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CISG CASE PRESENTATION

Russia 18 October 2005 Arbitration proceeding 21/2005 (Varnish and paint machine case) [translation available]
[Cite as: http://cisgw3.law.pace.edu/cases/051018r1.html]

Primary source(s) of information for case presentation: Case text

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Case identification

DATE OF DECISION: 20051018 (18 October 2005)

JURISDICTION: Arbitration ; Russian Federation

TRIBUNAL: Tribunal of International Commercial Arbitration at the Russian Federation Chamber of Commerce and Industry

JUDGE(S): Unavailable

CASE NUMBER/DOCKET NUMBER: 21/2005

CASE NAME: Unavailable

CASE HISTORY: Unavailable

SELLER'S COUNTRY: Germany (respondent)

BUYER'S COUNTRY: Cyprus (claimant)

GOODS INVOLVED: Varnish and paint machine


Classification of issues present

APPLICATION OF CISG: Yes [Article 1(1)(b)]

APPLICABLE CISG PROVISIONS AND ISSUES

Key CISG provisions at issue: Articles 7 ; 25 ; 26 ; 35 ; 48 ; 49 ; 81 ; 82 [Also cited: Article 30 ]

Classification of issues using UNCITRAL classification code numbers:

7C23 [Gap-filling by domestic law: tribunal looked to domestic law for application of Art. 25 definition of fundamental breach];

25B [Definition of fundamental breach];

26A [Notification of avoidance: effective declaration required];

35A [Conformity of goods to contract: quality required by contract];

48A [Cure by seller after date for delivery: seller's right to remedy any failure to perform];

49A ; 49B [Buyer's right to avoid contract (ground for avoidance): fundamental breach; Buyer's loss of right to declare avoidance after delivery: timeliness of notice];

81C [Effect of avoidance on obligations: restitution by each party of benefits received];

82B [Buyer's inability to return goods in same condition: loses right to avoid unless ...]

Descriptors: Gap-filling ; Avoidance ; Fundamental breach ; Conformity of goods ; Cure ; Restitution

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Editorial remarks

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Citations to case abstracts, texts, and commentaries

CITATIONS TO ABSTRACTS OF DECISION

(a) UNCITRAL abstract: Unavailable

(b) Other abstracts

Unavailable

CITATIONS TO TEXT OF DECISION

Original language (Russian): M.G. Rozenberg, Praktika Mezhdunarodnogo kommercheskogo arbitrazhnogo suda pri TPP RF 3a 2005 z.. [Arbitration decisions rendered by the International Commercial Tribunal at the Russian Federation Chamber of Commerce and Industry in 2005], published by "Statut" (2006), Case No. 35 [292-300]

Translation (English): Text presented below

CITATIONS TO COMMENTS ON DECISION

Unavailable

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Case text (English translation)

Queen Mary Case Translation Programme

Russian Federation arbitration proceeding 21/2005 of 18 October 2005

Translation [*] by Gayane Nuridzhanyan [**]

Edited by Alexander Morari [***]

1. SUMMARY OF RULING

      1.1 The parties agreed on the Russian law as the law applicable to their contract for the international sale of goods. Therefore, by virtue of the Constitution of the Russian Federation and the Vienna Convention 1980 [UN Convention on Contracts for the International Sale of Goods (1980), hereinafter CISG], the CISG is applied to the relations of the parties to the contract and the Russian law is applied as a subsidiary statute.

      1.2 Clarification of the notion of "fundamental breach of contract with regard to the quality of the goods" is provided by the Tribunal using the provisions of the Civil Code of Russian Federation [hereinafter, the Russian Civil Code] (art. 475(2)) which is a subsidiary statute on the basis of the rules of art. 7(2) CISG.

      1.3 Existence of design flaws of the machine which repeatedly revealed themselves and emerged after their removal is considered a fundamental breach of contract which entitles the [Buyer] to avoid the contract by virtue of the provisions of the CISG.

      1.4 In view of the specific circumstances of the case, the Tribunal concluded that the [Buyer] did not lose its right to avoid the contract owing to the delayed declaration of avoidance.

2. FACTS AND PLEADINGS

The action was brought by [Buyer], a Cypriote organization, against [Seller], a German organization, in connection with delivery of a machine with unrepairable defects supplied under the contract for international sale of goods concluded by the parties on 19 July 1999.

[Buyer]'s claims included:

      -    Avoidance of the contract;
      -    Recovery of the price of the machine paid by the [Buyer]
      -    Recovery from the [Seller] of the arbitration fee.

According to the [Buyer], failures in the operation of one of the machine units started two months after the machine was put into operation and repeated thirteen times. Repair which was carried out by the [Seller] numerous times did not allow this machine unit to reach failure-free operation. The [Buyer] presented expert findings on the grounds of which the [Buyer] alleged that the defect is that of design and is of an irremovable character. In view of this, the [Buyer] demanded from the [Seller] the recovery of the funds paid for the machine along with returning the machine to the [Seller], i.e., the [Buyer] declared the avoidance of the contract.

The [Seller] did not acknowledge the action. The [Seller] contended that the defect discovered in the machine section, which is its special accessory, could have been easily replaced with a new section which was suggested by the [Seller] a number of times. Moreover, the [Seller] referred to the fact that the cost of this section amounts to 7% of the total cost of the machine. In [Seller]'s opinion, by virtue of the contractual terms, the compensation of damages by means of substitution of the machine with a new one was not foreseen in the contract at all. At the same time, pecuniary compensation could be carried out only under the conditions of complete inefficiency of the machine which was not the case. The [Seller] believed that the [Buyer] was deprived of the right to demand replacement of the machine or to avoid of the contract by virtue of the provisions of the CISG since the [Buyer] made a declaration of avoidance of the contract with considerable delay and the [Buyer] could not return the machine in the same condition in which it received it. The [Seller] presented findings of the expert examination carried out in Germany.

At the hearings, the parties were invited to agree on which expert examination findings would be regarded as final in view of the differences in the expert examinations presented by them. However, the parties failed to reach such an agreement. The [Seller] suggested substituting the defective machine unit for a unit of improved design. However, the [Buyer] did not consent to this.

3. TRIBUNAL'S REASONING

The award of the Tribunal contained the following main points.

      3.1 [The competence of the Tribunal]

      It follows from materials of the case, that the [Buyer] and the [Seller] are legal entities by virtue of the legislation of Cyprus and Germany, respectively, i.e., they are foreign legal entities, which makes it possible for the Tribunal to arbitrate the present dispute, provided the parties have consented to that (arts. 1(2) and 7 of the Law of the Russian Federation "On International Commercial Arbitration" and section 1(2) of the Rules of the Tribunal). The Tribunal concluded that such an agreement is contained in clause 18.1 of the contract of 19 July 1999 out of which the dispute arose:

"All disputes and differences which may arise out of or in connection with the contract, should the parties fail to reach an agreement amicably, are subject to settlement, excluding the jurisdiction of general courts, at the International Commercial Arbitration Tribunal in Moscow at the Chamber of Commerce and Industry of the Russian Federation [Tribunal] in accordance with its Rules."

An arbitration clause is also contained in clause 8 of the protocol signed by the parties on 28 October 2004:

"The International Commercial Arbitration Tribunal in Moscow at the Chamber of Commerce and Industry of the Russian Federation [Tribunal] shall be called upon to arbitrate disputes between the parties which arose out of the contract or in direct connection with the contract if the parties fail to reach a mutually acceptable decision by negotiations."

The parties did not contest the competence of the Tribunal either during the preparation of the case for hearings or during the hearings of the case.

Taking into account the above, the Tribunal declared itself competent to consider the present dispute.

      3.2 [Applicable law]

      According to art. 28(1) of the Law of the Russian Federation "On International Commercial Arbitration" and section 13(1) of the Rules of the Tribunal, the Tribunal considers the dispute on the grounds of the provisions of the applicable substantive law agreed upon by the parties. The Tribunal found that clause 18.2 of the contract concluded between the [Buyer] and the [Seller] contains a provision according to which "the law applicable to the contract is the substantive law of the Russian Federation."

Art. 15(4) of the Russian Constitution provides that international agreements of the Russian Federation are a component part of its legal system. If an international agreement of the Russian Federation contains provisions other than provisions of its national law, the provisions of the international agreement shall be applied. Having analyzed the contract provisions, the Tribunal determined that the contract at issue is a sales contract concluded between parties which have their places of business in different States. Based on the fact that Germany is a Contracting State to the CISG and the Republic of Cyprus is not and taking into consideration that the rules of international private law lead to the application of the law of the Russian Federation (a Contracting State to the CISG), the CISG is applicable in accordance with its art. 1(1)(b). At the same time, by virtue of art. 7(2) of the CISG, questions concerning matters governed by the CISG which are not expressly settled in it and cannot be settled in conformity with the general principles on which it is based shall be regulated by the law applicable by virtue of the rules of private international law.

Thus, the national law of the Russian Federation is applicable as a statute subsidiary to the CISG.

      3.3 [Contractual goods used as part of statutory capital]

      The Tribunal found that relations between the [Buyer] and the [Seller] in connection with the delivery of the machine are based on the provisions of the contract signed by the parties which provides its delivery on the terms: "CIP: Carriage and Insurance paid to St. Petersburg - place of assembling" (Incoterms 1990), machine assembling and instruction of [Buyer]'s personnel. It follows from the Certificate on the putting of the machine into operation of 24 February 2000 and the protocol signed by the parties on 28 October 2004 that, in performance of the [Seller]'s obligations under the contract, the [Seller] carried out the delivery of the machine to the [Buyer]. At the same time, under the Act (delivery note) No. 1 for the acceptance of main assets of 21 December 1999, the machine was deposited as a contribution into the statutory capital of a Russian joint-stock company which, in its turn, leased the machine to another Russian joint-stock company under a contract of 1 March 2000 and, after reorganization of the latter Russian joint-stock company, it passed the machine to a third Russian company under a lease contract of 1 January 2003. However, in connection with the discovered defects of the machine which hindered its normal operation, the lessee avoided the lease contract of 1 January 2003 and the machine was returned to the lessor under the equipment return act of 14 January 2005.

In its turn, the lessor passed the machine to the [Buyer] under the equipment return act of 14 January 2005 concerning the equipment contributed into its statutory capital.

      3.4 [Legal grounds for avoidance of the contract]

      Examining the legality and validity of the [Buyer]'s claim for avoidance of the contract due to the delivery of the defective machine and conduct of the mutual restitution, the Tribunal found that a buyer is entitled to avoid a contract and claim mutual restitution if the failure by the seller to perform any of its obligations under the contract amounts to a fundamental breach of contract (art. 49(1)(a) CISG). According to art. 25 CISG:

"A breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the same circumstances would not have foreseen such a result."

The Tribunal held that the claim for the avoidance of the contract made by the [Buyer] on the grounds of art. 49 of the CISG is based on the allegation that the [Seller] committed a fundamental breach of the quality requirements of the delivered machine and, therefore, it is necessary to determine whether [Seller]'s breach of the quality requirements of the delivered machine did take place and whether this breach amounts to a fundamental breach.

The Tribunal states that art. 25 CISG is a general rule on fundamental breach of contract and, therefore, does not specify particular cases of fundamental breaches of contract with regard to the quality of the goods. Following art. 7(2) CISG, the Tribunal finds it necessary to apply the provisions of Russian legislation which specify cases of fundamental breach of the requirements as to the quality of the goods under a sales contract (art. 475(2) of the Russian Civil Code). According to art. 475(2) of the Russian Civil Code, a fundamental breach implies:

"irremovable defects, defects which cannot be removed without disproportionate costs or costs of time, recurrent defects or newly emerged defects after their removal, and of other similar shortcomings."

      3.5 [Establishing a substantial breach of contract]

      Having examined the evidence presented by the parties as to the quality of the supplied machine, the Tribunal found the following.

In the course of the operation of the machine, its quality defects were revealed numerous times, in particular, in the varnish unit (section) of the machine which initially became apparent as extraneous hammering in the varnish unit, as the backlash in the adjusting axle-bearings, and later as the outage of the varnish section because of the breakage of the attachment points of the master cylinder and anilox roll of the varnish section and, as a consequence, the non-operability of the machine (see, for instance, letters addressed to the [Seller] of 25 May 2000, 14 April 2003, 21 April 2003 and 31 July 2003).

The Tribunal noted that the repair of the breakages in the machine varnish units, consisting in particular in the replacement of the axle bearing of the raster roll, was carried out four times (in March 2001, January 2002, April 2003 and December 2003). However, after each repair the defects emerged again after their removal and the [Seller] could not obtain failure-free operation of the varnish section of the machine.

An examination of the machine carried out by the expert of the Russian regional office of the Chamber of Commerce and Industry (report of 3 February 2004) revealed that approximately one month after the repair of the varnish section in December 2003, the operation of the machine varnish section was accompanied by a strong mechanical hammering in the attachment points of the master cylinder and anilox roll and by the vibration of the machine varnish section (para. 8.4 of the report). With the increase of the speed of the operation of the machine, the loudness of the hammerings and vibration of the machine varnish section increased considerably which, in the expert's opinion, makes it impossible to operate the machine. Operation of the machine with such a varnish section does not ensure the performance in terms of its operational speed declared by the producer (paras. 8.2 and 9.5 of the report). Along with that, surplus varnish is generated and it falls on the edges of the finished products causing its gluing.

During the examination of the axle-bearings which had broken down earlier, the expert attested that they had the same defect, i.e., uneven diameter wear and wear of the opening in the frame (cast iron - steel pair) which is unacceptable. In the expert's opinion, the cause of the wear of the axle-bearing is a design defect of this component, which is a manufacturing defect (para. 9.4 of the report).

Also, the expert report points out that the other machine of the same producer (the [Seller]) operated by the same Russian company has a varnish section of similar design. However, the attachment points of the master cylinder and anilox roll of this other machine are designed differently (frictionless bearings are used) and, though operated intensely, these components work reliably (para. 8.4 of the report).

The Tribunal notes that the expert examination report of the Leipzig Chamber of Commerce and Industry of 1 September 2005 presented by the [Seller], in its part dealing with the existence of the said defect in the varnish-and-pain section of the machine, does not contradict the expert examination report presented by the [Buyer] and in fact confirms the conclusion of the latter report as to the existence of the design defect. It is mentioned in the expert examination report presented by the [Seller] that, as to the similar machines of the upgraded type, the production of the varnish section is stable (para. 9(5) of the expert examination findings). The varnish section of the upgraded type is equipped with essentially different bearings of the raster roll (previous version had friction bearings, the new one has frictionless bearings) and by softer structure of the varnishing master cylinder (ample clearance). Both of these features prevent wear of the raster roll bearings under excessively high pressure during lengthy periods. Thus, the defects of the machine (malfunctions of the varnishing section) were design defects of a constant, and irremovable character.

As follows from the above, the machine defects, which repeatedly revealed themselves and emerged after their removal, were of a constant and unrepairable character. According to art. 475(2) of the Russian Civil Code, this qualifies as a fundamental breach of the requirements as to the quality of goods. Therefore, in violation of the obligations set forth in arts. 30 and 35 of the Vienna Convention, the [Seller] delivered to the [Buyer] a machine with such a lack of conformity that it amounted to a fundamental breach of the requirements as to the quality of goods.

      3.6 [Confirmation of the right to declare the contract avoided]

      The Tribunal cannot agree with the [Seller]'s arguments that the [Buyer] lost the right to declare the avoidance of the contract on the grounds of art. 49(2) CISG owing to the [Buyer]'s failure to notify the [Seller] about the avoidance of the contract within a reasonable time after the first notification by the [Buyer] about the malfunctions of the varnish section (letter of 25 May 2000). In accordance with art. 49(2) CISG:

"... the buyer loses the right to declare the contract avoided if he fails to declare the avoidance of the contract within a reasonable time after he knew or ought to have known of the fundamental breach."

In the Tribunal's opinion, the letter of 25 May 2000, being the first notification of the varnish section malfunctions, cannot be regarded as notification of the fundamental breach of the requirements as to the quality since the situation described in it does not conform to the notion of the fundamental breach mentioned in art. 475(2) of the Russian Civil Code. From the expert examination report issued on 3 February 2004, the [Buyer] knew for certain about the fact that a fundamental breach of the contract occurred (design defect of the machine varnish unit). Thus, the first notification claiming repayment of the funds and restitution of the machine was presented on 3 February 2004 by the machine user in the letter of 3 February 2004 as well as by the [Buyer] itself in the letter of 24 June 2004, i.e., within a reasonable time after the expert examination report.

Additionally, the Tribunal considers that the [Buyer] did not lose the right to declare the contract avoided due to the impossibility to make restitution of the machine substantially in the condition in which the [Buyer] received it (art. 82(1) CISG). According to art. 82(2)(a) CISG, art. 82(1) CISG shall not apply if it is impossible to make restitution of the goods or to make restitution of the goods substantially in the condition in which the buyer received them under circumstances in which this is not due to the [Buyer]'s act or omission. As follows from the materials of the case, on 21 December 1999 the machine was deposited by the [Buyer] as a contribution into the statutory capital of a Russian joint-stock company (Act (delivery note) No.1 for the acceptance of main assets of 21 December 1999) which implies transfer of the title to the machine to another Russian joint-stock company (art. 66(1) of the Russian Civil Code) and forfeiture of [Buyer]'s right to the machine. Moreover, the machine was used by third parties with which the Russian joint-stock company concluded lease contracts of 1 March 2000 and 1 January 2003, respectively. Since starting from 21 December 1999, the [Buyer] was deprived of any rights to the machine, the impossibility to return the machine substantially in the condition in which the [Buyer] received it could not have been caused by [Buyer]'s act or omission.

Therefore, the [Buyer] is entitled to avoid the contract on the grounds of art. 49 CISG.

      3.7 [Judicial avoidance of the contract]

      The Tribunal found that [Buyer]'s claim for avoidance of the contract is contained in the letter of 23 June 2004. The Tribunal states that [Buyer]'s declaration of avoidance of the contract was made in conformity with provisions of art. 26 CISG. Since the [Buyer]'s demand was not voluntarily fulfilled by the [Seller] as of the date of the hearings of the case, the Tribunal finds it justified to judicially avoid the contract concluded between the [Buyer] and the [Seller].

      3.8 [Recovery of the price and restitution of the goods]

      In conformity with art. 81of the CISG, in case of avoidance of the contract:

"A party who has performed the contract either wholly or in part may claim restitution from the other party of whatever the first party has supplied or paid under the contract."

In view of the absence of the evidence of any other amount paid by the [Buyer] to the [Seller] for the machine, when considering [Buyer]'s claim for the recovery of the funds, the Tribunal confirmed the sum established by the parties in the protocol of 28 October 2004.

Thus, [Buyer]'s claim for the recovery of the funds is to be granted in the specified amount.

At the same time, the [Buyer] is obliged to return the machine to the [Seller]. In addition, refund of the purchase price by the [Seller] and restitution of the machine by the [Buyer] shall be carried out concurrently (art. 81(2) CISG).

      3.9 [Arbitration fee]

      According to section 6(1) of the Regulations on Arbitration Fees and Expenses, if the parties did not agree otherwise, the arbitration fee is imposed on the party against which the Tribunal made an award. Consequently, the arbitration fee paid by the [Buyer] is to be recovered from the [Seller].


FOOTNOTES

* All translations should be verified by cross-checking against the original text. For purposes of this translation, Claimant of Cyprus is referred to as [Buyer] and Respondent of Germany is referred to as [Seller].

** Gayane Nuridzhanyan, junior associate at the law firm Danylko, Kushnir, Soltys & Yakymyak, Attorneys & Counselors at Law, Kyiv, Ukraine <http://www.dksylaw.com/>, student at Kyiv International University with major in private international law; participant of Canada-Ukraine Parliamentary Program, member of Ukrainian team at 2005 Telders International Moot Court Competition, The Hague.

*** Alexander Morari, born in the Republic of Moldova, has taken part in a number of international moot courts as a member of the Moldovan Team and as the coach of a Russian team.

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