. In the first, the seller never comes into possession of the breached goods; although he or she plans to acquire such goods before the buyer’s breach, he or she rightfully elects not to acquire them after the buyer’s breach. [Citation.] In the second, the seller possesses some or all of the breached goods, but they are of such an odd or peculiar nature that the seller lacks a post-breach market on which to sell them; they are, for example, unfinished, obsolete, or highly specialized. [Citations.] In the third situation, the seller again possesses some or all of the breached goods, but because the market is already oversupplied with such goods (i.e., the available supply exceeds demand), he or she cannot resell the breached goods without displacing another sale. [Citations.] [Court’s footnote: In passing, we observe that this lost volume situation can be described in several ways. Focusing on the breached unit, one can say that due to a market in which supply exceeds demand, the lost volume seller cannot resell the breached unit without sacrificing an additional sale. Focusing on the additional unit, one can say that but for the buyer’s breach, the lost volume seller would have made an additional sale. Focusing on both units, one can say that but for the buyer’s breach, the lost volume seller would have sold both units. Each statement is equivalent to the others.] Frequently, these sellers are labeled “jobber,” “components seller,” and “lost volume seller,” respectively, [citation]; in our view, however, such labels confuse more than clarify. * * * In this case, Kenco did not order the breached goods before Williams repudiated. After Williams repudiated, Kenco was not required to order the breached goods from the factory, [UCC §§2–703, 2–704(2)]; it rightfully elected not to do so; and it could not resell the breached goods on the open market. Here, then, “the measure of damages provided in subsection (1) is inadequate to put [Kenco] in as good a position as [Williams’] performance would have done;” [UCC §2–708] subsection (2) states the applicable measure of damages; and Kenco is entitled to its lost profit of $11,133. II The second issue is whether Kenco is entitled to reasonable attorneys’ fees. The parties’ contract provided that the prevailing party would be entitled to such fees. Kenco is the prevailing party. On remand, the trial court shall award Kenco reasonable attorneys’ fees incurred at trial and on appeal. Reversed with directions to enter an amended judgment awarding Kenco its lost profit of $11,133; reasonable attorneys’ fees incurred at trial and on appeal; and any ancillary amounts required by law. 25-1f Recover the Price A seller may recover the price (1) upon the buyer’s acceptance, (2) where conforming goods are lost or damaged after the risk of loss has passed to the buyer, and (3) where identification has occurred and there is no ready resale market. The seller must hold identified goods for the buyer. CISG — seller may require buyer to pay the price, take delivery or perform other obligations unless the seller has resorted to a remedy that is inconsistent with this requirement. 25-1g Recover Incidental Damages Recoverable on buyer’s breach and includes commercially reasonable charges, expenses or commissions directly resulting from the breach. 25-1h Cancel the Contract Where the buyer wrongfully rejects or revokes acceptance of the goods, fails to make a payment due on or before delivery, or repudiates the contract in whole or in part, the seller may cancel the part of the contract that concerns the goods directly affected. Cancellation effects a discharge of contract duties while preserving the right to any appropriate remedies. CISG — seller may declare the contract avoided if buyer commits fundamental breach, or if buyer does not, within an additional time, pay price or take delivery. Avoidance releases both parties, but does not affect any provision for the settlement of disputes or any provision governing the rights and obligations consequent upon the avoidance of the contract. 25-1i Reclaim the Goods upon the Buyer’s Insolvency The seller may demand return of the goods if the buyer is insolvent and the request is made within ten days of the date that the buyer received the goods. In cases where the buyer perpetrated a fraud as to her insolvency in writing and within three months of delivery, the ten day rule is inapplicable. Reclaiming goods excludes a seller from any other remedies with respect to those goods. NOTE: See Figure 25-1: Remedies of the Seller. *** Chapter Outcome (part 2)*** Identify and explain the goods-oriented remedies of the buyer. Identify and explain the obligation-oriented remedies of the buyer. Identify and explain the money-oriented damages of the buyer. Identify and explain the “specific performance” remedies of the buyer. 25-2 REMEDIES OF THE BUYER A seller’s breach may consist of: • repudiation of the contract • failure to deliver the goods • delivery or tender of goods that do not conform to the contract Some remedies are available for all three types of breaches, but others are available for only one type. The first remedy listed below is obligation-oriented; the second through fourth and ninth through eleventh are money-oriented; and the fifth through eighth are goods-oriented. NOTE: A summary of these remedies of the buyer may be found in Figure 25-2: Remedies of the Buyer. CISG — If the seller fails to perform, buyer may require seller to perform or fix an additional period of time for the seller to perform. Unless the seller informs buyer that he will not perform during this time, buyer may not resort to any remedy for breach. If the breach is fundamental or if buyer fails to perform, seller may avoid contract and has the right to damages. If goods are nonconforming, the buyer may reduce the price accordingly. 25-2a Cancel the Contract The buyer may cancel the contract with respect to the goods involved if the seller repudiates, or fails to deliver, or if the buyer rightfully rejects or justifiably revokes acceptance of the goods. If a breach by the seller concerns the whole contract, the buyer may cancel the entire contract. The buyer must give the seller notice of his cancellation, and is then excused from further performance or tender on his part. CISG — buyer may declare the contract avoided if seller commits fundamental breach, or if seller does not, within an additional time, deliver the goods. Avoidance releases both parties, but does not affect any provision for the settlement of disputes or any provision governing the rights and obligations consequent upon the avoidance of the contract. 25-2b Recover Payments Made If seller breaches the contract, buyer may recover as much of the price as he has already paid. 25-2c Cover Permits the buyer to purchase substitute goods following seller’s breach. The buyer must act in good faith and without unreasonable delay. Cover is an elective choice and is not required of the buyer, but the buyer may not recover consequential damages if they could have prevented by cover. The buyer may recover the difference between the cost of cover and the contract price, plus incidental and consequential damages less expenses saved. CISG — if contract is avoided and buyer has replaced goods in a reasonable manner and time, he may recover difference between contract price and price paid for replacement goods, plus consequential damages. CASE 25-2 BIGELOW-SANFORD, INC. v. GUNNY CORP. United States Court of Appeals, Fifth Circuit, Unit B, 1981 649 F.2d 1060 http://scholar.google.com/scholar_case?q=649+F.2d+1060&hl=en&as_sdt=2,34&case=1321952788859215 37&scilh=0 Kravitch, J. [The plaintiff, Bigelow-Sanford, Inc., contracted with defendant Gunny Corp. for the purchase of 100,000 linear yards of jute at $0.64 per yard. Gunny delivered 22,228 linear yards in January 1979. The February and March deliveries required under the contract were S not made, though 8 rolls (each roll containing 66.7 linear yards) were delivered in April. With 72,265 linear yards undelivered, Gunny told Bigelow-Sanford that no more would be delivered. In mid-March, Bigelow-Sanford turned to the jute spot market to replace the balance of the order at a price of $1.21 per linear yard. Since several other companies had also defaulted on their jute contracts with Bigelow-Sanford, the plaintiff purchased a total of 164,503 linear yards on the spot market. Plaintiff sues defendant to recover losses sustained as a result of the breach of contract.] * * * Gunny contends that appellee’s [Bigelow-Sanford] alleged cover purchases should not have been used to measure damages in that they were not made in substitution for the contract purchases, were not made seasonably or in good faith and were not shown to be due to Gunny’s breach. [W]e disagree. * * * UCC §2–712 defines cover: (1) After a breach * * * 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 * * *, 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. * * * Most importantly, “whether a plaintiff has made his cover purchases in a reasonable manner poses a classic jury issue.” [Citation.] The district court thus acted properly in submitting the question of cover damages to the jury, which found that Gunny had breached, appellee had covered, and had done so in good faith without unreasonable delay by making reasonable purchases, and was therefore entitled to damages under §2–712. Gunny argues Bigelow is not entitled to such damages on the ground that it failed to make cover purchases without undue delay and that the jury should not have been permitted to average the cost of Bigelow’s spot market purchases totalling 164,503 linear yards in order to arrive at the cost of cover for the 72,265 linear yards Gunny failed to deliver. Both arguments fail. Gunny notified Bigelow in February that no more jute would be forthcoming. Bigelow made its first spot market purchases in mid-March. Given that it is within the jury’s province to decide the reasonableness of the manner in which cover purchases were made, we believe the jury could reasonably decide such purchases, made one month after the date the jury assigned to Gunny’s breach, were made without undue delay. The same is true with respect to Gunny’s second argument: Bigelow’s spot market purchases were made to replace several vendors’ shipments. Bigelow did not specifically allocate the spot market replacements to individual vendors’ accounts, however, nor was there a requirement that they do so. The jury’s method of averaging such costs and assigning them to Gunny in proportion to the amount of jute if [sic] failed to deliver would, therefore, seem not only fair but well within the jury’s permissible bounds. * * * [Judgment for Bigelow is affirmed.] 25-2d Recover Damages for Nondelivery or Repudiation Available if the buyer doesn’t cover. Damages are difference between the market price at the time when the buyer learned of the breach and the contract price, plus incidentals and consequential damages less expenses saved. (May not recover consequential damages if they could have avoided by cover.) CISG — if the contract is avoided and seller has not replaced goods, he may recover difference between contract price and the current price at the time of the avoidance and at the place where delivery of goods should have been made, plus consequential damages. 25-2e Recover Identified Goods on the Seller’s Insolvency If some or all of the purchase price has been prepaid, a buyer acquires a special property interest in identified goods and may recover the goods from a seller who has become insolvent within ten days following receipt of the first installment of the price. This special property interest exists even if the goods are nonconforming and the buyer would have the right to return or reject them. To exercise this remedy, the buyer must tender to the seller any unpaid portion of the price. 25-2f Sue for Replevin Allows buyer to recover specific identified goods being held unlawfully by the seller. The buyer must have been unable to cover or the goods must have been shipped with a security interest reserved in the seller and satisfaction of the interest previously tendered. 25-2g Sue for Specific Performance Specific performance is an equitable remedy compelling the party in breach to perform the contract according to its terms. Specific performance is available if legal remedies are inadequate, where goods are unique, or in other proper circumstances. CISG — buyer may require seller to perform; if goods do not conform and nonconformity constitutes a fundamental breach, buyer may require substitute goods or may require remedy by repair, if reasonable. A court is not bound to enter a judgment for specific performance unless it would do so under its own law outside of the provisions of the CISG. 25-2h Enforce a Security Interest in the Goods A buyer having possession of goods following a rightful rejection or revocation will have a security interest in the goods adequate to the extent of any expenses incurred and for any part of the price paid to the seller. The buyer may hold such goods and resell them in the same manner as an aggrieved seller may resell goods and then return the proceeds beyond the amount of her security interest to the seller. 25-2i Recover Damages for Breach in Regard to Accepted Goods Damages are available to the buyer who accepts the goods and then gives timely notification of breach due to non-conforming goods or breach of warranty. In breach of warranty the measure of damages is the difference at the time and place of acceptance between the value of the goods that have been accepted and the value that the goods would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount. Where appropriate, incidental and consequential damages may also be recovered. CASE 25-3 MIDWEST HATCHERY v. DOORENBOS POULTRY Court of Appeals of Iowa, 2010 783 N.W.2D 56 http://scholar.google.com/scholar_case?q=783+N.W.2d+56&hl=en&as_sdt=2,34&case=17039907567362199216&scilh=0 Zimmer, S.J. Doorenbos Poultry, Inc., is a company that keeps chickens for egg production, and sells the eggs. The company conducts its business at two barn facilities in Sioux County [Iowa]. One of the barns can house 112,000 birds and the other has a capacity of 134,000. The evidence presented at trial reveals that hens generally do not begin laying eggs until they are seventeen or eighteen weeks old. They reach their peak production at approximately twenty-six weeks and are generally most productive in laying eggs between the ages of twenty to eighty weeks old. At about eighty weeks, the chickens molt and go through a period where they are less productive. After that, they usually continue producing eggs until they are about 110 weeks old. The practice of Doorenbos Poultry has been to keep all chickens of a single age group through their productive life, and then simultaneously replace those birds with new chickens that are seventeen to eighteen weeks old. This practice maximizes production and continues some cash flow without interruption. Midwest Hatchery & Poultry Farms, Inc. is a producer and seller of poultry products. Midwest sells hatch eggs, baby chicks, and started pullets, which are female hens that have reached the age of laying eggs. In the fall of 2006, Doorenbos Poultry entered into a written contract with Midwest, to purchase 112,000 pullets (young hens) of the Hy-Line W-36 variety, at eighteen weeks of age, to be delivered on December 28, 2006. The contract listed a price of $1.27 per pullet, plus the cost of feed from the time of hatching to the date of delivery. The contract provided, “Deliveries are subject to availability of the Products, availability of transportation, and availability due to demand from Seller’s other customers.” The contract also provided, “If Seller breaches this Contract, at Seller’s option, customer is entitled to either replacement or refund of the price paid by Customer.” Prior to the delivery date of December 28, 2006, Midwest notified Doorenbos Poultry it would be unable to deliver the chickens ordered on the date contemplated by the parties’ contract. Doorenbos Poultry agreed to the delay, and cancelled arrangements to slaughter the approximately 110,000 chickens it had in one of its facilities at that time. Over January 16, 17, and 18, 2007, Midwest delivered 115,581 pullets to Doorenbos Poultry. As the new chicks arrived, the old pullets were moved out. Scott Doorenbos, the president of Doorenbos Poultry, thought the new chickens looked small. Because of his concerns, he had two of the delivery trucks weighed before the pullets were unloaded. Doorenbos concluded the birds delivered were thirteen to fourteen weeks of age rather than eighteen weeks. Doorenbos testified he could not cancel the order and return the chickens because his former flock had already been removed. He explained that the barns in which the chickens are kept do not have heating. Because the buildings maintain their temperature from the body heat of the birds, Doorenbos believed the water lines in the barn would have frozen if he had not kept the pullets. Doorenbos testified the pullets delivered by Midwest did not start laying eggs until February 18, 2007. From the time the pullets were delivered and the existing flock was removed until the pullets reached their “laying” phase, Doorenbos Poultry incurred feeding and other maintenance costs for the pullets with no egg production to generate revenue. * * * When this case was tried to the court in late September 2008, Doorenbos Poultry had kept the pullets delivered by Midwest in production through 117 weeks and was intending to keep them in production until at least 119 weeks. On January 20, 2007, Midwest sent Doorenbos Poultry an invoice for $267,916.76, which represented $146,787.87 for the cost of 115,581 pullets, $112,460.31 for feed, and $8,668.58 for vaccine. Doorenbos Poultry did not pay for the birds Midwest delivered when it received the invoice. Doorenbos Poultry contacted Midwest within thirty days after the pullets were delivered and complained that it had not received chickens that were eighteen weeks old, as specified in the contract. Because it believed the chickens were younger than eighteen weeks, Doorenbos Poultry sought a reduction in the contract price. It stated it lost income while the chickens were not mature enough to lay eggs. Doorenbos Poultry did not seek to have any of the pullets replaced. * * * * * * On August 19, 2007, Doorenbos Poultry sent Midwest a check for $184,135.18, which was what it believed should have been the cost for the younger pullets. Doorenbos Poultry never returned any chickens to Midwest. [On September 14, 2007, Midwest filed an action for a money judgment alleging breach of contract. Doorenbos Poultry responded with a counterclaim alleging breach of contract by Midwest. The parties waived their right to a jury trial, and their case was tried to the court. In a decision filed January 9, 2009, the district court concluded that about 80 percent of the pullets were three weeks too young, and about 20 percent were four weeks too young. The district court determined that (1) this action was governed by the Uniform Commercial Code (UCC); (2) because Doorenbos had accepted and kept the pullets, Midwest is entitled to the unpaid balance of the contract price; and therefore (3) Doorenbos Poultry was liable for the full amount billed by Midwest Hatchery, meaning it still owed $83,781.58 for the pullets that had been delivered. The court also concluded that (1) Doorenbos Poultry’s acceptance of the pullets did not preclude its breach of contract claim against Midwest; (2) Midwest had breached the contract by providing pullets that were not of the specified age; (3) the limitation of damages clause in the parties’ contract failed in its essential purpose; and (4) Doorenbos Poultry had lost profits of $31,732.79 because it was not able to replace its existing flock with eighteen-week-old birds. The court set off the amount of the loss against the balance Doorenbos Poultry still owed Midwest and entered judgment against Doorenbos Poultry for $52,048.79 ($83,781.58 minus $31,732.79). Doorenbos Poultry appealed the decision of the district court.] * * * Breach of Contract * * * Article 2 of the UCC “relaxes many of the legal formalisms and technicalities of contract formation associated with the common law of contracts.” [Citation.] Under the UCC, section [2–607] provides, “The buyer must pay at the contract rate for any goods accepted.” A buyer accepts goods when the buyer “take[s] or retain[s] them in spite of their nonconformity.” [Section 2–606(1)(a).] A buyer also accepts goods if the buyer “does any act inconsistent with the seller’s ownership.” [Section 2–606(1)(c).] * * * Under the UCC, if a buyer accepts goods, despite their nonconformity to the specifications of the contract, the buyer must pay the contract rate for the goods accepted. [Citation.] We determine there is substantial evidence in the record to support the finding of the district court that Doorenbos Poultry accepted the chickens delivered by Midwest within the meaning of section [2–606], despite their nonconformity. * * * * * * Limitation of Remedies Provision * * * Before we begin our discussion of the limited remedy issue, we believe it is appropriate to express our agreement with the district court’s conclusion that the acceptance of the nonconforming goods by Doorenbos Poultry did not preclude its counterclaim for breach of contract against Midwest. There is no dispute on appeal that Midwest breached the contract by providing nonconforming chickens. Section [2–607(2)] states, “acceptance does not of itself impair any other remedy provided by this Article for nonconformity.” * * * Clearly, acceptance of the pullets does not preclude Doorenbos Poultry from asserting a claim based on breach of contract by Midwest. We now turn to the arguments concerning the limited remedies provision in the parties’ contract. Under the UCC, the parties to a contract may agree to limit the remedies available if the seller breaches the contract by providing nonconforming goods, as follows: [T]he 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 nonconforming goods or parts. [UCC Section 2–719(1)(a).] In this case, the parties’ contract specifically provided, “If Seller breaches this Contract, at Seller’s option, customer is entitled to either replacement or refund of the price paid by Customer.” Section [2–719(2)] provides, “Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this chapter.” A remedy’s essential purpose “is to give to a buyer what the seller promised him.” [Citation.] The focus of analysis “is not whether the remedy compensates for all damage that occurred, but that the buyer is provided with the product as seller promised.” [Citations.] Where repair or replacement can give the buyer what is bargained for, a limitation of remedies does not fail of its essential purpose. [Citation.] In other circumstances, however, repair or replacement is not sufficient, and then a court may find the remedy failed of its essential purpose. [Citation.] * * * Upon our review of the record, we agree with the district court’s ultimate conclusion that the limited remedy provision of the parties’ contract failed of its essential purpose. The chickens were delivered over January 16, 17, and 18, 2007. Doorenbos Poultry notified Midwest that the pullets were not as specified in the contract within thirty days after delivery. We agree with the trial court’s conclusion that the reference to a replacement or refund in the contract contemplates the entire sale with Midwest taking back the entire flock of birds. At the time Scott Doorenbos informed Midwest that the pullets delivered were not eighteen weeks old, it is clear that Doorenbos Poultry was not interested in having the pullets replaced, and Midwest made no offer to replace them. When it was notified of the breach, we agree that Midwest could have exercised its option under the contract, taken back the entire flock, and either replaced the chickens with eighteen week old pullets or refunded the entire purchase price. The record supports the conclusion that this did not happen because, as the district court noted, it was plainly impractical. It would have been extremely inefficient for both parties to replace the pullets Midwest had delivered. The pullets that Doorenbos Poultry had in its barn would have had to have been rounded up, placed in cages, and loaded into trucks while more that 100,000 replacement birds were moved into the barn. As Scott Doorenbos testified, a simultaneous exchange would have been necessary because the birds provided the only source of heat for the barn. In addition, it does not appear that either party was interested in the option of removal and refund. * * * Under the circumstance presented here, we conclude the district court did not err in concluding the limitation of remedies provision in the parties’ contract failed in its essential purpose. We next consider Doorenbos Poultry’s alternative claim that the trial court improperly calculated its damages. Amount of Damages Because the limitation of remedies provision failed in its essential purpose, a consideration of damages reverts to section [2–714(1)], which provides for the recovery of damages for “the loss resulting in the ordinary course of events from the seller’s breach as determined in any manner which is reasonable.” Thus, any manner that is reasonable may be used to determine a buyer’s damages for nonconforming goods. [Citation.] Here, the district court found “a loss of profits would have been an expected loss resulting in the ordinary course of events from the nonconformity of the pullets delivered by Midwest under § [2–714(1)].” Under section [2–714(2)], damages are measured by the difference between the value of the goods at the time of acceptance, and their value if they had been as specified in the contract, “unless special circumstances show proximate damages of a different amount.” The court noted that neither party submitted any evidence as to the value of fourteen- or fifteen-week-old pullets and expressed skepticism that there would be any recognized value for pullets that were between fourteen and fifteen weeks old and did not have the ability to lay eggs. As a result, the court concluded the “special circumstances” provision of section [2–714(2)] should apply. * * * After carefully considering the evidence presented, the district court concluded that eighty percent of the chickens were three weeks too young, and the feeding costs and lost revenues for those birds would have been sixty percent of the amount claimed by Doorenbos Poultry. Similarly, the court concluded that the feed costs and lost revenues for the chickens four weeks too young would have been eighty percent of the amount claimed by Doorenbos Poultry. The court calculated these pro-rated amounts and arrived at the total of $31,732.79 for the damages to be awarded Doorenbos Poultry on its counterclaim. * * * We affirm the decision of the district court. * * * 25-2j Recover Incidental Damages The buyer may also recover incidental damages, in addition to remedies such as covering, recovering damages for nondelivery or repudiation, or recovering damages for breach in regard to accepted goods. Includes expenses related to inspection, receipt, transportation, care and custody, and other commercially reasonable charges. 25-2k Recover Consequential Damages Those damages that result from the goods not meeting the buyer’s requirements, which were reasonably foreseeable by the seller, or from defects which proximately caused injury or property damage based on breach of warranty. Particular needs of the buyer usually must be made known to the seller, whereas general needs usually need not be. NOTE: See Figure 25-2: Remedies of the Buyer. *** Chapter Outcome *** Describe the basic types of contractual provisions affecting remedies and the limitations the Uniform Commercial Code imposes upon these provisions. 25-3 CONTRACTUAL PROVISIONS AFFECTING REMEDIES Within specified limits, the Code permits the parties to a sales contract to agree to modify, exclude, or limit the remedies or damages that will be available for breach of that contract. 25-3a Liquidation or Limitation of Damages Specified damage awards may be provided for in the contract but will be upheld only if reasonable. Excessive liquidated damages provisions will not be enforced. CASE 25-4 COASTAL LEASING CORPORATION v. T-BAR S CORPORATION Court of Appeals of North Carolina, 1998 128 N.C.App. 379, 496 S.E.2d 795 http://scholar.google.com/scholar_case?q=496+s.e.2d+795&hl=en&as_sdt=2,34&case=3451040025275367441&scilh=0 Walker, J. Plaintiff entered into a lease agreement (lease) with defendant T-Bar S Corporation (T-Bar) in May of 1992, whereby plaintiff agreed to lease certain cash register equipment (equipment) to T-Bar. Under the lease, T-Bar agreed to monthly rental payments of $289.13 each for a total of 48 months. Defendants George and Sharon Talbott (appellants) were the officers of T-Bar and personally guaranteed payment of all amounts due under the lease. After making 18 of the monthly payments, appellants and T-Bar defaulted on the lease in December of 1993. On 28 February 1994, plaintiff mailed a certified letter to appellants and T-Bar, return receipt requested, advising them that the lease was in default and, pursuant to the terms of the lease, plaintiff was accelerating the remaining payments due under the lease. They further advised appellants and T-Bar that if the entire amount due of $8,841.06 was not received within 7 days, plaintiff would seek to recover the balance due plus interest and reasonable attorneys’ fees, as well as possession of the equipment. The record shows that appellants and T-Bar each received this letter on 1 March 1994. On 10 March 1994, plaintiff mailed a certified letter and “Notice of Public Sale of Repossessed Leased Equipment” (notice of sale) to appellants and T-Bar at the same address, again return receipt requested. This letter advised appellants and T-Bar that plaintiff had taken possession of the equipment and was conducting a public sale pursuant to the terms of the lease. Although the date on the notice of sale stated that the sale was to be held on 23 March 1994, the sale was actually scheduled to be held on 25 March 1994. This letter and notice of sale were returned to plaintiffs “unclaimed” on 29 March 1994. Plaintiffs conducted a public sale of the equipment on 25 March 1994 and no one appeared on behalf of appellants or T-Bar. There being no other bidders, plaintiff purchased the equipment at the sale for $2,000.00. On 4 October 1994, plaintiff leased some of the same equipment to another company at a rate calculated to be $212.67 for 36 months. Plaintiff then filed this action on 6 October 1994 seeking to recover the balance due under the lease, minus the net proceeds from the 25 March 1994 public sale, plus interest and reasonable attorneys’ fees. Appellants filed an answer and counterclaim on 27 July 1995. Plaintiff then filed a motion for summary judgment against appellants on 8 July 1996. * * * After a hearing, the trial court entered summary judgment on 15 January 1997 in favor of plaintiff on its complaint and appellants’ counterclaims and entered judgment against appellants for the sum of $7,223.56 plus interest and attorneys’ fees of $1,083.54. * * * * * * Since both parties agree that the transaction at issue in this case is not a security interest, but rather is a lease, Article 2A controls. [Article 9 controls security interests and is discussed in Chapter 37.] * * * In their appeal, appellants contend that the trial court erred by granting summary judgment in favor of plaintiff because there exists a genuine issue of material fact as to whether: (1) the liquidated damages clause contained in Paragraph 13 of the lease is reasonable in light of the then-anticipated harm caused by default; * * *. As to appellants’ first contention, the official commentary to Article 2A states that “in recognition of the diversity of the transactions to be governed [and] the sophistication of many of the parties to these transactions * * *, freedom of contract has been preserved.” [UCC §] 2A–102 Official Comment. Also, under general contract principles, when the parties to a transaction deal with each other at arms length and without the exercise by one of the parties of superior bargaining power, the parties will be bound by their agreement. [Citation.] Article 2A recognizes that “[m]any leasing transactions are predicated on the parties’ ability to agree to an appropriate amount of damages or formula for damages in the event of default or other act or omission.” [UCC §] 2A–504 Official Comment. [UCC §] 2A–504 states, in pertinent part: (1) Damages payable by either party for default, or any other act or omission * * * may be liquidated in the lease agreement but only at an amount or by a formula that is reasonable in light of the then-anticipated harm caused by the default or other act or omission. This liquidated damages provision is more flexible than that provided by its statutory analogue under Article 2, [UCC §] 2–718. * * * “The basic test of the reasonableness of an agreement liquidating damages is whether the stipulated amount or amount produced by the stipulated formula represents a reasonable forecast of the probable loss.” [Citation.] However, “no court should strike down a reasonable liquidated damage agreement based on foresight that has proved on hindsight to have contained an inaccurate estimation of the probable loss. * * *” [Citation.] And, “the fact that there is a difference between the actual loss, as determined at or about the time of the default, and the anticipated loss or stipulated amount or formula, as stipulated at the time the lease contract was entered into * * *,” does not necessarily mean that the liquidated damage agreement is unreasonable. [Citation.] This is so because “[t]he value of a lessor’s interest in leased equipment depends upon ‘the physical condition of the equipment and the market conditions at that time.’” [Citation.] Further, in determining whether a liquidated damages clause is reasonable: [A] court should keep in mind that the clause was negotiated by the parties, who are familiar with the circumstances and practices with respect to the type of transaction involved, and the clause carries with it a consensual apportionment of the risks of the agreement that a court should be slow to overturn. [Citation.] In this case, Paragraph 13 of the lease (the liquidated damages clause) reads as follows: 13. REMEDIES If an event of default shall occur, Lessor may, at its option, at any time (a) declare the entire amount of unpaid rental for the balance of the term of this lease immediately due and payable, whereupon Lessee shall become obligated to pay to Lessor forthwith the total amount of the said rental for the balance of the said term, and (b) without demand or legal process, enter into the premises where the equipment may be found and take possession of and remove the Equipment, without liability for suit, action or other proceeding, and all rights of Lessee in the Equipment so removed shall terminate absolutely. Lessee hereby waives notice of , or hearing with respect to, such retaking. Lessor may at its option, use, ship, store, repair or lease all Equipment so removed and sell or otherwise dispose of any such Equipment at a private or public sale. In the event Lessor takes possession of the Equipment, Lessor shall give Lessee credit for any sums received by Lessor from the sale or rental of the Equipment after deduction of the expenses of sale or rental and Lessor’s residual interest in the Equipment. * * * Lessor and Lessee acknowledge the difficulty in establishing a value for the unexpired lease term and owing to such difficulty agree that the provisions of this paragraph represent an agreed measure of damages and are not to be deemed a forfeiture or penalty. * * * * * * After a careful review, we conclude the liquidated damages clause is a reasonable estimation of the then-anticipated damages in the event of default because it protects plaintiff’s expectation interest. The liquidated damages clause places plaintiff in the position it would have occupied had the lease been fully performed by allowing it to accelerate the balance of the lease payments and repossess the equipment. Therefore, since there is no evidence that plaintiff exercised a superior bargaining position in the negotiation of the liquidated damages clause, no genuine issue of material fact exists as to its reasonableness, and the trial court did not err by enforcing its provisions. 25-3b Modification or Limitation of Remedy by Agreement The sales contract may expressly allow remedies in addition to or instead of those provided in the Code and may limit or change the measure of damages recoverable in the event of breach. A remedy provided by the contract, however, is optional unless it is expressly agreed to be the sole remedy. Where circumstances cause an exclusive or limited remedy to fail in its essential purpose, the injured party may resort to the remedies provided by the Code. 25-3c Statute of Limitations Any action for breach of a sales contract must be begun within four years after the cause of action has accrued. Part Five: Negotiable Instruments CONTENTS Chapter 26 Form and Content Chapter 27 Transfer and Holder in Due Course Chapter 28 Liability of Parties Chapter 29 Bank Deposits, Collections, and Funds Transfers ETHICS QUESTIONS RAISED IN THIS PART 1. Should a customer have the right to stop payment on a check? If so, under what circumstances? Who should bear the expense of a stop payment order: Why? 2. Who should bear the loss for a forged check–the bank or the account holder? Why? What should be the determining factor(s) in deciding who should bear the risk of loss? 3. What obligations does a bank have to inform its customers of their rights as a depositor? What obligations does a customer have to inform himself of his rights? 4. What essential services should a bank or other financial institution provide for its customers? Should banks be allowed to charge small customers more for financial services than they charge large customers? 5. Should a bank be allowed to "hold" deposited checks before making the funds available to their depositors? If the bank is allowed to "hold" the checks, should the bank be allowed to profit by counting the deposited checks on their books while refusing to allow the customer the use of the funds for check writing purposes? 6. Why would the banks prefer automatic funds transfer over the use of checks? Does a customer who uses automatic funds transfer have the same protections as one who uses a checking account to write checks? What happens if the bank makes a mistake? Who is responsible? 7. Futurists like to talk about a future cashless, checkless society. What ethical issues are raised by a society that operates without cash or checks? 8. From an ethical perspective, is it fair for a holder in due course to protect himself from personal defenses such as failure of consideration or fraud in the inducement? Why? 9. Home mortgage notes are sold on national exchanges similar to the New York Stock Exchange. Does the lending bank have any obligations to the maker of a mortgage note in this regard? Does a large financial institution that holds home mortgage notes have any ethical obligations to the people who made the notes? ACTIVITIES AND RESEARCH PROBLEMS 1. Has your state adopted Revised Article 3? If so, why? If not, why not? 2. Visit a local bank to see first-hand how the check collection process works, or have someone from the bank visit the class to tell about the process. 3. Have students bring copies of the customer agreements from their own banks and compare the provisions of these agreements. Discuss the obligations of the bank and of the customer. Are the provisions in these agreements in accordance with the provisions in the UCC? 4. Research the role of the Federal Reserve Banks in the check collection system? How important is the Federal Reserve to this system? 5. Research cases in your state involving holders in due course. Do any of these cases involve “unfair” results? Then discuss the policy reasons behind maintaining special protections for holders in due course. Has the FTC’s holder in due course rule had any effect on frauds committed upon consumers? Chapter 26 FORM AND CONTENT Cases in This Chapter Heritage Bank v. Bruha NationsBank of Virginia, N.A. v. Barnes Cooperatieve Centrale Raffeisen-Boerenleenbank B.A. v. Bailey Chapter Outcomes After reading and studying this chapter, the student should be able to: • Describe the concept and importance of negotiability. • Identify and describe the types of negotiable instruments involving an order to pay. • Identify and describe the types of negotiable instruments involving a promise to pay. • List and explain the formal requirements that an instrument must meet to be negotiable. • Explain the effect on negotiability of an instrument’s (1) being undated, antedated, or postdated; (2) lack of completion; and (3) ambiguity. TEACHING NOTES The term "negotiable instruments" (instruments) refers to checks, drafts, checks, promissory notes and certificates of deposit. For a number of reasons, payment by noncash means is preferable in many transactions. Noncash payments take two forms: paper (checks and drafts) and electronic (debit cards, credit cards, automated clearinghouse [ACH], and prepaid cards). By number of transactions, electronic payments now exceed three-quarters of all noncash payments while payments by check are now less than one-quarter of all noncash payments. By value, electronic payments constitute about 55 percent of all noncash payments while checks represent 45 percent of all noncash payments. More specifically, in the United States in 2009, the number of checks paid was approximately 24.5 billion with a value of approximately $32 trillion. Although by number of transactions, debit cards are now the most used noncash payment in the United States, by value, debit card payments amount to only 2 percent of all noncash payments. The financing or credit function of negotiable instruments is indispensable. • promissory notes are used extensively in financing sales of goods • corporations fund their operating expenses or current assets by issuing commercial paper in the form of short-term promissory notes • corporations obtain long-term financing by issuing long-term promissory notes (bonds) • promissory notes (mortgages) are also used in financing sales of real estate • a certificate of deposit (CD) is a promissory note issued by a bank and is used by many individuals as a type of deposit account that typically offers a higher rate of interest than a regular savings account In 1990, the American Law Institute and the National Conference of Commissioners on Uniform Laws approved a Revised Article 3 to the Uniform Commercial Code (UCC). Named “Negotiable Instruments,” the new Article maintains the basic scope and content of prior Article 3 (Commercial Paper). In 2002, the American Law Institute and the Uniform Law Commission completed updates to Articles 3 and 4. All States except New York have adopted the 1990 version of Article 3 and at least ten States have adopted the 2002 version. This part of the text will discuss the 1990 version of Revised Article 3 but will also point out the major changes from prior Article 3. The 1990 version of Revised Article 3 is presented in Appendix B. *** Chapter Outcome *** Discuss the concept and importance of negotiability. 26-1 NEGOTIABILITY Negotiability is a legal concept that allows written instruments to be used as a readily accepted form of payment in substitution for money; it defines the way in which rights and obligations are assigned in the area of negotiable instruments. 26-1a Development of Law of Negotiable Instruments Under common law, and as far back as the Middle Ages, the payment of money was a contract right only of the intended payee; contract rights and obligations could not be assigned. Eventually, however, the law permitted contractual rights to be assigned, giving the assignee the right to collect on the debt, and making the assignee subject to all the defenses available to the obligor. This remains the law of assignments: the assignee stands in the shoes of his assignor. Merchants involved in the flourishing trade of the time still wanted more reform, because it was difficult to find people willing to accept an assignment. Thus, the concept of the holder in due course developed, allowing certain good faith transferees who give value to acquire the right to be paid, free of most of the defenses to which an assignee is subject. 26-1b Assignment Compared with Negotiation The obligee's contractual rights to payment could not be assigned. Over time, however, contract rights to the payment of money became assignable. In an assignment, the assignee gets only the contract rights that the assignor had and is subject to the same claims as the original obligor had against the assignor. *** Chapter Outcomes *** Identify and describe the types of negotiable instruments involving an order to pay. Identify and describe the types of negotiable instruments involving a promise to pay. 26-2 TYPES OF NEGOTIABLE INSTRUMENTS Drafts and checks each contain orders or directions to pay money. Notes and certificates of deposit each contain promises to pay money. 26-2a Drafts A draft involves three parties: The drawer, (owner or controller of the money) orders a second party, the drawee, (who is in posses¬sion of money that belongs to the drawer) to pay a fixed amount of money to a third party, the payee. NOTE: See Figure 26-1 for an outline of this relationship. A time draft is a draft payable at a specified future date; a sight draft is payable on presentation to the drawee. NOTE: A sample of a draft instrument is reproduced in Figure 26-2. 26-2b Checks A check is a specialized form of draft drawn on a bank and payable on demand (that is, upon the payee’s or holder’s request for payment). NOTE: See Figure 26-3. A cashier’s check is a check drawn by a bank on itself to the order of a payee. In this case, the bank serves both as the drawer and the drawee. The Check Clearing for the 21st Century Act (also called Check 21 or the Check Truncation Act), which went into effect in late 2004, creates a new negotiable instrument called a substitute check or image replacement document (IRD). The law permits banks to truncate original checks, to process check information electronically, and to deliver substitute checks to banks that want to continue receiving paper checks. A substitute check would be the legal equivalent of the original check and would include all the information contained on the original check. The law does not require banks to accept checks in electronic form nor does it require banks to use the new authority granted by the act to create substitute checks. This newly authorized document is more fully discussed in Chapter 30. 26-2c Notes A promissory note involves two parties; the maker promises to pay to the order of a second party, the payee, a stated amount of money. A note payable at a certain time is referred to as a time note. A note payable upon the request or demand of the payee or holder is a demand note. NOTE: See Figure 26-5. 26-2d Certificates of Deposit A certificate of deposit, or a CD as it is frequently called, is a specialized form of a promissory note, given by a bank, to pay money. The bank (the maker) acknowledges the receipt of money from a payee, and promises to repay the payee on demand or at a stated date, with interest calculated at a stated rate. NOTE: See Figures 26-4 and 26-6. *** Chapter Outcome *** List and explain the formal requirements that an instrument must meet to be negotiable. 26-3 FORMAL REQUIREMENTS OF NEGOTIABLE INSTRUMENTS Because negotiability is a matter of form not all negotiable instruments will qualify for this special status. The four corners rule requires that the instrument contain all the elements of negotiability within the document itself. Reference to other documents is not permitted. If the paper is non-negotiable, the law of assignment applies to the transferee. CASE 26-1 HERITAGE BANK v. BRUHA Supreme Court of Nebraska, 2012 283 Neb. 263, 812 N.W.2d 260 http://scholar.google.com/scholar_case?case=17014896784596098115&q=283+Neb.+263&hl=en&as_sdt=2,34 Connolly, J. * * * [Jerome J. Bruha signed a promissory note on December 16, 2008, with Sherman County Bank. The note evidenced a promise to pay "the principal amount of Seventy-five Thousand & 00/100 ($75,000.00) or so much as may be outstanding, together with interest on the unpaid outstanding principal balance of each advance." The note stated that it "evidence[d] a revolving line of credit." The note contained a variable interest rate. The rate was subject to change every month and calculated on an index maintained by Sherman County Bank. On this note, Bruha received advancements in the amount of $10,000 on December 16, 2008, $40,000 on December 17, and $1,000 on January 30, 2009. This totaled $51,000. Bruha then invested the money in accounts with a trading company, which allegedly shared management with Sherman County Bank. There are a few typographical errors on the note. First, the maturity date on the note is February 1, 2008, which, read literally, means that the note would have matured about 10 months before Bruha signed it. Other notes he had signed stated maturity dates of February 1, 2009. Second, in a section titled "COLLATERAL" the note reads: "Borrower acknowledges this Note is secured by an assignment of hedge account from Jerome Bruah [sic] to Sherman County Bank dated DATE [sic]." Thus, Bruha's name is misspelled and a line for a date is unfilled. Sherman County Bank eventually failed, and the Federal Deposit Insurance Corporation (FDIC) was appointed as receiver. The FDIC then sold and assigned some of Sherman County Bank's assets to Heritage. These assets included the note signed by Bruha. Heritage sued Bruha to enforce the note. In his answer, Bruha admitted that he signed the note but claims that he did not do it voluntarily. He claimed that Sherman County Bank had procured his signature "by fraud and/or misrepresentation." Bruha also claims that the typographical errors destroyed the negotiability of the promissory note. Moreover, Bruha claims that Sherman County Bank misled him into borrowing money that, in turn, he invested with a trading company that generated trade commissions through risky and speculative commodity trading. Bruha admitted that he had not paid the note but denied that he was obligated to do so. The district court granted summary judgment to Heritage and awarded it $61,384.67 ($51,000 plus interest) on this note. The court disallowed Bruha’s defenses because, under federal law, for certain defenses to be asserted against the FDIC or its assignees, the defenses must be evidenced in writing. The court found that there was no evidence in writing of a defense that would invalidate the note. The court also concluded that the FDIC had become a holder in due course and thus not subject to most defenses. Bruha appealed.] The primary issues are whether either the holder-in-due-course rule of Nebraska's Uniform Commercial Code or federal banking law bars Bruha's defenses to the enforcement of the note. * * * Bruha argues that Heritage is not a holder in due course. Similarly, he argues that the FDIC was not a holder in due course when it held the note. A holder in due course is, with some exceptions, "immune to defenses, claims in recoupment, and claims of title that prior parties to commercial paper might assert. The holder in due course always enjoys certain pleading and proof advantages." So if Heritage were a holder in due course, it would enjoy an advantageous position in litigation with Bruha. We conclude, however, that Heritage is not a holder in due course because the note was not "negotiable" and article 3 of the Uniform Commercial Code does not apply to this case. Neb. U.C.C. § 3-104(a) provides: "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. …" (Emphasis supplied.) Here, the note fails to meet the definition of a "negotiable instrument" because it was not a promise "to pay a fixed amount of money." Although the Uniform Commercial Code allows notes to have a variable interest rate, under § 3-104(a), the principal amount must be fixed. "A fixed amount is an absolute requisite to negotiability." This is because unless a purchaser can determine how much it will be paid under the instrument, it will be unable to determine a fair price to pay for it, which defeats the basic purpose for negotiable instruments. We applied this principle in [citation], in which we stated that "[a] guaranty is not an agreement to pay a fixed amount and is therefore not a negotiable instrument subject to article 3 of the Nebraska Uniform Commercial Code." To meet the fixed amount requirement, the fixed amount generally must be determinable by reference to the instrument itself without any reference to any outside source. If reference to a separate instrument or extrinsic facts is needed to ascertain the principal due, the sum is not "‘certain’" or fixed. Here, the text of the note states that Bruha "promises to pay … the principal amount of Seventy-five Thousand & 00/100 Dollars ($75,000.00) or so much as may be outstanding . …" Further, the note states that it "evidences a revolving line of credit" and that Bruha could request advances under the obligation up to $75,000. This fails the "fixed amount of money" requirement of § 3-104(a); one looking at the instrument itself cannot tell how much Bruha has been advanced at any given time. So, the note is not negotiable. Stated simply, "[a] note given to secure a line of credit under which the amount of the obligation varies, depending on the extent to which the line of credit is used, is not negotiable . . . ." For a person to be a holder in due course, the instrument must be negotiable. Because the note was not a negotiable instrument, neither the FDIC nor Heritage could ever become a holder in due course of it under Nebraska law. And further, because this note is not a negotiable instrument, article 3 does not apply. * * * [The Supreme Court of Nebraska reversed the district court’s finding that the holder-in-due-course rule of Nebraska's Uniform Commercial Code bars Bruha's defenses. The Supreme Court, however, concluded that Federal law bars Bruha's defenses and thus affirmed the district court’s summary judgment in part. The Supreme Court also held that Bruha had failed show how the typographical errors had invalidated the note. But because the Supreme Court found a minor error in the district court's calculation of interest, the Supreme Court remanded the case to the district court for correction.] To be negotiable, an instrument must meet the following criteria: 26-3a Writing This requirement is given a broad interpretation. Printing and typewriting are included, and the writing need not be on paper. 26-3b Signed May be any symbol executed or adopted by a party with the intention to authenticate a writing; may be any word or mark used in place of a written signature, such as initials, an X, or a thumbprint. It can also consist of a trade name or an assumed name. Location of the signature on the document is unimportant. Revised Article 1 changes the word “authenticate” to “adopt or accept.” 26-3c Promise or Order to Pay A negotiable instrument must contain either a promise to pay money (with a note or certificate of deposit) or an order to pay (with a draft or check). Promise to pay — Promises to pay must be more than mere acknowledgments that a debt exists. The so-called I.O.U. is not a promise to pay for negotiability purposes and will not transform the document into a negotiable instrument. Order to Pay — This is a direction or command to pay. It must be more than an authorization or request to pay, and it must identify with reasonable certainty the person to be paid. 26-3d Unconditional A promise or order to pay is unconditional if it is absolute and not subject to any contingencies or qualifications. Reference To Other Agreements — destroys negotiability if the instrument is made subject to the terms of another agreement, but not if another instrument is merely mentioned. The Particular Fund Doctrine — Prior Article 3 considered a promise to pay only out of a particular fund nonnegotiable, but Revised Article 3 reverses this. 26-3e Fixed Amount You should be able to determine from the instrument itself the minimum specific amount that the holder is entitled to receive. The "fixed amount" provision refers only to the principal, so the instrument’s provisions may increase the amount of payment that can be recovered under certain circumstances, such as the costs of collection and attorney’s fees upon default in payment. Interest may be stated in an instrument as a fixed or variable rate or amount of money. It may even require reference to an external source without destroying the negotiability of the instrument. 26-3f Money The term money means legal tender. It must be a medium of exchange authorized or adopted by a sovereign government as part of its currency; does not include commodities which are not sanctioned as legal tender. (Revised 1–201(b)(24) adds that the authorized or adopted currency must be the current official currency of the government.) 26-3g No Other Undertaking or Instrument A negotiable instrument must contain a promise or order to pay money, but it may not contain an order or promise to do an act in addition to paying money. 26-3h Payable on Demand or at a Definite Time A negotiable instrument must “be payable on demand or at a definite time.” Demand — Demand paper includes instruments payable “on sight” or “on presentation”. Also any instrument that does not state a time for payment, such as a check, is payable on demand. CASE 26-2 NATIONSBANK OF VIRGINIA, N.A. v. BARNES Virginia Circuit Court, Twentieth Circuit, 1994 33 Va.Cir. 184, 24 U.C.C. Rep.Serv.2d 782 http://scholar.google.com/scholar_case?case=5103666188878568597&q=33+VA.+CIR.+184&hl=en&as_sdt=2,10 Horne, J. This matter is before the court on Plaintiff’s Motion for Partial Summary Judgment. Defendants have filed a Grounds of Defense, asserting certain affirmative defenses to liability. Plaintiff argues that it is entitled to partial summary judgment. As discussed more fully below, Plaintiff s motion will be granted in part and denied in part. The court will address Defendant’s affirmative defenses as they relate to each note specifically, and to both Notes in general. * * * The following facts are undisputed with respect to the 1991 Note which is the subject of Count II of the Motion for Judgment. Defendants Ad Barnes, Trustee, Ad Barnes and Elaine Barnes executed a * * * Note to Sovran Bank, N.A. on August 27, 1991, in the principal amount of $200,000. Plaintiff NationsBank is the successor by merger to Sovran and is now the holder of this Note. * * * By letter dated February 17, 1993, NationsBank made demand on the 1991 Note. The factual question still in dispute concerning the 1991 Note is whether it is a demand note. Plaintiff argues that the language of the note is unambiguous and is clearly a demand note. Defendants argue that the detailed enumeration of events constituting default is inconsistent with a demand note. Thus, a standard of good faith must be applied before a demand for accelerated repayment can be made. [UCC] §1–203 establishes a general duty of good faith in every contract governed by the Commercial Code. Under any contract providing for accelerated payment at will, §1–208 states that the option is to be exercised I only in the good faith belief that the prospect of payment or performance is impaired. However, the Official Comment to this section indicates that it is not applicable to a demand instrument. [UCC] 3A-108(a) [UCC Revised §3–108(a)] states that a note is payable “on demand” if it says it is payable on demand or states no time for payment. In this case, the 1991 * * * Note is a standard form with different forms of repayment set out on the first page. The box marked payable “on demand” has been checked in this instance. There is no time set for repayment, only a provision requiring monthly payments of interest. It is the court’s opinion that the 1991 Note is unambiguous and is clearly a demand note. Thus, Plaintiff is under no obligation to show good faith before requesting payment on the note. Since demand has been made by Plaintiff, Defendants are liable. Thus, Plaintiff is entitled to summary judgment on the issue of liability under the 1991 Note. Definite Time — Time paper refers to all other instruments that are payable at a definite time but not on demand. A definite payment date is established when the instrument is payable: 1. at a fixed date or dates, 2. at a definite period of time after sight or acceptance, or 3. at a time readily ascertainable at the time the promise or order is issued. At a Definite Time and On Demand — An instrument may retain negotiability if it is made payable on demand up to a fixed date; if demand is not made prior to the date, it becomes payable on the stated date. 26-3i Be Payable to Order or to Bearer Words of negotiability must be present on the face of the instrument (not in an indorsement) at the time it is first issued or when it comes into the possession of the bearer. The magic words of negotiability typically are "to the order of" or "to bearer", although other words that carry the same meaning may also fulfill this requirement. Revised Article 3 allows checks that meet all requirements except this one to still be considered negotiable. Revised Article 3 further disallows use of the word "assigns." Payable to Order — Negotiable instruments are payable to the order if it is payable to the order of an identified person or to an identified person or order. Most checks, for example, read “pay to the order of __________,” and the drawer fills in the named person. Payable to Bearer — Bearer paper, on the other hand, is a negotiable instrument that is payable to the bearer, or the holder of the instrument. An instrument is defined as bearer paper if, by its terms, (1) it is payable to the bearer, or to the order of the bearer, (2) it does not designate a specific payee, or (3) it is payable to “cash,” or to the order of “cash.” CASE 26-3 COOPERATIEVE CENTRALE RAIFFEISEN-BOERENLEENBANK B.A. v. BAILEY United States District Court, Central District California, 1989 710 F.Supp. 737 http://scholar.google.com/scholar_case?case=15799376056319723245&q=710+F.Supp.+737&hl=en&as_sdt=2,10 Rea, J. This matter comes before the court on the motion of both parties to this action for partial summary adjudication and on plaintiff’s motion for summary judgment. * * * This is an action for collection on a promissory note brought by plaintiff, Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. (“the Bank”), against the maker of the note, William Bailey, M.D. (“Bailey”). Bailey executed the note in December, 1982, in favor of “California Dreamstreet,” a joint venture which solicited investments in a cattle-breeding operation. California Dreamstreet negotiated the note in 1986 to the Bank, which in turn filed this action on August 29, 1988. The note states in relevant part: DR. WILLIAM H. BAILEY * * * hereby promises to pay to the order to CALIFORNIA DREAMSTREET * * * the sum of Three Hundred Twenty Nine Thousand Eight Hundred ($329,800.00) Dollars. * * * * * * By this motion for partial summary adjudication, the parties seek to determine, as a threshold matter, whether the subject promissory note is a negotiable instrument. * * * [The parties] agree that the sole issue is whether the unusual language in the note obliging Bailey to “pay to the order to California Dreamstreet” renders the note non-negotiable. Whether an instrument is negotiable is a question of law to be determined solely from the face of the instrument, without reference to the intent of the parties. [Citation.] To be negotiable, an instrument must “be payable to order or bearer.” Code §3–104(1)(d) [Revised §3–104(a)(i)]. “Payable to order” is further defined by Code §3–110(1), as follows: (1) An instrument is payable to order when by its terms it is payable to the order or assigns of any person therein specified with reasonable certainty, or to him or his order, or when it is conspicuously designated on its face as ‘exchange’ or the like and names a payee. [Compare Revised §3–109(b).] It is well established that a promissory note is nonnegotiable if it states only: “payable to (payee),” rather than “payable to the order of [payee].” [Citations.] Bailey claims that the instant note, which states “pay to the order to [payee],” falls between these two alternatives and should therefore be deemed non-negotiable. The authorities are unhelpful. There is apparently no case on record in which a variance this small from the language of the Code has been called into question. Both parties direct the Court’s attention to Official UCC Comment 5 to Code §3–104, which states: 5. This Article omits the original Section 10, which provided that the instrument need not follow the language of the act if it ‘clearly indicates an intention to conform’ to it. The provision has served no useful purpose, and it has been an encouragement to bad drafting and to liberality in holding questionable paper to be negotiable. The omission is not intended to mean that the instrument must follow the language of this section, or that one term may not be recognized as clearly the equivalent of another, as in the case of ‘I undertake’ instead of ‘I promise,’ or ‘Pay to holder’ instead of ‘Pay to bearer.’ It does mean that either the language of the section or a clear equivalent must be found, and that in doubtful cases the decision should be against negotiability. In the court’s opinion, the Comment fails to persuasively support either party’s position. Rules of grammar belie the Bank’s argument that the preposition “to” is an apt substitute for “of” since the resulting sentence, read literally, is not just ambiguous but incomplete. On the other hand, the Comment expressly disavows Bailey’s argument that the Code drafters intended to set forth certain “magic words,” the absence of which precludes negotiability. What does emerge from the Comment is the need for certainty in determining negotiability. Though sensitive to this goal and to the potentially harsh result of such a finding, the court does not find the instant facts to present the kind of “doubtful” case which should be resolved against negotiability. In this context, the phrase “pay to the order to” can plausibly be construed only to mean “pay to the order of.” While other explanations are possible, none are realistic. To hold otherwise would, in this court’s opinion, set an overly technical standard that could unexpectedly frustrate legitimate expectations of negotiability in commercial transactions. * * * For all the above reasons, It Is Hereby Adjudged that the promissory note which is the subject of this action is a negotiable instrument. It is further Ordered that plaintiff’s motion for summary judgment is denied without prejudice to its being renewed upon the completion of discovery. *** Chapter Outcome *** Discuss the effect on the negotiability of an instrument’s (1) being undated, antedated, or postdated; (2) lack of completion of the instrument; and (3) ambiguity. 26-3j Terms and Omissions and Their Effect on Negotiability Certain omitted provisions or ambiguous terms may cause questions about an instrument’s negotiability or at least may cause problems with the interpretation of the instrument. Accordingly, the UCC contains rules for the construction of negotiable instruments that apply to every type. Dating of the Instrument — An instrument’s negotiability is not affected by the fact that it is antedated or postdated. If undated, the date of issuance is used; if unissued, the date of first possession is used. Incomplete Instruments — Occasionally, a party will sign a paper that is clearly intended to be an instrument, yet is incomplete because the party omitted a necessary element, such as the promise or order, the designation of the payee, the amount payable, or the time for payment. Such an instrument is not negotiable until it is completed. Ambiguous Instruments — If doubt exists as to whether an instrument is a draft or a note, the holder may treat it as either one and present it for payment to the drawee or to the person signing it. If handwritten or typewritten language is inconsistent with the printed words: The handwritten words control the typewritten and the printed words; the typewritten words control the printed words. If the amount payable is set forth on the instrument’s face in both figures and words, and the amounts differ, the words control the figures. If the words are ambiguous, however, the figures control the payable amount. Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
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