Friday, June 15, 2012

Implied Warranties and the Distribution Chain.

Big companies have big legal departments. The purpose of those legal departments is to minimize risk for the company. In large companies that deal in goods, most of them will attempt to disclaim what is called the Implied Warranty of Fitness for a Particular Purpose ("IWFPP"). Usually, a disclaimer of IWFPP will accompany a disclaimer of the Implied Warranty of Merchantability ("IWM") and any express warranties. These generally work, but not always.

IWM can be disclaimed by mentioning "merchantability" in the disclaimer, and it must be conspicuous. Words like "as is" in connection with the purchase contract can be used. Additionally, circumstances such as failure to notice a defect upon inspection or a refusal to inspect, or courses of performance or dealing can also exclude implied warranties. IWFPP can be disclaimed by stating that "[t]here are no warranties which extend beyond the description on the face hereof." [1] IWFPP can also be disclaimed by specific language excluding the IWFPP.

Whether an implied warranty has or has not been disclaimed has real-world consequences. An implied warranty is predicated upon an an unmentioned assumption made by the buyer to which the seller either has or has not taken exception. There are problems if B buyer purchases goods from S seller, and those goods turn out to be defective in a way that incorporates an implied warranty, because either B buyer or S seller are going to have to pay unexpected costs. B buyer will have to pay unexpected costs if S seller has properly excluded implied warranties. S seller will have to pay unexpected costs if S seller has not properly excluded implied warranties.

There are further issues when there is an intermediary company, like a representative or distributor. If the first company in the chain of distribution excludes all implied warranties, the next level of distribution is sometimes hanged out to dry. The goal of the next level of distribution is to sell the product of the company higher up in the distribution chain. As a result, a number of things can happen. The terms and conditions of the original company may not be transmitted that disclaim implied warranties. Express warranties may be made by the lower level of the distribution chain. New implied warranties can also be created.

In the latter two situations, involving express warranties and new implied warranties, the lower level of the distribution chain is exposed to often unreasonable levels of liability. Let us consider a hypothetical involving a large company, A, that has produced a widget. D is a distributor of A's widget, and B buyer purchases the widget. A supplies D with however many widgets that D can sell. D needs to sell A's widgets to make money, and carrying inventory is costly. So D will attempt to sell these as quick as is practicable. A has terms and conditions like all large companies, that disclaim IWM and IWFPP. In D's attempts to sell A's widgets, it is unreasonable to assume that D will not create a new IWFPP.

The elements of IWFPP are: (1) the seller had reason to know of the buyer's particular purpose; (2) the seller had reason to know the buyer was relying on the seller's skill or judgment to furnish suitable goods; and (3) the buyer in fact relied on the seller's skill or judgment to furnish suitable goods. [2] In nearly every case that D sells A's widget, D will have created an IWFPP. A buyer of a good will tell D the purpose for which the good is being purchased. D will direct the buyer to a particular good. Thus is the IWFPP created.

Depending on the relationship between A and A's widgets and D distributor, A may be liable to B buyer. D distributor may have actual, implied or apparent authority, in which case B buyer can sue A. If B buyer sues to recover from A, A would then be able to recoup the amount for which A is liable from D distributor.

In the real-world, this ultimately comes down to an economic analysis. If D distributor made an implied warranty over goods that cost a lot, A may or probably will attempt to recover from D distributor. If D distributor made an implied warranty over goods that do not cost a lot or did not create a lot of legal liability, A probably will not attempt to recover from D distributor.

[1] UCC 2-316(2).
[2] Renze Hybrids, Inc. v. Shell Oil Co., 418 N.W. 2d 634, 637 (Iowa 1988).

Monday, June 11, 2012

Precision with Legal Definitions in F.O.B. Destination.

In my last post, I discussed some of the difficult issues faced by buyers and sellers of goods when those goods are damaged in transit. Basically, if the contract is silent on who bears the risk of loss or damage to the goods in transit, then responsibility for damage to the goods is with the buyer after the seller tenders delivery to the freight carrier. Article 31 of the CISG has comparable rules with some nuances.

I thought it might be useful to delve into the definitions of "receipt" and "tender of delivery." They do not mean the same thing, and are tantamount when examining issues or potential issues with carriage. "Receipt" means taking physical possession of goods. In many cases, delivery will be tendered and the buyer has title or ownership to the goods, yet the buyer will not have physical possession of them.

From a buyer's standpoint, this is not inconsistent with the default rule when goods are to be shipped and the contract is silent on who owns the goods in transit. If A manufacturer sells goods to B buyer, and B buyer takes ownership of the goods after tender of delivery, and the goods are damaged in transit, then B buyer is responsible for replacing the goods. The result is the same when the situation is examined through the F.O.B. concept.

Tender is such performance by the tendering party to render the other party in breach or default if they do not perform. Tender of delivery requires the seller to place and hold conforming goods at the buyer's disposition, as well as give the buyer notification reasonably necessary to enable the buyer to take delivery. Note that it says conforming goods, which are those meeting the obligations of the contract. In other words, the goods are in such condition that the seller has met its legal obligation.

Tender does not require the seller to give physical possession of the goods to the buyer. Delivery requires voluntary transfer of possession. Tender of delivery can mean transfer of physical possession if the parties so contract, but the default rule when a contract is silent demarcates physical possession and delivery.

So, tender of delivery essentially means that the seller must place goods at the buyer's disposition, and a voluntary transfer of possession occurs, but not necessarily physical possession. If contracted-for goods are shipped F.O.B. Origin, then tender of delivery does not mean the same thing as receipt. If the goods are shipped F.O.B. Destination, then tender of delivery does mean the same thing as receipt.

Tuesday, June 5, 2012

The importance of F.O.B. Destination.

If you deal in goods, chances are that you are familiar with the terms "F.O.B. Origin," and "F.O.B. Destination." Alternatively, you may hear the terms, "F.O.B. Factory", "F.O.B. Shipping Point," and "F.O.B. Jobsite." Part 5 of UCC Article 2 deals with tender, delivery, shipment and risk of loss as it pertains to F.O.B. F.O.B. means "Free on Board," although one may also hear it as "Freight on Board." F.O.B. specifies whether the buyer or seller bears the risk of loss to the goods during shipment, and where responsibility is transferred.

In many cases, there is not a breaching party. The seller dutifully tenders the goods to the freight carrier or other method of transit, and the buyer is not aware that the goods may be damaged in transit. If the goods are F.O.B. Origin, the risk of loss or damage to the goods in transit rests with the buyer. If the goods are F.O.B. Destination, the risk of loss or damage to the goods in transit rests with the seller. To the buyer, having goods shipped F.O.B. Destination is a sort of insurance while they are in transit.

People may think this is not fair, and it is not. It is not fair that the buyer of goods who has no control over damage in transit be responsible for paying to replace goods damaged. But this is exactly what happens. It causes enormous problems in business relationships, as the buyers sometimes are so angry that they henceforth avoid doing business with the seller.

Article 2 allows the parties to contract around the default rules for shipment. The circumstances of a case, trade usage or practice, and a course of dealing or performance also allow parties to evade the default rules of Article 2 for shipment. These latter options, however, involve proving the shipment terms in court, which is almost certainly going to ruin business relationships.

If there is a breach by the seller, then the default rules do not apply. The seller cannot deliver damaged goods to the carrier and shift the risk of loss onto the buyer. The issue with this is that the ability to discern whether the seller delivered damaged goods to the transit company is sometimes exceedingly difficult. Unless damage is clearly due to the rigors of transit, a buyer may not be able to tell whether the goods were damaged before or during transit. The resolution of issues like this often comes down to prudent, shrewd or accommodating businesspersons. A prudent seller admits that the goods were damaged when they delivered them to the carrier, especially when there is a future business relationship in the balance. A shrewd or dishonest seller will not admit the goods were damaged, especially when there is not a likely future business relationship in the balance. An accommodating seller will admit their mistake if the goods were damaged, and may accept the risk of loss even if they believe the goods were not damaged when they were delivered to the carrier.