UCC 1

Copyright Information (bibliographic) Document Type: Book Chapter Title of book: Sales Law Domestic and International (3 rd Edition) Author of book: Clayton P. Gillette, Steven D. Walt Chapter Title: Chapter 1 Introduction to Sales Law Author of Chapter: Clayton P. Gillette, Steven D. Walt Year: 2016 Publisher: Foundation Press Place of Publishing: United States of America The copyright law of the United States (Title 17, United States Code) governs the making of photocopies or other reproductions of copyrighted materials. Under certain conditions specified in the law, libraries and archives are authorized to furnish a photocopy or other reproduction. One of these specified conditions is that the photocopy or reproduction is not to be used for any purpose other than private study, scholarship, or research. If a user makes a request for, or later uses, a photocopy or reproduction for purposes in excess of fair use that user may be liable for copyright infringement. Chapter 1 INTRODUCTION TO SALES LAW I. The Statutory Development of Commercial Law A. Article 2 of the UCC Sales law involves legal doctrines that regulate the relationship between parties involved in an exchange of goods for a price. As a general matter, sales law only addresses transfers of tangible personal .property, not real estate or intangibles such as intellectual property rights. Sales law, therefore, is a subset of contract law. Unlike general contract law doctrine, which has evolved primarily through the common law process of judicial decision, sales law is found in statutory law. For domestic transactions, the primary statute is Article 2 of the Uniform Commercial Code ("UCC"), which has been enacted as part of the statutory law of every state other than Louisiana, as well as the District of Columbia and the Virgin Islands. As we will see, state law has been augmented by certain provisions of federal law, particularly in the area of consumer sales. For international transactions in goods, the United Nations Convention on Contracts for the International Sale of Goods (the "CISG" or "Convention") has quickly become a major source of law, at least for those countries that have agreed to be bound by its provisions. As of this writing, 83 nations are Contracting States (as signatories to the CISG are called) under the CISG. These include major commercial nations, such as the United States, Germany, France, Canada, Japan and China. Among the major commercial nations, only the United Kingdom, South Africa and India have yet to become Contracting States. The UCC was originally promulgated under the auspices of the American Law Institute ("ALI") and the National Conference of Commissioners on Uniform State Laws ("NCCUSL" now renamed the "Uniform Law Commission") in the 1940s in order to bring a greater level of certainty and predictability to an increasingly national commercial system. The UCC was intended to deal not only with sales, but with a range of transactions involving commercial parties, from the use of negotiable instruments to secured transactions. The entire project was headed by Professor Karl Llewellyn of the Columbia Law School. Much of the UCC, and Article 2 in particular, reveals Llewellyn's commitment to legal realism and to his desire to allow commercial parties to dictate the 1 2 INTRODUCTION TO SALES LAW Ch. 1 proper scope and doctrine of the law that was to govern their practices. Llewellyn assumed that these parties were in a better position than judges or legislators to determine socially desirable commercial arrangements. Thus, in many ways the UCC seeks primarily to give state sanction to private rules developed by merchants. This is clear both from § 1-302(a), 1 which permits parties to contract out of the rule supplied by the UCC, and from the inclusion of several provisions that contain vague, almost vacuous, admonitions of proper commercial conduct. Llewellyn believed that the courts that would inevitably be required to interpret these provisions should do so by reference to the practices of the trade under investigation, rather than by the imposition of some external standard of appropriate commercial conduct. Thus, one finds multiple provisions that require courts to make judgments by reference to "reasonableness" or "commercial reasonableness"2 and to incorporate "trade practices" and "course of dealing"3 into their constructions of contracts between commercial parties. Notwithstanding their general reliance on commercial parties within a trade to establish legal standards of conduct, the drafters of the UCC were willing to provide some guidance to both commercial parties (and their legal advisors) and courts as to the meaning of the UCC's provisions. Each provision is followed by an "Official Comment" which elucidates the intended application of the provision's terms. While these Comments generally have not been enacted by legislatures and generally do not have the force oflaw,4 courts (and students) typically take great solace from these statements in interpreting UCC provisions. Indeed, early versions of the UCC contained proposed statutory authorization for courts to consult the Comments when interpreting specific provisions. In addition, states frequently have little in the way of legislative history that would provide an alternative interpretative aid. It is essential to recall, however, that the drafters did not consistently revise the Comments as they were revising the corresponding provisions. Thus, while the student of the UCC may take significant comfort in the analysis found in the Comments, it is always 1 All references to Article 1 refer to the revisions of Article 1 in 2001. As of this writing, almost every state has adopted the revisions to Article 1. See, e.g., §§ 2-206(2), 2-207(1), 2-715(1).

See, e.g., § 2-316(3)(c). The Iowa legislature has adopted the following non-uniform provision: To the extent that they are consistent with the Iowa statutory text, the 1972 Official Comments to the Uniform Commercial Code are evidence of legislative intent as to the meaning of this chapter as amended. However, prior drafts of the Official Text and Comments may not be used to ascertain legislative intent. Iowa Code§ 554.11109 (2014). 3 THE STATUTORY DEVELOPMENT OF Sec. I COMMERCIAL LAW necessary to distinguish those interpretive guides from the provisions that alone constitute the law. Regardless of what courts ought to do, commentators have found that, as a practical matter, courts use the Comments in at least one of three ways. First, courts employ the Comments to assist in exposition of the UCC as well as to describe and explain the meaning of each provision. Second, they have used the Comments to fill gaps in areas not specifically addressed by the text of a provision, but arguably subsumed within it. For instance, § 2-504 imposes duties on the seller when the sales contract allows or requires a carrier to transport the goods to the buyer. The section applies only when "the contract does not require [the seller] to deliver them at a particular destination." This implies that a seller's duties under a sales contract requiring him to deliver at a particular destination may be different. Section 2-504, however, is silent about obligations when a contract requires the seller to deliver goods to a particular destination. The silence can be a problem when the sales contract calling for carriage fails to expressly address the seller's delivery obligations. Official Comment 5 to § 2-503 fills the gap, stating that "... under this Article the 'shipment' contract is regarded as the normal one and the 'destination' contract as the variant type." A "shipment" contract does not require the seller to deliver goods to a particular destination. Thus, given Comment 5, § 2-504 applies to sales contracts that simply call for transport by a carrier. A contract merely requiring the seller to "arrange for delivery" is an example. Finally, courts may use the Comments to confirm a view of the provision that they advocate on some independent grounds. For instance, a court may find it makes good policy sense to apply § 2­ 504 to sales contracts that call simply for the seller to "arrange for delivery." These contracts, the court may find, do not "require [the seller] to deliver" the goods "at a particular destination." Buyers typically may have different preferences for the details of carriage concerning delivery at the destination, as well as better information and risk-bearing abilities in the matter than their sellers. They typically may know more than their sellers about the condition of the goods when delivered to them by the carrier. If so, buyers may be in a superior position to negotiate desirable terms with the carrier concerning the specifics of delivery at the destination. The court could conclude that in the circumstances carriage costs are lower for most buyers when sellers enter into "shipment" contracts. Having reached that conclusion on these grounds, the court may further justify it by finding the outcome consistent with the Official Comment: "shipment" contracts are the "normal" carriage contract, "destination" contracts "deviant." 4 INTRODUCTION TO SALES LAW Ch. l The drafters of the UCC also recognized that the practices they wanted to regulate or leave to self-regulation of the particular trade could change over time. In order to make clear that courts were to allow legal doctrine to keep pace with those changes, the drafters explicitly indicated that courts were to construe UCC provisions liberally to promote its underlying purposes and policies. Those policies explicitly include the modernization of commercial law and recognition of "the continued expansion of commercial practices through custom, usage and agreement of the parties." 5 Notwithstanding these efforts to allow commercial practices to evolve without changes in statutory commercial law, many commentators and practitioners have found that a law drafted in the 1940s is inadequate for the 21st century. Technological innovations, such as computerization, made prior means of doing business obsolete, and have resulted in changes in statutory law affecting the UCC. Important among these changes are the Electronic Signatures in Global and National Commerce Act ("E­ Sign"), the Uniform Electronic Transactions Act (UETA), and the controversial Uniform Computer Information Transactions Act (UCITA) (the last enacted in only two states). In addition, the appearance and persistence of difficult issues have led to conflicting judicial interpretations that threaten the uniformity of commercial law. As a result, most of the UCC has recently been subjected to revision efforts. Perhaps most relevant to this text is the approved revision of Article 1, which contains the UCC's general provisions.

We incorporate the revised provisions of Article 1 in this text, since they have been adopted by almost every state. Although its revisions are not substantial, one deserves mention. A majority, but not all of the states that have enacted revised Article 1 have included the expanded definition of "good faith" in § 1-201(b)(20). The original definition of that term required only "honesty in fact" in the transaction. The revised definition also requires "the observance of reasonable commercial standards of fair dealing'' for parties and transactions subject to a good faith requirement standard under another Article. In 2001, a drafting committee of the ALI and NCCUSL produced a draft proposing some organizational and substantive revisions of Article 2. The draft contained some controversial provisions, including some that would have affected the content of contracts formed with conflicting writings or other records. When it became clear that no state was ikely to adopt the proposed revisions to Article 2, the ALI and NCCUSL withdrew them. We therefore § 1-103(a)(2). 5 THESTATUTORYDEVELOPMENTOF Sec. I COMMERCIAL LAW ignore the proposed revisions and discuss only the existing version of Article 2. B. The United Nations Convention on Contracts for the International Sale of Goods As the international sale of goods has increased, so have the pressures to bring to international trade the same level of legal uniformity and certainty that the UCC has made possible for domestic transactions. Efforts to create greater uniformity in international sales date back to the 1930s, when the International Institute for the Unification of Private Law ("UNIDROIT") began work on treaties that would govern international commercial transactions. UNIDROIT ceased its efforts during and immediately after World War II, but ultimately submitted a draft to a diplomatic conference in The Hague in 1964. The conference adopted two conventions, one on the international sale of goods and the other on the formation of contracts for the international sale of goods. These conventions were criticized as insufficiently international in scope and too tied to the legal traditions of continental Western Europe. Neither convention was widely adopted. Subsequently, the United Nations Commission on International Trade Law ("UNCITRAL"), organized in 1966, convened an additional conference to determine whether the Hague treaties could be modified to generate wider acceptance. The result was a series of meetings in Vienna, attended by 62 nations, that led to the adoption in 1980 of the CISG. Under Article 99 of the CISG, it became effective a year after deposit of the tenth instrument of adherence. As a result, the CISG went into effect among 11 nations in 1988.

Many of the principles underlying the CISG should be familiar to a student of the UCC. Primary among these is the principle of freedom of contract, or "party autonomy." Under Article 6, parties to a contract may exclude the application of the CISG or derogate from or vary the effect of almost all of its provisions. Thus, parties whose contracts would otherwise be governed by the CISG may select the law of a particular jurisdiction to govern their transaction, or they may negotiate between themselves a contract term that reflects their particular transaction, even though that term is inconsistent with the CISG provision covering the same issue and the CISG governs the balance of their contract. In either case, the parties' selection will trump the CISG. We discuss in Chapter 2 the extent to which implied versus express exclusion of the CISG is permissible. Although the CISG has been adopted by 83 countries, its "success" as a source of uniform law remains questionable. The 6 INTRODUCTION TO SALES LAW Ch. 1 capacity of the CISG to generate truly international commercial law is primarily limited by the absence of any international commercial court to resolve disputes. Instead, the CISG is interpreted by domestic courts. One would imagine that interpretation will be crucial to the meaning of the CISG, since so many of its provisions include obligations to act "reasonably" or contain other vague standards that require further emanation to provide guidance to commercial parties. 6 Thus, the ability of courts from different jurisdictions to converge on similar meanings of CISG provisions is crucial to uniformity. Although Article 7(1) of the CISG also explicitly admonishes courts to recognize and adhere to the international character of the Convention and to promote uniformity in interpreting the Convention, such convergence is difficult. This is true for various reasons. First, the CISG itself was promulgated in six, equally authoritative versions: Arabic, Chinese, English, French, Russian, and Spanish. Given the complexities of translation, terms in one language will be imperfect substitutes for the same terms in another language. Thus, domestic courts may vary in their interpretations, depending on which "official" language they use. 7 Second, courts and arbitration panels may display a "homeward trend" and interpret the CISG provisions in light of domestic law. This is not entirely inappropriate, as long as courts use domestic law in a limited fashion. Certainly domestic law that reflects CISG provisions may be probative of the meaning of those provisions, but they should not be considered as authoritative or determinative of the meaning of the CISG. Rather, the CISG should be viewed as an autonomous body of commercial law. But some courts, notably United States courts, have perhaps gone too far by equating UCC provisions with CISG provisions and failing to consider interpretations of the latter by other national courts. s Third, respect for uniformity also requires that courts construing these provisions pay substantial attention to precedents 6 The use of vague standards, such as reasonableness, was due in part to the need to address a variety of commercial situations, which precludes writing very specific rules that might be appropriate for one industry, but not for another industry. But the CISG also suffers from the fact that it was drafted largely by political officials and academics who did not necessarily seek to incorporate commercial practice or preferences. Instead, many provisions reflect political compromises in order to ensure the support of nations that participated in the drafting process, rather than to enhance commercial contracting. See, e.g., Clayton P.

Gillette & Robert E. Scott, The Political Economy of International Sales Law, 25 Int'l Rev. L. & Econ. 446 (2005). 7 See, e.g., Court of Appeals Miinchen (Germany), 3 December 1999, available at http://cisgw3.law.pace.edu/cases/991203gl.html (different meanings in French and English versions of Article 3). See, e.g., Raw Materials Inc. v. Manfred Forberich GmbH, 2004 WL 1535839 (N.D. Ill. July 7, 2004). 7 THE STATUTORY DEVELOPMENT OF Sec. I COMMERCIAL LAW of courts in other jurisdictions that have adopted the CISG. This could cause courts to be relatively proactive in their interpretations of the CISG in order to articulate precedents that will then become authoritative, if not binding, for subsequent courts. More realistically, however, political considerations could interfere with the deference to foreign decisions necessary to international uniformity. It is difficult to imagine certain courts deferring to the decisions of foreign legal systems to interpret a convention of which that court's country is a signatory. A United States court, we suspect, is unlikely to adopt an interpretation of a CISG provision favored by a Lithuanian or Ugandan court simply because that decision was promulgated first. This is true not only because each court system is likely to be somewhat nationalistic in its desire to shape law under the CISG. Difficulties of obtaining and translating foreign opinions also frustrate efforts by courts in one Contracting State to have easy access to authoritative versions of the decisions of every other Contracting State. Nevertheless, there have been some notable decisions, particularly from Italy, in which courts have explicitly incorporated the CISG decisions from other nations on the issues involved in the litigation. 9 Fourth, even if courts are willing to defer to decisions from other jurisdictions, substantial issues remain with respect to the international availability of decisions. Pace Law School has maintained a comprehensive website that seeks to collect judicial and arbitral CISG decisions from around the world. That website, available at http://www.cisg.law.pace.edu/, also contains translations of large numbers of decisions into English, but those constitute only a minority of the decided cases. UNCITRAL has established the CLOUT ("case law on UNCITRAL texts") reporting system for collecting and publishing abstracts of court decisions and arbitral awards relating to the texts produced by UNCITRAL. That database is available at http://www.uncitral.org/uncitral/en/case_ law.html. CLOUT's abstracts are submitted by national correspondents who monitor, collect and summarize decisions and awards in one of the United Nation's official languages. UNCITRAL also publishes Digests of CISG opinions and makes them publicly available.

Some degree of uniformity may be achieved by careful judicial use of the legislative history of the drafting process. A rich documentary history of the Vienna Conference has been compiled, 10 See, e.g., District Court Vigevano (Italy), 12 July 2000, available at http:// cisgw3.law.pace.edu/cases/000712i3.html; District Court Rimini (Italy), 26 November 2002, available at http://cisgw3.law.pace.edu/cases/021126i3.html. 1 0 See Documentary History of the Uniform Law for International Sales (John 0. Honnold ed., 1989). 9 8 INTRODUCTION TO SALES LAW Ch. 1 and contains earlier drafts of the CISG and commentaries by parties during their deliberations. The 1978 draft contains a Secretariat Commentary, much of which remains relevant. It is important, however, to recall that this draft, and hence the Secretariat Commentary, precedes the 1980 version of the CISG that was ultimately adopted. In addition, a self-styled "CISG Advisory Council" has formulated opinions that seek to reconcile potentially conflicting decisions. But it is important to note that, although some of these opinions have been cited by courts and arbitration panels, they constitute only the analyses of the private individuals who serve on the Advisory Council. Neither that Council nor its opinions have the official imprimatur of the United Nations.

To some extent, the CISG itself limits the possible scope of international uniformity. The CISG allows Contracting States to opt out of certain provisions. Other provisions allow courts within a Contracting State to apply domestic law in certain circumstances, even though the CISG would otherwise apply. For instance, Article 96 allows a Contracting State to exclude from its version of the CISG those provisions that concern contract formation, and Article 28 allows the availability of specific performance to depend on the domestic law of the place where the court hearing the case is located. Various provisions of the CISG are subject to reservations that a Contracting State may adopt when it accedes to the CISG. Where that happens, the applicable Articles of the CISG will not apply to disputes governed by the law of that Contracting State, even though the same dispute would be governed by those Articles if heard under the law of another Contracting State. Finally, as we will see in Chapter 2, the CISG explicitly excludes certain aspects of sales law that are at issue in a contract that is generally governed by the CISG. Most importantly, Article 4 recites that matters of contract validity and the effect of a contract on property rights in the goods sold are beyond the CISG's scope.

Thus, nothing in the CISG addresses issues such as unconscionability, capacity defenses, or the rights of a bona fide purchaser to goods that turn out to have been stolen, even when other aspects of the same transaction are subject to the CISG.

These issues will continue to be resolved by reference to domestic law. Whether these limitations on uniformity are problematic depends on whether one views uniform international law as a positive development. The drafters of the CISG were obviously of the view that it was. But the desirability of uniform law is not fully apparent. Uniform law, when embodied in statutory form, is difficult to alter, even if changes in technology or trade practices reveal that amendments to existing provisions would be desirable. 9 PRINCIPLES OF SALES CONTRACTS­ Sec. II HEREIN OF DEFAULT RULES For instance, the CISG contains no mechanism for its amendment. Moreover, law, like other products and services, may be more likely to improve when it is subject to competition. If commercial parties can select among multiple different legal rules, one would imagine that jurisdictions that wish to serve as the forum for commercial disputes or to have their attorneys involved in commercial transactions will compete for law that is most hospitable to commercial purposes. Of course, the presence of uniform law does no harm if commercial parties can easily opt out of it, as Article 6 allows, by selecting another body of law to govern their transactions. But since the CISG governs transactions within the scope of its application unless the parties have opted for an alternative, the parties' knowledge of the underlying law may matter. If we believe that parties will be unaware that uniform law will be imposed on them if they fail expressly to select a specific domestic law, then perhaps the uniform law becomes a trap for the unwary. That is likely to be the case with respect to commercial parties who only occasionally enter into an international sales transaction, and who therefore have little expertise in the vagaries of international sales law. This does not necessarily mean that there should be no uniform law; after all, if uniform law competes with domestic law, then each may strive to reflect the needs of commercial parties. The only question is whether uniform law, and the CISG in particular, should be a system that parties must explicitly opt into, or whether it should be a system that commercial parties to international sales must explicitly opt out of, as is currently the case. II. Principles of Sales Contracts-Herein of Default Rules Our mention of freedom of contract principles in the UCC and the CISG reveals a particular understanding of the function of commercial law. After all, if parties are permitted to deviate from legislatively created legal doctrine, then why have that doctrine in the first place? Why wouldn't parties simply draft their agreements according to their preferences without any background rules of law? The answer to this question, we believe, lies primarily in the concept of transaction costs. Contracting is an expensive process, as parties must decide which terms they prefer, negotiate those terms with their trading partners, and reduce their agreement to writing. These costs are reduced significantly if state-supplied law provides a background set of rules that the parties can accept through contractual silence. In this event, parties need not negotiate or draft terms, since their failure to address particular issues will cause courts to fill in the contractual gaps with the state-supplied "off-the­ 10 INTRODUCTION TO SALES LAW Ch. 1 rack" prov1s10n. In effect, this means that the objective of commercial law is to do for the parties what they otherwise would have done for themselves. Any other set of rules will simply require the parties involved in a substantial number of transactions to incur the costs of drafting rules that circumvent the state-supplied rules.11 Of course, there may be situations in which particular parties desire terms other than those supplied by the state, even though they will have to incur costs they would have been able to avoid had they accepted the default rule. For instance, legal doctrine may place the risk of loss on sellers during transit, but a particular buyer may prefer to accept the risk of loss at an earlier time. (Perhaps the buyer enjoys an advantage in obtaining insurance or wants to use a particular carrier.) To the extent that we allow parties to deviate from the state-supplied doctrine, legal rules are default rules. They apply unless the parties have decided otherwise. They are to be contrasted, therefore, with mandatory rules, from which parties cannot deviate even if they desire to do so. For the most part, the transaction cost-reducing function of legal default rules operates properly only if these rules reflect what a majority of commercial parties would prefer. Otherwise, the purpose of the rules will be defeated as most commercial parties bargain away from the default, thereby incurring the very costs that the rules were intended to avoid. As long as default rules reflect the preferences of the majority of relevant actors and the cost of contracting for desired terms is the same for all parties, however, total transactions costs will be minimized.

Nevertheless, the existence of a default rule may have some effect on the risk allocations in the ultimate transaction. Assume, for instance, that the default rule places the risk of loss on seller in a situation where the buyer believes it faces an additional expected loss of $2 as a result of the legal risk allocation. The buyer may believe, for example, that there is a 2 percent greater risk that the goods will suffer $100 worth of damage if the seller bears the risk of loss than if the buyer bears it. In these circumstances, the buyer might negotiate to bear the risk of loss, perhaps for a decrease in the sales price. If, however, the buyer anticipates that the costs of negotiating with the seller will exceed $2, then the buyer is better off accepting the default rule than contracting out of it, even though, transactions costs aside, the buyer would have preferred the alternative allocation of risk of loss. 11 For further development of the theory underlying this objective, see Charles J. Goetz & Robert E. Scott, The Limits of Expanded Choice: An Analysis of the Interactions Between Express and Implied Contract Terms, 73 Cal. L. Rev. 261 (1985). 11 PRINCIPLES OF SALES CONTRACTS­ Sec. II HEREIN OF DEFAULT RULES Even though we believe that commercial law should by and large embody default rules consistent with the preferences of most commercial actors, legal rules are not always intended to minimize transactions costs. Sometimes legal rules impose an obligation on parties because, left to their own devices, they would reach a solution that was contrary to the interests of non-parties. Price­ fixing arrangements, for instance, might be perfectly acceptable to the parties to the contract, but impose costs on others who do not have an opportunity to bargain for a different rule. We can think of actions that impose costs on non-parties as the "externalization" of those costs. In contrast, costs of the transaction that are borne by the parties to the transaction are "internalized." Rules that protect non-parties tend to be mandatory, rather than default rules, since parties would frequently bargain away from them if given the opportunity to do so. In addition, some legal rules serve paternalistic objectives. Legal rules could protect parties from bargains they would otherwise make against their own interest. The classic case is the rule against contracts for slavery. One defense of such rules is that we fear that individuals who face short-term needs will underestimate the long-term costs of such a contract and enter into it, only to regret their decision at a later time. In short, as opposed to the case of externalities, in which we fear that contracting parties will be inattentive to the interests of others, we allow courts to invalidate parties' contracts where we fear that individuals will be insufficiently attentive to their own interests or where we believe that parties are incapable of attending to their own interests. Where we wish paternalistically to protect people from their own bad judgment, a mandatory rule again may be appropriate. One example of such a rule is the unconscionability doctrine of § 2-302, which allows a court to refuse to enforce the bargain made by the parties because it is too one-sided. Nevertheless, there are other occasions on which we feel strongly about what bargain the parties should reach, but not so strongly as to prohibit them from bargaining for a different rule. In this case, we might state a rule as a default rule to indicate a social preference, or to call special attention to the option presented by the default rule and ensure that parties who bargain away from that rule incur significant costs that might lead them to think seriously about the appropriateness of their actions. Examples of this function of default rules are more difficult to find in Article 2, perhaps because those provisions envision relatively sophisticated buyers and sellers. But other parts of the UCC which deal with a mix of sophisticated and less sophisticated parties contain rules that have this characteristic. For instance, under Article 9 of the 12 INTRODUCTION TO SALES LAW Ch. 1 UCC, certain creditors are required to notify their debtors of pending sale of the collateral after foreclosure. This obligation may not be waived or varied as a general matter, but a debtor may sign a statement after default that renounces or modifies the right to notification of sale. 12 The default rule of notification provides a social preference for that rule and induces parties to adhere to it. It also signals the debtor who is asked to sign a post-default waiver that the request involves an extraordinary act and thus encourages contemplation about whether a waiver is appropriate. At the same time, the default nature of the rule suggests that there may be sufficient cases in which a waiver would be appropriate that we do not want to prohibit waivers by making notification mandatory. A final use for default rules involves what has become known as "information forcing." Rules with this characteristic purport to solve problems that arise when one party has more information relating to a transaction than another party. Under these circumstances, we say that the parties have "asymmetric information." Assume, for instance, that a widget buyer expects to suffer $1000 in damages if the good being sold does not operate properly, even though most buyers in the same position would only suffer $10 in damages. (Maybe our buyer has an unusually profitable downstream contract that can be filled only if the widget operates properly.) If the seller is unaware of the buyer's unique situation and knows only what happens when more typical buyers purchase widgets, the seller will only take precautions sufficient to avoid the standard $10 in damages rather than this buyer's idiosyncratic $1000 damages. Nevertheless, the seller might be in a superior position to avoid the $1000 loss by ensuring proper operation of the widget. If that is the case, we would want the seller to take the precaution to avoid the wasteful loss from materializing. But seller will do so (and charge buyer a price accordingly) only if it is aware of buyer's greater than average potential loss.

A default rule that requires an ignorant seller only to compensate the average expected damage, but that makes a knowledgeable seller responsible for all damages induces, or "forces," the buyer to convey the relevant information to the seller. In this way, buyers will take advantage of their superior information about the transaction by conveying the information to sellers, and sellers will take advantage of their superior ability to avoid losses by taking precautions in an amount equal to the higher expected loss. Since each party performs that act that it is best positioned to perform, the parties are presumably doing what each would agree to do, since that assignment of responsibilities will 12 § 9-624(a). 13 PRINCIPLES OF SALES CONTRACTS­ Sec. II HEREIN OF DEFAULT RULES minimize the costs of the transaction. If a seller were responsible for its buyer's idiosyncratic and unknown damages, for instance, the cost of contracting would increase. The seller would likely incur higher bargaining costs to negotiate a liability cap, or invest more than the expected value of transactional breakdown to ensure that goods performed properly, or charge more for goods, in order to insure against the occasional idiosyncratically high damage award when goods did not perform properly. These consequences suggest that most commercial parties would prefer a default rule that induced the party with superior information to disclose it. Thus, information-forcing default rules are likely to be majoritarian rules as well. We discuss this principle further in Chapter 3. Notwithstanding the various functions that default rules may play, we maintain in this text that for transactions between sophisticated commercial parties, the primary objective of commercial law is to replicate the bargain that parties otherwise would have reached and thus to reduce the transaction costs that they must incur. Most commercial parties are profit-maximizing firms that participate in markets with substantial competition. The alternative objectives of legal default rules, such as paternalism, have less application to these parties. Thus, our critique of the rules embodied in the UCC and the CISG proceeds through the lens of minimizing transaction costs. This objective assumes that parties want the law to reflect the position that they would have preferred ex ante, that is, at time of entering into the contract, rather than ex post, at the time when a particular risk materializes. In this manner, commercial parties seek to constrain what we refer to as strategic or opportunistic behavior. Basically, this means that commercial law should recognize that parties allocate risks between them at the time of contracting, and the party to whom a risk has been allocated should not attempt to act in a manner that imposes that same risk on the counterparty when circumstances subsequently change. Assume, for instance, that a buyer agrees to purchase goods from the seller six months after the execution of the contract between them at a price determined in the contract. We assume that commercial parties would agree in advance that the buyer should not attempt to renege on the contract should the market price of the good decline during the intervening six months and the seller should not attempt to avoid the contract should the market price of good increase during that period. The whole idea of fixing a price in the contract, in short, was to allocate the risk of subsequent market price changes. Thus, the parties agreed ex ante that if the market price subsequently declines, the buyer should not be able to take advantage of a technical breach by the seller, such as a delivery that is late but 14 INTRODUCTION TO SALES LAW Ch. 1 that causes no harm to the buyer, to get out of a deal that it regrets. In this text we describe parties who seek to avoid contractual obligations because they have come to regret their prior deal, rather than because of a defective performance by the other party, as acting "strategically'' or "opportunistically." Because we believe that the parties would agree ex ante to bar strategic behavior, we would expect legal rules will similarly be generated and interpreted to avoid the strategic behavior that the parties would otherwise have explicitly prohibited. Again, much of our discussion in this book will be directed at the capacity of legal rules to constrain such conduct. III. Commercial Contracts as Discrete and Relational Contracts-Herein of Reputation A. Reputation and Relational Contracts If default rules truly reflect the preferences of a majority of transacting parties, written contracts should be relatively incomplete. That is, they will not provide for every future contingency that might materialize during the contract term. Parties will spend little time dickering over terms because the gaps created by their silence are filled by the default terms to which they presumably would have agreed had they negotiated explicitly.

Commercial sales contracts, however, may be incomplete for other reasons. The difficulty or cost of foreseeing all contingencies may prevent complete contracting. Parties who anticipate that their interaction will span a significant time period will have difficulty anticipating all the risks that might materialize during their relationship. They will therefore be reluctant to attempt an explicit allocation of all risks. They might fear that they will allocate a risk to a party who is less able to avoid it when the contingency threatens to materialize. Alternatively, parties will not want to invest significant time negotiating the allocation of risks that seem remote. The low probability of an event makes the expected value of some risks not worth the cost of deciding how to allocate them. For instance, it is unlikely that the parties to a 20-year contract for the supply of lumber produced in Oregon will spend much time allocating the risk of Oregon seceding from the Union and placing an embargo on lumber shipments to the remaining states. In addition, a party might fear that its insistence on negotiating to allocate the risk of remote contingencies signals to its counterparty that it will prove to be a difficult contracting partner. Another reason for incomplete contracting is the cost of a court verifying contingencies provided for in a contract. Judicial enforcement of the contract requires a court to observe that a contracted-for contingency has occurred, and the court may have difficulty acquiring reliable information necessary to do so. In such Sec. III COMMERCIAL CONTRACTS 15 circumstances, parties may decide not to provide for such contingencies. 13 An important type of incomplete contracting involves "relational" contracts. Relational contracts are characterized by long-term arrangements, heightened uncertainty at the negotiation stage about future consequences of present acts, and the investment of resources unique to the transaction and thus not easily usable in other transactions. These characteristics induce the parties to accommodate each other's needs during the period of performance, even though no explicit contractual allocation requires such an accommodation. The fact that each party has invested in the transaction makes it more difficult to exit from the relationship even when things go better than expected for one party and worse than expected for the other. Instead, the relational character of the contract induces each party to accommodate the interests of the other. For instance, a shipper of coal who constructs a railroad track to serve a particular customer is likely to act in a manner that preserves the relationship with the customer because the track is otherwise useless and creating a new track with a replacement customer would be costly. If the customer has purchased railroad coal cars that cannot easily be moved to other tracks, the parties have each made "relationship-specific investments" that can bond them to each other and induce them to overcome short-term difficulties that might otherwise induce strategic behavior. The long-term nature of the transactions reinforces the tendency towards accommodation, since each party may be wary that at some future point it will need the assistance of the other party. Thus, each party has an incentive to realize the maximum joint gains of their transaction, that is, to maximize their combined benefits, even though doing so on a particular occasion requires one of the parties to sacrifice an opportunity to obtain personal gains at the expense of another. We contrast this result with activity in which one party takes advantage of the other's vulnerability, even though the gains to the selfish party are outweighed by the losses to the other party. In a relational situation, the joint interests of the parties would be served by forgoing the selfish action. For instance, one party might maximize joint interests by agreeing to price concessions where the contract term required sales to occur at a fixed price, but the market price of the goods had declined 13 Much of the legal literature on incomplete contracts relies on intuitive hunches about the presence of these factors. For criticism of the unformalized basis of incomplete contracting, see Kirsten Foss & Nicolai J. Foss, Theoretical Isolation in Contract Theory: Suppressing Margins and Entrepreneurship, 7 J. Econ. Meth. 313 (2000); Jean Tirole, Incomplete Contracting: Where Do We Stand?, 67 Econometrica 741 (1999). 16 INTRODUCTION TO SALES LAW Ch. 1 dramatically from the parties' expectations when they first entered into the contract. The lesson to be learned is that even where a contract fails to allocate certain risks, parties in a relational contract may still be able to protect themselves. Commercial parties in such relationships have incentives to work matters out as the contract is implemented, to forgive small deviations from contract requirements, or to accede to demands of the other party rather than instigate litigation or cancel the contract. To suggest that parties to relational contracts have incentives to cooperate, however, is not to suggest that the law should require them to cooperate. There may be valid reasons for courts to allow behavior that might be considered opportunistic. We discuss this issue when we explore the scope of permissible excuse in Chapter 6. Relational contracts therefore are to be distinguished from "discrete" transactions, characterized by the "one-shot" deal in which parties face each other, transact, and do not meet again. The salient distinction between these types of contracts is the extent to which the parties will confront each other in a subsequent interaction, that is, the likelihood that they will be "repeat players." Their repeated interactions cause the parties to care about their reputations at least as much as their legal rights. While legal rights are clearly. important, commercial parties may often ignore their rights and rely on reputation rather than fear of lawsuits to reduce opportunistic or strategic behavior by trading partners. Lawsuits are expensive to initiate and, even if successful, are unlikely to be fully compensatory. Damages in commercial contract suits will rarely cover litigation costs or the lost value of the award between the time of breach and the time of recovery. Informal norms, such as refusing to cooperate with or transact with a party who has a reputation for acting selfishly, may be much more effective than legal rules in dissuading commercial parties from acting in an opportunistic manner. B. Reputation Without Repetition Reputation will also matter where parties do not interact frequently, but where they are both members of the same trade or industry and members of the trade or industry can easily disseminate reliable information about each other. Assume, for instance, that you and I are involved in a transaction in which you make a relationship-specific investment, but I do not. For instance, you may construct a railroad spur that can only be used for our contract, but I need not make any investment that cannot readily be redeployed to another transaction. Under these conditions, I may be able to exploit you by making demands that impose additional costs 17 Sec. III COMMERCIAL CONTRACTS on you, as long as they do not exceed the costs that you would incur by exiting our transaction. You, however, may not have the opportunity to retaliate by exploiting my relationship-specific investment, because I have not made one. Reputation, however, may limit my willingness to exploit your vulnerability. If you are a member of a network with which I frequently trade, any strategic behavior in which I engage can quickly become known to others, and they may be less willing to deal with me in the future. Reputation within a network of related actors may be particularly important in international law. Parties to international sales may be unfamiliar with their trading partners, and may be suspicious about mutual performance because geographic distance and differences in legal regimes can render contract enforcement difficult. Thus, parties to international contracts may rely on the reputation of potential trading partners before entering into even a discrete transaction. As the above discussion implies, reputation affects legal rules in at least two ways. First, reputation reduces the need for legal constraints on strategic behavior because legal sanctions may be secondary to informal sanctions. Threats by members of an industry to shun parties who violate the norms of the trade will be a more effective sanction than the possibility of damages for a breach at some point in the future. Law becomes necessary, however, when reputation is ineffective. Assume, for instance, that a seller is on the verge of bankruptcy, but may be able to avoid business failure by chiseling on a particular contract. Reputational constraints may not prevent the seller from acting improperly, since failure to do so means that there will be no business to enjoy a good reputation. The threat of legal liability, however, may forestall the misconduct if damages can be collected against the seller individually and not just from the defunct business. Second, the force of reputation justifies a limited judicial role in the construction of commercial contracts. Reputation gives commercial parties incentives to act reasonably and in accordance with industry or trade standards, in order to avoid retaliation. It is largely for this reason that Llewellyn's appeal to commercial practices to complete the interstices of the law makes sense. If commercial actors have significant extra-legal incentives to act in a manner that is consistent with the joint welfare of the parties, and if the pursuit of joint welfare has limited negative effects on non­ parties, then there is less need to impose some externally generated standard on those parties. Thus, it makes sense for a court that is interpreting vague statutory admonitions to act "reasonably" or in "good faith," to consider the conduct of persons in the trade rather than to decide independently what parties should have done in the 18 INTRODUCTION TO SALES LAW Ch. 1 situation. It is largely for this reason that we frequently see judges invoke the principle that courts do not rewrite contracts for parties or intervene to relieve parties from allegedly improvident bargains. 14 14 See, e.g., Vermont Teddy Bear Co. v. 583 Madison Realty Co., 807 N.E.2d 876 (N.Y. 2004); Envirotech Corp. v. Halco Eng'g, Inc., 364 S.E.2d 215, 220 (Va.

1988) ("[W]here, as here, experienced parties agree to allocate unknown or undeterminable risks, they should be held to their bargain; courts, or juries, should not be permitted to rewrite the agreement").