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1 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu Slide 2 2 Conditions and Warranties Promises ConditionsWarranties Election Forfeiture DamagesDamages only Slide 3 Warranties With a warranty a seller assumes a risk as to the product The prior question is whether the risk should be born by the seller or the buyer 3 Slide 4 4 Lets say seller sells a whizbang Slide 5 5 The whizbang 50% chance of a whiz It might go whiz Slide 6 6 The whizbang 50% chance of a whiz, 50% of a bang It might go whiz or it might go bang Slide 7 7 The expected monetary value of an accident is p*L Evaluating risk: Expected Values Slide 8 8 The expected monetary value of an accident is p*L where p is the probability of occurrence And L is the cost of the accident on occurence Evaluating risk: Expected Values Slide 9 9 So the expected monetary value for an accident with a 50 percent probability of a loss of $250 is $125 Evaluating risk: Expected Values Slide 10 10 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs The Least-Cost Risk Avoider Slide 11 11 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 The Least-Cost Risk Avoider Slide 12 12 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 The Least-Cost Risk Avoider Slide 13 13 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 Seller is the least-cost risk avoider The Least-Cost Risk Avoider Slide 14 14 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? The Least-Cost Risk Avoider Slide 15 15 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk The Least-Cost Risk Avoider Slide 16 16 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk And what will this do to the purchase price? The Least-Cost Risk Avoider Slide 17 17 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk What is the range of prices between which the parties will bargain? The Least-Cost Risk Avoider Slide 18 18 Assume that the expect cost of a bang is $125 Seller (but not Buyer) can eliminate this risk at a cost of $100 How will the parties assign the risk? Buyer will pay seller to assume the risk Seller will not accept less than $100 and (risk-neutral) buyer will not pay more than $125 The Least-Cost Risk Avoider Slide 19 19 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Buyer (but not Seller) can eliminate this risk at a cost of $100 What happens now? Lets flip this Buyer as Least-Cost Risk Avoider Slide 20 20 Seller sells a whizbang to Buyer for $1,000, with no warranties as to bangs Assume that the expected cost of a bang is $125 Buyer (but not Seller) can eliminate this risk at a cost of $100 Buyer will spend $100 to eliminate a risk with an EMV of $125 Lets flip this Buyer as Least-Cost Risk Avoider Slide 21 21 The parties will seek to assign the risk to the party who can most efficiently eliminate it. The Least-Cost Risk Avoider Slide 22 22 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem If bargaining is costless, does it matter who bears the risk? The Least-Cost Risk Avoider Slide 23 23 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem And if bargaining isnt costless? The Least-Cost Risk Avoider Slide 24 24 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Youre a judge. You have a pretty good idea who the least-cost risk avoider is. The parties have left the question of risk silent in their contract. How do you assign the risk? The Least-Cost Risk Avoider Slide 25 25 The parties will seek to assign the risk to the party who can most efficiently eliminate it. An application of the Coase Theorem Mimicking the market The Least-Cost Risk Avoider Slide 26 26 Same example. But now neither party can eliminate the risk for less than $125. On whom should the risk fall? Does it matter? A second way of thinking about Least-Cost Risk Avoiders Slide 27 27 Same example. But now neither party can eliminate the risk for less than $150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? A second way of thinking about Least-Cost Risk Avoiders Slide 28 28 Same example. But now neither party can eliminate the risk for less than $150. On whom should the risk fall? Does it matter? Suppose that seller is a large corporation and buyer is an impecunious consumer. Does that make a difference? Do risk preferences matter? A second way of thinking about Least-Cost Risk Avoiders Slide 29 Are you an EMVer? An EMVer always selects the payoff with the highest expected monetary value (p*O) 29 Slide 30 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (p*O) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $2. Would you pay me 50 for the ticket? 30 Slide 31 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $2. Would you pay me 50 for the ticket? EMV =.5($2) = $1.00 31 Slide 32 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $10,002. Would you pay me $5,000 for the ticket? 32 Slide 33 Are you an EMVer? An EMVer always selects the payoff with the highest expect monetary value (pO) Suppose I offer you a lottery ticket with a.5 probability of 0 and a.5 probability of $10,002. Would you pay me $5,000 for the ticket? EMV =.5($10,002) = $5,001 33 Slide 34 34 Three kinds of people EMVers are risk neutral They always take the gamble with the highest EMV Slide 35 35 Three kinds of people EMVers are risk neutral Most people are risk averse Theyll pass on some opportunities with a positive EMV Slide 36 36 Three kinds of people EMVers are risk neutral Most people are risk averse Risk lovers are risk prone They will accept some gambles with a negative EMV Slide 37 37 Recall what we said about utility Utility is the economists measure of well-being (cf. utilitarianism) Ordinal Utility measures preferences without weighing them (first, second, third are ordinal numbers) Cardinal Utility (Benthams utils) weighs utility (one, two, three are cardinal numbers) Slide 38 38 Cardinal Utility plotted against EMV Utility $EMV For EMVers, utility is linear with money Slide 39 39 Cardinal Utility Utility $EMV For the risk averse, the marginal utility of money declines (more money generates increasingly smaller increases in utility). Slide 40 40 Cardinal Utility Utility $EMV A justification for progressive income taxation? Slide 41 41 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 Would you assume that firms are risk- neutral and consumers risk averse as to a loss of $250? This suggests a second way of thinking about Least-Cost Risk Avoiders Slide 42 42 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 Would you assume the firms are risk- neutral and consumers risk averse? Would you expect the risk to be born by the wealthier party? This suggests a second way of thinking about Least-Cost Risk Avoiders Slide 43 43 There is a 50 percent probability of a loss of $250 Same example. But now neither party can eliminate the risk for less than $125 On whom should the risk fall? Does it matter? Suppose that seller sells 10,000 whizbangs and buyer buys only one? Does that make a difference? Now--A third way of thinking about Least-Cost Risk Avoiders Slide 44 Probability distribution for buyer 44 $EMV 7501,000 $750 %.5 Slide 45 Probability distribution for seller of 60 whizbangs 45 $EMV %.5 875 Slide 46 Probability distribution for seller of 10,000 whizbangs 46 $EMV 875 % 1.0 Slide 47 Probability distribution for seller of 10,000 whizbangs 47 875 % 1.0 All Curves have the same mean value ($875) but different risk (dispersion from the mean). Slide 48 Probability distribution for seller of 10,000 whizbangs 48 875 % 1.0 All Curves have the same mean value ($875) but different risk (dispersion from the mean). Slide 49 Probability distribution for seller of 10,000 whizbangs 49 $EMV 875 % 1.0 Slide 50 50 1.Where one party is better able to reduce the risk or the harm (or to value the loss) 2.Assuming risk aversion, where one party is wealthier than the other 3.Assuming risk aversion, where one party is a better insurer because he can diversify the risk Three kinds of Least-Cost Risk Avoiders Slide 51 51 Where one party is better able to reduce the risk or the harm (or to value the loss) Assuming risk aversion, where one party is wealthier than the other Assuming risk aversion, where one party is a better insurer because he can diversify the risk Where might third party insurance substitute? Three kinds of Least-Cost Risk Avoiders Slide 52 52 Where might third party insurance substitute? Liability for a faulty transmission? Break-in of a house? Emotional Distress World War III? Three kinds of Least-Cost Risk Avoiders Slide 53 Sessa v. Riegle Was there a finding that the horse that was sold was defective? 53 Slide 54 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the later case, buyer took the risk 54 Slide 55 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable In the former case, who took the risk? UCC 2-501(1)(a), 2-504 55 Slide 56 Sessa v. Riegle Was there a finding that the horse that was sold was defective? Tendenitis might have resulted from the drive, or from unclean conditions in Sessas stable Thrombosis might have been a pre- existing latent condition Might the seller be liable for this? 56 Slide 57 Sessa v. Riegle Was this a promise that the horse would be sound after the sale Like a 5 year warranty on a sale of a car? 57 Slide 58 Sessa v. Riegle Was this a promise that the horse would be sound after the sale E.g. 5 year warranty on a sale of a car Was this a promise that the horse was sound at the time of the sale? the horse is sound the horse is a good one you will like him 58 Slide 59 Sessa v. Riegle Why not within UCC 2-313? 59 Slide 60 Sessa v. Riegle Why not within UCC 2-313 an affirmation of fact? Statements of opinion: UCC 2-313(2) Mere puffs 60 Slide 61 Sessa v. Riegle Why not within UCC 2-313 an affirmation of fact Statements of opinion: UCC 2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures 61 Slide 62 Sessa v. Riegle Why not within UCC 2-313 an affirmation of fact Statements of opinion: UCC 2-313(2) Mere puffs A special rule for horse traders? horses are fragile creatures Frederickson Distinguish McNair What if soundness was guaranteed 62 Slide 63 Royal Business Machines Copy machine: Was of high quality Frequency of repair was very low Would remain so Will bring buyer substantial profits 63 Slide 64 Royal Business Machines Copy machine: Machines were tested 64 Slide 65 Royal Business Machines Copy machine: Machines will not cause fire 65 Slide 66 Specificity: Searls v. Glasser recession resistant? Keith: sure-footed seaworthiness? 66 Slide 67 67 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu Slide 68 Flippo Remedy in tort? 68 Slide 69 Flippo Remedy in tort? Remedy in contract? What were the goods? 69 Slide 70 Flippo Remedy in tort? Remedy in contract? Implied warranty of merchantability What were the goods? Cf. Prosser on p. 672 UCC 2-313B 70 Slide 71 Implied UCC Warranties Merchantabilty: UCC 2-314 Fitness: UCC 2-315 71 Slide 72 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC 2-314, cmt. 13 72 Slide 73 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC 2-314, cmt. 13 Does reliance come into this? 73 Slide 74 Implied UCC Warranties I sell you a car whose transmission fails six months later? Qu. Lapse of time UCC 2-314, cmt. 13 Does reliance come into this? I sell you a car which proves unsuitable for off-terrain driving 74 Slide 75 Fitness: UCC 2-315 How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance 75 Slide 76 Fitness: UCC 2-315 How is this different from merchantibility? What more is needed? Seller knows or has reason to know Particular purpose Buyers reliance Why no warranty in Lewis and Sims at 674? 76 Slide 77 Warranty of Workmanlike Performance Construction and services contracts Could any contractor be thought to resist such a duty? 77 Slide 78 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average 78 Slide 79 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC 2-316(3)(a) 79 Slide 80 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC 2-316(3)(a) What if it had been proven that seller knew it was a clunker. Morris v. Macks 80 Slide 81 Exemption Clauses Pelc v. Simmonds Oral statements by Simmons Only thing wrong is the a/c Good little car, above average As is clause. UCC 2-316(3)(a) What if seller in Pelc had said its in perfect condition or I guarantee its in good shape 81 Slide 82 Exemption Clauses Does an as is clause exclude express warranties? Only if not unreasonable UCC 2- 316(1) 82 Slide 83 Exemption Clauses What were the warranties in Pelc? Qu. the finding that the representations were not improper? 83 Slide 84 Exemption Clauses What were the warranties in Pelc? Qu. If the representations had been fraudulent? 84 Slide 85 Weisz v. Parke-Bernt Can you spot the fake Van Gogh? 85 Slide 86 Weisz v. Parke-Bernt Why was the exemption clause ignored? 86 Slide 87 Weisz v. Parke-Bernt Just what is a Raoul Dufy?? 87 Slide 88 Weisz v. Parke-Bernt The old fundamental breach doctrine 88 Slide 89 Substantial Performance vs. Perfect Tender Perfect tender required in UCC 2- 601 Substantial Performance Restatement 229 (no disproportionate forfeiture unless material event) Restatement 237 (no uncured material failure 89 Slide 90 Substantial Performance vs. Perfect Tender Perfect tender required in UCC 2- 601 Substantial Performance Restatement 229 (no disproportionate forfeiture unless material event) Restatement 237 (no uncured material failure Materiality defined in 241 90 Slide 91 Substantial Performance in Jacob & Young 91 Slide 92 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? 92 Slide 93 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? 93 Slide 94 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Could you draft a clause that would have given Kent a right to rescind? 94 Slide 95 What is Reading Pipe? This is Reading Pipe Slide 96 This is not Reading Pipe Slide 97 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Would the parties have agreed to such a clause? Why not? 97 Slide 98 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? 98 Slide 99 Substantial Performance in Jacob & Young Could the parties to a building contract bargain for perfect tender? Did they in Jacob & Young? Was this like Grun Roofing? What is substantial performance for a roof? 99 Slide 100 Haymore v. Levinson 100 Slide 101 Grun Roofing vs. Haymore Personal taste or fancy vs. operative fitness mere taste may be controlling in the former case 101 Slide 102 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of s loss? 102 Slide 103 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of s loss? The substantial performance standard 103 Slide 104 Measure of damages Plante v. Jacobs at 688 Cost or repair or diminished value? What is the proper measure of s loss? Would perfect tender open the door to opportunism? 104 Slide 105 105 Things looked simple at common law Promises ConditionsWarranties Election Forfeiture DamagesDamages only Slide 106 Theyre more complicated in the UCC Buyers Remedies 2-601 Perfect Tender required Conforming goods 2-106 106 Slide 107 Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 107 Slide 108 Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Action for price paid 2-711 Incidental Damages 2-711, 2-713 Cover 2-711, 2-712 108 Slide 109 Cure by Seller 2-601 Perfect Tender required Accept2-606Reject 2-602 Cure 2-508Dont cure 109 Slide 110 Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715 110 Slide 111 Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715Revocation of Acceptance 2-608, 2-607 111 Slide 112 Buyers Remedies in the UCC 2-601 Perfect Tender required Accept2-606Reject 2-602 Damages 2-714, 2-715Revocation of Acceptance 2-608, 2-607 Cancel 2-711, 2-106(4) Damages 2-711, 2-713 Specific performance? 2-711(2) 112 Slide 113 Sellers Remedies Goods not deliveredGoods delivered Withhold delivery 2-703 Stoppage in transitu 2-705 Damages 2-703, 2-708 113 Slide 114 Sellers Remedies Goods not deliveredGoods delivered Action for the price 2-709 Damages 2-710 114 Slide 115 115 George Mason School of Law Contracts II Warranties F.H. Buckley fbuckley@gmu.edu Slide 116 Opportunism and Perfect Tender? The problem of buyer opportunism is addressed by the sellers right to cure 116 Slide 117 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? 117 Slide 118 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% 118 Slide 119 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? The sulfur content was promised to be 0.5% The price of oil had fallen by 25% 119 Slide 120 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 When was delivery to take place? 120 Slide 121 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 When was delivery to take place? When was the substitute delivery to occur? 121 Slide 122 Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date: 2-508(1) Cure after: 2-508(2) Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance 122 Slide 123 Whats the opportunism problem under perfect tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Cure after Seasonable notice Reasonable time Seller had reasonable grounds to believe would be acceptable, with or without money allowance Must seller know that tender will be non- conforming? Nordstrom on Sales 123 Slide 124 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? 124 Slide 125 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date 125 Slide 126 Opportunism and Perfect Tender? TW Oil: Why did buyer reject? Cure: 2-508 Before delivery date Seasonably notify buyer---why? What if first tender is junk? Ramirez at 697: an unconditional right to cure before the delivery date Cf. proposed 2003 revision 126 Slide 127 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 127 Slide 128 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? 2-508(2) Slide 129 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods? 2-606 129 Slide 130 Why no cure permitted in Ramirez? Delivery scheduled for August 3 Rejection on Aug. 14 Did sellers effect a cure? Did buyers accept the goods? Did buyers revoke acceptance and cancel? 2-608, 2-711 130 Slide 131 Can 2-508 be waived by seller? Qu. Consumer goods where seller specifies goods satisfactory or money refunded I order a shirt on-line, which is torn. Can seller resend? 131 Slide 132 When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets 132 Slide 133 When is perfect tender most in need of cure rights? Buyers opportunism especially a problem in: Idiosyncratic goods Volatile markets In other cases, weakened cure rights? Zabriskie Chevrolet Might cure rights give sellers misincentive to cheat on terms? 133 Slide 134 134 George Mason School of Law Contracts II Anticipatory Repudiation F.H. Buckley fbuckley@gmu.edu