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Contract formation

Good faith in negotiating

Is there an obligation to use good faith when negotiating a contract?

In the United States, the Uniform Commercial Code (UCC) generally governs commercial agreements (such as supply contracts for the sale of goods and services), and has been codified by each state, with some states making modifications to certain UCC requirements. Thus, both state statutes and common law concerning commercial contracts vary among states, so a careful analysis of the state law governing the contract is recommended.

Generally, absent an agreement to negotiate in good faith, there is no such obligation for parties to negotiate a contract in good faith. Some parties may execute a preliminary agreement - such as a term sheet or letter of intent - as part of their negotiations before entering into a formal written contract, especially for more complex transactions. Often, such preliminary agreements include a provision that expressly states that the parties agree to negotiate the deal points within the term sheet or letter of intent in good faith. Some states will enforce these agreements to negotiate in good faith, while other states have held such provisions to be unenforceable. Some courts that have enforced such an obligation in a preliminary agreement do not necessarily find that the duty assumes exclusive negotiations, and other courts have further stated that the term sheet or letter of intent should be detailed and include a ‘framework’ for the court to determine whether the duty has been breached.

‘Battle of the forms’ disputes

How are ‘battle of the forms’ disputes resolved in your jurisdiction?

A ‘battle of the forms’ arises in the United States when, rather than preparing a single contract for the sale of goods, the offeree and offeror each send the other party what they consider to be their respective standard terms and conditions. Of course, such terms tend to be inconsistent - and more favourable to each respective party - resulting in a conflict over which party’s terms will govern the contractual relationship. When such a conflict occurs, as a general rule, no contract is formed because each communication is considered a counter-offer, not an acceptance of the other party’s terms. A ‘conditional acceptance’ is a type of counter-offer that purports to ‘accept’ the other party’s offer, but only with additional or different terms. Most states require express language for a conditional acceptance. In this situation, approval by the other party remains necessary to form a contract.

The UCC has a ‘merchant rule’ for commercial contracts between merchants. Under the UCC, the additional terms will automatically become part of the contract unless the offer expressly limits acceptance to the terms of the offer; the additional terms materially alter the agreement; or one of the parties has notified the other party that it objects to the additional terms (or notified the other party within a reasonable time). Most state courts have held that this merchant rule applies just to additional terms and does not include different or inconsistent terms; instead, the different or inconsistent terms are cancelled out and replaced by the ‘gap-filling’ provisions under the UCC (such as provisions for the course of performance and the time and place of delivery). Other states will treat the additional terms and inconsistent terms in the same way; thus, the different terms become a part of the contract between merchants unless one of the exceptions listed above applies. A review of state-specific laws and court interpretations is recommended to determine how the state has adopted the UCC’s rule.

Language requirements

Is there a legal requirement to draft the contract in the local language?

There is no obligation in the United States to draft commercial contracts in English; however, the vast majority of both domestic and international contracts are prepared in English. A review of state-specific laws is recommended if entering into a consumer contract. Some states, like California, can require certain consumer contracts to be translated into another language.

Online contracts

Is it possible to agree a B2B contract online?

Yes. In the United States, a legally binding contract generally does not need to be in any particular form. With some exceptions, commercial contracts may be formed electronically and are subject to the Electronic Signatures in Global and National Commerce Act at a federal level, and the Uniform Electronic Transactions Act as adopted by all states except for Illinois, New York and Washington. These laws authorise electronic signatures in most commercial and business transactions, subject to certain exceptions. The terms of the contract must be accessible for review, and it is recommended that the full text be provided (such as via a click-to-accept scroll box).

Statutory controls and implied terms

Controls on freedom to agree terms

Are there any statutory or other controls on parties’ freedom to agree terms in contracts between commercial parties in your jurisdiction?

In the United States, parties are generally free to draft commercial contracts with terms of their choosing without any statutory or other controls. Yet, there are statutes that regulate certain aspects of contracts, including the Federal Arbitration Act (which governs contract arbitration clauses) and the Magnuson-Moss Warranty Act (which governs written warranties and some aspects of implied warranties on consumer products). As a general matter, commercial parties cannot enter into contracts that are contrary to public policy of the state in which the contract is made or to be enforced (eg, requiring indemnification for intentional tortious conduct or an overly broad non-competition covenant). Commercial parties also cannot enter into contracts that would violate the law if enforced as written.

Standard form contracts

Are standard form contracts treated differently?

For commercial contracts between two businesses, standard form contracts are treated the same as negotiated commercial contracts. The general rules regarding contract construction and enforceability are the same.

Implied terms

What terms are implied by law into the contract? Is it possible to exclude these in a commercial relationship?

The UCC creates implied warranties in contracts for the sale of goods. The two implied warranties are the warranty of ‘merchantability’ of the goods being sold, and the warranty that the goods are ‘fit for a particular purpose’.

For goods to meet the definition of merchantability, goods must be at least of average quality, properly packaged and labelled, conform to their labels and fit for the ordinary purposes they are intended to serve. The implied warranty of fitness for a particular purpose applies when the seller of the goods is aware that the buyer plans to use the purchased goods for a particular purpose. If the seller knows that the goods will not be suitable for the buyer’s specific purpose, the seller will breach the implied warranty if it continues to sell the buyer goods for that specific purpose.

Implied warranties can be disclaimed with express language in the contract. A common method for disclaiming implied warranties is an ‘as is’ clause, which provides that the buyer is purchasing the product with no implied warranty. Disclaiming implied warranties must be done with conspicuous contract language (eg, in bold, all caps font) and cannot be concealed in the fine print.

Vienna Convention

Is your jurisdiction a signatory to the United Nations Convention on Contracts for the International Sale of Goods (the Vienna Convention)?

Yes, the United States became a signatory to the Vienna Convention in 1981.

Good faith in entering and peforming

Is there an obligation to use good faith when entering and performing a contract?

Yes, each contract may contain an implied covenant of good faith and fair dealing. The implied covenant requires each party not to do anything that will deprive the other party of the benefits of the contract, and a breach of this covenant by failure to deal fairly in good faith gives rise to a potential action for damages.

There are a myriad of potential problems that can arise between contracting parties during a contractual relationship. The implied covenant of good faith and fair dealing was established by courts to address these issues. States generally imply this duty into most consumer contracts, and the UCC has also adopted it for contracts it governs. The UCC defines good faith as ‘honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade’.

The determination of whether a party failed to act in good faith does not depend on societal standards of fairness or reasonableness, but instead emphasises the adherence to the contractual agreement and the reasonable expectations of the other party. The failure of one party to act in good faith does not necessarily discharge the other party’s obligation to perform. While parties may have an obligation to act in good faith, the implied covenant of good faith and fair dealing generally cannot be used by a party to override express language in the contract or improve its position. Thus, breach of the implied covenant of good faith will not be found where the other party merely enforces rights it bargained for under the contract, regardless of its motive for enforcing those rights as written.

Limiting liability

Prohibition on exclusions and limitations

What liabilities cannot be excluded or limited by a supplier in a contract?

There is a trend in favour of limitation of liability clauses in contracts subject to certain exceptions. For example, a contract governed by the UCC may include terms that limit or exclude consequential damages ‘unless the limitation or exclusion is unconscionable’. Under the UCC, the limitation of consequential damages for injury to the person in the case of consumer goods is prima facie unconscionable, but the limitation of damages where the loss is commercial is not.

The ability to limit liability in a contract may also vary depending upon the state law that governs that contract. Most courts disfavour contract provisions that limit a party’s liability for gross negligence, fraud or intentional torts. Some states also refuse to enforce these clauses if the party seeking protection acted in bad faith.

Financial caps

Are there any statutory controls on using financial caps to limit liability for breach of contract?

No, there are no statutes that enforce financial caps on contracts to limit liabilities, but contracting parties are free to include financial caps within their contract. Also, most jurisdictions in the United States adhere to the traditional common law rule against punitive damages for breach of contract, if there is no tortious conduct. In the consumer setting, financial caps can be set aside if found to be unconscionable. While commercial parties are generally free to contract as they see fit, parties seeking to take advantage of such provisions would be wise to include such financial caps in clear, conspicuous language and also include representation and warranties about the provision, providing further additional evidence as to their reasonableness for the situation at hand.

Indemnities

Are there any statutory controls on indemnities used to cover liability risks in contracts?

Indemnification provisions are interpreted under the same rules that govern other provisions in contracts, including the general rule that contracts are interpreted to give effect to the intent of the parties. Most states do not permit indemnification clauses for intentional wrongful acts or punitive damages, as they are deemed against public policy. Also, many states restrict businesses that provide essential services to the public from being indemnified for their own negligence, due to public policy considerations.

Liquidated damages

Are liquidated damages clauses enforceable and commonly used in your jurisdiction?

Liquidated damages clauses are generally enforceable in the United States and commonly used, especially in the commercial setting. Courts have upheld such damages where ‘they are a fair and reasonable attempt to provide just compensation for an anticipated loss resulting from a breach of contract.’ Under the UCC, liquidated damage provisions will be enforced unless they are considered ‘excessive’ and, if deemed to be so, are ‘considered unenforceable as a penalty on the grounds of public policy’. Disproportionate liquidated damages may be declared a penalty, which will void the clause and limit recovery to the actual damages resulting from the breach.

As a general matter, courts consider two things in determining whether a liquidated damages clause is enforceable: whether the injury caused by the breach is difficult to calculate, and whether the amount of the liquidated damages is reasonable in proportion to the anticipated injury.

Payment terms

Statutory time limits on payments

Are there statutory time limits for paying invoices? Is it possible to agree a different payment period?

While there are no statutes in the United States specifically addressing the timing of payment of invoices, the UCC provides a time frame as one of its ‘gap-filling’ provisions to be implied when a contract for the sale of goods is silent on this issue. Under the UCC, if the contract is silent with respect to the time for payment, the time will be when the purchaser is to receive the goods.

Further, the payment obligation under the contract would be subject to the statute of limitations under the UCC and applicable state law. The statute of limitations for breach of contract under the UCC (ie, non-payment of an invoice) is four years from the cause of action; however, this can vary by each state’s commercial code (for example, the statute of limitations for breach of contract claims in New Jersey is six years). Generally, parties do agree to a payment schedule, either within the contract itself or within the terms of the invoice, such as ‘net thirty (30) days’ from the date of the invoice.

We note that while there are no statutes addressing time limits for paying invoices with respect to general commercial contracts, there are such statutes in some states for other types of contracts, such as construction or government contracts.

Late payment interest

Is statutory interest charged on late payments? Is it possible to agree a different rate of interest?

Yes, subject to state law. In most states, statutory interest may be charged on late payments under a commercial contract; however, state law varies on the rate of interest and when interest begins to accrue (usually the due date). When a commercial contract does not include an interest rate, the pre-judgment interest laws of many states may impose a statutory interest rate on late payments, which can vary widely. For example, under Illinois law, the legal interest rate is 5 per cent (or as agreed to by contract), while in Nebraska, the legal interest rate is 12 per cent (or as agreed to by contract). Some states do not impose an interest obligation on late payments under a commercial contract that does not expressly include such a provision. Typically, the law that governs the amount of the interest rate and when it accrues is where the money owed is payable. The interest is generally simple interest, and may be different from the maximum interest rate for loans under state law.

Although commercial contracts are not generally considered to be loans, courts will examine a transaction to determine whether a contract for the sale of goods is actually a loan - in which case usury laws will apply. Usury laws apply to loans and set limits on the maximum interest rate that can be charged to avoid excessively high rates.

Civil penalties

What are the civil penalties for failing to comply with statutory interest rate or late payment of invoices?

The civil penalties for failing to comply with a statutory interest rate vary by state. For example, in Illinois, if a party knowingly contracts for or receives unlawful interest, the obligor may recover twice the total of all interest, discount and charges determined by the loan contract or paid by the obligor, whichever is greater, plus such reasonable attorneys’ fees and court costs as may be assessed by a court.

For late payment of invoices, some states have what are known as ‘prompt payment laws’ for certain kinds of contracts that include civil penalties; however, these laws tend to focus on contracts where the government or a government agency is a party.

Termination

Implied terms

Do special rules apply to termination of a supply contract that will be implied by law into a contract? Can these terms be excluded or limited by including appropriate language in the contract?

Under the UCC, if a contract is indefinite as to duration, it will be valid for a reasonable time. Unless the parties agree otherwise, either party may terminate the contract at any time (though many courts have held that reasonable notification to the other party is required).

Parties to a long-term contract for the sale of goods may expressly agree to certain termination provisions. Some provisions may permit one or both parties to terminate for convenience, meaning a party can simply terminate at will, without the other party being in breach. These ‘at will’ provisions may be subject to other applicable laws or notice requirements.

A contract may also include the right to terminate for cause. Termination for cause typically occurs when one party is either in general breach of the agreement or one or more enumerated ‘events of default’ have occurred (for example, non-payment, failure to deliver, or breach of warranty). Again, reasonable notification is typically required to terminate, unless the parties agree otherwise.

Notice period

If a contract does not include a notice period to terminate a contract, how is it calculated?

Under the UCC, reasonable notification is that which will give the non-terminating party reasonable time to seek out an alternative arrangement. What is reasonable will depend on the particular facts and circumstances applicable to the case.

Automatic termination on insolvency

Will a commercial contract terminate automatically on insolvency of the other party?

Although it is common for commercial contracts to provide for immediate termination upon the insolvency or bankruptcy of a party (an ipso facto provision), these clauses are subject to US business bankruptcy laws and are therefore not always enforceable if the insolvent party has filed for bankruptcy. If the insolvent party has not filed for bankruptcy, however, the other party may be able to rely on the ipso facto provision to terminate the contract. Although the insolvency of a party does not automatically terminate a commercial contract, it is generally considered to be sufficient grounds to terminate a contract in connection with other factors that constitute a default.

Termination for financial distress

Are there restrictions on terminating a contract if the other party is in financial distress?

Yes, if the distressed party has filed for bankruptcy, the other party may not be able to terminate the contract, as mentioned above. US bankruptcy laws generally protect the distressed business’s property, assets and contract interests during the proceedings and give the distressed party additional time and rights to determine what to do with the contract (cure and perform, reject, etc). If bankruptcy has not been filed and the distressed party has defaulted under the contract, the other party may issue a notice of default (as specified in the contract) or terminate under an ipso facto provision.

Force majeure

Is force majeure recognised in your jurisdiction? What are the consequences of a force majeure event?

Yes. In commercial contracts, force majeure events typically include acts of God, war, acts of terrorism or similar events, fires, strikes, embargoes or other government actions, natural disasters, riots, shortages of power or transportation, or other events beyond the control of either party.

The parties may include a force majeure clause in the contract, which serves to excuse non-performance due to a force majeure event, or allocate the risk if certain events were foreseeable (for example, a severe hurricane in the south-eastern region of the United States) by negotiating the monetary terms of the contract. If a contract is silent as to a force majeure event, the court will look to its foreseeability to determine whether to excuse non-performance under the contract. If a force majeure event was foreseeable, the court will generally hold that the non-performing party bore the risk of the event and is therefore not excused from performance. If the force majeure event was not foreseeable, the non-performing party is generally excused.

Subcontracting, assignment and third-party rights

Subcontracting without consent

May a supplier subcontract its obligations under the contract without seeking consent from the other party?

Generally, it is assumed that both parties are permitted to subcontract a commercial contract without the other party’s consent, unless the contract states otherwise. Most commercial contracts between businesses typically address subcontracting rights within their boilerplate provisions. There are exceptions to this general rule for personal service and other types of contracts.

Statutory rules

Are there any statutory rules that apply to subcontracting in your jurisdiction?

No, not with respect to subcontracting general commercial contracts for the supply of goods and services between two businesses; however, states may regulate subcontracts within certain industries (such as construction).

Assignment of rights and obligations

May a party assign its rights and obligations under the contract without seeking the other party’s consent?

Contracts are typically freely assignable absent an anti-assignment provision to the contrary unless an assignment would violate public policy or materially alter the circumstances of the contract (the duty of the obligor would be materially changed, the burden or risk on the obligor would increase materially, or the assignment would materially reduce the value of the contract to the obligor). Some examples of assignments that would violate public policy include assignments of claims for personal injuries, or rights that are personal, such as those under a non-compete. Federal law also limits the assignment of rights under certain government contracts.

Further, with respect to the delegation of obligations under a commercial contract, a party may delegate its duty to perform under the contract unless otherwise agreed or unless the other party has a substantial interest in having the original promisor perform or control the acts required by the contract. The delegation of performance does not relieve the party delegating of any duty to perform or any liability for breach. If the delegating party wishes to relieve itself from liability for non-performance under the contract, it must obtain the non-delegating party’s consent, which is referred to as a novation. Generally, in a novation, the delegating party, the non-delegating party, and the delegatee agree that the delegatee is substituted for the delegating party; the delegating party is no longer liable for performance; and the delegatee is liable for performance.

What statutory controls apply to the assignment of rights or obligations under a supply contract?

In general, contracts for the sale of goods are also assignable and the rights thereunder are generally delegable, although there are exceptions for a contract for exclusive requirements, or for a unique product. Under the UCC, if performance is delegated, the delegation may be treated as a reasonable ground for insecurity, and the non-delegating party may request assurances of performance from the delegating party. If the delegating party does not oblige, it can be treated as a repudiation of the contract.

The UCC also permits a party to assign its right to sue for breach of contract, notwithstanding any anti-assignment and anti-delegation provisions. Further, the UCC invalidates assignment restrictions on accounts, including the right to receive payment under the contract, so that a party cannot be restricted from using receivables as collateral to borrow money from a lender or selling its receivables to a third party.

Enforcement by third party

How may a third party enforce a term of the contract?

Generally, a person or entity that is not a party to a contract only has enforcement rights if the contract expressly states an intent to grant them to the third party. An ‘intended beneficiary’ under a contract is one who acquires a right to enforce the contract by virtue of the promise made under the contract, while an ‘incidental beneficiary’ is one who benefits by the performance of a promise, but is not a party to the contract or an intended beneficiary and cannot enforce the contract. Courts have consistently held that the language of the contract must clearly state an intent to grant the third party the right to enforce the contract.

Disputes

Limitation periods

What are the limitation periods for breach of contract claims? Is it possible to agree a shorter limitation period?

Statutes of limitations vary among the states and also vary in relation to the type of contractual claim. For example, New York allows a party six years from the date of execution of a written or oral contract to bring a claim for breach of contract, but only three years after the alleged injury occurred. California allows a party to bring a claim within four years of the date of execution of a written contract (and two years for an oral contact), and the claim must be brought within two years of the alleged injury. Under the UCC, a breach of any contract for sale must be commenced within four years after the cause of action has accrued. If claims are not brought within these times, they will generally be barred.

Most states do allow parties to agree to a shorter period in which claims must be brought. Service-based contracts often include clauses that shorten the statute of limitations. Most states have statutes setting a minimum period for shortening the time to bring an action. The UCC also allows parties to reduce the period of limitation in a commercial contract for the sale of goods to a minimum of one year.

Choice-of-law clauses

Do your courts recognise and respect choice-of-law clauses stipulating a foreign law?

In the United States, contracting parties are generally free to choose the law that governs the contract. Yet, some states require there be a reasonable relationship between the jurisdiction of the chosen law and the transaction. Certain states, such as New York, will allow parties to apply New York law to commercial contracts if the underlying transaction is valued at or more than US$250,000, even if the parties have no relationship to New York.

Do your courts recognise and respect choice-of-jurisdiction clauses stipulating a foreign jurisdiction?

US courts typically enforce forum selection clauses in an international context based upon international comity and public policy. Jurisdictions within the United States have differing case law related to forum selection clauses, but they are generally enforced unless the challenging party can identify drastic and unexpected changes in the forum’s legal process since the contract was executed, and show that these changes deprive the challenging party of its day in court.

Efficiency of local legal system

How efficient and cost-effective is the local legal system in dealing with commercial disputes?

The US legal system is not commonly characterised as efficient or cost-effective. First, litigants are generally responsible for their own legal fees (the ‘American rule’), though at times the prevailing party may be able to recover its attorneys’ fees in certain contractual causes of action or based on certain statutes. For commercial contract claims, most attorneys will work for an hourly fee, though there is a recent trend towards ‘alternative billing arrangements’. Under these arrangements, some attorneys are willing to handle a party’s litigation for a flat fee, capped fee, or some other arrangement, but this is still a minority trend.

Attorney cost structures are generally the same when arbitrating, but most parties find that arbitration costs are cheaper than normal litigation because a binding decision is reached more efficiently and quickly. Arbitration usually does not involve the costly discovery obligations that are imposed in judicial proceedings; and this is becoming more significant in recent years owing to the high costs of producing vast quantities of electronically stored information. If the contracting parties desire to narrow the type of discovery or the time periods over which claims are arbitrated, it is best to include such terms in the arbitration agreement. Among other things, it is also important to include language in the arbitration agreement describing the types of claims to be arbitrated. The parties can agree to arbitrate some claims but not others. It is important to consider state and US law when drafting the arbitration agreement.

New York Convention

Is your jurisdiction a signatory to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards? Which arbitration rules are commonly used in your jurisdiction?

Yes, the United States is a signatory to the New York Convention. Arbitrations in the United States are commonly governed by the set of rules explicitly named in the contract. The Federal Arbitration Act will apply if the case could be filed in federal court. State law will normally govern the contract unless foreign law is chosen. Parties tend to use different arbitration rules and fora to decide their disputes, including the American Arbitration Association, CPR International Institute for Conflict Prevention and Resolution, or JAMS. The rules for the particular organisation chosen to administer the dispute must be considered, as each differs.

Remedies

Available remedies

What remedies may a court or other adjudicator grant? Are punitive damages awarded for a breach of contract claim in your jurisdiction?

A court or other adjudicator generally can grant all remedies available under the law, unless the parties’ contract or the applicable rules provide otherwise. The main categories of remedies available in a cause of action arising from contract law are:

  • monetary damages (the most common remedy), which provides compensation to put the non-breaching party in the same position that it would have been in but for the breach of contract;
  • declaratory judgment, which declares the rights of the parties;
  • injunctive relief, which prohibits the defeated party from performing an act or requiring the party to perform an act; and
  • specific performance, which requires the defeated party to perform its obligations under the contract.

Monetary damages primarily fit into one of three categories:

  • expectation damages, which are not based on a sustained injury but rather on a loss of some future or speculative income;
  • reliance damages, which are sustained when a party acts in reliance on a party who failed to fulfil their obligation; and
  • restitution damages (or unjust enrichment), which occur where one party has conferred a benefit on another party but cannot collect the full payment for that benefit.

Punitive damages are rarely awarded for a breach of contract claim, but have been awarded where a party has engaged in tortious conduct.