Michigan Bar Journal42November 2010The Uniform Commercial CodeCommercial ImpracticabilityA ND FA IR A L L OCAT ION UNDER UCC 2- 615By John R. TrentacostaWhen the economy makes its long-awaited turnaround, thereundoubtedly will be stresses and pressures on the supplychain. At many companies, production has been at less than fullcapacity for years. As the ramp-up takes place, there will be shortages at various points in the supply chain. What if a supplier simplycannot procure enough raw material to meet customer demand?Section 2-615 of the Uniform Commercial Code (UCC) setsforth the scope of the defense of commercial impracticability.1This defense is available to a supplier of goods that is unable tomake delivery as required by contract, either whole or in part. Ifa supplier can show that delivery of all goods required under acontract is commercially impracticable but the supplier can makepartial delivery, UCC 2-615 mandates that such deliveries be allocated among customers in a manner that is “fair and reasonable.”This article discusses the application of UCC 2-615, including thequestion of what is a fair and reasonable allocation.Statutory AuthoritySection 2-615 of the UCC 2 governs commercial impracticability. In relevant part, UCC 2-615 provides:(a) Delay in delivery or nondelivery in whole or in part by a sellerwho complies with paragraphs (b) and (c) is not a breach ofhis duty under a contract for sale if performance as agreed hasbeen made impracticable by the occurrence of a contingencythe nonoccurrence of which was a basic assumption on whichthe contract was made or by compliance in good faith withany applicable foreign or domestic governmental regulationor order whether or not it later proves to be invalid.(b) Where the causes mentioned in paragraph (a) affect only apart of the seller’s capacity to perform, he must allocate production and deliveries among his customers but may at hisoption include regular customers not then under contract aswell as his own requirements for further manufacture. Hemay so allocate in any manner which is fair and reasonable.FA S T FA C T SA seller that is unable to perform its contractual obligations may, under appropriate circumstances,assert the defense of commercial impracticability.Under UCC 2-615, nonperformance may be excused if performance has been made impracticableby a contingency, the nonoccurrence of which was a basic assumption of the contract.If the supplier can supply some, but not all, of what is required under the contract, the suppliermust allocate on a fair and reasonable basis across its customer base.
November 2010Michigan Bar Journal43Commercial Impracticability GenerallyAsphalt International, Inc v Enterprise Shipping Corp, S.A.When the parties have allocated certain risks by contract (e.g.,force majeure clauses), courts tend to defer to those contractualterms.3 However, in situations in which the parties did not allocatesuch risk by contract, UCC 2-615 acts as a “gap filler” when the unexpected occurs. A number of courts have applied a three-part testin analyzing whether the definition of commercial impracticability under section 2-615 is available to a nonperforming seller:In Asphalt International, Inc v Enterprise Shipping Corp, S.A.,7the court upheld a commercial impracticability defense to the performance of a charter contract when a tanker was damaged tothe point that cost of repair exceeded its precollision fair marketvalue. The plaintiff chartered a tanker from the tanker’s owner.The tanker sustained extensive damage when it was struck byanother vessel. Under the contract, the defendant was responsible for routine maintenance, including minor damage repairs, butthere was no allocation of risk for major damage. The cost of repair was 1.5 million, which was twice the precollision value ofthe ship. The plaintiff instituted a breach of contract claim for failure to repair the tanker. The court held that, although certain riskswere allocated by contract, the extensive damage to the tankerwas a contingency, the nonoccurrence of which was a basic assumption of the parties at the time of contracting. Therefore, thedefendant’s duty to repair was commercially impracticable.(1) The seller must not have assumed the risk of some unknown contingency;(2) The nonoccurrence of the contingency must have been abasic assumption underlying the contract; and(3) The occurrence of that contingency must have made performance commercially impracticable.4Foreseeability is a major factor to consider in any commercialimpracticability analysis. If the contingency was foreseeable, theparties should have made their contract with the expectation thatsuch contingency might occur. If an event was foreseeable, it wasnot “a contingency the nonoccurrence of which was a basic assumption.”5 Consequently, if a seller foresees a risk but does notinclude a contract provision against assuming that risk, that willbe evidence that such risk is assumed.Decisions Finding a Defenseof Commercial ImpracticabilityThe following is a summary of representative cases in whichthe court held that the doctrine of commercial impracticabilitywas applicable.Selland Pontiac-GMC, Inc v KingIn Selland Pontiac-GMC, Inc v King,6 the court applied thecommercial impracticability defense when a contract requiredthe seller to use a specified supplier and that supplier ceasedbusiness operations. The seller contracted with the buyer for thesale of four school bus bodies to be manufactured by a specifiedsupplier. The specified supplier ceased operations due to financial difficulties, and the bus bodies were never manufactured.Both the seller and the buyer testified that they had no knowledge of the supplier’s questionable financial circumstances whenthey contracted. The court held that,where supply of a single, mutuallycontemplated source was a basic assumption on which the contract wasmade and the seller had no reason toknow of the supplier’s inability beforehand, the seller was entitled toavail itself of the defense of commercial impracticability.Aluminum Company of America v Essex Group IncA cost increase brought on by regulatory changes was held sufficient to invoke a commercial impracticability defense in Aluminum Company of America v Essex Group Inc.8 The buyer and theseller entered into a toll conversion service contract under whichthe buyer would supply the seller with alumina. The seller wouldconvert the alumina by a smelting process into molten aluminumthat would then be picked up by the buyer for further processing.In the mid-1970s, new regulations for oil and pollution controldramatically increased the seller’s smelting costs and would havecaused the seller to lose more than 75 million during the life ofthe contract, while the buyer conversely stood to gain a windfallprofit. The court found that regulatory changes of this sort werean unforeseen supervening circumstance, not within the contemplation of the parties at the time of contracting. To the relief ofthe seller, the court found that the seller’s performance becamecommercially impracticable.Mishara Construction Company, Inc v Transit -Mixed CorpThe commercial impracticability defense was successfully invoked when an unforeseen labor dispute disrupted performancein Mishara Construction Company, Inc v Transit-Mixed Corp.9The plaintiff was a general contractor on a housing project forthe elderly. The plaintiff contracted with the defendant to supplyForeseeability is a major factor to consider in any commercialimpracticability analysis. If the contingency was foreseeable,the parties should have made their contract with theexpectation that such contingency might occur.
Michigan Bar Journal44November 2010The Uniform Commercial Code — Commercial Impracticability and Fair Allocation Under UCC 2-615ready-mixed concrete to be used on the project. The defendantwas obligated to supply all the concrete needed on the project ata specified price, with deliveries to be made at the times and inthe amounts as ordered by the plaintiff. An unexpected strike disrupted work on the job site. Although work resumed, a picket linewas maintained on the site until the completion of the project,preventing the defendant from delivering the concrete. Throughout this period, with very few exceptions, no deliveries of concrete were made by the defendant. The plaintiff sued for breachof contract. The court upheld the defense of commercial impracticability, finding the labor dispute was unforeseen.Federal Pants, Inc v StockingIn Federal Pants, Inc v Stocking,10 the court applied the commercial impracticability defense when a supplier terminated a seller’s dealership rights, thereby making it impossible for the sellerto deliver products to the buyer. The seller, an authorized purchaser of Nike goods, had agreed to sell Nike goods to the buyer.The buyer would then resell Nike goods at discounted prices.When Nike learned of the contract between the seller and thebuyer, it terminated the seller’s dealership rights. The court heldthat Nike’s unexpected termination of the seller’s rights constituted a contingency, the nonoccurrence of which was a basic assumption on which the contract between the seller and the buyerwas made. Therefore, the occurrence of this contingency madethe seller’s performance impracticable.commercial impracticability as a defense. Notably, the importerhad sent a letter to the distributor weeks before the contract execution, referencing a previous devaluation of the dollar in relation to the franc. The court held that the letter showed currencyfluctuation was a foreseeable event, thereby foreclosing any claimof commercial impracticability.Alamance County Bd of Educ v Bobby Murray Chevrolet, IncIn Alamance County Bd of Educ v Bobby Murray Chevrolet,Inc,12 the court held that the commercial impracticability defensedid not excuse a dealership from its failure to supply a schoolboard with bus chassis because there were alternative sources ofsupply from which the dealership could have purchased and soldthe bus chassis. The dealership contracted to sell a specified number of bus chassis to a school board. The dealership intended topurchase the chassis from a single manufacturer, GM. Weeks after the contract was executed, GM informed the dealership thatit would not accept any further chassis orders. The court heldthat, because the contract did not contain an agreed-upon manufacturer and no clause conditioned the dealership’s performanceon its ability to obtain bus chassis from a specific manufacturer,the dealership’s performance was not excused.Steel Industries, Inc v Interlink Metals and Chemicals, IncThe following is a summary of representative cases in whichthe court held that the defense of commercial impracticability didnot excuse a party’s nonperformance.The reasoning of the Alamance County case was applied inSteel Industries, Inc v Interlink Metals and Chemicals, Inc,13 whichheld that commercial impracticability was not a valid defensewhen a supplier of steel was faced with a shortage of supplyfrom its current supplier. The supplier purchased steel from a Russian mill at a discounted price and sold the steel to the manufacturer. The supplier passed its discount down to the manufacturerby charging less than it would had it purchased steel from a U.S.mill. When the Russian mill experienced resource cost increases,it notified the supplier that it would no longer deliver at the reduced prices. The supplier contacted a number of Russian millsto ascertain whether they could deliver the steel, but never soughtout any other sources. The court held that the supplier did notexplore all reasonable means of fulfilling its contractual obligation and bore the risk of its chosen supplier’s nonperformance.Bernina Distrib, Inc v Bernina Sewing Machine CoRoth Steel Products v Sharon Steel CorpA cost increase due to currency fluctuations was held insufficient to invoke a commercial impracticability defense in BerninaDistrib, Inc v Bernina Sewing Machine Co.11 That case concerneda contract between the defendant, an importer, and the plaintiff,a distributor of sewing machines. The importer purchased themachines from a Swiss manufacturer and paid in Swiss francs. Thedistributor then purchased the machines from the importer andpaid in U.S. dollars. When the dollar was devalued as a result ofcurrency fluctuations, making the machines more expensive forthe distributor to purchase, the distributor attempted to invokeThe court also rejected a commercial impracticability defensein Roth Steel Products v Sharon Steel Corp14 when the seller continued to accept an unprecedented volume of purchase orderseven though it knew that raw materials were in short supply. Theseller was an integrated steel producer that sold steel to the buyerat agreed-upon prices that were substantially lower than the seller’s published prices. When federal price controls discouraged foreign producers from importing steel and conversely led domesticproducers to export steel in an effort to avoid the price controls,substantial increases in the cost of steel resulted. The seller triedThe foregoing cases demonstrate that the defense of commercial impracticability may be available to a seller under a varietyof circumstances. The key for the seller is to establish that thenonoccurrence of a problematic event was a basic assumption ofthe contract, and that the occurrence of the problematic eventrendered performance commercially impracticable.Decisions Rejecting a Defenseof Commercial Impracticability
November 2010Michigan Bar Journal45to withdraw its price concessions. The court held that the sellerknew raw materials were in short supply and was therefore precluded from asserting the affirmative defense of commercial impracticability by accepting many more purchase orders than itwas capable of fulfilling.The preceding cases are representative situations in which theparty to a contract that could not perform failed to escape liability with the defense of commercial impracticability. The defenseis not easy to establish, nor should it be. The circumstances under which a nonperforming party should be allowed to escapeculpability should be limited to truly extraordinary unforeseeable circumstances.Fair and Reasonable Allocation GenerallyAssuming that the event of commercial impracticability doesnot result in the complete inability of a party to supply, we turn tothe issue of fair and reasonable allocation. The supplier will lookto allocate its limited supply across its customer base. But what is“fair” and what is “reasonable”? UCC 2-615 is silent on the question. However, Comment 11 to Section 2-615, in part, provides:An excused seller must fulfill his contract to the extent which thesupervening contingency permits, and if the situation is such thathis customers are generally affected he must take account of allin supplying one . . . . Customers at different stages of the manufacturing process may be fairly treated by including the seller’smanufacturing requirements . . . . However, good faith requires,when prices have advanced, that the seller exercise real care inmaking his allocations, and in case of doubt his contract customers should be favored and supplies prorated evenly among themregardless of price.Allocation Schemes Deemed “Fair and Reasonable”The following is a summary of representative cases in whichthe court held that a supplier’s allocation scheme was “fair andreasonable.”Intermar, Inc v Atlantic Richfield CoIn Intermar, Inc v Atlantic Richfield Co,15 the court held that agasoline supplier’s method of allocation was fair and reasonable.The supplier will look to allocate its limitedsupply across its customer base. But what is“fair” and what is “reasonable”?The defendant supplied gasoline to both service station dealersthat leased their premises from the defendant (“lessee-dealers”)as well as dealers that either owned their own premises or leasedtheir premises from a third party (“independent dealers”). Thedefendant initiated a “control procedure” whereby it limited thegasoline that it would supply to its customers to a certain percentage of gasoline supplied to those customers during the comparable calendar month of the prior year. In the event that a recent customer lacked sales history for the comparable calendarmonth of the prior year, the defendant limited its supply of gasoline to that customer by that customer’s estimated yearly consumption divided by 12. The plaintiff, an independent dealer thatowned and operated a retail gasoline station in contract with thedefendant, experienced a curtailment of its supply of gasolinefrom the defendant that caused it to eventually shorten its hoursof operation and reduce its number of employees. At the sametime, the defendant’s lessee-dealers located in the same area asthe plaintiff experienced no curtailment. Nonetheless, the courtruled that the control program was a fair and reasonable allocation of gasoline, finding there was no arbitrary or discriminatoryconduct by the defendant.Terry v Atlantic Richfield CoA second case involving Atlantic Richfield is also instructive.In Terry v Atlantic Richfield Co,16 the court affirmed the lowercourt’s holding that a gasoline supplier’s system of allocation wasfair and reasonable. In that case, the plaintiffs were not satisfiedwith the allocation scheme the defendant selected in response tothe gasoline shortage of 1973. The defendant distributed gasoline
Michigan Bar Journal46November 2010The Uniform Commercial Code — Commercial Impracticability and Fair Allocation Under UCC 2-615to its dealers in 1973 based on the dealers’ monthly volume for thecorresponding month in 1972. The allocation system provided forhardship adjustments, but the plaintiffs did not meet the criteria.All dealers, including contract dealers, lessee-dealers, and stationsoperated by defendant-owned subsidiaries, were treated alike.Unlike other stations, the plaintiffs exhausted their gasoline allotment in the first week of each month. The court held that the existence of an alternate scheme that may have benefited the plaintiffs did not require rejection of the adopted scheme. In accordwith comment 11 to UCC 2-615, the court also held that allocatingsupply to both pre-existing contractual customers and regular customers not under contract did not make the allocation scheme unfair or unreasonable.Cecil Corley Motor Co, Inc v General Motors CorpThe use of past sales figures as a basis for allocation was approved in Cecil Corley Motor Co, Inc v General Motors Corp.17 Thedefendants’ allocation system consisted of distribution of vehicleson the basis of past sales history, i.e., dealers receive a pro ratapercentage of those units based on their past sales so that themore vehicles a dealer sells, the more units it will receive. Thiseffectively divided production equally among dealers and wasdeemed to be fair and reasonable.These cases demonstrate that in order to prevail on defense ofa “fair and reasonable” allocation of goods, there must be a logicaland credible plan for the allocation. A seller should therefore attempt to document that a plan was developed after much thoughtand deliberation. While the plan generally must be reasonable,there is no requirement that every party be treated equally.Allocation Schemes Not Deemed“Fair and Reasonable”The following is a summary of representative cases in whichthe court held that a supplier’s allocation scheme was not fairand reasonable.Roth Steel Products v Sharon Steel CorpThe court disapproved of advantageous self-dealing in a supplier’s method of allocation in Roth Steel Products v Sharon SteelCorp.18 The parties in that case entered into a fi xed-price contractfor steel products pursuant to which the defendant was to supplysteel to the plaintiff in varying monthly quantities. In early 1973,however, several factors influenced the steel market that diminished the defendant’s ability to supply steel products as requiredunder the contract. The plaintiff sued the defendant for damagesfor breach of contract and the defendant asserted the defense ofcommercial impracticability. In addressing the defendant’s allocation scheme, the court focused on the defendant’s establishment of a wholly-owned subsidiary to which the defendant haddiverted steel while curtailing shipments to the plaintiff. Most importantly, the court noted that the subsidiary was neither undercontract nor a regular customer of the defendant at the time theallocation system was established. The court concluded that thedefendant’s plan failed to allocate its production and deliveries ina fair and reasonable manner.Chemetron Corp v McLouth Steel CorpSuch self-dealing was also rejected in Chemetron Corp vMcLouth Steel Corp.19 In Chemetron, a supplier of liquid oxygenA seller should attempt to document that aplan was developed after much thought anddeliberation. While the plan generally mustbe reasonable, there is no requirement thatevery party be treated equally.
November 2010Michigan Bar Journal47and liquid nitrogen could not fully meet the needs of its customers and implemented an allocation scheme. In addition to supplying liquid product to the plaintiff, the defendant supplied liquidproduct to its own steel mill. The court held that the allocationscheme was not fair and reasonable, noting that the defendantsupplied the plaintiff with only one-third of the plaintiff’s needswhile there was no evidence that the defendant supplied its steelmill with anything less than 100 percent of its requirements.Haley v Van LieropThe court applied the same principle prohibiting unfair selfdealing in Haley v Van Lierop.20 In Haley, a supplier of gladiolusbulbs could not meet the plaintiff’s requirements because of anunforeseen crop shortage. The defendant proceeded to allocatebulbs to its customers on a pro rata basis. One of the customersto which bulbs were allocated was a partnership in which thedefendant was one of the two sole members; another customerto which bulbs were allocated was an employee of the defendantwho worked for a salary and returned all profits to the defendant. The court ruled that these two customers could not be included in the calculation of gladiolus bulb allocation on a prorata basis. The court concluded that since the defendant was selfdealing for the purpose of realizing a profit, such prorating wastherefore inequitable.Cosden Oil & Chemical Cov Karl O. Helm AktiengesellschaftAn allocation scheme that resulted in a complete cessation ofshipments to a disfavored buyer was rejected in Cosden Oil &Chemical Co v Karl O. Helm Aktiengesellschaft.21 The court affirmed the jury’s finding that, while a shortage of polystyreneproducts caused by plant shutdowns was a sufficient basis for acommercial impracticability defense, the seller’s method of allocation was not fair and reasonable because the seller simply stoppedsupplying the product to the buyer altogether. The record showedthat the seller supplied polystyrene to other customers during theperiod in dispute and, despite the difficulties that the seller wasexperiencing, it had inventory and production capability withwhich it could have provided the buyer with an allocation ofpolystyrene. Under these circumstances, the seller could not successfully invoke a commercial impracticability defense.In re F. Yeager Bridge & Culvert CoThe court rejected an allocation scheme as unreasonable inIn re F. Yeager Bridge & Culvert Co.22 The supplier asserted a commercial impracticability defense premised on certain steel pricecontrols that had been implemented by the government. The supplier also contended that its failure to supply the contracted-forquantities of steel was excused because it subsequently enteredinto “reformed” contracts with the buyers for lesser quantities ofsteel. The buyer disputed the supplier’s claim and sued for dam-ages as a result of the supplier’s failure to supply the contracted-forsteel. The court held that because the “reformed” contracts werenot formed until after the supplier had already surpassed its steelquota, the seller had acted unreasonably.ConclusionUCC 2-615 presents an opportunity for a breaching party toexcuse its nonperformance. While the bar is high, in appropriatecircumstances commercial impracticability is a defense that canand should be raised by a seller that experiences an unforeseenshortage. In the event that a shortage leads to an allocation scenario, the seller’s allocation must be “fair and reasonable” but neednot always treat all buyers equally. Self-dealing likely will not beallowed. A scheme that attempts to “fairly and reasonably” dealwith a difficult circumstance should be permitted. John R. Trentacosta is a partner in the Detroit office of Foley & Lardner LLP. He practices in thearea of contract, UCC, and commercial litigation.He is the editor and contributing author of theleading contract law treatise, Michigan ContractLaw (Institute of Continuing Legal Education,1998) and co-author and editor of Michigan Legal Forms—Uniform Commercial Code (Lawyers Cooperative Publishing, 1995). He graciously acknowledges the assistanceof Jason Menges and Adam Wienner on this article.FOOTNOTES1. See, e.g., Trentacosta, Michigan Contract Law (ICLE).2. MCL 440.2615 (section 2-615 of the UCC has been adopted by Michiganin its entirety).3. 1 White & Summers, Uniform Commercial Code, §3-10 (5th ed).4. Iowa Electric Light & Power Co v Atlas Corp, 467 F Supp 129 (ND Iowa, 1978).5. MCL 440.2615(a).6. Selland Pontiac-GMC, Inc v King, 384 NW2d 490 (Minn App, 1986).7. Asphalt International, Inc v Enterprise Shipping Corp, S.A., 667 F2d 261(CA 2, 1981).8. Aluminum Company of America v Essex Group Inc, 499 F Supp 53 (WD Pa, 1980).9. Mishara Construction Company, Inc v Transit -Mixed Corp, 310 NE2d 363(Mass, 1974).10. Federal Pants, Inc v Stocking, 762 F2d 561 (CA 7, 1985).11. Bernina Distrib, Inc v Bernina Sewing Machine Co, 646 F2d 434 (CA 10, 1981).12. Alamance County Bd of Educ v Bobby Murray Chevrolet, Inc, 465 SE2d 306(NC App, 1996).13. Steel Industries, Inc v Interlink Metals and Chemicals, Inc, 969 F Supp 1046(ED Mich, 1997).14. Roth Steel Products v Sharon Steel Corp, 705 F2d 134 (CA 6, 1983).15. Intermar, Inc v Atlantic Richfield Co, 364 F Supp 82 (ED Pa, 1973).16. Terry v Atlantic Richfield Co, 72 Cal App 3d 962; 140 Cal Rptr 510 (1977).17. Cecil Corley Motor Co, Inc v General Motors Corp, 380 F Supp 819 (MD Tenn,1974) (decided under Michigan law).18. Roth Steel Products v Sharon Steel Corp, 705 F2d 134 (CA 6, 1983)19. Chemetron Corp v McLouth Steel Corp, 381 F Supp 245 (ND Ill, 1974).20. Haley v Van Lierop, 64 F Supp 114 (WD Mich, 1945).21. Cosden Oil & Chemical Co v Karl O. Helm Aktiengesellschaft, 736 F2d 1064(CA 5, 1984).22. In re F. Yeager Bridge & Culvert Co, 150 Mich App 386; 389 NW2d 99 (1986).
force majeure clauses), courts tend to defer to those contractual terms.3 However, in situations in which the parties did not allocate such risk by contract, UCC 2-615 acts as a "gap ﬁ ller" when the un-expected occurs. A number of courts have applied a three-part test in analyzing whether the deﬁ nition of commercial impracticabil-