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CISG CASE PRESENTATION

China 29 March 1999 CIETAC Arbitration proceeding (Flanges case) [translation available]
[Cite as: http://cisgw3.law.pace.edu/cases/990329c1.html]

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

Case Table of Contents


Case identification

DATE OF DECISION: 19990329 (29 March 1999)

JURISDICTION: Arbitration ; China

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

JUDGE(S): Unavailable

DATABASE ASSIGNED DOCKET NUMBER: CISG/1999/14

CASE NAME: Unavailable

CASE HISTORY: See companion Flanges case of 30 March 1999

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

BUYER'S COUNTRY: United States (claimant)

GOODS INVOLVED: Flanges


Classification of issues present

APPLICATION OF CISG: Yes

APPLICABLE CISG PROVISIONS AND ISSUES

Key CISG provisions at issue: Articles 4 ; 11 ; 35 ; 36 ; 38 ; 39 ; 40 ; 73 ; 74 ; 75 ; 77 ; 78 ; 80 ; 96

Classification of issues using UNCITRAL classification code numbers:

4B [Scope of Convention (issues excluded): statute of limitations, fraud];

11A1 [Formal requirements: inapplicability of domestic requirements (but see arts. 12 and 96)];

12A [Effect of reservation under article 96 rejecting article 11];

35A [Conformity of goods: quality, quantity and description required by contract];

36B [Time for assessing conformity of goods: lack of conformity occurring after passage of risk (guarantee of continued conformity)];

38A [Buyer's obligation to examine goods: time for examining goods]:

39A2 ; 39B [Requirement to notify seller of lack of conformity: buyer must notify seller within reasonable time; Cut-off period of two years];

40B [Seller's knowledge of non-conformity (sanction for seller failing to disclose non-conformity): seller loses right to rely on articles 38 and 39];

73A1 [Avoidance in installment contracts (fundamental breach with respect to installment): declaration of avoidance with respect to installment]'

74A ; 74A1 [General rules for measuring damages: loss suffered as consequence of breach; Includes loss of profit];

75A [Damages established by substitute transaction: substitute transaction after avoidance]

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

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

80A [Failure of performance caused by other party (party causing non-performance): loss of rights]

Descriptors: Scope of Convention ; Statute of limitations ; Fraud ; Formal requirements ; Waiver ; Declaration, Art. 96 ; Conformity of goods ; Guarantees ; Examination of goods ; Lack of conformity notice, timeliness ; Lack of conformity known to seller ; Latent defects ; Installment contracts ; Fundamental breach ; Avoidance ; Damages ; Profits, loss of ; Cover transactions ; Mitigation of loss ; Set-off ; 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) 1999 vol., pp. 1652-1694

Translation (English): Text presented below

CITATIONS TO COMMENTS ON DECISION

English: Dong WU, CIETAC's Practice on the CISG, at nn.74, 164, 225, 236, 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

Flanges case (29 March 1999)

Translation [*] by Xiaotong Yuan [**]

Edited by John W. Zhu [***]

     Setting the Arbitration in Place

  1. Facts
    (I)   Outline of the contracts
    (II)  The [Buyer]'s reasoning and arbitration application
    1. The serious quality problems that gradually appeared
    2. Measures to compensate [Buyer]'s losses
    3. Quality problems revealed by evidence on flanges tested
    (III) The [Seller]'s defense
    (IV)  Differences between the positions taken by the parties. Issues over:
                 (i)    Whether the quality of the goods was materially defective
                 (ii)    The contract basis and other legal basis for [Buyer]'s claims
    (V)    Differences concerning the [Buyer]'s claims to compensate its economic losses
    (VI)   Differences concerning the [Seller]'s counterclaims
  2. Reasoning of the Arbitral Tribunal
    (I)   Applicable law
    (II)  The quality issue
                 (i)    The experts' investigation and evaluation report
                 (ii)    Opinions of the parties on the report
                 (iii)   Conclusions drawn by the Arbitral Tribunal
    (III) Rulings on [Buyer]'s right to claim damages or other relief
                 (i)     Concerning statute of limitations for arbitration and the period of claim
                 (ii)    Concerning quality issues and contract provisions on claims
    (IV)    Rulings on amounts claimed by the [Buyer] for:
                 (i)     ...   inventory flanges unable to sell
                 (ii)    ...   loss of profit from unsold inventory flanges
                 (iii)   ...   loss of profit from flanges undelivered
                 (iv)   ...   economic losses suffered from flanges sold
                                as "original goods without any change"
                 (v)     ...  expense for settlement
                 (vi)    ...  expenses for tests
                 (vii)   ...   money for returns from other clients
                 (viii)  ...   interest
                 (ix)     ...   taxes
                  (x)     ...   attorneys' fees
                  (xi)    ...   the arbitration fee
                 (xii)    ...   expenses for experts' investigation and evaluation
    (V)    Rulings on [Seller]'s counterclaim for:
                  (i)      ...   payment in arrears
                  (ii)     ...   losses for flanges rejected by the [Buyer]
                  (iii)    ...   losses for inventory flanges
                  (iv)    ...   attorneys' fees
                  (v)     ...   the arbitration fee for the counterclaims
  3. The Award

SETTING THE ARBITRATION IN PLACE

The China International Economic and Trade Arbitration Commission (formerly known as the Foreign Economic and Trade Arbitration Committee of China Council for the Promotion of International Trade, hereafter referred to as the "Arbitration Commission") accepted this arbitration case in accordance with:

   -    The written arbitration application filed by Claimant, US ×× Valve Company (hereinafter referred to as "[Buyer]"); and
 
   -    The arbitration clause in contracts for the sale of flanges signed on 24 January 1987, 25 January 1988 and 20 October 1989, respectively, between the [Buyer] and Respondent, Shanxi ×× Import & Export Company (formerly known as China ×× Import & Export Company Shanxi Branch Company, hereinafter "[Seller]").

Mr. A, nominated by the [Buyer], Mr. D, designated by the [Seller], and Mr. P, the presiding arbitrator appointed by the Chairman of the Arbitration Commission in accordance with the Arbitration Rules of the Arbitration Commission, formed the Arbitral Tribunal to hear this case. [Seller], following the relevant procedures, raised counterclaims against the [Buyer] within the time limit stipulated by the Arbitration Rules. The Arbitration Commission and the Arbitral Tribunal ruled that the claims of the [Buyer] and the counterclaims of the [Seller] would be jointly heard.

Whereas a mass of documents were submitted by the parties prior to the hearing (including the written arbitration application and its enclosures) which involved the issues of translation, transmission, preparation and contact, the hearings were not held until April 1996. The hearings were held on 18, 19 and 20 April 1996. The parties or their agents appeared before the Tribunal, made full oral presentations and arguments on the facts, claims and submitted the bases for their claims in law and under the contracts.

The primary issues in dispute were connected with the existence of deficiencies or concealed deficiencies of the goods and the authenticity of the testing data. After discussions, the Arbitral Tribunal concluded that it was necessary to carry out an independent investigation of the goods which were still stored in [Buyer]'s warehouse, the goods which had been tested and returned to the [Seller], and the testing institution which conducted the testing for Claimant [Buyer]. At the hearing, according to the Arbitration Rules, the Arbitral Tribunal proposed to send experts to carry out investigations on the spot. [Buyer] agreed to this, while the [Seller] took the position that the parties should bear the burden of proof according to the principle of "the party who makes claims bears the burden to prove its claims" and that it was unnecessary for the Tribunal to conduct on-the-spot investigations. However, the [Seller] acknowledged that the Arbitration Tribunal had the authority to make the decision on this issue. The Arbitral Tribunal asked questions of both parties at the hearing. In addition to their answers and explanations provided at the hearing, several times after the hearing the parties also submitted supplemental written evidence or statements by their attorneys.

After the hearing, the Arbitral Tribunal contacted both parties via mail and telephone and sent a notification that an on-the-spot investigation would be conducted by experts in the USA. The [Buyer] paid for the investigation expenses in advance. On behalf of the Tribunal, the Secretariat Office of the Arbitration Commission entrusted the China International Economic Cooperation Society and its affiliate, Zhuojian Consulting Company, to appoint two experts to conduct the investigation. Mr. Jin (Vice Chief Engineer, Research Fellow of the China Research Center on Boiler and Pressure Container Test) and Mr. Zhang ×× (Vice Chief Engineer of the China General Institute on Iron Research) were selected to conduct the investigation. They are both experienced experts on iron material research and had participated in many international testing and evaluation projects for boilers and pressure containers. After accepting the task of investigating and evaluating the flange quality in this case, they temporarily left their working institutions and worked independently as qualified experts. From 2 to 12 December 1996, accompanied by Mr. P, the Presiding Arbitrator of the Arbitral Tribunal, and Ms. S, the Secretary in charge of this case at the Secretariat Office of the Arbitration Commission, with the assistance offered by the parties to this dispute, the two experts went to Houston, Texas where the goods were stored for the investigations. The investigation team examined the self-test equipment, experimental process and the testing approach implemented by the [Buyer] and also visited Lab M in Houston which had examined these flanges previously. For the purpose of retesting, the experts, together with the [Buyer] and the [Seller], took eight samples from the goods delivered by the [Seller], which the [Buyer] claimed have defects or concealed defects.

Under the supervision of the Presiding Arbitrator of the Arbitral Tribunal and the two experts, each sample for examination was cut into two pieces and sealed with a mark. The parts were sent to the New Jersey International Testing Laboratories ("International Testing Laboratories") and the Central Iron & Steel Research Institute of the PRC Ministry of Metallurgical Industry ("PRC Iron & Steel Institute") for independent physical and chemical examinations, respectively. Testing Reports issued by these two laboratories were sent to the experts for further analysis, based on which an Expert Report on Investigation and Evaluation (hereafter, "Investigation Report") was produced. The Report was sent to both parties and to the three arbitrators separately in March 1997. The parties were given sufficient time to present their comments on the Report. Both parties sent written comments to the Arbitral Tribunal on the Expert Report on Investigation and Evaluation.

Both parties recognized the essential parts of the Investigation Report and addressed their own understandings with certain different explanations on some issues. In accordance with the Arbitration Rules, the Arbitral Tribunal believed that it was necessary to hold another hearing to invite the experts to explain certain issues on the investigation. The Tribunal notified both parties to attend the hearing on 28 October 1997. Due to the change of the two experts' schedule, the hearing had to be rescheduled to 9 December 1997. Both parties agreed.

The rescheduled hearing was held on time with the attendance of the attorneys of both parties. The [Seller] at this time asked the Arbitral Tribunal to rule on whether the Claimant [Buyer] had lost its capacity as a business entity based on a certificate issued by the Secretary of State of Texas on 27 September 1997, which referred to the [Buyer] as "×× Valve Company registered in Oregon 15 May 1986 with its operation in Texas" and declared that the above named company had been terminated in its registration place (Oregon) since 4 April 1997." Therefore, the [Seller] alleged that ×× Valve Company was not eligible to be the Claimant in this case. [Seller] alleged that, even though the original ×× Valve Company has filed the arbitration application and conducted other relevant arbitral activities, the [Buyer] had no right to carry out these activities due to the expiration of its corporate capacity. The [Seller] pleaded that the Arbitration Tribunal should rule on this significant issue and dismiss all of the claims made by the [Buyer] and its attorneys in the arbitration. The [Seller] also asked the Arbitral Tribunal to suspend the hearing until this important procedural issue is resolved; otherwise, the whole proceeding would be meaningless.

In response to [Seller]'s capacity allegation, the [Buyer] stated that ×× Valve Company had simply changed its registration place from Oregon to Delaware due to a change in equity ownership, but this did not affect its independent corporate personality and operations. [Buyer]'s original place of business in Texas still acted as a "foreign corporation registered in other states" to carry out its operations within its original business fields in this state. Because ×× Valve Company was a public company with shares listed in the USA, the change of its equity ownership and registration place would not affect its corporate personality, external debts and credits, nor would it affect its legal status in litigation and arbitration proceedings. ×× Valve Company did not experience bankruptcy, liquidation and winding up. The [Buyer] also pointed out that the certificate the [Seller] presented was signed by the Secretary of State of Oregon on 29 September 1997, while the [Seller] signed the letter to require the investigation and termination of the arbitration on 2 December 1997. Furthermore, the [Seller] delayed submitting this letter to the Tribunal till the second hearing. Despite the possibility of unfamiliarity with American laws or any other reasons, this showed that the [Seller] delayed and affected the arbitration proceeding on purpose. After a temporary adjournment, the Arbitral Tribunal clarified that this hearing was held to listen to the experts' explanations on their report and the materials submitted by the [Seller] to prove the [Buyer]'s lack of capacity had not been confirmed, so the Tribunal suggested continuing the hearing and listening to the experts' explanation. However, the [Seller] insisted that the hearing be suspended. In response, the Tribunal terminated this hearing and required the [Buyer] to submit the material proving its corporate capacity and relationship with ×× Valve Company in Delaware. With the agreement of both parties, the [Buyer] was offered a period of time to prepare the materials. The [Buyer] reserved the right to claim compensation against the [Seller] for its losses of traveling fee and other costs to attend the hearing.

On 19 January 1998, the [Buyer] submitted materials to prove the changes of the equity structure of ×× Valve Company and its registered address and materials to support [Buyer]'s position that there had been no change in its legal status. The articles of association of ×× Valve Company registered in Delaware made it clear that all credits, debts, liabilities and rights of ×× Valve Company registered in Oregon were inherited by ×× Valve Company registered in Delaware. All of the materials were delivered to the [Seller] and the three arbitrators. The Arbitration Commission determined that ×× Valve Company registered in Delaware was the successor of the [Buyer], ×× Valve Company registered in Oregon, and was eligible to participate in arbitration activities and was entitled to the rights and obligations of the arbitration award.

The Arbitral Tribunal considered it necessary to point out that the date of delivering the award was postponed several times due to complicated issues in this case including the experts' investigation and evaluation, the translation and the service of a great many documents. The postponement was approved by the Arbitration Commission based on the applications presented by the Arbitral Tribunal in compliance with the Arbitration Rules. On 28 May 1997, the Arbitration Commission ruled that the date for issuance of the award was postponed to 1 December 1997. The Arbitral Tribunal decided to schedule another hearing on 28 October 1997 to invite the experts to provide explanations on their investigation report. Due to the schedule of the experts, the date to hold the second hearing was postponed to 9 December 1997 and the two parties agreed with this postponement and appeared at the postponed hearing on time. Before this, the Arbitral Tribunal had applied to the Arbitration Commission to postpone the date for issuance of the award to 30 April 1998, which was approved by the Arbitration Commission. Based on the agreement of both parties to the second hearing and the time left for the [Buyer] to offer written evidence on the validity of its corporate qualification, the proceeding of this case was not suspended. The Secretary assisting the Arbitral Tribunal in this case proposed to notify of the postponement after the [Buyer] provided the additional evidence to prove its eligibility, so the approval by the Arbitration Commission to postpone the delivery of the award to 30 April 1998 was not sent out until 14 January 1998. On 2 March 1998, the Arbitration Commission received a communication from the [Seller] declaring its objection to the extension of the date of the award. The Secretariat Office of the Arbitration Commission replied to this objection in written form on 28 April 1998. On 15 June 1998, the [Seller] objected to the extension of the award for a second time. It alleged the fact that [Seller] did not receive the notice from the Arbitration Commission to postpone the date of delivering the award to 30 April 1998 before 29 November 1997, nor did [Seller] receive the arbitration award, meant the termination of the arbitral proceeding. [Seller] alleged that the second hearing on 8 December 1997 and the activities of the Arbitral Tribunal conducted after 29 November 1997 were invalid due to non-compliance with the requirements of the Arbitration Rules. With respect to this issue, in accordance with the Article 81 of the Arbitration Rules, the Arbitral Tribunal asked the Arbitration Commission to interpret Article 52 of the Arbitration Rules regarding to the postponement of the delivery date of the arbitration award.

The Arbitration Commission's interpretation is:

"The Arbitration Law of the PRC is silent on the duration of an Arbitral Tribunal formed in compliance with legal procedures and on the time limit for the Arbitral Tribunal to formulate an award. Article 52 of the Arbitration Rules of this Arbitration Commission is a provision calling for attention but will not void the legal effects of the Arbitral Tribunal's activities. Neither does this article provide for whether and when the extension of the time limit is to be notified to the two parties in disputes, nor does it specify the effect of postponing an award. Therefore, once the time limit of nine months expired, even though postponement procedures had not been completed in accordance with this Article, such a failure is a problem in the work of the Arbitral Tribunal or the Secretariat Office of the Arbitration Commission, which is to be handled by the Arbitration Commission based on the actual conditions. In other words, the Arbitral Tribunal does not lose the legal basis for its existence, so the Arbitral Tribunal is still lawful and the award made by the Arbitral Tribunal is legal and effective."

The Arbitral Tribunal held that the [Seller] had misunderstood the time limit stipulated in Article 52 as a time limit to terminate the Arbitral Tribunal and its activities. In fact, even after the Arbitral Tribunal makes the award, it is not terminated immediately. It is revealed in Articles 56, 61 of the Arbitration Law and Articles 61, 62 of the Arbitration Rules that the deadline to make the award is not a deadline of the Arbitral Tribunal to end its effective existence. In addition, the Arbitral Tribunal applied to the Arbitration Commission for an extension before 29 November 1997 and the Arbitration Commission had approved this application and made the corresponding decision. It was a problem in the working process that the official delivery of the notice of postponement to the parties was delayed. The Arbitration Commission could deal with this problem on the basis of facts and circumstances which should not affect the legal existence of the Arbitral Tribunal and the effectiveness of its award. Furthermore, the two parties accepted the decision that the second hearing was postponed to 9 December 1997 and both parties attended this hearing. At this hearing, the [Seller] proposed to the Tribunal a new issue -- "verifying the subject qualification of the [Buyer] in arbitration" -- and agreed to reserve time for the [Buyer] to offer written evidence. The [Seller] did not raise any objection on the issue of time, which means that the [Seller] actually had accepted the deferred hearing and award according to Article 45 of the Arbitration Rules.

The deadline date approved by the Arbitration Commission to decide the case was 30 March 1999. After deliberation, the Arbitral Tribunal has now made its award.

The following are the facts, the opinion of the Arbitral Tribunal and the award.

I. FACTS

(I) Outline of the contracts

The [Buyer] and the [Seller] signed Contract No. 87 MEXMR-137201C on 24 January 1987, in which it was agreed by the parties that the [Buyer] would purchase forging carbon steel flanges from the [Seller]. Afterwards, the parties entered into other two contracts (Contract No. 88MEXM-13306C and Contract No. 88MEXMR-137230C) for the sale of the same goods (forging carbon steel flanges) on 25 January and 20 October 1988, respectively. Each contract had the same terms on quality, examination, compensation and arbitration but different terms on quantity, specifications, price and time of delivery. The following table sets forth the contracts' dates signed and total amounts.

Contract No. Date signed Sum (US $)
87MEXMR - 137201C 24 January 1987 US $1,073,219.50
88MEXMR - 13308C 25 January 1988 2,117,984.50
88MEXMR - 137230C 20 October 1988 4,825,300.05
Total   US $8,016,504.05

Each contract had a specific order for goods attached to it. Each order contained detailed specifications (including pressure and diameter), quantity, unit price, total prices (C&F Houston), and the deadline for delivery (the period of shipment, shipment in installments). It is stipulated that the contracts' total prices will be adjusted to the amount of the goods actually delivered (5% more or less are permitted). Payment was to be made by Letter of Credit [L/C].

Exhibit A listed the technical specifications of the goods with the principal requirements as follows:

      All flanges should meet the US steel flange Standard ANSI-B16.5 and the US material experiment Standard ASTM-A105. In addition, several requirements beyond the A105 Standard were added:

   (i)   Carbon content should be not more than 0.27% [The Arbitration Tribunal's note: 0.35% (maximum) required in the A105 Standard.];
 
   (ii)   Manganese content should be not less than 0.6% [The Arbitration Tribunal's note: 0.6 - 1.05% required in the A105 Standard.]
 
   (iii)   All flanges should go through normalizing heat treatment. [The Arbitration Tribunal's note: In the A105 Standard, only the flanges applied under the pipe pressure over 300 Psi should go through "normalizing" heat treatment.]

The process of normalizing heat treatment in the A105 Standard refers to:

After being forged or heat-rolled, the forgings should be cooled by a temperature below 1,000°F (638°C) instantly, then should be heated to a temperature between 1,550°F (843°C) and 1,700°F (927°C); exposure to the air to cool the forgings is permitted.

Exhibit A of the contracts also provides that, after normalizing heat treatment, the factory should issue a Mill Test Report (for short, "MTR") for each flange to specify its heat treatment temperature, chemical composition analysis and physical properties. The numbers of heaters and the label of "A105N" should be printed on each piece of flange to indicate that this flange has passed the "normalizing" heat treatment. Each piece of flange should also be printed with the size, pressure class, applicable standard (ANSIB16.5) of flanges and standard (A105) for materials, heat treatment method ("normalizing", N), material heat number, enterprise identification mark (DSI in the contract) and the origin country. Flanges with repair welding should have the mark "W" printed on them.

With respect to the mechanical properties of flanges, the A105 Standard sets forth that the tensile strength should be not less than 70,000 Psi (or 485 MPa), subdue strength should be not less than 36,000 Psi (or 250 MPa), extension rate should be not less than 22% (depending on the thickness of the flanges), shrinkage rate should be not less than 30% and Brinell hardness should be not more than 187 HB.

There are two provisions in the contracts with respect to examination and compensation for claims.

"Examination of goods. The first batch of goods shall be examined by the buyer before they are packed; if the goods are qualified, the goods delivered afterwards may or may not be examined, but the right to examine the goods is an inseparable part of this contract."

"Quantity/Quality Discrepancy. In case of quality discrepancy, claims should be filed by the buyer within three months after the arrival of goods at the destination port. In case of quantity discrepancy, claims should be filed by the buyer within 15 days after the arrival of goods at destination port. The seller is not liable for any discrepancy of the delivered goods in quality and quantity for which the insurance company, shipping company, other transportation organization or port office shall be liable."

(II) The [Buyer]'s arbitration application and reasoning

The [Buyer] alleged in its arbitration application and statements made at the hearing that:

Under the three contracts aforesaid, the [Buyer] sent out seven orders for the purchase of 1,143,861 pieces of flanges altogether. The [Buyer] had received 818,483 flanges with a total value of US $8,191,666.88. There were 462,932 pieces of flanges not delivered with a total value of US $3,638,367.18. (Note: Each order set forth the numbers of each type of flanges of different diameters and pressure classes. Among the flanges delivered, the amount for several types of flanges exceeded the number required by the orders, but was included in the total amount of 818,483. However, the number of flanges which were not delivered or not fully delivered for certain types was calculated into the amount of 462,832. Therefore, the sum of the amounts delivered (818,483 pieces) did not equal the total number set forth in the orders. )

The [Buyer] had sent an employee who occasionally visited the [Seller] and its manufacturing factory. The person sent by the [Buyer] checked some flanges, examined their size and sometimes gave advice on how to guarantee compliance with the technical standards. This manufacturing factory had its own lab and they committed to the [Buyer] that the flanges would be produced strictly in accordance with the contracts and specifications. In particular, the [Seller] presented Mill Test Reports to the [Buyer] for each forging part. Due to the reliance on the [Seller]'s MTRs, the [Buyer] neither examined the goods in the lab in China, nor did [Buyer] examine the goods after they arrived at the port. The [Buyer] alleged that this practice followed international trade usages. Each flange bears the mark of the quality standard (B165 and A105N) and was enclosed with the MTR showing the chemical composition, mechanical and physical properties and the temperature of normalizing heat treatment tested in the production process with the signature of the testing personnel and the seal of the producers. [Buyer] alleged that this is actually a quality certificate provided by the suppliers and producers to users, and that, according to industrial usages, the dealers always rely on the seller's MTR when they resell the goods in the market.

Before 1991, some trivial quality problems were found during the sales. The [Buyer] sent notice to the [Seller] and the [Seller] provided quick responses and expressed that it would give its attention to this and take correction measures. However, serious quality problems appeared since January 1991.

      i. The serious quality problems that gradually appeared

      In January 1991, one of the [Buyer]'s important clients, FAIRMONT, sold the imported flanges to DuPont, which is a famous US company. DuPont later found a broad range of defects over this batch of flanges and DuPont had to return to the [Buyer] all of the flanges (about 500 pieces) purchased. The [Buyer] had notified the [Seller] the nature of this severe issue. The [Seller] sent a letter to the [Buyer] on 2 February 1991 and made a commitment that all of the flanges the [Seller] had provided to the [Buyer] during the period from 1987 to 1990 were in compliance with the standard ASRM-A105-87A. However, the complaints by the [Buyer]'s clients on the quality of the flanges has increased. In particular, EBASCO, a leading international contractor, found that a piece of flange purchased from the [Buyer]'s client, TEAM Industrial Company, was a welded flange when it built a pipe for Exxon. [Buyer] alleges that such a defect was obviously concealed on purpose. The [Buyer] has notified the [Seller] of this defect and the nature of this serious problem. The [Seller] acknowledged that this was a problem and stated that it would bear all the responsibilities arising from this issue. And the [Seller] also alleged that this defect was a coincidence which was caused by a retired worker of the [Seller] who tried to cover his apprentice's negligence in processing the flange and assured that there would be no such defect in other flanges.

Because of this serious defect, EBASCO was becoming suspicious of the quality of the goods. Then, it took measures to check the quality of the rest of the flanges. It sent several samples to Houston ×× Lab to carry out various tests. The results were disappointing. There, 30 pieces of flanges were tested in all, among which 27 pieces were provided by the [Seller]; among these 27 pieces, 20 pieces were found with various defects. The main defects are:

   -    The flanges which had not passed normalizing heat treatment were indicated as having been treated by normalizing heat treatment in the Mill Test Reports and were printed with the mark "N" (normalizing); and
 
   -    The chemical composition of the flanges was not consistent with Standard A105. Some flanges bearing the same heat number showed quite a different chemical composition.

Therefore, EBASCO stopped using all of the Chinese flanges provided by the [Buyer] and claimed compensation for losses including the costs incurred in replacing the defective flanges used in the pipe project for Exxon with qualified flanges. TEAM Industrial Company, as the dealer which sold the flanges to EBASCO, returned all of the flanges to the [Buyer] and claimed compensation of US $825,000 against the [Buyer]. (After investigation, the [Buyer] noted that TEAM Industrial Company had returned 2,754 unused flanges altogether, of which 2,552 pieces were provided by the [Seller], accounting for 94% of the total returned flanges.) To mitigate the loss, after negotiation, the [Buyer] paid US $605,000 to TEAM Industrial Company to settle this case.

The [Buyer] and the [Seller] negotiated over the compensation for almost one year, but reached no agreement. In September 1992, after conducted a survey on defects in Chinese flanges over America, the US National Board of Boiler and Pressure Vessel Inspectors issued a Special Report on the Investigation of Chinese Flanges (hereinafter "Special Report"). The report was influential in America's engineering field. The Special Report illustrated several serious deficiencies in the flanges imported from China and warned that "these flanges are not consistent with the requirement of the ANSI standard or ASTM A105; and that using these high pressure products is extremely dangerous to the safety of the people's life and property." In the Special Report, it was mentioned that the flanges provided by the [Seller] to the [Buyer] were defective and at least two pieces of flanges produced by the [Seller] were referred to as evidence of the serious quality problems.

As the result of the adverse affect of this Special Report, the [Buyer], which was a major importer of Chinese flanges, was unable to sell the imported inventory flanges in the course of common business. Therefore, the [Buyer] should have the right to reject any undelivered flanges from the [Seller] under the contracts.

      ii. Measures to compensate [Buyer]'s losses

      The [Buyer] alleged that after finding serious quality problems with the flanges, the [Buyer] negotiated with the [Seller] for compensation. Meanwhile, the [Buyer] also took other remedies to mitigate its losses.

In August 1991, the [Buyer] informed the [Seller] of the fact that TEAM Industrial Company had returned a number of flanges produced by the [Seller] and claimed compensation. In addition, the [Buyer] also told the [Seller] that it had to compensate TEAM Industrial in the amount of US $605,000 to settle the dispute. Upon the [Buyer]'s request, the [Seller] sent a group to visit the [Buyer] in Houston in December 1991 in order to discuss the quality problems. The [Seller] did not deny its responsibilities for the [Buyer]'s losses arising from the deficiencies in the flanges. However, the [Seller] was not willing to compensate the losses with cash and it proposed to compensate the [Buyer] with its products in future transactions. Till 8 April 1992, the [Seller] proposed a compensation plan with a total amount of US $200,000. It also asked the [Buyer] to continue to purchase its flanges and other products. The two parties did not reach any agreement on the compensation plan. In October 1992, the [Buyer] had to require the [Seller] to take back flanges with a value of US $2,500,000 stored in [Buyer]'s warehouse and asked for compensation of US $3,800,000. However, the [Seller] did not respond anymore and left the [Buyer] in a mess.

To mitigate losses, the [Buyer] had to carry out non-destructive, simple and plausible examinations on a large part of the flanges in storage. Because it is too expensive to hire an independent professional lab for inspection, the [Buyer] purchased Arc Met 900 portable emission spectrum analyzers and Swiss EQUOTP portable Sclero-meters to examine the goods by itself. Up to October 1994, the [Buyer] tested 30,006 pieces of flanges produced by the [Seller], of which, 44.5% of the flanges (13,444 pieces) were found defective. [Buyer] alleged that, if a destructive testing method had been used, a much higher percentage of quality defects would have been found, and that the results of the self-test were shocking and unacceptable. After the inspection, all of the unqualified goods were abandoned, prohibited from entering into the market and stored in the [Buyer]'s warehouses. With respect to the rest of the flanges, for which it cannot be proved whether or not they had been normalized by the [Buyer] (because this can only be proved by a professional lab using destructive fractography analysis), in order to mitigate the losses, the [Buyer] had to sell them at a lower price, with the goods marked as "original goods without any change and no quality guarantee (normally not providing the Mill Test Report)". (The Arbitration Tribunal notes: Some buyers may use such flanges to connect normal low-pressure pipes). Therefore, the [Buyer] alleged that the [Seller] should compensate the losses suffered from reselling the flanges at low prices.

      iii. Quality problems revealed by evidence on flanges tested

      During the hearing, the [Buyer] presented two volumes of testing data to prove the serious quality problems in the flanges supplied by the [Seller]. One volume contained the testing results which were produced by the Houston ×× Lab or Houston Metallurgy Lab appointed by the flanges' end users who returned the goods to the [Buyer]. This volume included the testing report, analytical conclusion, fractographic pictures and the relevant Mill Test Reports attached to the goods by the [Seller]. Another volume contained the original testing records and the overall results made by the [Buyer] itself, which only focused on the chemical composition, hardness and surface defects. The records were summarized as follows:

            (a) 41 pieces of flanges were sent to the independent ×× Lab and Houston Metallurgy Lab for testing. The lab concluded that 22 pieces did not meet the requirements of Standard A105N, this accounted for 54% of the flanges tested. Of these unqualified flanges, for 16 flanges, which account for 39% of the tested goods, it was concluded that they did not go through normalizing heat treatment or that the normalizing heat treatment was improper. For 10 flanges, which account for 46% of the tested goods, it was found that the chemical composition did not comply with the contract requirements. In addition, 21 flanges were tested for extensibility and hardness, among which the extensibility of three pieces was under 22% and the hardness of two pieces was beyond 187HB. (Note: Because some flanges are unqualified both in chemical composition and normalizing heat treatment, the sum of the number of the unqualified flanges under each testing item is more than the total number of 22 defective flanges.)

            (b) There were 30,006 pieces that were tested by the [Buyer] itself. The testing was on the flanges' inner diameter, outer diameter and other size, for visible defects (including cracks, repairing welding and defects on the surface), and of the hardness gauged by the portable sclerometer and the chemical composition measured by the portable emission spectrum analyzers. The testing revealed that 13,444 pieces were unqualified, accounting for 44.5% of the tested flanges. Among the unqualified flanges, there were 468 pieces with size differences (accounting for 1.55% of the tested flanges), 989 pieces with surface defects (accounting for 3.3% of the tested flanges), 2,420 pieces with unqualified hardness (accounting for 8.1% of the tested flanges), and 9,467 pieces with unqualified chemical composition (accounting for 31.55% of the tested flanges).

[Buyer] alleged that the above tests revealed that the quality problems with the flanges were so serious that no buyer would accept them.

      iv. Contract and legal bases for the [Buyer]'s claims (to be discussed in another section)

      v. The [Buyer]'s arbitration claims

      The [Buyer] alleged that the quality of the flanges supplied by the [Seller] was seriously inconsistent with the relevant technical standards and requirements provided in the contract. The latent defects of the goods were exposed in the course of their actual use by the final users, which caused the users to return the goods. This was made publicly known and impeded the sale of the goods in the US. After a partial test of the goods in store, it was found that a large percentage of goods had quality defects and were seriously inconsistent with the Mill Test Reports provided by the [Seller]. These facts revealed that the [Seller] had already known or could not have been unaware of the bad quality of the goods, but the [Seller] did not inform the [Buyer]. The [Buyer] consequently suffered serious damage in its goodwill and economic losses for goods returned or goods not being sold any more. The [Buyer] therefore has the right to claim compensation against the [Seller]. The [Buyer] asked the Arbitral Tribunal to rule that the [Seller] should compensate the [Buyer] for all of its economic losses (listed below in accordance with the supplementary materials submitted as of 20 June 1996).

The [Buyer]'s claims

[Buyer] claims:

(1) Losses for unsold inventory flanges. The purchase cost of the inventory of flanges which have not been sold was US $1,065,883 (including all import duties and the freight to carry the goods to the warehouse);

(2) Profit losses for unsold inventory flanges. The profit losses amounted to US $641,899 determined by subtracting the purchase cost of US $1,065,883 from the market value of US $1,707,782 of the inventory flanges in accordance with the actual market conditions from 1991 to 1992.

(3) Profit losses from the undelivered flanges. The purchase cost amounted to US $3,929,475 which was the sum of the order prices of the undelivered flanges, the custom duty (8% of the total price), port fees, storage expenses and agent fees. The sales value was calculated as the purchase cost divided by 0.65%. The gross profit should be US $3,929,475 ÷ 0.65% × 0.35% US $2,115,871.

(4) Losses suffered from selling flanges as "original goods without any change and quality promise"

      a. With respect to the flanges that were confirmed as having been provided by the [Seller], the total sales price was US $74,977.51. The purchase cost was US $216,807.20. The losses actually suffered amounted to US $141,830, the difference between the sales price and purchase cost.

The actual market price of this batch of flanges should be US $329,477. Therefore, the loss of expected profit amounted to US $254,499 (US $329,477 - US $74,977.51), the difference between the market value and actual sales price.

      b. With respect to the flanges which had been sold but for which the supply source could not be confirmed, the losses which the [Seller] should compensate should be calculated based on the percentage of [Buyer]'s goods among the total goods. This percentage was 36.4%. Therefore, the loss actually suffered amounted to US $49,045, the difference between the purchase cost (US $20,574.4) and the actual price (US $156,699).

The actual market value of this part of the flanges was US $316,529. The loss of expected profit amounted to US $159,830 (US $316,529 - US $156,699).

(5) The settlement fee paid to TEAM Industrial Company. The total compensation to TEAM Industrial Company was US $605,000, of which goods supplied by the [Seller] accounted for 94%; therefore the [Seller] should pay US $578,000 for its part in the total damages.

(6) Testing expenses. The total expenses paid for testing amounted to US $883,348 for the purpose of mitigating the losses. Since the goods supplied by the [Seller] accounted for 45.5% of the total goods, the [Seller] should bear the part of US $401,923. These expenses included rent paid for special testing field and the amortization charge of depreciation cost for purchased equipment.

(7) Flanges returned by other clients. Other than the flanges returned by TEAM Industrial Company, losses suffered from flanges returned by other clients supplied by the [Seller] were US $21,915.

(8) Interest. The interest on the testing fees, storage fees for the inventory flanges and the settlement expenses paid to TEAM Industrial Company was US $566,700, calculated at 7% per annum for four years.

(9) Taxes. The [Seller]'s contribution of property tax imposed by local government for inventory flanges unable to be sold was US $85,236.

(10) Attorneys' fees. US $243,717 had been paid to the counsel for this case.

(11) Arbitration fee. The arbitration fee was US $78,422.

The expenses in an aggregate amount were US $5,992,441.

(III) The [Seller]'s defense and counterclaim

In its arbitration defense and counterclaim application, the [Seller] alleged that:

      The [Seller] has performed the three contracts that were executed with the [Buyer] in 1987 and 1988. The flanges provided by the [Seller] were produced and processed by Oriental Chemical Machinery Factory in Shanxi Province. The [Buyer] had visited the factory to inspect the production equipment and product quality. As of July 1991, the [Seller] had delivered 165 batches of flanges according to orders with an aggregate value of US $7,478,349.91. When these flanges arrived at the destination port in the United States, the [Buyer] accepted all the goods. Throughout this period, the parties communicated on the quality of individual flanges, yet the [Buyer] had never claimed quality defects against any batches of goods and its orders for purchasing flanges kept increasing. The [Buyer] did not encounter any difficulty in its sales. It was evident in the data in the arbitration application provided by the [Buyer] that the flanges unsold and stored in the warehouse accounted for only a small part (18%) of the total flanges which the [Buyer] purchased from the [Seller]. These facts showed that the flanges provided by the [Seller] were generally accepted on the US market.

For these reasons, in early 1991, the two parties signed Contract Number 91YCSG/10-523. However, when the [Seller] shipped 15 containers of flanges to the US port in July 1991; the [Buyer] refused to accept these goods and refused to pay for them, which caused the [Seller] to suffer economic losses from reselling goods to other clients.

The quality standard originally specified in the contracts was ASTM-A105-84C. The [Buyer] once raised higher requirement for the quality standard in Exhibit A of the contract. For example, the standard of carbon content was changed from 0.35 MAX to 0.27 MAX. The standard of manganese content was changed from 0.6 - 1.05 MIN to 0.6 MIN. The requirement that only flanges which would be used under pressure over 300psi should go through normalizing heat treatment has been extended to all of the flanges. However, on 7 August 1987, the [Buyer] gave the [Seller] a revised Mill Test Report which changed the quality standard from A015N to A105. The carbon content and manganese were changed back to 0.35 MAX and 0.60 - 1.05 MIN, respectively. These facts proved that the [Buyer] had disregarded the higher requirements listed in Exhibit A and implicated that the flanges should comply with Standard A105. Therefore, the [Seller] strictly followed this standard. Though the carbon content of certain pieces of flanges was beyond 0.27%, yet the [Buyer] had never raised any claims. However, in [Buyer]'s arbitration application, the [Buyer] emphasized that the flanges supplied by the [Seller] were not in compliance with the quality standard specified in the contracts but ignored the fact that the quality standard had been changed on 7 August 1987, which is inconsistent with [Buyer]'s written notice to the effect that the quality standard was changed.

The [Seller] further alleged:

      (i) The [Buyer]'s statement on the deficiencies of the flanges

      The [Buyer]'s statement on the deficiencies of the flanges was not consistent with the facts. After analyzing the evidence provided by the [Buyer], the [Seller] alleged that it was not objective, and that it was unconvincing and questionable, and could not be taken as evidence.

            (1) With respect to the repairing of the welded flange, the [Seller] found that it was processed by a retired employee and it was the only one with such a problem. The [Buyer] did not complain about the quality of other flanges in the same installment of goods. With respect to the two pieces mentioned in the Special Report, one of them which was said to be consistent with the ASTMA105 in chemical composition and hardness test is a slip-on flange which was not delivered by the [Seller]. According to the label printed on its surface, the other one is not the [Seller]'s goods either.

            (2) The [Buyer] referred to the goods returned by DuPont and EBASCO and the adverse report by the Wall Street Journal to prove its losses. However, among the goods returned by customers, the [Buyer] could not clarify the place of origin, quantity of the defective flanges, the nature of the quality problem and the percentage of [Seller]'s goods in all of the returned goods. Though the adverse report caused difficulty to sell the goods, yet these facts could not be taken as a legal basis for the [Buyer]'s claims against the [Seller].

            (3) The testing conclusions made by ×× Lab and the sampling method adopted by the [Buyer] in the self=testing were unclear. The [Buyer] ordered flanges from various suppliers and the storage was not well organized. Therefore, even for products with the same heat number, they might have been provided by different suppliers (during performance of the contract, the [Buyer] used to send a list of heat numbers carved on the flanges and required the [Seller] to ascertain whether these products were manufactured by the Oriental Chemical Machinery Factory; after investigation, the [Seller] answered the [Buyer] and most of the results were negative). With respect to the 14 flanges which were tested by ×× Lab and which the [Buyer] alleged to be the products of the [Seller], by identifying the characters printed on the flanges, the [Seller] could conclude that these flanges were not provided by it. In addition, ×× Lab claimed in its testing report that "our letter and report are only applicable to the tested samples and do not implicate the quality of other similar or identical products." One report (No. 910783) gave a positive conclusion that "the overall products are acceptable and in compliance with ASTM -A105, except for certain small problems."

            (4) The results of [Buyer]'s self-testing were doubtful. The [Buyer] did not issue any official testing report and clarify the sampling method for the testing. Because this test was conducted by the [Buyer] alone, the testing result made thereof should have no probative force. In its self-tests report, the [Buyer] concluded that the unqualified products accounted for 44.5% of the total flanges provided by the [Seller]. This conclusion is absurd. The [Buyer] had sold flanges supplied by the [Seller] in an aggregate amount of US $6.7 million during the period of 1988 to 1991. The goods were returned in 1991 and the amount was US $73,000 which accounted for approximately 1% of the total flanges sold. Therefore, the allegation that the unqualified products accounted for 44.5% of the total flanges provided by the [Seller] was unreliable.

The [Seller] stated that some individual unqualified products in a huge production would be inevitable and acceptable in commercial practice. All of the flanges claimed to be unqualified by the [Buyer] only consisted of several pieces. And there is no provision stipulating the rate of qualified production in the contract. Therefore, the [Buyer] could not deny the quality of [Seller]'s overall products. Based on the sales data of the [Buyer], it can be found that [Seller]'s flanges were well accepted by US customers before 1990. The US began to apply Standard ASTM-A105-87A, but the three contracts specified that the flanges should comply with Standard A-105-84C. (The main difference between these two standards is: Standard 84C only requires measuring and setting out the chemical composition of C, Si, Mn, P, S; whereas Standard 87A requires measuring and setting out the chemical composition of Cr, Ni, Mo, Cu, V besides the five elements listed in Standard 84C.) By the end of 1990, the parties agreed that the subsequent deliveries of the flanges should comply with Standard ASTM-A105-87A instead of the requirements in the contract. Therefore, the inventory of [Buyer] in compliance with Standard 84C received before that change could not be sold out. The [Buyer] had asked the [Seller] to provide a statement that the flanges previously provided were also in compliance with Standard 87A so as to facilitate its sales. This implicates that the failure to sell the flanges was not completely due to the quality problems. After the Special Report was published, the [Buyer] encountered more difficulties in sales. However, these facts are the common commercial risks of business and it is unreasonable to transfer these risks to the [Seller]. Therefore, the Tribunal should not support these claims.

      (ii) The [Buyer]'s claims do not have legal and contractual basis

      Based on the contracts and the law, the [Seller] asks the Tribunal to dismiss the claims of the [Buyer]. (Details will be presented in another section.)

      (iii) The [Seller] suffered losses from the breach of contract by the [Buyer]

      The [Seller] raised counterclaims as follows.

            (1) The [Buyer] should pay the outstanding price payment. After the contracts were executed since 1987, the [Seller] delivered the goods in accordance with [Buyer]'s orders and payments were made with letters of credit. However, in February 1991, the [Buyer] required a change in the payment method, to sales on account. In order to maintain good relations, the [Seller] proposed that 85% of the contract price can be made with L/C and 15% be made after the goods reached the destination port and were examined. The [Buyer] agreed to this and the examination period was agreed to be 30 days. However, for the goods sent on 20 July 1991, the [Buyer] did not express any opposition nor [Buyer] examine the goods, and [Buyer] did not make the 15% payment in arrears. Up to that time, the delinquent payment amounted to US $211,684.93. In addition, the contract price of the extra goods delivered in June and July 1991 by the [Seller] and accepted by the [Buyer] but unpaid amounted to US $52,118.93 in total. The [Buyer] claimed that it did not order these goods and refused to make payment. The total amount of these two shipments was US $263,803.86.

            (2) The losses resulting from the [Buyer]'s refusal to accept the goods at destination port. The [Buyer] declared to terminate [avoid] the contracts on 7 August 1991 and sent a notice to the [Seller] to stop shipment. The [Buyer] also refused to accept the three batches of goods which had been delivered to the destination port. Therefore, the [Seller] had to resell the goods to other clients at the destination port. For this reason, the [Seller] has paid the extra customs duty, storage and transportation expenses which amounted to US $11,700.

            (3) The losses suffered from re-processing for the inventory goods of [Seller]. Before the [Buyer] unilaterally terminated [avoided] the contracts, the [Seller]'s supplier had manufactured the goods according to the [Buyer]'s orders and put the [Buyer]'s trademark logo on every flange. Because of the [Buyer]'s unilateral termination [avoidance] of the contract, in order to mitigate the losses, the [Seller] had to resell the goods. For the purpose of facilitating the resale, the [Seller] had to spend US $101,280 to reprocess the goods.

            (4) The losses of tax refunding of the unsold flanges were US $144,973.95.

            (5) Storage expenses for the unsold flanges were US $36,434.53.

            (6) The profit loss of the unsold flanges was US $46,272.3.

            (7) The interest loss for items (2) to (6) above amounted to US $903,129.90.

The losses suffered by the [Seller] in an aggregate amount were US $1,507,594.54.

In addition, the [Seller] also counterclaimed that the [Buyer] should bear the arbitration fees, the arbitration fees for the counterclaims and the attorneys' fees and other expenses that the [Seller] had paid for the arbitration.

(IV) Parties' position on the issues in dispute and their basis in law and the contracts

In their statements at the hearing and in the supplementary materials supplied by the parties, each party submitted his own opinions on the legal and contractual basis for their claims and presented intensive arguments.

      (i) Whether the quality of the goods supplied by the [Seller] was materially defective

            (1) The [Buyer] alleged that its statementat the hearing had illustrated the process of discovering the quality problems and the serious nature of these problems.

            The [Buyer] claimed that:

            1) The fact that the [Buyer] had sold a large number of the flanges did not mean that they were not defective in quality. The flanges were sold because they were accompanied by Mill Test Reports and printed with the mark of "ASTM-A105N", which could be regarded as a guarantee for quality. Moreover, the fact that serious problems did not occur on the flanges in use may have been because the pipe pressure sustained by the pipes was far less than the specified pressure and strength stipulated in the standard. Unanticipated problems (for example, the repairing of the welded flange) that occurred in use later caused suspicion, testing and checking. The testing exposed further problems which led to returns and claims.

            2) As revealed by the testing committed by the independent labs, the unqualified flanges accounted for a large percentage of the total flanges supplied by the [Seller], which caused the [Buyer]'s US clients to refuse to use this kind of flanges. The most common issue is the normalizing heat treatment. The test reports issued by the independent labs illustrated that some flanges delivered by the [Seller] as having being tested had not gone through normalizing. (In the testing reports issued by the two independent labs, among the 44 flanges sent to be examined, 22 flanges were defective, which accounted for more than 53%; and there were 16 flanges that had not been normalized.) This was not consistent with the technical requirements in the contracts. In addition, the flanges that had not gone through normalizing were stamped with the mark of "N" for being normalized and the temperature of normalizing heat treatment was recorded in the Mill Test Reports. The producer should know whether a flange has or has not gone through normalizing heat treatment. The fact that flanges that had not gone through normalizing were recorded in the Mill Test Reports as having passed normalizing including the temperature of heat treatment and with the mark "N" stamped on them constituted a fraud by the [Seller]'s concealing the truth.

For the deficiencies of chemical composition and other aspects, the report issued by the independent labs revealed that though most flanges met Standard A105 (carbon content 0.35%), they did not satisfy the requirement of the contracts (carbon content 0.27%). Among the MTRs submitted by the [Seller], it was found that there were two or three Mill Test Reports with totally different chemical composition for flanges of the same heat number. This could only illustrate that these MTRs were filled out arbitrarily and could not reflect the real testing results of the flanges in the process of production. How can such quality gain the trust of users?

            3) The serious quality defects of the flanges provided by the [Seller] caused serious problems. The Special Report issued by the US National Board of Boiler and Pressure Vessel Inspectors pointed out that to use unqualified flanges was extremely dangerous for people's life and personal safety and may cause great losses of property. Accordingly, the Board warned US users to be very cautious when using Chinese flanges. The [Buyer] alleged that the warning in the Special Report was not alarmist talk and it was not unusual to encounter serious accidents of pipe split caused by flanges with bad quality in some countries and areas. For this reason, the volume of flanges imported from China to the US decreased sharply from US $25 million in 1991 to only US $2.46 million in 1993.

As a US valve company importing Chinese flanges, the [Seller] suffered great losses since the imported but unsold Chinese flanges had to be stored in a warehouse. These losses were completely caused by the material breach of contracts by the [Seller] and by its improper behavior; so the [Seller] should compensate the [Buyer]'s losses.

            The [Seller]'s defense

            1) The [Seller] acknowledged that a certain quality deficiency of individual flanges among such a large quantity of goods was possible and the [Seller] had attached great attention to such quality problems. For example, the [Seller] had investigated the matter of the repairing of the welded flange and agreed to bear the responsibilities. However, it could not be concluded that the quality defects on certain individual flanges would lead to the high unqualified percentage. If the flanges provided by the [Seller] had accounted for an unqualified percentage of around 45% to 53%, how could the [Buyer] have sold 80% of the goods (amounting to 100,000 flanges) during the period of 1987 to 1990 without raising any serious quality complaints? It is evident that the [Seller] exaggerated the quality problems on purpose to transfer to the [Seller] the business risk it later experienced in the market.

            2) The [Buyer]'s conclusion that there was a high percentage of unqualified goods was drawn from the testing reports issued by two independent labs after examining 41 flanges provided by the [Seller] and the testing results made by the [Buyer] itself after testing about 30,000 flanges in its storage. The [Seller] analyzed the reports provided by the [Buyer]. In Report No. 910783 issued by XX Lab, only one flange among the ones provided by the [Seller] did not pass the normalizing heat treatment, while the [Buyer] alleged two flanges. In Report No. 910816, it was said that three flanges among seven provided by the [Seller] did not pass the normalizing heat treatment, but after consulting the experts, the [Seller] concluded that these three flanges had passed the normalizing heat but the normalizing process was improper. The same situation happened to the six flanges tested in Report No. 910844, in which it was said that six flanges among seventeen provided by the [Seller] did not pass the normalizing heat treatment and one flange was not normalized properly. However, the experts appointed by the [Seller], after analyzing the metallograph, concluded that these flanges were just not normalized properly instead of not being normalized. The Houston Metallurgy Lab tested twelve flanges provided by the [Seller] and concluded that five flanges were processed through improper normalizing or did not pass the normalizing. However, the experts appointed by the [Seller] concluded, based on the metallograph, that only one flange was processed through improper normalizing and the rest were qualified as to the normalizing process.

The [Seller] agreed to the essential parts of the lab's analysis and conclusions on the chemical composition testing of the 41 flanges. Although certain indicators deviated from the standard to a small extent, taking the permitted deviation into consideration, the chemical composition of the flanges was in compliance with Standard A-105. The sulfur or phosphorus content of very few flanges was found to be 0.085% or 0.108%, respectively; that seldom happened. According to the general practices, double testing should be taken to make a final conclusion.

It was alleged that the Mill Test Reports showed different chemical composition for flanges produced with the same heat number. The experts appointed by the [Seller] explained that the chemical composition of the different parts of an individual steel billet (the raw material for flanges) might be different due to the differences in segregation extent caused by different moulding speed and temperature or the die design. Therefore, it was possible that the chemical compositions of the flanges with the same heat number deviated from one another. In addition, the flanges with the same heat number but delivered in different batches were tested by different examining methods and experts. This can also cause differences and deviation in the testing results. Therefore, the [Seller] stated that if the deviation was within a reasonable range, it could not be concluded that the MTRs data were fabricated.

The [Seller]'s experts also noted that it was in dispute in the academy to just rely on the metallograph to justify a conclusion whether the flanges have gone through normalizing heat treatment or not. Therefore, the different conclusions always implied certain individual opinions. The correct method was to analyze the results of the metallograph testing with mechanics performance testing. For flanges, if the mechanics performance meets the requirements (four indicators of intensity and flexibility), the debate on normalizing is meaningless. Therefore, the [Seller] claimed that since the 41 pieces of flanges had been qualified with all the mechanic performance requirements according to the testing data, they were qualified products. So the flanges provided by the [Seller] were all qualified.

            3) The [Seller] entrusted independent institutions or labs to prove its products were qualified.

                  (i) In June 1995, the [Seller] asked the Import and Export Commodity Inspection Bureau in Tianjin to test the chemical composition, mechanics performance and metallograph of 20 pieces that were taken as samples from the flanges stored in Tianjin due to the breach by the [Buyer]. The conclusion was that these pieces all complied with ASTM-A105-87A. The goods' quality qualified ratio was 100%.

                  (ii) On 20 January 1997, having changed the [Buyer]'s logo on the three batches of flanges which were rejected by the [Buyer], the [Seller] had to resell them to other customers. Since the flanges broke when the users were welding them, the [Seller] submitted seven welded-neck flanges to the Houston×Lab for testing and analysis on 2 January 1992. The testing results showed that the quality of the flanges was in compliance with Standard A105. The flanges broke due to improper welding.

                  (iii) The [Seller] once randomly took ten flanges as samples from the goods to be delivered and submitted to Shanxi ××Machine Tools Examination Center for testing. The testing report issued 21 June 1995 showed that all ten flanges were in compliance with Standard A-105-87A.

These testing results listed above indicate that [Buyer]'s conclusion that the qualified percentage of [Seller]'s goods had reached 44.5% was wrong and exaggerated on purpose.

      (ii) The issues concerning the contract terms and the legal basis for claims

            The [Buyer] and the [Seller] presented arguments, put forward their own positions and explanations for and against the contractual and legal basis for the [Buyer]'s claim for compensation on the basis of the contracts, the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, General Principles of the Civil Law ("GPCL"), the United Nations Convention on Contracts for the International Sale of Goods (the "CISG"), and related international usages or trade usages.

            The [Buyer]'s position

            1) Articles 18, 19 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest and Articles 111, 112 of the GPCL provide that if a party fails to fulfill its contractual obligations (i.e., breaching the contract), the other party shall have the right to claim compensation and that the party who breaches a contract shall be liable for damages equal to the losses suffered by the other party for such breach.

The People's Republic of China and the United States are both Contracting States of the CISG. In accordance with Articles 5, 6 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, the CISG and international usages are applicable to this case. In accordance with Article 74 of the CISG, the damages should include the loss of expected profits.

Furthermore, Article 36 of the CISG provides:

"The seller is liable in accordance with the contract and this Convention for any lack of conformity which exists at the time when the risk passes to the buyer, even though the lack of conformity becomes apparent only after that time. ... The seller is also liable [if this] lack of conformity ... is due to a breach of any of his obligations, including a breach of any guarantee that for a period of time the goods will remain fit for their ordinary purpose or for some particular purpose, or will retain specified qualities or characteristics."

The [Buyer] believed that the flanges subject to the contracts were steel-made products whose chemical composition and physical nature were not going to change over a long time of storage and in the process of use. When the [Seller] delivers the goods, the [Seller] should, in accordance with the contracts, not only provide goods, but also provide correct testing reports prepared according to actual and authentic testing results. The mark which represented the conformity to the agreed standard was to be stamped on these products, acting as a guarantee of qualified products and compliance with the special quality and nature required.

In fact, the goods provided by the [Seller] were inconsistent with the terms of the contracts, inconsistent with the chemical composition and/or with the physical properties written in the Mill Test Reports submitted by the [Seller] and inconsistent with the standard stamped on the goods. As a matter of fact, a large number of the flanges had serious deficiencies which were potentially dangerous to the safety of people's life and property. This caused the [Buyer]'s clients to return large quantities of goods. These discrepancies also attracted serious concern from the US National Board of Boiler and Pressure Vessel Inspectors and stimulated criticism from the mass media, which caused the [Buyer] to suffer serious economic losses, impairment of goodwill and profit loss resulting from the failure to sell its large quantity of inventory goods. The [Buyer] believes that its claims are totally consistent with contract terms and applicable laws and regulations.

            2) In the beginning of the long-duration negotiations between the [Buyer] and the [Seller], the [Seller] did not deny its liability. However, as the negotiations proceeded, the [Seller] raised unreasonable excuses to avoid its responsibility under the contracts and relevant laws. The [Seller] denied the [Buyer]'s claim on the basis of the inspection clauses in the contracts and alleged that the [Buyer]'s claim was not filed within "90 days after the goods arrived at the destination port" as stipulated in the "quality/quantity discrepancies" clause. Therefore, the [Seller] concluded that the [Buyer] had lost its right to claim compensation. At the same time, with reference to Article 9 of the contracts' supplemental enclosure which provides that "the [Buyer] may carry out examination before the first batch of goods is shipped and if the goods are qualified, each batch of goods delivered hereafter may be examined or not, but the examining right is an inseparable part of this agreement", the [Seller] alleged that the fact that the [Buyer] itself did not carry out a timely examination meant that it had given up its rights entitled by the contracts.

The [Buyer] believed that the [Seller]'s position on these terms is not tenable. The [Buyer]'s position is that:

                   a) The contracts permit the [Buyer] to carry out examination before the goods were shipped. However, as a matter of fact, the [Seller] did not make any arrangement for the [Buyer]'s examination of the goods in the lab. In the plants of the manufacturer of the goods, the [Seller] can only do selective examination regarding the external size of the flanges. The manufacturer and the [Seller] repeatedly asserted that they had an integrated laboratory, in which each batch of goods had passed strict examinations, and that the Mill Test Reports attached to the goods recorded the actual testing data. Therefore, the [Buyer] had the right not to examine the goods and to believe that the testing data in the MTRs are real and reliable. However, such reliance does not mean that the [Buyer] had given up the right to claim damages after the deficiencies of the goods appear.

                   b) It is the same case with respect to the time limit stipulated in the "quality/quantity discrepancies" clause in the contracts. The [Buyer] could trust that the goods supplied by the [Seller] were consistent with the MTRs. As a matter of fact, the [Seller] has never denied its liability for the quality problems that occurred after a long while when the goods arrived at the destination port (in many cases, the quality problems occurred three months, even over one year after the goods arrived at the destination port) on the grounds that the [Buyer]'s claims was not filed within "90 days after the goods arrived at the destination port". For example, for the repairing of the welded flange which was produced in June 1998 and three years later was found to have quality problems in use, after having been notified of this quality problem, the [Seller] agreed to bear the compensation of US $200,000 and did not rely on the expiration of the examination period. These facts actually reflected that though terms of time limit for inspection and "quality/quantity discrepancies" claims were written in the contracts, yet the two parties never proposed to examine goods within 90 days after the arrival. In other words, by their acts, the two parties modified the contracts and removed the restrictions.

                   c) Moreover, according to Article 36(2) of the CISG, the time limit for "quality/quantity discrepancies" claims in the contracts should not apply to the goods in this case. The flanges are goods that should remain fit for their ordinary purpose of use for a long period of time after delivery and the quality should not deteriorate within such period. At the same time, the flanges had been provided with Mill Test Reports attesting to their specified qualities or characteristics and stamped with quality standard marks. Moreover, certain functions (metallographical tissue and mechanical performance) of the flanges could not be tested without damage; if there were deficiencies in these aspects, they were latent defects. Latent defects could only be found by destructive test or in the process of use. Therefore, the trade custom acknowledged throughout the world is that goods like flanges could only be sold with the MTRs which record the testing data in the process of production. The users could rely on the Mill Test Report or "standard mark" printed on the goods when they purchase the flanges. Article 36(2) of the CISG stipulates that, under such circumstances, the seller is also liable for any lack of conformity which occurs after the time when the risk passes to the buyer. Article 15(3) of the Regulations of People's Republic of China on Purchase-and-Sale Contracts of Industrial-and-Mineral Products also stipulates that, for goods whose deficiencies could only be found after installation and operation, quality objections could be claimed within six months after its operation. There are similar laws on product liability in many jurisdictions. In this case, all such deficiencies and claims were raised within six months in operation after the exposure of deficiencies, which was consistent with Article 36 of the CISG and the stipulations in the Regulations of the PRC on Contracts for Sale of Industrial-and-Mineral Products.

                   d) The claims in this case involved not only the issue of products with poor quality, but also the issue that the [Buyer] considered that the [Seller] replaced the results with different product test reports. For example, products not having gone through normalizing were not only printed with the mark of "N" (normalizing), but had also filled in so-called data on heat treatment temperature in its Mill Test Report. Such irresponsible and intentional behavior constitutes commercial fraud. Since deficiencies of certain kinds of goods could only be found in the use of the goods and then be notified to the seller, Article 39 of the CISG stipulates that the time limit to give notice to the seller for lack of conformity of the goods is within two years after receiving the goods. The notices for the lack of conformity of the goods in this case were all sent within twenty-four months, for example, in August 1991, EBASCO and TEAM Industrial Company returned a large number of goods and claimed compensation within twenty-four months after the arrival of the goods at the port. Most flanges tested in July 1991 by ×× Lab were delivered to the [Buyer] in 1990.

In particular, the [Buyer] points out that, in accordance with Article 40 of the CISG, the [Seller] had no right to rely on the time limit for notification of the lack of conformity with the contract as stipulated in Articles 38 and 39. Article 40 should be applied because the suppliers (including the [Seller] in this case and other producers) had known or should have known that the goods were inconsistent with the contract (for example, flanges not having gone through normalizing that were marked as having gone through normalizing, and non-forging parts that were used to make forging flanges under the contract.)

Based on the above, the [Buyer] alleged that its claims are consistent with the PRC laws and the CISG, and that the [Seller]'s defense that the [Buyer]'s claims are inconsistent with the "quality/quantity discrepancies" clause in the contracts should not be accepted by the Arbitral Tribunal.

            The [Seller]'s opinion

            1) The [Seller] agreed that the Law of the PRC on Economic Contracts Concerning Foreign Interests and the CISG should apply to the instant case.

The [Seller] alleged that if the goods delivered by the [Seller] were inconsistent with the contracts, the [Buyer] had the right to present the relevant evidence and claim damages. There is a "quality/quantity discrepancies" clause governing the parties' quality objections and "quality/quantity discrepancies" claims in the contracts, which is consistent with the PRC laws and the CISG. The contracts offered the [Buyer] two opportunities to examine the goods.

   -    First, examination could be carried out before the first batch of goods was shipped. If the goods were qualified, subsequent shipments of goods could be or not be examined, and the right to examine was an inseparable part of this contract. The [Buyer] claimed that the test was not carried out before shipment of goods because it had no means (equipment, lab, etc.) to carry out spot examination. This is an unreasonable argument. The [Buyer] sent his employees to the [Seller]'s factory, which has a lab with all the necessary experimental equipments, and there were other eligible labs that could serve the [Buyer]'s examination need where the factory was located. On the contrary, the [Buyer] never asked the [Seller] to assist it to arrange the examination. It was the [Buyer] who decided not to carry out the examinations and that meant the [Buyer] automatically gave up its rights in the contracts.
 
   -    Second, as stipulated in the contracts, the [Buyer] could carry out another examination after the arrival of goods at the destination port. Of course, the [Buyer] could choose whether to take the examination. But the contract clause provided clearly that if the [Buyer] proposed to claim damages against the quality of the goods, the claims should be raised within three months after the arrival of goods at the destination port. The [Seller] points out that the examination before the shipment is made to avoid the export of unqualified goods while the examination after the arrival is made to collect evidence of unqualified goods for compensation claims. It was unreasonable that the [Buyer] attributed the failure of examination after the goods arrived at the port to [Buyer]'s trust in the [Seller] and the guarantee in the Mill Test Reports. The MTRs were the results of the self-tests concluded by the [Seller]. If the [Buyer] wanted to claim compensation, it should conduct its examination within the time limit stipulated in the contract.

            2) The [Buyer] alleged that the acts of the parties in the performance of the contracts constituted an alteration or removal of the term which requires that examination of the goods and claims for damages shall be within the time period after the arrival of goods. The [Seller] does not agree with this argument and stated that this is inconsistent with the facts, the contracts and the law. Before 1991, the [Buyer] did inform the [Seller] of the quality problems of a few flanges and inquired whether certain flanges with a problem were supplied by the [Seller]. The [Seller] clarified these issues with friendly cooperation and took responsibility in accordance with the contracts. However, for such issues, the [Buyer] did not officially claim compensation against the [Seller]. Therefore, the [Seller] did not rely on the time limit in the "quality/quantity discrepancies" clause. However, this does not imply that the [Seller] had modified or abandoned the "quality/quantity discrepancies" clause. Though Article 11 of the CISG provides that it is not necessary to conclude or evidence a contract by writing, yet the PRC declared a reservation to this Article when it approved the Convention. According to the Law of the PRC on Economic Contracts Concerning Foreign Interests, all valid contracts shall be concluded in writing and be signed by the parties, and any notice or agreement purported to modify or dissolve the contract shall also be in writing. In the instant case, the parties never negotiated on or agreed to modify or remove the "quality/quantity discrepancies" clause, nor did they notify the other party in writing to such effect. Therefore, the "quality/quantity discrepancies" clause has been valid since the execution of the contracts.

With respect to the [Seller]'s promise to pay damages of US $200,000 to the [Buyer], after provided a detailed description of the facts, the [Seller] alleges that: In February 1991, because of the [Buyer]'s insistence, the parties confirmed by fax to continue to perform the contracts but made a modification of the payment clause to the effect that "85% of the payment will be paid with a letter of credit and the remaining 15% will be paid after the examination conducted by the [Buyer] and the examination period is 30 days." This modification was confirmed by both parties by fax, but it only related to the changes of means of payment and the examination period without any prejudice to the "quality/quantity discrepancies" clause. However, during the period of more than one year till April 1992, the [Seller] received no payment and suffered losses from a large amount of unshipped inventory due to the breach of contract by the [Buyer]. The [Seller] had to suggest paying the damages of US $200,000 to the [Buyer] upon condition that the [Seller] should test the 25 pieces of flanges at once, make the 15% price payment in arrears and continue to perform three contracts. Since the [Buyer] did not intend to perform these conditions, the [Seller]'s suggestions did not become effective. Since the suggestions were not binding on the parties, they did not change or modify the terms in the original contracts.

The [Seller] alleged that the [Buyer] had no reason or legal basis to deny the time limit for claims specified in the contracts.

            3) The [Seller] stated that Articles 36, 38, 39 and 40 of the CISG could not support [Buyer]'s claims. The essential spirit of these articles of the CISG is consistent. It requires that the seller should be responsible for the conformity of the goods with the contract. The buyer should be entitled a reasonable period to examine the goods and the buyer must examine the goods, or cause them to be examined, within as short a period as is practicable in the circumstances [Article 38]. The buyer must give notice to the seller specifying the nature of the lack of conformity within a reasonable time after he has discovered it or ought to have discovered it; otherwise he will lose the right to rely on a lack of conformity of the goods [Article 39(1)]. In any event, the buyer loses the right to rely on a lack of conformity of the goods if he does not give the seller notice thereof at the latest within a period of two years from the date on which the goods were actually handed over to the buyer, unless this time-limit is inconsistent with a contractual period of guarantee [Article 39(2)]. It is obvious that all of these articles require that the seller examine the goods within a reasonable time or within as short a period as is practicable in the circumstances. The [Seller] noted that the contracts specify a period of three months after the arrival of goods at the destination port as the contractual period for the [Buyer] to examine the goods and give notice to the [Seller] about quality defects or claim compensation. However, the [Buyer] did not examine the goods within the period confirmed in the contracts, nor did [Buyer] claim lack of conformity of the goods.

The [Buyer] attempted to rely on Article 15 of the PRC Regulations of People's Republic of China on Purchase-and-Sale Contract of Industrial-and-Mineral Products which provides six months as the examination period. However, Article 15 actually sets forth an exception to its applicability if the period is otherwise provided by law or agreed to by the parties in their contract. In this case, the parties specified in the contracts that the time limit for claims of lack of conformity is to be within three months after the arrival of goods. In addition, Article 15(5) provides that if the buyer does not raise claims in writing for the lack of conformity within the time limit provided in the contract, the goods will be regarded as in compliance with the contract. The [Buyer] did not raise the claims for lack of conformity within the time limit provided in the examination and "quality/quantity discrepancies" clause in writing. The [Buyer] cannot deny this fact.

The [Seller] disagrees with the [Buyer]'s allegation that, according to Article 40 of the CISG, the [Seller] concealed the quality defects on purpose. Such an allegation is not consistent with the facts. The [Buyer] could not arbitrarily deduce, only based on the defects in a few flanges among a large quantity of goods during the long-term business relationship and which were found through destructive testing, that the [Seller] knew or could not have been unaware of the defects and did not disclose them to the [Buyer]. The [Buyer] was a middleman and the [Buyer] clearly knew the fact that the [Seller] was not the manufacturer who produced the flanges. In fact, the [Buyer] sent persons to the manufacturer's factory to inspect the quality of goods and gave certain direct instructions. The [Seller] never concealed any facts from the [Buyer].

            4) As to the nature of the MTRs, the [Seller] also pointed out that a Mill Test Report is only a test certificate issued by the manufacturing factory to indicate the specifications on certain batches of goods. Generally speaking, a Mill Test Reports shows the raw materials, chemical composition and mechanical performance and other specifications of the goods and does not contain any content to the effect that a guarantee, or scope and period of a guarantee has been made. A MTR is not a guarantee. Therefore, the MTRs did not modify the "quality/quantity discrepancies" clause provided in the contracts. The [Seller] does not accept [Buyer]'s position that the MTRs attached to the goods had acted as a guarantee in writing and replaced the clause in the contracts.

In addition, the [Buyer] also relied on the time limit provisions in PRC laws and the CISG and claimed that it was legitimate that [Buyer] gave the notice of the lack of conformity of goods which was not consistent with the contracts within two or four years. The [Seller] considers that the [Buyer] confuses the statute of limitations and period of claim in the "quality/quantity discrepancies" clause. The statute of limitations provided by laws sets forth the period within which the parties can file proceedings before a court or arbitration tribunal. The [Buyer] filed its arbitration application with the Arbitration Commission within such a period, and the Arbitration Commission accepted this case. However, such a procedural time limit cannot be used to challenge the effectiveness of the "quality/quantity discrepancies" clause in the contract. [Buyer]'s application for arbitration was accepted, but this does not mean the [Buyer] will win the arbitration. The "quality/quantity discrepancies" clause sets forth the substantive rights and obligations of the parties under the contracts. The [Buyer] did not claim its rights within the period specified in the contracts; so it can only be concluded the [Buyer] had abandoned these substantive rights.

(V) The different positions of the parties on the [Buyer]'s claims for its economic losses

The [Buyer] alleged that, according to the relevant laws and contracts, it was reasonable to require the [Seller] to compensate all of its economic losses including expected profits resulted from the bad quality of the goods. The [Seller], in turn, analyzed and refuted the [Buyer]'s specific claims, respectively.

      (i) The inventory flanges that [Buyer] was unable to sell

      The [Buyer]'s position

      The [Buyer] alleged that, based on the reasons above, the flanges provided by the [Seller] could not be sold in the US due to the inconsistency between the contracts and the Mill Test Reports, the percentage of unqualified goods over 44%, the returns and claims from many purchasing companies, and the warning of the US National Board of Boiler and Pressure Vessel Inspectors. The [Buyer] also alleged that, except for a small part of the goods sold at a lower price as "original goods without any change" (sold without the MTRs), the rest of the goods could not be sold. These inventory goods amounted to US $1,065,833 of the CFR price, which could only be returned to the [Seller]; therefore, the [Buyer] requested the [Seller] to repay for these goods at the CFR price.

      The [Seller]'s position

      During the four years of performing the contracts, the [Seller] delivered 862,060 flanges to the [Buyer] in an aggregate amount of US $7,478,349.91. The flanges stored in the warehouse amounted to US $1,065,833 and represented only 14.25% of the total goods provided by the [Seller]. (Note: these ratios were calculated on the basis of the data contained in the supplementary materials submitted by the [Buyer] on 20 June 1996.) The amount of the inventory goods was reasonable to the [Buyer] which was the biggest supplier of industrial valves in the US with eight representative institutions and warehouses. The [Buyer]'s large inventory was due to many factors including market competition, political factors disseminated by mass media and market demand of different types of flanges. The [Buyer] had no reason to attribute the large unsold inventory to the quality of goods.

It is questionable that all the inventory flanges were not marketable. On 29 August 1991, the business representative of the [Buyer] informed the [Seller] that the [Buyer]'s inventory had reached three or four million dollars. On 13 October 1992, in another letter, the [Buyer] claimed the value of inventory was US $2.5 million. But in April 1995 when this dispute was accepted by the Arbitration Commission, [Buyer] claimed US $1.48 million. It could be found that the [Buyer] had sold more than US $2.0 million worth of additional goods. Therefore, the [Buyer]'s claim that the inventory could not be sold is untrue and inconsistent with the principle of good faith.

      (ii) The loss of gross profits

      The [Buyer]'s position

      The [Buyer] alleged that, in accordance with the CISG, compensation should include loss of profit. Based on the 1991 US price catalogue and the invoices for goods actually sold, the [Buyer] estimated that the market value of these flanges reached US $1,707,782, and the gross profit loss would have been US $641,899 (US $1,707,782 - US $1,065,833 = US $641,899).

      The [Seller]'s position

      The [Seller] pointed out that gross profit loss has never been confirmed by any court or arbitration tribunal. In addition, after deducting the cost, the gross margin of the gross profit loss was very high. According to the data in the [Buyer]'s arbitration application, the gross profit rate is 54.2%. And based on the modified data in the supplementary materials submitted by the [Buyer] on 20 June 1996, the gross profit rate is up to 60.2%. This calculation method clearly showed the [Buyer]'s intent to obtain unreasonable profits.

      (iii) Loss of profit from flanges undelivered

      The [Buyer]'s position

      In the same calculation method as above, for the goods undelivered by the [Seller], the [Buyer] claimed that it should have made an expected profit of US $2,115,871. The [Buyer] alleged that it had the right to require the [Seller] to compensate the losses in accordance with the CISG.

      The [Seller]'s position

      The [Seller] alleged that part of the flanges was not shipped due to the unilateral breach of contract by the [Buyer]. Furthermore, since the [Buyer] terminated the contracts, the flanges produced on [Buyer]'s orders were stored in the warehouse and at Tianjin port and caused severe losses to the [Seller]. The third batch of goods delivered to the destination port was rejected by the [Buyer]; so the [Seller] suffered losses from looking for other purchasers.

In addition, the [Seller] stated that the total price of the three contracts was US $8,016,504.05. After deducting US $7,478,349.91, the price for the goods already delivered and the price for the undelivered flanges was US $538,100. It is also unreasonable for the [Buyer] to count the amount in its orders -- but beyond the total price specified in the contracts -- as a part of the value of the undelivered goods.

      (iv) As to the profit loss suffered from flanges sold as "original goods without any change and quality guarantee"

      The [Buyer]'s position

      The [Buyer] stated that the flanges could not be sold and became overstocked in that the Mill Test Reports provided by the [Seller] were inconsistent with the goods supplied. The [Buyer] had to sell some inventory flanges at a lower price as "original goods without any change and quality guarantee" (i.e., sold without MTRs and stating that heat treatment and mechanical function test were not carried out), which was a measure to mitigate its losses. The profit loss suffered from this should be compensated by the [Seller], which breached the contract.

      The [Seller]'s position

      The [Seller] considered that the sales contracts between the parties were the basis of the legal relationship between the parties. The way in which the [Buyer] would sell or decide the price of the flanges was independently determined by the [Buyer] and it was another legal relationship with no relation with the [Seller]. It is unreasonable and illegal for the [Buyer] to attempt to transfer the business risks and consequences of its own behavior to the [Seller]. On the contrary, the sales by the [Buyer] implicated that the [Buyer] had accepted the flanges and its claim that Chinese flanges were completely unable to be sold in the US was untrue. Moreover, this also proved that the [Buyer] did not have an acceptable basis for its allegation that 44.5% of the flanges supplied by the [Seller] were unqualified.

      (v) The settlement fee paid to TEAM Industrial Company

      The [Buyer]'s position

      The [Buyer] alleged that, after it found that the flanges purchased from the [Buyer] had serious quality problems, TEAM Industrial Company returned a lot of flanges to the [Buyer], replaced the flanges which had been installed in the pipe project and claimed damages. The [Buyer] had informed the [Seller] of these facts and claims in time and advised that it would have caused more severe losses if the parties had not settled this dispute. The [Buyer] negotiated with the [Seller] for compensation of the settlement. The [Seller] made a commitment to compensate part of the settlement, but the [Buyer] did not accept the compensation of US $200,000 offered by the [Seller]. It was found that 94% of this batch of goods was provided by the [Seller], so the [Buyer] required the [Seller] to compensate US $578,000 as 94% of the settlement fees (US $605,000) paid to TEAM Industrial Company by the [Buyer].

      The [Seller]'s position

      The [Seller] stated that TEAM Industrial Company requested returns and claimed its losses in June 1991. However, the returned flanges were shipped to the destination port in the US before the end of 1990 and the three-month period for examination had passed then. Moreover, the settlement agreement was only entered and effective between the [Buyer] and TEAM Industrial Company. The [Seller] was not involved in the negotiation of the settlement and did not make a confirming compensation commitment. So the settlement expenses should be borne by the [Buyer] itself.

      (vi) The testing fee

      The [Buyer]'s position

      The [Buyer] had to stop selling the flanges supplied by the [Seller] due to serious quality problems; so the [Buyer] had to find a place to stack them. To mitigate the losses, the [Buyer] also had to sort the flanges and carry out partial tests (with the exception of destructive tests on mechanical strength and metallograph). The total amount reached US $883,348 including storage, sorting, purchasing spectrum equipment and manpower cost, of which, the [Seller] should assume 45.5%, i.e., US $401,923, based on the percentage of the flanges supplied by the [Seller] in store.

      The [Seller]'s position

      The storage, transportation, test and depreciation of equipment purchased were all reasonable, normal expenses of the [Buyer] as an importer and wholesaler. The [Buyer] had no reason to impose these expenses on the suppliers.

      (vii) Losses suffered from returns of other clients

      The [Buyer]'s position

      There were flanges with a sum of US $21,915 returned for quality problems by clients of the [Seller] other than TEAM Industrial Company. These returned goods were proved to be the [Seller]'s goods which were accompanied with their heat number, Mill Test Reports, and evidence on payment of returns for checking. This loss should be assumed by the [Seller].

      The [Seller]'s position

      For the same reason as in the "settlement fee paid to TEAM Industrial Company", the [Buyer] itself should be liable for this.

      (viii) Interest loss and taxes

      The [Buyer] alleged that the interest loss on the storage, testing costs and settlement fees, together with the property tax levied on the inventory goods were actual costs and losses suffered by the [Buyer]. The [Seller] should be liable in proportion to the percentage of its goods in all of the goods.

However, the [Seller] stated that the undesirable build-up of inventory flanges was caused by [Buyer]'s wrong judgment on the market situations. The [Seller] delivered goods in accordance with [Buyer]'s orders. The [Buyer] should be liable for the interest and taxes incurred because of its superfluous purchasing of goods. In addition, the testing costs should be assumed by the [Buyer] including the interest.

(VI) Positions taken by the parties with respect to [Seller]'s counterclaims

      (i) Payment in arrears for the delivered flanges

      The [Seller]'s position

      The [Buyer] and the [Seller] had agreed in February 1991 that 85% of the payment would be by letters of credit and that the remaining 15% would be paid after the examination after the arrival of the goods at the destination port. When the [Seller] shipped the goods, the [Buyer] accepted the goods but took no examination, nor did [Buyer] make the payment in accordance with the contracts, which constituted a breach of contract. Furthermore, it was illegal for the [Buyer] to accept but not pay for the extra goods delivered in June and July 1991 by the [Seller]. The [Buyer] should pay for these extra goods.

      The [Buyer]'s position

      The flanges delivered by the [Seller] were found to have serious quality problems and caused serious losses to the [Buyer]. The [Buyer] had the right to refuse to make the payment in arrears as compensation.

      (ii) Extra losses suffered by the [Seller] due to the refusal of the [Buyer] to accept the goods

      The [Seller] claimed that the extra costs incurred at the destination port due to [Buyer]'s refusal to accept the goods should be paid by the [Buyer].

The [Buyer] stated that it had informed the [Seller] to terminate the performance of the contracts. The [Buyer] had the right to refuse to accept goods with material defects. In addition, the [Seller] did not submit any evidence of its losses.

      (iii) Inventory losses of the [Seller]

      The [Seller]'s position

      Inventory losses shall consist of the expenses for re-processing, losses of tax refund, storage fee, losses of profit and interest (as listed above) which were substantiated by detailed evidence and data on the calculation basis. These losses were caused by the unilateral termination of contracts by the [Buyer]; therefore, the [Buyer] should be responsible for them.

      The [Buyer]'s position

      In accordance with the CISG, the [Seller] had the duty to mitigate its losses. With respect to the customized flanges the [Seller] produced for [Buyer]'s orders, if the [Seller] believes in their quality, it could remove the special mark for the [Buyer] and resell them to other clients. The [Seller] actually did sell part of the flanges delivered to other clients in the US. It can be found that [Seller]'s allegation that the flanges had been stored in the warehouse for a long time was inaccurate. In addition, some part of the losses claimed by the [Seller], such as losses of tax refund, storage fee, were only estimated and not supported by evidence. The [Buyer] alleged that [Seller]'s counterclaims should be dismissed.

II. THE ARBITRAL TRIBUNAL'S OPINION

(I) The applicable law

The parties did not choose the applicable law in the contracts. In accordance with the principle that the laws of the country with which the contracts has the closest relationship are to be applied, since the place of business of the [Seller], the contracting place and the place of arbitration of this case are all in China, the laws of the PRC should apply.

In accordance with Article 6 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, because both the U.S. and China are Contracting States of the CISG, the CISG will be applied to settle the disputes in connection with the contracts, except for any reservations declared by the two countries.

In accordance with Article 5 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, international customs can be applied where there is no stipulation in the PRC laws.

(II) The quality issue

The focus of the dispute in this case was the quality of the goods. To make a correct and reasonable evaluation of the quality problem, the following issues need to be investigated or clarified:

   -    What provisions in the contracts set forth the requirements and standards for the quality of the goods?
   -    Whether the goods were defective in quality?
   -    What quality problems arose and how serious they were (the scope and degree of harm)?
   -    The nature of the quality problems and possible remedies.

The opinions of both parties and the testing results concluded by each party have been presented in the details of the case above. After received the parties' concurrence, the Arbitral Tribunal appointed experts to carry out an examination in accordance with the Arbitration Rules. The testing results provided by the two parties (made in their self-tests), sampling tests and the evaluation of experts could be taken as a reference for the Arbitral Tribunal to analyze the quality problems associated with the goods. Considering that the parties' opinions and the relevant testing results are outlined in the details of the case section of this award above, only several key points pertaining to the experts' investigation and evaluation directed by the Arbitral Tribunal are discussed below in the following sequence: (i) the nature of the experts' investigation and evaluation report; (ii) the opinions of the parties on this report; and (iii) the conclusions drawn by the Arbitral Tribunal.

      (i) The nature of the experts' investigation and evaluation report

            (1) The experts' investigation and evaluation is not a test provided for in the contracts or the applicable laws, nor can it replace the [Seller]'s merchandise test for exports or the [Buyer]'s test on imported goods for claims. The experts have been employed to report on special topics in this case for reference to the Arbitral Tribunal in holding its hearings in accordance with the Arbitration Rules. The Arbitral Tribunal is to decide whether the experts' opinions are to be accepted. For the performance of this investigation and evaluation, the Arbitral Tribunal has ruled that:

   -    It is not appropriate to select lots of flanges for test at random from all inventory flanges;
   -    Only several samples selected from the flanges which were still in the [Buyer]'s warehouses and determined by the [Buyer] to be unqualified are to be tested;
   -    Each sample is to be divided into two parts, one of them will be tested by independent inspection institute in America and the other one will be tested in China on their chemical, physical, metallographical and mechanical functions;

The experts have analyzed and compared their results, made independent judgment on the quality problems of flanges in accordance with their knowledge and experience and prepared written evaluation opinions.

            (2) The selection of samples and authorization for test

            The samples were selected from the inventory flanges, which had been determined "unqualified" by the [Buyer]. The [Buyer] had divided "unqualified" inventory flanges into three types: "unqualified" by self-test of the [Buyer], "unqualified" by test of ×× Lab and Houston Metallurgy Lab, and "unqualified" by returns from users. The two parties were present when selecting samples. The printing marks on flanges and their corresponding Mill Test Reports were checked. Altogether, nine flanges were selected, which were determined to be goods supplied by the [Seller], and marked by paint from No. SX-1 to SX-9. Flange No. SX-3 was a blind flange and it cracked when the user drilled several holes in the middle part. Flange No. SX-3 was suspected to be welded with two rolled steel plates. Under the supervision of the Presiding Arbitrator, the Secretary and experts, each sampled flange was split into two parts and sent to Beijing and New York City, respectively. When SX-3 (a blind flange) was cut, it was clearly found that it was not welded with two steel plates but was a forged piece with serious defects. It could be concluded that it was an unqualified product, so no further testing would be taken for SX-3.

The labs in China and US were jointly selected by the Arbitration Tribunal and the experts. The United States International Testing Laboratories is a well-equipped lab with a long history from 1934. It has provided testing services for many well-known manufacture factories and is recognized by various professional associations and institutes. The China Iron & Steel Research Institute is a testing center which has the most advanced and comprehensive metal materials testing instruments in China and many senior researchers. The Institute has often been authorized by Chinese or foreign institutions and the CCIB to carry out testing on metal materials. The selection of the above two US and China labs satisfied the principles of independence and fairness.

The China International Economic Cooperation Society authorized by the Arbitral Tribunal signed agreements on testing the nine samples separately with the above laboratories and made an overall arrangement on testing items, standards and testing methods after sending experts to discuss the matters with the two labs. To guarantee the accuracy of the analysis of chemical composition, it was determined that the China Central Iron & Steel Research Institute lab was to check data by wet analysis test as the final result (wet analysis test is the most accurate among the testing methods, but it involves considerable labor, long time and considerable costs. In dealing with conflicts, wet analysis testing is always recommended.)

      (3) The testing results and the conclusions of the experts

            The testing results by the China and the US independent labs revealed that most figures were very close, but some chemical composition data were found to be quite different (the main differences were in the manganese content of SX-2, SX-4, SX-6, SX-7 and SX-9, the Cr content of SX-8, SX-9 and the residual element content of SX-9). It was decided to use the wet analysis data as the final results. At the request of China International Economic Cooperation Society, the International Testing Laboratories did the testing again. The lab confirmed in the letter dated 11 July 1997 that its testing data with atomic absorption spectroscopy was close to the data of the China Iron & Steel Research Institute.

The Arbitral Tribunal concluded that the testing results provided by the two labs were reliable. (See the enclosed "Comparison between the Mill Test Report and the Testing Figures of the China and US labs.") [Note: The Comparison chart is not reproduced in this translation].

The experts analyzed the testing results of the two laboratories and submitted the following opinions:

            1) Chemical composition

            Among the eight flanges which were alleged to be unqualified, two flanges (SX-1 and SX-4) were consistent with Standard A105. With respect to SX-7, only the residual elements content (Cr, Mo) appeared to be a little high but other common element content were consistent with the standard. SX-2 and SX-6 were qualified products with manganese content at the critical value. Two flanges (SX-8 and SX-9) were completely unqualified. The carbon content of SX-8 was too high and the hardness (HB) was beyond the standard. The residual element content for Cr. Ni, M of SX-9 was beyond the standard, respectively, and the total content of residual elements was also beyond Standard A105.

            2) Mechanical performance and hardness

            Except for SX-8, the other seven flanges were concluded qualified. SX-8 had over-high hardness and unqualified chemical element content.

            3) Normalizing heat treatment

            The normalizing heat treatment of four flanges (SX-4, SX-5, SX-6, and SX-8) was good. Three pieces (SX-1, SX-7, and SX-9) did not pass the normalizing heat treatment. The normalizing process of SX-2 was improper.

Based on the above results, the experts concluded that, among the eight flanges, four (SX-1, SX-7, SX-8, and SX-9) were unqualified due to over-high chemical composition and hardness (SX-8), or excess ion of residual elements content (SX-7, SX-8 and SX-9), or improper normalizing heat treatment (SX-1, SX-7, and SX-9).

      (4) The experts' opinions on other quality and testing issues

      In accordance with the requirements of the Arbitral Tribunal, the two experts submitted their own opinions concerning other quality and testing issues - as reference for the Arbitral Tribunal.

            1) Many flanges were tested and determined "unqualified" by the [Buyer]. After investigating the instruments used for testing and the testing procedure applied by the [Buyer], the experts concluded that the equipment could be used for testing but the testing results could not be regarded as the basis to determine whether the chemical composition of flanges were qualified or not. The main reason was that the sampling was not in the middle part between the inner surface and the exterior surface, which did not fulfill the provisions of Standard A105. So the testing by the [Buyer] was only a surface test which had a comparatively large deviation. The test of hardness was carried out by converting Dietmar Leeb hardness into Brinell hardness, which may be subjective and personal, so the testing result was unstable and inappropriate to be deemed as the basis to declare the flanges unqualified.

            2) As for the 16 flanges determined to be unqualified among the 30 flanges supplied by the [Seller] and tested by MAXIM Lab (formerly named ×× Lab) from 1991 to around 1996, after investigation and discussion with the technical persons in charge, the experts concluded that:

(1) The analyzing standard of chemical composition cited in its test reports was incorrect;
(2) It was inappropriate to disregard the allowed deviation provided by Standard A105;
(3) It was inappropriate for the lab to take CE (Carbon Element) 45% as the standard to decide whether flanges were qualified;
(4) It was inappropriate and one-sided to determine the flanges not passing normalizing heat treatment only by resorting to the growth of crystals and the character of Dendritic Structure or the ferrite in the edge of crystals.

            3) The Houston Metallurgy Lab. The experts did not visit the Houston Metallurgy Lab during the investigation period, but analyzed its testing reports for 12 flanges. The experts concluded that the chemical composition testing data was consistent with the wet testing data obtained by the China Iron & Steel Research Institute and the testing reports of the lab was creditable. However, it was inappropriate for the lab to conclude whether the flanges passed normalizing heat treatment only on the basis of the crystal grain size.

            4) Surface deficiencies. The experts checked flanges that [Buyer] found to have surface deficiencies in its self-tests. The experts concluded that most surface deficiencies were hollows and forging foldings which were all exposed on the surface. These deficiencies were visible and easy to detect if the purchaser had examined the flanges in time. (Some deficiencies could not affect the function and use of the flanges after simple and easy polish.)

            5) It was found in the investigation that some flanges were repaired by welding. Standard A105 provides that repair by welding is allowed, but the welded products must pass a technical assessment that must be carried out before welding; normalizing heat treatment must be carried out after repair by welding; and the mark of W" should be printed on flanges repaired by welding. The investigation determined that all flanges repaired by welding were not printed with the mark of "W". This was not consistent with the provisions of Standard A105.

            6) With respect to crackles created by users' welding, the experts concluded that crackles created by welding should be treated differently. Some crackles were caused by the bad quality of the flanges, for example, unqualified chemical composition of the flanges could cause crackles in welding. And some crackles were engendered by the improper welding, such as the adoption of improper technical parameters or improper technical operation in welding. In this case, flange SX-4 was returned for the reason of crackles caused by the user's welding, whose chemical composition, mechanical performance and hardness were all qualified. The two labs found that this flange went through normalizing heat treatment, which completely met Standard A105N. The welding crackles should be attributed to the welding techniques but are not a product quality problem.

            7) Mill Test Reports. After comparing these testing results with the testing data listed on the Mill Test Reports, the experts concluded that the data on the MTRs had a comparatively large deviation. Some products with the same heat number were confirmed by Houston Metallurgy Lab to be produced from the same heat, taking the allowed deviation into account. However, some products (SX-8 and SX-9) were recorded with the same heat number, but the chemical compositions varied greatly. This could not happen under any circumstance. Therefore, the experts concluded that this problem reflected considerable loopholes in the factory's production administration.

      (ii) Opinions of the parties on experts' investigation and evaluation report

      The Arbitral Tribunal noted that the [Buyer] and the [Seller] agreed with most of the experts' report. They acknowledged that many of the technical ideas and opinions expressed by the two experts in their report were acceptable to both of them. For example, the [Buyer]'s expert Mr. Ollemnu expressed that "the experts' investigation and evaluation report was scientific; it reflected the real quality of the flanges in dispute; the Arbitral Tribunal could rely on the experts' opinion in the investigation and evaluation report to judge the quality of all the flanges sold from Shanxi" and "the experts' hard work deserved praise and honor". The [Buyer] also said that "this report is precise and reliable; the two experts' opinion in the report was very helpful for the resolution of the parties' dispute".

At the same time, the Arbitral Tribunal also noted that when applying the ideas and opinions in the experts' report, each party placed emphasis on the selected data and opinions for its side, while other opinions were not cited and mentioned, or regarded as doubtful.

      The [Buyer]'s position

      The [Buyer] stated that the experts' report effectively supported the [Buyer]'s allegation on product quality with the arguments:

            (1) Though all the flanges were printed with "N" mark and the MTRs stated that the flanges passed normalizing heat treatment, yet not all the flanges passed normalizing.

            (2) The chemical composition of a large amount of flanges did not reach Standard A105 nor did they meet the requirements of the contracts.

            (3) Flanges repaired by welding were not printed with the mark of "W" and the flanges that were repaired by welding flanges did not pass normalizing heat treatment.

            (4) The chemical composition was greatly different for flanges even printed with the same heat number. As pointed out by the experts, flanges SX-8 and SX-9 with the same heat number could not be produced from the same heat, which reflected considerable problems in the factory's production administration.

            (5) It was only by the destructive test that the experts could make a correct judgment about whether these flanges had not gone through normalizing heat treatment. This situation supported the allegation by the [Buyer] that "the defects involved in this case were definitely 'latent' defects as provided by the CISG." The exposure of deficiencies and serious problems in welding also illustrated that these problems could only be found in the process of production and use.

            (6) Though the experts did not take further testing for the blind flange (SX-3), the experts found it had serious defects due to the crackles inside. These inside crackles can only be detected through examining the flanges one by one by destructive examination, unusual X-ray or ultrasonic testing. Therefore, the [Buyer] cast doubt on [Seller]'s production techniques and quality control.

            (7) Though the experts expressed that the testing equipment, procedure and methods adopted in the [Buyer]'s self-tests cannot "guarantee the precision of the testing data" and "cannot be the basis for deciding whether the chemical content was qualified or not", they concluded that the [Buyer]'s testing equipment and method were qualified for the non-destructive testing and sorting the goods in the ordinary course of business. As a company engaged in commerce, it is unreasonable to require the [Buyer] to purchase the expensive testing equipment and facilities or to appoint a professional lab to examine a large quantity of the flanges at considerable expenses. Furthermore, the experts' report confirmed that serious defects found by [Buyer] did exist. The quality problems discovered by the experts evidenced that a large amount of flanges did not reach the quality requirements specified by the contracts.

            (8) The [Buyer] raised suspicion or different opinions as to several aspects of the experts' report. For example, the crackles in flange SX-4 were engendered by the production problems but not the welding techniques. ***

      The [Seller]'s position

            (1) The experts denied the basis on which the [Buyer] relied for its claims against the quality of flanges.

Therefore, the [Seller] considered that the [Buyer] did not provide evidence with probative force to support its claims and its claims should be dismissed.

            (2) The experts' report indicated that the defects with the flanges could be found through normal testing. The surface defects, such as hollows and forging foldings, were all exposed on the surface. The [Buyer] did not need to take any destructive testing; merely normal testing procedures could discover such defects. Therefore, if the [Buyer] had performed the examination as provided by the contracts, it could have found the defects in time and raised claims within the three-months time limit.

            (3) As for the normalizing heat treatment, the [Seller] agreed with the experts' opinions that it was inappropriate and one-sided to conclude, based only on the metallurgy structure of the flanges, that some flanges did not pass the normalizing. It is stated in the experts' report that for flanges used under the level of 300 Psi, normalizing heat treatment was only an additional requirement, because normalizing treatment places no remarkable influence on mechanical performance. The [Seller] considered that it could not be concluded that the [Seller] did not carry out normalizing process on purpose.

            (4) The experts pointed out that the deviation of the data in the Mill Test Reports from the data in the experts' investigation and evaluation report went beyond a reasonable extent. Taking the deviation allowed and the testing conditions into account, it was unreasonable and illegal to attribute the data deviation to the [Seller]'s fraud.

            (5) The experts explained that they only tested the flanges that the [Buyer] had concluded were unqualified and did not draw conclusions with respect to all of the flanges supplied from Shanxi Province. The conclusions in the experts' investigation and evaluation report cannot be extended to other flanges. The [Seller] alleged that, in the 830,000 flanges sold to the [Buyer], the testing results on the eight flanges could only show the quality of the flanges tested and could not show the overall quality of all of the flanges.

      (iii) Conclusions drawn by the Arbitral Tribunal on flange quality problems

The Arbitral Tribunal carefully examined the opinions of both parties, the evidence they presented on the quality problems and the experts' report on the investigation and evaluation. Before drawing its conclusions, the Arbitral Tribunal held that it was necessary to examine basic opinions on the manner in which the experts' report on investigation and evaluation was applied, and proposed opinions on several key issues concerning the flanges' quality.

            (1) The Arbitral Tribunal's assessment of the experts' report

The Tribunal noted that, even though the parties had different views on some aspects of the experts' report, both parties held that the experts' investigation and evaluation was helpful for the resolution of the parties' dispute", "the report is precise and reliable" and "the Arbitral Tribunal could rely on the experts' opinions in the investigation and evaluation report". The Arbitral Tribunal also understood that:

   -    After accepting the authorization in this case, the two experts were not subject to the administration of their original working units. They acted as independent and qualified experts, and provided consultation services for the Arbitral Tribunal, based on their own knowledge and experience.
 
   -    They completely abided by the appointment, strictly carrying out the provision of "not carrying on independent contact with any party in the dispute", and acted in accordance with the principle of "respecting the facts, being scientific and cautious in their analysis, analyzing reasonably, and fair treatment."
 
   -    With the permission of the Arbitral Tribunal, the two experts invited several experts on steel material testing and carried out discussions on special academic issues such as determining the heat treatment of metallographical organizations via metallographs. These experts were scholars and researchers on metallurgy and materials in related colleges, universities and institutions. The discussions did not involve the specific dispute in this case, nor were the names of the two parties in dispute mentioned. Therefore, it was beyond any doubt on the experts' activities, cautiousness and their earnest attitude.

The Arbitral Tribunal therefore held that the experts report on investigation and evaluation could be regarded as important evidentiary material in hearing the case and the experts' evaluation and opinions are to be considered as important references.

            (2) Whether the flanges supplied by the [Seller] contained defects inconsistent with the contracts

The Arbitration Tribunal noted that the experts commented on the accuracy of the self-tests by the [Buyer] on the chemical composition analysis and hardness of the flanges. The experts also presented different opinions on the testing standard and methods of the two labs (the former Houston ×× Lab and Metallurgy Lab) for testing the 41 flanges and concluded that certain conclusions of the labs were wrong. However, the experts never did deny the whole testing performed by the two labs and other reasonable conclusions. The experts did not re-examine all of the flanges which have been identified as unqualified by the Houston ×× Lab and Metallurgy Lab. The experts only selected nine flanges (including the blind flange). Based on the testing results of the two selected labs, it was concluded that at least three flanges (SX-1, SX-7, and SX-9) did not pass the normalizing heat treatment and one flange (SX-2) was processed with improper normalizing. The chemical composition of two flanges (SX-8, and SX-9) was inconsistent with Standard A105. The manganese content of SX-5 was lower than the standard. The carbon content of SX-1 was beyond the requirement in the contracts (C0.27%). As for the blind flange, the area of crackles inside covered 50% and this flange was found by the experts to have unacceptable serious defects.

Therefore, the Arbitration Tribunal concludes that the flanges supplied by the [Seller] did contain quality defects inconsistent with the contracts and standard specification. The Arbitration Tribunal does not support the [Seller]'s defense that the [Buyer]'s basis for its conclusion of the goods' lack of conformity was defective in technology, unscientific and unreliable."

            (3) What defects did the flanges contain?

            Based on the experts' report and testing data, the main quality defects are, among other things, as follows.

                  a) The contracts require that all of the flanges should pass the normalizing heat treatment. Standard ASTM-A105 requires that the flanges to be used under pressure higher than 300 Psi must pass the normalizing heat treatment. As confirmed in the experts' report, among the eight flanges tested, three flanges (SX-1, SX-7, and SX-9) did not pass the normalizing heat treatment and one flange (SX-2) was processed with improper normalizing. The experts concluded that the flanges which did not pass the normalizing or that were improperly normalized did not comply with the contracts. The Arbitration Tribunal concludes that three flanges (SX-1, SX-2, and SX-7) are flanges to be used under pressure of 600 Psi and the defects related to normalizing are inconsistent with the contracts and Standard A105. Flange SX-9 is to be used under pressure of 150 Psi. Though Standard A105 does not require that flanges to be used under pressure lower than 300 Psi must pass the normalizing, yet the contracts require normalizing. The goods should be consistent with the contracts, so flange SX-9 was inconsistent with the contracts. The more serious problem is that the flange that did not pass normalizing was printed with the "N" mark and the Mill Test Report showed the normalizing temperature.

                  b) The contracts require the flanges to be produced with forged steel consistent with Standard A105 with carbon content of 0.27% (Max), manganese content of 0.60 (Min). Standard A105 requires carbon content of 0.35% (Max), manganese content of 0.60% - 1.05%. The requirement on the carbon content in the contracts is stricter than Standard A105. The flanges delivered before the end of 1990 were produced with Standard ASTM-A105-84C. For the flanges delivered after the end of 1990, the parties decided to apply Standard ASTM-A105-84A. The latter standard sets forth the maximum limit for residual elements (Cn 0.4%, Ni 0.4%, Cr 0.3%, Mo 0.12%, V 0.03%, Nb 0.02%, Cr + Mo 0.32%, Cu + Ni + Cr + Mo 1.0%). Based on the chemical testing results of the eight flanges selected by the experts, the carbon content of two flanges (SX -1, SX-8) is beyond the contract requirement and SX-8 is beyond Standard A105. The residual element content of three flanges (SX-7, SX-8, SX-9) is beyond Standard ASTM-A105-87A (for SX-7, Cr + Mo = 0.4%; for SX-8, Cr + Mo = 0.41%; for SX-9, Cu + Cr + N + Mo = 1.47%). The manganese content of SX-5 is close to being low. These facts indicate that the flanges contain chemical composition defects.

                  c) The experts compared the Mill Test Reports and the testing data of the labs, but concluded that the data in the MTRs are greatly different from the testing data. Especially for flanges SX-8 and SX-9 printed with the same heat number, the chemical composition is different and the experts concluded that they could not be from the same heat number in any event. The experts pointed out that this fact implicated some great problems in administration of the factory. The conclusion of the experts casts doubts on the creditability of the Mill Test Reports.

                  d) The experts pointed out that all of the flanges which have been found passed through welding repair were not printed with the W" mark. Both the ASTM-A105-84C and the ASTM-A105-87A standards require that the products with welding repair must be printed with the "W" mark. The experts stated that the welding repair must be taken in compliance with techniques provided by Standard A105 and the flanges after welding repair must pass normalizing heat treatment. Though the investigation did not focus on these two requirements, yet the flanges with welding repair reviewed on the spot and serious crackles found in the test report reflected that the welding techniques were defective.

             (4) The seriousness of the quality defects

            As for the seriousness of the defects in the flanges supplied by [Seller], the Tribunal had expected the experts to provide analysis and comments. However, in this investigation, tests were only carried out among selected "unqualified" products determined by the [Buyer] on the flanges returned from the users and only nine flanges were selected (one blind flange was found unqualified in cutting and no further testing was made for it). The full evaluation of the seriousness of the quality defects was therefore limited.

The Arbitral Tribunal held that the seriousness of deficiencies was able to mainly be evaluated from the following two aspects: The percentage of products with quality problems; and The nature of the quality defects and the harm they caused.

As to the percentage of products with quality problems, quality problems alleged by the [Buyer] appeared in the 41 flanges tested by two US labs, and [Buyer]'s self-tests for deficiencies of chemical composition, hardness and visible defects illustrated that flanges with quality defects accounted for a large percentage of these flanges. However, the labs did not test the goods in batches and at random, and the accuracy of the [Buyer]'s self-tests may be limited by factors such as testing instruments, methods and testing conditions. As a result, it is difficult to regard [Buyer]'s percentage figures as a scientific and lawful basis to determine the real percentage of quality defects.

The nature of the quality defects is discussed below.

The flanges provided in this case are the connecting parts used in pipes. It was known from the specifications in the specific orders of the flanges that the size of flanges supplied in this case range from 3/4 inch to 24 inches, whose high pressure levels were 150 Psi, 300 Psi to 600 Psi (equaling to 10, 20, 40 atmospheric pressure). If there were problems in the connecting parts of pipes and cracks were caused, no matter whether the media transported by this kind of pipe was poisonous or not, the consequences could be highly serious due to the state of high pressure. Therefore, it was extremely necessary to require that the connecting parts (flanges) produced and supplied should fulfill Standard A105 and the additional conditions requested by the clients in the contract.

For example, as for the requirement of normalizing heat treatment, in the process of forging, raw materials for flanges may appear to have bad distribution of crystal organizations or to have remaining stress. Normalizing heat treatment could not only polish the crystal structure to improve the tensile strength, but also improve the welding and processing performance of flanges. Since most flanges are to be welded or processed for the use of connecting pipes, normalizing heat treatment was necessary. The Arbitral Tribunal noted, however, that the experts mentioned that for flanges at the level of 300 Psi, especially for steel with a carbon content 0.25%, even though normalizing heat treatment was not carried out, the actual function of such flanges was not greatly affected. At the same time, the experts also pointed out that the contracts required normalizing for all flanges. If the flanges supplied had not gone through normalizing heat treatment or passed the correct normalizing heat treatment, it apparently did not follow the contract provisions." The testing results obtained by the independent labs in China and US indicate that some flanges to be used under pressure of 600 Psi did not pass normalizing heat treatment either. The Arbitration Tribunal regards this as inconsistent with the contracts and the standard.

The experts' report disclosed large deviations for chemical composition in the Mill Test Reports. Flanges repaired by welding were not imprinted with the mark of "W" and flanges that had not gone through normalizing heat treatment were imprinted with the mark of "N". In addition, there were many MTRs with different data for flanges of the same heat number. All of these would cause purchasers and users to seriously doubt the credibility and reliability of the Mill Test Reports and the marks printed on the flanges.

However, the number of flanges tested was very limited, compared with the quantity -- more than thousands of flanges - therefore, it was hard to estimate scientifically and accurately what percentage of flanges had the above deficiencies. At least from the present evidence, it was determined that the above deficiencies were not rare.

The Arbitral Tribunal notes that, due to the special nature of flanges for high pressure pipes, the provisions of Standard A105 are very strict.

   -    The rejection and return provisions of the standard (A105-84C or A105-87A) provide that "each forging part with harmful deficiencies found should be rejected in the time of processing and application";
 
   -    The supplementary requirements of this standard provide in the article on "Product Analysis" that "any forging part is to be selected at random from the forging parts ordered of different size and shape; if it is unqualified after analysis, each forging part is to be checked or the whole batch is to be rejected."
 
   -    The article on "Product Marks" in Standard A105-87A specifically requires the producer to print the test and verifying marks. The standard especially suggests that verifying marks recognized by an organization should be attached in order to "prove that pipe fittings are produced, sampled and tested in accordance with this standard and the result is determined in accordance with the standard." Therefore, it is strongly emphasized in the standard that the marks must reflect the facts and comply with the standard.

Based on the above, the Arbitral Tribunal held that some Mill Test Reports and marks on the flanges supplied by the [Seller] were not consistent with the real quality conditions of the flanges. The inconsistency casts doubt on the creditability of the record in the Mill Test Reports and the marks on the flanges. The Arbitral Tribunal concludes that this is a serious violation of the contract.

The [Seller] claimed that among the hundreds of thousands flanges supplied by the [Seller], the [Buyer] had sold about 80% of them and no accident due to quality problems had ever occurred. The [Seller] relied on this fact as its defense that the [Buyer] had exaggerated the quality problems. The Arbitral Tribunal believes that, whether the flange deficiencies can immediately trigger a quality accident is connected with the actual environmental conditions and the pressure under which the flanges were used. At the same time, the quality indicators required by the standard generally set forth a comparatively large safety margin. The fact that the flanges in use did not cause accidents does not prove that the quality of the flange was consistent with the contract and the standard. The contract required that the quality of the flanges must be consistent with the standard in order to prevent accidents, because if accidents occurred on high pressure pipes, the consequence could be worse than any expectation. The Arbitral Tribunal does not accept the [Seller]'s opinion that the absence of accidents illustrates the consistent quality of the flanges.

The Arbitration Tribunal agreed with the [Buyer]'s claim that the flanges supplied by the [Seller] contain the quality problems as described above and concludes that these quality defects that were revealed here are due to [Seller]'s breach of the contracts.

The Arbitral Tribunal also notes that the [Buyer] based many of its allegations of deficiencies on the results of simple self-tests methods and concluded that more than 44% of all flanges were unacceptable "unqualified" products, which was also applied to illustrate that the flanges quality deficiency had reached a very serious degree. However, the experts stated in their evaluation report that while the [Buyer]'s self-tests method, instruments could only meet a requirement for sorting flanges commercially, [Buyer]'s chemical composition test had a comparatively large deviation. In addition, the Dietmar Leeb hardness was not listed in the ASTM standard, so it was improper to use the self-tests as the basis to determine whether flanges were qualified. Accordingly, the Arbitral Tribunal will not conclude that "more than 44% of the flanges are unacceptable unqualified products."

The Arbitral Tribunal also held that it was necessary to point out that neither the contracts signed by both parties nor the applicable laws and regulations specify what threshold of unqualified products with deficiencies should be reached for claims for damages. Therefore, although the Arbitral Tribunal does not accept the above rate of unqualified products alleged by the [Buyer], the Arbitral Tribunal holds that this does not preclude the [Buyer] from submitting reasonable claims for compensation based on other reasons.

(III) [Buyer]'s right to claim damages

The parties' arguments involved the following issues:

   -    The statute of limitation for arbitration and the period of claim;
   -    The quality discrepancy and the time limit for claim provided in the contract;
   -    The [Buyer]'s right to claim damages and the [Buyer]'s obligation to notify its objections to the quality in time.

The Arbitral Tribunal presents the following analysis of each of these issues.

      (i) The statute of limitation and period of claim

      Article 39 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest provides that "the time limit for commencing an action or arbitration is four years concerning contractual disputes on buying and selling goods, which starts from the day the party knows or should have known that his rights were infringed."

The instant case is a contractual dispute that arose out of a series of consecutive contracts for the sale of the same goods. Since the quality problem of repairing welded flanges appeared in June 1991, the parties to the contracts have been negotiating on the compensation issues but failed to reach any agreement. In October 1992, the [Buyer] sent a notice to the [Seller] to the effect that if the [Seller] did not make the compensation, it would bring a lawsuit against the [Seller]. In March 1995, the [Buyer] filed its application for arbitration with the Arbitration Commission.

The Arbitral Commission determined after examination that this case was within the time limit for "commencing an action or arbitration"; therefore, the case was accepted. Furthermore, the [Seller]'s act of answering the arbitration and filing counterclaims expressed that the [Seller] had accepted the Arbitration Tribunal's jurisdiction of this case. The right to file specific claims is a substantive issue that needs to be addressed at the hearing. It should be determined on the basis of parties' contracts, the related laws and regulations. The right to file specific claims, which is an issue connected with the statute of limitation, belongs to the category of substantive rights rather than procedural rights. The Arbitral Tribunal noted that this is consistent with the [Seller]'s understanding on statute of limitation for arbitration and periods of claim.

      (ii) Quality discrepancy and period of claim provided in the contracts

      The Arbitral Tribunal noted that there is a "quality/quantity discrepancies" clause in Remark 3 in each of the three contracts signed by the parties (the "Sales Confirmations" signed by the [Buyer]). It provides that, if the [Buyer] claims for compensation in terms of quality discrepancies, the claim must be raised within three months after the arrival of goods at the destination port. It also provides that if the [Buyer] claims for compensation in terms of quantity discrepancies, the claim must be submitted within fifteen days after the arrival of goods at the destination port. For any discrepancies which the insurance company, shipment company or other carriers should be responsible, the [Seller] will take no responsibility.

In Section (IV)(ii) of the above details of the case, the Arbitral Tribunal reported on the two parties' opinions on the period of claim. Without repetition here, the Arbitral Tribunal presents its conclusions on the following issues:

   -    The effectiveness of the "quality/quantity discrepancies" clause in the contracts;
   -    The latent defects and the period of claim;
   -    The nature of the Mill Test Report and "quality/quantity discrepancies" claim;
   -    The intentional act of concealing facts and the period of claim.

            (1) The effectiveness of the "quality/quantity discrepancies" clause in the contracts;

                  1) The Arbitral Tribunal holds that "quality/quantity discrepancies" clause in the contracts that is cited above is an important article setting forth the parties' rights and obligations. It had been confirmed by the parties' signatures and should be an effective term binding the parties' performance of the contracts. The parties should abide by this clause unless it is contrary to related laws and regulations.

                  2) The Arbitral Tribunal examined the evidence such as the parties' correspondence. It is found that the parties had confirmed by fax in February 1991 that 85% of the payment will be by letter of credit and the remaining 15% will be paid after the examination conducted by the [Buyer] and that the examination period is thirty days. No other notice or mail is found that modifies the "quality/quantity discrepancies" clause. Therefore, the Arbitral Tribunal holds that the quality / quantity discrepancies and compensation claims for the flanges shipped before February 1991 should follow the "quality/quantity discrepancies" clause in the contracts.

                  3) The [Buyer] alleged that the parties did not plan on having the products examined in the U.S. within ninety days after the arrival of the goods at the port. The reason was that the Specifications in the contract clearly provided that the buyer should examine the goods before shipment, i.e., examination was to be carried out in China. However, Remark 3 of the contracts provided that quality objections should be proposed within ninety days after the arrival of goods at the port. The [Seller] alleged that Remark 3 of the contracts concerning quality objections made the testing provisions in Specifications and other tests meaningless. This is an illogical explanation and should be denied. The [Buyer] also illustrated with examples that the two parties did not rely on the ninety-day restriction for quality objections in dealing with the quality problems of flanges in performing the contracts. The [Buyer] alleged that this meant that the parties had altered this "quality/quantity discrepancies" clause by their behavior, i.e., that any time limitation for filing claims was abolished.

The Arbitral Tribunal decides that the examination carried out by the [Buyer] before the shipment of goods was not contradictory to examinations after the arrival of goods at the port for the purpose of claims for compensation. The examination before shipment may help to find deficiencies of goods at an early time and reduce as much losses as possible caused by deficiencies when the goods were transferred to the [Buyer]. No matter whether the [Buyer] examined goods before shipment or after the goods were delivered to the [Buyer], the [Buyer] should have the right to carry out examinations of the goods, which is also specified in the CISG.

Concerning whether the parties altered the terms of the contracts by their acts in performing the contract, the Arbitral Tribunal found no document in the evidence submitted by the parties to the effect that a claim which was not consistent with the "quality/quantity discrepancies" clause has been admitted and fulfilled. Therefore, the Arbitral Tribunal cannot conclude that the "quality/quantity discrepancies" clause in the contract had been altered by the parties' agreement or had been denied or abolished by the acts of the parties.

                  4) The Arbitral Tribunal noted that the "quality/quantity discrepancies" clause in the contracts specifically provides for claims raised by the [Buyer] (the first sentence of this clause begins with "if the buyer claims for damages ...   "). Any claims for damages in terms of quality defects shall be substantiated by evidence which can only be obtained by the necessary examinations of the goods. Therefore, it is provided in the CISG that the buyer shall be entitled to have the time and opportunity to carry out examinations of goods and the buyer is required to "examine the goods or cause them to be examined, within as short a period as is practicable in the circumstances" (Article 38). If the goods are not in conformity with the contracts, the buyer must be notified the seller of these non-conformities "within a reasonable period of time after he has discovered [the lack of conformity] or ought to have discovered it" (Article 39). These provisions illustrate that the buyer had the obligation to carry out examination after receiving goods and to notify the seller in a reasonable period of time. Article 39(1) of the CISG further provides that:

"The buyer loses the right to rely on a lack of conformity of the goods if he does not give notice to the seller specifying the nature of the lack of conformity within a reasonable time after he has discovered it or ought to have discovered it."

The Arbitral Tribunal decides that the "quality/quantity discrepancies" clause in the contract is consistent with the CISG and should be observed.

At the same time, the Arbitral Tribunal noted that the [Buyer] mentioned "trade custom" to allege that the usual practice of the trade in the U.S. and other places in the world was that, if imported flanges had been tested as satisfactory in accordance with certain established industrial standard, examinations were often abandoned. The [Buyer] alleged that it was a trade custom to rely on the seller to satisfy the requirement of specifications and for the seller to provide documents (Mill Test Reports), which allow the buyer's clients and governmental agencies to assess the quality and the nature of the steel from the original steel factory and the producing factory. The Arbitral Tribunal holds that the parties' contracts do not eliminate the trade customs. However, if an issue is clearly provided in the contracts and confirmed by the parties' signature, the contract terms should be observed. In a word, the trade customs are supplementary in their application. This is a common practice in international trade. In the instant case, it is provided in the three contracts signed by the parties that the time limit for proposing objections was three months, which should be observed by the parties in accordance with the contracts. Therefore, the Arbitral Tribunal concludes that the parties should abide by the contracts on examination. As to matters that may not be subject to this time limit, they will be discussed below.

            (2) Latent defects and the period of claim

            Although there is no reference to "latent defects" in either the contracts or in the PRC laws applicable to this case, this is an inevitable issue in international trade practice which has been discussed in many noteworthy cases and authorities. The so-called latent defects normally refer to defects that cannot be found by reasonable observation or test and those deficiencies which could only be exposed or found in real use. For latent defects, once found, the time limit for the aggrieved party to identify problems and ask for remedies such as a claim for damages is not subject to the period of claim in terms of the quality defects agreed by the two parties. The provisions of Articles 36(2) and 39(2) of the CISG in fact can be applied to deal with the disputes on the latent defects.

The defects in the goods in this case can be divided into two categories: latent and non-latent.

Non-latent defects. The defects that were visible on the surface and defects which could be known to be inconsistent with the standard and contract by normal fast-test of chemical composition obviously do not belong to the category of latent defects. The Arbitral Tribunal holds that it is not difficult to detect this kind of non-latent defect by carrying out non-destructive spot tests within three months after the arrival of the goods at the port in accordance with the "quality/quantity discrepancies" clause in the contracts. The [Seller] submitted evidence to prove that when the first batch of flanges arrived at the port (shipped on 30 May 1987), the [Buyer] asked Bryan Laboratory Inc. to carry out testing and issue a report. This fact indicates the testing is practicable and possible by sampling.

Latent defects. As to the normalizing heat treatment and mechanical functions of the flanges, they could only be determined by destroying the products and making samples for tests of metallograph, tensile strength and extension. Though these tests could be processed by selecting samples, a large amount of products would need to be destroyed for the test since the tests can be representative only if the testing samples are selected separately from each batch of normalizing heat treatment. The Arbitral Tribunal considers that it should be reasonable to regard the deficiencies on normalizing heat treatment and mechanical performance of the products as latent defects for this kind of product. As to this kind of latent defect, the [Buyer] could only rely on the [Seller]'s warranties of the quality of the goods in compliance with the contracts and industrial standards. The findings and claims relating to these defects should not be subject to the period of claim of three months provided in the "quality/quantity discrepancies" clause in the contracts in this case. The time limit of two years provided in Article 39(2) of the CISG is, however, to be applied, because it would be inconsistent with the spirit of the CISG to require the seller to compensate for the losses caused by the buyer's commercial undesirable buildup of the inventory goods for an excessively long period of time.

            (3) The nature of the Mill Test Report and "quality/quantity discrepancies" claims

            The [Buyer] alleged that, based on trade customs, a Mill Test Report is a warranty on the composition and character of the products and the procedure used for production of flanges by the manufacturer. The [Buyer] further pointed out that the nature of the flanges should be stable without any change during the whole period of the contractual relationship. The [Buyer] alleged that, in essence, the Mill Test Report was a "permanent" contractual warranty on the mechanical nature and chemical composition of flanges, and that in accordance with Article 36(2) of the CISG, the [Seller]'s responsibility for its goods that are inconsistent with the Mill Test Report is not subject to a period of claim.

The [Seller], in turn, stated that the Mill Test Reports were issued by the manufacturer after sampling inspection. A Mill Test Report is a statement of the specifications of a batch of goods without any wordings like "warranties" or "the scope and limit of guarantee". Therefore, it was not a permanent quality warranty. In addition, there were no quality warranty terms in the contracts which required that the [Seller] should be liable for the conformity of the quality of the flanges within a time limit after put in use.

The Arbitral Tribunal notes that:

   -    The three contracts set ASTM-A105-84C (or A105-87A) as the quality standard;
 
   -    The enclosures to the contracts in this case all stated that a Mill Test Report should be provided; and
 
   -    The ASTM standard lists these test reports as certifications, which indicates that this is a kind of quality certification proving that the products are produced in accordance with Standard ASTM-A105.

The Arbitral Tribunal does not totally agree with the [Seller] or the [Buyer]. The Arbitral Tribunal holds that the Mill Test Report, as a "qualification certification", certainly should have the meaning of warranty for the products as consistent with a certain standard. The Arbitral Tribunal also holds that, as a warranty of the quality for a specific period which is connected with the claims for damages, as a usual rule, there is a statement of "quality assurance period" (like foods and medicine). In the instant case, there is no such "quality assurance period" provision in the Mill Test Reports; therefore, the Mill Test Report should not be regarded as a permanent warranty as alleged by the [Buyer] under any conditions (including storing conditions and use conditions and so on) without any time limit, which can provide the basis for claims at any time. Meanwhile, a Mill Test Report is not just a statement of specifications of the goods as alleged by the [Seller]. As a "qualification certification" filled with on-the-spot testing data of the same heat number on chemical composition, mechanical performance, state of heat treatment and other testing data, the [Seller] should be liable for any inconsistency between the truth and the content of the Mill Test Reports.

The Arbitral Tribunal holds that Article 36 of the CISG refers to the basic principle on time limit for the seller being responsible for goods inconsistent with contract and Articles 38 and 39 provide that if the buyer is to claim damages, he should examine the goods and notify the seller of any non-conformities with the contract within a certain period of time. Article 38 requires the goods to be examined within as short a period as is practicable in the circumstances, while Article 39 requires that the seller be notified within a reasonable period of time.

As far as this case is concerned:

   -    Under normal conditions, the [Buyer] should examine the goods within three months after the arrival of the goods at the destination port. Since the latent defects cannot be found by ordinary testing, based on Article 39(2), the [Buyer] should give the seller notice of lack of conformity within two years; otherwise, the [Buyer] will lose its right to claim the lack of conformity of the goods.
 
   -    As to the Mill Test Report, it should be regarded as a quality certificate. If the period for warranty of quality was not specified (for example, some products are clarified as "valid for five years"), the [Buyer]'s right for claims is subject to the period of claim of three months or the maximum period of two years.

            (4) The intentional act of concealing facts and the period of claim

            The [Buyer] alleged that many deficiencies of the flanges supplied by the [Seller] in this case were deficiencies of which "the seller ... knew or could not have been unaware and which he did not notify the [Buyer]." The [Buyer] listed certain facts.

   -    A quantity of flanges with the mark "N"(normalizing) and normalizing temperatures recorded in the Mill Test Reports had not gone through normalizing heat treatment;
 
   -    A quantity of flanges which were repaired by welding did not bear the "W" mark;
 
   -    Flanges which were not produced in the same heat bear the same heat number and have been attached with the MTRs in the same heat number which indicate that the MTRs could not reflect the facts;
 
   -    Welded and blind flanges were found.

The [Buyer] alleged that as the producer and supplier of flanges, the [Seller] should be clearly aware of whether flanges had gone through normalizing heat treatment, whether flanges were repaired by welding; and that the seller should also be aware that materials used for flanges belonged to different heat numbers. Why were the real facts not reflected in the MTRs?

The [Buyer] alleged that concealing the real nature of flanges with deficiencies was an act of fraud on the part of the [Seller]. The [Buyer] stated, with reference to Article 40 of the CISG, that under such conditions, the [Buyer]'s right for claims was not subject to the time limitation under the contractual terms or under Articles 38, 39 of the CISG.

The [Seller], in turn, stated that the MTRs were issued by the producer based on a sampling test method which was internationally accepted and that the results from this sampling test method could be used to represent the qualification rate for batch products. However, with such a method, the non-conformity with the contracts (for example, different positions in the normalizing heat treatment, and bad-distributed temperature affected that some flanges had not gone through good normalizing) of some flanges might be inevitable and was normally accepted by buyers in the ordinary course of business. The [Seller] alleged that it was not reasonable to presume that it was the [Seller]'s intentional act of fraud based on the appearance of this kind of exceptional or few defects (compared with total amount of hundreds of thousands flanges).

The [Seller] also stated that the [Buyer] knew that the flanges supplied by the [Seller] were produced by a large-size state-owned enterprise with solid technical forces. Furthermore, the [Buyer] visited the factory to examine the quality and the procedures of production and testing. It was impossible for the [Seller] to commit the fraud intentionally. The [Seller]'s Mill Test Reports were filled out by the producer, so it was even more impossible for the [Seller] to conceal facts on the MTRs intentionally. In addition, the basis for overruling the MTRs by the [Buyer] was not executed through an independent, reliable and fair test. The sources of flanges for testing were very complicated (flanges ordered by the [Buyer] came from many companies), and the samples could not be completely concluded as the goods provided the [Seller]. Therefore, the [Seller] declared that the allegation of fraud was completely unacceptable.

The Arbitral Tribunal studied the evidentiary materials provided by the two parties carefully, especially the testing result of the nine selected flanges supplied by the [Seller], which illustrated that there did exist deficiencies of flanges asserted by the [Buyer]. The experts had pointed out that these quality defects were inconsistent with the provisions of the contracts and the standard and some of them were very serious. For example, the carbon content of SX-8 is as high as 0.43% and the hardness is more than 200HB. The defect in the blind flanges is a kind of unacceptable defect. The chemical composition of SX-8 and SX-9 is very different but the Mill Test Reports state that they are produced from the same heat (No. 414). Therefore, the experts concluded that this reflected several large problems in the [Seller]'s production techniques and quality control.

The Arbitral Tribunal noted that Article 40 and all other articles of the CISG do not deal with issues of commercial fraud. The act of fraud should be determined and dealt with in accordance with the applicable domestic laws of the contract. In commercial trade, it is very common that the "buyer" is not the end-user and the "seller" is not the actual producer, therefore it is hard to draw an objective conclusion consistent with the facts on determining whether some facts should be regarded as the intentional fraud of the buyer or seller. Based on the evidence, the Arbitral Tribunal cannot conclude that in this case the [Seller] carried out an intentional fraud. However, in this case, the content of the Mill Test Reports and the marks on the flanges were not consistent with the facts. In particular, the name of the [Seller] was written on the MTRs and the producing factory filled in was also the name of the [Seller]. Therefore, according to the contract law, the [Seller] shall be liable for such non-conformities, while the liabilities between the [Seller] and his producing factory could be determined in accordance with their contractual relationship.

      (iii) The [Buyer]'s right to claim damages and the timeliness of [Buyer]'s objections as to quality

      Based on the above analysis, the Arbitral Tribunal's opinions on the [Buyer]'s claims for damages are:

            (1) The issue of statute of limitations had been considered by the Arbitration Commission at the time of accepting this case and was determined to be within the statutory limitation period. The [Seller] had presented a substantive defense and raised counterclaims in the arbitration, which illustrates that the [Seller] agreed that this case had not passed the statutory limitation period for arbitration.

            (2) It is provided in the "quality/quantity discrepancies" clause in the three contracts that the period of claim in terms of quality deficiencies should be "three months after the arrival of the goods at the destination port." This clause was confirmed by the two parties' signatures and used repeatedly in another two contracts signed twelve months and twenty-two months later, respectively. In performing these contracts, there was no written alteration of this article. Modification of this article relating to quality objections, claims and settlement of claims by the parties never happened. Therefore, this clause is an effective contractual provision.

            (3) The [Buyer] is entitled to examine the goods under the contracts. The contracts also provide that the [Buyer] is obligated to examine the goods and notify the [Seller] of any lack of conformity within a "reasonable" period of time after receiving the goods (within three months after the arrival at the destination port). These provisions comply with the applicable laws. The Arbitral Tribunal holds that, for defects which could be found after regular commercial testing (for example, superficial deficiencies, spot test for chemical composition, deficiencies caused by repaired welding, etc.), if the [Buyer] decided not to open packages for examination or carry out sampling tests and did not notify this kind of quality discrepancies to the [Seller] within the said time limit, the [Buyer] would lose its right to rely on such quality discrepancy claims because of its failure to give notice to the seller specifying the nature of the lack of conformity within a reasonable time after the [Buyer] has discovered it or ought to have discovered it.

            (4) The defects of the goods which can only be found by destructive sampling test (e.g., metallograph of normalizing heat treatment and mechanical performance) on flanges of different heat numbers and different heat treatment batches separately can be regarded as latent defects. In accordance with the CISG, the time limit to raise quality objections against this kind of deficiencies should be extended. But in accordance with the provision of Article 39(2) of the CISG, if there is no specific time limit for warranty in the contract, the longest time limit to notify of lack of conformity of the goods with the contract is "within two years from the date on which the goods were actually handed over to the buyer" [the restricting words of "in any event" are used in Article 39(2)].

            (5) As to the Mill Test Reports provided to the [Buyer] with the goods, the Arbitral Tribunal neither supports the [Buyer]'s statement regarding them as a "permanent warranty", nor does the Tribunal support the [Seller]'s statement regarding them as simply an statement of specifications in production testing. The MTRs are qualification certificates to prove that the materials under each heat number are made into flanges in accordance with the standard. However, the objections against the inconsistency between the goods sold and these qualification certificates should also be notified within three months after receiving the goods or a maximum of two years (for latent defects).

            (6) In accordance with the evidentiary materials available to the Tribunal and the continuous performance of the contracts between the parties for many years, the Arbitral Tribunal does not decide as proposed by the [Buyer] that the [Seller] had carried out an intentional fraud. However, some of the defects of flanges supplied by the [Seller] in this case should be regarded as defects of which the [Seller] "could not have been unaware." No matter how the [Seller] administered and supervised the quality of flanges manufactured by the production factory, as far as the legal contractual relationship is concerned in this case, the [Seller] should be liable for breach of contract for this kind of defects of flanges. For these defects, the [Buyer] is not restricted by the "quality/quantity discrepancies" clause in the contracts or the time limitation recited in Article 39 of the CISG.

            (7) The Arbitral Tribunal determines that it is necessary to point out that, though the Tribunal makes the above analysis to the effect that, according to the different nature, different periods of claim should be applied to different defects (the visible defects, the latent defects and the defects of which the [Seller] could not have been unaware), which is consistent with the contracts and related provisions of the applicable laws. However, because no overall sampling test have been conducted to the present inventory of flanges in accordance with the relevant commodity inspection rules, the Tribunal cannot make precise evaluations of the specific numbers and percentages of the flanges with different defects in all the goods. So it is difficult to divide the liabilities between the two parties. Under such conditions, the Arbitral Tribunal holds that the Tribunal can only make its decision on the basis of reasonable analysis and judgment and exercise its power of discretion in accordance with the specific circumstances.

            (8) Based on the above analysis, the Arbitral Tribunal holds that it is necessary to point out that since the two parties both agreed in their contracts that the period of claim should be three months after the arrival of goods at the port, the two parties should observe this agreement.

If the [Buyer] had carried out appropriate examinations or testing within the time agreed in the contracts and did not find substantial quality defects, but substantial quality defects were found later, would the [Buyer] necessarily lose the right to file claims? The answer is No. For example, if substantial latent defects are found, the [Buyer] can still claim indemnities.

Vice versa, if the [Buyer] received a large amount of goods, did not make any test at all, and took no regard for the claims provisions of the agreements it signed, then if a quality defect was found later, could [Buyer] file claims at any time and for whatever defects? The answer is No. For superficial deficiencies and deficiencies which can be found by normal testing, the [Buyer] has no right to claim indemnities again.

The [Buyer] did not conduct a single surface examination or testing of the goods and allege that more than 45% of the goods were unqualified until one or two years after the period of examination and claim agreed upon in the contract had expired. In any event, the [Buyer] was negligent in this respect.

The Arbitral Tribunal holds that the fundamental reason for the goods' lack of conformity with the quality requirements of the contracts and the standards was the manufacturer's poor production management and quality control. Therefore, the [Seller] shall afford the principal liability for such lack of conformity. However, the [Buyer]'s omission to examine the goods when the goods arrived at the destination port caused a failure to discover these problems. Without discovering these defects, more and more orders were executed between the parties and more and more defective goods were delivered by the [Seller] to the [Buyer], which aggravated the damages. Therefore, the Arbitral Tribunal holds that the [Buyer] should be liable correspondingly for the additional losses caused by its own negligence. These are the basic facts and principles which must be taken into account by the Arbitral Tribunal when it hears this case and decides the award.

(IV) The amounts claimed by the [Buyer]

In its arbitration application, the [Buyer] outlined the specific amount for each of its claims and submitted the relevant evidence and calculation basis. The Tribunal examined them claim-by-claim. Its opinions are as follows:

      (i) The inventory flanges that [Buyer] was unable to resell

      [Buyer]'s position

      The [Buyer] calculated that the purchase cost of the unsold inventory flanges (including importing duties and the freight to carry the goods to the warehouses) purchased from the [Seller] was US $1,065,883. The claim for this amount should be dealt with as returns. The Arbitral Tribunal has noted that the reasons alleged by the [Buyer] for returns are that, though all flanges were not tested, it was known from more than 30,000 flanges tested that the rate of unqualified goods reached as high as 44.5%. The defects tested only included unqualified chemical composition, unqualified hardness, visible deficiencies, and unqualified size. If tests on all aspects of flanges (for example, destructive test on metallograph and mechanical performance, etc.) were counted, the [Buyer] alleged that the rate of unqualified goods would be much higher. The [Buyer] provided some letters sent by its client to return the goods claiming that the unqualified products presented a high percentage and could not be used.

      Ruling by the Arbitral Tribunal

      The Arbitral Tribunal pointed out in (III)(iii)(3) of the section of "The Opinion of the Arbitral Tribunal," that visible deficiencies and deficiencies in chemical composition could be easily found by opening the packaging for tests and by regular testing. The discrepancy claim for these defects should be raised "within three months after the arrival of goods at the destination port" in accordance with the contracts. The Arbitration Tribunal even found from [Buyer]'s testing statistic list that some flanges delivered during 1987 to 1988 (Order No. 102703) were not sold and tested until September 1992, when the US National Board of Boiler and Pressure Vessel Inspectors issued its Special Report. It was claimed that all of these flanges could not be sold in American market due to their bad quality. This is obviously unfair for the [Seller].

Although [Buyer] attributed the undesirable buildup of the inventory goods and the inability to sell them to bad quality of flanges, which inhibited the sale of flanges in the US market, the Arbitral Tribunal yet holds that there were many reasons for the [Buyer]'s failure to sell the inventory flanges that had been supplied by the [Seller] at a value of US $1,065,833, including the accuracy of market forecasts in the preliminary stage and the later influence by the Special Report and media reports on the quality problems of flanges produced in China. Some flanges have defects in chemical composition and visible deficiencies and had not been inspected through regular testing by the [Buyer] within three months after delivery of goods. The [Buyer], therefore, has lost the right to raise objections and claim indemnities. Some flanges may have involved latent defects which cannot be found through non-destructive tests; the time limit for quality discrepancy claims for such defects is allowed to be extended to a longer period. Some flanges were completely consistent with the requirements of the contracts and the standard.

The Arbitral Tribunal decides not to support the [Buyer]'s claim of returning all of these inventory flanges, and decides that:

            (1) The inventory flanges which are to be used under pressure of 600 Psi are taken as returned goods. These flanges will be used under high pressure. Even though very few of them did not pass normalizing heat treatment, all of them should be regarded to be inconsistent with Standard A105 since the [Buyer] cannot test all the flanges for each heat number. Based on the evidence provided by the [Buyer] on 20 June 1996, there are 1,188 flanges belonging to the category of 600WN and the cost price is US $35,431.55. There are 961 flanges belonging to the category of 600SO and the cost price is US $23,921.41. There are 163 flanges belonging to the category of 600BLIND and the cost price is US $4,990.05. The total amount of flanges is 2,312 flanges with a cost price of US $64,343.

            (2) The rest of the flanges were 54,369 pieces (56,681 - 2,312) and their cost price is US $1,001,539.73 (US $1,065,882.74-64,343.01). Since all of these flanges were to be used at a pressure lower than 300 Psi, these flanges can be sold with a lowered price. Based on the evidence provided by the [Buyer] on 20 June 1996, the ratio between the loss suffered from lowered price and the cost price is 44.24% (513,335 ÷ 1,160,291). Therefore, the compensation for this part should be US $443,081 (US $1,001,539.73 × 44.24%).

The aggregate compensation for the unsold inventory flanges amounts to US $507,424.

      (ii) The profit losses for inventory flanges

      [Buyer]'s position

      Based on the [Buyer]'s method of evaluating the profit, the purchase cost of unsold inventory flanges was US $1,065,882.74 and the average gross profit on these flanges was US $641,899, which equals 60.22% of the purchase cost for these flanges.

      Ruling by the Arbitral Tribunal

      The Arbitral Tribunal will not comment whether this level of profit is reasonable, but addresses the following points:

(1)   Flanges ordered by the [Buyer] were not to be sold all at one time. They were stored in the [Buyer]'s warehouses and planned to be sold to different clients who have different specifications requirement (sales in batches). In this way, the [Buyer]'s profit would fluctuate with the demand of the goods and the price changes in the market; in this way, the "importer and wholesaler" may earn more profit, while he have to bear a higher risk at the same time. The Arbitral Tribunal holds that there are many uncertain factors associated with the method of calculating profit proposed by the [Buyer]. It is an incorrect and unreasonable practice to require the seller of goods to compensate profit losses based on a calculation method containing uncertain factors.
 
(2)   As has been pointed out in the previous part, the [Buyer] alleged that a quantity of goods were defective in chemical composition and had visible deficiencies. The Arbitral Tribunal noted that all these deficiencies were easy to be discovered within three months after the goods arrived at the destination port. However, the [Buyer] failed to open the packages to carry out a surface examination and a regular sampling test (including authorizing others to carry out tests). The [Buyer] also did not notify the [Seller] of the nature of the lack of conformity between the goods and the contracts within the agreed time limit in the contracts so as to facilitate the [Seller]' ability to make remedies. Therefore, the [Buyer] should be liable for this breach of contract.

In the previous section on "the inventory flanges that [Buyer] was unable to resell", for those flanges, the Arbitration Tribunal supports part of the [Buyer]'s claims for compensation taking into account that the latent defects were hard to find. But as to the profits, for the two points above, the Arbitral Tribunal holds that it is unreasonable for the [Buyer] to claim profit losses in accordance with a method with uncertain factors while the [Buyer] itself did not observe the contract strictly. However, the Arbitral Tribunal believes it reasonable that each party bears a half of the profit losses and the profits are calculated with a margin of 15%. So the [Seller] should compensate the [Buyer] the profit losses of US $79,941.20 (1,065,882.74 ÷ 2 × 15%).

      (iii) The profit losses for the flanges undelivered

      The [Buyer] alleged that the contract price of the flanges undelivered is US $3,638,403. Based on the same calculation method for calculating the profits of the unsold inventory flanges, the profit loss for the flanges undelivered is US $2,115,871.

      The [Seller] stated that the total price for the three contracts was US $8,016,504.31. The price for the flanges already delivered was US $7,478,349.81 and the price for the flanges undelivered was US $538,100. The calculation method for the profit used by the [Buyer] showed an extremely high profit margin (58.15%).

      Ruling by the Arbitral Tribunal

      (1) The Arbitration Tribunal has noted that the parties have different statistical numbers for the ordered amount, the delivered amount and undelivered amount of the flanges. As stated by the [Buyer], the contract price of the flanges it has received amount to US $8,191,666.88 which is beyond the total amount of US $8,016,504.31 of the three contracts. The amount of US $3.6 million for the undelivered flanges claimed by the [Buyer] may include the undelivered flanges for previous orders and the flanges which were later ordered in excess of the amount specified in the contracts. The [Seller] calculated the amount of flanges based on previous orders and did not include the flanges beyond the amount of previous orders and the flanges required by the [Buyer] beyond the amount specified in the contracts. The numbers calculated by the two parties are different even for six times. During the arbitration proceeding, the [Buyer] did not clarify the difference. The Arbitration Tribunal has noted that the contracts allow only 5% more or less of the goods and require that the orders must be confirmed by signature. The Arbitration Tribunal decides that it only has the jurisdiction to rule on the disputes on quantity, quality of the goods and the contractual terms. The issues that arose out of deals other than the contracts in this case between the [Seller] and the [Buyer] which have not been identified as the extension, modification and supplementation to the contracts expressly were out of the Tribunal's jurisdiction. Among the number of the delivered flanges, the Arbitration Tribunal considers the amount of US $538,100 proposed by the [Seller] for undelivered flanges is closer to the amount specified in the contracts (together with the amount of the flanges accepted by the [Buyer] (US $8,191,666.88), the total amount is US $ 8,729,766.88 (US $8,191,666.88 + US $538,100), which is 9% more than the total amount of the contract price of the three contracts).

      (2) The [Buyer] calculated the profit of the undelivered flanges with reference to the same calculation method as in the profit calculation of the unsold inventory flanges. The Arbitration Tribunal has noted that such a method comes up with a gross profit instead of net profit (the difference between the expecting sales price and the purchase cost). For the delivered flanges, the custom duties, transportation expenses and the expenses for management, storage and sales were actually paid. But these have not happened to the undelivered flanges. If the [Buyer] applied the same calculation method to the delivered and undelivered flanges, the compensation for undelivered flanges would include the expected profit and certain expenses which did not or would never happen. It is unreasonable and the profit margin of 15% is reasonable.

Since the [Buyer] did not clarify whether the undelivered flanges were confirmed by both parties and whether the letter of credit was issued, the Arbitration Tribunal will only support the compensation of US $80,715 (US $538,100 × 15%) for the profit loss.

      (iv)The economic losses suffered from flanges sold as "original goods without any change"

      [Buyer]'s position

      The [Buyer] alleged that if goods were sold whose Mill Test Reports and marks on the flanges were inconsistent with the real flanges, the [Buyer] would assume unbearable legal liabilities and suffer serious economic and reputation losses. Accordingly, the method of "original goods without any change" was to be applied to deal with the inventory flanges to reduce losses. This method of sale was applied by informing the purchaser that flanges did not go through the destructive testing on metallograph and mechanical intensity and most flanges could only sustain pressure of 150-300 Psi. Therefore, the purchasers could use these flanges to connect low pressure pipes for the transportation of ordinary media in accordance with the purchasers' own need.

      Ruling by the Arbitral Tribunal

      The Arbitral Tribunal holds that this sales method is a practical and reasonable measure to mitigate its losses in accordance with the circumstances. The [Buyer] submitted detailed materials for this claim, illustrating that the purchase cost of the flanges supplied by the [Seller] sold by this method was US $422,551 (US $216,807 + US $205,744), while the actual selling price was US $231,676 (US $74,977 + US $156,699), and the loss was US $190,875. The Arbitral Tribunal supports this claim.

      (v) The expense for settlement with TEAM Industrial Company

      The Arbitral Tribunal has examined all the available materials concerning the matter of TEAM Industrial Company's claim, which was caused by an inlaid flange purchased from the [Buyer]. Though some clients of the [Buyer] returned some goods in January to February 1991, the inlaid flange was considered to be a quality problem that the [Seller] could not have been unaware of. The inlaid flange was later found to be supplied by the [Seller], but it was due to an accidental mistake of a retired employee. The [Seller] had agreed to take responsibility for this and made a commitment that other flanges did not contain similar defects. The problems revealed in the use of flanges by [Buyer]'s clients caused the testing on the flanges supplied by the [Seller]. Two independent labs tested thirty flanges and found further problems which caused more returns and compensation claims. After the investigation, the experts offered opinions on the chemical composition testing and normalizing heat treatment of the flanges. The experts appointed by the Tribunal also concluded that the flanges were not consistent with the contracts. (For details, see the part of "Quality issues" of "The Arbitral Tribunal's Opinion" above)

The Arbitration Tribunal believes the quality defects of the flanges are the fundamental reason for the returns and compensation claims. The latent defects, such as improper normalizing heat treatment, were found within two years after the arrival of the goods at the destination port, so the [Seller] is still responsible for them. With respect to the surface defects, since the [Buyer] did not raise quality discrepancy claim in three months after the arrival of the goods, the Arbitration Tribunal will not support the [Buyer]'s claim that the [Seller] should take all of the responsibility.

The Arbitration Tribunal has also noted that the parties had negotiated on the compensation of US $650,000 which was paid to the TEAM Industrial Company as settlement fees for many items. The [Seller] once suggested that it would compensate US $200,000 to the [Buyer] in the subsequent transactions between the [Buyer] and the [Seller] with certain conditions, while the [Buyer] insisted on immediate payment of the compensation and quality warranty on the goods to be delivered. Though no final agreement was reached, it showed the intention of the parties to jointly bear the responsibility for the settlement expenses.

The [Buyer] claimed that the [Seller] should bear the settlement expenses of US $578,000. The Arbitration Tribunal concludes that the settlement expenses are actual losses suffered from the quality problems of the flanges provided by the [Seller] and they should be jointly borne by the parties. It is reasonable to require the [Seller] and the [Buyer] to bear US $280,000 and US $298,000, respectively.

      (vi) Testing expenses

      [Buyer]'s position

      The [Buyer] alleged that the total amount of the testing expenses was US $883,348 which consisted of expenses for renting field, buying equipment (only depreciation was included) and charges of labor services for the [Buyer] to carry out extensive testing and sorting the inventory flanges. Excepting the payment which should be borne by other suppliers, the [Buyer] alleged that the [Seller] should pay US $401,923.

      Ruling by the Arbitral Tribunal

      The Arbitral Tribunal holds that it is the buyer's contractual obligation to inspect the goods. If the [Buyer] had carried out sampling tests or authorized others to carry out sampling examinations in accordance with the terms agreed in the contracts after the arrival of goods, the [Buyer] could not only have saved a lot of testing expenses, but could also have found problems and raised quality objections in time, and gained the compensation for losses.

The Arbitral Tribunal does not support this claim where the [Buyer] did not carry out the examination in accordance with the contracts and the applicable law in time but asked for compensation for additional expenses on overdue tests.

      (vii) The refunds to other clients due to the returns of the goods

      The [Buyer] claimed that the [Seller] should cover the refunds to other clients of US $21,915 for the returns of the goods. The Arbitral Tribunal noted that it was substantiated by evidence submitted by the [Buyer] that these flanges were returned casually by some small clients of the [Buyer] from 1991 to 1992 and most of the reasons for returns were superficial and visible deficiencies such as surface cracks, forging deficiencies, cracks repaired by welding or deficiencies of holes for bolts. The Arbitral Tribunal holds that it is necessary to point out that the [Buyer] is not the agent of the [Seller] and the transactions between the [Buyer] and the [Seller] are one-off trade. The right of "quality/quantity discrepancies" claims can be available only if the quality discrepancies are claimed for the above deficiencies within three months after the arrival of goods at the destination port. The Arbitral Tribunal does not support this claim of the [Buyer].

      (viii) Interest

      The [Buyer] claimed US $566,700 for interest loss of the total compensation, including the interest on the cost of inventory flanges, the interest on the testing and storage expenses and the settlement expenses with Team Industrial Company. The Arbitration Tribunal decides that except for the interest on testing and storage expenses, it is reasonable to compensate the interest on the other two items.

The interest on the cost of unsold inventory flanges is US $213,118 (US $507,424 × 7% × 6). The interest on the settlement expenses with TEAM Industrial Company is US $137,200 (US $280,000 × 7% × 7). The total amount is US $350,318.

      (ix) Taxes

      The [Buyer] claimed that the [Seller] should pay the property tax of US $85,236 for the inventory flanges imposed by the local county government and the school zone where the flanges were stored.

The Arbitral Tribunal holds that the [Buyer] is an importing wholesaler which stores many flanges for future batch sales. To store the flanges in warehouses was the [Buyer]'s own unilateral decision. The property tax imposed by the local government is out of the [Seller]'s expectation when signing the contracts. At the same time, it is provided in Article 13 of the contracts that all taxes imposed by non-seller's countries are to be paid by the [Buyer]. In addition, the failure to sell some of the flanges in time was not completely due to the [Seller]'s act. The Arbitral Tribunal does not support this claim of the [Buyer].

      (x) Attorneys' fees

      The [Buyer] claimed that the [Seller] should pay the attorneys' fees of US $243,717 paid by the [Buyer].

The Arbitral Tribunal holds that, though the Tribunal does not support all of the compensation claims of the [Buyer], yet the Tribunal believes that this case arose out of the bad quality of the goods that were inconsistent with the contracts supplied by the [Seller]. And the Tribunal believes that the [Buyer]'s claims were substantiated by certain factual and legal basis. In accordance with the Arbitration Rules, the Arbitral Tribunal decides that the [Seller] should compensate the [Buyer] for attorneys' fees of US $60,000.

      (xi) The arbitration fees

      The arbitration fees for this case are US $78,422. The Arbitral Tribunal decides it is reasonable that 70% of the arbitration fees should be paid by the [Seller] and 30% of the arbitration fees by the [Buyer]. The [Seller] should pay the arbitration fees of US $54,895.40 which was paid by the [Buyer] in advance.

      (xii) Expenses for experts' investigation and evaluation

      In accordance with the Arbitration Rules, the Arbitral Tribunal authorized experts to carry out investigations and evaluations. In addition, the Tribunal authorized professional labs in China and US to sample unqualified flanges determined by the [Buyer] and carry-out testing. The evaluations provided an important reference to the Tribunal to make its award. The two parties in this case should jointly bear the sum of US $24,500 that was paid by the [Buyer] temporarily. The Arbitral Tribunal holds that it is reasonable for the parties to contribute 50% each. Therefore, the [Seller] should pay US $12,250 to the [Buyer] which was paid by the [Buyer] previously on behalf of the [Seller].

In addition, the Tribunal has noted that the [Buyer] claimed, in its supplementary claims, for the loss of US $25,000 including traveling and other necessary expenses for the postponed hearing. When the Tribunal held the second hearting to hear the explanation of the experts, the [Seller] suddenly submitted an incomplete document to deny the corporate capacity of the [Buyer] and to delay the arbitration procedure on purpose. The Arbitration Tribunal believes that the [Seller]'s behavior was inappropriate in that [Seller] did not submit the certificate issued by Secretary of State of Texas to the Tribunal in time. After discussions, the Tribunal decided to postpone the hearing since the [Seller] insisted on suspending the hearing. The Arbitration Tribunal discussed with the experts and the experts advised that their report could be only a reference to the Tribunal and they did not have further explanation. Therefore, the Tribunal decided not to hold the hearing again based on Articles 40 and 41 of the Arbitration Rules. Since the [Buyer] did not notify the Arbitration Tribunal and the [Seller] of the changes of his equity restructuring and registration place, it was necessary to clarify these facts for the arbitration proceeding. Therefore, the Arbitration Tribunal holds that the [Seller] should bear US $5,000, which is 20% of the compensation claimed by the [Buyer].

(V) The [Seller]'s counterclaims

      i) The payment in arrears by the [Buyer]

      The [Seller] claimed, in its counterclaims, that the [Buyer] should pay US $263,803.86 for the goods that had been received by the [Buyer]. The [Buyer] alleged that since the goods were found to have serious quality problems and the [Buyer] suffered great loss, the [Buyer] should have the right to dispose of these goods to compensate for this loss. The [Buyer] did not deny the fact it did not make the payment for the goods. The Arbitration Tribunal holds that the payment should be made and can be deducted from the amount of [Seller]'s compensation to the [Buyer] as ruled in this award.

      ii) The loss suffered from [Buyer]'s refusal to accept the goods

      The Arbitration Tribunal has found from the materials submitted by the [Seller] that on 7 August 1991 the [Buyer] informed the [Seller] to stop shipping the goods. The last batch of goods was shipped on 20 July 1991 (the date of the bill of lading) by the [Seller]. This batch of goods was prepared in accordance with the shipment notice (9/262-311) issued by the [Buyer]. The risk was transferred to the [Buyer] when the carrier signed the bill of lading. The [Buyer]'s refusal to accept the goods after the arrival of goods at the destination port is inconsistent with the CISG. The [Seller] has the right to taken remedial measures (such as re-sell to others) and the extra expenses should be compensated by the [Buyer]. The [Buyer] did not deny its responsibility for refusing to accept the goods in its defense against [Seller]'s counterclaims which was submitted on 8 January 1996, but pointed out this counterclaim was lacking of evidence. The Arbitration Tribunal requested the parties to provide evidence to support their claims and counterclaims. However, till the end of the hearings, the [Seller] had not provided detailed evidence for its compensation claim of US $11,700. Therefore, the Tribunal cannot make the decision on this issue because of insufficient evidence and substantiation.

      iii) Loss for the inventory flanges

      The losses for the inventory flanges claimed by the [Seller], which includes reprocessing fees, losses of tax refunding, storage expenses, expected profit loss and interest loss were as follows. (The amount in US dollars is converted into RMB at the exchange rate of 1:5.7. )

Expenses for reprocessing flanges US $101,280.00 (RMB 577,296.00)
Losses of tax refunding US $144,973.95 (RMB 826,351.60)
Storage expenses US $ 36,434.53 (RMB 207,676.80)
Profit loss US $ 46,272.30 (RMB 263,752.11)
Interest loss US $903,129.00 (RMB 5,147,840.46)

The Arbitration Tribunal reviewed the materials submitted by the [Seller] and found issues as follows:

            a) The [Seller] stated in its defense that the undelivered flanges amounted to US $538,100, including the flanges shipped but rejected by the [Buyer] (these goods had been resold later; the invoice value was US $51,220.37). However, in its counterclaim, the [Seller] claimed that 950 tons of flanges were stored as of 7 August 1991 with a value of RMB 4,275,000 equal to US $750,000 (exchange rate 5.7:1). The losses listed above are calculated on the basis of the latter number which is contradictory to the previous claim of the [Seller]. Therefore, this number is not reasonable.

            b) The [Seller] did not explain the status of the 950 tons of goods as of 7 August 1991. Based on the calculation of the losses, it seems all the 950 tons of flanges had been produced, processed and printed with marks at that time and been prepared for shipment. This batch of goods was stored in Tianjin for shipment and the storage expenses were calculated for five years. These facts indicate that the [Seller] did not take any remedial measures to mitigate its losses.

            c) Losses of tax refunds. The losses of tax refunds consist of two parts. One part is the losses of tax refunds for the outstanding payment which the [Buyer] did not paid in time. The Tribunal has decided the [Buyer] should compensate for the payment in arrears, so the [Buyer] should not compensate for this part of the loss of tax refunds. The other part is the loss of tax refunds for the inventory flanges. The [Seller] calculated this amount based on the fact that the goods were all resold to domestic clients, but [Seller] did not provide any evidence to prove that the goods had been resold.

            d) Profit loss. The Tribunal has noted that the contracts in the instant case were contracts for the delivery of goods by installments. The [Buyer] terminated [avoided] receiving the goods when [Buyer] found that the goods already delivered were materially inconsistent with the contracts and the [Seller] had not performed the contracts strictly in accordance with the contracts. So [Buyer]'s termination [avoidance] is consistent with the principles set forth in Article 73 of the CISG. The Arbitration Tribunal will not support the profit loss claimed by the [Seller] for the undelivered goods since the [Seller] breached the contracts first.

            e) The Arbitration Tribunal reviewed the evidence for the losses alleged in [Seller]'s counterclaims. Besides the issues mentioned above, the [Seller] did not provide the receipts or documents to prove the losses. For example, the documents for storage expenses indicate the rents from 26 November 1991 to 25 December 1991 and from 26 November 1992 to 25 December 1992. There is a letter dated 15 July 1995 issued by a transportation company and a letter dated 15 July 1995 issued by Sinotrans Tianjin Group Co. to prove that 950 tons of flanges were stored in their warehouse. The expenses for reprocessing flanges are supported by a receipt dated 15 June 1995 issued by Shanxi Xihua Machinery Company. The storage and expenses for reprocessing flanges were paid in 1995, but the interest for these expenses was calculated from July 1991 to June 1996 including the penalty interest. No evidence proves that this interest and penalty interest have ever been incurred and paid by the [Seller].

            f) As explained in section III(iii)(8), the [Buyer] did not take any examination or testing when the goods arrived at the destination port. Therefore, the quality problems were not discovered in time and the [Buyer] even enlarged the ordered amount. The losses were aggravated finally. The [Buyer] should take responsibility to a certain extent for the [Seller]'s undesirable buildup of the inventory flanges due to the termination of contracts. The Arbitration Tribunal holds that the [Buyer] should pay to the [Seller] a reasonable portion of the compensation for the expenses for reprocessing flanges, resale losses and expenses for the inventory flanges that amounted to US $538,100. The [Buyer]'s share of the compensation should not exceed US $80,000.

      iv) Attorneys' fees

      The [Seller] claimed that the [Buyer] should compensate the attorneys' fees and other expenses the [Seller] had paid for this case. However, the [Seller] did not provide any details or evidence. The Arbitration Tribunal does not accept this claim.

      v) Arbitration fees for the [Seller]'s counterclaims

      The Arbitration Tribunal holds that it is reasonable that the [Buyer] pay 30% and the [Seller] pay 70% of these arbitration fees, respectively.

III. THE AWARD

After deliberation, as to the claims brought by the [Buyer] and the counterclaims brought by the [Seller], the Arbitration Tribunal rules that:

(I) The [Seller] should pay US $507,424 to the [Buyer] for the losses suffered from the unsold inventory flanges.

(II) The [Seller] should pay US $79,941.20 to the [Buyer] for the profit loss from the unsold inventory flanges.

(III) The [Seller] should pay US $80,715 to the [Buyer] for the profit loss from the undelivered flanges.

(IV) The [Seller] should pay US $190,875 to the [Buyer] for the loss suffered from selling flanges as "original goods without any change".

(V) The [Seller] should compensate US $280,000 to the [Buyer] as the expenses for the settlement between the [Buyer] and TEAM Industrial Company.

(VI) The [Buyer]'s claim for the expenses of testing, fields rentals and storage fees for the unsold inventory flanges is dismissed.

(VII) The [Buyer]'s claim to have [Seller] pay the losses of the goods returned by the small clients sporadically is dismissed.

(VIII) The [Seller] should compensate US $350,318 for [Buyer]'s interest losses.

(IX) The [Buyer]'s claim to have [Seller] pay local property taxes is dismissed.

(X) The [Seller] should pay US $60,000 for the [Buyer]'s attorneys' fees.

(XI) The [Seller] should pay 70% of the arbitration fees and [Buyer] should pay 30%.

(XII) The expenses for the experts' investigation in this case are US $24,500. Each of the two parties to the dispute should assume 50%. As the [Buyer] had paid the full amount of US $24,500 for the experts' investigation in advance, the [Seller] should reimburse the [Buyer] US $12,250.

(XIII) The [Seller] should compensate US $25,000 to the [Buyer] for the losses from the interrupted hearing.

For (I) to (XIII), the [Seller] should compensate the [Buyer] in an aggregate amount of US $1,621,418.60.

(XIV) The [Buyer] should pay the arrears for the contract price of the delivered flanges of US $263,803.86.

(XV) The [Seller]'s claim for the expenses arising from the [Buyer]'s refusal to accept the goods is dismissed for lack of evidence.

(XVI) The [Buyer] should compensate US $80,000 to the [Seller] for the expenses for reprocessing flanges, storage fees and reselling expenses for the undelivered flanges.

(XVII) The [Seller]'s claim to have the [Buyer] pay his attorneys' fees and other expenses is dismissed.

(XVIII) With respect to the arbitration fees for the counterclaim, the [Seller] (Claimant in the counterclaim) should pay 70% and [Buyer] should pay 30%, respectively.

For (XIV) to (XVIII), the [Buyer] should pay US $351,979.76 to the [Seller].

(XIX) For (I) to (XIII), the [Seller] should pay US $1,621,418.60 to the [Buyer]. For (XIV) to (XVIII), the [Buyer] should pay US $351,979.76 to the [Seller]. The payments can be offset with each other. Therefore, the [Seller] should pay US $1,269,438.84 to the [Buyer]. The [Seller] shall make the payment to the [Buyer] within 30 days after this award takes effect; otherwise, 10% annual interest shall be added.

(XX) All the other arbitral claims and counterclaims brought by the parties not addressed above in this case are dismissed.

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 the United States is referred to as [Buyer] and Respondent of the People's Republic of China is referred to as [Seller]. Amounts in U.S. currency (dollars) are indicated as [US $].

** Yuan Xiaotong, LL.M., McGill University; LL.B. Renmin University of China.

*** John W. Zhu, LL.M. China University of Political Science and Law (National Graduate Scholarship); Bachelor of Law, Southwest University of Political Science and Law; Double Degree, English Literature, Sichuan International Studies University, Chongqing, China. Focus: International Economic Law.

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Pace Law School Institute of International Commercial Law - Last updated September 6, 2006
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