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Monday, April 22, 2013

Thoughts on Tongish v. Thomas and UCC § 2-713

Sunflower seedsA lot of very smart contracts scholars, including to name just a few, Omri Ben-Shahar and Lisa Bernstein (here), Victor Goldberg (here), and Peter Siegelman and Steve Thel (e.g., here), have thought long and hard about the seeming conflict between UCC § 2-713 and the general principles of damages set out in UCC § 1-305 (formerly § 1-106).  Most of them support the ruling in Tongish v. Thomas, to which I have just been introduced in teaching Sales for the first time this semester.  I am uncomfortable with the decision for two reasons, which I will set out below.

But first, a brief summary of the case: Tongish agreed to sell his sunflower seeds to the Decatur Coop Association (the Coop) for a fixed price.  The Coop had a deal with Bambino Bean & Seed, Inc. (Bambino) to sell the seeds to them for whatever price the Coop paid plus $0.55 per 100 pounds.  The price of seeds went up and Tongish breached.  The trial court awarded the Coop its lost profits, which came out to $455.51.  The Court of Appeals vacted that award and remanded the case for a calculation of damages based on UCC § 2-713 (and the Kansas Supreme Court upheld that ruling).  UCC § 2-713 allows a buyer to recover the difference between makret price at the time buyer learned of the breach and the contract price.  Under this section, the Coop would recieve not $455 but something like over $5500, despite the fact that it would not have been able to charge Bambino anything more than what it paid Tongish for his seeds.  In short, under the damages awarded by the appellate courts, the Coop gets about $5000 more than expectation damages.

I do not like the result, at least not based on the court's reasoning.  Subsequent law review articles (cited above) provide more sophisticated defenses of § 2-713 based on economic theory.  I cannot address those arguments here.  Instead, I focus on two issues: fault and contract and the court's characterization of UCC § 2-713 as a "statutory liquidated damages provision."  

FeldmanFirst, the case is grist for the mill of Friend of the Blog, Steve Feldman, who has been trying unsuccessfully for years to persuade me that courts not only do consider moral fault in assessing damages but should do so.  In Tongish, the Kansas Court of Appeals distinguished the case from a California case, Allied Canners Packers, Inc. v. Victor Packing Co.  In Allied, the California court limited the buyer's remedy to actual loss.  That case was different, says the Kansas court, because in Allied, the seller's crop had been destroyed and so it had no goods that it could deliver to buyer.  Here, Tonigish breached simply becasue the price went up, and so "the nature of Tongish's breach was much different" from that in Allied, because the Kansas court found, "there was no valid reason" for Tongish's breach.   Whether or not the court is right that there was no valid reason for the breach depends on one's views on the doctrine of efficient breach.  More to the point, I find no language in the UCC that indicates that the measure of damages turns on the state of mind of the breaching party.  That is, where in the UCC does it say that whether or not one can recover damages in excess of actual loss depends on whether the breach was innocent or willful?

The Kansas court then proceeds to an actual statutory analysis and notes the principle that a specific clause (in this case § 2-713, which the court reads to provide damages in excess of actual loss) trumps a general clause (§ 1-305, which limits damages to expectations).  Allowing the specific clause to trump the general clause generally makes sense, but I would invoke another canon of contruction and read § 1-305 as articulating the general remedial scheme in light of which the remainder of the Code is to be read.  Section 1-305 puts parties on notice that, unless they set out their own remedial schemes, though allocation of risk, liquidated damages and the like, they should expect that traditional expectation damages will be the most they can hope for in case of breach.  

Read in that light, § 2-713 does nothing more than describe the usual mechanism for calculating expectation damages.  It does not contemplate a contract such as the one at issue in Tongish in which the Coop, very far from demanding liquidated damages in the case of breach, has protected itself against loss by linking its purchase price from Tongish to its sale price to Bambino.  In so doing, it invited the very sort of efficient breach in which Tongish engaged, and it is absurd for it to now to claim entitlement to (effectively) a disgorgement remedy when it failed to negotiate such a remedy at the time of contracting.  

ScottThe Kansas court cites to Robert Scott's argument that limiting recovery to lost profits in such cases creates market instability by encouraging breach if the market fluctuates to the seller's advantage.  Applying § 2-713 to permit recovery of damages in excess of actual loss, on the other hand, "encourages a more efficient market and discourages the breach of contracts," says the court.  Once again, that determination turns on one's understanding of efficiency.  In any case, to the extent that the circumstances in Tongish encouraged breach, they were entirely a product of the way the parties drew up their contracts.  They in effect, allocated the risk of breach to the Coop, which had protected itself by finding a buyer who would accept any price so long as it was the same price as what the Coop had paid, plus a $0.55/100 lb. handling fee.  To allow the Coop to recover cover costs on top of lost profits actually creates an incentive for sellers with contractual protections such as the Coop had, to encourage breaches, since the court allowed them recovery ten times in excess of their actual harm.

[JT]

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Comments

Jeremy --

Thanks for the reference and for your thoughtful analysis of the Tongish case. It does appear that the court did take moral principles into consideration on the measure of damages.

As for the comment that no language in the UCC indicates that the measure of damages turns on the state of mind of the breaching party, could one argue that UCC 1-103(b) provides at least indirect support? The provision states in pertinent part, "Unless displaced by the particular provisions of chapters 1-9 of this title, the principles of law and equity. . . supplement its provisions." Because taking moral factors into consideration is not expressly forbidden or displaced by the UCC on calculating the measure of damages, one could conclude it becomes permissible to do so.

Regards,

Steve

Posted by: Steve Feldman | Apr 23, 2013 10:07:12 AM

In my view, Steve's response begs the question.

1-103 only supports the importation of moral considerations into damages if principles of law and equity already do so. I concede that principles of equity overlap with moral considerations, but principles of equity are not in play when it comes to 2-713 damages, and I persist in my view that courts should not (and in 99% of the cases do not) consider the extent to which legal breaches are also moral failings in calculating contractual damages.

Posted by: Jeremy Telman | Apr 23, 2013 10:15:51 AM

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