Supply Chain Survival Series: What Contract Terms Apply? (Article #3)

After working through two different customer disputes in as many weeks, you finally come up for some air. While you have the opportunity, you decide it is time to review ABC Corp.’s contracting practices for buying and selling materials and products. After experiencing how easily contracts are formed and the risk of unintentionally forming a contract, you decide to ask your lawyer for guidance on how to determine what contract terms apply when parties do form a contract. The lawyer tells you that the answer depends on how the parties entered into the contract. Did they exchange purchase orders (“POs”) and quotes? Did they sign an express contract? Did they begin to perform the contract or operate based on past performance or trade usage?

While it is easy to understand the terms that apply in situations where parties both sign the same written contract, in many situations, it may be impractical or overly burdensome for a party to enter into written counter-signed contracts with each of its suppliers and customers. Typically, if parties are going to enter into a single counter-signed agreement, the parties are going to involve their respective legal teams in reviewing and negotiating that agreement, which to each party’s dismay likely means additional time and money before the parties eventually reach the point of having a signed agreement. So, in many situations, a party may submit a PO to a supplier or a quote to a customer, attaching their standard terms and conditions of purchase or sale.

When the supplier or customer, without signing anything, fills the PO or pays the quoted amount for the products, determining what terms apply can be more difficult. However, generally, when one party provides a PO or quote to another party and the other party takes actions that would lead a “reasonable” person to believe they have agreed to the PO or quote (e.g., fulfilling the PO or paying the quoted price), the other party has “performed” at least part of the agreement. If the other party did not take any further steps, then any terms or conditions included with the PO or quote (i.e., a party’s standard terms and conditions) would apply. The party that began performing under the PO or quote would typically be bound by any terms and conditions included with the PO or quote.

But what happens in situations where the parties provide each other conflicting terms or a series of counter-proposals with no clear conclusion or agreement, and then begin performing? For example, if a party submits a PO or quote (attaching its standard terms and conditions) to a supplier or customer, and the supplier or customer responds by accepting the PO or quote but attaching its own standard terms and conditions and then begins performing, what terms would apply? This situation is frequently referred to as the “Battle of the Forms” and will be discussed in greater detail in our next article. Similarly, what happens if the parties exchange a series of written counter-proposals (e.g., emails) without reaching a clear conclusion and then one party begins performing? This presents one of the more difficult situations for determining what terms apply.

In unclear situations, courts, arbitrators, lawyers and parties may have to consider a variety of factors, including trade usage, course of dealing, and course of performance.¹

Under the UCC, trade usage, or “usage of trade” means “any practice or method of dealing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question.” Importantly, it is not necessary for both parties to be aware of the trade usage. It is enough if the trade usage justifies an expectation of its observance.

The UCC defines “course of dealing” as “a sequence of conduct concerning previous transactions between the parties to a particular transaction that is fairly to be regarded as establishing a common basis of understanding for interpreting their expressions and other conduct.” However, the mere exchange of terms (without anything more) does not create a course of dealing.

A “course of performance” is defined by the UCC as “a sequence of conduct between the parties to a particular transaction that exists if (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection. The distinction between course of dealing and course of performance turns on whether a party’s conduct falls within the same contract (course of performance) or across multiple contracts (course of dealing) between the parties.

If your head isn’t already spinning, you may be wondering how trade usage, course of dealing and course of performance are actually used in determining what contract terms apply. Each of these items can be used to supplement the express terms of an agreement between parties. In addition, they can be used to help give particular meaning to the express language in a contract between parties (resolving ambiguities). Finally, these items can supplement and qualify the express terms of a contract so long as they do not totally negate the express terms of the contract (i.e., parties cannot point to trade usage, course of performance, or course of dealing to completely contradict or attempt to get out of a clear express term in a contract). Generally, the express terms of a contract, trade usage, course of performance and course of dealing should be construed consistently with each other whenever reasonable. Otherwise, the UCC provides the following order of precedence: (1) express terms; (2) course of performance; (3) course of dealing; (4) trade usage.

In addition to interpreting a contract based on the principles discussed above, the UCC also imposes an obligation on each party to act in good faith when performing a contract.² This obligation does not apply to negotiations—only performance once a contract has been formed.

The obligation to act in good faith generally means that a party to a contract cannot unfairly take advantage of the other party in a manner that the parties did not contemplate when agreeing to the terms of the contract. It also prohibits a party from taking actions to inhibit the other party’s rights to receive the benefits of the contract. For example, Party A agrees to buy products on credit from Party B. The parties agree that until Party A pays off the debt it owes to Party B, Party A must purchase all of its requirements for the products from Party B. Before the debt is repaid by Party A, Party A enters into a new arrangement with Party C, a competitor of Party B. Under the new arrangement, Party A and Party C form a new legal entity owned jointly by Party A and Party C and managed by Party A. The new legal entity purchases all of its products (which are the same as were being provided by Party A) from Party C. This scenario could be considered a breach of Party A’s obligation to act in good faith under its contract with Party B because Party A evaded the requirement to purchase from Party B. This obligation of good faith automatically applies to every contract that falls within the scope of the UCC.

It is important to be aware that the way in which two parties enter a contract affects what terms govern them. As previewed above, one common, but complex, situation that arises between parties based upon the way in which they enter into a contract is the so called “Battle of the Forms,” which will be covered in the next article: Battle of the Forms (Article #4).

If you have questions, please contact the authors:

• Brandon Krajewski: (414) 277-5783 / brandon.krajewski@quarles.com
• Patrick Taylor: (414) 277-5523 / patrick.taylor@quarles.com
• Michael Chargo: (414) 277-5272 / michael.chargo@quarles.com

Quarles & Brady attorneys Hannah Schwartz and Lauren Zenk also contributed to this article.

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