The UCC Explained
The Uniform Commercial Code, commonly referred to as the "UCC", is a compilation of laws in the United States governing commercial transactions. The UCC is a set of model statutes that has been drafted and published by the National Conference of Commissioners of Uniform State Laws and the American Law Institute. It was first published in 1952, and has been updated substantially since then in an effort to have a uniform set of commercial laws in each state.
Forty-seven states have enacted the UCC in its entirety, and only Delaware, Louisiana and Alaska have not. Delaware enacted part of the UCC in 2005, and Louisiana has adopted the UCC, with modifications . Texas has adopted the majority of the UCC, but has not enacted Article 2, which covers sales, Article 2A, which covers leases, and Article 3, which covers negotiable instruments. Tennessee has adopted virtually every section of the UCC, but has declined to enact Article 2, and has only partially enacted Article 2A.
The UCC does not govern transactions, but only provides default rules. Thus, even if the parties to a contract do not have an express agreement as to a particular term or provision of the agreement, the UCC governs the agreement to fill the gap in the agreement. If the parties have an express agreement on any of the default rules provided by the UCC, then the express agreement of the parties controls, and not the UCC.
What is the Meaning of ‘Default’ under the UCC?
A term that is sometimes not well understood, "default" under the UCC is a term that often finds itself in contracts, but can be misunderstood in context. The UCC itself does not define "default", and the common understanding of default will vary depending on context. The UCC allows for many defaults, and Article 2 sets forth without limitation the following defaults:
-A breach of any provision
-Failure to make payment when due
-Impossibility or frustration of purpose that would discharge the duty of an EV buyer to take delivery of personal property (although case law holds that a frustration of purpose is not a defense for an EV Seller to perform its obligations to deliver personal property)
-Failure to make discharge payment
-Stopping payment on an instrument
-Dishonoring a check
-Breach of warranty (See Uniform Commercial Code § 2).
As a general matter, default can arise from the debtor or obligor, or the creditor. In some cases, the terms of the contract will be inconsistent with the UCC provisions. If inconsistent with the UCC, the contract between the parties will control, provided that it does not encourage an unlawful act or the performance of an unlawful act. However, the UCC rules are default rules that do not replace the contract terms, but rather are added to the contract terms unless there is an inconsistency.
Common situations in which a default might occur in a commercial transaction may include:
(i) Where a party refuses to perform a material term of a contract;
(ii) Where a party to a contract becomes insolvent or bankrupt;
(iii) Where a party cannot procure bonding or insurance required under the contract;
(iv) Where a contract is terminated by the owner of the contract upon the failure of a contractor to cure a default within a specified period after notice from the owner, or otherwise as permitted by law or by agreement; and
(v) Where a contractor that has a surety is discharged from liability under the contract by the surety’s conduct.
When the Default Rules are Relevant
The UCC default rules are a basic safety net for parties involved in commercial transactions. They kick in where a gap exists between what the parties have agreed to and the terms that govern the commercial law topic area in question (such as sales of goods, sales of services, secured transactions, etc.). These rules affect the substantive rights and obligations of the parties, and often the price, the security, the event of default, and remedies for default in the case of secured transactions.
Default rules operate in tandem with particular agreement-specific terms in establishing what will happen if the parties do not agree to an explicit legal arrangement, or if the legal arrangement itself is contrary to the public policy embodied in the UCC.
For example, the UCC provides default rules regarding the parties’ liability, and the rights and remedies available to them, for breach, but allows the parties to opt out of these rules, so long as the parties’ agreement does not violate public policy. In some instances it will be commercially desirable to "opt out" of the statutory default rule, if it will not apply the parties’ business relationship, or if some other, more sophisticated contractual approach, more correctly anticipates the expectations of the parties in that particular context. In other instances, the parties may want to "opt in" to the statutory default rule to resolve any outstanding disagreements between them as to how that particular situation will be handled legally, and in a way that comports with public policy. The default rules in the UCC can be thought of as the "floor" (in the sense of we will never go below this) and the "ceiling" (in the sense of we cannot go beyond this).
The parties’ agreement will ordinarily "trump" the default rules (if the parties do not explicitly provide otherwise – e.g., if the default rule cannot be altered by agreement, or excludes an existing agreement, or is intended just to be in effect absent a subsequent agreement to change it), because the default rules themselves are simply not a PART of the language of the parties’ agreement, but just SET the parameters of the agreement, ousting those parameters the parties have elected to displace (subject to the public policy constraints). In this way, the default rules serve to establish the outer boundaries (but not details) of what the parties’ agreement is and how their business relationship will be interpreted by the courts (and public agencies) unless expressly overridden by an explicit agreement.
There will be some situations, however, in which the default rule cannot be applied to the parties’ relationship, because neither of the parties is a "merchant," for the purposes of the UCC. In many cases this simply will be a matter of the parties’ status as a merchant or non-merchant not being relevant to the nature of the good or service involved in the particular transaction, or that the relationship among the parties is simply not affected by their scenario as a merchant/non-merchant. However, there may indeed be categories of transactions or agreements, or types of parties in this context, that are excluded from the application of the default rules. This does not happen often, but there are always contexts in which a type of transaction or parties simply no longer apply to the kinds of issues to which the UCC applies.
Other Articles Pertaining to Default under the UCC
The UCC employs a series of default rules that help define the rights and responsibilities of parties in various transactions. However, it is important to realize that not all parties are bound by the same UCC default rules for a couple of reasons. For example, there are various articles of the UCC that are applicable depending on the type of transaction, so there are differences in the UCC default rules across those different articles. Likewise, not all parties to a transaction are subject to the UCC default rules if, for example, they are merchant customers outside the scope of Article 2 of the UCC governing the sales of goods. In practice, merchants enter into transactions that are subject to a range of legal theories under various articles of the UCC. Therefore, in order to understand how default rules under the UCC can affect merchants, it is first necessary to look at the three articles of the UCC that govern the sales of goods and secured transactions, as merchants will encounter them.
Article 2 of the UCC governs the sales of goods and is generally applicable to agreements between buyers and sellers. For the purposes of Article 2, a merchant is defined as "a person who deals in goods of the kind or otherwise has knowledge or skill peculiar to the practices or goods involved." So, for example, if TireCo. sells tires to a motorist, that motorist is not a merchant but TireCo. is. A special aspect of Article 2 is that it only imposes default rules on parties that are merchants. Therefore, it places additional burdens on those parties to conform to standards applying uniquely to merchants. In other words, Article 2 states that merchants generally have higher standards than non-merchant parties. This fact is actually the primary utility of Article 2 and why understanding the UCC is so useful to merchants. If tire manufacturers and distributors enter into agreements with merchants, the manufacturers and distributors can rely on the UCC default rules that will have a greater impact on the merchants. Similarly, if they enter into agreements with non-merchants (i.e., consumers), the merchants can count on the fact that Article 2 will impose lower burdens.
Article 9 of the UCC governs secured transactions, and it is generally applicable to transactions regardless of whether the parties are merchants or non-merchants. Unlike Article 2, Article 9 does not make any distinctions between parties based on their merchant status. However, Article 9 does specifically define what constitutes a merchant and, more importantly, what constitutes a non-consumer goods transaction. To a certain extent, merchants can rely on the UCC default rules governing non-consumer transactions because they are not obviously deficient for merchant transactions. But this does not really help merchants like it does with Article 2, because, again, the non-consumer defaults are not distinct from the consumer defaults. The main take-away for merchants is that they should expect a lot of uniformity if they are engaging in transactions with non-merchants.
Overall, merchants engaging in transactions with consumers are usually going to be subject to very different types of default rules. Article 2 is generally the relevant article of the UCC governing merchants when dealing with consumers, while Article 9 is generally applicable to all merchants regardless of consumer status.
UCC Default Rules and Related Rights, Duties, and Remedies
The remedies available to creditors and the responsibilities of the debtor when default occurs are governed by the UCC’s default rules. The discussion that follows is a summary of those rules that is not itself be considered legal advice.
Creditor Rights
The creditor may normally cancel the contract if the contract has not been performed. If the buyer is in breach, the creditor may also either seek damages for convert or compel specific performance. If the debtor has goods in his/her possession, the creditor may also usually take back possession. If the creditor has not delivered the goods yet, it may cancel the agreement, delay delivery, and/or stop the goods in transit.
Seller Rights
When the seller is in breach of the contract, the creditor may seek monetary damages, seek equitable relief, withhold or cease performance, cancel the contract, or take back goods. Most of these remedies are fairly self-explanatory. One that needs some clarification is the remedy of withholding or ceasing performance. Essentially, until the debtor has paid the price due, the creditor can withhold performance of other parts of the agreement (i.e., delivering goods or services). In other words , the creditor does not need to perform anything more (if nothing else remains) until the debtor pays what he/she owes.
Buyer Rights
If the seller has delivered goods and is in breach of the contract, the buyer may seek money damages, seek equitable relief, cancel the contract, and/or cover. If the buyer has not received the goods yet, he/she may cancel the contract, buy similar goods on the market, and/or seek damages. The remedy of cover, using similar goods to mitigate damages, is as straightforward as it sounds. Essentially, the buyer may buy the same just from another source – usually at a higher price.
Debtor Responsibilities
The debtor’s responsibilities largely consist of complying with the contract. He/she must perform the obligations of the contract to the best of his/her abilities. Another responsibility deals with goods in his/her possession. Basically, the debtor has a responsibility to the creditor to not use or keep that property after the creditor has breached the contract. If the debtor has already disposed of it, then the debtor has the responsibility to pay the creditor for it, or at least the value it is worth.
Common Misconceptions Surrounding Defaults under the UCC
A standard UCC security agreement contains default provisions, typically allowing a secured party to accelerate the maturity of the debt or to make a demand which the debtor must answer within a certain period of time. But many people have a misunderstanding of these default provisions:
- They believe that, although they have defaulted, the secured party has no right to enforce its rights until it makes some demand or takes some step explicitly authorized by the security agreement. Not true. In Alabama, the right to remedy often arises upon default, and the secured party need not make any demand for payment. This is provided in Code of Alabama 7-9-601 and 7-9-607, the Alabama UCC.
- They believe that a secured party must sell collateral in a commercially reasonable manner only to the extent it sells the collateral in a commercially reasonable manner. Not true. Failure to sell in a commercially reasonable manner does not result in the amount of the debt diminished. Code of Alabama 7-9-625(b).
- They also believe that a secured party must in every case sell collateral in a commercially reasonable manner. Not true. A secured party does not have to sell the collateral where it will be commercially unreasonable to sell the collateral, such as in a case where the collateral will be destroyed in the sale. Code of Alabama 7-9-610(c).
Examples and Scenarios
Consider a common fact pattern involving a contract for the sale of goods: two parties (a buyer and a seller) reach an agreement where the seller will manufacture certain widgets, deliver them to the buyer, and the buyer will pay the purchase price. The seller’s manufacturing facility is in Grand Rapids, Michigan, while the buyer’s headquarters are in Port Angeles, Washington. The parties finalize the contract via email and have only discussed the transaction and the parameters of the deal in email or telephone conversations. Once the final details are hammered out via email, the seller makes the widgets and the buyer wire transfers the purchase price.
Because there are multiple scenarios that can be the basis for where the contract is "made," one of the simplest ways to determine where the contract is made is to see where the last act was when the contract was completed. These last acts in our hypothetical would be the seller shipping the widgets in Grand Rapids, Michigan, or the buyer wiring the purchase price at its headquarters in Port Angeles, Washington. As a hypothetical matter, where the contract is "made" depends on whether the seller shipped the widgets before the buyer wired the purchase price. If the buyer wired the purchase price first, the contract was formed in Port Angeles, Washington. But whether or not that purchase price was wired is not always clear until the fact finder makes a determination as to which party’s testimony is more credible. If that were the case here and the contract dispute eventually resulted in litigation, then the trier of fact would need to accept the buyer’s claim that the buyer wired over the purchase price before the sellers shipped or vice versa.
Let’s say in our hypothetical that the seller shipped the widgets before the buyer wired the purchase price, the sale of goods was worth more than $5,000, and the contract did not specify the applicable law. In that case, because the contract was made in Michigan, it is "governed by the law of [the] state which bears the closest relationship to the transaction." The relevant UCC sections would be those applying Michigan law, N.Y. U.C.C. § 1-105. When determining which state’s law governs when multiple states have some contact with the matter, several factors can be considered when contemplating which state will be determined to have the most significant contacts with the transaction. These factors include where the seller performed, where the buyer received performance, and where the contract was formed.
Final Thoughts and Best Practices
It is no doubt that default rules under the UCC are vitally important. As the UCC governs nearly all business transactions, it is critical for both parties to know these rules as a whole and understand what default rules apply to them under the UCC in order to ensure successful business interactions and prevent and/or effectively handle breaches and defaults. As discussed in the article, some of the default rules under the UCC, like the Secured Party’s Duty to Keep Goods in Good Condition, Secured Party’s Right to Redeem, Secured Party’s Right to Dispose in Conformity with the Code, or for a Consumer Obligation, Secured Party’s Obligation to Dispose of the Goods or Re-Deliver them to the Debtor may seem more "inconvenient" than an "unfair advantage" to the secured party. However, it is still important to understand those rules to avoid potential liability for damages and costs that might ensue from violating those rules after a default. The fact that these rules exist may also help minimize the chance of an inadvertent code violation. It is not difficult to imagine how even the most experienced secured party might violate the UCC default rules if they assume that the UCC will work the way they want and isn’t really paying attention to the specifics of how the UCC works. One best practice that is particularly helpful in avoiding code violations and inadvertent but very costly mistakes is to make yourself aware of and educate employees on the applicable UCC default rules. Create a cheat-sheet for the legal department , sales department and/or accounting department about the rules and contact information for a trusted lawyer who can be called to verify a legal assumption about what the code requires. It is better to be safe than sorry. Another way to prevent problems is to create templates for a multitude of scenarios, including notices that are sent to defaulting parties. Not only does this help avoid code violations, but it also provides a clearer paper trail in the event of litigation. Templates should include pre-printed information, with means of handwriting information such as correct dates and parties’ names, with blanks for any other information that could change depending on the transaction. Now when you need to send a notice or some other document, just fill in the blanks with the correct information and not only are you less likely to violate the code, but it is also much easier for your employees to do their jobs when they have proper templates to work with!