China 30 March 1999 CIETAC Arbitration proceeding (Flanges case) [translation available]
[Cite as: http://cisgw3.law.pace.edu/cases/990330c2.html]
DATE OF DECISION:
JURISDICTION:
TRIBUNAL:
JUDGE(S):
DATABASE ASSIGNED DOCKET NUMBER: CISG/1999/16
CASE NAME:
CASE HISTORY: See companion Flanges case of 29 March 1999
SELLER'S COUNTRY: People's Republic of China (respondent)
BUYER'S COUNTRY: United States (claimant)
GOODS INVOLVED: Flanges
PRC: Award of China International Arbitration Commission [CIETAC] 30 March 1999 (Flanges case)
Case law on UNCITRAL texts (CLOUT) abstract no. 770
Reproduced with permission of UNCITRAL
The case deals with the conformity of goods, notice periods and article 40 "safety valve", avoidance for fundamental breach and the calculation of damages.
An American buyer entered into multiple contracts with a Chinese seller for the purchase and transportation of forging carbon steel flanges ("flanges"). Each contract contained different terms: on quantity, specification, price, and time of delivery. However, other terms such as quality, examination, claims, and arbitration were the same. Furthermore, the seller was to provide the so-called Mill Test Reports ("MTRs") describing the chemical and heat data of the flanges. The buyer had the option to inspect the goods prior to shipment and the right of examination was an inseparable part of the agreement. In the early stages of the contractual relationship, some minor quality issues were resolved by the parties without reference to the contractual periods for claims.
After a few years, some quality deficiencies were discovered in the goods by one of the buyer's third-party customers. Therefore, the customer returned all Chinese flanges to the buyer and claimed compensation. The buyer requested compensation from the seller, but the negotiations were unsuccessful as the seller denied liability on the contractual grounds that claims could only be placed within 90 days of the arrival of the goods.
Eventually, the buyer agreed on compensation with the seller and mitigated the losses by selling flanges at lower prices. Further, the buyer notified the seller it would not accept any undelivered flanges called for under the contract.
When the case was heard by the arbitral tribunal, both parties agreed that the CISG was applicable pursuant to the laws of the People's Republic of China and since the parties' countries were signatories to the CISG. Experts were appointed to determine the existence of deficiencies in the goods and the authenticity of the testing data.
The buyer claimed for damages under CISG article 74 pursuant to breach of CISG articles 36(1), 36(2), and 40. It argued that since it had the right to inspect goods prior to or after shipment, failure to inspect goods prior to shipment did not waive any rights to inspect the goods after shipment. Further, it claimed that the MTRs should be considered as a quality warranty. As some of the flanges were found to be inconsistent with the MTRs, the buyer claimed an extended period to submit indemnity claims. Its argument that the MTRs should be considered a quality warranty was partially accepted by the tribunal.
The seller based its arguments on CISG articles 38(1), 39(1), and 39(2). It submitted that the buyer had failed to perform inspections which would have discovered many of the possible defects. The seller also claimed that the buyer had waived the right to claim for quality defects as it had not inspected the goods prior to shipment nor raised the claim within three months after the goods' arrival at the destination port. The seller maintained that the flanges were not defective, as evidenced by the buyer's own testing, and that the buyer's self-testing procedures were incorrect and therefore inaccurate. In addition, the seller requested that the buyer should pay for the remaining undelivered flanges determined in the contracts and compensate the seller for losses due to storage, reprocessing, and lost profit.
The experts' report concluded that some of the flanges tested were defective under the standards specified in the contracts. The experts also found that the buyer's independent and self-testing methods were not completely consistent with acceptable testing procedures and could not be used to determine defect rates.
The tribunal decided that the failure to inspect the goods prior to shipment did not waive the right to all later inspections, as the contract provisions stated that the buyer's right to examination was inseparable from the agreement. The tribunal found that CISG article 36(1) was in accordance with the contract provisions, stating that the seller was liable for any lack of conformity which existed at the time when the risk passes to the buyer, even though the lack of conformity became apparent only later on. The tribunal considered the seller liable under CISG article 36(2), in that the defective flanges were a breach of a guarantee that the goods would remain fit for their ordinary purpose. However, the guarantee period was not indefinite and would not extend past the two-year period set forth in CISG article 39(2).
As to the defective and non-conforming goods, the tribunal found that the seller should not be held liable for the non-latent defects after the three-month period stipulated in the contracts, as these defects could have been discovered by simple examination of the goods. The buyer should therefore share some of the liability for the losses due to its failure to perform inspections of the flanges [CISG article 38(1)]. However, the seller was found to be liable for latent defects beyond the three-month period up to two years, as these defects could only be discovered with destructive tests or through actual use. Although the tribunal concluded that some of the deficiencies in this case were defects of which the seller "could not have been unaware", the tribunal held that CISG article 40 is secondary to CISG article 39(2). The tribunal ruled that the language of CISG article 39(2) bars an indemnity claim beyond the two-year period recited therein.
The tribunal stated that the seller would be liable for latent defects where the buyer had raised a claim within two years after the acceptance of the flanges. Non-latent defect claims were dismissed as the buyer should have performed inspections and notified the seller within the three-month period of the contracts. The tribunal also found that the buyer's claim for lost profits on the undelivered flanges was unsupported by evidence of serious defects. The buyer's claims for losses were granted by the tribunal as an acceptable method of mitigating damages. The tribunal determined that the seller should bear no liability for the buyer's settlement of its dispute with its third-party customer.
Go to Case Table of ContentsAPPLICATION OF CISG: Yes [Article 1(1)(a)]
APPLICABLE CISG PROVISIONS AND ISSUES
Key CISG provisions at issue:
Classification of issues using UNCITRAL classification code numbers:
4B [Scope of Convention (issues excluded): fraud]; 9B [Implied agreement on international usage; standards]; 29A [Parties by agreement may modify or terminate the contract]; 35A ; 35B [Conformity of goods to contract: quality, quantity and description required by contract; requirements implied by law]; 36A ; 36B [Time for assessing conformity of goods (conformity determined as of time when risk passes to buyer): seller responsible when lack of conformity becomes apparent later; Lack of conformity occurring after passage of risk (caused by seller's breach of any of his obligations): guarantee of continued conformity]; 38A [Buyer's obligation to examine goods: time for examining goods]; 39A ; 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 when seller fails to disclose known non-conformity): seller loses right to rely on articles 38 and 39]; 49A [Buyer's right to avoid contract (grounds for avoidance): fundamental breach]; 74A ; 74A1 [General rules for measuring damages: loss suffered as consequence of breach; Includes loss of profit]; 77A [Obligation to take reasonable measures to mitigate loss]
Descriptors:
EDITOR: Camilla Baasch Andersen (14 March 2006)
Applying Article 40 to 39(2) as well as 39(1) -- Stockholm vs. Flanges
The question of whether Article 40 applies to 39(2) as well as 39(1) has been discussed in theory.[1]
Unlike Article 44, Article 40 is worded to apply to "Articles 38 and 39" and not to specific paragraphs, and although the cut-off period in Article 39(2) is considered an absolute cap by many,[2] it seems to be subject to Article 40 in some cases. This issue was considered in an arbitration award of the Stockholm Chamber of Commerce, concerning a press in China.[3] The Tribunal heard a case concerning a truck frame rails press, where the seller had replaced a part with a substitute part without informing the buyer of that, and without making the buyer aware of consequent necessary installation differences due to this substitute part. The buyer's notice of lack of conformity was not given to the seller until three years after delivery of the machine, when the machine failed and damaged itself. The buyer was not, however, barred from notifying of the non-conformity despite Article 39(2), as the Tribunal deemed that the seller knew of the replacement part, knew that it would be significant to the buyer, and did not inform the buyer of that. In this case, the Tribunal stated that:
"Article 40 is an expression of the principles of fair trading that underlie also many other provisions of CISG, and it is by its very nature a codification of a general principle."
Consequently, since the seller had consciously disregarded facts which were of relevance to the non-conformity, Article 40 could cut off the seller's reliance on Article 39(2).
A reported CIETAC Arbitration case from China, recently translated by the CISG W3,[4] apparently challenges this application of Article 40 to Article 39(2), by ranking the two-year cut-off period above the buyer's protection from a seller who knows of the defect. In this case, the Tribunal stated that:
"... some of the deficiencies of flanges supplied by the [Seller] in this case relate to facts of which the [Seller] "could not have been unaware."
This thus brings Article 40 into application. But, nevertheless, this Tribunal found that the cut-off rules should prevail, as:
"the longest time limit to notify of lack of conformity of the goods with the contract is 'within a period two years from the date on which the goods were actually handed over to the buyer.' This is so because the restricting words 'in any event' are used in Article 39(2)."
Upon closer inspection, the reasoning of the CIETAC Tribunal hinges on the fact that they consider the latent defects in question would have been discovered within the two-year time period if the buyer had not overstocked and thus used them before.[5] The Tribunal asserts that this is in the spirit of the Convention, and thus elevates this assumption that buyers do not commercially overstock to a general principle as well. If we contrast that with the elevation of the principle in Article 40 to that of a general principle in the Stockholm Arbitration case above, we have a serious discrepancy in the international application of the CISG. Moreover, it raises a difficult question: how is this issue to be "correctly" solved, in the light of two conflicting general principles?
The facts in the two cases differ significantly on one important point: in the CIETAC case, the goods are not used until the expiration of the cut-off because they are stock (deemed overstock by the Tribunal), whereas in the Stockholm case, the machine was taken into use and broke down as a result of a malfunction. We can support the CIETAC Tribunal's findings by reference to Articles 8/9, although the Tribunal does not do so itself. By using Article 8 and the interpretations of a reasonable person, and referring to trade practice in Article 9, it is not a far stretch to claim that there may be a general commercial assumption that goods are taken into use within a reasonable time after delivery; flexibly accommodating the different types of goods and trade sectors. In a situation where the buyer is overstocking, can the seller who is not actually fraudulent, but should have know that there is a problem with some flanges not expect to be free of any claims after the cut-off period? This question is, of course, directly linked to the question of whether the general principle of protection from a fraudulent buyer should overrule all, in the form of Article 40. Because if it does, then it makes no difference whether the goods were taken into use or lying around in a warehouse -- this does not change the seller's knowledge.
There is nothing in the travaux to indicate that Article 40 should not be applied identically to Article 39 in its entirety. Quite the contrary, a plain meaning reading of the words of Art 40 will show that unlike Art 44 it does NOT limit itself to the application of Art 39(1). What is worrying here is that this is perceived as something to which gap-filling measures like general principles can apply. But where is the gap? Surely, this is solely a question of interpreting according to plain meaning, or dynamically applying Art. 40 differently? There is an important distinction between gap-filling and interpretive guidelines, and we must be wary not to blur this line too much. The above two cases do that. And by using the very flexible and fuzzy concept of general principles to reach the decision which the Tribunal finds right, respectively, they are exercising a considerable freedom under the CISG -- one which was not intended to be there.
It might be argued that if Article 40 always applies to Article 39(2), then it is not, as deemed by many, an absolute cut-off rule. This, in itself, would support a view that applications of Article 40 be, if not hindered, then limited to cases of evident or flagrant breaches of good faith by the seller. This is one of those situations where the considerations of two provisions clash. On one hand, there is the idea behind 39(2); the need for resolving and finalizing business matters within a foreseeable future, the need for a party to be able to reach a point in time where he/she knows with certainty that all worries or considerations concerning a transaction can safely rest in peace, that business may move on. On the other hand, there is the consideration behind Article 40; the idea that under no circumstances should a fraudulent party be permitted to "get away with" anything. But, it can also be said that mandatory morality is not a part of the CISG, and should rather be relegated to domestic laws or other laws which an arbitral tribunal should wish to apply,
When comparing these two considerations, it is easy to see how a seller might get caught by Article 40 claims made, for example, five years after a transaction, long after he has considered himself safe from all claims and has discarded any documents or other evidence which may prove that there was no knowledge of any lack of conformity on his part. For this reason, it would certainly seem advisable to require an even more rigorously lifted burden of evidence [6] from the buyer, allowing for the fact that the seller was in his right to consider the case concluded, especially if we assert that there is a commercial assumption for not overstocking and using or applying goods within this period.
But, if the principle of protecting the buyer prevails, then none of the above considerations matters, as this principle proposes that under no circumstances may the seller be protected if he is fraudulent. And it is therefore suggested that the application of Article 39(2) to Article 40 is an indirect way for the Tribunal in the CIETAC case to affirm that the Seller is NOT fraudulent, but merely passed on some flanges produced elsewhere that he should have known were defective. It would have been preferable if the Tribunal in this case had applied these considerations to conclude that Article 40 thus does not apply, as they seem hesitant to apply it in legal terms. Because with the creation of a conflicting general principle to this issue, in contrast with the firm guideline laid down in the Stockholm case and quoted in the UNCITRAL Digest as the state of CISG law, a uniformity problem is created.
Consequently, despite the fact that these two cases are so different in fact, the conflict between two general principles is evident, and future case law must solve the problem of ranking their importance: which is more important under Articles 40 and 39(2): protecting the buyer from a fraudulent seller or allowing a seller to consider himself free of claims? It is this author's submission that the former principle must prevail over the latter, although it should not be seen as a mandatory one. In cases such as the CIETAC case where the Tribunal would find this to lead to unjust results, it is arguably because Article 40 should not have been applied in the first place as the standard of knowledge of the seller was too low to employ the rule. If the considerations of Art 40 are out of place in a case, then so is the provision itself. And if its consideration of protection against a fraudulent buyer is in place, then no amount of overstocking or other commercial rules should prevail.
However, this author's opinion will not generate a congruent application of this problem. If, however, a certain level of consensus among scholars in the scholarly jurisconsultorium is developed on this point, and emerging cases look to this and weigh both of these precedents and choose which one to follow in the creation of a practical jurisconsultorium, then the issue will presumably be on its way to a more similar solution if the same paths of reasoning are chosen.[7] And as long as the legal reasoning is sound and international, one path is hopefully going to be more preferred over the other.
FOOTNOTES
1. See, for example, Lookofsky in Understanding the CISG in Scandinavia, p. 64, and Schwenzer in: Schlechtriem & Schwenzer, Commentary on the UN Convention on the International Sale of Goods (CISG), 2d (English) ed., Oxford (2005), p. 480.
2. See, for example, John C. Reitz A History of Cut-off Rules as a Form of Caveat Emptor: Part I -- The 1980 U.N. Convention on the International Sale of Goods in 36 American Journal of Comparative Law (1988) 437-472 at p. 443, available at: <http://cisgw3.law.pace.edu/cisg/biblio/reitz1.html>
3. See the decision of the Arbitration Institute of the Stockholm Chamber of Commerce of 5 June 1998 in the case of "Beijing Light Automobile Co., Ltd v. Connell Limited Partnership" available at <http://cisgw3.law.pace.edu/cases/980605s5.html>.
4. China 30 March 1999 CIETAC Arbitration proceeding (Flanges case) available at: <http://cisgw3.law.pace.edu/cases/990330c2.html>.
5. "The limit of two years provided in Article 39(2) CISG is to be applied, because it would be inconsistent with the spirit of this Convention to require the seller to compensate for the losses caused by the buyer's commercial overstocking of goods for too long a period of time."
6. Comp. with the seller's burden of evidence in proving himself unaware following the buyers proof that awareness was likely in the Swedish arbitration case.
7. At the time of this publication, the CIETAC case has been published in translated form for only a few weeks, and there is thus only scholarly commentary to be found on the Stockholm arbitration case, and the UNCITRAL Digest only mentions this case. In time, other scholarly commentary on this case is bound to surface.
Go to Case Table of ContentsCITATIONS TO OTHER ABSTRACTS OF DECISION
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. 1703-1738
Translation (English): Text presented below
CITATIONS TO COMMENTS ON DECISION
English: Dong WU, CIETAC's Practice on the CISG, at nn.74, 158, 174, 223, 225, Nordic Journal of Commercial Law (2/2005); Ramos, Rules on Communication of Defects in the CISG, nn. 473-484 and accompanying text
Go to Case Table of Contents| Case text (English translation) | |
Flanges case (30 March 1999)
Translation [*] by Mingde Cao & Shengli Wang [**]
Edited by Yuan Xiaotong [***]
China International Economic & Trade Arbitration Commission (previously CCPIT Foreign Trade Arbitration Commission, name later changed to CIETAC, hereafter referred to as the "Arbitration Commission") accepted this arbitration case in accordance with:
| - | The arbitration clause in the sales contracts for flanges signed on 24 January 1987,
25 July 1988 and 20 October 1989 between Claimant, US ×× Valve Company
{hereinafter referred to as "[Buyer]") and Respondent (in the very beginning named
China ×× Import & Export Company ×× Branch Company, hereinafter "[Seller]");
and |
| - | The Arbitration Application filed by Claimant [Buyer]. |
The [Buyer] named Mr. A as arbitrator, the [Seller] named Mr. D as arbitrator, and the Chairperson of the Arbitration Commission named Mr. P as the Chief Arbitrator of the case according to the Arbitration Rules of the Arbitration Commission. Together they formed an Arbitral Tribunal to hear this case.
The hearing was not held until April 1996 as the parties offered many supporting materials (the applications and enclosures) prior to the hearing, and the case involved many issues calling for document translation, transmission, preparation and contact. The hearing was held for three days, i.e., 18, 19 and 20 April. The parties or their representatives appeared before the Tribunal, made full oral presentations and argued fully on the facts, their claims and the basis for their claims in law and under the contracts.
The hearing involved many issues over whether there were deficiencies or disguised deficiencies of the goods, and problems as to whether the testing data were true. After discussion, the Arbitral Tribunal decided that it was necessary to carry out an independent investigation on the goods still stored in [Buyer]'s warehouse, the goods which had been tested and returned, and the testing institution which committed the testing for Claimant [Buyer]. At the hearing, the Arbitral Tribunal proposed to send experts to carry out spot investigations according to the Arbitration Rules. [Buyer] agreed to this, while the [Seller] addressed that it was unnecessary to conduct spot investigations with the position that "whoever claims bears the burden of proof." The Arbitral Tribunal raised questions to both parties. In addition to their answers and explanations to these questions, the parties also submitted further supplemental written evidence or their representatives' statements.
After the April 1996 hearing, the Arbitral Tribunal contacted both parties via mail and telephone regarding the involvement of an expert in the investigation. [Seller] stated that the purpose of the investigation was not clear and it was unnecessary to carry out expert investigations, therefore, the [Seller] disagreed to the investigations. To the contrary, the Arbitral Tribunal considered it necessary to resolve some important issues (for example, the actual findings of the US lab and the [Buyer]'s self-test) and necessary for the Tribunal to carry out an expert investigation on some technical issues. In accordance with Articles 39, 40 and 41 of the Arbitration Rules, the Arbitral Tribunal decided to employ experts for investigation and consultation and sent the notice to carry out spot investigations in the U.S.. The expert investigation expenses were paid by the [Buyer] temporarily. Via the Secretariat of the Arbitration Commission, the Arbitral Tribunal authorized the China Association for International Understanding and its subsidiary, ×× Economic and Technology Consultation Company to recommend two experts. They were Jin ×× (Vice Chief Engineer, Research Fellow of the China Research Center on Boiler and Pressure Container Test) and Zhang ×× (Vice Chief Engineer of the China General Institute on Iron Research). Both are experienced experts on iron material research and had participated in many international test 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. During the period from 2 December 1996 to 12 December 1996, accompanied by Mr. P, the Chief Arbitrator of the Arbitral Tribunal, Ms. S, the Secretary handling the case in the Secretariat of the Arbitration Commission, and the two experts went to Houston, Texas where the goods were located to carry out spot investigations. The two parties to the dispute sent persons to attend the investigations (the [Seller] sent two representatives). In addition to examining the self-test equipment, experimental process and the testing approach of the [Buyer], the expert team, together with the parties, visited M. Lab in Houston which had examined these flanges previously. Later, the expert group selected eight samples for the second testing from the goods which had been considered by the [Buyer] to have defects or recessive defects and confirmed by the [Seller].
Under the supervision of the Chief Arbitrator of the Arbitral Tribunal and the two experts, the samples for examination were cut into two pieces and sealed with a mark. One part was mailed to China by air, another part was brought by the experts to New York. The New Jersey International Testing Lab (hereafter "International Testing Lab") and Central Iron & Steel Research Institute, Ministry on Metallurgical Industry (hereafter "Central Iron & Steel Research Institute") were then authorized to conduct separate and independent physical and experimental examinations on these two parts. Reports of the examinations from the two laboratories were sent to the experts for analysis, based on which an expert report on investigation and evaluation was written. The report was sent to both parties to the dispute and to the three arbitrators separately in March 1997. Sufficient time was given to the parties to offer their own comments. Both parties sent to the Arbitral Tribunal written comments on the expert report on investigation and evaluation.
Both parties to the dispute submitted basic arguments on the expert report on investigation and evaluation. Each offered its own understanding in which the explanations on some issues were different. According to the Arbitration Rules, the Arbitral Tribunal believed that it was necessary to hold another hearing to invite the experts to provide such explanations to the expert report on investigation and evaluation that were deemed necessary. The parties were notified to attend the hearing on 27 October 1997. Due to the fact that, abruptly, the two experts separately had to go abroad for other missions, the parties were notified that the hearing was rescheduled to 9 December 1997. Neither party had any objection to this. The rescheduled hearing was held in time with the attendance of the representatives of both parties.
The [Seller] asked the Arbitral Tribunal to rule on whether the Claimant [Buyer] had lost its capacity as an business entity based on a certificate issued by Secretary of State of Oregon on 29 September 1995, which referred to the [Buyer] as "×× Valve Company registered in Oregon 15 May 1986, and carrying out its operation in Texas" and declared that "the company named above had been terminated in its registration place (Oregon) since 4 April 1997." Therefore, the [Seller] held that ×× Valve Company did not have the capacity as Claimant [Buyer] in this case. Even though the original ×× Valve Company carried out activities of appeal and arbitration, [Seller] alleged that because its legal capacity had expired, the [Buyer] had no right to carry out these activities. The [Seller] applied to the Arbitral Tribunal to resolve this important procedural issue and to dismiss the claims of the [Buyer] and its agent, and to suspend the hearing.
The [Buyer] explained, stating that ×× Valve Company had simply changed its registration place from Oregon to Delaware for a change of stock ownership, but there was no change in its independent corporate personality and operation. [Buyer]'s original place of business in Texas still acted as a corporation registered in other states to carry out its operations within its original business fields in this state. Because ×× Valve Company was a US public company whose stocks had been listed, the change in its stock ownership and registration place would not affect its corporate personality, debts and credits, and 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 [Seller] might be unfamiliar with the US laws on company registration and cast unnecessary suspicion on the part of the [Seller]. The [Buyer] would like to make this issue clear by providing written materials after this hearing.
After a temporary adjournment, the Arbitral Tribunal decided that this hearing was only for listening to the experts' explanations on their report and the certificate of Texas offered by the [Seller] would to be confirmed later. Therefore, it was proposed to continue the hearing and listen to the experts' interpretation. The Arbitral Tribunal required the [Buyer] to offer written materials to prove the existence of its corporate personality. Both parties accepted the above opinions of the Arbitral Tribunal.
At the second hearing, the experts explained their report on investigation and addressed necessary explanations on questions raised by the two parties.
On 19 January 1998, the [Buyer] offered considerable materials in evidence on the change of ×× Valve Company's stock ownership and its registration address, and materials to support [Buyer]'s position that there had been no change in its legal status. It also offered evidence materials showing that the constitution of ×× Valve Company registered in Delaware had made it clear that all credits, debts, obligations and rights of ×× Valve Company registered in Oregon were inherited by ×× Valve Company registered in Delaware. This material was transmitted to the [Seller] and the three arbitrators. According to the facts and opinions on the motion of the case, the Arbitration Commission determined that ×× Valve Company registered in Delaware was the successor of the [Buyer], ×× Valve Company registered in Oregon, and able to attend arbitration activities and to perform the rights and obligations of the arbitration award, i.e., the [Buyer], ×× Valve Company still had the requisite subject qualification.
The Arbitral Tribunal held that it was necessary to point out that the award was postponed because of complexities, which involved experts' investigation and evaluation, and the translation and transmission of many documents, and that each postponement was applied for by the Arbitral Tribunal and approved by the Arbitration Commission according to 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 interpretations on their report on investigation and evaluation. Then the date to hold a hearing was postponed to 9 December 1997 for the reason that the experts had to go abroad, and the two parties agreed with this postponement and appeared at the postponed hearing in time. Previously, the Arbitral Tribunal had applied to the Arbitration Commission to postpone the date for issuance of the award to 2 May 1998, which was approved by the Arbitration Commission. In view of the fact that both parties agreed to the second hearing and the time left for the [Buyer] to offer written evidence material on its valid subject qualification, the arbitration process of this case was not suspended. The Secretariat of the Arbitration Commission handling the case of this Arbitral Tribunal notified of the postponement after the [Buyer] provided this additional evidence material. The approval by the Arbitration Commission was not sent out until 14 January 1998 when it was considered that the notice of postponement should be sent to both parties. It was so mailed by the Secretariat of the Arbitration Commission. On 16 February 1998, the Arbitration Commission received from the [Seller] mail claiming its opposition to the extension of award dated 22 January 1997. The Secretariat of the Arbitration Commission replied in written form according to the actual conditions on 28 April 1998. The [Seller] then submitted its objection to the extension of the award on 18 May 1998. It was held that the [Seller] did not receive the notice to extend the award to 2 May 1998 before 1 December 1997, nor did [Seller] receive the arbitration award, which meant the expiration of the arbitral activities, therefore, the second hearing on 8 December 1997 and the activities of the Arbitral Tribunal were beyond the requirement of the Arbitration Rules, and were invalid. Therefore, in accordance with the Article 81 of the Arbitration Rules, the Arbitral Tribunal submitted to the Arbitration Commission to provide an interpretation of the extension of an award under Article 52 of the Arbitration Rules. The Arbitration Commission explained:
"The Arbitration Law of the PRC has no specific stipulations on the period of continued existence of the Arbitral Tribunal after it is formed according to legal procedure or the time limit for the Arbitral Tribunal to make an award. Article 52 of the Arbitration Rules of this Arbitration Commission is a stipulation requiring attention but will not void the legal effects of the Arbitral Tribunal's activities. Neither does this article stipulate whether and when the extension of time limit should 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 be completed in accordance with this Article, such a failure is a problem of the Arbitral Tribunal or the Secretariat of the Arbitration Commission, which is to be handled by the Arbitration Commission based on the actual conditions. In another word, 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 hands down its 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 the deadline of the Arbitral Tribunal to end its effective existence. In addition, the Arbitral Tribunal applied to the Arbitration Commission for an extension before 1 December 1997, which had been approved by the Arbitration Commission, and the corresponding decision had been made. As to the working problem that the mailing this notice of extension to the parties was delayed, the Arbitration Commission could find the facts and make corresponding arrangements which was in no connection with 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 8 December 1997 and both appeared at this hearing. At this hearing, the [Seller] proposed a new issue of "applying to the Arbitral Tribunal to verify the subject qualification of the [Buyer]", and agreed to reserve time for the [Buyer] to offer written evidence material. The [Seller] did not advance any objection on the issue of time, which means that the [Seller] in fact had accepted the extension of this case and its award according to Article 45 of the Arbitration Rules.
The deadline approved by the Arbitration Commission for the last time to decide the case was 2 April 1999. The Arbitral Tribunal has now made its award.
The following are the details of the case, the opinions of the Arbitral Tribunal and the award.
(I) Outline of the contracts
The [Buyer] and the [Seller] signed Contract Number 88YCSG/2-019 (later changed to 88YCSG/0023-2) on 25 July 1988, which stipulated that the [Buyer] agreed to purchase (and the [Seller] agreed to sell) forging carbon steel flanges. Contracts Number 89YCSG/10-533 and Number 91YCSG/10-523 which called for the same goods (forging carbon steel flanges) were respectively signed on 20 December 1989 and in the early part of 1991. Each contract had different terms on quantity, specification, price and time of delivery, but their other terms such as quality examination, claims, and arbitration were the same. The following are the dates signed and amounts involved.
| Contract Number | Date signed | Sum (US $) |
| 88YCSG/2-019 | 25 July 1988 | US $2,345,834 |
| 89YCSG/10-533 | 20 October 1989 | 466,443 |
| 91YCSG/10-523 | In early 1991 | 272,273 |
| Total | US $3,084,570 |
Each contract was accompanied by a specific order for goods. Each order contained detailed specifications (including pressure and diameter), quantity, unit price, total sum (C&F Houston), and the deadline for delivery (the period of shipment, partial shipment). Payment was to be made by Letter of Credit [L/C].
The technical specifications in the contracts include the requirement that:
All flanges should satisfy the US steel flange Standard ANSI-B16.5 and the US material experiment Standard ASTM-A105N. In addition, several requirements surpassing the A105 Standard were added. That is:
| (i) | Carbon content should be 0.27% (maximum) [The Arbitration Tribunal's note:
0.35 (maximum) required in the A105 Standard.]; |
| (ii) | All flanges should go through normalizing heat treatment [The Arbitration Tribunal's note: the flanges under the pipe pressure beyond 300Psi should go through "normalizing" heat treatment as required in the A105 standard.] |
The A105 Standard specified the process of normalizing heat treatment as follows:
The forgings after being forged or heat-rolled are to be cooled by a temperature below 1,000° F (638° C) instantly, then are to 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.
The contract also stipulated that:
Mill Test Reports ("MTRs") are to be provided by the factory to specify the heat treatment data, the chemical ingredients analysis and the mechanical performance. 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 level, applicable standard (ANSIB16.5) of flanges and standard (A105) for materials, heat treatment method (normalizing, "N"), material heat number, agreed enterprise identification mark (DSI in the contract) and the country of origin. The flanges welded for another time should be printed a mark of "W" on them.
The mechanical performance of flanges requires a minimum tensile strength of 70,000 Pai (or 485 MPa), a minimum subdue strength of 36,000 Psi (or 250 MPa), a minimum rate of extension of 22% (has some connection with the thick wall of flanges), 30% shrinkage rate and a maximum of Brinell hardness 187 HB.
The contract signed in 1988 has two provisions on examination and compensation.
Article 10 provides:
"Examination of goods. The buyer will examine the first batch of goods before they are packed; if the goods are qualified hereafter the goods may or may not be examined, but the right of examination is an inseparable part of this agreement."
Article 15 states:
"Claims. After the arrival of goods at the destination port, if the buyer finds any discrepancy in quality and/or quantity/weight with the contract, except for the liability of the insurance company and/or the carrier, the buyer has the right to propose objections to the seller based on the test certificate issued by the testing authority agreed by the two parties. Quantity/weight objections must be made within 15 days after the arrival of goods at the port. The seller should reply within 30 days after receiving the goods."
The contracts signed in 1989 and 1991 were standard contracts, which were printed before negotiation. Furthermore, Article 10 above was omitted, while the period for quality objections provided in Article 15 was changed from "within 90 days after the arrival of goods at the destination port" to "within 30 days after the arrival of goods at the destination port." There were no further changes in other provisions.
(II) The [Buyer]'s reasoning and arbitration application
The [Buyer] alleged in his arbitration application and presentation at the hearing:
Among the above three contracts, the third, Contract (Number 91YCSG/10-533), signed in early 1991, was not performed. By early 1991, the [Seller] had shipped 107,841 flanges in total with a contract price of US $3,096,623.41, and 33,407 flanges were not delivered with a price of US $329,410.49 (including 32,030 flanges undelivered in the third contract with a contract price of US $272,273).
The [Buyer] once sent an employee to occasionally visit the [Seller] and his manufacturing factory who checked some flanges, examined their size and sometimes pointed out issues on how to guarantee compliance with the technical standards. This manufacturing factory has its own lab and they promised the [Buyer] that the flanges were produced strictly in accordance with the contract and standard regulations. In particular, the [Seller] presented Mill Test Reports to the [Buyer] for each forging part. The [Buyer], relying on the [Seller]'s MTRs, did not examine the goods in the lab in China, and did not examine the goods after they arrived at the port. The [Buyer] alleged that this practice followed the international trade practices, because each flange had printed on it the mark of the quality standard (B165 and A105N) and had enclosed with it the MTR which recorded the chemical ingredients, mechanical and physical performance and the temperature of normalizing heat treatment tested in the process of production with the signature of the testing personnel and the seal of the producers. This acts as a quality certificate provided by the suppliers and producers for the users. In accordance with trade practices, the dealers always rely on the seller's MTR when they resell the goods in the market.
i. The quality problem gradually appeared
In June 1991, a major international contractor, EBASCO, found that flanges purchased from the [Buyer]'s client, TEAM Industrial Company, had quality problems and asked to return the goods which had been used for a pipe for Exxon, the largest oil producer in the U.S..
TEAM Industrial Company carried out an investigation on 4,000 flanges purchased from the [Buyer], some of which were purchased by the [Buyer] from the [Seller]. TEAM Industrial Company authorized Houston ×× Lab to examine these flanges, and found that:
| - | Some flanges which had not passed normalizing heat treatment were indicated as having been treated by
normalizing heat treatment with the mark "N"(normalizing) printed on these
flanges; and |
| - | The chemical ingredients of some flanges were not consistent with the contract and the Mill Test Report. |
Therefore, EBASCO returned all Chinese flanges and claimed for US $825,000 suffered from this alleged breach. The [Buyer] had to arrange a settlement out of court to reduce compensation liability and counsel fees. The [Buyer] paid US $605,000 as a settlement. TEAM Industrial Company returned 2,754 flanges, most of which were supplied by another Chinese company (Shanxi Machinery Equipment Import & Export Company, hereafter referred as "Shanxi Company"). Only fifty-three of these flanges were supplied by the [Seller] in this case.
After finding that the flanges offered by the [Seller] had serious deficiencies, the [Buyer] notified the [Seller] and Shanxi Company, requiring the [Seller] to send representatives to Houston to discuss the issue of claims. However, it was not until December 1991 that the two parties began their negotiation. The [Seller]'s representatives did not deny that the [Seller] was liable for the damages that [Buyer] suffered from quality deficiencies of the products supplied by the [Seller], but they only agreed to bring the [Buyer]'s claims to China and consider it further. Thereafter, the [Seller] denied its liability after a long time of contacting and pressing. The [Seller] repeatedly emphasized that:
| - | Quality objections and claims could only be proposed within 90 days after the arrival of goods at the port; |
| - | There was no agreement between the [Seller] and the [Buyer]'s clients, TEAM Industrial Company and
EBASCO Company; |
| - | Therefore, the claims of EBASCO had no relationship with the [Seller]. |
The [Buyer] pointed out that the quality problems of flanges could not be found by testing. Certain potential deficiencies (e.g., not having gone through normalizing heat treatment) could only be found after installation, operation or test of consumption. The [Buyer] also mentioned that the two parties never thought that the contract clause requiring examination within 90 days had hard-binding force; the two parties never cited the "90 days time limit for claims" in treating quality problems. This meant that the parties, by their behavior, actually modified the terms of the contracts.
Nevertheless, the [Seller] took an attitude of refusal from the beginning to the end. This led to a situation in which the [Buyer]'s claims could not be reasonably resolved, despite the lapse of a long period of time. In September 1992, the US National Testing Commission on Boilers and Pressure Containers issued a Special Report on the Investigation of Chinese Flanges (hereinafter "Special Report").
The subject of this report was:
An investigation of Chinese Flanges:
An investigation of quality deficiencies of Chinese flanges throughout the US;
An investigation that caused great shocks in the US community on
engineering technology.
The report adduced evidence of serious deficiencies of flanges imported from China and sent out alarms stating that "these flanges are not consistent with the requirement of ANSI standard or ASTM norm A105; meanwhile, extreme risks to human body and property may be caused by using these high pressure products."
In the Special Report, it was mentioned that the flanges sold by the [Seller] to the [Buyer] had quality deficiencies and in particular there was filling material in the welding part of the flanges produced by "Shougang Company", which was considered forging. This report was enclosed with the Mill Test Report issued with the name of Shougang and its seal as a proof. The report made it impossible for the [Buyer], as the major merchant importing flanges from China, to sell his flanges in stock by normal trading.
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 remedial measures including notifying the [Seller] that the [Buyer] had reasons to refuse any flanges undelivered by the [Seller] to avoid further losses.
In addition, the [Buyer] had to carry out non-destructive, simple and plausible examinations on a large part of the flanges in storage. Because the expense to engage an independent lab is fairly high, the [Buyer] purchased Arc Met 900 portable emission spectrum analyzers and Swiss EQUOTP portable Sclero-meters to carry out self-tests. As of October 1994, the [Buyer] tested 5,609 flanges supplied by the [Seller], of which, 15.3% of the flanges (859 flanges) were found to have quality deficiencies. If a destructive testing method had been used, a much higher percentage of quality deficiencies would have been found. The results of the self-test were shocking and unacceptable. To reduce the loss of both parties, the [Buyer] had to sell the flanges as "original goods without any change and no quality guarantee (normally not providing the Mill Test Report)" at a lower price (The Arbitration Tribunal's 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
The test report of the independent laboratory on flanges provided by the [Buyer]'s clients revealed that the [Seller]'s flanges had the following problems.
| a. | The contract provided that all flanges should go through normalizing heat
treatment. However, the mark "N" was printed on some flanges that had not
passed the normalizing heat treatment. For example, reports from 57187-1 to
57187-4 issued by ×× Lab mentioned that among four tested flanges, three
had not passed the normalizing heat treatment and the tensile strength of the
other one flange was below the standard of 70,000 Psi. |
| b. | The chemical ingredients were not qualified. The carbon content of some
flanges reached 0.29%; this was beyond the 0.27% which was provided in the contract
and the silicon content reached 0.42%, which was beyond the 0.35% provided in the
contract. |
| c. | In particular, some flanges were printed with the same heat number, but were provided two or three Mill Test Reports which presented different chemical ingredients and data with much difference. This meant that some Mill Test Reports were fabricated. |
Among the 5,609 flanges tested by the [Buyer], 859 flanges did not qualify, accounting for 15.3%, including two with size errors, 484 with various deficiencies by visual measurement (such as cracks, etc.), 183 flanges with unqualified hardness and 190 flanges with unqualified chemical ingredients.
The above tests revealed that the quality problems with the flanges were so serious that no buyer would accept them. In particular, after the report on Chinese flanges issued by the US National Testing Commission of Boilers and Pressure Containers publicized the quality problems of the flanges produced by Shougang, the [Buyer]'s clients became aware of problems with the [Buyer]'s flanges and the [Buyer] also found so many problems in the self-test. No responsible dealer would wish to bear the high risk of getting involved in legal disputes and compensation claims and the [Buyer]'s clients would not use the flanges with such serious quality problems.
The [Buyer] also listed a statistic on the sharp decrease of sales of Chinese flanges to the US market, including sales volume of the [Seller]'s products to US market customers since 1993. The [Buyer], as the company that imported the most Chinese flanges in the US, suffered serious losses from this.
iv. Contracts and legal basis 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 not consistent with the requirements of the contract and its technical standards, and that the latent defects of the goods were exposed in the course of their actual use by the 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 deficiencies and were seriously not consistent with the Mill Test Report 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 reputation damage and economic losses for goods returned or goods not being sold anymore. 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 his economic losses (listed below in accordance with the additional materials of 20 June 1996).
The [Buyer]'s claims
[Buyer] claims:
(1) Losses for flanges unsold in store. US $929,368.80 for flanges unsold in store calculated with the CIF price (including all import duties and freight to store goods);
(2) Profit losses for flanges in store. The profit losses are US $573,912, determined by calculating the market value of US $1,503,281.20 for flanges in store in accordance with the actual conditions of 1991 to 1992, with the cost of US $929,369 subtracted therefrom.
(3) Profit losses of the flanges undelivered. The CIF cost of US $355,763 was calculated after putting the order price of flanges undelivered together with 8% duties, port fees, freight, the fees to putting goods in store, and the agency fees. The sales value was reached by dividing this sum by 0.65%. The gross profit should be US $3,929,475 ÷ 0.65% × 0.35% = US $191,565.
(4) Losses suffered from selling flanges in the manner of "original goods without any change and quality promise"
Of which:
1. The sales value of the flanges definitely determined to be offered by the [Seller] was US $19,974.15, the CIF value was US $53,861.79, and the gap between the two values was the losses actually suffered, i.e., US $33,887.64. Calculating the place of CIF value by the real market value of US $93,000.00, the profit losses are US $93,000.00 - US $19,974.15 = US $73,026.45;
2. Flanges sold without identifying the source of goods should be calculated by the percentage of the flanges sold. If the losses of expected profit are calculated by reducing the real sale price from the market value of US $79,132, this amounts to US $79,132 - US $39,175 = US $139,957.
(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 2%; therefore, the [Seller] should pay US $12,160 for its part in the total damage.
(6) Testing fees. The fees altogether paid to carry out the test were US $883,348 for the purpose of reducing the losses, of which the goods supplied by the [Seller] accounted for 24.8%; therefore, the [Seller] should pay US $216,420. These fees included rent paid for special testing field and the amortization charge of depreciation for equipment bought, to which the testing charge of US $9,320 paid by Maxim Technologies in May 1996 should be added. The total sum should be US $225,740.
(7) Flanges returned by other clients. In addition to TEAM Industrial Company, losses suffered from flanges returned by other clients supplied by the [Seller] were US $5,666.
(8) Interest. The interest on fees paid for testing and storing flanges for four years was US $268,086, calculated at 7% per annum.
(9) Taxes. The [Seller]'s contribution of property tax imposed by local government for flanges in store unable to be sold was US $45,896.
(10) Attorneys' fees. US $122,187 had been paid to the counsel for this case.
(11) Arbitration fee. The arbitration fee was US $43,816.
The above expenses add up to US $2,461,201 [or US $2,558,038] [The sum in the brackets was calculated in accordance with the gap between the market value of flanges and their actual sale price.]
(III) The [Seller]'s defense
The [Seller] alleged:
He carried out the contract smoothly after signing two contracts with the [Buyer] in 1988 and 1989. The [Seller] is a trade company of a large Chinese iron and steel factory, whose raw materials were provided by the steel falconry of the Shougang Group and produced into flanges by his own factory. The [Seller] always pursued quality goods and maintained a good reputation. The [Buyer] had sent representatives to the [Seller]'s factory many times to review [Seller]'s production equipment and the quality of his products.
By May 1991, the [Seller] delivered all flanges in accordance with these two contracts. After the goods arrived at the US port, the [Buyer] accepted all of the goods and, before the time limit for demanding compensation, the [Buyer] submitted no objections to the quality of the flanges. There was no hindrance to block the [Buyer] from selling the flanges provided by the [Seller]. It can be found in the [Buyer]'s arbitration application that flanges now in store and unable to be sold were only a small portion of the flanges ordered and that the flanges supplied by the [Seller] were commonly accepted in 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 to pay for them, which caused the [Seller] to suffer economic losses from reselling goods to other clients.
Although the [Buyer] claimed for the reason of so-called quality problems of products after many years; the actual reasons were that the market for flanges had reached its saturation point and became a bear market after 1990 because many companies were importing too many flanges. On the other hand, the sources of flanges were varied because of too many exports, of which some flanges with poor quality were supplied by some suppliers. This situation affected the reputation of the [Seller], a large enterprise which cares about quality and international reputation constantly. The [Buyer] searched for many excuses alleging that Shougang Group was a large enterprise with much capital at home and abroad, which was a good object to afford the commercial risk and so-called "losses" of the [Buyer].
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, or bore no probative force, or was questionable, and could not be regarded as evidence.
(1) The [Buyer]'s client, TEAM Industrial Company, resold the flanges imported by the [Buyer] to EBASCO Company, and EBASCO Company used these flanges and authorized ×× Lab to examine these flanges, finding that these flanges had an amazing rate of unacceptable quality deficiencies, which led to many returns. However, it can be found in the testing report of ×× Lab authorized by EBASCO Company that:
a) In Report Number 910844 submitted on 29 July 1991, eighteen flanges were tested, among which only one flange with the sample number of "Q" was supplied by the [Seller] and the test conclusion on it was "qualified";
b) In Report Number 910783 submitted on 17 July 1991, eight flanges were tested, among which only one flange with the sample number of "H" was supplied by the [Seller] and it was concluded as qualified in the chemical ingredients, mechanical performance, hardness and heat treatment;
c) In Report Number 910783 submitted on 28 June 1991, five flanges were tested, among which only one flange with the sample number of "D" was supplied by the [Seller], and it was concluded as qualified in the chemical ingredients, mechanical performance, hardness and heat treatment. Another flange with the number of "E" was not supplied by the [Seller] in accordance with the Mill Test Report and heat number (284) which revealed that it was purchased by the [Buyer] from Oriental Science Equipment Import and Export Company subject to Contract Number (90) OE 1409MR.
(2) The [Buyer] authorized ×× Lab to test flanges, including:
a) On 21 October 1991, it was concluded in the test report (No. 57189-4) of ×× Lab that only the tensile strength of the two flanges being tested with the same heat number was not qualified (the standard was 70,000 Psi, and the actual testing result was 68,800 Psi; the results of the two flanges had a gap of 1.7%). In the test reports (No. 57189-2 & No. 57189-3), all of the technical indicators were concluded as qualified. These two reports alleged that the flanges had not gone through normalizing, but they did not attach the metallograph and further basis for such conclusion;
b) On 15 June 1992, as recorded in the test report (No. 920672) by ×× Lab, six flanges were tested, among which two flanges with the sample numbers of 5 and 6 were supplied by the [Seller]. Only the flange (No. 5) had a carbon content of 0.29% which was slightly higher than the 0.27% required in the contract, but it satisfied the standard of 0.35% required by A105 standard. The lab concluded that it qualified.
The test reports as authorized by the [Buyer] himself were very simple, even with no metallograph.
(3) Self-test report provided by the [Buyer]:
The [Buyer] alleged that 5,609 flanges in store provided by the [Seller] were tested, among which 859 flanges were inconsistent with the quality requirements including 484 flanges (accounting for 56% of all the flanges with deficiencies) with defects which can be found by visual measurement.
However, since these deficiencies were clear by visual measurement and no equipment test was needed, why were they not examined until October 1994, several years later than the delivery?
On the other hand, since there were such a large part of the flanges in store found to have defects by visual measurement and unable to be sold, why was [Buyer] able to sell most of the 100,000 flanges which should contain a large number of flanges with the same defects?
Furthermore, the self-test reports contained discretionary changes and illegible records; moreover, many records were repeated and even with many negative numbers. These reports do not even contain the signature of the persons who filled out the forms, nor do they have the company seal. How can they be used as evidence for claims?
The [Seller] believed that it was revealed by some flanges supplied by the [Seller] after being tested by ×× Lab with the authorization of the [Buyer]'s client and the [Buyer] himself that these flanges were by and large qualified. And with respect to the self-test report of 1994 on flanges, it was not a formal test report and should be given no weight of evidence.
(ii) The Special Report issued by the US National Testing Commission on Boilers and Pressure Containers
The [Buyer] cited the Special Report in his arbitration application and many other evidence materials to support his claims that the [Seller] intentionally provided adulterated flanges (inferior materials were allegedly filled in the welding hole of the neck of flanges) and that the Special Report especially mentioned "Shougang", which made the flanges in store produced by Shougang impossible to be sold in the US market.
The [Seller] pointed out that the flange with the heat number 1-406 mentioned in the Special Report was definitely not produced by the [Seller], nor was it provided by the [Seller] to the [Buyer]. The Special Report listed the Mill Test Report of this flange which clearly showed that this flange was under Contract [No. (90) OE1409MR)] and Order (No. 109636) and its actual producing factory (Shandong). The [Buyer] himself clearly knew the source of this flange, but the [Buyer] did not inform the actual facts to the US National Testing Commission on Boilers and Pressure Containers while submitted this to the Arbitral Tribunal as evidence. The [Buyer] claimed that he suffered losses from the Special Report which listed the serious quality problems of flanges produced by Shougang. However, it was the [Buyer] himself who caused the mistake in the Report. The [Buyer] ordered the flange from the Oriental Equipment Co. and the flange was produced in Shandong, but he informed the US National Testing Commission on Boilers and Pressure Containers that the flanges were produced by Shougang. Moreover, after the Special Report was issued, the [Buyer], as the party who purchased this flange and an insider, did not write to ask for correction immediately, which made this wrong report wide-spread and caused a very bad influence on the reputation of Shougang. The [Buyer]'s behavior infringed on the reputation of Shougang. It is the [Buyer] who should be liable to pay compensation.
(iii) The allegations that "the flanges provided by the [Seller] were unable to be sold" and that "the [Buyer] suffered serious losses" are not true
It is not a fact as the [Buyer] claimed that the flanges supplied by the [Seller] could not be sold. The [Seller] provided the [Buyer] flanges with a total value of about US $3 million (US $3,090,000 in accordance with the [Buyer]'s arbitral application). In October 1992, the [Buyer] claimed that there were flanges in store with a value of US $1.25 million. That implied that, in more than three years from 1989 to 1992, the yearly average sale of flanges reached about US $460,000 [US $3 million - 1,250,00/3.8]. However, the [Buyer] stated in the arbitral application of April 1995 that there were about US [$720,000] worth of flanges in store. That meant that, in this period (two and a half years), the yearly sale of flanges provided by the [Seller] reached US $212,000 [1,250,000 - 720,000/2.5]. Therefore, even under such an "unfavorable" environment after the issuance of the Special Report, the [Buyer] still sold flanges with a value of US $212,000 each year, which revealed that flanges supplied by the [Seller] could be sold. As the "largest" company in the business of importing, storing and selling flanges, the [Buyer] imported Chinese flanges with a value of US $31 million by 1992. When it came to April 1995, only flanges with a value of over US $70,000 supplied by the [Seller] were stored as inventory which only accounted for a very small portion. In addition, the inventory flanges did not mean losses. Sales went slowly for two reasons: first, the [Buyer] imported too many Chinese flanges for their low prices; second, the market was saturated and the supplies surpassed the demand. It is improper that the [Buyer] attempted to transfer this commercial market risk to the [Seller]. The [Seller] would especially call the Arbitration Tribunal's attention to the fact that the [Buyer] purchased flanges from many exporters, and attributed the quality problem caused by importing low quality flanges supplied by some small enterprises to flanges supplied by the [Seller], but the test evidence provided was not sufficient to prove that the flanges provided by the [Seller] have bad quality. At the least, such allegation was unfair.
The [Seller] stated that the economic losses claimed by the [Buyer] were also not true. Calculated based on the sales price provided in [Buyer]'s evidence (the market price), the sales income from the flanges that the [Buyer] sold was much more than US $30 million that the [Buyer] paid for the flanges purchased from the [Seller]; this meant that the [Buyer] had gained much profits. However, the [Buyer] claimed US $2.36 million for the unsold flanges with a value of US $700,000, which equaled 3.2 times of the flanges in store. The claims were so high, but the [Buyer] did not provide any convincing evidence on the bad quality of flanges, which clearly reveals the absurdity of these claims
The [Buyer]'s claims contravened the contracts and did not have legal basis of laws and regulations. The [Seller] requests the Arbitral Tribunal to overrule all of the [Buyer]'s arbitral claims.
As to [Seller]'s specific claims against the [Buyer], the arguments will be presented in a separate section.
(IV) Different positions taken by the parties; and the legal and contract basis for differences
In their statements at the hearing and in the supplementary materials supplied by each party, each party submitted his own opinions on the legal and contractual basis for their claims and addressed intensive arguments.
(i) Whether the goods supplied by the [Seller] contained serious quality deficiencies
(1) The [Buyer] alleged that his statement had illustrated the process that revealed the quality problems and their seriousness.
The [Buyer]'s claim
1) The fact that [Buyer]'s goods had been sold in large quantity did not mean that they did not contain any quality deficiencies; this was 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 welding neck flanges were mixed with the flanges made of foreign materials) that occurred in use later caused suspicion, test and checking, which exposed even more problems which led to returns, claims and so on.
2) As revealed by the test of the independent lab, the flanges supplied by the [Seller] were not qualified, which caused the [Buyer]'s US clients to refuse to use this kind of flanges. The test report issued by the independent lab illustrated that some flanges delivered by the [Seller] as having being tested had not gone through normalizing. This was not consistent with the technical requirements of the contracts. In addition, 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 clearly know whether a flange has gone through normalizing heat treatment. 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 the mark "N" stamped on them, so it meant a behavior of fraud by hiding the real facts.
For the deficiencies of chemical ingredients and other aspects, the report issued by the independent lab revealed that though most flanges met Standard A105 (carbon content 0.35%), this did not satisfy the requirement of the contracts (carbon content 0.27%). Among the Mill Test Reports submitted by the [Seller], it was found that there were two, or even three Mill Test Reports with totally different chemical ingredients for flanges of the same heat number. This could only illustrate that these Mill Test Reports were filled out arbitrarily and could not reflect the real characteristics of the flanges in the process of production. How can such quality gain the trust of users?
3) The quality deficiencies of the flanges provided by the [Seller] caused serious consequences. The Special Report issued by the US National Testing Commission on Boilers and Pressure Containers indicated that the use of unqualified flanges may cause damage to human health and great losses of property and warned US users of flanges to be very cautious when using Chinese flanges. In addition, the [Seller]'s name (Shougang) was listed in the report. 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. Due to this reason, the volume of flanges imported from China to the US decreased sharply from US $25 million in 1991 to only US $2.45 million in 1993.
As a US valve company importing Chinese flanges, the [Seller] suffered great losses since the unsold Chinese flanges had to be stored in a warehouse. These losses were totally connected with the serious breach of the [Seller] and his improper acts. The [Seller] should compensate the [Buyer]'s losses.
The [Seller]'s defense
1) The [Buyer] did not identify the quality problems for the flanges which were supplied through different sources. The [Buyer] was very clear that many flanges containing quality problems were not provided by the [Seller]. For example, the Special Report mentioned the welding neck flanges with foreign materials were supplied by Shougang, the name of the supplier; these flanges were not produced and supplied by the [Seller]. In addition, the inlaid flanges, which were found by EBASCO and caused serious returns, were supplied by a Shanxi Company. Among the 31 flanges tested by ×× Lab authorized by EBASCO and TEAM Industrial Company, only three flanges were supplied by the [Seller] and the test conclusion on those three flanges was " all qualified". Another flange considered by the [Buyer] to be supplied by the [Seller] was unqualified with Si content of 0.4% , but this flange was actually purchased by the [Buyer] from Beijing Oriental Equipment Company. As to the 10 tested flanges authorized by the [Buyer] himself in October 1991 and June 1992, it was concluded that the one flange supplied by the [Seller] with a carbon content of 0.29% was consistent with the Standard A105.
In a word, the [Buyer] alleged that the unqualified rate of the flanges supplied by the [Seller] was very high, even to 15.3%, completely based on the [Buyer]'s self-test. The self-testing records were drafts which should not be regarded as evidence materials.
2) The [Buyer] stressed the seriousness of the normalizing heat treatment problem and alleged that this was a "latent defect".
As recorded in the first test report of ×× Lab provided by the [Buyer], only three flanges supplied by the [Seller] were tested and concluded as having gone through normalizing. The other test report, Number SWL-57189, claimed that the flanges with two heats (Heat number 8113769 and Heat number 8314118) had not gone through normalizing, but this report did not provide any metallograph, nor did it indicate the testing method.
The [Seller] pointed out that the flanges in this case should endure pressure under 300 Psi, so they were not required to go through normalizing in accordance with Standard A105. The [Seller] consulted the [Buyer]"whether 700 tons of material that had not gone through normalizing could be used", and the [Buyer] replied that it was acceptable. In fact, in accordance with the contracts, flanges stamped with the mark of "N" should go through normalizing; therefore, the [Seller] still normalized the flanges, which did not need to go through normalizing in accordance with the standard. This was proved by the report of ×× Lab. The [Buyer] strongly alleged that flanges supplied by the [Seller] that had not gone through normalizing were stamped with the mark of "N" and referred to this as a kind of fraud, but even when the Arbitral Tribunal held a hearing, the [Buyer] could not provide any effective evidence that the flanges supplied by Shougang had not gone through normalizing.
The [Seller] also pointed out that normalizing was carried out in batches and each batch may contain 50, 150, or 400 flanges. For different positions in the heat, the temperature may be slightly different, therefore, though going through normalizing in the same heat, the metallograph may show some difference in the test after going through normalizing. Therefore, the fact that some tests showed flanges not having gone through normalizing could not be regarded as purposefully filling the Mill Test Report with false information. The [Seller] stated that [Buyer]'s opinion which concluded that the inconsistency between the goods and the contracts and the MTRs as evidence of "arbitrariness and fraud" was unacceptable, wrong and legally unjustifiable.
3) As to the issue of the same heat number with so many Mill Test Reports and different data.
The [Seller] described the production process of flanges and the filing of material test reports in its "Supplementary Opinions" dated 14 June 1996.
The chemical ingredients in the test reports on materials were obtained directly through the following process: the molten steel was taken directly as a sample in the process of making steel; its chemical ingredients were tested; the steel was not formally discharged from the heat until its chemical ingredients were confirmed as qualified; the chemical ingredients at this time were filed as data in test reports on materials.
Because there were other procedures such as ingot casting, blank cutting, forging, processing and normalizing after steel making, all these procedures had some influence on the scattered distribution of chemical ingredients, the data on chemical ingredients obtained from product analysis was slightly different from that of the molten steel. In addition, since flanges of the same heat number may be produced out of materials in different positions of ingot casting, forging blank, for the phenomenon of irregular separating out in the process of solidification and irregular reallocation of molten steel in the process of crystallization, it was common to encounter differences in their chemical ingredients, which was an objective existence. The difference between the product test report and the Mill Test Report could not be regarded as evidence of arbitrary conduct.
(ii) The issues concerning the contract terms and the legal basis for claims
Both the [Buyer] and the [Seller] cited the terms and conditions of the contracts in this case, 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 practices or trade customs as the contractual and legal basis for the [Buyer] claiming rights for argument, and each party proposed its own opinions and explanations.
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 General Principles of Civil Law 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 that breaches a contract shall be liable for compensation equal to the losses consequently suffered by the other party.
The People's Republic of China and the United States governments are both Contracting States of the CISG and have ratified this Convention. 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 practice were applied to this case. In accordance with Article 74 of the CISG, the damages should include the loss of expected profits suffered. Furthermore, Article 36 of the CISG provides:
"The seller is liable ... 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" ... [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 these contracts were steel-made products whose chemical ingredients and physical nature would not deteriorate in quality over a long time of storage and in the process of use. When delivering the goods, the [Seller] was not only to provide goods, but also to provide correct test reports made according to actual and real test results in accordance with the contracts. The mark which represented the conformity to the agreed standard was to be stamped on these products, which was the guarantee of qualified products and compliance with the special quality and nature required.
In fact, the goods provided by the [Seller] were not consistent with the terms of the contracts, not consistent with the chemical ingredients and/or with the physical performance written in the Mill Test Report submitted by the [Seller], and not consistent with the standard stamped on the goods. These discrepancies, i.e., the goods had serious deficiencies which not only involved too many flanges, but might also be a risk to property and life; and led the [Buyer]'s clients to return large quantities of goods. These discrepancies also attracted serious attention from the US National Testing Commission on Boilers and Pressure Containers and supervision and criticism by news media, which caused the [Buyer] to suffer serious economic losses and losses of reputation and profit due to the failure to sell the large quantity of inventory goods. The [Buyer] believed that his claims were totally consistent with contract terms and applicable laws and regulations.
2) In the long period of negotiation between the [Buyer] and the [Seller], the [Seller] raised unreasonable defenses to shirk responsibility under contracts and legal principles.
The [Seller] replied on the indemnity clauses to allege that the [Buyer]'s claim was not filed within the deadline for compensation claim as stipulated "within 90 days after the goods reached the port", and therefore the [Buyer] lost his right to claim compensation. At the same time, the [Seller] also cited Article 10 of the contract enclosure providing that "the [Buyer] may carry out examination before the first batch of goods is shipped and if the goods are qualified, hereafter each batch of goods may be examined or not, but the examining right is an inseparable part of this agreement". The [Seller] stated that the fact that the [Buyer] himself did not carry out examination meant that he had given up the rights he was entitled to by the contracts.
The [Buyer] believed that the [Seller]'s position on these terms was not tenable. The [Buyer]'s position is:
a) The contracts stipulated that the [Buyer] was allowed to carry out examination before the goods were shipped, while in fact the two parties had no conditions to arrange for the [Buyer] to carry out lab tests. The [Buyer] could only carry out sampling test on their size, while the producing factory and the [Seller] once again showed that they had an integrated laboratory, each batch of goods going through strict examination, and the Mill Test Report providing the data tested in the laboratory. The [Buyer] had the right not to examine the goods and this right not to examine goods definitely included reliance on the [Seller]'s fulfillment of contract obligations. The [Buyer] correctly performed his right, but the [Seller] violated his contract obligations, which made the [Buyer] suffer damages caused by the [Seller]'s fault.
b) The same principle should also apply to the right of examination within 90 days after the arrival of goods at the port. The [Buyer] could trust that the goods supplied by the [Seller] were consistent with the Mill Test Reports provided. And in fact, in the process afterwards (quality problems were sometimes found beyond 90 days after the arrival of goods at the port), the [Seller] never refused to deal with the quality problems relying on the 90-days time limit for indemnity claim. These facts actually reflected that though the terms of time limit for indemnity 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 altered the contract and removed the restrictions. In fact, under the contracts in this case, there were thousands of flanges to be tested within 90 / 30 days, which was not enough time to carry out transportation, storage and testing.
c) The time limit for indemnity claims in the contracts should not apply to the goods in this case based on Article 36(2) of the CISG. The flanges are goods that could remain fit for their ordinary purpose of use for a long time after delivery and the quality should not go bad with the passage of time. At the same time, the flanges had been provided Mill Test Reports attesting their specified qualities or characteristics and stamped with quality standard marks. Moreover, for many functions (metallographical tissue and mechanical performance), 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 was that goods could only be sold after the seller provided the Mill Test Report in the process of production. The users could rely on the Mill Test Report or mark consistent with the standard printed on the goods to purchase the flanges. Article 36(2) of the CISG stipulated that sellers should be still liable for the goods not consistent with the contract after the risk had transferred to the buyer. Article 15(3) of the Regulations of the People's Republic of China on Purchase-and-Sale Contract of Industrial-and-Mineral Products also stipulated 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 Contract 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 the [Seller] replaced the results with different product test reports in his performance. 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 Mill Test Reports. This act of the producers - not regarding the consequences of purposeful acts - in fact, behaved as commercial fraud. For the deficiencies of some goods that could only be found in the use and notified to the seller, Article 39 of the CISG stipulated the time limit to give notice to the seller for the inconsistency of the goods was within two years after receiving the goods. The notice for the inconsistency of the goods in this case were all sent within twenty-four months, for example, in August 1991, EBASCO and TEAM Industrial Company returned goods in large batches 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] twenty four months before 1991.
The [Buyer] specially pointed 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, 39. Article 40 should be applied because the suppliers (including the [Seller] in this case and other producers) had known or had been unable not to know of some goods being 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 provided in the contract.)
Based on the arguments above, the [Buyer] alleged that the claims in this case were consistent with the PRC laws and the CISG, and that the [Seller] could not disclaim [Buyer]'s claims relying on the quality objections and indemnity article in the contracts.
The [Seller]'s opinions
1) The [Seller] agreed that the Law of the PRC on Economic Contracts Concerning Foreign Interests and the CISG should apply to the dispute in this case.
The [Seller] alleged that if the goods delivered by the [Seller] were inconsistent with the contract, the [Buyer] could certainly submit evidence for his compensation claims. There was a specific article concerning the quality objections and claims in the contracts, which was consistent with the PRC laws and the CISG. It was agreed in the first contract (Number 88YCSG/2-019) that the [Buyer] had the right to examine the products two times.
| - | First, examination was to be carried out before the first batch of goods was shipped,
if the goods were qualified, later shipments of goods could or could 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 for the
reason that he had no means (equipment, lab, etc.) to carry out spot examination,
which, it should be pointed out, is a totally unreasonable argument. The [Buyer] sent
his employees to the [Seller]'s factory, which was equipped with full lab appliances,
and there were labs that could serve the [Buyer] where the factory was located. On
the contrary, the [Buyer] never asked the [Seller] to help arrange for examination. It
was the [Buyer] who decided not to carry out the examinations and that meant the
[Buyer] automatically gave up his rights entitled by the contract. |
| - | Second, as stipulated in the contract, the [Buyer] could still carry out examination after the arrival of goods at the port. Of course, whether to examine or not depended on the [Buyer]'s option. But the article provided clearly that if the [Buyer] raised claims, the quality objection must be based on the test certification issued by a testing authority. The [Buyer] attributed the failure of examination after the goods arrived at the port to his trust in the [Seller] and the guarantee in the Mill Test Reports. It was incorrect. Even though the [Seller] provided a quality guarantee, the [Buyer] must examine the goods. A quality warranty could not exempt the [Buyer]'s obligation to examine goods. |
The CISG also clearly stipulates that "the buyer must examine the goods, or cause them to be examined within as short a period as is practicable in the circumstances."
The [Buyer] also emphasized that the examining period of 90/30 days stipulated in the contract was not enough to carry out transportation, storage and testing of goods, which was incorrect. Bulk goods are never examined one by one. The [Buyer] carried out the trade of import and export for a long period of time and fully knew that quality problems could be found by sample testing at random, which could be finished completely within 90/30 days. The [Buyer]'s excuse for not examining is not tenable.
2) The [Buyer] alleged that the acts of the parties had altered or removed the contract provisions on examination and claims after the arrival of goods. The [Seller] did not acknowledge this and stated that this was inconsistent with the facts, the contracts and the laws. In addition, Article 18(5) of the contract (Number 88YCSG/2-019) provided that "any alteration, supplemental of the contract or abandoning of any contract terms has to be subject to written confirmation, otherwise it is void." This illustrates that the two parties could not alter their contract by acts. The contracts signed in accordance with the laws had their own binding force, even though the time for filing claims was not cited or declared to deal with some specific quality problems, this did not mean abandonment. The two parties did not refer to many articles of the contract when performing the contract, which could not illustrate that these articles were void. In fact, the [Seller] sent a letter to the [Buyer] on 16 November 1992, declaring that terms concerning quality inspection and time limit for objections should be observed.
3) The issue concerning so-called "latent defects"
The [Seller] points out, the laws do not define "latent defects" and the [Buyer] did not make clear his own definition. The [Seller] alleged if there were "latent defects" in the flanges, then they should at least possess the feature that the defects could not be tested within 90/30 days after the goods arrived at the port. In fact, the so-called inconsistency of the flanges supplied by the [Seller] with the contracts and standard proposed by the [Buyer] now were discovered by ×× Lab and through self-test. If the [Buyer] had carried out this kind of test in accordance with the agreements after the arrival of goods at the port, could not the defects have been found? How could these be called "latent defects"? The [Seller] also cited the explanation on "latent defects" provided by experts and professors in the Chinese steel industry that indexes evaluations of flange quality including basic attributes such as chemical ingredients, mechanical function to judge whether the specific degree of standards requirement could be met; the deficiencies referred to the defects which would affect the use or cause damage of a work piece, such as surface and inner crackles and bubbles. Concerning the basic attributes: hardness and chemical ingredients could be tested first, which was easy and by which data could be obtained in a shorter time without breaking flanges. If chemical ingredients and hardness tests were passed, and found to be consistent with the contracts, normally there would be no mechanical function problems; if there were problems on chemical ingredients and hardness, flanges could be considered as unqualified though there might be no mechanical function problem, no more testing was necessary. If mechanical functions were needed to be known, samples could be selected to carry out a destructive test. Even though destructive test was to be carried out, it was also a normal test method and was unnecessary and impossible to require every work piece or lots of work pieces to pass the destructive test. The [Buyer] did not carry out any test at all within the agreed test period, which was not only inconsistent with the agreements, but also inconsistent with the provisions of the CISG, therefore, the [Buyer] should be liable for violating the contracts and laws, i.e., losing his right for claims.
4) The [Seller] also pointed out that the Mill Test Report was only a record of data of test on whether materials used were consistent with the standard and a material test report was not a guarantee. In this case, there was a warranty article in the contract that "the products are to be consistent with the specifications provided in Article 1 of this contract", and this article made it clear that "except for these, any representations, warranties and conditions of any kind are to be disclaimed". This kind of warranty term was different in nature from a quality guarantee period, so it could not be regarded as a permanent quality guarantee. The [Seller] also stated that, while the indemnity claim article could not restrict the warranty term, it confined the period and conditions to assume liabilities when violating the warranty. There was no time concept related to warranty terms, but there was a time concept related to assuming liabilities when violating warranty terms, which was subject to the indemnity claim article, i.e., the [Buyer] should submit claims within the agreed time limitation in the contracts when alleging that the [Seller] did not provide flanges according to the specifications in Article 1 of the contract.
Based on the above, the [Seller] stated that there were no latent defects in the flanges in this case and there was no so-called fraud; therefore, the [Buyer] had no right to rely on the provision of Article 40 of the CISG..
As to the Chinese Rules of Contract for Purchase-and-Sale of Industrial-and-Mineral Products cited by the [Buyer], the [Seller] alleged that the regulation applied to domestic disputes arising out of economic contracts and should not be applied to this case. As to the stipulation that the longest period to notify the inconsistency between goods and contract provisions stipulated in Article 39(2) of the CISG referred by the [Buyer], the [Seller] stated that the contracts in this case clearly provided the deadline for indemnity claims, so the contract provisions should precede the stipulation of Article 39(2) of the CISG.
As to the stipulation of Article 39 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest on time limit referred by the [Buyer], the [Seller] argued that this article applied to the issue of the right of action, on whether the [Buyer] had the right to commence an arbitration, and since this case had been accepted, the issue on time limit had been solved. But the right of quality claims was a substantive issue to be dealt with in accordance with the agreed contracts and substantive laws.
(V) Different positions taken by the parties concerning [Buyer]'s claims to compensate its economic losses
The [Buyer] alleged that it was reasonable to require the [Seller] to compensate all his economic losses including expected profits based on the quality deficiencies of the goods and the law and contract basis for his claims. The [Seller], in turn, analyzed and refuted the [Buyer]'s specific claims respectively.
(i) The flanges in store 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] were unable to be sold in the US because of the inconsistency with the contracts and in the Mill Test Reports, the percentage of unqualified goods was over 15%, there were returns and claims from many purchasing companies, and because of the warning of the US National Testing Commission on Boilers and Pressure Containers. Except for a small part of the goods sold at a lower price in the manner of "original goods without any change" (not providing the Mill Test Report), the rest of the goods could not be sold. These goods in store were calculated at US $929,368.87 by CFR, which could only be returned, therefore, the [Buyer] requested the [Seller] to repay for these goods by CFR.
The [Seller]'s position:
There were two arguments for the [Buyer]'s claims for the flanges in store.
First, the percentage of the flanges provided by the [Seller] inconsistent with the contracts reached over 15%, but this conclusion was made based on the tests conducted by the [Buyer] himself. The [Seller] had refuted the reliability and effectiveness of these evidence provided by the [Buyer] and the [Buyer] could not provide any further convincing and reliable evidence.
Second, the "Shougang" flanges (Heat Number 1-406 and Number 2-284) that were mentioned in the Special Report were not supplied by Shougang at all, but were the goods produced in Shandong Province and imported from Oriental Science Equipment Import and Export Company by the [Buyer]. It was misleading to mention "Shougang" in the preface of the Special Report. The [Buyer] clearly knew these facts but took no reasonable measures to clarify. If it was the Special Report that made Shougang flanges unable to be sold, the [Buyer] himself should be liable for this.
The [Seller] also alleged that the [Buyer] had altered his statistics many times. It was clear from the statistics provided by the [Buyer] that the yearly average sale of "Shougang" flanges stored by the [Buyer] reached US $212,000 between October 1992 and April 1995. This contradicted the [Buyer]'s statement that "Shougang flanges was unable to be sold", a statement that could not be supported by evidence. In addition, "goods in store" did not equal to losses. Therefore, [Seller] believes that the [Buyer] should assume the so-called inventory losses.
(ii) The profit loss of flanges in store
The [Buyer] alleged that, in accordance with the CISG, compensation should include loss of profit. Based on the US price index of 1991 and the invoices for goods actually sold, the [Buyer] estimated that the market value of these flanges reached US $1,503,218.2, and the gross profit loss would be US $573,912 (US $1,503,281.2 - US $929,369 = US $573,912).
The [Seller] does not acknowledge that the [Buyer] suffered inventory loss. The [Seller]'s position is that the [Buyer] suffered no profit loss from the flanges in store. Moreover, the calculation method and basis of the [Buyer] was not verified with evidence. Therefore, it also should be overruled for that reason.
(iii) Loss of profit from flanges undelivered
The [Buyer] alleged that there were flanges undelivered in three contracts altogether with a value of US $329,410 (contract price). The [Buyer] should get an expected profit of US $191,565 in accordance with the above storage and calculated by the same CFR cost and gross profit loss. The [Buyer] alleged that it had the right to require the [Seller] to compensate the losses in accordance with the CISG.
The [Seller] stated that the third contract (Contract Number 91YCSG/10-523) was signed in 1991. When some of the flanges subject to this contract were shipped to the US pursuant to that contract, the [Buyer] refused to accept them without any reason. The rest of the flanges which had been produced could not be shipped and had to be detained in China. The [Buyer] refused to accept the goods and breached the contract, which caused the [Seller] to suffer losses. Therefore, it was the [Buyer] who should compensate the [Seller] for losses. On the contrary, the [Buyer]'s claim for expected profits was ridiculous.
(iv) As to profit loss suffered from flanges sold in the manner of "original goods without any change and without any quality guarantee"
The [Buyer] stated that because the Mill Test Reports provided by the [Seller] were inconsistent with the goods supplied, the flanges could not be sold and became overstocked. The [Buyer] had to sell some stored flanges at a lower price in the manner of "original goods without any change and quality guarantee" (i.e., providing no accompanied Mill Test Report and stating that heat treatment and mechanical function test were not carried out), which was a measure to reduce losses. The profit loss suffered from this should be compensated by the [Seller] who breached the contract.
The [Seller] stated that if the [Buyer] did suffer loss from such sales, the [Buyer] should provide normal sales contracts, invoices (originals or notarized duplicates), sales contracts of "original goods without any change and quality guarantee," and have their invoices prove their specifications, quantity and price gap. Otherwise, [Buyer]'s allegations could not be proved. Meanwhile, the market price of products was related to supply and demand, which was a commercial risk assumed by the [Buyer].
(v) The cost for the settlement with Team Industrial Company
The [Buyer] alleged that because the flanges purchased by Team Industrial Company supplied by the [Seller] and another Chinese company (Shanxi Company) exposed serious quality problems, this led to a great amount of returns, great replacement of flanges which had been used in pipes, and caused a serious dispute over claims between the end user and the [Buyer]. Therefore, the [Buyer] compensated US $605,000 to Team Industrial Company for the settlement to resolve the dispute. The [Buyer] provided timely notification of this to the [Seller] and asked the [Seller] to contribute to this settlement. As examined among the returns from this client, the flanges supplied by the [Seller] accounted for 2%, therefore, the [Seller] should assume 2% of the above settlement fee, i.e., US $12,100.
The [Seller] stated that Team Industrial Company requested returns and claimed its losses based on the test result of over thirty flanges by ×× Lab authorized by EBASCO. Later the [Buyer] reached a settlement agreement with this end user and paid a settlement fee. It could be found from the test reports of ×× Lab that only three of the tested flanges were supplied by the [Seller] and the test results on them qualified as "no quality problems." Why should the [Seller] be expected to contribute compensation liability for the flanges with deficiencies supplied by others?
(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 reduce losses, the [Buyer] also had to sort the flanges and carry out partial tests (excluding 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 24.5%, i.e., US $216,420, which corresponded to the percentage of the flanges supplied by the [Seller] in store, and should be assumed by the [Seller].
The [Seller]'s position:
The storage, transportation, test and depreciation of equipment purchased were all reasonable, normal expenses of the [Buyer] as importer and wholesaler. They should be assumed by the [Seller].
(vii) Losses suffered from returns of other clients
The [Buyer]'s position:
There were flanges with a sum of US $5,665.79 returned for quality problems by the 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 check. This loss should be assumed by the [Seller].
The [Seller]'s position:
The report of returns listed superficial deficiencies of flanges, such as surface crackles, size, and bad welding. If these deficiencies did actually exist, they could have completely been found by test within 90/30 days after the arrival of the goods at the port. As the [Buyer] did not notify of quality objections within the time limit provided in the contract, the [Buyer] had lost his right for claims. The [Buyer] himself should be liable for this.
In the three-page list of flanges submitted by the [Buyer], some flanges (Order No. I09636, Contract No. (90) OE1409R) were not ordered through the contracts and orders between the [Buyer] and the [Seller]. Why should the [Seller] be liable for such compensation?
(viii) Interest loss and taxes
The [Buyer] alleged that the interest losses of storage and testing costs and the property tax on goods in store were actual costs and losses of the [Buyer] and that the [Seller] should contribute on the part which was supplied by the [Seller].
The [Seller] stated that, since the [Buyer] himself should assume the costs of storage and testing for the flanges, the [Buyer] should certainly assume the interest on these costs. As to taxes, based on Article 13 of the contracts, the [Buyer] should assume all the taxes in the importing country. Based on the above facts and reasons, the [Buyer] himself should assume this liability.
II. THE ARBITRAL TRIBUNAL'S OPINION
(I) The applicable law
The contracts in this case did not provide what laws the contracts would be governed by and construed in accordance with for any disputes. In accordance with the principle that laws of the country with which the contract 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 to this case.
In accordance with Article 6 of the Law of the People's Republic of China on Economic Contracts Involving Foreign Interest, the countries of the two contracting parties are the U.S. and China which are signing and ratifying states of the CISG, therefore, the CISG will be applied to settle the disputes in connection with the contracts except the reservation articles 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 has to do with 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? |
| - | What quality problems arose and how serious they were (the scope and degree of harm)? |
| - | The nature of quality problems and possible remedial measures. |
The opinions of both parties and the matters concerning tests have been presented in the above Details of the Case.
The Arbitral Tribunal decided to employ experts to carrying out an investigation and evaluation in accordance with the Arbitration Rules. The test results provided by the two parties to the dispute, sample 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 in this case. Matters concerning the views of both parties on past tests are outlined above in the "Details of the Case" section of this award. The key points pertaining to the experts' investigation and evaluation directed by the Arbitral Tribunal are:
(i) The nature of the experts' investigation and evaluation report
(1) The experts' investigation and evaluation does not belong to the merchandise test provided in the contracts or laws. Neither can it replace the [Seller]'s merchandise test for exports, nor can it replace the [Buyer]'s test on imported goods for claims. The experts are employed to report on special topics in this case for reference of 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. The Arbitral Tribunal has ruled that:
| - | It is not suitable to select lots of flanges for test at random from all flanges in store; |
| - | It is only required to properly select some samples from flanges which were still in the [Buyer]'s warehouses and determined unqualified by the [Buyer]. |
| - | Each sample is to be divided into two parts, China and US independent and fair test institutes were separately authorized to carry out the tests on chemical, physical, metallographical and mechanical functions. |
The experts 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 flanges in store, which had been determined "unqualified" by the [Buyer]. The [Buyer] had divided "unqualified" flanges in store into three types: "unqualified" by self-test of the [Buyer], "unqualified" by test of ×× Lab, and the returns from users. The two parties to the dispute were present when selecting samples. The printing marks on flanges and their corresponding Mill Test Reports were checked and altogether eight flanges were selected, which were determined to be goods supplied by the [Seller], and marked by paint from No. SG-1 to No. SG-8. The processing factory of Houston MAXIM Laboratory was authorized to cut each flange into two and pack them with the same package separately under the co-supervision of the Chief Arbitrator of the Arbitral Tribunal, the Secretary of the Arbitration Commission and the experts. One part was airmailed directly to Beijing and another part was carried by the experts to New York.
The China and US testing labs are independent labs selected by the Arbitral Tribunal and experts after co-investigation.
| - | The US International Testing Laboratories selected is a lab established in 1934 with a long history and comprehensive instruments, whose historical records revealed that it has provided testing services on all kinds of materials for tens of international renowned producing factories, and gained acknowledgement from numerous US professional associations and institutes; |
| - | The China Iron & Steel Research Institute selected is a testing center nominated by the state for testing all kinds of metal materials with the most advanced and comprehensive metal materials testing instruments in China and numerous high-level researchers. The institute was often authorized by agencies at home and abroad 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 authorized Chinese Association for International Economic Cooperation signed agreements on testing the eight samples separately with the above laboratories and made unified 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 ingredients, 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, but it involves considerable labor, long time and considerable costs. In dealing with conflicts, wet analysis testing is always recommended.) For two welding flanges, the Central Iron & Steel Research Institute was required to carry out two metallographical checks on the whole flanges and the welding seams.
(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. The Arbitral Tribunal concluded that the testing results 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.")
The experts analyzed the testing results of the two laboratories and submitted the following opinions:
1) Chemical ingredients
The chemical ingredients of all selected flanges with eight heat numbers meet the requirements of Standard ASTM A105 and are qualified products.
| - | Several testing reports from ×× Lab submitted by the [Buyer] in this case revealed that the che |