Forced to sign contract on dotted lines? – FULL

VERSION

Battle of Forms under “The Uniform Commercial Code” By

Karthik Kannappan S - Senior Corporate counselMadhusmita Borthkur – Researcher K.L.E. Society LAW College, Bangalore

Copyright © 2009 The following material is provided for informational purposes only. Before taking any action that could have legal or other important consequences speak with a qualified professional who can provide guidance that considers your own unique circumstances. The author does not accept any responsibility or liability whatsoever for loss damage or costs incurred or claimed in any manner as a consequence of any action or inaction of any person or party based on this Report.

Background:

1. Standard form contracts1, (i.e., contracts with preprinted terms containing “boilerplate” language), have been in common use in the United States since at least the late nineteenth century. There are various legal implications when alternate terms and conditions are proposed by either party.

2. At common law, a contract was not enforceable unless there was a meeting of the minds on all terms. But this “mirror image rule2” was abandoned by the Uniform Commercial Code3 (“UCC”), which allows parties to form a valid contract even if their proposed terms are not identical. Under UCC § 2-207 and state statutes modeled after it4, additional terms contained in an acceptance do not prevent contract formation. However, the question that remains is which of these additional terms will become part of the enforceable contract!

Issue # 1 Does UCC apply to Computer software service providers?

Issue # 2 Legal implication of varying terms or additional terms proposed by parties?

Issue # 3 Which of the additional terms will become part of the enforceable contract? Key strategy in drafting?

B. Issue # 1: Does UCC apply to Computer software service providers?

1. Software is often provided in combination with various types of services5 or used in the performance of service contracts6. Before examining such software transactions in detail, judicial treatment of analogous hybrid sale/service transactions generally must be reviewed.

2. Pure service contracts - the opposite end of the spectrum from pure sales transactions - generally fall outside of the domain of article 27. However, pure service and pure sale transactions represent the extreme ends of a continuum. Most transactions are hybrids involving both the sale of goods and the performance of services.

3. Conclusion: Courts view software as a good within the domain of article 2 of UCC8. Hence UCC does apply where software is involved.

C. Issue # 2: Legal implication of varying terms or additional terms proposed by parties?

The legal implication of any additional terms or varying terms proposed by either party is explained under the Uniform Commercial Code § 2-207 (Additional Terms in Acceptance or Confirmation) that states the following:

1. Under § 2-207 (1)9 a definite expression of acceptance or a written confirmation of an informal agreement may constitute a valid acceptance even if it states terms additional to or different from the offer or informal agreement.

1 Typically Standard forms are a strategy to help businesses become more efficiently by eliminating the need for extensive negotiations between the parties. This puts the Service providers at the disadvantage.2 Under mirror rule an acceptance had to be a “mirror image” of the offer in order for a contract to be formed. Thus, if differing terms were contained in the seller’s acknowledgement, no contract was formed. The party that fired the “last shot” was favored because that party’s terms were viewed as assented to and binding.3 Presently Commercial Code (UCC) is the dominant source of American commercial law and is applicable to the contracts. All 50 States have

enacted all or most of the UCC.4 See, e.g., N.J. Stat. Ann. § 12A:2-207; NY CLS UCC § 2-207.5 See, e.g., RRX Indus. v. Lab-Con., Inc., 772 F.2d 543, 546 (9th Cir. 1985) (software provided with employee training, repair services, and system upgrading.6 See, e.g., In re Community Medical Center, 623 F.2d 864 (3d Cir. 1980)7 See R. BERNACCHI & G. LARSEN, supra note 9, at 138 (U.C.C. does not cover contracts solely for services); Note, The Goods/Services Dichotomy and The U.C.C.: Unweaving the Tangled Web, 59 NOTRE DAME L. REV. 717, 717 n.3 (1984) (article 2 does not apply to contracts solely for services); Blottner, Derrico, Weiss & Hoffman v. Fier, 420 N.Y.S.2d 999, 1002 (N.Y. Civ. Ct. 1979) (providing of services is not covered by U.C.C.). See also R. ALDERMAN, A TRANSACTIONAL GUIDE TO THE UNIFORM COMMERCIAL CODE 7 (1983) (article 2 is not expressly applicable to service contracts); A. FARNSWORTH, CONTRACTS 33 (1982) (article 2 not applicable to service contract).8 In RRX Industries v. Lab-Con, Inc., 772 F.2d 543 (9th Cir. 1985) the court found the California version of the U.C.C. applicable to a contract for the purchase of software. The court, noting that for the U.C.C. to apply the software must be a good, had no difficulty concluding without analysis that the software was a good under U.C.C. section 2-105. The court then found that the sale of goods aspect, the sale of the software, was the predominant feature of the transaction, with the services being only an incidental part of the transaction. Consequently, the Ninth Circuit found, under the predominate feature test, that in this case the sale of software with accompanying services was a contract for the sale of goods covered by article 2.9 Refer § 2-207 (1) (Additional Terms in Acceptance or Confirmation)

2. Under § 2-207 (2)10 the additional or different terms are treated as proposals for addition into the contract. Between merchants, such terms become part of the contract unless(Refer Exhibit 1 & 2 attached to the document): a) the offer expressly limits acceptance to the terms of the offer, b) material alteration11 of the contract results, c) notifications of objection to the additional/different terms are given in a reasonable time after notice of them is received.

3. Under § 2-207 (3)12, if there is no contract under 2-207(1), then under UCC Sec. 2-207(3), conduct by the parties that recognize there is a contract may be sufficient to establish a contract. The terms for this contract include only those that the parties agree on the rest of UCC gap fillers (“Knock-out Rule”).

4. No material Alteration: Lists of terms that do not materially alter a contract are: limitation of damages clause13, clause fixing a reasonable time for complaint, clause providing for interest on overdue invoices, clause fixing standard credit terms where the terms are within a reasonable range.

5. Material Alteration: Lists of terms that do materially alter a contract are: clause adjusting price14, clause for indemnification15, choice of law clause16, choice of forum clause17, clause disclaiming warranties18, clause providing for attorneys’ fees19, clause changing quantities to be shipped in an installment contract20

D. Conflicting Terms - Knockout rule and UCC Gap Fillers under § 2-207 (3):

1. knock-out rule21: a. Most courts require affirmative assent from buyer/offeror to additional terms, even if proceeded with contract. Without assent

to additional terms, knock-out rule (2-207(3)) applies22. b. The “knock-out rule” is meant to resolve a “battle of the forms” when a seller and buyer exchange unilateral forms with

conflicting terms. The existence of conflicting terms is taken as mutual rejection, regardless of which was communicated first. As a result of this mutual rejection, the contract contains a gap. Accordingly, the Code supplements the gaps with its usual statutory gap-filler and, where applicable, with immanent business norms.

c. Points to consider of court interpretation on conflicting terms are as follows:i. Duration of warranty : In Northrop Corp. v. Litronic Industries23, the court knocked out the discrepant warranty terms and

filled the gap with a warranty for “reasonable” time24.ii. Disclaimer of Warranty : In Roto-Lith v. Bartlett25, Judge Grant Gilmore opined that “it would have been outrageous to have

saddled the seller with warranties which (as the buyer knew) he had expressly (and quite reasonably) disclaimed.”iii. Arbitration: In a landmark case the two arbitration clauses were knocked out and the dispute was referred to court even

though the seller was willing to concede and arbitrate under the buyer’s term26.iv. Limitation of liability (including consequential damages): The seller’s term, by excluding even foreseeable and ordinary

expectation losses, sets damages too low; the buyer’s term, by including unforeseeable and unpreventable components of the loss, sets damages too high. Seller’s limitation on remedies can be more reasonable than the buyer’s expansive remedy term when applied to a subset of losses and scenarios, but not to others. If the seller offers a limited repair and

10 Ibid.11 Term materially alters the contract if its incorporation without express awareness would result in surprise or hardship or is a significant element of the contract. 12 Refer § 2-207 (3) (Additional Terms in Acceptance or Confirmation)13 See Suzy Phillips Originals, Inc. v. Coville, Inc., 939 F.Supp. 1012 (E.D.N.Y. 1996)14 See Advanced Mobilehome Systems of Tampa, Inc. v. Alumax Fabricated Products, Inc., 666 So.2d166 (Fla. App. 1995)15 See Plamer G. Lewis Co. v. ARCO Chemical Co., 904 P.2d 1221 (Alaska 1995)16 See Dassault Falcon Jet Corp. V. Oberflex, Inc., 909 F.Supp. 345, 352 (M.D.N.C. 1995).17 See Dependable Component Supply, Inc. v. Pace Elec. Inc., 772 So.2d 582, 584 (Fla. Dist. Ct. App. 2000).18 See Tuck Indus. Inc. v. Reichhold Chems, Inc., 542 N.Y.S.2d 676, 678 (App. Div. 1989).19 See Herzog Oil Field Serv., Inc. v. Otto Torpedo Co., 570 A.2d 549, 551 (Pa. Super. Ct. 1990).20 See Steiner v. Mobil Oil Corp., 569 P.2d 751, 754 (Cal. 1977).21 “Knockout” rule of Section 2-207: material provisions over which the forms disagree are knocked out. 22 See Step Saver, footnote 34.Step-Saver Data Systems, Inc. v. Wyse Technology 939 F.2d 91 (3d Cir. 1991).23 29 F. 3rd 1173 (7th Cir. 1994). Seller’s form contained a 3-month warranty term; the buyer’s form contained a warranty with no time limit. The buyer first inspected the goods after 6 months, and upon discovering defects rejected the goods and sought remedies. The court did not have to designate a specific duration as the most reasonable; it merely decided that the 6 months it took the buyer to invoke the warranty was reasonable.24 The trial court relied on UCC §2-309 which allows buyer to reject non-conforming goods within a reasonable time. 25 297 F. 2nd 497 (1st Cir. 1962).26 Refer See Lea Tai Textile Co. v. Manning Fabrics Inc., 411 F. Supp 1404 (D.C.N.Y. 1975)

replacement remedy and can do so reasonably, the seller’s term ought to be regarded as more reasonable, especially in light of the seller’s statutory right to cure a defect before being subjected to damages. If, instead, the seller cannot repair the defect (say, the goods were destroyed), the seller’s term would be less reasonable27.

v. Damages: More generally, in line with the rule of §2-715, the buyer’s remedy term would be unreasonable if it entitles the buyer to recover damages that he could have prevented28.

2. UCC Gap Fillers: a. Once the parties’ conflicting terms drop out, the Code’s gap-fillers would be considered. One should keep in mind that these

gap-fillers are often significantly closer to the buyer’s form terms than to the seller’s29.

E. Additional term under § 2-207 (2):

a) Where no conflicting terms and additional terms are proposed, UCC Gap filler would not be applicable and it would be analyzed if such additional terms alter the material terms of the contracts. (Examples of material terms would be price, quantity, delivery date and payment terms).

b) As long at the additional terms do not alter the material terms they would not be struck out and they may positively be retained to form part of the contract.

c) NOTE: Typically most of the PO Standard Terms and conditions DO NOT have limitation of liability. They same should be proposed as additional terms while accepting to other terms and conditions. Courts decided that additional terms on Limitation of liability proposed by seller do not amount to alteration of material terms30.

F. Key Strategy in light of Courts interpretation of critical clauses:

1. No material Alteration : Include additional terms with reference to terms that do not alter the material terms.2. Material Alteration : Avoid additional terms that materially alter the contract if its incorporation without express awareness would

result in surprise or hardship. 3. Include liability cap: Include limitation of liability clause as additional terms. 4. Indemnification: For indemnification clause specifically state as, “notwithstanding anything Contractor shall indemnify only for third

party claim for Intellectual property misappropriation claim.” This way any conflicting clause would be struck out while the above mentioned limitation of liability would still protect the exposure of liability.

5. To ensure that desired terms become part of the contract and do not “fall out” as a conflicting term, sellers may include a provision in a responsive form or acknowledgment that explicitly states that formation of a contract between the parties is expressly conditional on the buyer’s agreement with the terms in the seller’s form. This type of conditional acceptance must be an explicit statement on the part of the seller.

27 White & Summers, supra note 3, at 660–662, discuss the reasonableness of sellers’ limitations on remedies under §2-719.28 §2-715 explains that consequential damages are limited by “refusing to permit recovery unless the buyer could not reasonably have prevented the loss by cover or otherwise.”29 For example, when the buyer’s warranty term and the seller’s disclaimer of warranty drop out, the Code’s gap-fillers include an ever-expanding warranty of merchantability and an express warranty arising from any affirmations of fact the seller may have made orally in the course the parties’ communications (which, under the Code’s weak version of the parol evidence rule, are often admissible). The result is therefore quite favorable to the buyer, at times identical to the warranty term the buyer’s form included originally. Similarly, when the buyer’s remedy terms and the seller’s limitations on remedies drop out, the gap-fillers are the generous remedies available to the buyer under the Code, including consequential damages30 In Zenith Electronics Corp. v. WH-TV Broadcasting Corp., 2003 WL 1627458 (N.D. Ill. 2003) court stated that Limitation of liability provision contained in sales order acknowledgment was not a material alteration to parties’ contract. Therefore, since buyer did not object to the term, such term was added to the contract, and buyer’s ability to recover lost profits was limited.

Exhibit 1 – Legal implication when Conflicting terms exist

Was Acceptance of different terms (that conflict opposed by

Supplier made conditional on assent from Buyer?

Conflicting terms will be “knocked out” in case there is a dispute between parties as per UCC§ 2-207 (3)

No Contract unless agreed upon by Buyer

Contract formed with non-conflicting terms. The surviving additional terms if any shall have to pass materiality clause test.

Did the parties continue to conduct

business?

No contract has been formed between the parties.

Contract has been formed between the parties by actual performance and “UCC gap fillers” would be applied by Court as per UCC§ 2-207 (3)

NO

YES

NOYES

Exhibit 2 – Legal implication when Additional terms exist

with

Was Acceptance Of Additional Proposed By

Supplier Made Conditional On Assent

From Buyer?

Did the Offer (with Add. Terms) Expressly Limit Acceptance to Terms of the offer?

Does Additional Terms Materially

Alter The Agreement?

Did the Buyer give Notification of

objection to the Seller?

Contract with Additional Terms

Contract without Additional Terms

No contract unless agreed upon by Buyer

Did The Parties Continue To

Conduct Business?

Contracts with UCC “gap fillers” as per UCC§ 2-207 (3)

No Contracts Formed Between The Parties.

YESNO

YES

YES

YES

YES

NO

NO

NO

NO