Article by San Diego Attorney Ethan Watts on Contract Formation Issues Under The California Commercial Code

Contract Formation Issues Under The California Commercial Code

By Ethan Watts

This article explores contract formation under Division 2 of the California Commercial Code, which applies to the sale of goods. Comm. Code § 2102. The article also explores the Commercial Code's treatment of requirements contracts. Although the Commercial Code's provisions are fairly comprehensive on these subjects, it is worth noting that where no specific Commercial Code provision is applicable to a given issue, general principals of California law and equity apply. Comm. Code § 1103(b).

Contract Formation

The general formation provision under the Commercial Code is section 2204:

UCC 2204. Formation in general (1) A contract for sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties which recognizes the existence of such a contract. (2) An agreement sufficient to constitute a contract for sale may be found even though the moment of its making is undetermined. (3) Even though one or more terms are left open a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy.

Commercial Code section 2204 abandons the “mirror image” rule of contract formation. As stated in comment 2 to section 2204, “‘a meeting of the minds on the essential features of the agreement’ is not required but merely an ‘intent to make a contract’”. Comm. Code § 2204, comment 2.

In addition to Commercial Code section 2204, section 2207 of the Commercial Code is relevant to the question of formation. Section 2207 states in full:

(1) A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon, unless acceptance is expressly made conditional on assent to the additional or different terms. (2) The additional terms are to be construed as proposals for addition to the contract. Between merchants such 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) Notification of objection to them has already been given or is given within a reasonable time after notice of them is received. (3) Conduct by both parties which recognizes the existence of a contract is sufficient to establish a contract for sale although the writings of the parties do not otherwise establish a contract. In such case the terms of the particular contract consist of those terms on which the writings of the parties agree, together with any supplementary terms incorporated under any other provisions of this code. [Emphasis added].

As stated in comment 2 to section 2207, “[t]he effect of this section is to allow the creation of a valid contract when there is mutual assent between the parties even though the acceptance is not in identical terms with the offer.”Comm. Code § 2207, comment 2.

Perhaps the most relevant and significant case interpreting sections 2204 and 2207 as they relate to contract formation is the California Supreme Court decision of Steiner v. Mobil Oil Corporation (1977) 20 Cal. 3d 90. In Steiner, plaintiff, an independent service station operator, brought an action against Mobil Oil Corporation (“Mobil”). Plaintiff purchased gasoline he sold at his service station from Mobil. When the third party that leased the service station property to plaintiff informed plaintiff the service station was for sale, plaintiff notified Mobil and Mobil informed plaintiff that Mobil was interested in helping plaintiff purchase the station. Steiner, 20 Cal. 3d 90, 94.

Plaintiff entered into extended negotiations with Mobil’s area manager and a sales representative’s superior. Although the area manager had made clear to plaintiff that neither the area manager or the sales representative’s superior possessed the authority to enter into a contract on behalf of Mobil, the negotiations culminated with a proposal to submit to Mobil’s general manager, who did possess authority to enter into a contract on behalf of Mobil. Id. at 94-95. The proposal was for plaintiff to enter into a 10-year contract with Mobil for the purchase of gasoline, and in exchange Mobil would help plaintiff with the down payment in purchasing the station, supply plaintiff with certain improvements and would give plaintiff a reduction on the price of gasoline over the 10-year contract. Id. at 95.

The proposal did not take the form of a documented single contract, but rather Mobil utilized a series of its standard forms, modifying the forms where necessary. Id. Plaintiff signed those documents that required his signature. Id. Near the close of assembling the proposal, plaintiff reviewed the form which would embody the reduction on the price of gasoline. Id. That form, which did not require plaintiff’s signature, stated that the reduction could be “changed or discontinued by [Mobil] any time upon notice to [plaintiff] in writing.” Id. When plaintiff discovered this form, he immediately called the area manager and told him he would not go ahead with the deal if Mobil could revoke the price reduction. Id. The area manager then sent plaintiff a letter, essentially telling plaintiff that there would be no agreement unless it was on the terms in plaintiff’s offer. Id. at 96.

The package of documents comprising the proposal was sent to the general manager of Mobil for his approval. Id. at 95. However, the package of documents included the form permitting Mobil to change or discontinue the price reduction and the area manager failed to include the letter he sent to plaintiff in the package of documents. Id. at 96. The general manager approved the proposal as submitted, and the area manager notified plaintiff of the approval by telephone. Id. Subsequently, a the package of documents approved by the general manager was delivered to plaintiff. Id. Plaintiff did not reread the documents approved by the general manager. Id. at 97. When Mobil later attempted to reduce the discount on gasoline, plaintiff sued. Id. at 97.

The trial court ruled in favor of plaintiff and found that Mobil had entered into a contract with plaintiff that guaranteed plaintiff the price reduction. Id. In affirming the trial court’s judgment, the California Supreme Court examined sections 2204 and 2207 of the Commercial Code.

The Steiner court began its analysis by noting that section 2207 “rejects the ‘mirror image’ rule” and “‘recognizes that in current commercial transactions, the terms of the offer and those of the acceptance will seldom be identical.’” Id. at 99. Rather, the court explained, “section 2207 inquires as to whether the parties intended to complete an agreement.” Id. “If the parties intend to contract, but the terms of their offer and acceptance differ, section 2207 authorizes a court to determine which terms are part of the contract, either by reference to the parties’ own dealings…, or by reference to other provisions of the code.” Id. at 99 – 100.

The court addressed Mobil’s argument that no contract had been formed under section 2204 by stating that “[t]he official comments accompanying section 2204, other provisions of the code, and the case law interpreting section 2204, all support the conclusion that section 2204 does not require mutual assent to all essential terms.” Id. at 103. The court further explained that section 2204 "does not, by its terms, require parties to a contract to assent to all essential terms. Instead, this provision states that a court, if it is to enforce a contract, must first make two findings. Initially, the court must find some basis for concluding that the parties engaged in a process of offer and acceptance, rather than inconclusive negotiations. Second, the court must find that it possesses sufficient information about the parties' incomplete transaction to apply the provisions of the California Uniform Commercial Code which fill in the gaps in parties' contracts." Id. at 104.

In finding that a contract had been formed, the Steiner court noted that section 2207 provides “A definite and seasonable expression of acceptance or a written confirmation which is sent within a reasonable time operates as an acceptance even though it states terms additional to or different from those offered or agreed upon…”. Id. at 100. The court found that an acceptance had occurred when “[plaintiff] telephoned [the area manager], Mobil’s employee, to inquire as to the fate of [plaintiff]’s offer [and the area manager] told [plaintiff] that Mobil had a check for him, that he should open an escrow account, and that he should go ahead with the purchase of the service station property.” The court stated that in context, this was a “clear statement that Mobil had approved the deal.” Id.

Thus, under Steiner, the formation of a contract occurs when the court makes two findings: 1) some basis for concluding that the parties engaged in a process of offer and acceptance, rather than inconclusive negotiations; and 2) that the court possesses sufficient information about the parties' incomplete transaction to apply the gap filler provisions of the Commercial Code. Also under Steiner, a phone conversation indicating that the parties had a contract, even though the parties disagree as to what some of the essential terms of the agreement are, is sufficient to constitute acceptance and the formation of a contract. See also National Controls, Inc. v. Commodore Business Machines, Inc. (1985) 163 Cal. App. 3d 688 (holding that the parties had reached an oral agreement and that a later submitted purchase order constituted a formal memoranda embodying the terms so far as agreed upon and adding terms not discussed.).

Requirements Contracts

Under section 2204(3) of the Commercial Code, “[e]ven though one or more terms are left open a contract for sale does not fail for indefiniteness if the parties have intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy.” Comm. Code § 2204(3). Moreover, the terms of any writing expressing the parties’ agreement may be explained or supplemented by evidence of course of dealing, usage of trade, and course of performance. Comm. Code § 2202, comment 2.

Additionally, section 2306 of the Commercial Code specifically deals with requirements and output contracts and states that such contracts are not too indefinite since they are held to mean the actual good faith output or requirements of the particular party. Reasonable elasticity in the requirements is expressly envisaged and good faith variations from prior requirements are permitted even when the variation may be such as to result in discontinuance. See Comm. Code § 2306, comment 2. As stated in comment 2 to section 2306, “a contract for output or requirements is not too indefinite since it is held to mean the actual good faith output or requirements of the particular party. Nor does such a contract lack mutuality of obligation since, under this section, the party who will determine quantity is required to operate his plant or conduct his business in good faith and according to commercial standards of fair dealing in the trade so that his output or requirements will approximate a reasonably foreseeable figure.” Comm. Code § 2306, comment 2. Comment 2 even goes as far to say that “[a] shut-down by a requirements buyer for lack of orders might be permissible.” Id. Thus, great latitude is given to parties in forming requirements contracts.

Contracts permitting one party to unilaterally modify the contract are generally not held to be illusory or lacking in mutuality, even when such contracts fall outside the scope of the favorable Commercial Code provisions. For example, in 24 Hour Fitness, Inc. v. Superior Court (1998) 66 Cal. App. 4th 1199, plaintiff employee entered into an agreement with defendant employer in the form of a personnel handbook. 24 Hour Fitness, Inc., 66 Cal. App. 4th 1199, 1214. Plaintiff argued the arbitration clause in the agreement was illusory and fatally lacking in mutuality because the agreement allowed the defendant to modify any provision in the personnel handbook unilaterally. Id. The court found that the agreement was not illusory or lacking in mutuality because “[defendant]’s discretionary power to modify the terms of the personnel handbook in writing indisputably carries with it the duty to exercise that right fairly and in good faith.” Id.

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The above discussion is intended to be a general commentary on legal issues. Each situation is different and this article is not intended as legal advice. Further, nothing in this article is intended to create an attorney-client relationship.

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