DOES THE UCC APPLY TO THE CONTRACT FOR THE SALE OF GOODS AND SERVICES

Posted on May 29, 2022May 29, 2022 by Edward Garber

What governs the transaction for the hybrid contract that includes both goods and services–the Uniform Commercial Code (UCC) or the common law? A question that is asked in numerous disputes. A good example is the recent case out of the Eleventh Circuit Court of Appeals, Wadley Crushed Stone Company, LLC v. Positive Step, Inc., 2022 WL 1639011 (11^th Cir. 2022), dealing with Alabama law.

In this case, the plaintiff (buyer) wanted to build a granite plant in Alabama that would process 500 tons of granite per hour. The plaintiff reached out to a defendant company to start the process of building a granite plant. The defendant company engaged vendors and professionals in the due diligence process to determine the equipment the plaintiff would need. After this due diligence, plaintiff and defendant entered into a contract that included equipment and services. Thereafter, the parties modified the contract to reduce the amount for the erection, installation, and electrical work (about $1.5 Million) as plaintiff planned to independently hire the contractor to perform that work. The modified contract was worth $4,059,224.43 of which there were 25 lines items for equipment totaling $3,887,274.43 with the balance (less than 5% of the contract amount) for engineering (done by a third party), installation, setup, and calibration of scales.

The plaintiff received its equipment but did not pay some of the invoices because it was unhappy with the functioning of its granite plant, i.e., it was not producing 500 tons of granite per hour. Almost five years after the plant was completed, the plaintiff sued the defendant for breach of contract because its plant did not produce 500 tons of granite per hour. The defendant moved to dismiss arguing that the statute of limitations expired. In particular, the defendant argued that the UCC’s four year statute of limitations applied to the breach of contract because the contract was for the sale goods. The trial court granted summary judgment in favor of the defendant finding that the transaction was governed under the UCC and the statute of limitations expired.

On appeal, the issue was whether the contract was for a sale of goods triggering the UCC or a sale of services where the UCC would not apply. Relying on Georgia law (but it would be the same in many jurisdictions), when a contract is for the sale both goods and services, the court will apply the predominant factor test. “When the predominant element of a contract is the sale of goods, the contract is viewed as a sales contract and the UCC applies even though a substantial amount of service is to be rendered in installing the goods.” Wadley, supra, at *3 (quotation and citation omitted).

Thus, the Eleventh Circuit looked to see whether the services included in the contract were incidental to the sale of the goods/ equipment; “[i]f they were, then the sale of goods was the predominant purpose, but, if the sale of goods was only incidental to the provision of services, then services predominate.” Id.

“To apply the predominant factor test, we must evaluate three aspects of the contract to determine whether goods or services are predominant: 1) the language of the contract—looking at how the parties refer to each other and the labeling of the contract; 2) the subject matter of the contract—looking to see if the contract is for a movable good; and 3) the billing of the contract—looking to see the proportion of the contract’s price dedicated to goods and services. If, after applying the predominant factor test, it is stillunclear whether the contract is for goods or for services, Georgia law says that the UCC should “be liberally construed and applied to promote itsunderlying purposes and policies.”

Wadley, supra, at *4 (internal citations omitted).

In looking at the first factor—the language of the contract—the Court noted that the contract, itself, was not clear whether it was a contract predominantly for goods or services as there was language in the contract that could cut both ways in favor of either party.

In looking at the second factor—the subject matter of the contract—the Court evaluated whether the thrust of the contract was for a movable good. In doing so, the Court observed 25 of the 27 line items in the contract were for movable goods, i.e., “[e]ach piece of equipment is a good that was movable when the contract was signed.” Wadley, supra, at *4.

In looking at the third factor –the billing of the contract—the Court looked at how the contract was billed. In doing so, the Court noted that over 95% of the contract price was for the movable goods/ equipment. Less than 5% of the contract price was for services, with the parties knowing that engineering would be done by a third party. The plaintiff tried to argue that baked into the 95% were service-related charges, but the Court did not buy this argument. “[Plaintiff] has cited no record document or case to suggest that the contracting parties agreed to the markups as disguised service charges, and it seems more logical to conclude that a sale of equipment will include a margin of profit for the sale. So, summary judgment is appropriate, because it is a contract for goods, and the UCC’s applicable four-year statute of limitations has passed.” Wadley, supra, at *5

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

HYBRID CONTRACTS FOR THE SALE OF GOODS AND SERVICES AND THE PREDOMINANT FACTOR TEST

Posted on January 2, 2021January 2, 2021 by Edward Garber

Florida’s Uniform Commercial Code (also known as the UCC) applies to transactions for goods. “Goods” is defined by Article II of the UCC as “all things (including specially manufactured goods) which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid, investment securities (chapter 678) and things in action.” Fla. Stat. s. 672.105(1).

The UCC does NOT apply to transactions for services. Transactions for services are governed by common law.

Oftentimes, transactions or contracts include BOTH goods and services. In this scenario, referred to as a hybrid contract, does the UCC or common law apply? In this scenario, courts apply the predominant factor test to determine whether the UCC or common law governs the transaction:

Whether the UCC or the common law applies to a particular hybrid contract depends on “whether the[ ] predominant factor, the [ ] thrust, the[ ] purpose [of the contract], reasonably stated, is the rendition of service, with goods incidentally involved (e.g., contract with artist for painting) or is a transaction of sale, with labor incidentally involved (e.g., installation of a water heater in a bathroom).” In such instances, the determination whether the “predominant factor” in the contract is for goods or for services is a factual inquiry unless the court can determine that the contract is exclusively for goods or services as a matter of law.

Allied Shelving & Equipment, Inc. v. National Deli, LLC, 154 So.3d 482, 484 (Fla. 3d DCA 2015) (citations omitted).

To illustrate, in Allied Shelving & Equipment, a vendor was hired to provide and install a pallet rack system (large shelves) in a warehouse. Each party claimed the other materially breached the contract. An issue on appeal was whether the trial court erred by applying the common law instead of the UCC to the hybrid contract which involved both the sale of goods (providing the racks) and services (installing the racks). The trial court found that the predominant factor of the transaction was services, hence the application of the common law. The appellate court affirmed (because the parties did not have a court reporter at the trial so the appellate court was not in a position to analyze the evidence introduced into the record.)

The Eleventh Circuit Court of Appeals in BMC Industries, Inc. v. Barth Industries, Inc., 160 F.3d 1322 (11^th Cir. 1998) provided some pointers to determine whether a contract is predominantly for the sale of goods or services:

First, the language of the contract itself provides insight into whether the parties believed the goods or services were the more important element of their agreement. Contractual language that refers to the transaction as a “purchase,” for example, or identifies the parties as the “buyer” and “seller,” indicates that the transaction is for goods rather than services.

Courts also examine the manner in which the transaction was billed; when the contract price does not include the cost of services, or the charge for goods exceeds that for services, the contract is more likely to be for goods.

BMC Industries, supra at 1330 (internal citations omitted).

In looking at these pointers, the BMC Industries’ Court found that the hybrid contract was predominantly for goods—meaning the UCC applied—based on the contract language including the fact that it was called a purchase order and over half the contract amount was allocated towards the delivery of the goods.

Whether the UCC or common law applies is an important consideration in any transaction. Goods are procured all the time in construction. Services are also procured all the time in construction. And, services and good are procured in the same transactions. Also, important, as contracts start to cater more towards modular construction and prefabrication, whether the UCC or common law applies is a consideration that needs to be factored in when preparing the contractual language.

A CONTRACTOR’S RIGHT TO SET-OFF AMOUNTS FROM A SUBCONTRACTOR

Posted on February 18, 2012February 18, 2012 by Edward Garber

Oftentimes, subcontractors perform trade work for the same contractor on multiple projects. Because of this, it is practical for contractors to include in the subcontract a provision that authorizes them to set-off the subcontract amount due to any defects, breaches, etc. by the subcontractor that occur on another project. On the other hand, subcontractors that understand the ramifications of this provision, want to delete this provision from any subcontract in order to keep their receivables from one project completely separate from another project.

In Carolina Consulting Corp. d/b/a Barrier Wall of South Florida v. Ajax Paving Industries, Inc. of Florida, 2012 WL 163927 (2nd DCA 2012), a roadway contractor subcontracted the paving work on two separate projects (in two different counties).

After the subcontractor completed its work for the first project (“Project One”), a payment dispute arose whereby the subcontractor asserted it was owed more money than it was paid. At this time, the second project (“Project Two”) had not begun and was severely delayed.

When Project Two was ready to commence, the paving subcontractor advised the contractor that it would not perform until it was paid in full for Project One and was issued a change order for the increase in material price due to the severe delay to the start date. The subcontractor later stated that it would not perform until it received adequate assurances from the contractor of the contractor’s ability and willingness to pay for Project Two. The contractor then terminated the subcontractor and hired another subcontractor to perform the paving work for Project Two at an increased rate and lawsuits between the contractor and paving subcontractor were initiated.

The trial court held the subcontractor was entitled to suspend its performance on Project Two until it received adequate assurance that it would be paid for the work. The trial court further found that the subcontractor should be awarded approximately $119,000 for unpaid work for Project One and approximately $105,000 for the contractor wrongfully terminating the subcontractor on Project Two.

The contractor appealed to the Second District Court of Appeal maintaining that the subcontractor breached the subcontract for Project Two when it decided to condition its performance on the receipt of adequate assurances of the contractor’s ability to pay. The Second District agreed and reversed the trial court.

In examining this issue, the Second District looked at Florida’s Uniform Commercial Code, particularly Florida Statute s. 672.609(1), dealing with the sale of goods. This statute, in short, provides that “a merchant has the right to demand adequate assurance of performance ‘[w]hen reasonable grounds for insecurity arise with respect to the performance of’ the other party.” Carolina Consulting, 2012 WL at *2.

The Second District, however, noted that it previously declined to address whether this right under the Uniform Commercial Code applies in the context of construction contracts. The Court further declined to address this issue in this case. Rather, it stated that under the facts of the case, the subcontractor did NOT have a reasonable basis to demand adequate assurances from the contractor because the contractor had a payment bond (which is designed to guarantee payment to subcontractors and suppliers, etc.). For this reason, the Court maintained that the subcontractor breached the subcontract for Project Two and the contractor had the right to set-off amounts for the breach for Project Two for any amounts the contractor may have owed the subcontractor for Project One.

On this point, the Second District stated:

“Under the terms of both subcontracts, upon Ajax’s [subcontractor] breach of subcontract, the contractor had the right to hire another subcontractor to perform the work and then deduct the cost from any amount owed to Ajax in connection with the Pasco County subcontract [Project One].”

This bolded language seems to suggest that the contractor’s subcontract included a provision that allowed it to deduct or set-off amounts owed on one project due to defects or breaches on another project. However, even without this contractual language, it would seem that any amounts owed to the subcontractor for Project One would be offset by any amounts owed to the contractor for Project Two (due to the subcontractor’s breach of that subcontract). In this scenario, the outcome could be the same irrespective of the contractual language. Although, without the contractual set-off language, and assuming the contracts permitted prevailing party attorneys’ fees, it would seem that the subcontractor would be entitled to its fees for the contractor’s breach of the subcontract for Project One and the contractor would likewise be entitled to its fees for the subcontractor breaching the subcontract for Project Two. With the contractual set-off language, it is highly possible that the subcontractor would not be entitled to recover its fees for the contractor’s breach of the subcontract for Project One because the contractor had the contractual right to set-off such amounts due to any breaches associated with Project Two. This is a confusing but important distinction.

As it relates to the subcontractor demanding adequate assurances, this case is important because it illustrates that if the contractor has a payment bond, it will be very difficult for a subcontractor to ever condition its performance on demanding adequate assurance of the contractor’s ability to pay (i.e., its creditworthiness). While, irrespective of the payment bond, such an argument seems extremely challenging if made under the Uniform Commercial Code–many times contracts (particularly prime contracts) will include language that allows a contractor to demand adequate assurance of the paying party’s creditworthiness. Even with this contractual language, it will still be a difficult argument to make if there is a payment bond in place. Also, expanding this rationale, because of lien rights, a court may find that because a contractor/subcontractor has the right to lien the project (a subcontractor can lien the project if there is not a payment bond), it is really never in the situation to reasonably condition its performance on adequate assurances because it could preserve or try to collateralize its payment claim by recording a lien on real property as well as pursue a breach of contract claim against the nonpaying party.