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CISG CASE PRESENTATION

China 8 August 1996 CIETAC Arbitration proceeding (Diaper machine case) [translation available]
[Cite as: http://cisgw3.law.pace.edu/cases/960808c1.html]

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

Case Table of Contents


Case identification

DATE OF DECISION: 1990808 (8 August 1998)

JURISDICTION: Arbitration ; China

TRIBUNAL: China International Economic & Trade Arbitration Commission [CIETAC] (PRC)

JUDGE(S): Unavailable

DATABASE ASSIGNED DOCKET NUMBER: CISG/1996/36

CASE NAME: Unavailable

CASE HISTORY: Unavailable

SELLER'S COUNTRY: Canada (claimant)

BUYER'S COUNTRY: People's Republic of China (respondent)

GOODS INVOLVED: Diaper machine


Classification of issues present

APPLICATION OF CISG: Yes

APPLICABLE CISG PROVISIONS AND ISSUES

Key CISG provisions at issue: Articles 25 ; 50 ; 71 ; 73 ; 74 ; 77 ; 78 ; 80

Classification of issues using UNCITRAL classification code numbers:

25B [Definition of fundamental breach: substantial deprivation of expectation, etc.];

50A [Buyer's right to reduce price for non-conforming goods];

71A12 [Suspension of performance when apparent that a party will not perform a substantial part of obligations: grounds for suspension by other party (conduct in performing or preparing to perform contract)];

73C1 [Fundamental breach with respect to installment contracts (defect in one delivery prevents use of other deliveries): avoidance for both past and future installments];

74A [General rules for measuring damages: loss suffered in consequence of breach];

77A [Obligation to take reasonable measures to mitigate damages];

78A [Interest on delay in receiving price or any other sum in arrears];

80A2 [Failure of performance caused by other party: general principle that party causing nonperformance loses rights (compromise case)]

Descriptors: Fundamental breach ; Avoidance ; Reduction of price, remedy of ; Installment contracts ; Damages ; Mitigation of loss ; Interest ; Failure of performance, other party

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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 (Chinese): Zhong Guo Guo Ji Jing Ji Mao Yi Zhong Cai Wei Yuan Hui Cai Jue Shu Hui Bian [Compilation of CIETAC Arbitration Awards] (May 2004) 1996 vol., pp. 1646-1656

Translation (English): Text presented below

CITATIONS TO COMMENTS ON DECISION

English: Dong WU, CIETAC's Practice on the CISG, at n.106, Nordic Journal of Commercial Law (2/2005)

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Case text (English translation)

Queen Mary Case Translation Programme

China International Economic & Trade Arbitration Commission
CIETAC (PRC) Arbitration Award

Diaper machine case (8 August 1996)

Translation [*] by Wei Xia, Yang [**] and Zhan Changzheng [***]

INTRODUCTION

China International Economic and Trade Arbitration Commission, Shanghai Commission [hereafter, the Arbitration Commission] accepted this arbitration application in accordance with:

   -   The arbitration clause in the Memorandum of 6 August 1994, which is supplementary to the agreement to purchase a ECE4 - 309 celatose diaper machine signed on 8 November 1993 by Claimant [Seller], Canadian ___ Company, and Respondent [Buyer], China ___ Pty Ltd; and 
   -   The written arbitration application submitted by [Seller] to the Arbitration Commission on 12 September 1995.

On 13 November 1995, after receipt of the Notice of Arbitration and [Seller]'s claims, [Buyer] submitted counterclaims to the Shanghai Commission. The Arbitration Commission accepted [Buyer]'s counterclaims and decided to hear them together with [Seller]'s claims.

The parties failed to appoint the presiding arbitrator. Following the Arbitration Rules, Mr. P was appointed by the Chairman of the Arbitration Commission as the presiding arbitrator. Mr. P, Ms. A, appointed by [Seller], and Mr. D, appointed by [Buyer], formed the Arbitration Tribunal on 17 October 1995 and heard the case.

The Arbitration Tribunal examined [Seller]'s arbitration application and evidence and [Buyer]'s defense, counterclaim and evidence. On 23 November 1995, the Arbitration Tribunal held a court session in Shanghai. Both parties sent representatives to the court session. They made oral statements of facts, presented arguments, and answered the Arbitration Tribunal's questions. The Arbitration Tribunal mediated with the consent of both parties during the court session, but without success. After the session, both parties submitted supplementary materials. On 26 January 1996, to investigate, the Arbitration Tribunal made a site visit to Shanghai A Children's Healthcare Products Company (hereafter, "A Company") where the Diaper machine that [Buyer] purchased is located. Representatives of both parties were present.

On 10 July 1996, the Arbitration Tribunal applied to the Arbitration Commission to extend the award date due to the complexity of the dispute. The Arbitration Commission authorized an extension until 17 August 1996.

The case has been concluded. The Arbitration Tribunal has handed down its award. The following are the facts, the opinion of the Arbitration Tribunal and the award.

I. FACTS OF THE CASE

- The purchase agreement

On 8 November 1993, [Seller] and [Buyer] signed the purchase agreement in Toronto Canada. The purchase agreement stipulates that [Buyer] purchases from [Seller] a No. ECE4-309 celatose diaper machine (hereafter, the machine) that was produced in 1984, including certain spare parts relating to this machine.

Price. The total contract price is US $925,000 which includes:

-    US $862,000 for the machine,
-    US $ 20,000 for disassembling, loading and packaging,
-    US $ 13,000 for transportation from Toronto to Shanghai,
-    US $ 20,000 for installation in Shanghai,
-    US $ 10,000 for training in Shanghai.

Goods. The machine is the one [Buyer]'s representative inspected at the Atlantic Packaging Plant in Scarborough. [Seller] guarantees that machine is in good operating condition and that it produces 250 diapers per minute.

Delivery. [Seller] agrees to disassemble the machine and ship it to Shanghai in cargo container by sea in an appropriate way.

Terms of payment. The method of payment is:

  1. [Buyer] shall make a nonrefundable down payment of 10% of the total contract price, i.e., US $92.000, by 22 November 1993. Within fifteen days after receipt of this down payment, [Seller] shall deliver to the [Buyer] a copy of the manuals for the machine;
  2. [Buyer] shall pay to [Seller] US $555,000 upon delivery of packed containers to the shipping company or its agent;
  3. [Buyer] shall pay to [Seller] the remaining US $277,500 upon successful operation of the machine.

Raw materials and installation. [Seller] shall supply raw materials for test-run adjustments free of charge till production reaches the level of 250 diapers per minute. [Seller] shall help [Buyer] hire the engineers for installation and pay the installation fee of US $20,000 on behalf of the [Buyer].

Training. After the installation, [Seller] shall provide fourteen days training service to [Buyer]'s staff by Mr. Tim Wright, an engineer from the Atlantic Packaging Plant. He shall stay in Shanghai until the machine produces 250 pieces diapers per minutes. During or after the fourteen days, [Seller] shall also provide training service to [Buyer]'s staff by Janice, an operator at the Atlantic Packaging Plant.

Applicable law. The contract shall be interpreted and ruled on in accordance with the law of Ontario Canada.

- Delivery of the diaper machine

The machine was shipped to Shanghai on 4 January 1994 and arrived on 16 April 1994. The machine was transported to [Buyer]'s work site on 14 June 1994.

- The supplementary agreement: English version and Chinese version

[Seller] and [Buyer] signed a supplementary agreement on 6 August 1994 in Shanghai. It is called "memorandum" in English and "Supplementary contract" in Chinese. It is stated that this document is a supplement to the purchasing agreement and that both the English and Chinese versions shall have equal force.

- The English version of the supplementary agreement

In the English version memorandum, both parties agreed that [Seller] is responsible to "supply 24 hours raw material, 16 hours of which will be at the normal/operation of 250ppm [Translator's note: "250ppm = 250 pieces per minute = 250 diapers per minute]. This total time will include the setup and adjustment of the machine." And [Seller] "will guarantee to have the machine running within ninety days of acceptance of this memorandum". Meanwhile, [Buyer] "is obligated:

  1. To pay the remaining funds upon successful operation of the machine, at 250 [diapers per minute], as follows:
    (1) To issue an irrevocable letter of credit in favor of SACF Holdings Limited, in the amount of US $234,400 (within 30 days of the acceptance of this memorandum);
    (2) To issue an irrevocable letter of credit in favor of SACF Holdings Limited in the amount of US $43,100 (within 90 days). After a 6 month period following acceptance, the letter will be released.
  2. To pay all duties, taxes and processing fees in Shanghai."

- The Chinese version of the supplementary agreement

In the Chinese version supplementary contract, both parties agreed that [Seller] is responsible to "supply 24 hours raw material (including raw material for the set-up and adjustment of the machine), 16 hours of which will be at the normal operation of 250 diapers per minute. The trial process includes the set-up and adjustment of the machine." [Seller] "guarantees to have the machine running within 90 days of acceptance of this memorandum." Then [Buyer] "will:

  1. Pay the remaining funds upon successful operation of the machine as follows:
    (1) Issue an irrevocable letter of credit in favor of SACF Holdings Limited, in the amount of US $234,400 within 30 days of the signing of this agreement;
    (2) Issue an irrevocable letter of credit in favor of SACF Holdings Limited in the amount of US $43,100 within 90 days of the signing of this agreement. The L/C will be released 6 months after satisfactorily inspection and acceptance of the machine.
  2. Pay all duties, taxes and processing fees in Shanghai."

Both parties agree in the abovementioned "memorandum" / "supplementary contract" that [Seller] would pay for the parts of the high voltage sprayer system and that deferral of the trial run can be allowed in the event of [Buyer]'s fault or force majeure. The parties agree that, within the 6 month's warranty, if the unit price for replacement of any damaged part exceeds US $800, [Seller] will bear the expenses. The replacement of the damaged parts should be approved in written by [Buyer], ____ Consulting Company and qualified engineers. The damaged parts should be delivered to [Seller] for verification.

- The Shanghai inspection report

Shanghai Import and Export Commodity Inspection Bureau issued Certificate of Commodity Inspection Report No. 574059-1 on 10 July 1995. The certificate states that:

  1. The machine was loaded in the container without any packaging.
  2. The machine was transported to [Buyer]'s work site and was installed under the instruction of the engineer designated by the [Seller]. Despite the long-term trial run by the parties, the machine failed to meet the stipulated "16 hours normal operation at 250 pieces per minute."

The Certificate of Inspection concludes:

"The technical status of the machine has not met the technical requirements of the purchase agreement signed in Canada on 8 November 1993 or reached the technical capacity of the memorandum signed on 6 August 1994."

After that, the [Buyer] and [Seller] disputed whether or not the trial run reached the contractual results, over which party should take responsibility for the extended unsuccessful adjustments, and whether the remaining payment should be made. After failed negotiations, [Seller] applied to the Shanghai Commission for arbitration.

II. POSITION OF THE PARTIES

- [Seller]'s position

[Seller] alleges that:

   -    [Buyer]'s refusal to open the letter of credit according to the purchase agreement and the memorandum constituted a fundamental breach of contract.
 
   -    [Seller] continued to perform its obligations and delegated experts to adjust the machine at [Buyer]'s new work site in harsh living and technology environments.
 
   -    [Seller]'s experts cooperated with [Buyer]'s technicians in the trial run of the machine. During the trial run, the machine once achieved the requirement of producing 250 diapers per minute. However, [Buyer] considered that, from a marketing aspect, the production of 250 pieces per minute was so rapid that an overstock would occur and also that so rapid a production may disadvantage the usage and maintenance of the machine in the long term. [Seller] therefore adjusted the technical parameters at [Buyer]'s request to change 24 pieces per pack to 12 pieces per pack and decreased the production speed accordingly. Through the parties' mutual efforts, the adjustment was finished on 8 March 1995. [Buyer] announced that the trial run had been completed.
 
   -    [Buyer] also signed an employment contract with French engineer Bernard in the name of its user - "A Company" to guarantee the smooth operation of the machine. [Buyer] took over the operation of the machine and had been prepared for normal production.
 
   -    Nevertheless, when [Seller] asked for the third installment payment, [Buyer] refused to pay with the excuse that the machine did not reach the production capacity of 250 pieces per minute. And [Buyer] asked Shanghai Commodity Inspection Bureau to issue a certificate to prove that.
 
   -    However, the production capacity is relevant to the associated technical parameters and [Seller] decreased the production speed at [Buyer]'s request. This was based on an oral agreement between [Buyer] and [Seller] to decrease the production speed. It was a further supplement to the purchase agreement and supplementary contract and was performed. [Buyer] should not have denied this further supplementary agreement and returned to the original contract when [Buyer] sought quality inspection.

[Seller] has tried to resolve the disputes through negotiation and conciliation. But [Buyer] kept on rejecting [Seller]'s settlement proposals. Therefore, [Seller] applied for arbitration with the Shanghai Commission and asks the Arbitration Tribunal to rule that:

1. [Buyer] should pay the remaining price of the machine, US $277,500 and interest on this payment (from 8 March 1995 to 31 August 1995);

2. [Buyer] should indemnify the [Seller]'s further economic loss, US $97,340; and

3. [Buyer] should pay the arbitration fees and the attorneys' fee.

[Seller] alleges that:

1. [Buyer] should bear the responsibilities for the extended adjustment of the machine. The machine is highly automated and programmed equipment, which has strict requirements in terms of the stability of electricity pressure, frequency and groundwork. The groundwork of [Buyer]'s worksite split because of lacking reinforcing steel bar. The adjusting process was directly affected by the unstable electricity pressure, unsuitable frequency, frequent blackout and water stoppage, and unqualified accessory parts bought by [Buyer] had negative influences on the process of the trial run.

2. [Buyer]'s refusal to issue the required letter of credit constituted a fundamental breach of contract.

3. [Buyer] asked [Seller] to change the technical parameters to decrease the production speed. The certificate issued in July 1995 by Shanghai Commodity Inspection Bureau emphasized that the production capacity of the machine did not reach the standards stipulated in the contract without mention of the unsatisfactory technical environments and technical parameter change.

4. [Seller] had [Buyer]'s permission to change the adjustment engineers. [Seller] was unable to recruit the engineers stipulated in the contract due to force majeure. [Seller] notified [Buyer] immediately of the newlt appointed engineers and received no objection from [Buyer]. After the adjustment was finalized on 8 March 1995, [Buyer] renewed the employment contract with the engineer in the name of its user "A Company" to guarantee the normal operation of the machine. [Buyer]'s action implies that [Buyer] accepted the change of the adjustment engineers and the adjustment result. [Buyer] actually took over the operation of the machine. There is no excuse for [Buyer] to refuse payment.

5. [Seller] repeatedly requested quality inspection after the adjustment of the machine was finalized on 8 March 1995. However, [Buyer] kept delaying initiation of the quality inspection procedure.

6. Mr Hu, the legal representative of [Buyer] knew that the machine [Buyer] purchased was a second-hand machine redesigned by its Canadian user when he visited Canada on 8 November 1993. [Seller] had delivered the whole set of technical information to [Buyer] according to the agreement. Without it, the parties were unable to install and adjust the machine to operate. [Buyer]'s erroneous impression that the technical data was incomplete -- which led to delay in adjustment -- was in fact caused by [Buyer]'s incapability to translate or interpret the technical information.

7. [Buyer]'s repeated violation of contract has caused [Seller]'s severe economic losses. In accordance with Article 18 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest (hereafter, Foreign Economic Contracts Law), [Seller] submits lawful and reasonable claims for the following losses:

   -    US $ 3,940 service fee charged by R Baker for urging [Buyer] to issue the letter of credit;
   -    US $20,000 for [Seller]'s extra service expenses for the delay in adjustment caused by the poor site conditions and unsuitable associate facilities;
   -    US $ 6,000 for replacement of thermal absorption tube. The tube was destroyed because of unstable electricity pressure;
   -    US $ 20,000 for SAP machine;
   -    US $ 2,000 for VPU computer system;
   -    US $ 600 for material import tax;
   -    US $ 4,800 for PLC control system;
   -    US $40,000 for [Seller]'s extra personnel expenses.

- [Buyer]'s position

[Buyer] defends that:

1. [Seller] failed to fully perform its contractual obligations after signing the purchase agreement

[Buyer] alleges that: According to the agreement, [Seller] should deliver the copies of the machine manual to [Buyer] within 15 days after receipt of the down payment. However, [Buyer] has never received the manual. It is not clear on what basis [Seller] alleges that [Buyer] was unable to translate it. The machine manual is the most important technical document in relation to the specification, setup, adjustment and operation of the machine as well as the layout design. [Seller] neither provided [Buyer] with the manual, nor advised [Buyer] on the environment criteria for the trial run. Moreover, the engineers to whom [Seller] assigned responsibility for installation and the trial run were not from the Atlantic Packaging Plant and were not familiar with the machine as promised. After assembling and disassembling the machine many times, the engineers still could not get the machine to operate to the technical standards stipulated in the agreement. According to the "supplementary contract", the precondition for [Buyer] to pay the remaining payment is that the machine can operate normally within 30 days after signing the "supplementary contract", that is, before 7 September 1994. However, the engineers delegated by [Seller] the second time put aside the machine and left China on 25 August 1994 when the machine was still in the process of installation and far from normal operation. [Buyer] therefore believed [Seller] had no intention to continue its contractual obligations. [Buyer] did not open a letter of credit because [Buyer] had to take measures to mitigate the loss, in accordance with the Foreign Economic Contracts Law. The truth of the case is that [Seller] had fundamentally breached the contract. Accordingly, [Buyer] thereafter took appropriate measures to mitigate the loss.

2. [Seller] distorts the facts in its arbitration application and makes false statements without any supporting evidence

     1) [Seller] alleges that [Buyer] should bear the responsibilities for the delay in the adjustment of the machine. [Seller] claims that the trial run was negatively influenced by split groundwork at the factory site caused by the absence of a reinforcing steel bar; that the electricity was unstable, that the frequency did not reach the standards; that the associated facilities did not meet the requirements; and that these factors affected the adjustment process. However, [Seller] provides no evidence to prove the genuineness of its claims. [Buyer] actually provided a newly built factory in 1994 which satisfied the adjustment conditions. There were no problems interfering with the process of the trial run at the worksite. The factory environment [Buyer] provided was better than the factory environment in the Atlantic Packaging Plant.

     2) [Seller] claims [Buyer] fundamentally breached the contract by not issuing the letter of credit. That is nonsense. [Seller] is the party that committed a fundamental breach of contract. [Seller] misinterpreted the contract and did not fully perform its obligations. [Seller] did not deliver the manual for the machine to the [Buyer]. Furthermore, notwithstanding the uncompleted trial run, [Seller] unilaterally withdrew the second batch of engineers thirteen days before the letter of credit was due, leaving the machine unadjusted. [Seller]'s behavior proved that it had no sincere intent to continue to perform its obligations. Therefore -- as a measure to mitigate loss because of [Seller]'s fundamental breach of contract - [Buyer] should not have to open the letter of credit.

     3) [Seller] tries to shift its liability for breach of contract by mixing up concepts. [Seller] claims it decreased the production speed and amended the technical parameters to change the 24 pieces per pack to 12 pieces per pack at [Buyer]'s request. These claims are fabricated. [Seller] made them up without any foundation. [Buyer] never expressed or notified [Seller] in writing of any such request at all. The machine has an unlimited speed shift gear. This means that the production speed can be adjusted in line with sales demand. There is no direct connection between the adjustment speed and the packaging specifications. [Seller] deliberately mixed these concepts. [Seller] claims the adjustment speed once reached 250 pieces per minute. But no one on the spot saw this, nor even mentioned "16 hours in the normal production status at 250 pieces per minute". [Seller] deliberately mixed the two concepts - dry run and normal run with raw materials -- in order to avoid its default liability.

     4) [Seller] claims that, by [Buyer]'s conduct, [Buyer] agreed to change adjustment engineers and accepted the trial run as successful. The reason that [Seller] could not adjust the machine to the level stated in the agreement -- after substituting engineers three times - is because [Seller] did not recruit engineers from the Atlantic Packaging Plant who were familiar with the machine. [Seller] claimed that the adjustment was finalized at a time when the machine was not in operation condition. [Seller] could not produce any evidence that [Buyer] accepted the adjustment result as satisfying the agreement. [Buyer]'s point of view is supported by the quality certificate issued by Shanghai Commodity Inspection Bureau. "A Company" hired one French engineer because [Seller] withdrew its other engineers and left the machine unadjusted. "A Company" retained the engineer as a remedy to continue adjusting the machine, not as [Seller] claims, to maintain normal operations. Moreover, "A Company" is an independent legal entity whose actions are separate from [Buyer]'s.

     5) [Seller]'s allegation that [Buyer] repeatedly delayed the quality inspection process is untrue. The parties had never signed any documents regarding the trial run results. After [Seller] withdrew the last batch of engineers on 8 March 1995, [Buyer] felt that [Seller] had no sincere intent to finish the adjustment. [Buyer], therefore, requested Shanghai Commodity Inspection Bureau to conduct the quality inspection. The Bureau believed the inspection could not be conducted, as the adjustment had not finished. The Bureau held an assessment meeting on 23 May 1995, analyzing fully the cause of failure in the trial run of the machine, and whether [Seller] should take responsibility for the failed adjustment. The Bureau scheduled the inspection in July according to the Bureau's work arrangement, which could not be changed by [Buyer].

     6) [Seller] cites the Foreign Economic Contracts Law as the legal basis for its claims of economic losses. [Seller]'s claims are unfounded and are contrary to the provisions of the purchasing agreement and supplementary contract signed by both parties. [Seller] did not perform its contractual obligations. Therefore, [Seller] lost its right to claim the remaining US $277,000 and interest thereon. Moreover, the economic expenses [Seller] claims all occurred during adjustment; therefore, they should be regarded as [Seller]'s obligation under the contract.

3. As abovementioned, [Seller]'s arbitration claims lack factual or legal support. [Buyer] therefore asks the Arbitration Tribunal to dismiss [Seller]'s application. [Buyer] submits counterclaims to the Arbitration Tribunal as follows:

     1) [Seller] should reduce the price, discount it by one-third (i.e., US $287,333.33) of the price of the ECE4-309 celatose diaper machine, for not meeting the quality requirements of the contract. The final price should be US $574,666.67;

     2) [Seller] should deliver the manual for the machine according to agreement;

     3) U.S. $10,000 should be deducted from the total payment because [Seller] did not provide fourteen days or twenty-one days training services to [Buyer]'s operators as stipulated in the agreement.

     4) [Seller] should pay back US $5,360 borrowed from [Buyer] during the trial run of the machine as well as interest of RMB 11,547.97;

     5) [Seller] should indemnify [Buyer] for economic losses of US $151,383.55 and RMB 287,522.09;

     6) [Seller] should pay the arbitration fees and the attorneys' fee.

[Buyer]'s counterclaim alleges that:

[Seller] did not perform its contractual obligations stipulated in the purchasing agreement or the supplementary contract. Nor did [Seller] deliver the machine manual to [Buyer]. [Seller] breached the contract by not satisfactorily adjusting the machine and caused [Buyer] numerous economic losses. By virtue of Articles 16 and 18 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, [Buyer] has the right to seek indemnity from [Seller]. In order to mitigate the losses, [Buyer] organized personnel to diagnose the problem and replaced damaged parts. [Buyer] incurred a large amount of expenses to finish the adjustment. It is reasonable for [Buyer] to request a price reduction, a one-third discount in the price (i.e. US $862,000). The total price should be settled at US $ 574,666.67 and the training fee of US $10,000 should be deducted from that amount. In addition [Seller] should deliver the manual to [Buyer] immediately and pay [Buyer] back the US $5,360 loaned during the trial run of the machine as well as interest of RMB 11,547.97. The direct economic losses incurred include:

   -    RMB 13,200 that [Buyer] paid on behalf of [Seller] for the accommodation expenses of the first contingent of engineers;
   -    RMB 242,920.26 plus $24,000 in labor expenses for the technicians who attended the adjustment from June 1994 to October 1995;
   -    US $127,383.55 in rental for the factory;
   -    RMB 20,501.83 electricity fee;
   -    RMB 10,900 international long distance telephone expenses

It is [Buyer]'s position that [Seller] should bear the above losses, the counterclaim fees and the [Buyer]'s attorneys' fees.

- [Seller]'s response to [Buyer]'s defense and counterclaims

1. Both parties reached agreement that the letters of credit should be issued within 30 days and 90 days after signing the supplementary agreement and that the remainder should be paid within six months after inspection. However, [Buyer] had never issued one letter of credit. This was a fundamental breach of contract. Therefore, [Buyer] lost the right to request [Seller] to fully perform its contractual obligations.

2. [Seller] provided [Buyer] with all of the technical information, data and drawings relevant to the set-up and adjustment of the machine. [Buyer] just talked abstractly about the manual for the machine, but never listed the details of the manual, like how many books or which pages, etc.

3. 75% of the Directors of the Board of "A Company" are from [Buyer]. [Buyer], therefore, has the final decision for all the matters in "A Company". "A Company" is under [Buyer]'s management and control. A Company's activities should be regarded as [Buyer]'s activities.

4. The requirement of producing 250 diapers per minute was satisfied before 8 March 1995. [Buyer] made no request for continuously operation for 16 hours when [Buyer] accepted the trial run result on 8 March 1995. [Seller] lacked commercial experience and trusted [Buyer]'s oral acceptance so much that [Seller] did not ask [Buyer] to issue the verification certificate. However, there is sufficient evidence to prove that [Buyer] had accepted the trial run results. For instance, the French engineer Bernard signed a "Certificate of Compliance" on 7 March 1995. Other experts who attended the trial run also witnessed successful adjustment. "A Company" hired the French engineer who was originally recruited by [Seller]. Furthermore, the Chairman of the Board of [Buyer]'s Board of Directors declared in his Report to Shareholders that "the adjustment of the machine has finished. The trial run has been done and the machine will be put in production operation this year " This demonstrates that [Seller] finished the adjustment as required by [Buyer] and that the result was accepted by [Buyer]. The machine is no longer in use because [Buyer] decided to seal the machine and discontinue the trial run.

5. In contrast to [Buyer]'s allegation that [Seller] set a trap for [Buyer], [Seller] in fact showed the utmost sincerity in its dealings with [Buyer]. The adjustment expenses for a trial run such as this should be around US $20,000 under normal site conditions. Because of the harsh working conditions, lacking stable water and electricity supplies and [Buyer]'s failure to cooperate, [Seller]'s expenses for the adjustment were increased from US $20,000 to US $200,000. [Seller] showed great sincerity in adding more to its budget and continuing to try to run the machine seriously until the user was satisfied, even though [Buyer] violated the agreement by not providing the required environment. [Buyer] had never opened one letter of credit. It is reasonable to suspect that [Buyer] had no intention to pay from the very beginning.

6. The adjustment conducted by [Seller] ended on 8 March 1995. [Buyer] took over the machine and made many modifications. The certificate from Shanghai Commodity Quality Inspection Bureau was issued on 10 July 1995. The machine inspected was not in the same condition as of 8 March 1995. [Seller] is not responsible for what happened after 8 March 1995. In the certificate, it was unclear who should take the responsibility. The Bureau did not certify that the whole set machine is faulty, so [Buyer] has no ground to request a one-third discount.

7. [Buyer] sent two delegations to Canada to investigate the local market and set the price accordingly. There was no misunderstanding or fraud in the pricing of the machine. The contract price for the machine is reasonable and cannot be amended by [Buyer] unilaterally. [Buyer]'s opinion that "they bought useless rubbish" is unfounded.

- To [Seller]'s assertions, [Buyer] responds:

1. [Seller] did not provide sufficient evidence to support its claims. The so-called experts witnesses were inconsistent.

2. A Quality Inspection Certificate is legally recognized legal evidence in international trade. This certificate is proof that this machine does not meet the requirements. Therefore, [Seller] should be responsible for violation of contract. If [Seller] has objections to the certificate and conclusions of the Import and Export Commodity Inspection Bureau, [Seller] can resolve them through review processing with the Bureau.

[Buyer]'s Chairman of the Board mentioned that the "trial run has been done" in his Report to Shareholders. [Seller] misinterpreted the concepts of "done" with "succeeded" or "completed". [Buyer] did not mislead shareholders.

II. OPINION OF THE ARBITRATION TRIBUNAL

The Arbitration Tribunal holds the following opinion on the basis of the written materials, court session and site visit:

1. The contract

The agreement and supplementary contract were reached and signed by both parties. They are legal binding documents, under which both parties should perform their contractual obligations.

2. The applicable law

It is stipulated in the agreements that the interpretation of the contract should be subject to the legislation of Ontario Canada, where jurisdiction applies. However, both parties refer to provisions of the CISG and the Economic Contract Law Involving Foreign Companies as their legal basis of the case, not the legislation of Ontario Canada. To respect both parties' wishes, the CISG, the Economic Contract Law Involving Foreign Companies, and international trade custom are applied.

3. The contract and the supplementary agreement

After reviewing the materials, the Arbitration Tribunal holds that the contracts contain ambiguous stipulations and that there are discrepancies between the Chinese and English versions of the supplementary agreement (the two version having equal force), for instance:

     1. The specifications. For this machine, that was sold for nearly one million US dollars, there were neither names nor specifications of the parts in the contracts. Nor was any technical information attached. In the contract, the only description of the machine was its product type, its year of production, and that [Seller] must supply the machine inspected at the Atlantic Packaging Plant by [Buyer]'s representatives.

     2. [Seller]'s guarantee and the quality standards for inspection. [Seller] guaranteed that the machine was in good operation condition and would produce 250 diapers per minute. Although the clause that the machine should produce 250 diapers per minute for 16 hours was added into the supplementary contract, it did not specify the quality standards for inspection.

     3. The manuals. It is stipulated that [Seller] should deliver a copy of the manuals for the machine to [Buyer] within 15 days upon receipt of the down payment However, each side has its own definition of the facts associated with the manuals.

     4. The last payment. Regarding the time for the last payment, it was only said that payment should be paid upon successful operation of the machine. What is successful operation is also ambiguous in the supplementary contract. This has been subject to dispute with each side holding different opinions. The ambiguousness of the responsibility caused losses for [Seller], [Buyer] and user, "A Company".

4. Issuance of the letter of credit

[Seller] alleges [Buyer] should have issued the letter of credit, without any limitation, within 30 days and 90 days after signing the supplementary contract and that, because [Buyer] did not do that, [Buyer] is in violation of contract. [Buyer]'s position is that a precondition for issuance of letter of credit is that the machine produce 250 diapers per minute for 16 hours continuously. [Buyer] asserts that non-issuance of the letter of credit is a measure to mitigate losses.

The Arbitration Tribunal holds that there was no clear clause in relation to the issuance of the letter of credit in the supplementary contract. [Seller]'s person in charge, Mr. Robert Baker, did, however write to [Buyer] on 1 October 1994 that the letters of credit are promises to pay and that no money needs to be paid until certain conditions are met. However, it is not clear what documents needed to be produced and when the letters of credit were due. It is also unknown if the paying bank had to see the verification certificate signed by both parties at the time of payment. [Seller] claimed mutual understanding was reached in the supplementary contract that the precondition for issuance of the letters of credit is 30 days and 90 days after signing the supplementary contract, and that the precondition for the last payment is six months after inspection of the machine.

The Arbitration Tribunal finds that the abovementioned payment methods were only written on the second letter of credit (with amount of US $43,100). The Arbitration Tribunal further finds that [Seller] promised in the supplementary contract that the machine would operate within 90 days of signing the supplementary contract.

But the supplementary contract was signed on 6 August 1994. The second contingent of engineers hired by [Seller] departed from China on 25 August 1994, one month earlier than previously scheduled at a time when the trial-run adjustment was not finished. It was only thirteen days before the date [Buyer] was expected to issue the first letter of credit. The engineers having left, [Buyer] thought [Seller] had no intention to perform the contract and therefore took the mitigation measure of not issuing the letter of credit. [Seller]'s third contingent of engineers arrived in Shanghai in October 1994 and departed for France to purchase spare parts on 1 November 1994. They returned to Shanghai in early December 1994 without any parts. Under these circumstances, [Buyer] had reason to believe it was impossible for [Seller] to finish adjustment in the timeframe, i.e., by 6 November 1994 so, to mitigate losses, no letter of credit was sought.

The Arbitration Tribunal does not support [Seller]'s opinion that [Buyer] non-issuance of the letters of credit constituted a breach of contract.

5. The manual and related information

[Seller] and [Buyer] had different explanations in relation to the manual. The Arbitration Tribunal notes that Shanghai Commodity Quality Inspection Bureau held a special conference on 23 May 1995 to reviewing and summarizing the trial run of the machine. The adjustment engineers attended and spoke at this conference. The signed seminar records, to a certain degree, reflect the technology data of the machine. On the basis of the relevant information, the Arbitration Tribunal holds that this was a second-hand machine produced by a French manufacturer and modified by the Canadian user. Because of lacking technology information and parts, the trial run could not be conducted smoothly. Disputes arose because there was no specification on the technology information in the contracts.

6. The trial run

The major dispute between [Seller] and [Buyer] is whether or not the trial run was successful. According to the agreement and supplementary contract, the trial run should succeed in 90 days after signed the supplementary contract, i.e., by 6 August 1994. The machine should operate normally for 16 hours continuously. The machine did not satisfy those requirements. The certificate issued on 10 July 1995 by Shanghai Commodity Quality Inspection Bureau supported the view that the trial run was unsuccessful. The Arbitration Tribunal made a site investigation and found a trial run record of 8 March 1995 stating the machine did not produce the qualified products as expected. But the possibility exists that adjustments may succeed after further trial and improvement. The evidence produced by [Seller] cannot demonstrate that the trial run was successful by 8 March 1995. The cooperative relationship between [Seller] and [Buyer] at the beginning of the trial runs deteriorated for conflict of interests. They blamed each other. The main reasons for failed trial runs are:

   -    The machine is second-hand and was used for many years;
   -    Its Canadian user altered the machine, but little record of the modifications were kept;
   -    The machine was disassembled and shipped through several transfers;
   -    The two engineers who were familiar with the machine were not hired as the contract stipulated; and
   -    The temporarily recruited engineers were not familiar with the machine or the modifications to it.
   -    Furthermore, engineers came and went frequently. It took time and energy to find the right methods and the correct parts.
   -    Not providing the required facilities and environments by [Buyer] also contributed to the failure of the adjustment.

In general, the reasons for the failure are complicated.

7. [Seller]'s claim for the remaining payment

The Arbitration Tribunal does not support [Seller]'s claim for the remaining payment of US $277,500 and interest on this amount, as the machine did not satisfy the requirements stipulated in the agreement and supplementary contract.

8. [Seller]'s other claims

The Arbitration Tribunal does not find contract basis to support the following claims for losses by the [Seller]:

   -    US $ 3,940 service fee charged by R. Baker to urge [Buyer] to issue the letter of credit;
   -    US $20,000 paid for [Seller]'s extra expenses because delay in the trial run caused by the poor site conditions and unsuitable associated facilities;
   -    US $ 6,000 paid for replacement of damaged thermal absorption tube;
   -    US $20,000 paid for SAP machine;
   -    US $ 4,800 paid for PLC control system;
   -    US $40,000 paid for additional work of [Seller]'s staff.

With respect to [Seller]'s further claim for US $2,000 for the VPU computer system, the General Manager of "A company" agreed to reimburse [Seller] for that after the trial run succeeds. As the trial run failed, [Seller] has little legal basis to request this payment. The Arbitration Tribunal finds that [Seller] and [Buyer] agreed in the supplementary contract that [Buyer] should bear the tariff and service fees in Shanghai. And the Arbitration Tribunal does not support [Seller]'s further claim for US $600 for material import tax because [Seller] did not submit relevant evidence.

9. [Buyer]'s counterclaim for a price reduction

[Buyer] requests [Seller] to reduce the price of the machine from the purchasing price US $862,000 to US $574,666.67, i.e., to provide a one-third discount on the basis that the machine did not perform to the standards stipulated in the contracts. The discount request was made referring to the price of another machine of similar type in the international market. Article 50 of CISG states:

"If the goods do not conform with the contract and whether or not the price has already been paid, the buyer may reduce the price in the same proportion as the value that the goods actually delivered had at the time of the delivery bears to the value that conforming goods would have had at that time."

It is true that the machine does not meet the criteria stipulated in the contracts. [Buyer] may therefore ask for discount. However, the purchase price was determined by both [Seller] and [Buyer] after negotiation. [Buyer] could not request a one-third discount simply because [Buyer] considers the price is much higher than the price for one of a similar type in the international market. The discount request shall be considered with [Buyer]'s claims for indemnification of damages.

Because of the ambiguous clauses of the contract, the rights and obligations of both parties were unclear. [Buyer] should also take partial responsibilities for the failed trial runs. Considering Arbitration Tribunal investigation of the case, the losses of both [Seller] and [Buyer] and the possibility of further success of the adjustment, the Arbitration Tribunal holds that the reasonable discount ratio should be 20%, i.e., from US $862,900 to US $689,6000.

10. Delivery of manual

At the time of signing the agreement, it is unclear about the rights and obligations in relation to the technical information. The Arbitration Tribunal does not support [Buyer]'s counterclaim for the delivery of the manual.

11. Training services

According to the agreement, [Seller] was obligated to arrange for training of [Buyer]'s staff by Tim Wright and Janice, engineers from the Atlantic Packing Plant. This training was never conducted. Considering the training services actually provided by [Seller], the Arbitration Tribunal holds that [Buyer] may deduct from the payment owed 50% of the training fee stipulated in the contract, i.e., $5,000.

12. The loan from [Buyer] to [Seller] and interest on it

The Arbitration Tribunal finds after investigation that [Buyer] and [Seller] signed an agreement on 13 January 1995 pursuant to which [Buyer] lent $5,000 to [Seller] for three months at an interest rate of 2.4% per month and at the rate 20% interest for overdue payments. [Seller] did not deny the agreement. It was connected with the trial run of the machine. The Arbitration Tribunal holds that the loan is relevant to the adjustment. However, as [Buyer] is not a financial institution, the loan agreement is invalid under Chinese legislation. Subject to the rules of nullification of invalid contracts under China law, [Seller] should repay the loan. [Buyer]'s claim for interest is, however, dismissed.

13. [Buyer]'s other claims

[Buyer] made counterclaims for [Seller] to indemnify [Buyer]'s economic losses. The Arbitration Tribunal dismisses [Buyer]'s claim for foreign engineers' accommodation expenses as these claims have no contract basis, and dismisses [Buyer]'s other claims due to lack of legal grounds. These are claims for the labor costs for technicians involved in the trial runs at the work site, claims for the expenses of the international long distance phone calls, and claims for rental and electricity expenses.

14. The amended claims

The Arbitration Tribunal will not consider the amended claims submitted by [Seller] on 15 January 1996 or the amended counterclaims submitted by [Buyer] on 7 May 1996 as neither party followed the relevant Arbitration Rules

15. Payment

Based on the above, [Buyer] should pay [Seller] US $95,100 after retaining the loan amount of US $5,000. The rights and obligations of both [Seller] and [Buyer] under the agreement and supplementary contract shall terminate after this payment.

16. Arbitration fees and attorneys' fees

The arbitration fee including the application and counterclaim fees will be borne 70% by [Seller] and 30% by [Buyer] after considering both sides performance of the contracts. Each party bears its own attorneys' fees.

III. AWARD

1. The purchasing price of the machine is US $689,600 and the training fee is US $5,000. [Seller] shall pay back to [Buyer] the loan of US $5,000. [Buyer] shall pay [Seller] US $95,100 within 45 days of this award. After 45 days, the daily interest rate will be 0.25%.

2. [Seller]'s request for the remaining payment for the machine, i.e., US $277,500 and the relevant interest from 8 March 1995 to 31 August 1995, is dismissed

3. [Buyer]'s requests for the handover of the manual for the machine and indemnity for economic losses US $151,383.55 and RMB 287,522.09, are dismissed

4. [Seller] shall pay 70% of the arbitration fee (RMB __ as application fee, RMB __ as counterclaim fee, totally RMB __) while [Buyer] shall pay 30%. [Seller] and [Buyer] paid the arbitration fee RMB __ and RMB __ respectively. [Seller] shall pay [Buyer] RMB __ within forty-five days of the date this award is handed down. After that, 0.5% daily interest shall be charged.

This is the final award.


FOOTNOTES

* All translations should be verified by cross-checking against the original text. For purposes of this translation, Claimant of Canada is referred to as the [Seller]; Respondent the People's Republic of China is referred to as the [Buyer]. Amounts in the currency of the United States (dollars) are indicated as [US $]; amounts in the currency of the People's Republic of China (renminbi) are indicated as [RMB].

** Wei Xia Yang, Master of Business Law. Monash University, Australia. BA in English (Translation), Beijing Foreign Studies University.

*** Zhan Changzheng is an Associate with Shanghai Haoliwen PRC Attorneys. He received his LL.M. from Xiamen University. He focuses on company law, international commercial arbitration law, and international trade law.

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Pace Law School Institute of International Commercial Law - Last updated May 24, 2006
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