Does Unconscionability Theory Lead to Greater Economic Problems?

Today is the second day of the International Contracts Conference hosted this year by Stetson University College of Law. Professor Xi George Zhou of the University of Sheffield presented his paper, An Economic Perspective on Legal Remedies for Unconscionable Contracts, where he argues that there are disincentives to trade created by unconscionability doctrine, precaution problems and potential abuse of rights. His paper asks whether a higher deterrence model leads to greater economic problems. He proposes that creating an effective remedy for unconscionable behavior may require a legal remedy that is lower, as a high sanction may result in less economic transactions due to precautions employed by traders. Thus, it is impossible to eliminate bad behavior through deterrence alone. In order to use any legal mechanism we need to focus on the effectiveness of the tactic. There are risks to all deterrence models.

Professor Zhou also presented a call for papers for the Society of Legal Scholars Conference September 5-8. This year's topic is Law in Politics, Politics in Law. All papers on any aspect of contract, commercial and consumer law are welcome, whether on topic or not. Paper proposals are due by March 4, 2011 to Professor Zhou at qi.zhou@sheffield.ac.uk.

-jsm

Card Networks Attempting to Block Debit Card Merchant Fee Regulation

In a surprise late addition to the financial reform legislation, Congress required the Federal Reserve to regulate the fees that merchants pay to accept debit cards. The statute requires the regulated rate to include only per transaction costs and certain anti-fraud expenses. In December, the FED put out for comment a proposed rate of 12 cents per transaction, nearly 75% below the current average fee of 44 cents. Current rates are based on a percentage of the sale price.

Merchants were pleased with the FED's proposal. Banks were not, claiming that a fee that low would force them to lose money on debit card programs unless they charged their own customers. (Imagine that.) One bank has filed a constitutional challenge to the legislation, arguing that it constitutes a taking of bank property without just compensation and violates the equal protection clause because only the largest banks will have their rates regulated. The period for comment ends next Tuesday, February 22, and the FED must promulgate a final rate by April 21.

In recent testimony before the House Financial Services Committee, FED Governor Sarah Bloom Raskin explained that board members were "reserving judgment on the final rule" until they can consider all of the comments. Some lawmakers have expressed concern the FED has not adequately considered the cost of fraud prevention. Visa has ramped up a vigorous lobbying campaign, urging Congress to enact new legislation delaying the implementation of the regulation. Observers believe that changes at this point are unlikely. Representative Barney Frank, however, told the press that while he would not support the delay that Visa has requested, he would support instructing the FED to include more factors in the fee calculation.

2011 Sales Survey

I just put the draft of the Sales Survey up on SSRN. It will appear in the Business Lawyer in August or September, but there are some really great cases this year. Yes, some really good examination ideas as well!

- JSM

Suffolk Law Visiting Position

Suffolk University School of Law is seeking potential visiting professors (assistant, associate, or full) to teach a 6 credit-hour Contracts course beginning Fall 2011. Candidates should have significant teaching experience and strong student evaluations. Suffolk University is conveniently located in the center of Boston. If anyone is interested, please feel free to contact Elizabeth Trujillo, Associate Professor, Suffolk University Law School, 120 Tremont Street, Boston, MA 02108-4977 Tel: 617-305-1672; etrujillo@suffolk.edu.

- JSM

Specific Performance, Parol Evidence and the Naughty Monkey

Here is a great case about specific performance, parol evidence and a yacht named the "Naughty Monkey!"

U.C.C. section 2-716 provides a more liberal attitude toward the remedy of specific performance of contracts for the sale of goods than the common law traditionally does, and a concomitant broader view about when the goods are unique. In Naughty Monkey LLC v. Marinemax Northeast LLC, No. C.A. 5095-VCN, 2010 WL 5545409 (Del. Ch. Dec. 23, 2010, the court considered a request for specific performance based on language in a yacht sales contract providing “TRADE VALUE GUARANTEED TO 15% LOSS WITHIN 18 MONTHS (PER ANDREW SCHNEIDER) SUBJ. TO MARINE SURVEY AND FINANCING” (the “Buyer Protection Clause”). Michael Stock (“Stock”) contacted Marinemax Northeast LLC (“Marinemax”) about the purchase of a new boat after seeing their boats at the National Harbor Boat Show. Eventually, Stock purchased a 62-foot Azimut yacht, which he named the Naughty Monkey, for $1,825,000 through an entity he named the Naughty Monkey LLC (“Naughty Monkey”). Concerned about losses on a yacht of this price, Stock negotiated some down side price protection in the form of the Buyer Protection Clause. About a year later, Stock decided that he did not want the Naughty Monkey and proposed that he trade the boat back to Marinemax for a boat for $2900 and Marinemax would make a cash payment to him for $1,633.350, the difference under the contract. Marinemax refused this request, taking the position that the agreement only allowed Stock to trade the Naughty Monkey in toward the purchase of a more expensive yacht. Stock brought suit for specific performance on the contract, as well as damages related to financing, insurance and maintenance costs for the yacht.

The first issue the court considered was the meaning of the Buyer Protection Clause. Without any reference to section 2-202, the court instead initially referenced certain traditional notions of interpretation, namely to “effect to the clear terms of agreements, regardless of the intent of the parties at the time of contract formation” and to use the “customary, ordinary and accepted meaning of the language.” Nevertheless, the court considered extrinsic evidence to select a meaning of the Buyer Protection Clause that neither party argued: that Stock could trade in the Naughty Monkey to Marinemax, but not for cash, toward the purchase of any merchandise, not only boats of higher value.

Turning to the issue of specific performance under section 2-716, the court ruled that a “remedy at law would do complete injustice in this case.” The court observed that having Marinemax pay monetary damages would inevitably deprive it of the benefit of the bargain which would permit it to sell Stock another yacht at retail cost which it only paid wholesale. Similarly, if the court were to give Stock monetary relief then he would get a liquid asset, which is more than he would have received under the agreement. Accordingly, specific performance, was the appropriate remedy.

- JSM

Good Faith in the Termination of Sales Contracts

Courts in several cases addressed claims for breach of contract based on a party’s failure to act in good faith. So, what does good faith require under UCC section 1-304? In the following case, the court did a nice job of tying an arbitration panel's implication of a reasonability requirement in the application of a termination provision in an agreement with the obligation of good faith.

In Burton Corp. v. Shanghai Viquest Precesion Industries Co., Ltd., No. 10 Civ. 3163(DLC), 2010 WL 3024319 (S.D.N.Y. August 03, 2010), the court affirmed an arbitration award in favor of Shanghai Viquest Precesion Industries Co., Ltd. (“Viquest”) to recover for unpaid shipments of snowboard bindings made to Burton Corp. (“Burton”) for use in its snowboards and for wrongful termination of the sales agreement. The agreement permitted Burton to terminate if Viquest’s “financial position pose[d] a risk to Burton's business.” Additionally, the agreement provided that Viquest would, upon request, return Burton’s molds upon termination for any reason. During the term of the agreement and while Burton owed Viquest $1.8 million for unpaid shipments, Burton terminated, claiming financial concerns, and requested return of the molds.

When Viquest did not return the molds, Burton had to replace the molds and filed an arbitration to recover its cost of replacement as the agreement provided for arbitration of disputes. Viquest counterclaimed for its lost profits due to the early termination. The arbitration panel concluded that Burton could only terminate under the financial clause if it reasonably believed that Viquest’s financial position threatened its prospects, which Burton did not prove. Accordingly, the arbitration panel awarded Viquest its lost profits for the early termination and denied Burton’s request for the cost of replacing the molds as Burton was not itself in conformance with the agreement and owed Viquest substantial sums.

The District Court for the Southern District of New York denied Burton’s request to vacate the arbitration award against it, confirming the award in full. The court treated the reasonableness as derived from the covenant of good faith and fair dealing, citing to the U.C.C. section 1-304 obligation of good faith contained in every contract. The court observed that the obligation of good faith required Burton to have a reasonable basis for terminating the agreement. Moreover, Burton’s failure to pay Viquest for outstanding invoices put pressure on Viquest’s financial condition.


- JSM

The Predominant Purpose Test Still Predominates Mixed Goods/Services Transactions

Here is another little bit from the upcoming Sales Survey in the business lawyer. Here are a couple of nice examples of recent mixed-goods/services transactions under UCC section 2-102. Use of the predominates test has been pretty consistent in cases I've seen of late.

In Blesi-Evans Co. v. Western Mechanical Service, Inc., 72 U.C.C. Rep. Serv. 2d (Callaghan) 115 (W.D.S.D. 2010), the court examined whether a contract for a boiler purchased for installation at the South Dakota School of Mines and Technology (SDSM&T) campus was one for the sale of goods. Western Mechanical Service (Western) had a contract for the replacement of the SDSM&T boiler that required it to pay $500 per day in liquidated damages if the installation was not substantially complete by October 13, 2006. Western ordered the boiler from Blesi-Evans (Blesi), which agreed to also provide start up and training for the boiler. When Blesi failed to deliver the boiler in time to meet the SDSM&T contract, Western installed a temporary boiler. Blesi brought suit for its contract price on the boiler and Western claimed the expense of the temporary boiler. The court correctly ruled that Article 2 governs transactions where goods and services are bundled if the “predominant purpose” of the contract was for the sale of goods and the services are merely incidental. The court noted that Blesi was to provide a boiler, something clearly movable. The court noted that some of the purchase documents failed even to mention the related services and the dispute that actually arose was one related to the provision of the good in a timely manner, not the services.

Similarly in Connie Beale, Inc. v. Plimpton, 2010 WL 398903 (Conn.Super. January 13, 2010), the court considered a claim for breach of an interior decorating contract. Applying the predominant purpose test, the court found a contract for interior design is predominantly one for services, even though the designer would present furniture, upholstery, window coverings, fabrics and flooring to the buyer for consideration. The court noted that “[a] transaction that requires the incorporation of materials does not make it an agreement for a sale . . . .” Moreover, the parties did not label the contract a sale of furnishings, even though decorating services would surely include some goods.

- jsm

2-204 Still Requires Contract Basics

It is the time of the year when I am working on the ABA's Sales Survey of Article 2 cases from 2010. So, I'll pass along a few nice ones here. Perhaps some of these will make good examination questions or just good basics. And the lesson of today's 2010 case, yes, an Article 2 contract still requires a basic agreement at least some definite terms.

While much litigation and scholarly attention surrounding contract formation under Article 2 centers on section 2 207, the decision in Teter v. Glass Onion, Inc., 723 F.Supp.2d 1138 (W.D. Mo. 2010) turned on the application of section 2 204. Gary Teter (“Teter”), an artist who paints historic scenes, met with the owners of the Glass Onion, Inc. (“Glass Onion”), the purchaser of a gallery with which Teter had done business in the past to discuss the continuation of the business relationship with the gallery under Glass Onion’s ownership. Thereafter, the parties had several sales transactions for original paintings by Teter where Glass Onion purchased the paintings and posted an image on its website. After some period of time, however, Teter’s agent advised that to continue the relationship, Glass Onion would need to execute a Dealership Agreement.

When Glass Onion did not become an authorized dealer, Teter’s agent requested that Glass Onion remove images from its web site and advertising. When Glass Onion did not remove the images, Teter brought suit against Glass Onion on various claims related to Glass Onion’s use of Teter’s works in its advertising. Glass Onion brought counterclaims on the grounds that Teter breached a contract to sell art to Glass Onion and provide it a geographic exclusivity. The court granted Teter’s motion for summary judgment on Glass Onion’s counterclaims. The court noted that while section 2-204 permits the making of a contract based on conduct of the parties, the basic elements of an agreement must still be present. While the eight purchases of artwork constituted contracts, the alleged ongoing agreement to sell artwork to Glass Onion for resale on the same terms as the predecessor owner of the gallery was too indefinite and lacked consideration to constitute a contract under section 2-204. Accordingly, Teter was under no firm obligation with Glass Onion or the previous gallery owner to continue selling artwork and could stop selling or refuse to sell paintings to the gallery without recourse.

For similar lines of reasoning, see Key Items, Inc. v. Ultima Diamonds, Inc., No. 09 Civ. 3729(HBP), 2010 WL 3291582 (S.D.N.Y. August 17, 2010) (companies related to buyer were not responsible on unpaid contract to which they were not a party); Harman Invs., Ltd. v. Shah Safari, Inc., No. C10-0216RSL, 2010 WL 3522517 (W.D. Wash. September 07, 2010)(financier was not party to contract for purchase of goods and not liable for non-payment thereon).

- JSM