As the Coronavirus crisis of 2020 has led to the voluntary or mandatory shutdown of innumerable businesses, it is likely that many companies have orders for the sale of goods that they either can no longer fulfill or that can only be fulfilled at exorbitant cost.[1] In such cases, rather than face liability for breaching its contracts, the seller’s performance may be excused in situations that meet the requirements of Section 2-615 of New York’s Uniform Commercial Code (the “U.C.C.”).
1. U.C.C. § 2-615(a): Is The Seller Off The Hook?
For contracts for the sale of goods governed by the U.C.C., Section 2-615 will excuse a seller from performance of its contractual obligations when such performance has been rendered impracticable by either (a) unforeseen and uncontracted-for contingencies or (b) supervening foreign or domestic governmental regulations. U.C.C. § 2-615(a). In either event, the test is whether the delivery of goods has become impracticable because of unforeseen supervening circumstances that were not within the contemplation of the parties when the contract was formed. U.C.C. § 2-615, cmt. 1.
The first of these tests excuses a seller from performance where it can show the existence of (1) a contingency (2) the impracticability of performance as a consequence of the occurrence of that contingency, and (3) that the nonoccurrence of the contingency was a basic assumption of the contract. See Dell's Maraschino Cherries Co. v. Shoreline Fruit Growers, Inc., 887 F. Supp. 2d 459 (E.D.N.Y. 2012). The official comments to Section 2-615 list as examples of possible contingencies: “a severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from
securing supplies necessary to his performance.” U.C.C. § 2-615. Performance under this doctrine will only be excused when it can only be done at extreme and unreasonable cost. See Asphalt Intern., Inc. v. Enterprise Shipping Corp., 667 F.2d 261, 266 (2d Cir. 1981) (applying maritime law but incorporating UCC §2-615 by analogy); Transatlantic Fin. Corp. v. U.S., 363 F.2d 312 (D.C. Cir. 1966). However, mere financial hardship is not sufficient to excuse performance. See Rochester Gas Electric Corporation v. Delta Star, Case No. 06-CV-6155-CJS-MWP, 2009 WL 368508 (W.D.N.Y. Feb. 13, 2009); Maple Farms v. City Sch. Dist., 76 Misc. 2d 1080, 1083 (Sup. Ct., Chemung Cty. 1974) see also U.C.C. § 2-615, cmt. 4.
In addition, if the hardship was foreseen by the parties, the doctrine of impracticablilty will not apply. See, e.g., Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900, 902 (1987); U.S. v. Brooks-Callaway Co., 318 U.S. 120, 122-23 (1943); Ahlstrom Machinery, Inc. v. Associated Airfreight, Inc., 251 A.D.2d 852, 853 (3d Dept. 1998). For example, if the contract between the parties include a force majeure clause specifically or impliedly covering epidemics, the terms of that contractual provision would control instead of the U.C.C. Similarly, companies that continued accepting orders as it became foreseeable that the Coronavirus would create considerable economic disruption may not be able to invoke the protections of Section 2-615. See Cliffstar Corp. v. Riverbend Prods., 750 F. Supp. 81, 84 (W.D.N.Y. 1990) citing Roth Steel Prods. v. Sharon Steel Corp., 705 F.2d 134, 149-50 (6th Cir. 1983).
Turning to the second prong of the UCC 2-615(a) test, the imposition of governmental regulations is an excuse to performance if it both renders performance genuinely impractical and was unforeseen at the time of contracting. See, e.g., Matter of A S Transp. Co. v. Cty. of Nassau, 154 A.D.2d 456, 459 (2d Dept. 1989); Moyer v. City of Little Falls, 134 Misc. 2d 299, 301 (Sup. Ct., Herkimer Cty. 1986) see also Barton Windpower, LLC v. N. Ind. Pub. Serv. Co., 13-cv-5329 (N.D. Ill. June 18, 2018) (applying N.Y. law).
For example, regulations that would render performance illegal would excuse the seller, assuming they were not foreseen at the time the contract was entered into. See, e.g., Matter of Kramer Uchitelle, Inc., 288 N.Y. 467, 471 (1942); Boer v. Garcia, 240 N.Y. 9, 16 (1925). Similarly, regulations that supersede existing contracts and require goods to be sold at the government’s direction would also constitute an excuse if unforeseen. Nitro P. Co. v. Agency of C.C. and F. Co., 233 N.Y. 294 (1922); Mawhinney v. Millbrook Woolen Mills, 231 N.Y. 290 (1921).
Accordingly, it is likely that a court addressing recent regulations such as N.Y. Executive Order 202.6, which required the closure of various “non-essential” businesses, would conclude that the affected businesses had a valid excuse for non-performance.[2]
Similarly, non-performance of contracts for the sale of goods that were superseded by the invocation of the Defense Production Act, 50 U.S.C. §§4501 et seq. or other legal provisions, is also likely excusable. There are, however, two possible caveats to that analysis. First, if a seller was found to have caused or colluded in the government action preventing performance, then this excuse would not apply, which may present problems for companies that affirmatively request that the Defense Production Act apply to them in order to supersede existing contractual obligations. MG Refining & Marketing, Inc. v. Knight Enterprises, Inc., 25 F. Supp. 2d 175 (S.D.N.Y. 1998); Cliffstar Corp. v. Riverbend Products, 750 F. Supp. 81, 84 (W.D.N.Y. 1990) citing Roth Steel Products v. Sharon Steel Corp., 705 F.2d 134, 149-50 (6th Cir. 1983). Second, performance is not excused if the supervening regulation was foreseeable, which may create some ambiguity regarding contracts entered into after the start of the Coronavirus crisis.
2. U.C.C. § 2-615(b): How Should Goods Already Produced Be Allocated?
If, despite commercial impracticability, a seller is able to produce some, but not all, of the contracted-for goods, Section 2-615(b) requires that the seller allocate production and delivery between existing customers, regular customers not then under contract, and their own manufacturing requirements in a fair and reasonable manner. U.C.C. § 2-615(b). As the official comments to Section 2-615 explain, this section is intended to provide “reasonable business leeway” to sellers in order to determine a fair and reasonable method of allocation.
Courts in New York have not had much opportunity to address whether allocations under Section 2-615(b) are fair and reasonable, and the courts which have looked at this issue have generally found that whether an allocation is reasonable is a question of fact for the jury. See, e.g., Cliffstar Corp., 750 F.Supp. at 87. In general, courts in other jurisdictions have upheld allocation schemes where goods were distributed according to objective, consistently applied criteria, such as prior sales volume. See, e.g., Cecil Corley Motor Co., Inc. v. General Motors Corp., 380 F. Supp. 819 (M.D. Tenn. 1974); Intermar, Inc. v. Atlantic Richfield Company, 364 F. Supp. 82, 99 (E.D. Pa. 1973). It can be permissible to include subsidiaries and affiliates in an allocation scheme assuming that they already either had contracts to receive goods and
were regular customers and were not given favorable treatment over other customers under the allocation criteria the seller determined. See Intermar, 364 F.Supp. at 99.
On the other hand, courts have generally been skeptical of allocation schemes that can be characterized as unfair self-dealing. See, e.g, Chemetron Corp. v. McLouth Steel Corp., 381 F. Supp. 245 (N.D. Ill. 1974); Haley v. Van Lierop, 64 F. Supp. 114, 116 (W.D. Mich. 1945), Courts have rejected allocation schemes that include parties other than customers with existing contracts or regular customers, such as new customers or newly formed subsidiaries. See, e.g., Roth, 705 F.2d at 151. Allocation schemes that completely cut out certain disfavored buyers have also been found to be unreasonable. Cosden Oil & Chemical Co. v. Karl O. Helm Aktiengesellschaft, 736 F.2d 1064 (5th Cir. 1984).
3. U.C.C. § 2-615(c): How Quickly Must Customers Be Told The Bad News?
Finally, Section 2-615 requires that sellers “seasonably” notify buyers that there will be delay or non-delivery and, in the event that there will be an allocation of goods under Section 2-615(b), the quota of goods available to the buyer. U.C.C. § 2-615(c). “Seasonable” is defined in U.C.C. as an action undertaken within a reasonable time depending on the nature, purpose and circumstances of that action. U.C.C. § 1-205. The U.C.C. does not specify a form that this
notice must take, just that the seller take such steps as reasonably required to inform the buyer in the ordinary course of business. U.C.C. § 1-202(d).
While I am not aware of any New York courts that have ruled upon what seasonable notice is in the context of Section 2-615, most courts that have considered similar requirements in other provisions of the U.C.C. have tended to treat the question of whether an action was done seasonably as a question of fact to be determined by the jury. See, e.g., Sherkate Sahami Khass Rapol v. Henry R. Jahn & Son, Inc., 701 F.2d 1049, 1051 (2d Cir. 1983). However, courts will determine what constitutes a reasonable time before trial when the facts will admit of only one inference. Tabor v. Logan, 114 A.D.2d 894 (2d Dept. 1985). Among the factors courts have considered in other contexts that may be relevant to disputes under Section 2-615(a) are whether the goods at issue were subject to rapid fluctuations in price and whether the aggrieved party was substantially prejudiced by the delay in notice. See, e.g., Simply Natural Foods LLC v. Polk Mach. Co., Case No. 11-CV-3911(JS)(SIL), 2015 WL 5599152 (E.D.N.Y. Sep. 22, 2015); Levin v. Gallery 63 Antiques Corp., Case No. 04-CV-1504 (KMK), 2006 WL 2802008, (S.D.N.Y. Sep. 28, 2006).
4. Conclusion
For companies faced with contracts for the sale of goods that they are unable to fulfill due to Coronavirus-related disruptions, they may be excused performance under U.C.C. § 2-615 if they can show that performing is either commercially impracticable or prohibited under
governmental mandates and that the disruption was not foreseeable. In addition, for companies that can partially fulfill orders, they must allocate goods between customers in a fair and reasonable manner, ideally in accordance with objective and consistently
applied criteria. Finally, companies wishing to invoke U.C.C. § 2-615 must notify customers within a reasonable time, with prompt notification especially necessary if the goods in question are subject to rapid fluctuations in price of if counterparties are likely to be substantially prejudiced by delay.
[1] This blog post only addresses contracts for the sale of goods. Other contracts are governed by a somewhat different legal regime, which will be addressed in a subsequent post.
[2] With the possible exception of contracts entered into shortly before the issuance of Executive Order 202.6, when it arguably became foreseeable.