Friday, July 18, 2008

Of Settlements and Sales: Hanson Staple Co. v. Ole Mexican Foods, Inc., A08A0658.

In one of the better-reasoned cases on this topic I have read, the Georgia Court of Appeals has explained why settlement agreements that arise from disputes regarding sales of goods should not normally be considered sales contracts, even when those settlements require one of the settling parties to purchase additional goods.

The parties’ dispute centered on Ole Mexican Foods’ decision to stop buying packaging materials from Hanson, and instead to purchase the necessary materials from one of Hanson’s former employees. In its suit for breach of contract, Hanson contended it was left holding more than $300,000 worth of packaging materials that it had customized for Ole Mexican Foods and could not resell. In its counterclaim, Ole Mexican Foods claimed it should be relieved from its contractual obligations due to the fact that Hanson had tendered defective materials. Hanson, of course, vigorously defended against this contention, claiming the goods were merchantable.

The parties negotiated a settlement whereby Ole Mexican Foods agreed (1) to purchase at least $130,000 worth of inventory from Hanson, (2) to test Hanson’s remaining inventory and, if it proved satisfactory, to purchase additional inventory, and (3) to begin to do business once again with Hanson.

Unfortunately, the settlement agreement did not end the parties’ dispute. Instead, Ole Mexican Foods refused to perform, and Hanson moved the trial court to enforce the settlement agreement. In response, Ole Mexican Foods claimed, among other things, that Hanson had violated the parties’ agreement by insisting that Ole Mexican Foods purchase inventory without regard to its merchantability. In support of its claim, Ole Mexican Foods contended that the Uniform Commercial Code’s implied warranty of merchantability found in 2-314 should apply to the settlement agreement.

The trial court accepted this argument, and Hanson appealed. In properly reversing, the Court of Appeals applied the predominant purpose test and held that the predominant purpose of the settlement agreement was to resolve the parties’ dispute regarding an earlier sales agreement, not to create an additional agreement of the kind to which implied warranties of quality would normally apply. Instead of turning on the merchantability of Hanson’s goods, Ole Mexican Foods’ duties under the settlement agreement would be governed by principles of good faith and “honest judgment.”

Although the court did not expressly say so, one reason why the court’s holding is so clearly correct is that a contrary holding would essentially eviscerate the purpose of this particular settlement: since one of the central disputes in the underlying litigation was whether Hanson’s goods were merchantable within the meaning of the Uniform Commercial Code, and since the case was settled rather than having this issue decided by the court, applying the implied warranty of merchantability to the settlement agreement would almost certainly require the parties to relitigate the question of merchantability.

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