Attorneys for Appellant
Stephen L. Vaughan
Thomas J. Campbell
Locke Reynolds Boyd & Weisell
Indianapolis, IN
Attorneys for Appellee
Robert A. Garelick
Bryan S. Redding
Cohen, Garelick & Glazier
Indianapolis, IN
IN THE
INDIANA SUPREME COURT
RHEEM MANUFACTURING
COMPANY,
Appellant (Defendant below),
v.
PHELPS HEATING & AIR
CONDITIONING, INC.,
Appellee (Plaintiff below).
)
) Supreme Court No.
) 49S02-0003-CV-219
)
) Court of Appeals No.
) 49A02-9807-CV-620
)
)
)
)
APPEAL FROM THE MARION SUPERIOR COURT
The Honorable Steven H. Frank, Judge
Cause No. 49D13-9607-CT-1202
ON PETITION TO TRANSFER
May 9, 2001
SULLIVAN, Justice.
Phelps expended considerable sums repairing Rheem furnaces that Phelps
had sold and installed. We hold that the language of the UCC precludes
Phelps from recovering consequential damages from Rheem for breach of
express warranty and that the language of the express warranty at issue
precludes Phelps from recovering for labor expenses. However, Phelps may
still have valid claims for indemnity and breach of implied warranty.
Background
We will briefly explain the background of this case; for a complete
discussion, see the Court of Appeals opinion in Rheem Mfg. Co. v. Phelps
Heating & Air Conditioning, Inc., 714 N.E.2d 1218 (Ind. Ct. App. 1999).
Rheem Manufacturing Company (“Rheem”) makes furnaces for use in homes
and offices. During the late 1980s and early 1990s, Rheem sold its
furnaces through a distributor, Federated Supply Corporation (“Federated”).
Federated in turn sold Rheem furnaces to Phelps Heating and Cooling
(“Phelps”), a central Indiana contractor.
The box in which every furnace was shipped contained the following
warranty:
Manufacturer, RHEEM AIR CONDITIONING DIVISION, warrants ANY PART of
this furnace against failure under normal use and service within the
applicable periods specified below, in accordance with the terms of
this warranty.
(R. at 105.) This express warranty was limited by three clauses that are
at the heart of this appeal. First, Rheem limited the remedies available
for breach of the warranty to replacement of parts:
Under this Warranty, RHEEM will furnish a replacement part that will
be warranted for only the unexpired portion of the original warranty
... .
(Id.)[1] Second, Rheem disclaimed consequential and incidental damages:
ANY CLAIMS FOR INCIDENTAL OR CONSEQUENTIAL DAMAGES ARE EXPRESSLY
EXCLUDED.
(Id.) Finally, Rheem disclaimed any liability for the cost of servicing
the furnaces:
This Warranty does not cover any labor expenses for service, nor for
removing or reinstalling parts. All such expenses are your
responsibility unless a service labor agreement exists between you and
your contractor.
(Id.)
During the early 1990s, several types of Rheem furnaces malfunctioned
after Phelps installed them. A Phelps executive testified that from “late
1989 until 1993, Rheem had virtually no high efficiency furnaces on the
market that were not experiencing reliability problems … .” (R. at 326.)
While Rheem issued numerous “technical service bulletins” offering
instructions on how to fix these problems, Phelps customers experienced
difficulties for another three to four years.
Phelps executives met with a Rheem service representative on May 11,
1994. At this meeting, Phelps requested between $40,000 and $65,000 to
compensate it for the cost involved in servicing the furnaces. Rheem
rejected this request.
Phelps brought suit against Rheem and Federated on August 8, 1994,
claiming that Rheem breached its express and implied warranties and was
negligent in its manufacture of the furnaces. Underlying all of these
claims is Phelps’s assertion that the furnaces “shut down and were not
operational after installation. Among other things, the pilot assemblies,
hot surface ignitors, flame sensors and ignition controls failed.” (R. at
26.) The complaint first contended that Rheem breached the implied
warranty of fitness for a particular purpose because Rheem and Federated
“knew that Phelps intended to use the furnaces and install them in
properties serviced by Phelps” (R. at 21) but the furnaces were “defective,
and after they had been installed … they failed to function properly.”
(Id.) Similarly, Phelps sought damages for breach of the implied warranty
of merchantability, contending that Rheem and Federated were merchants but
that the defects in the furnaces made them “unsuitable and posed a risk of
personal injury and property damages to customers serviced by Phelps … .”
(R. at 23.) Phelps also asserted a claim under the express warranty,
arguing that it “incurred substantial expenses and other damages in
remedying the problems caused by the defective furnaces.” (R. at 25.)
Finally, Phelps claimed that “Rheem and Federated Supply were negligent and
careless in their design and sale of the furnaces by failing to manufacture
and provide furnaces which were operational and in reasonable working
order.” (R. at 26.)
Phelps described its damages as including “but not limited to, lost
customers, lost profits, and the additional cost of servicing the defective
furnaces and remedying the defects therein.” (R. at 22.) In answers to
interrogatories, Phelps listed its warranty damages as “lost service
charges,” “lost labor charges,” “lost profits” from two customers who would
no longer do business with Phelps, and the “approximate value of office
time spent … comput[ing] damages.” (R. at 225.)
Rheem moved for summary judgment on all of these claims. Rheem’s
brief in support of its motion asserted that the damages Phelps sought on
the warranty theories were precluded by the limitations in the express
warranty and by lack of privity on the implied warranties. Rheem also
argued that Phelps could not claim tort damages for the purely economic
injuries that resulted from the failure of the furnaces to operate as
intended. The trial court granted Rheem’s motion for summary judgment in
regards to negligence, but denied it as to the warranties.
Rheem sought an interlocutory appeal on the warranty claims and the
trial court certified its order. The Court of Appeals affirmed the denial
of summary judgment. Rheem Mfg. Co. v. Phelps Heating & Air Conditioning,
Inc., 714 N.E.2d 1218 (Ind. Ct. App. 1999). As for the express warranties,
the Court of Appeals found a genuine issue of material fact as to “whether
the cumulative effect of Rheem’s actions was commercially reasonable.” Id.
at 1228 (emphasis in original). On the implied warranty claims, the court
stated that the evidence establishing privity was “slight.” The court
nevertheless held that “perfect vertical privity is not necessary in this
case” and then found a genuine issue of material fact as to whether Rheem
breached its implied warranties and whether its conduct in doing so was
“reasonable.” Id. at 1231.
Discussion
When reviewing an entry of summary judgment, we stand in the shoes of
the trial court. Summary judgment is appropriate only when there is no
genuine issue of material fact and the moving party is entitled to judgment
as a matter of law. See Ind. Trial Rule 56(C). We do not reweigh the
evidence, but will consider the facts in the light most favorable to the
nonmoving party. See City of Gary v. Indiana Bell Telephone Co., 732
N.E.2d 149, 153 (Ind. 2000).
Rheem’s appeal raises three issues which require us to analyze the
operation of express and implied warranties under Indiana’s version of the
Uniform Commercial Code (“the UCC”).
I
Rheem first argues that the trial court should have granted summary
judgment as to Phelps’s claim for lost profits under the express warranty
because the warranty excluded consequential damages.[2] This argument
requires us to examine the interplay between Indiana Code §§ 26-1-2-719(2)
and (3), the UCC subsections pertinent to damage exclusions and remedy
limitations in express warranties:
(2) Where circumstances cause an exclusive or limited remedy to fail
of its essential purpose, remedy may be had as provided in IC 26-1.
(3) Consequential damages may be limited or excluded unless the
limitation or exclusion is unconscionable. Limitation of
consequential damages for injury to the person in the case of consumer
goods is prima facie unconscionable, but limitation of damages where
the loss is commercial is not.[3]
Rheem and Phelps present conflicting constructions of these
subsections. Both parties appear to accept that the remedy provided by
Rheem failed of its essential purpose and that Phelps is entitled to the
benefits of the express warranty.[4] But Phelps contends that, under § 2-
719(2), where a limited remedy “fail[s] of its essential purpose, remedy
may be had as provided in IC 26-1,” which includes consequential damages.
Phelps argues that because Rheem’s repair attempts failed for roughly four
years, the limited remedy of replacement of parts failed of its essential
purpose and Phelps could claim all buyer’s remedies provided by the UCC,
including consequential damages. Rheem counters that its exclusion of
consequential damages is controlled by § 2-719(3). Rheem argues that
despite the failure of the limited remedy under § 2-719(2), § 2-719(3)
allows an exclusion of consequential damages to operate unless it is
unconscionable.[5]
These arguments pose the question of whether an exclusion of
consequential damages survives when a separate contract provision limiting
a buyer’s remedies has failed of its essential purpose. The courts that
have faced this issue have fallen into two camps that are divided along the
lines of the parties’ arguments in this case. One group takes what is
known as the “dependent” view and reads § 2-719(2)’s reference to remedies
“provided in [the UCC]” as overriding a contract’s consequential damage
exclusion. See, e.g.¸ Middletown Concrete Prod. v. Black Clawson Co., 802
F. Supp. 1135, 1151 (D.Del. 1992) (collecting cases). This gloss on § 2-
719 makes an exclusion of consequential damages dependent on whether a
limited remedy fails of its essential purpose. See Adams v. J.I. Case Co.,
261 N.E.2d 1, 8 (Ill. App. 1970). Other courts take an “independent” view
and reason that because §§ 2-719(2) and (3) are separate subsections with
separate language and separate standards, the failure of a limited remedy
has no effect on an exclusion of consequential damages. See Waters v.
Massey-Ferguson, Inc., 775 F.2d 587, 592-93 (4th Cir. 1985) (collecting
cases).
The Court of Appeals accepted the independent view. However, the
court also grafted onto § 2-719 a requirement of “commercial
reasonableness” and affirmed the denial of summary judgment on the ground
that a triable issue existed as to whether Rheem’s consequential damages
exclusion and limited remedy were commercially reasonable.
We hold that Indiana Code § 26-1-2-719(2) does not categorically
invalidate an exclusion of consequential damages when a limited remedy
fails of its essential purpose. See Schurtz v. BMW of North America, Inc.,
814 P.2d 1108, 1112 (Utah 1991) (using tools of statutory interpretation in
applying independent view). Our first step in interpreting any Indiana
statute is to determine whether the legislature has spoken clearly and
unambiguously on the point in question. See Poehlman v. Feferman, 717
N.E.2d 578, 581 (Ind. 1999) (“When a statute is clear and unambiguous, we
need not apply any rules of construction other than to require that words
and phrases be taken in their plain, ordinary, and usual sense. Clear and
unambiguous statutory meaning leaves no room for judicial construction.”),
reh’g denied; Benham v. State, 637 N.E.2d 133, 136-37 (Ind. 1994) (“When a
statute is clear and unambiguous, there is no need to apply any rules of
construction other than that requiring words and phrases to be taken in
their plain, ordinary, and usual sense.”). A statute is ambiguous when “it
is susceptible to more than one interpretation.” In re Lehman, 690 N.E.2d
696, 702 (Ind. 1997). See also Amoco Production Co. v. Laird, 622 N.E.2d
912 (Ind. 1993).
In light of the depth of disagreement among the courts that have
faced this issue, it is evident that the UCC is ambiguous on this point.
See Clark v. International Harvester Co., 581 P.2d 784, 800 (Idaho 1978)
(“The UCC is ambiguous with respect to the effect that a failure of a
limited remedy under [§ 2-719(2)] has on other contractual provisions.”).
The UCC subsections at issue are susceptible to two interpretations – one
dependent, one independent – and as such we have no plain language to
apply.
Faced with an ambiguous statute, we turn next to other applicable
canons of construction. First, we note that “[o]ur main objective in
statutory construction is to determine, effect and implement the intent of
the legislature.” Melrose v. Capitol City Motor Lodge, Inc., 705 N.E.2d
985, 989 (Ind. 1998). See also Seifert v. Bland, 587 N.E.2d 1317, 1319
(Ind. 1992), reh’g denied. In ascertaining this intent, we “presume that
the legislature did not enact a useless provision” such that “[w]here
statutory provisions are in conflict, no part of a statute should be
rendered meaningless but should be reconciled with the rest of the
statute.” Robinson v. Wroblewski, 704 N.E.2d 467, 474-75 (Ind. 1998). See
also Spaulding v. International Bakers Services, Inc., 550 N.E.2d 307, 309
(Ind. 1990) (“Where possible, every word must be given effect and meaning,
and no part is to be held meaningless if it can be reconciled with the rest
of the statute.”).
Several aspects of Indiana Code §§ 26-1-2-719(2) and (3) point to a
legislative intent consistent with the independent view. First, as many
independent courts have noted, the drafters of the UCC inserted distinct
legal standards into each provision. A limited remedy will be struck when
it fails of its essential purpose; an exclusion of consequential damages
fails when it is unconscionable. Moreover, these subsections are distinct
in who applies the standards they set out. Whether a limited remedy fails
of its essential purpose is an issue of fact that a jury may determine.
See, e.g., Delhomme Indus., Inc. v. Houston Beechcraft, Inc., 669 F.2d
1049, 1063 (5th Cir. 1982). Conversely, an exclusion of consequential
damages stands unless it is unconscionable, and unconscionability is
determined by a court as a matter of law. See Ind. Code § 26-1-2-302
(1993).[6] These facial distinctions between §§ 2-719(2) and (3) suggest a
legislative intent that the provisions should function independently of one
another.
Second, the independent view is consistent with the principle of
statutory interpretation that “[w]here possible, we interpret a statute
such that every word receives effect and meaning and no part is rendered
‘meaningless if it can be reconciled with the rest of the statute.’”
Bagnall v. Town of Beverly Shores, 726 N.E.2d 782, 786 (Ind. 2000) (quoting
Spaulding, 550 N.E.2d at 309). See also Schurtz v. BMW of North America,
Inc., 814 P.2d 1108, 1114 (Utah 1991) (“This independent reading of the two
provisions also conforms to the general rule that we should construe
statutory provisions so as to give full effect to all their terms, where
possible.”). The dependent view renders § 2-719(3) inoperative by deleting
an exclusion of consequential damages without any analysis of its
unconscionability. See id. (“If we were to read subparts (2) and (3) as
dependent, we would effectively read out the unconscionability test of
subpart (3) … .”). Cf. Middletown Concrete Prod. v. Black Clawson Co., 802
F. Supp. 1135, 1151 (D.Del. 1992) (noting that dependent courts award
consequential damages by “[f]ocusing solely on the language of subsection
(2) … .”). On the other hand, the independent view allows both provisions
to operate: § 2-719(2) will strike a failed limited remedy, allowing the
buyer to claim damages, but not consequential damages if a valid clause
excludes them under § 2-719(3). This construction harmonizes the language
in § 2-719(2) that “remedy may be had as provided in IC 26-1” with the
unconscionability test imposed by § 2-719(3). The “remedy” clause in § 2-
719(2), which is crucial to the dependent argument, must be taken in its
fullest sense. See, e.g., Ind. Code § 26-1-1-102 cmt. 1 (West 1995). On
its face, the phrase refers to all of the UCC, not merely its remedy
provisions.[7] Therefore “remedy may be had” under subsection (2) only to
the extent that it is not limited by subsection (3), which is part of “IC
26-1.” Cf. Clark v. International Harvester Co., 581 P.2d 784, 800 (Idaho
1978) (“The official comment states that if a remedy fails of its purpose,
‘it must give way to the general remedy provisions of this article’ ... .
The remedy provisions of that [article] not only provide for the recovery
of consequential damages, but also for their exclusion where not
unconscionable.”) (citations omitted).
Third, the UCC instructs us to construe its provisions with three
specific legislative purposes in mind, all of which comport with the
independent view:
(1) IC 26-1 shall be liberally construed and applied to promote its
underlying purposes and policies.
(2) Underlying purposes and policies of IC 26-1 are:
(a) to simplify, clarify, and modernize the law governing
commercial transactions;
(b) to permit the continued expansion of commercial practices
through custom, usage, and agreement of the parties;
(c) to make uniform the law among the various jurisdictions.
Ind. Code § 26-1-1-102 (1993) (emphasis added) (“Purposes; rules of
construction; variation by agreement”). See also id. cmt. 1 (“The Act
should be construed in accordance with its underlying purposes and
policies. The text of each subsection should be read in the light of the
purpose and policy of the rule or principle in question, as also of the Act
as a whole … .”); Kearney & Trecker Corp. v. Master Engraving Co., 527 A.2d
429, 432 (N.J. 1987) (relying on § 1-102 to apply independent view). The
independent view serves all of the enumerated purposes. The independent
view supplies simplicity and clarity by allowing a clearly expressed
agreement to control a transaction. See Ind. Code § 26-1-1-102(2)(a)
(1993). The independent view is also the modern trend. See Middletown
Concrete, 802 F. Supp. at 1152. The independent view aids sound commercial
practice by allowing the parties to anticipate clearly the results of their
transaction, while the dependent view retains the specter of unknown
damages for the seller despite the parties’ explicit understanding to the
contrary. See Ind. Code § 26-1-1-102(2)(b) (1993).[8] The fact that courts
are divided on this issue indicates that precise uniformity is impossible.
See Ind. Code § 26-1-1-102(2)(c) (1993). See, e.g., Chatlos, 635 F.2d at
1086 (noting that as of 1980 neither view carried a majority). However, as
we have noted, the modern trend is towards the independent view. See
Riegel Power Corp. v. Voith Hydro, 888 F.2d 1043, 1047 (4th Cir. 1989).
Finally, the legislature’s intent to follow the independent view is
also supported by the UCC’s general policy favoring the parties’ freedom of
contract. The UCC tells us that one of its paramount concerns is enabling
contracting parties to control their own relationships. See, e.g., Ind.
Code § 26-1-1-102(3) (1993) (“The effect of provisions of IC 26-1 may be
varied by agreement, except as otherwise provided in IC 26-1 … .”); Id.
cmt. 2 (“Subsection (3) states affirmatively at the outset that freedom of
contract is a principle of the [UCC] … .”). Official Comment One to
Indiana Code § 26-1-2-719 states that “[u]nder this section parties are
left free to shape their remedies to their particular requirements and
reasonable agreements limiting or modifying remedies are to be given
effect.” However, the dependent view ignores the intent of the parties and
allows a buyer to recover consequential damages despite an explicit
contract term excluding them. The dependent courts essentially presume
that the parties intended the exclusion of consequential damages to depend
on the limited remedy. See, e.g., Kathryn I. Murtagh, Note, UCC Section 2-
719: Limited Remedies and Consequential Damage Exclusions, 74 Cornell
L.Rev. 359, 369 (1989) (“Dependent courts begin by presuming that the
parties intended to link the consequential damage exclusion and limited
remedy.”).[9] On the other hand, the independent view refuses to override
categorically an exclusion of consequential damages and will give effect to
the terms of the contract. Indeed, consistent with the principle of
freedom of contract, the independent view allows the parties to agree to a
dependent arrangement.
This freedom to set contract terms is especially important in the
context of a commercial transaction. Sophisticated commercial actors
should be free to allocate risks as they see fit, and courts should not
interfere simply because such risks have materialized. This is the view
shared by Professors White and Summers:
In general we favor the [independent] line of cases. Those cases
seem most true to the Code’s general notion that the parties should be
free to contract as they please. When the state intervenes to
allocate the risk of consequential loss, we think it more likely that
the loss will fall on the party who cannot avoid it at the lowest
cost. This is particularly true when a knowledgeable buyer is using
an expensive machine in a business setting. It is the buyer who
operates the machine, adjusts it, and understands the consequences of
its failure. Sometimes flaws in such machines are inherent and
attributable to the seller’s faulty design or manufacture. But the
fault may also lie in buyer neglect, in inadequate training and
supervision of the operators or even in intentional use in ways
forbidden by the seller. Believing the parties to know their own
interests best, we would leave the risk allocation to the parties.
White & Summers, Uniform Commercial Code § 12-10, at 605 (3rd ed. 1988)
(hereinafter “White & Summers”). See also S.M. Wilson & Co. v. Smith
Intern., Inc., 587 F.2d 1363, 1375 (9th Cir. 1978) (“Risk-shifting is
socially expensive and should not be undertaken in the absence of a good
reason. An even better reason is required when to so shift is contrary to
a contract freely negotiated.”); Polycon Indus., Inc. v. Hercules, Inc.,
471 F. Supp. 1316, 1325 (E.D.Wisc. 1979) (“[T]he exclusion of consequential
and special damages was an allocation of risks agreed to between two
commercial parties of equal strength and should be given effect.”).
Phelps attempts to escape this conclusion by arguing that the furnace
sales were not a sophisticated commercial transaction worthy of such
deference. Appellee’s Br. in Opposition to Transfer at 8. Phelps notes
that the warranties were simply found inside of the furnace box and were
not the product of detailed negations. Cf. American Electric Power Co. v.
Westinghouse Elec. Corp., 418 F. Supp. 435 (S.D.N.Y. 1976). Phelps’s
argument here may prove too much, i.e., that only the ultimate customer,
and not Phelps at all, was to benefit from the warranty. If Phelps is a
beneficiary of the warranty (as we have noted both parties appear to
assume), Phelps cannot escape the conclusion that these goods were
relatively sophisticated and flowed between businesses entities. See,
e.g., S.M. Wilson, 587 F.2d at 1375 (“Parties of relatively equal
bargaining power negotiated an allocation of their risks of loss. … The
machine was a complex piece of equipment designed for the buyer’s
purposes.”). This context is far different than those confronted in the
many dependent cases that focus on losses suffered by consumers at the
hands of large commercial entities. See, e.g., Kelynack v. Yamaha Motor
Corp., 394 N.W.2d 17, 21 (Mich. App. 1986); Goddard v. General Motors
Corp., 396 N.E.2d 761, 765 (Ohio 1979).
The Court of Appeals applied the independent view, but found a genuine
issue of material fact as to whether “the cumulative effect of Rheem’s
actions was commercially reasonable.” Rheem Mfg. Co. v. Phelps Heating &
Air Conditioning, Inc., 714 N.E.2d 1218, 1228 (Ind. Ct. App. 1999). The
court pointed to no statutory authority that requires these exclusions or
limitations to be “commercially reasonable,” nor did it define this
term.[10] The court did make some passing references to Official Comment
One to § 2-719, which assures a buyer an “adequate” remedy in the face of a
breach of warranty. Id. at 1228 (“We remain mindful that even as Comment 1
to Ind. Code § 26-1-2-719 advises that ‘reasonable agreements limiting or
modifying remedies are to be given effect,’ the next sentence also cautions
that ‘it is of the very essence of a sales contract that at least minimum
adequate remedies be available.’”). This comment, however, makes no
reference to commercial reasonableness. Indeed, the court stated frankly
that its primary concern was with the “fairness of the outcome” and
reaching an “equitable result.” Id. In light of our conclusion that the
legislature intended the independent view to apply to these
circumstances,[11] we are constrained to reject the commercial
reasonableness test applied by the Court of Appeals and to reverse the
trial court’s denial of summary judgment on Phelps’s claims for incidental
and consequential damages.[12]
II
Rheem next argues that the trial court erred by denying summary
judgment on Phelps’s claims for labor expenses incurred in fixing its
customers’ furnaces. The record shows that Phelps lost nearly $100,000 by
servicing Rheem furnaces under a service labor warranty that Phelps gave to
its customers.[13] Rheem argues that a “service labor exclusion” found in
the express warranty prevents Phelps from claiming damages in this form:
“This Warranty does not cover any labor expenses for service, nor for
removing or reinstalling parts. All such expenses are your responsibility
unless a service labor agreement exists between you and your contractor.”
(R. at 105.) Phelps counters by arguing that this remedy clause failed of
its essential purpose and therefore Phelps could claim all UCC damages.[14]
The first step in determining whether a limited remedy failed of its
essential purpose is to parse out exactly what purpose the remedy was to
serve. See Martin Rispens & Son v. Hall Farms, Inc., 621 N.E.2d 1078, 1086
(Ind. 1993). While the parties, the trial court, and the Court of Appeals
make no reference to this inquiry,[15] both the terms of the warranty and
the record illuminate the remedy’s purpose. The limitation is addressed to
the end-user, warning them that they must look to the contractor for
repairs: “All such expenses are your responsibility unless a service labor
agreement exists between you and your contractor.” (R. at 105.) Further,
a Rheem officer testified that the “custom, practice and standard method of
dealing in the gas furnace industry is that the manufacturer’s warranty is
for parts only and excludes reimbursement for labor expenses for service or
for removing or installing parts, consequential and incidental damages.”
(R. at 102.) Similarly, the president of Phelps testified that “standard
procedure throughout the industry was that a dealer would supply a one-year
warranty for labor. And then the parts, depending on the manufacture[r] …
usually had a one-year warranty … .” (R. at 165, 174.) In addition,
Phelps at one time marketed extended service warranties as part of its
business.
These facts demonstrate that the limited remedy was intended to
maintain a reasonable division of responsibilities between the manufacturer
and the contractor when customers experienced problems. Rheem’s parts-only
warranty worked in tandem with Phelps’s labor warranties to let customers
know that they had to seek repair service from the local contractor, not
the distant manufacturer. Phelps benefited from this relationship by
marketing extended warranties on top of its one-year service warranty. If
the warranty held Rheem liable for repairs, Rheem would naturally skip over
Phelps and sell extended service warranties directly to the customer. For
its part, the limited remedy gave Rheem the reassurance that it would not
be liable for repairs on its furnaces at distant locations around the
country. With this limitation in place, customers could rely on local
repair service, Phelps could market extended warranties, and Rheem could be
sure it would not be obligated to make repairs. Thus the apparent purpose
of this limited remedy was to facilitate the manufacturer/contractor
distinction for the benefit of all parties.
We must next determine whether circumstances caused the remedy to fail
of this purpose. We set out the basic framework for analyzing the failure
of essential purpose in Martin Rispens:
Commentators have suggested that § 2-719, as it relates to failure of
essential purpose, is not concerned with arrangements which were
oppressive at the inception which is a question of unconscionability,
but with the application of an agreement to “novel circumstances not
contemplated by the parties.” White & Summers, § 10-12. In addition,
they have suggested that this provision should be triggered when the
remedy fails of its essential purpose, not the essential purpose of
the UCC, contract law, or of equity. Id. One author suggests that
the method used to decide whether a particular limitation fails of its
essential purpose is to identify the purpose underlying the provision
and determine whether application of the remedy in the particular
circumstances will further that purpose. If not, then, and only then,
is there a failure of essential purpose. Jonathan A. Eddy, On The
“Essential” Purposes of Limited Remedies: The Metaphysics of UCC § 2-
719(2), 65 Cal.L.Rev. 28, 36-40 (1978).
621 N.E.2d at 1086. See also Indiana Comment to Ind. Code § 26-1-2-719
(Burns 1974) (“[T]he parties’ substitute arrangement may fail, in unusual
circumstances.”) (emphasis added); White and Summers, § 12-10 at 602.
(“There are probably relatively few situations where a remedy can fail of
its essential purpose.”).
Using this analysis, we hold that the remedy served its purpose.
Rheem, as the manufacturer, had technical expertise in the functioning of
its product. It was reasonable for Phelps to expect Rheem to use this
expertise to supply replacement parts and technical guidance in the event
of malfunctions.[16] Phelps, as the contractor, had the manpower and
facilities to implement these fixes in the field. It was reasonable for
Rheem to expect Phelps to use these tools to go into local homes and
offices to fix the furnaces. With the extended warranties, Phelps could
even profit through this process. By supplying technical guidance and
replacement parts, Rheem’s limited remedy lived up to the purpose it was
designed to serve. See Martin Rispens, 621 N.E.2d at 1086.
Phelps main argument as to the failure of essential purpose is that
the furnaces experienced problems for roughly four years. However, the
purpose of the limited remedy was not to guarantee that every furnace would
be easily fixed, but to guarantee that the most logical party would be
charged with making the repairs. Phelps was that party, and under this
limitation it accepted the risk that repairs would be difficult and labor
intensive. In Martin Rispens, we stated that a limited remedy fails only
in the face of “‘novel circumstances not contemplated by the parties.’” 621
N.E.2d at 1085 (citation omitted). As Comment One to Indiana Code § 26-1-2-
719 puts it, a limited remedy fails when its application “operates to
deprive either party of the substantial value of the bargain.” Thus a
limited remedy fails of its essential purpose when an unexpected
circumstance arises and neither party accepted the risk that such
circumstance would occur. See Osgood v. Medical, Inc., 415 N.W.2d 896,
902 (Minn. App. 1987) (“This case involves the allocation of risks between
two merchant manufacturers. That is exactly the intended effect of the
Special Terms. We will not apply [2-719(2)] to overturn that result when
the case involves the allocation of risk between two merchant
manufacturers.”); V.M. Corp v. Bernard Distributing Co., 447 F.2d 864, 865
(7th Cir. 1971) (Ҥ 2-719 was intended to encourage and facilitate
consensual allocations of risk associated with the sale of goods. This is
particularly true where commercial, rather than consumer sales are
involved. Even where the defects of the goods cause substantial
difficulties to those involved in wholesale and resale distribution, § 2-
719(2) need not automatically require disregard of the particular
limitation … .”).
Even if we were to find that this remedy failed of its essential
purpose, Phelps would not be entitled to the damages it seeks under the
warranty. The parties characterize these service repair costs as either
consequential damages or direct damages. In either event, Phelps is not
entitled to recovery under the warranty and summary judgment should be
entered.
The parties characterize the service labor as a form of consequential
damage because Rheem should have foreseen that its failure to provide
functioning furnaces would have caused Rheem to make multiple repairs under
its service warranty. See Ind. Code § 26-1-2-715 (1993). To the extent
these repair costs were consequential damages, they are excluded by Rheem’s
warranty as discussed in Part I, supra.
The parties also characterize the repair costs as a form of direct
damages. A buyer’s remedy for breach of warranty is typically the
difference between the goods as warranted and the goods as accepted. See
Ind. Code § 26-1-2-714(2) (1993). However, the cost of repair may serve as
a proxy for direct damages. See, e.g., Jones v. Abriani, 169 Ind.App.
556, 350 N.E.2d 635, 646 (1976) (“In this case, one reasonable way of
measuring the difference in the value of the goods between what was
actually delivered (a defective mobile home) and what was warranted (a
mobile home with the defects repaired) is the cost of repairing the
defects.”), Schroeder v. Barth, Inc., 969 F.2d 421, 424 (7th Cir. 1992)
(applying Indiana law).[17] Phelps argues that it should be able to
recover the cost of repairing the furnaces in the event that the limited
remedy failed of its essential purpose.
We hold, however, that Phelps is not in a position to claim this form
of remedy. Typically, a buyer claiming repair damages is suing its
immediate seller. See, e.g., Abriani, 350 N.E.2d at 646. Recovering the
repair cost replicates the typical warranty damages – value of goods as
warranted minus value of goods as delivered – by awarding the amount spent
to put the goods in the warranted condition. See White and Summers, § 10-2
at 504. This measure of damages reflects the fact that a properly
functioning market would deduct from the price of the item the cost of
repairs a purchaser would have to make. The repair costs that Phelps seeks
to recoup serve no such purpose because Phelps is not in possession of the
goods.
We conclude by noting that, while Phelps, as an intermediate seller,
is not entitled to these direct warranty damages, it may have a claim
sounding in indemnity or subrogation for damages suffered by those with
which it shared privity. See, e.g., Black v. Don Schmid Motor, Inc., 657
P.2d 517, 529 (Kan. 1983) (“A right of indemnity exists where a party is
compelled to pay damages that rightfully should have been paid by another
party. 41 Am.Jur.2d, Indemnity, § 20. Thus, a seller that is liable for
damages to a purchaser of defective goods may seek indemnity from the
manufacturer where the damages were the proximate result of the
manufacturer’s breach of warranty.”). Whether or not Phelps can recover on
an indemnity theory is an issue to be decided on remand.
III
We summarily affirm the Court of Appeals as to Phelps’s implied
warranty claims. See Martin v. Amoco Oil Co., 696 N.E.2d 383, 386 n.4
(Ind.), cert. denied, Zrnchik v. Amoco Oil Co., 525 U.S. 1049 (1998).
.
Conclusion
Having previously granted transfer, we reverse the order of the trial
court on Phelps’s express warranty claims and remand this case for
proceedings consistent with this opinion.
SHEPARD, C.J., and BOEHM, J., concur.
RUCKER, J., not participating.
DICKSON, J., dissents with separate opinion.
In The
INDIANA SUPREME COURT
RHEEM MANUFACTURING ) Supreme Court No.
COMPANY, ) 49S02-0003-CV-219
Appellant (Defendant below), )
)
v. ) Court of Appeals No.
) 49A02-9807-CV-620
PHELPS HEATING & AIR, )
CONDITIONING, INC., )
Appellee (Plaintiff below). )
________________________________________________
APPEAL FROM THE MARION SUPERIOR COURT
The Honorable Steven H. Frank, Judge
Cause No. 49D13-9607-CT-1202
________________________________________________
On Petition To Transfer
May 9, 2001
DICKSON, Justice, dissenting.
I am persuaded that Indiana Code § 26-1-2-719(2) should be construed
to invalidate an exclusion of consequential damages when a limitation of
remedy fails of its essential purpose. I further conclude that the trial
court properly denied Rheem's motion for summary judgment as to Phelps's
claims for labor expenses incurred in fixing its customers' furnaces.
Phelps is entitled to a trial on whether Rheem's "service labor exclusion"
failed of its essential purpose, an issue of fact and not law.
-----------------------
[1] On its face, it is unclear if this remedy is exclusive, but this
ambiguity is clarified by a subsequent term: “RHEEM’S SOLE LIABILITY WITH
RESPECT TO DEFECTIVE PARTS SHALL BE AS SET FORTH IN THIS WARRANTY ... .”
(Id.)
[2] While Phelps seeks both consequential and incidental damages, the
same analysis applies to each and we will discuss only consequential
damages.
[3] The first section of the same statute expressly allows such
limitations and exclusions:
(1) Subject to the provisions of subsections (2) and (3) and of IC 26-
1-2-718 on liquidation and limitation of damages:
(a) the agreement may provide for remedies in addition to or in
substitution for those provided in IC 26-1-2 and may limit or
alter the measure of damages recoverable under IC 26-1-2, as by
limiting the buyer’s remedies to return of the goods and
repayment of the price or to repair and replacement of
nonconforming goods or parts; and
(b) resort to a remedy as provided is optional unless the remedy
is expressly agreed to be exclusive, in which case it is the
sole remedy.
Ind. Code § 26-1-2-719(1) (1993).
[4] The trial court did not certify the question of whether the remedy
actually failed of its essential purpose and Rheem concedes that this issue
“is not in debate.” Appellant’s Reply Br. at 11. See also Rheem Mfg. Co.
v. Phelps Heating & Air Conditioning, Inc., 714 N.E.2d 1218, 1223 (Ind. Ct.
App. 1999) (“Rheem’s argument seems to be that the failure of essential
purpose vel non is irrelevant.”). We express no opinion as to this issue
here. See generally Martin Rispens & Son v. Hall Farms, Inc., 621 N.E.2d
1078, 1085-88 (Ind. 1993), Hahn v. Ford Motor Co., Inc., 434 N.E.2d 943,
948 (Ind. Ct. App. 1982). Similarly, both parties appear to assume that
the warranty and its remedy limitations are applicable and we also express
no opinion on this issue.
[5] Phelps does not argue that the clause at issue was unconscionable.
See, e.g., Appellee’s Br. at 25-28.
[6] The two sections also aim at distinct contractual functions:
A contract may well contain no limitation on breach of warranty
damages but specifically exclude consequential damages. Conversely, it
is quite conceivable that some limitation might be placed on a breach
of warranty award, but consequential damages would expressly be
permitted.
The limited remedy of repair and consequential damages exclusion
are two discrete ways of attempting to limit recovery for breach of
warranty. The Code, moreover, tests each by a different standard. … We
therefore see no reason to hold, as a general proposition, that the
failure of the limited remedy provided in the contract, without more,
invalidates a wholly distinct term in the agreement excluding
consequential damages. The two are not mutually exclusive.
Chatlos Systems v. National Cash Register Corp., 635 F.2d 1081, 1086 (3rd
Cir. 1980).
[7] If the drafters of the UCC intended to refer only to buyer’s
remedies, they would have referred to “IC § 26-1-2-711 et seq.” or a
similar designation.
[8] Sound commercial practice may require sellers in certain
industries to exclude exposure to possibly expansive consequential damages:
[T]he potential significance of liability for consequential
damages in commercial transactions undoubtedly prompted the Code’s
drafters, consistent with the Code’s endorsement of the principle of
freedom of contract, to make express provision for the limitation or
exclusion of such damages. For certain sellers, exposure to liability
for consequential damages could drastically affect the conduct of
their business, causing them to increase their prices or limit their
markets. … In a commercial setting, the seller’s right to exclusion of
consequential damages is recognized as a beneficial risk-allocation
device that reduces the seller’s exposure in the event of breach.
Kearney, 527 A.2d at 433. A Rheem executive testified that such exclusions
of consequential damages are standard in the gas-powered furnace industry.
(R. at 102.)
[9] Phelps argues that the dependent view “more accurately reflects
the parties’ intent” because it is what a “rational buyer” would expect.
Appellee’s Br. in Opposition to Transfer at 6. However, this type of
“presumed” intent is no substitute for an analysis of the parties’ actual
expectations.
[10] The UCC does refer to “reasonable commercial standards” in
defining what is “good faith” for a merchant. Ind. Code § 26-1-2-103(b)
(1993). The UCC in turn “imposes an obligation of good faith in [a
contract’s] performance or enforcement.” Id. § 26-1-1-203. However, the
limitations and exclusions at issue here were added to the contract during
formation, and § 1-203, which covers only performance or enforcement, is
inapplicable. No other UCC provision purports to place a duty of
“commercial reasonableness” on a party’s ability to contract.
[11] We note, however, that some language in Professors Pratter and
Townsend’s Indiana Comments to Indiana Code § 26-1-2-719 arguably suggests
that the commentators subscribed to the dependant view: “A statutory scheme
of remedies, if well drafted, should be adequate for a great variety of
situations. But the parties’ substitute arrangement may fail, in unusual
circumstances. If so, the statutory remedies will still be available.”
Indiana Comment to Ind. Code § 26-1-2-719 (Burns 1974) (emphasis added).
[12] As a final matter, we note that our holding today is consistent
with a pre-UCC Indiana case that arguably gave effect to an exclusion of
consequential damages when a limited remedy failed of its essential
purpose. Nave v. Powell centered on the sale of a stallion named “Major
McKinley.” 52 Ind.App. 496, 96 N.E. 395, 399 (1911). Although Powell
purchased the horse for breeding, Major McKinley proved to be “barren and
unprolific” after “60 fruitful mares were bred to him ... none of which
were gotten in foal.” Id. at 397. Powell argued that Nave had “impliedly
warranted said horse to be fit and suitable for breeding purposes and a
reasonably sure foal-getter” because Nave knew the horse was purchased for
breeding. Id. Nave countered with contractual language that he claimed
limited Powell’s remedy to a substitute horse:
In the event that the above-named stallion, in perfect health, with
proper usage, and the mares to him regularly returned and tried or
bred on one full service season’s trial does not get with foal 50
[percent] of the producing mares regularly tried and bred to him, then
on return of the said stallion to me ... I agree to furnish the above-
named purchaser without further charge, another imported or pure bred
stallion of equal quality in exchange.
Id. at 397. The contract also stated that “[s]hould the above-named
stallion hereafter become injured or disabled through accident or disease
... this warranty shall be null and void and of no effect and all
obligations incurred by me herein shall be considered fulfilled and ended.”
Id. at 400. These clauses arguably limited the damages Powell could claim
for breach of the warranty. Unfortunately, Major McKinley died before
Powell could return him to Nave and request a replacement, as the warranty
required. Id. at 398. Despite the contract’s limited remedy and exclusion
of damages, Powell sued for the expense of feeding and stabling Major
McKinley and the cost of advertising the stallion’s services. Powell also
sought compensatory damages in the form of the difference in value between
the sterile stallion he received and the fair market price of a fertile
stallion. Id. The Court of Appeals recognized that contracting parties may
limit the remedies available for the breach of warranty:
It must not be forgotten that in contracts of warranty, the same as in
all other contracts, the contracting parties have a perfect right to
put into such contract all its terms and conditions, and provide all
and entire the remedies contemplated and agreed upon by the parties.
... When the parties do agree upon such remedies and their contract by
its terms expresses a clear intent and purpose in that respect, they
are bound thereby and limited to the remedies, or remedy, so provided.
Id. at 398. The court then held that the warranty limited Powell’s
remedies to a replacement horse and reversed the trial court’s refusal to
dismiss the complaint. Id.
[13] Evidence in the record suggests that the repairs may have been
made to help Phelps maintain goodwill with its customers and not to comply
with its warranties. Phelps argued in its brief that its warranty did not
cover the quality of the furnaces, but merely warranted the quality of the
services it provided. Rheem replied that this characterization by Phelps
means that the repairs were made gratuitously and Indiana law precludes
indemnification for voluntary payments. See Vernon Fire & Cas. Ins. Co. v.
Graham, 166 Ind.App. 509, 510, 336 N.E.2d 829, 830 (1975) (“Indemnity does
not cover losses for which the indemnitee is not liable, but which he
voluntarily pays.”). Rheem points to testimony that the warranties were
only “part” of the reason Phelps made the repairs and that “customer
goodwill” was also a factor. (R. at 172-73.) However, other evidence shows
that Phelps gave “one-year labor warranties on all new installations of
furnaces” (R. at 166) which included a one-year warranty on labor and a one-
year warranty on parts. The complaint itself stated that “Phelps had a
contractual obligation [to its customers] to remedy the defects of the
furnaces.” In reviewing a summary judgment order, we view the facts in the
light most favorable to the nonmoving party. See Havens v. Ritchey, 582
N.E.2d 792, 795 (Ind. 1991). Therefore we must assume that Phelps did in
fact fix the furnaces in order to comply with its warranties and not as a
means of preserving customer goodwill.
[14] The UCC applies to these service labor issues because the
“predominant thrust” of the entire transaction was clearly a sale of goods.
See Insul-Mark Midwest, Inc. v. Modern Materials, Inc., 612 N.E.2d 550,
554 (Ind. 1993) (holding that to determine whether a contract is for the
sale of goods or the rendition of services, courts must look to the
predominant thrust of the transaction).
[15] In fact, the Court of Appeals rendered no holding as to the
service labor issues, even though it attempted to set out the arguments
involved. See Rheem, 714 N.E.2d at 1231.
[16] There is nothing in the record to suggest that Rheem failed to
deliver replacement parts.
[17] The New Mexico Court of Appeals explained this process in
Manouchehri v. Heim:
[Although 2-714] sets the measure of direct damages for breach
of warranty as the difference between the value of the goods as
warranted and the value of the goods as accepted, often that
difference can be approximated by the cost to repair the goods so that
they conform to the warranty. For example, if it costs $200 to fix [a]
machine so that it performed as a 100/100 machine, then one could
assume that the unrepaired machine (the “goods accepted”) was worth
$200 less than the repaired machine (the goods “as warranted”). Thus,
the cost of repair is commonly awarded as the direct damages.
941 P.2d 978, 981 (N.M. Ct. App. 1997).