Supply Chain Survival Series: Is There a Contract? (Article #2)

After working through the weekend, you and your attorney are able to work out a plan for how to respond to your angry customer and your resin supplier. As you’re settling in at your desk at ABC Corp. feeling glad to have that issue behind you (you hope), Jessica from sales walks into your office with a new issue. Jessica tells you that, two weeks ago, a customer placed a purchase order (“PO”) for 10,000 products with delivery marked as “ASAP within 30 days.” Jessica explains to you that ABC Corp. didn’t have capacity to supply all 10,000, but did have 1,000 products available right away and could have another 1,000 ready to go the following week. Jessica intended to respond to the customer to explain the capacity constraints, but now she can’t find the email, and realizes that she may not have sent it. Instead ABC shipped 1,000 products to the customer, and shipped another 1,000 units the following week. Jessica then explained to the customer that the 2,000 products ABC had shipped was all that it could currently supply and that it would be at least six weeks before it could start production on the remaining 8,000 units.

This morning, Jessica received a letter from the customer’s lawyer saying that ABC was contractually committed to supply all 10,000 units within 30 days of the PO date, and that ABC had agreed to be bound by the customer’s one-sided legal terms and conditions. The customer’s lawyer claimed that ABC would be responsible for all of the customer’s damages, including their lost profits and attorneys’ fees, if it didn’t supply all 10,000 units by the end of the month. Jessica is sure she never signed the customer’s terms and conditions, though, so she thinks this is an empty threat.

Time to call your lawyer again.

Issues like this come up more often than we care to admit, and they tend to raise the same question: How is a binding contract formed? Everyone understands that if two people sign a document that says “CONTRACT” in bold letters at the top, they have entered into a contract. But what about when they have a handshake deal? When they send a PO or quote? When a customer calls and orders product over the phone? The question of whether a contract has been formed is typically the first question that needs to be answered in any commercial dispute, and we’ve found that the answer is often surprising to business executives.

At its most basic form, a contract is any voluntary agreement that creates obligations or benefits. In a typical contract, each party agrees to pay something or to do something, and they get something back in return. The UCC says that a contract can be formed “in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract.”¹ In other words, if both parties act as though they have an agreement, then they probably do. The formation of a contract generally starts with an offer by one party, and an acceptance by another party. However, what that offer and acceptance look like can vary quite a bit depending on the situation.

In the context of a manufacturing business, the two most common types of offers are purchase orders and quotations. If a buyer issues a PO, the buyer has offered to buy the products described in the PO. Similarly, if a seller issues a quote, that is an offer to sell the products described in the quote. In addition to these common types of offers, though, offers may be made through less formal methods, such as emails or even, in some cases, phone calls.

Once an offer has been made, the next question is whether the offer was accepted. Whether or not an offer is accepted is typically determined objectively; i.e., if a “reasonable” person would think that your actions were intended to accept the offer, then you probably accepted it, even if you didn’t actually mean to do so. Acceptance can come in an obvious way, such as countersigning a PO, or sending an order acknowledgement. It can also be done less formally, such as through a reply email or (again, in some cases) a verbal acceptance. In addition (and most dangerously, as Jessica is going to find out in our example above), acceptance can come by beginning performance. If a buyer places an order, and a seller ships some goods under that order, the seller has effectively accepted the order. We’ll get more into what legal terms apply in our next article, but for now it’s important to understand that shipping products in response to a PO is a way of accepting the order and legally committing to fulfill it, just as if you had signed a contract.

Now that we’ve scared you with how easy it is to form contracts, it’s worth noting that there are some limitations on how contracts are formed. While there are a number of such limitations (for example, that a contract cannot require a party to do something that is illegal, and each party to a contract must be receiving some benefit—a.k.a. “consideration”), the limitation that is probably the most relevant in a business’s day-to-day operations is the requirement that certain contracts be in writing. We noted above that verbal contracts are only enforceable in some cases. The UCC’s Statute of Frauds² requires that contracts for goods priced at $500 or more must be in writing to be enforceable. Between merchants, however, that writing is sufficient even if it is not signed by the parties, such as in our example above regarding a PO followed by ABC Corp.’s performance. The writing requirement can even be satisfied by an email, so long as the email sets forth the basic terms of the offer (i.e. what are you buying or selling). So, while verbal contracts are only enforceable with respect to very small purchases, it doesn’t take much to satisfy the requirement that a contract be in writing.

As the example above makes clear, it is dangerously easy to form a contract. Every day, lawyers are getting calls from clients who are surprised to learn that they are bound by a contract, when they never actually signed a formal document that said “CONTRACT” at the top. It’s critically important for not only business executives, but also their purchasing and sales teams, to realize this, and to be careful to avoid unintentionally binding their business to unexpected contractual obligations.

Once we’ve determined that a contract exists, the next step is to determine what the terms of the contract are. This will be covered in the next article in the series – What Contract Terms Apply? (Article #3).

• Brandon Krajewski: (414) 277-5783 / brandon.krajewski@quarles.com
• Patrick Taylor: (414) 277-5523 / patrick.taylor@quarles.com

END NOTES

¹UCC 2-204

²UCC 2-201

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