This is the second article on the Uniform Commercial Code (UCC) and its effect on owners/developers, contractors, subcontractors, and suppliers. See the initial article, "Are Your Goods and Services UCC Worthy?" (September 2017), for an overview of the UCC.
A recent dispute between our client, a large wood flooring manufacturer, and a developer here in New York gives rise to this next periodic installment on our coverage of the UCC. Now, I want to get a little more specific and discuss the UCC sections that deal with purchases of materials and equipment for a construction project.
UCC Article 2
The rules on purchases and sales of goods are codified in UCC Article 2. It is likely that UCC Article 2 governs many, if not all, purchases of materials and equipment on construction projects. Therefore, it is good to be familiar with UCC Article 2's rules and comply with them to best protect your company's interests.
The nice thing about UCC Article 2 (as with many of the other UCC articles) is that most of the sections have been adopted by all states. The rules are generally consistent among the states. The obvious goal of the legislation was uniformity in the rules governing commercial purchases and sales, as made clear by the statute's name.
UCC Article 2 generally replaces a hodgepodge of different and inconsistent laws enacted by the states. However, even though the UCC's rules generally are the same among the states, there may be some local changes and nuances, so it is always best to check the laws in the state that applies to your transaction.
Failure to Comply
UCC Article 2 sections are pretty straightforward and, in many cases, codify common-sense rules. However, there are pretty severe consequences for failing to comply with the requirements in the sections. A contractor/subcontractor or developer who fails to follow the inspection, rejection, or acceptance procedures within Article 2 may be liable for the full purchase price of the materials or equipment ordered, even if they are nonconforming or defective. Even more compelling, the failure to meet the statutory requirements can result in the contractor/subcontractor or developer being responsible for paying the full purchase price—even though the materials or equipment are not even delivered to the site.
Given the strict consequences that can result from failing to comply with the UCC sales requirements, it is helpful to look at the applicable sections and see what needs to be done to comply. As discussed in my September 2017 column, the UCC Article 2 applies only to the sale of "goods"; "goods" basically applies to anything movable. Thus, all materials and equipment purchased for the construction projects likely will be covered by UCC Article 2.
Perfect Tender Rule
The "Perfect Tender Rule" basically says that the seller/supplier must tender delivery to the buyer-contractor/subcontractor or owner/developer exactly what was ordered. If the tender is not perfect, the buyer has the right to reject the materials or equipment. If the tender is perfect, then the buyer has an obligation to pay the purchase price.
The specific rules and formal UCC language surrounding the "Perfect Tender Rules" focus on terms such as "rejection," "acceptance," and "inspection." Once the seller makes a "perfect tender," a buyer must timely "inspect" the items. After that, the buyer may accept or reject the items. Once there is an acceptance of the materials or equipment (or if there is a failure by the buyer to reject the materials or equipment), the onus shifts to the buyer contractor/subcontractor or owner/developer and requires them to pay the purchase price for the materials or equipment. While it is possible to "revoke" an acceptance, that topic is beyond the scope of this article.
What about Defects?
Keep in mind that, although the buyer may be required to pay the purchase price based on the failure to reject, or based on an actual acceptance of the materials or equipment, the buyer still can make a claim against a seller for defects or for breach of warranty. Paying the purchase price doesn't affect the right to make a claim for defects—it's just that you will be forced to pay the purchase price and then try to recover for the defects later on.
Let's take a look at the actual UCC language and some examples.
The "Perfect Tender Rule" appears in UCC § 2-601, which has what seems like some straightforward and harmless language.
§ 2-601. Buyer's Rights on Improper Delivery
[I]f the goods or the tender of delivery fail in any respect to conform to the contract, the buyer may
(a) reject the whole; or
(b) accept the whole; or
(c) accept any commercial unit or units and reject the rest.
UCC § 2-602 addresses the issue of rejection and the timing for rejection and also deals with the question of what a buyer has to do with the materials or equipment if the buyer does give proper and timely notice of rejection. The section says the following.
§ 2-602. Manner and Effect of Rightful Rejection
(1) Rejection of goods must be within a reasonable time after their delivery or tender. It is ineffective unless the buyer seasonably notifies the seller.
(2) Subject to the provisions of the two following sections on rejected goods …
(a) after rejection any exercise of ownership by the buyer with respect to any commercial unit is wrongful as against the seller; and
(b) if the buyer has before rejection taken physical possession of goods in which he does not have a security interest … he is under a duty after rejection to hold them with reasonable care at the seller's disposition for a time sufficient to permit the seller to remove them; but
(c) the buyer has no further obligations with regard to goods rightfully rejected.
Each section of the UCC has an "Official Comment" by the drafters to explain what the section means. The Official Comment to UCC § 2-602 is helpful in discussing the implications of the "Perfect Tender Rule." It says the following.
Official Comment to UCC 2-602
A tender or delivery of goods made pursuant to a contract of sale, even though wholly non-conforming, requires affirmative action by the buyer to avoid acceptance. Under subsection (1) [to UCC 2-602,] therefore, the buyer is given a reasonable time to notify the seller of his rejection, but without such seasonable notification his rejection is ineffective. The sections of this Article dealing with inspection of goods must be read in connection with the buyer's reasonable time for action under this subsection. Contract provisions limiting the time for rejection fall within the rule of the section on "Time" and are effective if the time set gives the buyer a reasonable time for discovery of defects. What constitutes a due "notifying" of rejection by the buyer to the seller is defined in § 1-201.
Subsection (2) lays down the normal duties of the buyer upon rejection, which flow from the relationship of the parties. Beyond his duty to hold the goods with reasonable care for the [seller's] disposition, this section continues the policy of prior uniform legislation in generally relieving the buyer from any duties with respect to them, except when the circumstances impose the limited obligation of salvage upon him under the next section.
The present section applies only to rightful rejection by the buyer. If the seller has made a tender which in all respects conforms to the contract, the buyer has a positive duty to accept and his failure to do so constitutes a "wrongful rejection" which gives the seller immediate remedies for breach. Subsection (3) is included here to emphasize the sharp distinction between the rejection of an improper tender and the non-acceptance which is a breach by the buyer.
The provisions of this section are to be appropriately limited or modified when a negotiation is in process.
UCC 2-606 deals with how or when a buyer-contractor/subcontractor or owner/developer "accepts" materials or equipment. UCC 2-607 deals with the consequences of an acceptance. These sections state the following.
2-606. What Constitutes Acceptance of Goods
1. Acceptance of goods occurs when the buyer
a. after a reasonable opportunity to inspect the goods signifies to the seller that the goods are conforming or that he will take or retain them in spite of their non-conformity; or
b. fails to make an effective rejection (subsection (1) of Section 2-602), but such acceptance does not occur until the buyer has had a reasonable opportunity to inspect them; or
c. does any act inconsistent with the seller's ownership; but if such act is wrongful as against the seller it is an acceptance only if ratified by him.
2. Acceptance of a part of any commercial unit is acceptance of that entire unit.
2-607. Effect of Acceptance; Notice of Breach; Burden of Establishing Breach After Acceptance; Notice of Claim or Litigation to Person Answerable Over
1. The buyer must pay at the contract rate for any goods accepted.
2. Acceptance of goods by the buyer precludes rejection of the goods accepted and if made with knowledge of a non-conformity cannot be revoked because of it unless the acceptance was on the reasonable assumption that the non-conformity would be seasonably cured but acceptance does not of itself impair any other remedy provided by this Article for non-conformity.
3. Where a tender has been accepted
a. the buyer must within a reasonable time after he discovers or should have discovered any breach notify the seller of breach or be barred from any remedy.…
Issues Raised by the Perfect Tender Rule
Tender. UCC 2-601 says that a seller must deliver or "tender" delivery of the materials or equipment. This can create an issue for an owner, contractor, or subcontractor purchasing materials or equipment for a project. The obligation to pay the full purchase price is tied to the tender of delivery and not necessarily the actual delivery. As a result, if plumbing, flooring, or heating, ventilation, and air conditioning (HVAC) materials or equipment are ordered and the seller is ready, willing, and able to deliver at the time agreed in the purchase order/contract, that can give rise to the responsibility to pay the full purchase price, even if you are not ready to take delivery. In that case, the seller has "tendered" delivery, but you, as the buyer, were not ready to take delivery.
As the federal court in New York said in the case of North Bloom & Son (Antiques), Ltd. v. Skelly, 673 F. Supp. 1260: "Tender of delivery is a condition to the buyer's duty to accept the goods and, unless otherwise agreed, to his duty to pay for them. Tender entitles the seller to acceptance of the goods and to payment according to the contract."
Rejection. The Perfect Tender rule in UCC 2-601 goes on to say that if the seller tenders delivery of materials or equipment that do not conform to the purchase order/contract, then the owner, contractor, or subcontractor can "reject the whole delivery." There are many cases looking at words, actions, or conduct that constitute a "rejection" by a buyer/owner, contractor, or subcontractor. Nondefinite language may not constitute a rejection. As a result, that can then give rise to the buyer's duty to pay the full purchase price for the materials or equipment.
Timing of Rejection. UCC 2-602 addresses the issue of timing and says that a rejection of materials or equipment has to be "timely" to be effective. What is timely is not defined and varies depending on the materials or equipment being delivered and the parameters of the transaction. A delivery of chemicals or perishables may require a rejection, for defects, within a day or two of delivery. A delivery of appliances or furniture may require a rejection within 30 days to be considered timely. A federal court in New York had the following to say on timing in Knic Knac Agencies v. Masterpiece Apparel, Ltd., 94 Civ. 1073 (LMM), 1999 U.S. Dist. LEXIS 3267, 1999 WL 156379 (S.D.N.Y. 1999).
Plaintiffs [Sellers] also assert that there is a question of fact as to whether defendants [Buyers] accepted the goods. However, plaintiffs' evidence showing when they shipped the goods and when defendants may have taken possession of the goods fails to raise [an issue] as to acceptance. Because acceptance does not occur until a buyer has had a reasonable time to inspect the goods, see U.C.C. § 2-606, the fact that a buyer takes temporary possession of the goods does not mean that he has accepted them. ("[A]cceptance is only tangentially related to buyer's possession of the goods. Often the buyer will have had possession of the goods for some time before it has 'accepted' them….") As long as defendants rejected the goods within a reasonable time after tender and seasonably notified plaintiffs of their defects and/or untimeliness, they effectively rejected the goods.
"What is a reasonable time for taking any action depends on the nature, purpose and circumstances of such action." … Here, plaintiffs [Sellers'] evidence shows that defendants [Buyers] may have taken possession of some goods as early as February 18, … defendants formally rejected the Logo 7 goods and canceled future orders on February 24 … at the latest. The Court finds as a matter of law that defendants' notice came within a reasonable time after tender. See Texpor, 720 F.Supp. at 1110–11 (notice was seasonable where shipment arrived on January 29, quality audits took place by Feb. 4, and by mid-February, buyer met with seller and stated that goods were defective and it would not accept them); D.C. Leathers Inc. v. Gelmart Indus., Inc. (rejection was timely where it occurred within one month after receipt of goods).
The Contract Rules
Keep in mind that a purchase order or purchase agreement can define the timing for the transaction. For example, a purchase order may say that the buyer must inspect the materials within 14 days after delivery. While the standard in the industry may set 30 days as a proper time for inspection and rejection for a certain type of material or equipment, the UCC allows the agreed purchase order to redefine and limit that time, and the purchase order language will govern. Regardless, if a buyer/owner, contractor, or subcontractor waits too long to notify the seller of the rejection, then the rejection will not be effective and will give rise to the obligation of the buyer/owner, contractor, or subcontractor to pay the full purchase price even if the goods are defective.
Clearly, this seems to be a major issue on construction projects—where owners/contractors or subcontractors may take delivery of materials or equipment well before they are actually installed or started up and then find problems long after delivery. We've had a number of clients who took delivery of generators, boilers, ceramic tile, wood flooring, appliances, plumbing, or HVAC equipment and stored them, only to find months later that they were defective. The clients then tried to "reject" the items but are told by the suppliers that the rejection is too late.
I mentioned at the beginning of this article that we represent a large, high-end wood flooring manufacturer and that they recently had a dispute with a developer. The facts seemed pretty straightforward. Our manufacturer client had to deliver selected wood flooring for a large condo development in Manhattan. The wood had been selected from samples shown to the developer. The purchase order clearly stated that the wood was a natural material, and each and every plank/slat was unique. The purchase order had a disclaimer saying that colors may vary and the manufacturer does not guarantee consistency.
The wood was shipped from overseas and delivered to a local warehouse. The developer was advised that our manufacturer/client was ready, willing, and able to deliver the wood flooring to the project site. However, the developer said that the project was not ready, so they could not take delivery at that time. Apparently, the developer had a dispute with the project's contractor, and there were substantial delays getting the units ready for the flooring. The developer did go to the warehouse and opened various boxes of the flooring and said they were fine. As a result of the delays, the project became ready for the delivery of the wood flooring 8 months after the wood was delivered to our manufacturer/client's warehouse.
When the developer opened the boxes at the site and began installing the wood, the developer found that the wood color was not consistent and was "darker" than the interior design folks wanted. I recall my first reaction was, "So?" The developer refused to pay the balance of the purchase price due. You can probably guess our position: Our manufacturer/client complied with the Perfect Tender rule by tendering delivery to the developer. The developer made an inspection and did not reject the flooring. Therefore, the developer became liable for the purchase price—end of the conversation. We wound up settling it—but I was pretty sure the developer understood that he had very little support for his refusal to pay the purchase price.
Another example is from a case in upstate New York—D.C. Leathers, Inc. v. Gelmart Industries, Inc., 125 A.D.2d 738, 509 N.Y.S.2d 161 (App. Div. 1986). It's not really a construction case but gives a pretty good overview of the sales rules that we are talking about.
The buyer was a manufacturer of knit gloves with leather palms. The buyer had a manufacturing plant in the Philippines and a warehouse in Queens, New York. The seller fabricated the leather palms, which were sold to the buyer and then sewn into the gloves by the buyer. The seller delivered a shipment of the leather palms to the buyer's warehouse in Queens, and the buyer then shipped the leather palms to its manufacturing plant in the Philippines.
Once the leather palms reached the Philippines, they were inspected by the buyer and found to be defective. The buyer rejected the leather palms and refused to pay the applicable price. The seller sued. The court provided a good discussion of the Perfect Tender Rule and related UCC sections.
Plaintiff [Seller] next asserts several principles of commercial law in support of its claim that it is entitled to the full amount of the invoices. First, plaintiff [Seller] suggests that defendant [Buyer] was required under UCC 2-513 to inspect the goods at its warehouse in Queens County. The buyer's right of inspection may be exercised at any reasonable time or place and in any reasonable manner (UCC 2-513 Official Comment 3….) Particularly relevant in determining the reasonableness of the time, place or manner of the inspection are trade customs and the past practices between the parties…. Here, the evidence is clear that throughout their business association, plaintiff [Seller] knew that defendant [Buyer's] Queens County warehouse was only a temporary receiving point and that defendant transshipped the goods to their main destination in Manila.
Plaintiff [Seller] in fact, actually packaged the goods for immediate export. The Queens County warehouse did not have appropriate inspection facilities. Further, it was not the practice of the industry to open the cartons and inspect the thousands of leather palms in advance of the time they were to actually be used. Hence, we concur with [the lower court's] conclusion that Manila was a reasonable place for inspection of the goods.
Next, plaintiff [Seller] urges that it did not receive adequate notification of rejection from defendant [Buyer] (UCC 2-602 ) and, thus, defendant [Buyer] is deemed to have accepted the goods (UCC 2-606[b] ). At trial, however, a series of letters from defendant [Buyer] indicating that the leather palms were defective were put into evidence. It is reasonable to infer that the letters constituted notice to plaintiff [Seller] that there was a continuing problem with nonconforming goods.
Plaintiff [Seller] further asserts that defendant [Buyer's] rejection was not timely. However, in light of the fact that rejection occurred within one month after receipt of the goods and was done in compliance with the reasonable practices of the industry, we conclude that [the lower court] correctly found defendant [Buyer's] inspection and rejection to be timely.
Obviously, it is very helpful for you to be familiar with the requirements in UCC Article 2. When purchasing materials or equipment for a project, make sure your company "timely" inspects the items. If there are defects, notify the seller promptly with emails and a paper trail that will make any lawyer happy. If you order materials or equipment and cannot take delivery when anticipated, try to work out a reasonable extension with the seller for the storage and handling of the items. That way, you can avoid having to pay the seller as a result of the seller's "perfect tender" of the items purchased. Also, be mindful of the terms and conditions in the purchase order since those may detail time frames for inspection and rejection.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI.
Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion.
If such advice is needed, consult with your attorney, accountant, or other qualified adviser.