Opinion ID: 3009593
Heading Depth: 1
Heading Rank: 4

Heading: The District Court Erred When It Rewrote

Text: the Parties' Contract in Favor of U&W Under the UCC as adopted by the Virgin Islands, V.I. Code Ann. tit. 11A, § 1-203 (1987), and the Restatement (Second) of Contracts § 205 (1981),5 all contracts impose an obligation of good faith and fair dealing in their performance and enforcement. See also Action Eng'r v. Martin Marietta Aluminum, 670 F.2d 456, 460 n.8 (3d Cir. 1982). This obligation of good faith 5 . The blanket contracts do not provide what local law is to govern their construction or interpretation. The parties assume that the law of the Territory of the Virgin Islands applies. Because the contract was entered into and performed in the Virgin Islands by two corporations organized and existing under the laws of the Virgin Islands, we agree and will apply Virgin Islands law. The Virgin Islands look to the Restatement for their common law. V.I. Code Ann. tit. 1, § 4 (1984); see also St. Surin v. Virgin Islands Daily News, Inc., 21 F.3d 1309, 1315 n.5 (3d Cir. 1994). incorporates honesty in fact as well as reasonable commercial standards of fair dealing. See V.I. Code Ann. tit. 11A, § 1-201 (defining good faith); Restatement (Second) of Contracts § 205 cmt. a. We have held that UCC section 1-203 imposes a general requirement of fundamental integrity in commercial transactions falling under the UCC. Skeels v. Universal C.I.T. Credit Corp., 335 F.2d 846, 851 (3d Cir. 1964). In this case, it is U&W's burden to prove that MMA acted in bad faith. See Tigg Corp. v. Dow Corning Corp., 962 F.3d 1119, 1123 (3d Cir.), cert. dismissed, 113 S. Ct. 834 (1992); HML Corp. v. General Foods Corp., 365 F.2d 77, 83 (3d Cir. 1966);6 see also V.I. Code Ann. tit. 11A, § 2-306. Because of the risk U&W agreed to expose itself to under the blanket contracts by undertaking to maintain a parts inventory adequate to meet MMA's usual production requirements, the district court decided that the duty of good faith which U.C.C. § 1-203 implies required it to add a notice term otherwise missing from the contract. We disagree. The implied duty of good faith and fair dealing in commercial contracts that section 1-203 imposes controls the manner in which the contracting parties carry out the obligations they have undertaken in a 6 . In Tigg we noted two different theories by which a court may decide who should bear the burden of proving bad faith: the case law approach, implying the burden should be placed on seller, and the commentator approach, favoring placing the burden on whoever is to benefit from a showing of bad faith. Tigg Corp., 962 F.2d at 1123-24. In HML Corp., we simply placed the burden on the plaintiff. HML Corp., 365 F.2d at 83. Here, under either theory, U&W is the appropriate party on which to place the burden. contract; it does not give a court the power to impose additional obligations on one contracting party because a court concludes it is unfair to have the other shoulder a market risk that the former expressly bargained to avoid and the other expressly agreed to assume. The district court relied on Tymshare, Inc. v. Covell, 727 F.2d 1145 (D.C. Cir. 1984), and KLT Industries, Inc. v. Eaton Corp., 505 F. Supp. 1072 (E.D. Mich. 1981) to reach its conclusion that the duty to act in good faith necessitated MMA's giving notice to U&W. Tymshare was a breach of contract action brought by a salesman against his former employer. The salesman alleged the employer breached the implied contractual duty of acting in good faith when it altered sales quotas in such a way as to deprive the plaintiff of previously earned commissions. Then-Judge Scalia noted that the doctrine of good faith performance is a means of finding within a contract an implied obligation not to engage in the particular form of conduct which . . . constitutes 'bad faith.' Tymshare, 727 F.3d at 1152. The court then noted that the object of our inquiry is whether it was reasonably understood by the parties to this contract that there were at least certain purposes for which the expressly conferred power to adjust quotas could not be employed. If not, then [the employer] is correct that no action in this regard could constitute 'bad faith'--or, as we would put it, there is no implicit contractual restriction. Id. at 1153. The court stated that the implied covenant of good faith does not countermand acts specifically authorized, id. (quoting VTR, Inc. v. Goodyear Tire & Rubber Co., 303 F. Supp. 773, 778 (S.D.N.Y. 1969), nor should it be permitted to dictate an outcome contrary to the intent of the parties. Id. (quoting MacDougald Constr. Co. v. State Highway Dep't, 188 S.E.2d 405 (Ga. 1972)). But, as the court in Tymshare noted, the trick is to tell when a contract has been so drawn. Id. (emphasis in original). KLT Industries provides one example of how a duty to notify may be included in the generalized obligation to act in good faith. In that case, two parties entered into an agreement where the plaintiff would design and fabricate six highly specialized test stands to be used by the defendant in testing and adjusting cruise control devices. Although the plaintiff did not perform on time, the defendant did not object and plaintiff continued on in the design and fabrication of the parts. Then the defendant, without notice, canceled the contract without giving the plaintiff an opportunity to demonstrate it could complete the contract. The court held that termination without notification violated the duty to act in good faith: The good faith obligation imposed by the UCC requires reasonable notification before termination to avoid surprise, protect good faith judgment and reduce uncertainty. Under the circumstances here [defendant's] conduct led [plaintiff] to reasonably believe it would have the opportunity to perform under the contract. At least [plaintiff] was entitled to the opportunity to demonstrate to [defendant] it could perform under the contract within the time frame contemplated . . . . KLT Indus., 505 F. Supp. at 1079-80. Thus, where the defendant permitted the plaintiff to continue a specialized contract and failed to object to a performance that did not strictly conform to the agreement, the defendant was required to give some notice of its intention to cancel the contract. Neither of these cases stands for the proposition that a party invariably has a good faith obligation to notify a supplier before reducing, altering or canceling an agreement. Instead, they merely acknowledge certain circumstances in which a general implied obligation to act in good faith will command or prohibit acts not specifically delineated in the agreement. But, as Tymshare recognized, the language of the agreement and expressed intent of the parties always guide the application of the implied duty of good faith. Here, MMA did not act in bad faith when it reduced or canceled some of the individual purchase orders issued under the contracts. When MMA sent U&W the individual purchase order reductions in July or August of 1984, it did so under section 18(a) of the contract. That section required no prior notice of such reductions but made MMA liable to pay U&W only for materials committed to the manufacture of PRODUCT ordered hereunder prior to the time of such cancellation. Jt. App. at 248.7 The district court incorrectly treated MMA's decision to reduce its own inventory as a change in MMA's requirements. 7 . U&W does not contend that MMA owes it any money for materials committed at the time of these cancellations and/or reductions. Although MMA decided to reduce its individual purchase orders because it wanted to reduce its own inventory and use up stocks on hand, it continued to maintain normal production and accordingly continued to place individual purchase orders with U&W as necessary to meet its usual production requirements until it closed its plant in May 1985. The blanket contracts were not canceled by MMA's actions because MMA continued to order parts from U&W and U&W continued to supply parts to MMA to meet MMA's normal production levels, in accordance with the blanket contracts. See infra note 12. Despite MMA's additional reliance on U&W for parts that resulted from MMA's decision to reduce its own inventory, MMA told U&W not to order certain additional parts until MMA told U&W it needed them and never objected to U&W's decision to reduce its own inventory of some of the parts it had agreed to supply to MMA. Indeed, with MMA's knowledge and implicit approval, U&W thereafter curtailed its own orders from its suppliers and delayed placing them until absolutely necessary to meet MMA's continuing requirements. In fact, this caused U&W's inventory of the parts it had agreed to supply to MMA to fall below that which would have been required to meet the estimated production levels MMA continued to maintain, thus putting U&W itself in technical breach of its express obligation to maintain an inventory adequate to meet MMA's unchanged production requirements.8 MMA 8 . This is consistent with Knorr's testimony that he understood if [U&W didn't] have the quantities on hand even up to the end of the agreement[,] the agreement can be terminated. Jt. App. at 311. not only acquiesced in this, it told U&W not to order certain additional parts unless advised otherwise.9 In order to help U&W reduce its inventory, U&W's Knorr testified MMA also extended delivery times on orders for items U&W still had on its shelves. MMA's previously specified production levels were the guide the blanket order agreement required U&W to use in deciding how many parts it had to keep on hand to meet its obligations under the blanket contracts. Paragraph 19 of the blanket contract required MMA to give U&W notice of changes in its production level because MMA's production level was the basis for U&W's inventory levels. See Jt. Ap. at 248. Ross testified MMA's production levels and its commensurate needs did not change until shortly prior to the plant's closing on May 12, 1985, and there is no other evidence in the record showing that MMA decreased its production levels between July of 1984 and May of 1985.10 Under the blanket contracts, MMA was not obligated to buy any product from U&W beyond placing one initial order within ninety days of entering into each contract. U&W expressly agreed to bear the market risk of disposing of unneeded inventory it had 9 . We note, however, that the court did correctly grant summary judgment to MMA on the two blanket contracts under which MMA had advised U&W not to order additional parts. 10 . Knorr did testify that he noticed a decrease in MMA's production levels during the first quarter of 1984, (App. at 317) but U&W does not claim any damages resulted from this reduction. Although U&W alleges it was harmed by a decrease in MMA's production levels in July of 1984, there is no evidence supporting U&W's allegation that MMA's production decreased between July 1984 and May 1985 when the plant closed. purchased to meet MMA's normal requirements when its contract with MMA was terminated. See Jt. App. at 248. This unrebutted evidence contradicts any implicit finding the district court may have made that MMA dealt unfairly, dishonestly or unreasonably with U&W.11 Thus, U&W, the moving party on its motion for partial summary judgment, has failed to produce evidence from which it could be inferred that MMA acted in bad faith. See HML Corp., 365 F.2d at 83. U&W took a calculated business risk when it agreed to supply MMA with parts as needed. It accepted the risk that it would have to dispose of unused inventory if MMA canceled the contract or went out of business. This risk is inherent in requirements contracts. The contract did not oblige MMA to make any more than one order, let alone notify U&W if it would not be placing its usual amount of purchase orders. It is indeed unfortunate that U&W was unable to return the parts it had on hand when MMA terminated the contract in May of 1985, but this is a risk it assumed when it agreed to supply MMA's requirements on MMA's terms.12 In a requirements contract, 11 . The district court stated that MMA's unbridled discretion [to expose U&W to great risk in requiring it to keep the same inventory even though MMA had decreased its own] requires a corresponding duty to act in good faith. Jt. App. at 209. Thus, it implied a notice provision because a good faith performance required advanced notice. Id. The court never expressly found that MMA acted in bad faith but that finding is implicit in its decision to add a second notice requirement into the blanket order agreements. 12 . U&W co-owner John McCallum (McCallum) testified he did not try to return any of his stock when he received the reduction and/or cancellation orders from MMA because he did not believe the contracts were terminated by MMA's actions. He testified [t]he seller assumes the risk of all good faith variations in the buyer's requirements, even to the extent of a determination to discontinue the business. Welded Tube Co. of Am. v. Phoenix Steel Corp., 377 F. Supp. 74, 79 (E.D. Pa. 1974), aff'd in relevant part, 512 F.2d 342 (3d Cir. 1975); see also HML Corp., 365 F.2d at 81. MMA did not breach its contract with U&W or contravene its duty to act in good faith in May of 1985, when it closed its Virgin Islands bauxite plant, or in July of 1984, when it notified U&W it planned to reduce its own inventories while maintaining pre-existing production levels. See Welded Tube Co., 377 F. Supp. at 79.13