Q4, 2023—"Goods Identified to the Contract: What Does It Mean?"

Canadian companies buying or selling goods in transactions with US companies should be mindful of the Uniform Commercial Code (UCC)—specifically, whether it applies and ramifications if it does. Whether it applies may be answered by the choice of law provision that may be either in a master supply agreement or in the terms and conditions of any particular purchase order. If the choice of law provision says that a US state’s law applies and the transaction is predominantly for the sale of goods, the UCC will apply.

Notably, UCC provisions often defer to contract provisions. Therefore, we strongly suggest that your contracts are carefully crafted to give you maximum protection.

Article 2 of the UCC, regarding sales, is generally similar from state to state. Nevertheless, there are differences, and the UCC of the particular state that is designated as the law of the contract should be checked.

Assuming the New York State UCC applies and the contract does not vary the UCC, when does a buyer have a right to goods it is expecting to receive from the seller? The answer lies, in part, in the murky provisions of Parts 4 and 5 of Article 2 of the UCC.

UCC Section 2-401(1) provides that:

Title to goods cannot pass under a contract for sale prior to their identification to the contract (Section 2-501), and unless otherwise explicitly agreed the buyer acquires by their identification a special property as limited by this Act. Any retention or reservation by the seller of the title (property) in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest. Subject to these provisions and to the provisions of the Article on Secured Transactions (Article 9), title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed on by the parties. (Emphasis added.)

Parsing this section, the first thing the buyer needs in order to assert “title” in the goods it has ordered from the seller is for the goods to be “identified to the contract.” If the goods are “identified to the contract,” the buyer acquires a “special property” in the goods. How are goods identified to the contract, what is a “special property,” and why is any of this important to the buyer?

UCC Section 2-501(1) explains when goods are identified to the contract, thereby conferring a “special property” upon the buyer. The rules are broken into three categories, namely existing goods, future goods, and farm products:

(1) The buyer obtains a special property and an insurable interest in goods by identification of existing goods as goods to which the contract refers even though the goods so identified are non-conforming and he has an option to return or reject them.  Such identification can be made at any time and in any manner explicitly agreed to by the parties.  In the absence of explicit agreement identification occurs

1. when the contract is made if it is for the sale of goods already existing and identified;
2. if the contract is for the sale of future goods other than those described in paragraph (c), when goods are shipped, marked or otherwise designated by the seller as goods to which the contract refers;
3. when the crops are planted or otherwise become growing crops or the young are conceived if the contract is for the sale of unborn young to be born within twelve months after contracting or for the sale of crops to be harvested within twelve months or the next normal harvest season after contracting, whichever is longer.

According to Official Uniform Comment to UCC Section 2-502, if the goods are identified to the contract and if the seller becomes insolvent, the buyer has a right to recover the goods “if the seller becomes insolvent within 10 days after the seller receives the first installment on their price.” Whether and when a seller may become insolvent could be a matter of intense litigation if the stakes are high enough. If the seller “becomes insolvent” after the 10 days, the buyer may nevertheless have acquired a security interest in the goods if the buyer has properly created a security interest in them under the provisions of Article 9 of the UCC governing secured transactions. 

Whether the buyer has a security interest in the goods that are in the hands of the seller becomes a huge issue if the seller files bankruptcy and also if there are competing creditors. For example, what happens if the seller’s lender has filed a financing statement listing all assets of the seller as securing the loan—who has the right to the goods, the buyer or the lender? The secured transactions provisions of the UCC are even murkier and even more complex than the sales provisions. We’ll explore this subject in a future article.

If the goods are identified to the contract and the buyer has a special property in them, who bears the risk of loss if the goods are lost or damaged while still in the custody of the seller? Generally speaking, even in this instance, it is the seller who usually bears the risk of loss. Official Uniform Comment 4 to UCC Section 2-501 explains:

. . . despite identification the risk of loss remains on the seller under the risk of loss provisions until completion of his duties as to the goods and all of his remedies remain dependent on his not defaulting under the contract. (Emphasis added.)

Unless the risk of loss is contractually controlled or unless there is a breach of contract, the seller completes their “duties as to the goods” and thereby shifts the risk of loss as explained in UCC Section 2-509:

Section 2-509. Risk of Loss in the Absence of Breach.

1. Where the contract requires or authorizes the seller to ship the goods by carrier
   1. if it does not require him to deliver them at a particular destination, the risk of loss passes to the buyer when the goods are duly delivered to the carrier even though the shipment is under reservation (Section 2-505); but
   2. if it does require him to deliver them at a particular destination and the goods are there duly tendered while in the possession of the carrier, the risk of loss passes to the buyer when the goods are there duly so tendered as to enable the buyer to take delivery.
2. Where the goods are held by a bailee to be delivered without being moved, the risk of loss passes to the buyer
   1. on his receipt of a negotiable document of title covering the goods; or
   2. on acknowledgment by the bailee of the buyer's right to possession of the goods; or
   3. after his receipt of a non-negotiable document of title or other written direction to deliver, as provided in subsection (4)(b) of Section 2-503.
3. In any case not within subsection (1) or (2), the risk of loss passes to the buyer on his receipt of the goods if the seller is a merchant; otherwise the risk passes to the buyer on tender of delivery.
4. The provisions of this section are subject to contrary agreement of the parties and to the provisions of this Article on sale on approval (Section 2-327) and on effect of breach on risk of loss (Section 2-510).

Under UCC Section 2-509(4), if the parties have not contractually allocated the risk of loss, the seller will bear the risk of loss.

And even under the circumstances in UCC Section 2-509, if the seller breaches the contract UCC Section 2-510 explains the effect of breach on the risk of loss:

Section 2-510. Effect of Breach on Risk of Loss.

1. Where a tender or delivery of goods so fails to conform to the contract as to give a right of rejection the risk of their loss remains on the seller until cure or acceptance.
2. Where the buyer rightfully revokes acceptance he may to the extent of any deficiency in his effective insurance coverage treat the risk of loss as having rested on the seller from the beginning.
3. Where the buyer as to conforming goods already identified to the contract for sale repudiates or is otherwise in breach before risk of their loss has passed to him, the seller may to the extent of any deficiency in his effective insurance coverage treat the risk of loss as resting on the buyer for a commercially reasonable time.

UCC Section 2-613, entitled Casualty to Identified Goods, continues this theme of the seller bearing the risk of loss. That section explains risk of loss when the goods are identified at the inception of the contract and when the loss is not the result of an act by either the seller or the buyer:

Where the contract requires for its performance goods identified when the contract is made, and the goods suffer casualty without fault of either party before the risk of loss passes to the buyer, or in a proper case under a “no arrival, no sale” term (Section 2-324) then 

1. if the loss is total the contract is avoided; and
2. if the loss is partial or the goods have so deteriorated as no longer to conform to the contract the buyer may nevertheless demand inspection and at his option either treat the contract as avoided or accept the goods with due allowance from the contract price for the deterioration or the deficiency in quantity but without further right against the seller.

As in Section 2-509, sellers can contractually protect themselves from bearing the loss. Official Uniform Comment 2 to UCC Section 2-613 explains: “Where under the agreement . . . the risk has passed to the buyer before the casualty, the section has no application.”

The practice point is that to the extent that you can contractually deal with UCC issues, you should. But if you can’t, then it is imperative to understand whether the UCC will apply to your transaction(s) and, if so, then abide by and plan for the application of the UCC rules.