Title, Risk, & Insurable Interest
The sale of goods transfer ownership (title) from the seller to the buyer. Often, a sales contract is signed before the actual goods are available. For example, a sales contract for oranges may be signed in May, but the oranges may not be ready for picking and shipment until October. Any number of things can happen between the time the sales contrat is signed and the time the goods are actually transferred to the buyer's possession. For example, fire, flood, or frost may destroy the orange groves, or the oranges may be lost or damaged in transit. Because of these possibilities, it is important to know the rights and liabilities (duties) of the parties between the time the contract is formed and the time the goods are actually received by the buyer.
Before the creation of the UCC, title -- the right of ownership -- was the central concept in sales law, controlling all issues of rights and remedies of the parties to a sales contract. There were numerous problems with the concept. For example, frequently it was difficult to determine when title actually passed from seller to buyer, and therefore it was also difficult to predict which party a court would decide had title at the time of loss. Because of such problems, the UCC divorced the question of title as completely as possible from the question of the rights and obligations of buyers, sellers, and third parties (such as subsequent purchasers, creditors, or the tax collector). In some situations, title is still relevant under the UCC and the UCC has special rules for locating title. In most situations, however, the UCC has replaced the concept of title with three other concepts: (1) identification, (2) risk of loss, and (3) insurable interest.
Identification is a designation of goods as the subject matter of a sale contract. Title and risk of loss cannot pass to the buyer unless the goods are identified to the contract. [UCC 2-105(2)] Identification is significant because it gives the buyer the right to insurce (or obtain an insurable interest in) goods and the right to recover from third parties who damage the goods.
Once the goods are in existence, the parties can agree in their contract on when identification will take place. If they do not so specify, however, the UCC determines when identification takes place. [UCC 2-505(1)]
Existing GoodsIf the contract calls for the sale or lease of specific and ascertained goods that are already in existence, identification takes place at the time the contract is made. For example, you contract to purchase a fleet of five cars by the serial numbers listed for the cars.
Future GoodsIf a sale involves unborn animals to be born within twelve months after contracting, identification takes place when the animals are conceived. If a sale involves crops that are to be harvested within twelve months (or the next harvest season occurring after contracting, whichever is longer), identification takes place when the crops are planted or begin to grow. In a sale of any other future goods, identification occurs when the goods are shipped, marked, or otherwise designated by the seller or lessor as the goods to which the contract refers.
Goods that are Part of a Larger MassGoods that are part of a larger mass are identified when the goods are marked, shipped, or somehow designated by the seller as the particular goods to pass under the contract. Suppose that a buyer orders 1,000 cases of beans from a 10,000-case lot. Until the seller separates the 1,000 cases of beans from the 10,000-case lot, title and risk of loss remain with the seller.
A common exception to this rule deals with fungible goods. Fungible goods are goods that are alike naturally, by agreement, or by trade usage. Typical examples are specific grades or types of wheat, oil, and wine, usually stored in large containers. if these goods are held or intended to be held by owners in common (owners having shares undividied from the entire mass), a seller-owner can pass title and risk of loss to the buyer without an actual separation. The buyer replaces the seller as an owner in common. [UCC 2-105(4)]
For example, A, B, & C are famrers. They deposit, respectively, 5,000 bushels, 3,000 bushels, and 2,000 bushels of grain of the same grade and quality in a bin. The three become owners in common, with A owning 50% of the 10,000 bushels, B 30%, and C 2%. A could contract to sell 5,000 bushels of grain to D and, because the goods are fungible, pass title and risk of loss to D without physically separating 5,000 bushels. D now becomes an owner in common with B and C.
When Title Passes
Shipment & Destination ContractsIn the absence of agreement, delivery arrangements can determine when title passes from the seller to the buyer.
In a shipment contract, the seller is required or authorized to ship goods by carrier, such as a trucking company. Under a shpment contract, the seller is required only to deliver the goods into the hands of a carrier, and title passes to the buyer at the time and place of shipment. Generally, all contracts are assumed to be shipman contracts if nothing to the contrary is said in the contract.
In a destination contract, the seller is required to deliver the goods to a particular destination, usually directly to the buyer, although sometimes the buyer designates that the goods should be delivered to another party. Title passes to the buyer when the goods are tendered at that destination. [UCC 2-401(2)(b)]. A tender of delivery is the seller's placing or holding of conforming goods at the buyer's disposition (with any necessary notice), enabling the buyer to take delivery. [UCC 2-503(1)]
Delivery Without Movement of the GoodsWhen the contract of sale does not call for the seller's shipment or delivery of the goods (when the buyer is to pick up the goods), the passage of title depends on whether the seller must deliver a document of title, such as a bill of lading or a warehouse receipt, to the buyer. A bill of lading is a receipt for goods that is signed by a carrier and that serves as a contract for the transportation of the goods. A warehouse receipt is a receipt issued by a warehouser for goods stored in a warehouse.
When a document of title is required, title passes to the buyer when and where the doument is delivered. Thus, if the goods are stored in a warehouse, title passes to the buyer when the appropriate documents are delivered to the buyer. The goods never move. In fact, the buyer can choose to leave the goods at the same ware house for a period of time, and the buyer's title to those goods will be unaffected.
When no documents of title are required, and delivery is made without moving the goods, title passes at the time and place the sales contract is made, if the goods have already been identified. If the goods have not been identified, title does not pass until identification occurs. For example: Rogers sells lumber to Bodan. That agree that Bodan will pick up the lumber at the yard. If the lumber has been identified (segregated, marked, or in any other way distinguished from all other lumber), title passes to Bodan when the contract is signed. If the lumber is still in storage bins at the mill, title does not pass to Bodan until the particular pieces of lumber to be sold under this contract are identified. [UCC 2-401(3)].
Sales by Non-OwnersProblems occur when persons who acauire goods with imperfect titles attempt to sell them. Sections 2-402 and 2-403 of the UCC deal with the rights of two parties who lay claim to the same goods sold with imperfect titles. Generally, a buyer acquires at least whatever title the seller had to the goods sold.
Void TitleA buyer may unknowingly purchase goods from a seller who is not the owner of the goods. If the seller is a thief, the seller's title is void -- legally, no title exists. Thus, the buyer acquires no title, and the real owner can reclaim the goods from the buyer. Fro example, if Jim steals goods owned by Mark, Jim has a void title to those goods. If Jim sells the goods to Sally, Mark can reclaim them from Sally, even though Sally acted in good faith and honestly was not aware that the goods were stolen.
Voidable TitleA seller has a voidable title if the goods that he is selling were obtained by fraud, paid for with a check that is later dishonored, purchased from a minor, or purchased on credit when the he was insolvent. (A person is insolvent when he ceases to pay "his debts in the ordinary course of business or cannot pay his debts as they ecome due or is insolvent within the meaning of federal bankruptcy law."
In contrast to a seller with void title, a seller with voidable title has the power to transfer a good title to a good faith purchaser for value. A good faith purchaser is one who buys without knowledge of circumstances that would make a person or ordinary prudence inquire about the validity of the seller's title to the goods. One who purchases for value gives legally sufficient consideration (value) for the goods purchased. The real owner normally cannot recover goods from a good faith purchaser for value. If the buyer of the goods is not a good faith purchaser for value, then the actual owner of the goods can reclaim them from the buyer (or from the seller if the goods are still in the seller's possession).
The Entrustment RuleAccording to UCC 2-403(2), when goods are entrusted to a merchant who deals in goods of that kind, and the merchant sells the goods to a buyer in the ordinary course of business, that buyer obtains good title to the goods. This is known as the entrustment rule. Entrustment includes both delivering the goods to the merchant and leaving the purchased goods with the merchant for later delivery or pickup. A buyer in the ordinary course of business is a person who, in good faith and without knowledge that the sale violates the ownership rights or security interest of a third party, buys in ordinary course from a person (other than a pawnbroker) in the business of selling goods of that kind.
For exmple, Jan leaves her watch with a jeweler to be repaired. The jeweler sells both new and used watches. The jeweler sells Jan's watch to Kim a customer, who does not know that the jeweler has no right to sell it. Kim, as a good faith buyer, gets good title against Jan's claim of ownership. Kim, however, obtains only those rights held by the person entrusting the goods. Suppose that Jan had stolen the watch from Greg and then left it with the jeweler to be repaired. The jeweler then sold it to Kim. Kim would have obtained good title against Jan, who entrusted the watch to the jeweler, but not against Greg (the real owner), who neither entrusted the watch to Jan nor authorized Jan to entrust it.
Risk of Loss
Delivery with Movement of the Goods -- Carrier CasesWhen there is no specification in the agreement, the following rules apply to cases involving movement of the goods (carrier cases).
In a shipment contract, if the seller is required or authorized to ship goods by carrier (but not to a specific destination), risk of loss passes to the buyer when the goods are duly delivered to the carrier. For example, a seller in Texas sells 500 cases of grapefruit to a byer in New York, "F.O.B. Houston" (that is, the buyer pays the transportation charges from Houston). The contract authorizes a shpment by carrier; it does not require that the seller tender the grapefruit in New York. Risk passes to the buyer when conforming goods are properly placed in the possession of the carrier. If the goods are damaged in transit, the loss is on the buyer. (Buyers have some recourse against the carrier and can always insure the shipment.)
In a destination contract, the risk of loss passes to the buyer when the goods are tendered to the buyer at the specified desintation. In the preceding example, if the contract had been "F.O.B. New York," risk of loss during transit to New York would have been the seller's and would not pass to the buyer until the carrier tendered the goods to the buyer in New York.
Delivery Without Movement of the GoodsThe UCC also addresses situations in which the seller is required neither to ship nor to deliver the goods. Frequently, the buyer is to pick up the goods from the seller, or the goods are to be held by a bailee. A bailment is a temporary delivery of personal property, without passage of title, into the care of another, called a bailee. Under the UCC a bailee is a party who, by a bill of lading, warehouse receipt, or other document of title, acknowledges possession of goods and contracts to deliver them. A warehousing company, for example, or a trucking company that normally issues documents of title for the goods it receives is a bailee.
Goods Held by the SellerIf the goods are held by the seller, a document of title is usually not used. If the seller is a merchant, risk of loss to goods held by the seller passes to the buyer when the buyer actually takes physical possession of the goods. If the seller is not a merchant, the risk of loss to goods held by the seller passes to the buyer on tender of delivery.
Goods Held by a BaileeWhen a bailee is holding goods for a person who has contracted to sell them and the goods are to be delivered without being moved, the goods are usually represented by a negotiable or nonnegotiable document of title (a bill of lading or a warehouse receipt). Risk of loss passes to the buyer when (1) the buyer receives a negotiable document of title for the goods, or (2) the bailee acknowledges the buyer's right to possess the goods, or (3) the buyer receives a non-negotiable document of title and has had a reasonable time to present the document to the bailee and demand the goods. Obviously, if the bailee refuses to honor the document, the risk of loss remains with the seller.
Conditional SalesBuyers and sellers sometimes form sales contracts that are conditioned either on the buyer's approval of the goods or on the buyer's resale of the goods. Under such contracts, the buyer is in possession of the goods. Sometimes, however, problems arise as to whether the buyer or seller should bear the loss if, for example, the goods are damaged or stolen while in the possession of the buyer.
Sale or ReturnA sale or return is a type of contract by which the buyer purchases the goods but has a conditional right to return the goods within a specified time period. When the buyer receives possession at the time of sale, the title and risk of loss pass to the byer. Title and risk of loss remain with the buyer until the buyer returns the goods to the seller within the time period. If the buyer fails to return the goods within this time period, the sale is finalized. The return of the goods is made at the buyer's risk and expense. Goods held under a sale-or-return contract are subject to the claims of the buyer's creditors while they are in the buyer's possession.
The UCC treats a consignment as a sale or return. Under a consignment, the owner of the goods (the consignor) delivers them to another (the consignee) for the consignee to sell or to keep. If the consignee sells the goods, the consignee must pay the consignor for them. If the consignee does not sell or keep the goods, they may simply be returned to the consignor. While the goods are in the possession of the consignee, the consignee holds title to them, and creditors of the consignee will prevail over the consignor in any action to repossess the goods.
Sale on ApprovalUsually, when a seller offers to sell goods to a buyer and permits the buyer to take the goods on a trial basis, a sale on approval is made. The term "sale" here is a misnomer, as only an offer to sell has been made, along with a bailment created by the buyer's possession.
Title and risk of loss (from cuases beyond the buyer's control) remain with the seller until the buyer accepts (approves) the offer. Acceptance can be made expressly, by any act inconsistent with the trial purpose or the seller's ownership, or by the buyer's election not to return the goods within the trial period. If the buyer does not wish to accept, the buyer may notify the seller of that fact within the trial period, and the return is made at the seller's expense and risk. Goos held on approval are not subject to the claims of the buyer's creditors until exceptance.
It is often difficult to determine which exists: a "sale on approval" or a "sale or return." The UCC says "if the goods are delivered primarily for resale," the transaction is a "sale or return."
Risk of Loss when a Sales Contract is BreachedThere are many ways to breach a sales contract, and the transfer of risk operates differently depending on which party breaches. Generally, the party in breach bears the risk of loss
When the Seller BreachesIf the goods are so nonconforming that the buyer has the right to reject them, the risk of loss does not pass to the buyer until the defects are cured (that is, until the goods are repaired, replaced, or discounted in price by the seller) or until the buyer accepts the goods in spite of their defects (thus waiving the right to reject). For example, a buyer orders blue widges from a seller, F.O.B. seller's plant. The seller shps black widgets isntead. The black widgets (nonconforming goods) are damaged in transit. The risk of loss falls on the seller. Had the seller shipped blue widgets (conforming goods) instead, the risk would have fallen on the buyer.
If a buyer accepts a shipment of goods and later discovers a defect, acceptance can be revoked. REvocation allows the buyer to pass the risk of loss back to the seller, at least to th extent that the buyer's insurance does not cover the loss.
When the Buyer BreachesThe general rule is that when a buyer breaches a contract, the risk of loss immediately shifts to the buyer. There are three important limitations to this rule:
(1) The seller must already have identified the the contract goods;
Insurable Interest of the BuyerA buyer has an insurable interest in identified goods The moment the contract goods are identified by the seller, the buyer has a special property interest that allows him to obtain necessary insurance coverage for those goods even before the risk of loss has passed.
For example, in March a farmer sells a cotton crop he hopes to harvest in october. The buyer acquires an insurable interest in the crop when it is planted, because those goods (the cotton crop) are identified to the sales contract between the seller and the buyer.
Insurable Interest of the SellerA seller has an insurable interest in goods as long as he retains title to the goods Even after title passes to a buyer, however, a seller who has a security interest in the goods still has an insurable interest and can insure the goods. Hence, both a buyer and a seller can have an insurable interest in identical goods at the same time. Of course, the buyer or seller must sustain an actual loss to have the right to recover from an insurance company.
Performance of Sales Contracts
To understand the obligations of the parties under a sales contract, it is necessary to know the duties and obligations each party has assumed under the terms of the contract. "Duties and obligations" include those specified by the contract, by custom, and by the UCC.
In the performance of a sales contract, the basic obligation of the seller is to transfer and deliver conforming goods. The basic obligation of the buyer is to accept and pay for conforming goods in accordance with the contract. Overall performance of a sale or lease contract is controlled by the agreement between the parties. When the contract is unclear and disputes arise, the courts look to the UCC.
The Good Faith Requirement
Good faith can mean that one party must not take advantage of another party by manipulating contract terms. Good faith applies to both parties, even the nonbreaching party. The principle of good faith applies through both the performance and the enforcement of all agreements or duties within a contract. Good faith is a question of fact for the jury.
Obligations of the Seller
Tender must occur at a reasonable hour and in a reasonable manner. Unless the parties have agreed otherwise, the goods must be tendered for delivery at a reasonable hour and kept available for a reasonable period of time to enable the buyer to take possession of them. All goods called for by a contract must be tendered in a single delivery unless the parties agree otherwise, or the circumstances are such that either party can rightfully request delivery in lots.
Place of DeliveryThe UCC provides for the place of delivery pursuant to a contract if the contract does not Of course, the parties may agree on a particular destination, or their contract's terms or the circumstances may indicate the place.
Noncarrier CasesIf the contract does not designate the place of delivery for the goods, and the buyer is expected to pick them up, the place of delivery is the seller's place of business or, if the seller has none, the seller's residence. if the contract involves the sale of identified goods, and the parties know when they enter into the contract that these goods are located somewhere other than at the seller's place of business, then the location of the goods is the place for their delivery.
Carrier CasesIn many instances, attendant circumstances or delivery terms in the contract make it apparent that the parties intend that a carrier be used to move the goods. There are two ways a seller can complete performance of the obligation to deliver goods in carrier cases -- through a shipment contract and through a destination contract.
Shipment Contracts: Unless otherwise agreed, the seller must do the following:
Destination Contracts: In a destination contract, the seller agrees to see that conforming goods will be duly tendered to the buyer at a particular destination. The goods must be tendered at a reasonable hour and held at the buyer's disposal for a reasonable length of time. The seller must also give the buyer appropriate notice. In addition, the seller must provide the buyer with any documents of title necessary to enable the buyer to obtain delivery from the carrier. Sellers often do this by tendering the documents through ordinary banking channels.
The Perfect Tender RuleThe seller has an obligation to ship or tender conforming goods, and this entitles the buyer to accept and pay for the goods according to the terms of the contract. Uner the common law, the seller was obligated to deliver goods in conformity with the terms of the contract in every detail. This was called the perfect tender rule. The UCC preserves the perfect tender rule by saying that if goods or tender of delivery fail in any respect to conform to the contract, the buyer has the right to accept the goods, reject the entire shipment, or accept part and reject part.
Exceptions to the Perfect Tender RuleBecause of the rigidity of the perfect tender rule,several exceptions to the rule have been created. They are: (1) Agreement of the parties; (2)Right to cure; (3) Substitution of Carriers; (4) Installment contracts; (5) Commercial Impracticability; (6) Destruction of Identified Goods. I've decided they are not worth inflicting on you. Its not that they aren't important, but they would require an entire day by themselves and its not likely that you will need this kind of intimate knowledge of the UCC unless to work in a high specialized commercial practice.
Obligations of the BuyerOnce the seller has adequately tendered delivery, the buyer is obligated to accept the goods and pay for them according to the terms of the contract.
PaymentIn the absence of any specific agreements, the buyer must make payment at the time and place he receives the goods. When a sale is made on credit, the buyer is obliged to pay according to the specified credit terms, not when the goods are received. The credit period usually begins on the date of shipment. Payment can be made by any means agreed on between the partys -- cash or any other method generally acceptable in the commercial world. If the seller demands cash when the buyer offers a check, credit card, or the like, the seller must permit the buyer reasonable time to obtain cash.
Right of inspectionUnless otherwise agreed, or for C.O.D. transactions, the buyer has an absolute right to inspect the goods. This right allows the byer to verify, before making payment, that the goods tendered or delivered are what were contracted for or ordered. If the goods are not what the buyer ordered, the buyer has no duty to pay. An opportunity for inspection is therefore a condition precedent to the right of the seller to enforce payment.
nless otherwise agreed, inspection can take place at any reasonable place and time and in any reasonable manner Generally, what is reasonable is determined by custome of the trade, past practices of the parties, and the like. Costs of inspecting conforming goods are borne by the buyer unless otherwise agreed.
AcceptanceA buyer can manifest assent to the delivered goods in the follwoing ways, each of which constitutes acceptance:
1. Three is an acceptance if the buyer, after having had a reasonable opportunity to inspect the goods, signifies agreement to the seller that the goods are either conforming or are acceptable despite their nonconformity.
2. Acceptance is presumed if the buyer has had a reasonable opportunity to inspect the goods and has failed to reject them within a reasonable period of time.
3. In sales contracts, the buyer will be deemed to have accepted the goods if he performs any act inconsistent with the seller's ownership, e.g., use or resale of the goods.
If the latter course is pursued, the UCC permits the breaching party (subject to some limitations) to "retract" his repudiation. This can be done by any method that clearly indicates an intent to perform. Once retraction is made, the rights of the repudiating party under the contract are reinstated.
Source: Clarkson, Miller, Jentz, & Cross, West's Business Law, 7th Edition (1998).