Previously on this blog, we wrote about the UCC’s silly rule that order quantity must be in writing for a supply chain contract to be enforceable. Among other things, we discussed the difficulties this rule poses for supply chain partners who want to do business on a blanket purchase order basis, popular in many industries.
This week, we continue with the “UCC is sometimes the worst” theme by pointing out another silly UCC rule: the rule that allows supply chain contracts to be enforceable even if the parties have not agreed on price.
Silly UCC Rule No. 2: The UCC allows a supply chain agreement to be enforceable even though the parties do not agree on price.
Just using common sense, you might think that price is the one term that supply chain partners should be required to agree on before they can form a binding contract. Or before a court decides that they have formed a binding contract. After all, who buys or sells something without knowing how much it costs? But because common sense is sometimes too common for the UCC, you would be wrong.
Sure, “price” in supply chain contracts is not always expressed as an integer. Sometimes, price is expressed as a formula. Sometimes, as a function of a market index. And sometimes, price is subject to periodic renegotiation based on production costs, or changed circumstances. But in all of these situations, there is still a definable, calculable price. For a supply chain contract to be enforceable, however, you don’t need to agree on any price mechanism.
This particular bit of silly is brought to you by UCC 2-305, which provides that commercial parties “can conclude a contract for sale even though the price is not settled.” If supply chain partners are ultimately not ever able to agree on price, a court will establish “a reasonable price at the time for delivery.”
In reality, there are not many true open price term cases under the UCC because most commercial parties know how to avoid this kind of trouble. But when one comes along, it is a mess.
Consider the recent case of AM General LLC v. Demmer Corp., 2014 U.S. Dist. LEXIS 141546 (N.D. Ind. Oct. 6, 2014). AM General involved the supply chain relationship between the manufacturer of Humvee vehicles ultimately sold to the U.S. government and its armored doors supplier. The supplier had historically been the sole source of doors for the program, and when it was asked to bid on 2010 shipments, it was the only supplier asked to submit a bid.
The parties were not able to agree on the 2010 price before 2010 began, so the supplier began shipping doors temporarily subject to 2009 prices, with both parties agreeing that 2010 prices would be less than 2009 prices. At some point during 2010, the buyer submitted purchase orders to the buyer with a not-to-exceed price set at the 2009 prices, and the parties agreed to negotiate 2010 price once the buyer conducted an audit of the supplier’s costs, required because the program was a government contract. The supplier, meanwhile, resisted and delayed auditing because (reportedly) the direct labor costs stated in its 2010 bid were inflated.
During price negotiations, the buyer proposed a price that was well beneath the supplier’s bid, and the supplier refused. The supplier proposed a price in between the buyer’s price and its 2009 pricing, but the buyer refused. Ultimately, the buyer sued, petitioning the court to set a reasonable price pursuant to the UCC’s open price term provision. After a five-day bench trial, the court set the price at the supplier’s actual costs plus a 12.5% profit, despite the supplier’s argument that its 2010 bid price was the lowest it had ever sold the product for, that it would never have bid on the contract at the price set by the court, and that other suppliers on the program received higher profits.
The bottom line here is – the best practice is to fully agree to and set product price before beginning production. As we have stated elsewhere, it is really best to agree to all supply contract terms before beginning production. Having a fully negotiated supply contract in place before performance begins ensures that the parties’ expectations for the relationship are the same, and avoids costly supply chain contract disputes.