Are Your Goods and Services UCC Worthy?

All Construction Parties Are Affected

It really does not matter what tier you are: the UCC will govern or affect many of your transactions, whether you are an owner/developer, contractor, subcontractor, or supplier. The UCC also affects transactions with sureties and insurers and with the group of so-called consultants and attorneys.

So, now is a good time to take a look at your operations to be sure you meet the requirements of the UCC and to get a better feel for how it will impact your day-to-day operations. It is also a good time to begin to review your contracts and purchase orders and to review your check writing, cashing, and depositing procedures to make sure you are protected and are not at risk.

At the outset, let me mention that my goal in this column is to sensitize you to the coverage of the UCC and to get you more familiar with how it affects your operations. However, the statute is so broad that it is impossible to give you a useful analysis in just one column. It's almost as if I were to say that I'd like to give you a general overview of the Internal Revenue Code—while one or two words may be descriptive enough, it's not something that can be done in one limited article.

My challenge is that I hate writing columns that are more general in nature. Those of you who have read my legal columns for the Contractors Business Management Report or who used to read the entire newsletter, when I was writing that entire publication, knew that we avoided "fluff" and tried to provide useful information in each article. However, since the UCC is so broad, and its coverage so wide, I will use this month's column to give you more of a "fluffy" overview. I will leave it to future columns (or colleagues) to go into more detail later on.

Overview of the Overview

The primary sections of the UCC that apply to your daily operations are Article 2 "Sales" and Articles 3 and 4 dealing with "Commercial Paper," which include checks and promissory notes, and "Banking." Other relevant articles of the UCC deal with leasing goods and equipment, letters of credit, and secured transactions.

Which States Have Adopted the UCC?

The UCC has been adopted in all states. Louisiana was the last holdout but adopted portions of the UCC in 1990, I believe. You always have to be careful when you're dealing with issues that are affected by Louisiana state law—not because it's weird but because their system is based on a different model than all other states. You also have to be careful when you're dealing with issues that are affected by California state law—and that's because it's weird. I'm guessing that the rulings in Louisiana and California on UCC transactions are similar to what would result in other states, but, at this point, it's only a guess.

Which State Law Applies?

This is a common question whenever any legal issue arises. It is especially compelling (traumatic?) in the insurance field, where one state can have laws and court rulings that are significantly more insurer friendly than another state, and vice versa. However, this is much less of an issue with most commercial transactions governed by the UCC. That's because—as the name suggests—the Uniform Commercial Code is designed to create "uniformity" or consistency in how state courts address and rule upon many commercial transactions. This is a major benefit—since you have a right to believe that certain areas of the law generally will be the same as you deal across state lines. Thus, the UCC was designed to give you some level of comfort and predictability in making your interstate commercial transactions.

While all of the states have adopted some form of the UCC, states did have options and alternatives on which sections to adopt and make law. In addition, certain sections have alternatives in the language, and each state is encouraged to adopt the alternative that best addresses the local state issues. As a result, there isn't total consistency among all states, but it's not bad, so be mindful of that.

UCC Article 1

Article 1 of the UCC sets out its primary goal. It says, at § 1–103:

This act must be liberally construed and applied to promote its underlying purposes and policies, which are:

• (1) to simplify, clarify, and modernize the law governing commercial transactions;
• (2) to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties; and
• (3) to make uniform the law among the various jurisdictions.

The creators of the UCC tried to keep it user-friendly. Obviously, some of the sections have confusing language, but each section has a comment portion, explaining what is covered and what is being accomplished by the section. Each section may also have some local comments saying what the specific state attempted to address by the section.

For example, in New York, we have each section of the UCC, followed by the "official" comments of the drafters and then followed by comments from the local New York authors. The courts frequently look to the comments to see what the intent of the section is and to try to resolve the issues in accordance with that intent. You know—make it easy for the readers, especially if they are judges.

UCC Article 2

Article 2 of the UCC cover "Sales." It probably should be titled "Purchases and Sales," but I will put that in the suggestion box for later consideration. I think it is fair to say that this article likely has a major impact on your operations on a day-to day basis. After all, almost everything you buy on your construction projects is governed or affected by Article 2 of the UCC: roofing materials, flooring materials, plumbing supplies, pipes, generators, boilers, Sheetrock, joists, ducts, tiles, chillers, tools, nails, screws, glue, striping materials, or adhesives—all purchases covered by UCC Article 2.

I will go one step further and suggest that everything you bought for your offices (e.g., desks, chairs, file cabinets, liquor cabinets, alcohol to stock those cabinets, pens, pads, or papers) are all affected by Article 2 of the UCC in one way or another.

Why such broad coverage? UCC Article 2 controls transactions for the sales of "goods." "Goods" is defined basically as anything that can be moved—and it's not limited to "anything that can be moved easily" but anything that is movable.

UCC § 2–105 defines goods as follows.

(1) "Goods" means 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 (Article 8) and things in action. "Goods" also includes the unborn young of animals and growing crops and other identified things attached to realty as described in the section on goods to be severed from realty.

What's not covered? Basically, the broad categories that are not covered are transactions involving the sale of real estate, transactions involving the sale of businesses (although other articles of the UCC can and will apply), and transactions involving "intangibles, such as goodwill, patents, trademarks, and copyrights."

Another pretty large category of transactions that are not covered by UCC Article 2 is "services." Article 2 does not apply to contracts for services. Why is that important to us? Because most construction contracts are considered to be contracts for services. Therefore, the standard construction agreements between owner and contractor, owner and construction manager, owner and architect, owner and insurer/broker, contractor and subcontractor, and subcontractor and sub-subcontractors are not governed by UCC Article 2.

However, all of your contracts and purchase orders to buy the materials and supplies that are used on the project are covered by the UCC. So, while your formal agreement to perform the work may not be covered by UCC Article 2, all of your purchase orders and supply contracts likely will be covered.

How Does That Affect Construction?

The typical issue that comes up in this area is whether a contract really is one for "services" or one for the sale of goods. If it is for services, then UCC Article 2 does not apply; if it is for goods, then UCC Article 2 does apply. The challenge is that many construction agreements involve providing services and selling goods.

For example, on a project to replace a roof on a school building—is that primarily for the construction services to remove and replace the roof or for the overall purchase of the roofing materials? How about replacing a boiler or air conditioning unit for a local restaurant? Is that a service contract or one for the sale of goods? If the contract is, on the whole, for the sale of goods, then UCC Article 2 will apply, with all its protections and requirements. If the agreement is a "services" contract, then other state laws will apply and not UCC Article 2. The danger is that you expect one set of rules to apply, but a different set actually controls, and your expectations are out the door.

I had a case in New York a while ago involving this exact issue, Franklin Nursing Home v. Power Cooling, 227 A.D.2d 374 (N.Y. App. Div. 2d Dep't May 6, 1996). Power Cooling was hired to furnish and install an air conditioning unit at the nursing home. The unit was installed and accepted. The nursing home later claimed there were noise issues with the unit and that the nursing home had to install sound barriers to comply with local codes. The nursing home sued Power Cooling for the cost of the sound barriers. However, the lawsuit was started more than 5 years after the unit was installed.

I represented Power Cooling. While we argued that the unit, when installed, complied with all applicable codes, we also defended by saying that the agreement was subject to UCC Article 2. If UCC Article 2 applied, then the limitations period for bringing a lawsuit was 4 years after installation. However, if UCC Article 2 did not apply, then the limitations period for bringing a lawsuit was 6 years after installation. The nursing home missed the 4-year limitations period but met the 6-year limitations period.

UCC Article 2 would apply—and we would win—if this were a transaction for the sale of goods. However, if it were for services, then UCC Article 2 would not apply, and we would lose on the limitations issue.

The appeals court ruled in our favor. Here's a part of what the court said.

Contrary to the plaintiff's [Nursing Home's] contention, the four-year Statute of Limitations enunciated in UCC 2–725 applies in this case because the parties' contract was predominantly for the sale of the air conditioning unit, not for the providing of services.... To this end, the subject contract clearly evinces that the sale of the air-conditioning unit was not merely incidental or collateral to the parties' transaction.

Furthermore, the plaintiff's causes of action accrued when installation of the unit was complete ... which the plaintiff acknowledges to have occurred in May 1989. It is uncontroverted that the plaintiff did not commence this action until August 1994, which was after the four-year Statute of Limitations had expired.... Accordingly, since all of the plaintiff's claims are time barred, the defendant's motion to dismiss should have been granted in its entirety.

UCC Article 2 covering sales of goods has other major sections in addition to the section that limits the time within which a claim can be brought. These sections include the following.

A. Do you have a valid contract, and is your contract enforceable? UCC Article 2 has strict requirements for enforceable contracts involving transactions in goods. If you do not comply with those sections, you may find that your contract or purchase order is not valid or enforceable. So, be sure your purchase orders meet the guidelines in UCC Article 2, so they are enforceable.

B. What happens if there is a battle of the forms? How often does it happen that you send a form agreement to the other side and get back a confirmation that is close but not exactly the same? How often does the transaction go forward even though the differences are not ironed out? Well, if your transaction is governed by UCC Article 2 and is primarily for the sale of goods, then UCC Article 2 will govern how the forms are read and who has what rights.

C. When does the obligation to pay the "purchase price" accrue? UCC Article 2 has a number of sections covering when a seller can validly demand payment for "goods" and when a buyer can refuse to pay. However, you need to be familiar with those sections in order to protect your position, whether you are considered the seller or the buyer.

Also, consider the situations where an owner and contractor (or contractor and subcontractor) decide to split their agreement between work/labor and materials. I've seen a number of transactions lately where an owner and contractor, or a contractor and subcontractor, will have two contracts instead of one. The first contract will be for the labor, and the second contract will be for the materials. As a result, you may be in a position where the labor/work/services agreement is not covered by the UCC, but the separate contract for the goods is covered. That's fine—just be mindful that the requirements for each may be different.

D. What are the requirements for "rejecting goods," or "accepting goods," or "revoking an acceptance?" If you have a contract "predominantly" for the sale of goods, then these are terms that you should become familiar with. They are major components of the sections in Article 2.

E. What implied warranties apply to your transaction? UCC Article 2, has a number of implied warranties that are made a part of the contract/transaction unless they are properly removed from the contract. For example, the implied warranty of fitness for a particular use and the implied warranty of merchantability generally are made part of every transaction involving the sale of goods. What are those warranties, and what do they cover? How can you disclaim those warranties if you want to? Those issues are addressed by UCC Article 2.

But wait, there's more. UCC Article 2, of course, goes on to cover many more facets of the commercial transactions involving goods. In addition, UCC Article 3 addresses issues dealing with your standard checks and check-writing policies and procedures. These include issuing and handling joint checks, issuing checks to fictitious payees, forged signatures and endorsements, checks with payees separated by "virgules," and most other issues concerning checks and notes. It is handy to be familiar with the requirements in these articles as well.

Conclusion

So, while this column is more general in nature, it is hoped that it has created some incentive to take a look at how the UCC articles affect your daily operations. It's not a question "if" those articles apply, but how often and to what extent. Doing some research can put you in a position to handle issues that arise under the UCC and avoid the adverse consequences of not meeting the UCC's requirements.