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Terms and Conditions That Minimize the Risk Of Loss In Shipping & Destination Contracts


From the July 2001 edition of Managing Exports

Many of us have been exposed to legal risk of loss concepts as far back as early childhood. When children play ball, one inherent risk is that the ball may land in the woods and not be found. Children can sometimes be seen in pre-game negotiations in which the players agree whether or not the owner of the ball assumes the risk that some other player might accidentally hit or throw the ball into the woods.

Purchasing managers and suppliers deal with similar risk of loss issues, although in their case the stakes can run into many thousands of dollars. Even if neither seller nor buyer is at fault, goods intended for the buyer may be lost or damaged. If the buyer has the risk of loss, and the goods are lost before they reach the buyer, the buyer may be obligated to pay for them. Conversely, if the seller is found to have the risk of loss, the seller will have to replace the lost goods or be liable to the buyer for breach of contract.

In negotiating a contract, the purchasing manager should be aware of the rules stated in the Uniform Commercial Code (UCC). Under the UCC, the parties may make an agreement concerning risk of loss. However, the UCC sets forth a detailed set of rules that will govern unless the parties agree otherwise.

In some cases, the parties set out a specific agreement regarding risk of loss. However, even if they do not have time to draft a detailed agreement, they can use certain terms, described below, that have a universally recognized meaning in terms of allocating the risk of loss.

If the seller and buyer have adequately protected themselves with insurance to cover casualty losses involving the goods, then litigation, if any, will simply be between the buyer's and continued on page 10 seller's insurers to determine which of them must pay the loss. However, anyone who engages in risk management for either the seller or buyer should be familiar with the risk of loss rules, in order to determine the amount and type of insurance coverage that is needed.

Before discussing the specific UCC sections governing risk of loss, it is helpful to define certain terms. In some cases, the risk of loss passes to the buyer upon the seller's ¤tender of deliveryË of the goods. UCC Section 2-503, which relates to tender of delivery, states that the seller must put and hold the goods at the buyer's disposition and give the buyer any notification reasonably necessary to enable him or her to take delivery. Moreover, the seller must tender goods at a reasonable hour (normal business hours, not 3 A.M. on a Sunday morning), and keep them available for the period of time reasonably necessary for the buyer to take possession. In addition, unless otherwise agreed, the buyer must provide facilities reasonably suited to the receipt of goods.

It is inadvisable to direct the seller to deliver the goods after normal business hours, when there are no competent people around to receive them. If the goods, say, are left outside the buyer's place of business and are stolen, the buyer absorbs the loss.

It is also important for the seller to instruct delivery personnel to make sure that the goods are left with an authorized representative of the buyer. In one case, a delivery person left the goods with an unidentified person, outside the buyer's business premises, and the goods were subsequently lost. The court held that the delivery was ineffective to pass the risk of loss to the buyer.

UCC Section 2-504 governs contracts calling for delivery of goods to the to the buyer by means of a common carrier (ships, trucks, air freight, etc.). Such contracts are of two types: shipping contracts and destination contracts.

In a shipping contract, the seller is required only to put the goods in the hands of a carrier and to make such a contract for transportation as may be reasonable, having regard to the nature of the goods; arrange for transmission to the buyer of any documents necessary for the buyer to obtain possession of the goods; and to promptly notify the buyer of the shipment. For example, if the goods are fragile or perishable, the seller has to arrange with the carrier for special handling, so that the goods will likely be received by the buyer in satisfactory condition. In a destination contract, however, the seller is legally responsible for the shipment of the goods to an agreed-upon destination (usually at or near the buyer's place of business). Unless the contract specifically states that it is a destination contract, the law assumes that the parties intended a shipping contract. In one case, where the carrier's receipt printed the names and addresses of 12 different buyers, but did not specifically require that the goods be delivered to specific destinations, the court held that a shipping contract, rather than a destination contract, was intended.

UCC Section 2-319 explains the terms F.O.B., it means ¤free on boardË and F.A.S. ¤free along side. These terms were first used many years ago when ships were the means for delivery of goods. They are still used in connection with marine transportation, but can also be used where the contract calls for delivery by some other means, such as trucks or airplanes. Where the contract states ¤F.O.B. place of shipment,Ë the seller must at that place (usually in the city where the seller does business) ship the goods are bear the expense and risk of putting them into the hands of the carrier. On the other hand, where the contract states ¤F.O.B. place of destination,Ë the seller must at his own expense and risk arrange for transportation of the goods to that place and tender delivery to the buyer (usually at or near the buyer's place of business). Suppose the seller is located in California and the buyer is located in Ohio. Under an ¤F.O.B. place of shipmentË contract, the risk of loss passes to the buyer after the seller places the goods into the hands of a carrier in California. However, if an ¤F.O.B. destinationË contract is used, the seller would be legally responsible if the goods were lost between California and Ohio.

The F.O.B. term generally controls even if other language in the contract contains seemingly contradictory risk of loss terms. Suppose the contract says ¤F.O.B. Miami Beach,Ë but in another place states ¤ship to Waikiki Beach in Hawaii.Ë What happens if the goods are lost in transit between Miami Beach and Hawaii? Some buyers might attempt to argue that the term ¤ship to HawaiiË made this a destination contract, but most courts would say that use of the word ¤F.O.B. MiamiË would control, so that the carrier's responsibility would end upon delivery of the goods to the carrier in Miami Beach.

If a contract uses the term ¤F.A.S. vessel,Ë this means that the seller must, at his own expense and risk, deliver the goods alongside the vessel in the manner usual in that port or on a dock designated and provided by the buyer. Thus, once the seller delivers the goods alongside the vessel, the seller's obligation is completed, and if the goods are thereafter lost or damaged, the buyer absorbs the loss.

Note that even if the seller is not legally responsible for the loss, the buyer may be able to recover the loss from the carrier, provided that the loss was due to the fault of the carrier. Where the buyer has insurance, the buyer's insurer will compensate the buyer for the loss and then, if possible, recover reimbursement from the carrier.

UCC Section 2-509 is the main section that applies to risk of loss in cases where neither the seller nor the purchaser has breached the contract. If a shipping contract is used, the risk of loss passes to the buyer when the goods are delivered to the carrier.

On the other hand, if a destination contract is used and the goods are tendered to the buyer while they are still in possession of the carrier, the risk of loss passes to the buyer when the goods are so tendered as to enable the buyer to take delivery. This means that if the buyer is notified that the goods are now available to be picked up from the carrier, and they are lost or damaged before the buyer picks them up, the buyer absorbs the loss.

  • The second part of Section 2-509 deals with cases where the goods are in the possession of a third party, known as a bailee (e.g. the owner of a warehouse) who is holding them for the benefit of either the seller or buyer, as the case may be. Even though the goods are not being moved, the contract calls for the transfer of goods from the seller to the buyer. In such a case, the risk of loss passes to the buyer on either the buyer's receipt of a negotiable document of title covering the goods, or some other act or writing of the bailee acknowledging the buyer's right to possession. Court decisions have said that it is not enough for the bailee to merely notify the buyer that the goods are now being held for the buyer; there must be some direct notification of to the buyer before the buyer will assume the risk of loss of the goods.
  • The third part of Section 2-509 governs cases that do not fall within the first two parts. For example, it is common for contracts to call for the buyer's pickup of the goods at the seller's place of business. In such cases, the risk of loss passes to the buyer upon of the goods, if the seller is a merchant; otherwise, the risk passes to the buyer on the tender of delivery. In most situations faced by purchasing managers, sellers are considered merchants (see UCC Section 2-104 for definition), so that once the buyer picks up the goods, they are his or her responsibility.

UCC Section 2-327 deals with risk of loss in cases where the contract gives the buyer the absolute right to return the goods within a defined time period. This is called a ¤sale on approvalË if the goods are intended for use by the 11 buyer, and a ¤sale or returnË if the goods are intended to be resold to the buyer's own customers. With a sale on approval, the buyer does not assume the risk of loss until acceptance of the goods (either express acceptance, or deemed acceptance if the buyer fails to notify the seller within a reasonable time of his or her intent to return the goods).

If the buyer notifies the seller within a reasonable time of his or her intent to return the goods, and follows any reasonable instructions of the selling in effecting the return, the seller assumes the risk if the goods are lost or damaged on route from the buyer back to the seller. On the other hand, with a sale or return, the buyer is legally responsible for the safe return of the goods back to the seller.

What happens if the seller sends goods to the buyer which do not meet the contract specifications? The UCC calls these ¤non-conformingË goods. UCC Section 2-510 states that if defects in the goods are sufficiently severe as to give the buyer the legal right to reject them, the risk of loss remains on the seller until the seller cures the defect or until the buyer agrees to accept the goods in their less-than-perfect condition.

What if the buyer accepts the goods but later discovers defects that give rise to a legal right to revoke acceptance? In that case, the buyer gets compensated for the loss by his own insurance carrier, but the seller absorbs the loss to the extent of any deficiency in insurance coverage.

Where, however, the problems are relatively minor, the purchasing manager should not assume that the risk of loss is still on the seller. In one case, a buyer bought a piece of equipment which worked well, but the seller had inadvertently omitted a chart which was needed to calibrate the machine. The particular chart would have readily been available from neighboring equipment dealers or could have been obtained quickly simply by calling a toll-free number. In any event, the seller promptly mailed the missing chart to the buyer. The machine was destroyed by fire after it was delivered but before the chart arrived. The court held that in the interests of fairness, the buyer, rather than seller, had to bear the loss.

If a purchasing manager is dissatisfied and plans to return the goods regardless of the outcome of any legal dispute relating to the alleged defects, special care must be taken. If a court later rules that the buyer had no legal right to reject the goods, and they are lost or damaged in transit, the buyer will absorb the loss to the extent that it is not covered by the seller's insurance.

Where the contract in question involves a substantial amount of money, it is best to have a specific agreement regarding risk of loss, rather than leaving the matter for interpretation by a court. In any event, however, purchasing managers should communicate regularly with the company's insurance or risk manager to make sure that the company has enough insurance to cover the loss of goods.

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