TKO'ing The UCC's "Knock-Out Rule"

Saturday, November 1, 2008 - 01:00

At common law, a contract was not enforceable unless there was a meeting of the minds on all terms. But this "mirror image rule" was abandoned by the Uniform Commercial Code ("UCC"), which allows parties to form a valid contract even if their proposed terms are not identical. Under UCC § 2-207 and state statutes modeled after it,1additional terms contained in an acceptance do not prevent contract formation. However, the question that remains is which of these additional terms will become part of the enforceable contract?

Round One: "Battle Of The Forms"

Manufacturer, Inc. learns that Distributor Corp. wants to buy Manufacturer's widgets (say, boxing gloves). Manufacturer sends a quotation to Distributor inviting a purchase order for the widgets. The quotation form contains Manufacturer's boilerplate terms, including a statute of limitations provision stating that any claim arising from the sale of widgets must be brought within one year of delivery. In response, Distributor sends Manufacturer a purchase order for 100 widgets. The purchase order contains Distributor's standard terms, including a clause allowing it to bring claims against Manufacturer for three years. Manufacturer accepts payment and fills the purchase order, and Distributor accepts delivery of the widgets. Two years later, Distributor discovers that the widgets are defective and unsellable. Distributor sues Manufacturer, who moves for summary judgment based on the one-year statute of limitations included in its quotation. Distributor opposes the motion, citing the three-year statute of limitations in its purchase order.

In this "battle of the forms," does Manufacturer's one-year statute of limitations prevent Distributor from pursuing the claim or does Distributor's three-year statute of limitations control? Or neither?

The New Jersey Appellate Division encountered a similar situation in Richardson v. Union Carbide Industrial Gases, Inc. , 347 N.J. Super. 524 (App. Div. 2002). In that case, Rage Engineering, Inc. contracted with Hoeganaes Corp. to sell Hoeganaes a piece of machinery. Rage submitted a form quotation that contained its boilerplate indemnification clause requiring Hoeganaes to indemnify Rage for loss in connection with the machinery. Hoeganaes responded by sending its form purchase order including an indemnification clause that required Rage to indemnify Hoeganaes. After both parties performed their obligations under the contract, an employee of Hoeganaes was injured by the machinery and sued both Hoeganaes and Rage. Rage brought a cross-claim against Hoeganaes for indemnification based on the contract. The court was faced with two conflicting indemnification clauses and needed to determine which, if either, became part of the final contract.

Round Two: The "Knock-Out Rule"

Section 2-207 of the UCC rejects the common law "mirror image rule" and allows for the creation of an enforceable contract even if the acceptance contains terms in addition to those offered. In this "battle of the forms" situation, additional terms become part of the contract unless (a) the offer expressly limits acceptance to the terms of the offer; (b) they materially alter it; or (c) the offering party notifies the accepting part of its objection to the additional terms. UCC § 2-207(2) (a)-(c).

The "knock-out rule" is applied by courts to resolve a "battle of the forms" when the forms contain conflicting terms. In this situation, a contract is still formed but the rule operates to reject both parties' terms if there is a disagreement between the forms exchanged. On the inconsistent item, the parties' form terms are knocked out of the contract and replaced by the gap-filler provisions of Article 2 of the UCC. In Richardson , where the two parties each submitted forms with conflicting indemnification clauses, the Appellate Division adopted the "knock-out rule" in New Jersey, 347 N.J. Super. at 533. The court held that N.J. Stat. § 12A:2-207, identical to the UCC provision, operated to knock out the conflicting indemnification terms and replace them with UCC gap-filler provisions.

Similarly, Manufacturer's motion for summary judgment based on its one-year statute of limitations will fail because of the "knock-out rule." The term in Manufacturer's quotation is directly in conflict with the three-year statute of limitations term contained in Distributor's purchase order. Therefore, both parties' terms are knocked out of the contract and replaced by UCC § 2-725's default four-year statute of limitations.

Round Three: Knocking Out The "Knock-Out Rule"

But Manufacturer and Rage, like most sellers, wanted their own favorable terms to control the transaction, not the neutral UCC gap-fillers. So how can they ensure that their terms will be enforced despite the fact that their customers' form purchase orders contain conflicting terms? The purpose of § 2-207, the UCC's solution to a "battle of the forms," is to come as close as possible to ascertaining the true intent of the contracting parties. When a seller and a buyer exchange two different unilateral form contracts with contradictory terms, it is not as simple as when one party includes an additional term and the parties' intent can be assessed by operation of § 2-207(2)(a)-(c). Where terms directly conflict, the parties obviously did not agree on that issue. There, the "knock-out rule" applies as a default to straighten everything out.

But if the result of sales negotiations is one bilateral contract between the parties instead of two unilateral forms, the terms of that contract are enforceable, and there is no need for the "knock-out rule." In other words, if the parties' intent is clear, the "knock-out rule" will not apply. Therefore, a seller can knock out the "knock-out rule" by adding one simple step to its order intake process, designed to avoid a "battle of the forms" in the first place: requiring both parties to sign one contract - a sales confirmation - instead of accepting a form purchase order that may contain terms contradictory to its own.

Upon learning that a prospective buyer wants to purchase widgets, the seller should send a quotation inviting an order but specifically state that no agreement can be made until the parties sign a sales confirmation to be provided by the seller after the order details are specified. This precaution defines how a contract can be formed and ensures that the buyer's response to the quotation will not be construed as an acceptance with conflicting terms.

The buyer can then specify the details of its order. If it does so by submitting a form purchase order with its own boilerplate terms, this will not be considered an acceptance and thus does not create an enforceable contract with conflicting terms. Therefore, whatever terms contained in the purchase order are inconsequential.

In response to the order, the seller should send a sales confirmation to the buyer. This sales confirmation should detail the order placed by the buyer and state the seller's terms. It should also contain an integration clause stating that those terms govern the sale and supersede all prior terms that may have been discussed by the parties. Most importantly, the sales confirmation should make clear that (1) a contract for the sale will not be formed until the sales confirmation is signed by both the seller and the buyer; and (2) the "knock-out rule" will not apply if interpretation of the contract is required at some later date.

The additional step taken by the seller requiring the buyer to sign a sales confirmation ensures that the buyer will not have an opportunity to include additional or conflicting terms, thus avoiding a "battle of the forms" and effectively eliminating the chance that an interpreting court will apply the "knock-out rule." Instead of exchanging two unilateral forms, the agreement is formed by both parties signing one contract with one set of terms. The integration clause and statement that the "knock-out rule" does not apply will further support the notion that the sales confirmation is the complete contract that reflects both parties' intent. This arrangement will likely be upheld by courts so long as there is not such a disparity in bargaining power between the seller and buyer that the adhesion sales confirmation's terms would violate public policy.

Round Four: Knocking Out The "Knock-Out Rule" In E-Commerce

The solution discussed above is somewhat complicated in the realm of e-commerce, where a flurry of forms can be exchanged in seconds by electronic data interchange ("EDI"). However, an internet seller may still utilize a sales confirmation to ensure that its terms are not knocked out by operation of § 2-207 if the buyer responds to an e-quotation with a form of its own. In situations where the seller's price lists are posted on its website or where it e-mails a quotation to a prospective buyer, it should explicitly state that the formation of a contract for sale is contingent on a signed sales confirmation. Such a notice should be posted on the website or included in the e-mail quotation.

Once the customer submits its order via EDI, the seller should respond by transmitting a sales confirmation and instruct the buyer that, in order to complete the purchase and enter into a contract, it must sign the sales confirmation (or affix an appropriate digital signature) and return a digital copy of the signed confirmation to the seller.

Conclusion

The "knock-out rule" is meant to resolve a "battle of the forms" when a seller and buyer exchange unilateral forms with conflicting terms. In that situation, each party's true intent is opposed by the other's terms. However, the sales confirmation serves as a bilateral agreement between the seller and buyer that eliminates the underlying "battle of the forms." Therefore, the "knock-out rule" is not implicated because the parties' intent is expressed in a single, fully integrated contract - a sales confirmation. 1See, e.g., N.J. Stat. Ann. § 12A:2-207; NY CLS UCC § 2-207.

Marc S. Friedman is Chair of the Intellectual Property Group at Sills Cummis & Gross P.C. and practices in the firm's New York City office. He is in The International Who's Who in E-Commerce & Internet Law. Eric D. Wong is an Associate in the firm's Litigation Group and practices primarily in the Newark, N.J. office.

Please email the authors at mfriedman@sillscummis.com or ewong@sillscummis.com with questions about this article.