COVID-19 and UCC Sales of Goods – Impracticability and Other Issues Likely to Arise

It goes without saying that the coronavirus pandemic has rattled the economy; as a result, businesses are facing difficulties honoring contracts. This DGS legal alert focuses on contracts for the sale of goods—generally governed by Article 2 of the Uniform Commercial Code (“UCC”)—and some UCC provisions that may arise in these uncertain times.

First, parties should consider whether performance under the goods contract has become “impracticable” due to COVID-19 or the various government orders instituted as a result of the pandemic. Under UCC § 2-615, a seller’s inability to deliver goods as agreed is not a breach of the contract if (1) its ability to do so “has been made impracticable” because of unforeseen events or compliance with an applicable government law; and (2) it properly notifies the buyer.[1] Where only a part of the seller’s capacity to deliver is affected, it “must allocate production and deliveries among his customers . . . in any manner which is fair and reasonable.”[2] Whether the seller has satisfied these requirements is generally an issue of fact decided by a jury (or, if acting as factfinder, the court).[3]

As drafted, this section appears to apply only to sellers. However, both the UCC Official Code Comments and some courts indicate that buyers may invoke § 2-615 to excuse performance.[4]

But no matter the party asserting the defense, a mere increase in cost or collapse in the market is unlikely to constitute impracticability.[5] Parties suffering generally from the bad COVID-19 economy are not automatically excused from honoring their contracts. Rather, an impracticability defense should invoke a specific circumstance such as “a severe shortage of raw materials or of supplies due to a contingency such as . . . unforeseen shutdown of major sources of supply or the like.”[6]

There may also be challenges asserting impracticability where the parties’ contract has already allocated the risk of nonperformance in some way. For instance, the Tenth Circuit analyzed whether the buyer’s performance was excused under a “take-or-pay” contract.[7] In such a contract, a buyer may perform in either of two ways: It may “take” specified amounts of product or “pay” the seller a penalty.[8] Relying on “settled law” that “the impracticability of one alternative” is not an excuse if “performance by means of the other alternative is still practicable,” the Tenth Circuit held that the impracticability of the buyer’s duty to take did not automatically absolve it of its duty to pay.[9] However, the court’s decision leaves open the possibility that a buyer could be excused from both obligations if unforeseen events or compliance with a government law renders both obligations impracticable.

In addition to impracticability, COVID-19 and related economic difficulties might trigger these other UCC Article 2 provisions:

• UCC § 2-502 – Buyer’s Rights upon Seller’s Insolvency.

Under this section, [10] a buyer may recover goods if the seller becomes insolvent and certain other circumstances are present. The UCC says a buyer or seller is insolvent if the party has (1) ceased to pay its debts in the ordinary course of business, (2) cannot pay debts as they become due, or (3) is bankrupt as defined by federal bankruptcy law.[11] The goods sought to be recovered must generally be “identified,”[12] meaning that the goods have been designated or set aside as the ones to be delivered to the buyer.[13]

• UCC §§ 2-702 and 2-705 – Seller’s Rights upon Buyer’s Insolvency.

On the flip side, a seller who discovers that a buyer has become insolvent may refuse delivery of goods (except where the buyer pays in cash)[14] or halt the delivery of goods possessed by a shipper or bailee.[15] The seller should be sure to give reasonable notice to the shipper or bailee.[16] This section should also protect a shipper or bailee who complies with a seller’s demand to stop shipment, giving the shipper a defense in any suit by the buyer.[17]

• UCC § 2-712—Cover.

Under this section, if the seller fails to deliver the contractual goods, the buyer may “cover” by purchasing substitute goods and seeking from the seller the difference in price and related damages.[18] Nonetheless, the buyer should be wary of “upgrading” or purchasing goods superior to those contemplated in the contract. If an equivalent product is available, a buyer is unlikely to recover the full cost of cover for an upgraded product.[19] Notably, however, the UCC says that, “[f]ailure of the buyer to effect cover within this section does not bar him from any other remedy.”[20] That may be good news for buyers who would find it difficult to secure substitute goods in a challenging market but bad news for sellers who are potentially exposed to greater buyer-side damages.

• UCC § 2-716—Replevin.

Where the seller fails to deliver, the buyer may be able to retrieve the goods in lieu of damages if the goods are “unique” or “other proper circumstances” support retrieval.[21] Generally, the goods must be identified (as discussed above) and cover must be “reasonably unavailable.”[22] Unique goods may be those that are “specifically designed” for the buyer.[23]

• UCC § 2-609—Right to Adequate Assurance of Performance.

When a seller or buyer experiences “reasonable grounds for insecurity” with respect to the other party’s performance, “the other may in writing demand adequate assurance of due performance.” Until the party “receives such assurance,” the party “may if commercially reasonable suspend any performance for which [it] has not already received the agreed return.”[24] Whether there are “reasonable grounds for insecurity” is ultimately a question for the factfinder and thus an issue that presents some risk for a party demanding assurances.[25]

It is also imperative to adhere to the statute’s other requirements for demanding assurances of performance. In Scott v. Crown, the court observed that there were “serious problems with the timing, form, and content of Seller’s demand for assurances of performance.”[26] Although there were reasonable grounds for insecurity, the seller suspended performance after orally demanding assurances (rather than in writing) and did not specify that he was demanding assurances of performance. As a result, the court construed seller’s suspension of performance as an anticipatory reputation of the contract,[27] giving the buyer the right to cancel the contract and pursue other remedies.[28]

* * *

This illustrates the various rights available to buyers and sellers of goods confronting COVID-19 and related uncertainties. But with those rights come certain traps for the unwary. Davis Graham & Stubbs LLP’s attorneys have experience litigating UCC disputes from inception through trial and are well positioned to advise parties on how to exercise their rights under the UCC without falling into any of those traps.

Please contact Ben Strawn or Gabrielle Robbie if you have further questions on this topic.

[1] U.C.C. § 2-615; see also C.R.S. § 4-2-615 (Colorado UCC).

[2] U.C.C. § 2-615(b); see also C.R.S. § 4-2-615(b).

[3] 1 White, Summers, & Hillman, Uniform Commercial Code § 4:22 & n.11 (6th ed.) (almost all courts consider impracticability an issue for the trier of fact and collecting cases); see Cliffstar Corp. v. Riverbend Prod., Inc., 750 F. Supp. 81, 87 (W.D.N.Y. 1990) (“The court finds that the question whether [seller]’s allocation to [buyer] was ‘fair and reasonable’ is one of fact to be decided by the jury.”).

[4] U.C.C. § 2-615, cmt. 9; C.R.S. § 4-2-615, cmt. 9; Golsen v. ONG W., Inc., 756 P.2d 1209, 1220 (Okla. 1988) (Kauger, J., concurring) (observing that Idaho, Illinois, and Iowa courts have applied § 2-615 to buyers).

[5] U.C.C. § 2-615, cmt. 4; C.R.S. § 4-2-615, cmt. 4.

[6] Id.

[7] Int’l Minerals & Chem. Corp. v. Llano, Inc., 770 F.2d 879 (10th Cir. 1985).

[8] Id. at 885.

[9] Id.

[10] See also C.R.S. § 4-2-502.

[11] U.C.C. § 1-201(23).

[12] 1 White, Summers, & Hillman, Uniform Commercial Code § 7:37 (6th ed.).

[13] Matter of CSY Yacht Corp., 42 B.R. 619, 621 (Bankr. M.D. Fla. 1984) (yacht buyers were not entitled to recover yacht materials under UCC § 2-502 because there was no evidence that the materials were set aside or designated for buyers’ yacht).

[14] UCC § 2-702; C.R.S. § 4-2-702.

[15] UCC § 2-705; C.R.S. § 4-2-705.

[16] UCC § 2-705(3)(a); C.R.S. § 4-2-705(3)(a).

[17] See Stephen A. Hess, 3 Colo. Prac., Methods of Practice § 88:15 & n. 7 (“It is not necessary for the bailee to establish that the stoppage was rightful. Merely establishing that the seller had in fact stopped the delivery of the goods will suffice.”).

[18] U.C.C. § 2-712; C.R.S. § 4-2-712.

[19] Nartron Corp. v. Amway Corp., No. 201487, 1999 WL 33435058, at *2 (Mich. Ct. App. Oct. 12, 1999).

[20] U.C.C. § 2-712, cmt. 3 (“[C]over is not a mandatory remedy for the buyer. The buyer is always free to choose between cover and damages for non-delivery . . . .”).

[21] U.C.C. § 2-716; C.R.S. § 4-2-716.

[22] U.C.C. § 2-716, cmt. 3.

[23] Colorado-Ute Elec. Ass’n, Inc. v. Envirotech Corp., 524 F. Supp. 1152, 1159 (D. Colo. 1981).

[24] UCC § 2-609(1); C.R.S. § 4-2-609(1).

[25] Scott v. Crown, 765 P.2d 1043, 1046 (Colo. App. 1988).

[26] Id.

[27] Under U.C.C. § 2-610, where one party notifies the other by words or actions that it will not perform, the other party may bring a breach of contract action even though the performance is not yet due. See also C.R.S. § 4-2-610 (same).

[28] Scott, 765 P.2d at 1046.