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Commercial Contracts: What Happens If You Lack a Formal Agreement
by Michael Gustafson, Barokas, Martin and Tomlinson
One of our firm’s oldest clients, Bill, frantically called me the other day with a million dollar question. He has been supplying specially made Ultra-Sized Widgets to Widgets R Us for years as their exclusive provider, unfortunately, without a formal contract. Last week, Bill’s delivery truck was turned away at the loading dock. It seems Widgets R Us no longer wishes to purchase the Ultra-Sized Widgets Bill has been specially making for them and delivering every 90 days. Bill called the store’s owner, Buzz Buzzkill, who coldly reasoned, “We don’t need to pay you for that order; there is no contract. Buzz off!” Bill is afraid he is now stuck with a million dollars worth of specially made widgets, for which there is no market elsewhere, and is kicking himself for not having a formal contract.
First, Bill should be kicking himself for not having a formal contract. The first piece of advice any business lawyer gives to any small, medium or big business is “put everything in writing.” There is no such thing as a handshake agreement, and even your good friends “forget” they agreed orally when money is on the line. However, we were able to help Bill get paid for the Ultra-Sized Widgets because, unbeknownst to Mr. Buzzkill, there actually is a contract. Here’s why.
Products sold in this country (and in the EU) are subject to the Uniform Commercial Code (UCC) and the European equivalent. UCC 2-207 (3) anticipates that in many cases, parties will have dealt with each other over a long period of time without a formal written contract. If the conduct of the parties over the years shows that both sides proceeded on the assumption that an enforceable agreement existed between them, then a contract is provided. In that case, the “contract” is construed from the writings that do exist between the parties, usually in the form of invoices, along with UCC gap-fillers.
In other words, the “contract” shall consist of those terms the parties’ writings agree on (in this case: price, quantity and quarterly delivery) plus supplemental terms supplied by the UCC. The UCC will also look at the past dealings between the parties (on this and prior matters) to supplement terms. The UCC also looks to the “custom and usage” in the industry to determine what rules and practices have been generally adopted in the industry through common use. The UCC uses these customs as a backdrop to fill in other gaps in the contract.
Bill had another issue for us to deal with in this case. Because his Ultra-Sized Widgets were specially made for Widgets R Us, there was no way Bill could adequately mitigate his damages (which is generally a requirement when the other party breaches a contract). Mitigation means lessening or reducing the amount of damages when the other side breaches, usually through re-selling the goods to another buyer. When a supplier specially makes goods for the retailer and there is no other market for the goods, the retailer cannot argue that the manufacturer failed to mitigate by not selling to a third party.
As a result of all these factors, we successfully argued that there was indeed a contract between the two parties (thanks to Bill having saved his invoices and prior delivery instructions from Widgets R Us) – a contract the retailer breached by not paying when Bill delivered the Ultra-Sized Widgets. The remedy in this case called for Widgets R Us to fully pay (as they had in the past) for the specialty widgets. In order to stop an ongoing supply contract, they were required to give adequate notice in advance that they wished to discontinue receipt of the Ultra-Sized Widgets. They could not simply refuse to pay and hide behind the lack of a formal contract.
The bottom line is this: when your business is contracting with another business on a sale or delivery of goods, the UCC almost always infers the existence of a contract based on the actions and communications of the parties. The UCC assumes both sides are experienced enough and wise enough to protect themselves in the contracting process. As a result, the UCC ignores a lot of the formalities of general contract law and will create a contract between the parties baesd on agreed-upon terms and general terms from the UCC as well as the past dealings between the parties and the “custom and usage” in the industry. This is different from contracts between a company and an individual consumer. In that case, ambiguities and uncertainties will be implied against the company. But that is the subject of Bill’s next problem.
This article is the second in the series from Barokas, Martin and Tomlinson.
[PRINTER FRIENDLY VERSION]
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About Michael Gustafson
Michael Gustafson is an Associate at Barokas Martin and Tomlinson. He works in the areas of business and corporate law and writes and lectures on civil litigation, contracts and collections.
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