Integrated Circuits Unlimited appeals from a final judgment entered on August 10, 1988 in the United States District Court for the Eastern District of New York (Weinstein, J.) in its favor against appellee E.F. Johnson Co. in the sum of $4,638.73 for breach of contract respecting the sale of certain microprocessors. Appellee cross-appeals. Judgment reversed and vacated, and matter remanded to district court to grant judgment and award damages to cross-appellant.
Appellant Integrated Circuits Unlimited (ICU), a seller of electronic components, appeals from an order of the United States District Court for the Eastern District of New York (Weinstein, J.) dated August 10, 1988, ordering defendant-appellee, E.F. Johnson Co. (Johnson) to pay ICU the sum of $4,638.73. The district court's opinion is reported at 691 F. Supp. 630 (E.D.N.Y. 1988). ICU had sought recovery of the full contract price amounting to $160,725 for the microprocessors it sold to Johnson. Johnson cross-appeals arguing that the district court's legal analysis should be upheld, but that the logic of its decision requires that the judgment be modified to award no damages to ICU, and instead to award judgment in Johnson's favor in the amount of $10,359.
This appeal is a diversity case which arises from a dispute regarding a series of contracts for the sale of goods, and is therefore controlled by Article 2 of the Uniform Commercial Code (U.C.C. or Code), as adopted by the State of New York. Here, the issues that we must decide are whether, under the Code: (1) a buyer's effective rejection of goods, wrongful or not, entitles the buyer to obtain a refund of the purchase price it paid, subject only to the refund being discounted by the amount of the seller's actual damages; or (2) if the buyer's rejection is effective, but wrongful, may the seller maintain either an action for the purchase price or for its lost profits?
ICU sells electronic components. Johnson manufactures two-way taxi radios. When, in early 1984, Johnson found itself unable to obtain necessary electronic parts from its usual sources of supply because the demand for certain types of microprocessors exceeded the available supply, it purchased several lots of these parts from ICU. The price of the components would ordinarily have been about $30 each, but because of the short supply Johnson's three purchase orders in March 1984 were at least $55 per unit above the previous market price. It placed purchase order number WO4746 for 2,500 UPD8748 microprocessors at $85 each, order number WO4747 for 2,500 D8748H microprocessors at $87.50 each, and order number WO4750 for 1,100 D8749 microprocessors at $120 each. Johnson bought a total of 6,100 of these electronic devices. From March to April 1984 ICU delivered to Johnson in several separate shipments, 1,709 UPD8748 microprocessors, and Johnson paid $23,800 on March 30 for 280 of them. Johnson also received all 1,100 D8749's, for which it paid the full contract price of $132,000. No other payments were made in March or April 1984.
On April 24 Johnson sent ICU a letter in which it purported to reject 130 of the UPD8748's that had been shipped in late March. The rejection was based upon tests conducted by an independent laboratory which indicated that an unacceptable percentage of the devices were of substandard quality. The next day Johnson sent ICU a similar letter stating that the D8749 units had also failed to meet its acceptable quality level, and offered their return for credit. On May 8 Johnson sent ICU a list of 1,973 microprocessors that it wished to return based on these test results. Under separate cover, it sent ICU 18 samples of those rejected so that ICU could conduct its own tests.
On a number of occasions from May until August 1984 the buyer requested authorization from the seller to return the rejected devices. ICU continued to demand payment of its invoices, and refused to accept the rejects. On May 21 Johnson paid $70,465 to ICU in full payment for 829 parts received in mid-April. On August 15, 1984 Johnson informed ICU that it was returning the entire lot of rejected devices -- consisting of 1,973 microprocessors -- and at the same time debited ICU's account $170,450, the amount equal to the value of the rejected parts, minus the 18 samples previously returned and debited. Johnson also withheld payment on two unpaid ICU invoices totalling $160,725. When a carrier attempted delivery of the rejected parts, ICU refused delivery and the goods were returned to Johnson, which has since held them in good condition for ICU's account.
In considering the merits of the parties' respective contentions, the district judge properly distinguished between substantively wrongful and procedurally ineffective rejections. See N.Y. U.C.C. § 2-602 (McKinney 1964); see also J. White & R. Summers, Uniform Commercial Code 314 (2d ed. 1980). The basic principle is that the buyer may make a procedurally "effective" rejection of goods it purchased, even though such rejection is substantively wrongful. "Wrongful" refers to a rejection of conforming goods, whereas an "effective" rejection is timely and indicates the buyer has satisfied the procedural obligations attendant upon his rejection. The distinction is important because if a buyer's rejection is procedurally effective -- even though wrongful -- a seller is barred from recovering the contract price. But the buyer is subject to liability for the seller's actual damages brought about by the buyer's refusal to accept the goods it purchased. See White & Summers, supra at 258 ("'[Buyer] may have the power to make an 'effective' rejection even though his action is in breach of contract and subjects buyer to liability for damages.'" (quoting 1 N.Y. State Law Revision Comm'n 1955 Report 520 (1955))).
Although the trial court initially concluded that Johnson's rejection of all 1,973 parts had been substantively wrongful, in its final memorandum and order it reconsidered this earlier conclusion and held that the defects found in five percent of the parts rendered the shipments "nonconforming in their entirety." 691 F. Supp. at 632. The district court also ultimately concluded that all but 174 of the 1,973 parts listed in Johnson's letter of May 8 had been rightfully rejected. It held that regardless of whether Johnson's rejection had been substantively justified, it had been procedurally effective. Thus, it correctly concluded that ICU was limited to recovering nonacceptance damages on the 174 wrongfully rejected parts, and could not maintain an action for the purchase price under U.C.C. § 2-709, which requires an "acceptance" by the buyer as a prerequisite to the seller's recovery of the price. Acceptance, which is defined under § 2-606 as "[failure] to make an effective rejection," never occurred. In addition, the district court also held that Johnson's actions following its rejection had been proper. It ruled that the buyer had complied with U.C.C. § 2-602 by holding the rejected goods with reasonable care for a long enough period of time to permit ICU to remove them.
Judge Weinstein did not believe Johnson had any obligation under U.C.C. § 2-603 to resell the rejected parts because the goods were not perishable and ICU -- as a seller of microprocessors -- was in a better position to resell than Johnson, which had no access to the market for these devices. 691 F. Supp. at 635. The inflated market price at which Johnson had contracted to purchase the microprocessors was found by the district court to have continued as the market price for several months after Johnson's rejection. Thus, ICU should have accepted the returned goods and promptly resold the 174 wrongfully rejected parts on the open market. Had ICU elected to pursue this course of action, it would thereafter have been entitled to recover the difference, if any, between the contract price and the resale price, plus its incidental damages. See U.C.C. §§ 2-706 & 2-710.
Because ICU failed to accept and resell the rejected goods, it was thereby limited in the damages it could recover to the difference between the contract price and the market price at the time Johnson rejected the goods. U.C.C. § 2-708(1). Using the contract price/market price differential as the measure of damages, the district court concluded that ICU was entitled to none; the contract and market prices for microprocessors at all times relevant to this suit were the same, and ICU failed to prove any incidental damages. Further, given the limited supply of these parts the trial court ...