Commercial law, as codified by the Uniform Commercial Code (“UCC”), recognizes certain important commercial realities as a basis to override property law. In a new article, I examine that recognition in connection with the UCC’s allocation of the risk of loss to goods in transit. The general rule, provided by UCC § 2-509, is that the risk of loss is borne by the party who “control[s] the goods and can be expected to insure his interest in them,” whether or not that party owns the goods at the time of their loss. Promoting that reality over the “arbitrary shifting” of rights based on property has been widely praised. Among other things, it avoids the extensive litigation under prior law over who had title at the time of the loss. This reality-based allocation of the risk of loss has also been adopted by the United Nations Convention on Contracts for the International Sale of Goods (CISG).

Shortly after UCC § 2-509 was enacted, however, it was modified by a new UCC provision, § 2-510, which governs risk of loss where there has been a breach. My article analyzes § 2-510, criticizing its fatally flawed rationale that breaching a business contract is morally wrong. Furthermore, the article shows that § 2-510’s convoluted risk reallocation undermines commercial realities and can produce unreasonable, if not absurd, results.

The legislative history of UCC § 2-510 itself reflects the controversy. After that section was enacted, the Permanent Editorial Board for the Uniform Commercial Code (“PEB”) published a report recommending that the section be repealed or revised. The report observed that § 2-510’s reallocation of the risk of loss for breach does not require that the breach have caused the loss, nor is the fact of breach tied to which party is the least-cost insurer of the goods. Its effect, therefore, is sometimes to reallocate the risk from the party in the better position to insure to the contract breacher who, presumably, is not. This result makes little sense in a commercial statute. Nonetheless, the PEB’s report ultimately was ignored due to concerns that repealing or revising § 2-510 would be too controversial.

My article argues for that repeal or revision. Fundamentally, § 2-510 is inconsistent with efficient-breach theory. Breaching a contract is not morally wrong, at least in a modern commercial context, because the party affected by the breach has an economic remedy: It receives money damages in place of performance. Section 2-510 is also inconsistent with the UCC’s general theory of risk allocation: to allocate risk of loss based on who would be expected to insure the goods at the time of their loss. This inconsistency can produce absurd results.

For example, assume that a manufacturer ships goods to a buyer pursuant to a standard contract, which requires or authorizes the goods to be shipped by a common carrier. Under UCC § 2-509(a)(1), the risk of loss would pass to the buyer when the manufacturer delivers the goods to the carrier. At that point, the buyer – and no longer the manufacturer – would normally insure the goods. Nonetheless, as next illustrated, the buyer could sometimes use § 2-510 to unexpectedly shift the risk of loss back to the manufacturer.

Say, for example, an accident to the carrier causes the goods to sink in a river. If the buyer hires a diver that finds just one non-conforming widget, the “tender or delivery of goods” would, under § 2-510(1), “so fail[] to conform to the contract as to give a right of rejection” because UCC § 2-601 (the “perfect tender rule”) gives such a right of rejection for failure “in any respect to conform to the contract.” In that case, “the risk of . . . loss remains on the seller.” That reversal of the risk of loss could be devastating to the manufacturer, especially if (as would be the commercial norm) its insurance on the goods terminates once they are loaded onto the carrier.

Nor do the few cases decided under UCC § 2-510 make a compelling case for its retention. In one prominent case, for example, a buyer purchased a mobile home with the seller’s promise to do a “complete set-up,” which included anchoring the home. Shortly after its delivery, the home was destroyed by a windstorm. The court ruled that the seller was in breach because it did not anchor the mobile home; therefore, under § 2-510(1), the risk of loss remained with the seller. The existence of UCC § 2-510(1) was not essential, though, to that outcome because under other provisions of the UCC, the buyer had not yet accepted the mobile home and, therefore, the risk of loss had not yet shifted to the buyer.

Another case, however, suggests that subsection (3) of UCC § 2-510 might arguably make commercial sense. A plaintiff-manufacturer contracted to deliver 40,000 pounds of plastic pellets to the defendant-purchaser. The manufacturer contacted the purchaser after producing the pellets, requesting payment and delivery instructions. The purchaser responded that it would send instructions but in fact never did. Over a month later, the manufacturer’s warehouse burned down, destroying the pellets, which – because the pellets should already have been shipped to the purchaser – were no longer covered by the manufacturer’s insurance. The court held that the purchaser breached the contract by not accepting and paying for the pellets; therefore, under UCC § 2-510(3), the breach shifted the risk of loss to the purchaser. Subsection (3) thus might make sense in similar situations, in which a buyer’s breach leads to a scenario where a reasonable seller is no longer insuring the risk of loss, thereby creating a link between the breach and casualty to the goods.

This post comes to us from Steven L. Schwarcz, the Stanley A. Star Distinguished Professor of Law & Business at Duke University School of Law. It is based on his recent article, “UCC § 2-510: A Commercial Law Blunder?” available here.