Are you Selling Goods or Services? Why it Matters.

Monday, April 19, 2021

Metal-finishers typically plate or coat a customer’s metal parts with a finish, for a per unit fee.  The metal finisher purchases the finish materials, but neither buys nor sells the part itself, instead holding the parts as a bailee of the customer. 

In Challenge Mfg. Co. v. Metokote Corporation, Case No. 19-10312 (Kent County Circuit Court, March 24, 2021), the Court addressed whether the metal finisher is selling goods or services.  The question matters because the rules of contract law differ depending on whether goods or services are being sold. The sale of goods is governed by Article 2 of the Uniform Commercial Code (UCC), a statute that has been enacted in all 50 states.  As the name suggests, the UCC was intended (and has imperfectly succeeded) to bring 50 state uniformity to the law of contracts for the sale of goods.  Conversely, services are governed by the common law of contracts, i.e. centuries of case law, with greater state to state variation.  And there are a host of important practical questions that turn on which body of law applies.  For example, the statutes of limitation differ, as do rules for contract formation, modification and interpretation, “battle of the forms,” implied warranties and many other things.  Of course, the goods vs. services question arises in many contexts, not merely metal finishing.  So, the question matters to many commercial parties

Sometimes the categorization is obvious, but when the business transaction involves both goods and services, it is far from obvious.  For example, a roofer installs (a service) shingles (a good).  A plumber unclogs a drain by replacing the trap.  A seller of industrial equipment provides sophisticated design, engineering and installation services. A new automobile cannot be sold without extensive post-sale warranty services.  The examples are myriad.  Does the UCC or the common law of contracts apply in those situations?   As shall be seen, courts have struggled to provide clear answers to that question.

Michigan Law

In Michigan, the question of goods or services is decided under the “predominant purpose” test, i.e., whether the acquisition of goods is the buyer’s predominant purpose or “ultimate goal,” with related services incidental, or vice versa.  But “predominant purpose” provides, at most, a conceptual framework, not clear answers in hard cases.  As a result, there is an extensive body of case law answering the “predominant purpose” question through a highly fact-specific analysis that does not yield rules that are readily applied to the next case, with its unique facts.

It is this “predominant purpose” test which the Court sought to apply to metal finishing in Challenge Mfg.  (Before further explaining the case, note that it is a trial court decision, and thus is not binding on any other court).  The transaction involved both goods and services because the metal finisher was providing both the coating material (a good) and its application (a service).

The Court concluded that the buyer’s predominant purpose was to receive goods, not services, based on three grounds.  First, it relied on an unpublished (and thus not precedential) Michigan Court of Appeals decision holding that metal finishing was considered a good.  But, as the Court acknowledged, the case involved a dispute under Michigan’s Single Business Tax, not a contract case, and which tax rate applies to a transaction need not have the same answer as which body of contract law applies.  Second, the Court reasoned that “it was the actual coatings . . . that added value to its customers' automotive parts.”  But this conclusion is questionable, at best.  Presumably the customer typically uses a metal finisher because of its skill in applying the coating, not because it owns a bucket of chemicals.  Also, even if the Court’s analytic framework were correct, that would seem to require a case by case factual analysis, not one that lends itself to a broad rule.  It would seem to matter, for example, whether the cost of coating chemicals represent 90% or 10% of the fee charged by the metal finisher.  Moreover, Michigan law actually has answered the house painter question posed above— it is a service, with the paint being incidental.  But it is presumably a painted wall that adds value to a home, not the act of applying paint (or of owning a can of paint).  The analogy between house painting and metal finishing seems close, but it was ignored by the Court.  A Michigan court has likewise held that a seller which receives a customer’s goods as a bailee and uses its ingredients and services to process those goods for a fee is providing a service not goods.  Again, the analogy seems close.  In sum, the Court’s first two reasons are questionable.

The third reason is more provocative and perhaps more persuasive.  The Court explains:

Participants in supply chain transactions in the automotive industry have come to rely upon the detail, precision, and certainty afforded by the UCC, which was adopted in Michigan and other states to ensure uniform rules of engagement.

Although the Court doesn’t frame it this way, this suggests a potentially appealing answer to the goods or services question: If it is a close question, choose goods, because the UCC provides clearer and more consistent answers than the common law of contracts.  Or, from a different perspective, had the parties thought about it when they entered into the contract, they likely would have chosen the UCC because, all things being equal, commercial parties prefer clearer and more consistent answers.  And commercial parties prefer quick and inexpensive answers to the goods or services question.  It is a fair guess that few businesspersons would consider time and money spent on arguing about whether a transaction should be labelled a good or services as money well spent. (Of course, the relevant perspective is at the time of contracting; once a dispute arises, a party will always prefer whichever answer supports its position).

Practical Advice

As is usually the case, the best way for contracting parties to avoid legal uncertainty is to expressly answer the question in the contract.  Don’t leave it to a court to decide (and attorneys to argue about) the question. Thus, a contract might specify that Article 2 of the UCC does (or does not) apply.  And, although not necessarily determinative, care should be taken in characterizing the transaction within the contract.  Referring to the subject matter of the contract as “goods,” when it is intended to be a service is not helpful.

As to whether the UCC or common law is substantively preferable (i.e., will give the answer you prefer), there is no answer in the abstract.  “Who’s asking” is the only sensible answer to the question “is a 4-year (UCC) or a 6-year (common law) statute of limitations better.”  If a business is repeatedly confronted by a particular type of dispute, it might be possible to analyze which body of law is preferable for that particular type of dispute, but that is usually difficult.  More importantly, if that is the case, the question can be specifically addressed in the contract.  If you want certainty about the statute of limitations, the contract can say “all claims most be brought within X years of Y event. Similarly, those familiar with the UCC know that the seller automatically gives certain implied warranties, unless the contract says otherwise.  If you are a seller that does not want to be subject to implied warranties, it is far better to say so in the contract, rather than to argue about whether it is a goods or services contract.

Although there is not a generalizable substantively correct answer, there is still a strong basis for preferring the UCC because, as recognized in Challenge Mfg., the UCC usually provides clearer and more consistent answers. 

Finally, the goods or services issue again illustrates that time spent upfront at the contracting stage is generally time and money well spent, as compared to waiting for litigation to answer important questions.

For further information about these issues, please contact the author of this Client Alert.

Sheldon Klein

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