Attorneys for Appellee

Robert A. Garelick
Bryan S. Redding
Cohen, Garelick & Glazier
Indianapolis, IN

Appellant (Defendant below),

                       v.
                        

                       

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)    Supreme Court No.
)    49S02-0003-CV-219
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)    Court of Appeals No.
)    49A02-9807-CV-620
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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.

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”).
    

    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 constru ction. 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). See footnote 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. See footnote 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). See footnote 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.”). See footnote 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 Opposi tion 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 m aterial 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. See footnote 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, See footnote 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. See footnote

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 e ntered.

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). See footnote Phelps argues that it should be able to recover the cost of repairing the fu rnaces 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.

    I am persuaded that Indiana Code § 26-1-2-719(2) should be construed to invalidate an exclusion of cons equential 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.