Canusa Corporation v. A & R Lobosco, Inc.

Brief Fact Summary. At issue was a potential breach of an output contract between two companies involved in recycling.  One corporation was obligated to provide another with a certain amount of material per month, but never met their obligation.

Synopsis of Rule of Law. Under New York law, in an output contract, instead of the stated estimate, good faith controls whether a breach has occurred.

Facts. The Plaintiff, Canusa Corporation (the "Plaintiff"), is in the business of recycling and brokering waste paper.  The Plaintiff seeks damages for lost sales and attorneys fees as a result of an alleged breach of contract by the Defendant, A&R Lobosco, Inc. (the "Defendant").  The Defendant does various things, including selling the recycled paper to paper mills.  In late 1992, the Defendant entered into an agreement with the City of New York to accept "850 tons per week (3,400-3,500 tons per month) of material to be recycled."  The Defendant needed to purchase a baler to process the recycled paper and did so through the Plaintiff because they would provide financing.  The Plaintiff and the Defendant entered into an "Output Agreement" (the "Agreement") "stating that Lobosco would initially ship 1100 tons per month of number 8 quality old news print (ONP 8) per month to Canusa in 1993, and 1500 tons per month thereafter (1994-97)."  Both parties understand this number was the minimum number of tons the Defendant was obligated to provide the Plaintiff per month.  The Agreement also stated that the price per ton would be set each month.  ONP 8 was defined as "anything that normally comes in a household newspaper."  Two other categories of materials provided for in the agreement include outthrows and prohibitives.  No prohibitives were allowed by the contract, but a certain percentage of outthrows was acceptable.  There were many problems with the Agreement, and the Defendant only came close to the 1500 ton per month requirement during one month. 
•    During the trial, Michael Lobosco ("Mr. Lobosco") offered certain reasons why the Defendant corporation never reached the requisite amount.  In September 1993, the Plaintiff offered to accept 500 tons per month of ONP 7/8 in instead of the higher quality ONP 8.  Mr. Lobosco never signed the agreement memorializing this, but did act in accordance to it.  The Defendant again never reached the requisite amount.  In January of 1994, the Plaintiff offered to scrap the agreement and charge the Defendant $3.00 per ton.  Another offer to modify occurred in March of 1994, which the Defendant never accepted.  On June 27, 1994, the Plaintiff filed this action for breach of contract, fraudulent inducement and replevin of the baler.  The only claim before the court was the breach of contract claim.

Issue. "[W]hat is the effect of an estimate in an output contract when the supplier produces less than the stated estimate"?

Held. Under New York law, in an output contract, instead of the stated estimate, good faith would control whether a breach has occurred.  Section 2-306 of the Uniform Commercial Code ("UCC") governs output contracts.  It reads in pertinent part:  "A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded."  The court relied on three different cases, two of which were from other jurisdictions.  Those cases included [Feld v. Henry S. Levy & Sons, Inc.], [Empire Gas Corp. v. America Bakeries Co.], and [Atlantic Track & Turnout Co. v. Perini Corp.].  The court found their reasoning compelling, first, because "good faith is the general standard by which output contracts are measured."  Second, as the [Empire Gas] court recognized, the "unreasonably disproportionate" language in §2-306 is "a specific construction of good faith in the context of increased output or demand, and has no relationship to a good faith analysis of a decrease."  Like a requirements contract, the court determined that "in an output contract, the buyer takes the risk that the seller may reduce its production to zero." Additionally, "[a]pplying good faith rather than an estimate does not give the seller an un-bargained for advantage; rather, it merely preserves the essential character of contracts that lack a fixed term, albeit through the somewhat elusive concept of good faith."  The court additionally refused to treat the estimate as a fixed goods contract.  Further, the court concluded that the Defendant did not demonstrate good faith because the only explanation given for the failure to meet the agreed upon estimates was that "it would cost more to clean the material to reach the ONP 8 standard [ ] especially where there is no showing that the additional costs would not have made the contract unprofitable."

Discussion. This case includes an interesting discussion about the role of good faith in commercial output contracts.