LASER FASHION CO. LTD. v. CFL ENTERPRISE LTD.

HCA 15711/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 15711 OF 1998

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J U D G M E N T

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Background

1. The Plaintiff is a garment manufacturer with a factory in Thailand. It is now suing for the price of 9,224 pieces of leather garments allegedly sold and delivered to the Defendant's US customer (hereinafter called "Limited Inc") under five contracts. The Defendant admits receiving two deliveries of 119 pieces and 1,376 pieces making a total of 1,495 pieces. Its defence is that there was a mutual understanding between the parties that the garments shall be accepted subject to approval of sample test by Limited Inc and that the garments delivered failed the test. The Defendant counterclaimed for handling and storage charges for the 1,495 pieces of garments pending litigation.

2. At the hearing, Mr Sadhwani applied for leave to amend the Plaintiff's statement of claim to the effect that only 1,495 pieces of garments had been delivered by the Plaintiff but alleged anticipatory breach on the part of the Defendant in respect of the balance of the delivery. Despite the Defendant's objection, I allowed the application as the proposed amendment accords with the defence case and the Defendant was not prejudiced. I imposed a condition that the Plaintiff shall pay the Defendant's costs of the amendment. However, after taking instruction, Mr Sadhwani withdrew the application and proceeded on the basis of the statement of claim and reply to defence and counterclaim without amendment, notwithstanding that he had been duly cautioned of the limitation that may be imposed on the Plaintiff's claim by the pleadings as they stand.

3. Though the defence is that the garments shall be accepted subject to approval of sample test by Limited Inc, in my view, Limited Inc may not capriciously disapprove the samples at will. If there is a requirement for approval, there must be a certain standard against which to gauge the propriety of such approval or disapproval. So far as colourfastness is concerned, which is the standard now in dispute, it is not a quality that could readily be assessed by visual inspection and tests are required. The lab tests only provide evidence as to whether the standard as regards colourfastness is met. Thus the issue is not whether the samples shall be subject to approval by Limited Inc, but what have the parties agreed, i.e. what is the standard as regards colourfastness of the leather to be used. The other issues, as the pleadings now stand, are whether all the garments meeting the required standard have been delivered as scheduled.

The standard

4. Mr Kirn is the managing director of the Plaintiff. He has 30 years experience in the leather garment industry and is experienced with the US, European and Japanese markets. In 1997, Mr Kirn had his first contact with the Defendant's office in Thailand and sold leather garments to one of the Defendant's US customers, J Crew. The quality and standard of the garments was overseen by the Defendant. The Defendant's customer was also involved in approving the quality and samples.

5. In January 1998, Mr Kirn negotiated with the Defendant's Thailand staff and Hong Kong merchandiser, Ms Ann Chang and entered into the five contracts on 7 February 1998. A number of purchase orders were then placed pursuant to those contracts. According to Mr Kirn, the Defendant never mentioned any requirement for lab test reports or nomination to any laboratory for testing the leather garments as a term of the contract. He said it was for the buyer to set the standard required for testing. He said Ms Chang was inexperienced in leather garment manufacturing and asked for his assistance as to how to set up the standard. Thus, at her request, he gave her a sample report from Springborn Testing Research (HK) Ltd in respect of leather sample from his tannery for her consideration. But no standard was set up. It was not until May or June 1998 that the issue of lab test reports was raised for the first time.

6. In my view, Mr Kirn is telling partial truth. On 17 January 1998, the Defendant's Thailand office wrote to Mr Kirn and posed him the following specific question about lab test:

"How [you] handle on lab test?? I.e. wet crocking, dry crocking etc. We [are] not much familiar with leather proceeding much. [Please] give [your] suggestion what's the best to handle the [colour], lab test etc. How to control the shading? Can [you] control shading W/N GMT? We need as much [information] as possible so can guild to Limited for proper handle bulk [production], in future. This is important. We need [your] more inputs here."

Though admittedly the Defendant was not experienced in leather garment manufacturing, its staff knew well about the requirement to set up standard as regards colourfastness, which is what wet and dry crocking tests are about.

7. Between then and signing of the contract, Ms Chang sent him three faxes. On the morning of 5 February 1998, she wrote to Mr Kirn asking for a sample test report and for a full leather sample for Limited Inc to set up quality standard. On the same evening, she sent another fax chasing for the report and asking for results of dry and wet crocking tests. On 6 February 1998, she wrote and repeated her request for the leather sample to enable Limited Inc to set up standard and her request for lab test report. Eventually on 9 February 1998, she wrote to Mr Kirn saying "I will let Mr Kirn to set up the standard with our New York office" when Mr Kirn met the Defendant's and Limited Inc's staff in his US trip.

8. Again on 17 February 1998, when the Defendant's Thailand office wrote to Mr Kirn about the possibility of sourcing the leather in Hong Kong, it mentioned:

"I would like you have Laser send me skin with snap (not only one [piece], should be a few [pieces]) which they can offer on bulk. I need this swatch because I need to do the lab testing, this testing is to ensure the snap will not have problem by using the [advanced] cleaning method 'dry clean'."

Even though in the end the leather was not sourced from Hong Kong but by the Plaintiff, the Plaintiff knew that the leather should meet certain standard as regards dry cleaning.

9. While Mr Kirn tried to put the blame on Ms Chang's inexperience in the leather garment industry, the uncontrovertible documentary evidence shows she was very capable. Ms Chang had about 10 years experience in textile garments. She admitted frankly that she had no experience in leather garments but asserted that the considerations relevant to textile garments were equally applicable to leather garments. She rejected the Springborn report as being irrelevant as it related to the azo dye test for carcinogenic amines, which is a requirement for the German market but not the US market. She repeatedly asked for other test reports on dry and wet crocking tests. The fax from the Defendant's Thailand office, the three faxes from Ms Chang before the signing of the contracts and her fax two days after signing the contract, asking Mr Kirn to set up the standard with New York office show that both before and after the signing of the contract, the request for leather samples, standard and lab tests had all along been active subjects on the agenda. Mr Kirn was not telling the truth when he said nothing was mentioned about standard or lab test.

10. In the face of the documentary evidence, Mr Kirn cannot dispute that he had been asked to set up the standard with the Defendant's New York office. However, he said that the meeting in New York with Limited Inc was a brief one lasting about 20 to 30 minutes. He said the purpose of the meeting was to discuss about building up the Defendant's leather business with his expertise. There was no discussion about quality standard, though he had asked the buyer to set up the standard. He asserted that no standard had been imposed before the Defendant entered into the five contracts in February 1998. Hence he started the manufacturing process, which was supervised by the Defendant's inspectors. Then when the garments were about to be shipped in May 1998, he informed Ms Chang that no standard had been set up and requested for extension of time to 2 June 1998 to deliver the first lot of 119 pieces of garments.

11. Ms Chang immediately followed that up with her telephone conversation with Mr Wann of the Plaintiff on 19 May 1998 and then her fax of 21 May 1998. In that fax, she demanded leather samples and mentioned that Limited Inc requested lab test. She granted the Plaintiff extension of time until 2 June 1998 to deliver the 119 pieces of garments placed under the test order. As the lab test report was not available by 2 June 1998, Ms Chang enquired from Limited Inc, through the Defendant's New York office, whether it would accept the garments without lab test reports. As Limited Inc replied that it would only accept the garments on condition that they pass the lab test, Mr Leung of the Defendant's Thailand office asked Mr Kirn to sign an undertaking to that effect, which Mr Kirn did. The undertaking is in the following terms:

"Due to the deadline off shipment date is on June 2, 1998, we agreed to allow you to take the risk of shipping the above captioned merchandises to our buyer Limited under this letter that the samples are not yet approved by limited before shipment as the reason of the delay of sending first production sample to CFL/HK office."

12. Mr Kirn explained that the guarantee was signed on practical considerations. Firstly, it was just in respect of a small quantity of garments. In fact it was and the total value was just US$2,086.10. It was not worth quarrelling for such a small amount in a contract of that size. Secondly, he said that the garments had been approved by the Defendant's inspectors on 27 April 1998 and hence the risk that they would be rejected was small. However, the approval he was referring to was the Defendant's approval as to style, workmanship, pattern, size and quality of the leather, but not its colourfastness which required lab testing. Colourfastness of the leather was the single issue that raised the need for the guarantee because Limited Inc had not yet satisfied itself as to the colourfastness of the leather. Thirdly, Mr Kirn said that inspection certificates were going to be issued on the purchase order in relation to 119 garments, which would mean that the letter of credit issued earlier would be paid. However, that the Plaintiff would be paid is not indicative of the quality of the garments in view of the undertaking. It also defies common sense for the Defendant to require the letter of guarantee if it was not going to have any effect.

13. I reject Mr Kirn's evidence that he signed the undertaking as a matter of practicality. From the fact that Mr Kirn signed the undertaking under the circumstances outlined above, I draw as the only reasonable inference that there was indeed an understanding between the parties that the Plaintiff shall produce garments using materials of certain standard to be set between the parties.

14. Further, even according to Mr Kirn's witness statement, Limited Inc would be involved in approving the price and samples. Under cross examination, he retracted what he said about Limited Inc approving the price but confirmed in unequivocal terms that Limited Inc was involved in approving the sample. This further confirms that the garments shall conform to certain standard.

15. I do not think the Plaintiff may shun its obligation by its neglect or deliberate inaction in not setting the standard and force on the Defendant to accept garments made of leather of any standard. The contract is a simple document like an invoice. It is silent as to standard and requirement for lab test. There is no evidence that the leather shall be subject to approval of Limited Inc. However, the correspondence show that both before and after the signing of the contract, supply of leather sample, standard, lab tests as regards dry and wet crocking and dry cleaning have all along been live issues. In default of agreement as to the standard, to give business efficacy to the contract, it must be implied into the contract a term that the leather shall comply with the usual standard for the American market where the garments will be sold to the ultimate consumers, which is the American Association of Textile Chemists And Colorist ("AATCC") 132 standard. Mr Kirn does not dispute that according to that standard, the leather should achieve a grading of Class 3 for dry crocking test, Class 2 for wet crocking test and Class 4 for dry cleaning test. But he argues that for wet crocking, Class 1.5 is acceptable for black leather as 2.0 is difficult to achieve. I reject his assertion as being unsupported by expert evidence and industry practice. I find as a fact that in default of agreement, the AATCC 132 standard shall apply to the contract.

The deliveries

16. The first lot of 119 pieces was duly shipped on 2 June 1998 on the basis of the Plaintiff's undertaking that the delivery was subject to the garments passing the lab test. A few days later, Ms Chang received the lab test report from Hong Kong Merchandise Testing Laboratory ("MTL Report") in respect of the Plaintiff's leather swatches which she had sent to them for testing earlier. The samples failed the test. Ms Chang informed the Plaintiff accordingly.

17. Subsequent to that, in about mid June 1998, Mr Kirn informed the Plaintiff that another lot of 1,376 pieces of black lamb nappa skirts were ready for shipment. Mr Peter Fong and Mr Longman Leung of the Defendant and Mr Kirn agreed to have the garments delivered by air on the same basis as the first lot of 119 pieces. Pursuant to that verbal conversation, Ms Chang faxed an undertaking to the Plaintiff for signature on 24 June 1998. However, the Plaintiff did not sign or return the undertaking. At that time, the Defendant had knowledge that the Plaintiff's first lot of garments failed the dry cleaning and wet crocking tests. As it had the caution of requiring an undertaking in relation to the test sample of 119 pieces, I have no doubt that they had imposed the same undertaking in respect of this lot of 1,376 pieces, though the Plaintiff did not sign the undertaking.

18. Upon arrival of the 1,376 pieces under the second delivery, Limited Inc arranged for a lab test. As the garments failed the crocking test, Limited Inc refused to accept the delivery. Ms Chang informed the Plaintiff and requested further samples for testing.

19. Thereafter there were further communication between the Plaintiff and the Defendant. The Plaintiff requested for extension of time for delivery and produced other lab test reports from SGS (India) and SGS (Thailand) showing that the leather sample passed the dry and wet crocking tests.

20. On 21 July 1998, the Defendant offered to accept delivery of garments other than those in black colour on condition that the Plaintiff would send them by air by the end of July 1998 and pay the difference between air freight and sea freight. The Defendant repeated its request on 23 July 1998. But a week later, on 30 July 1998, the Plaintiff solicitors issued a letter to the Defendant demanding full payment and acceptance of all the garments within 4 days.

21. The Defendant then caused their quality control inspectors to conduct an inspection in the Plaintiff's factory on 6 August 1998 and found that about 30% of the garments had not even been produced. Production of 1,332 pieces had not started because of problem with the leather from Taiwan while about 1,100 pieces were still in the production line. Leather in respect of 100 pieces of garments had not yet been cut. The inspection report was acknowledged by the Plaintiff's staff. Mr Kirn explains that the Plaintiff did not complete the production because it had no assurance that the Plaintiff would ever be paid. Thus as at the date of the demand by the Plaintiff's solicitors, a substantial portion of the outstanding balance of 7,729 pieces of garments have not even been completed. By that time, delivery time has long lapsed. On those facts, it is difficult for the Plaintiff to prove repudiation on the part of the Defendant and hence anticipatory breach. Instead, all the evidence point to the Plaintiff's failure to perform the contract in accordance with its terms, both as regards standard and delivery dates.

22. The facts also show a total lack of credibility in the Plaintiff's claim which adversely reflects on the credibility of Mr Kirn. The Plaintiff knew it had not completed production of all the garments and yet demanded full payment. It knew it had not delivered all the goods, yet it instructed its solicitors to sue on the basis that the goods had been delivered. Mr Kirn's allegation that lab test report was never raised until May 1998 is another piece of evidence destroying his credibility. He was entrusted with the obligation to set up the standard with Limited Inc or the Defendant's New York office. He did not do so and did not inform Ms Chang, despite he knew the question of standard had always been a live issue. He started production and now seeks to argue that the Plaintiff is entitled to produce garments using leather of any standard. I consider him an incredible witness. On the other hand, I find Ms Chang and Mr Fong credible. Their accounts are inherently credible and supported by contemporaneous documents.

Whether the samples meet the AATCC 132 standard

23. A number of lab test reports have been produced by the parties. The question is what weight should be given to these reports.

24. In the MTL Report dated 5 June 1998, four swatch samples in hay, walnut, black and buttercup colour in relation to the 119 test orders were tested. The hay colour sample failed the dry cleaning test. The black sample failed the wet crocking test in achieving a grading of 1.5 on both the face side and the back side and a grading of 2.0 for dry crocking on the back side. Later, two samples in black and walnut colour were submitted to MTL for crocking test. On 24 June 1998, MTL reported that the face side of the black sample failed the wet crocking test, while the back side of the walnut sample failed both the dry and wet crocking tests. On 30 June 1998, MTL issued another report in respect of a pepper berry leather sample which passed the crocking test but failed the dry cleaning test. An all spice sample was also sent to MTL on 29 June 1998 for testing. It passed both the crocking and dry cleaning tests but failed some other tests, which I do not consider relevant. In summary, these reports show that most of the samples failed the dry cleaning test and all the black samples failed the crocking test.

25. The Plaintiff produced a set of reports from SGS (India) dated 19 June 1998 which show that eight leather samples of various colours passed the dry and wet crocking test. The samples have not been tested for dry cleaning or professional leather cleaning. Mr Kirn explained that the reports were obtained from India because the leather was sourced from India and it was Plaintiff's policy to require tanneries to provide reports on leather quality for the Plaintiff's protection. However, when what Mr Kirn said is tested against the evidence regarding the delivery of the 1,376 pieces of garments, it is apparent that these reports do not relate to the leather used for those garments. According to the reports, the samples were delivered to SGS (India) on 19 June 1998. That must presumably be delivered before shipment of the bulk leather from India to the Plaintiff's factory for production, otherwise there was no useful purpose to obtain the reports from the tannery in India after the bulk leather had already been shipped to Thailand. Ms Chang's fax requesting for undertaking is dated 24 June 1998. The production of the garments must have been finished and inspected by the Defendant's inspectors well before that date. Thus it is unlikely that the leather samples examined by SGS (India) could have come from the same bulk leather as it was impossible for the leather to be shipped from India and turned into garments within just a few days. Further the SGS (India) reports do not identify the standard applied for the tests. I give no weight to these reports as they do not relate to the two shipments.

26. In July 1998, Ms Chang sent 15 leather samples she received from the Plaintiff to Limited Inc for testing. These samples were received after the two shipments and in response to the Plaintiff's SGS reports. The samples were sent to the Leather Industries Research Laboratory of the University of Cincinnati (UOC) for crocking test. On 14 July 1998, the UOC reported that all four black samples, one pepper berry and one northpine sample failed the crocking test.

27. Mr Kirn took the view that the UOC is a research laboratory and not a proper testing laboratory and the methodology differed from that of SGS because UOC conducted the test under conditions of controlled temperature and humidity. I do not think there is any substance in Mr Kirn's complaint. Testing the material under controlled condition is more favourable to the Plaintiff than to have the material tested under conditions involving changing temperature and humidity. In any event, the result of the UOC tests are consistent with those of MTL.

28. Mr Kirn also criticised the Defendant for testing on the back side of the leather as well. He said the back side of the garment was protected by lining and could not stain the clothes of the person wearing them. Be that as it may, all black samples failed the crocking test on the face side and the Defendant was willing to accept the garments of all the other colours despite some of the samples failed the crocking test on the back side. In view of that I do not think there is any substance in Mr Kirn's criticism.

29. For reasons as explained above, I give no weight to the reports from SGS (India). The MTL reports and UOC reports are consistent. They are comprehensive and report on both sides of the leather sample tested. The UOC reports, in particular, are impressive as to details and methodology. Given Mr Kirn's general lack of credibility, I am left in a doubt if the leather sample he gave to SGS (Thailand) came from the same bulk leather as used in production of the garments. I prefer the MTL or the UOC reports to the SGS (Thailand) reports.

30. Mr Kirn did not dispute that it was a required standard that the leather should be suitable for professional leather cleaning as the tags made for the skirts were labelled "professional leather clean only". However, he said that MTL applied the "professional leather dry clean" test which is not a requirement under the contract. He said he had never heard of such a cleaning process in all of his 35 years of experience. The burden is on the Defendant to show that the Plaintiff failed to meet the agreed standard. But be that as it may, "dry cleaning" must be a milder or less punishing method of cleaning than "wet-cleaning", if I could be excused for using that inapt term to bring out the difference. In the absence of evidence as to the two methods of leather cleaning, in my view, "professional leather dry clean" and "professional leather clean" must mean the same process, especially as it is done professionally and as Mr Kirn himself said he had never heard about "professional leather dry clean" in his 35 years experience.

31. However, whether professional dry clean or professional leather clean are the same process is unimportant in the present case. There were four different colours on two different kinds of leather, but only three samples were tested. Not all colours on the two different kinds of leather were tested. Such a sampling test could not be representative of all the colours and certainly not of the bulk. I do not think the Defendant could rely on these results as evidence that the leather failed the dry cleaning test. In fact, neither the Defendant nor Limited Inc considered the dry cleaning test material as Limited Inc was prepared to accept delivery of all garments other than those in black colour, even though the hay and pepper berry samples failed the dry cleaning test.

32. The MTL and UOC reports show that all the black leather samples failed the crocking test. Having accepted the UOC and MTL reports and rejected the SGS (Thailand) reports, I am satisfied that the black garment manufactured by the Plaintiff did not meet the standard of colourfastness as required under the contract. I consider the Defendant is entitled to reject the black garments.

The Plaintiff's claim

33. On the pleadings as they now stand, the Plaintiff claims that all the garments had been delivered on the various dates as pleaded in Paragraph 5 of the Statement of Claim. In Paragraph 4 of the Defence and Counterclaim, the Defendant admits delivery of 1,495 pieces but denies delivery of the balance of 7,729 pieces. By joining issue with the Defendant upon its Defence, the Plaintiff disagrees with the Defence allegation that the 7,729 pieces had not been delivered and repeats that they have been delivered and repeats its claim for the price. The Plaintiff has not raised the issue of anticipatory breach and the Defendant is not required to deal with that in its evidence because that is not the case the Defendant is asked to meet. Counsel's attention had been drawn to the limitation that may be imposed on the claim by reason of the pleading. He refused to amend the pleadings and the Plaintiff must be bound by them. On the fact, only 1,495 pieces have been delivered. The Plaintiff's claim in respect of the balance of 7,729 pieces must fail.

34. The 1,495 pieces delivered are part of the bulk of over 10,000 pieces ordered or 9,224 pieces as claimed by the Plaintiff. All black samples failed the crocking test. As the black garments made up of more than one third of the garments ordered, I consider the Plaintiff's failure in respect of the black garments a substantial breach. Without a complete colour range for the garments and with the bulk of the garments rejected, the contract as performed in relation to the garments of the other colours would be substantially different from that which the parties had originally contracted. The Plaintiff was unable to deliver all the garments as scheduled. While Limited Inc was prepared to take partial delivery of all the garments other than those in black colour, the offer was rejected by the Plaintiff. By its solicitors' letter dated 30 July 1998, the Plaintiff insisted the Defendant to accept all the garments including one third of which was defective. In failing to deliver garments of the contracted standard and quantity as scheduled and by insisting the Defendant to take delivery of a substantial quantity of substandard garments and out of time, the Plaintiff was not performing the contract in accordance with its terms. Its solicitors' letter of 30 July 1998 is clear evidence of repudiation on the part of the Plaintiff, which the Defendant was entitled to accept. Accordingly, I find the Plaintiff, and not the Defendant, has repudiated the contract.

35. The Defendant is entitled to reject the 59 of the 119 pieces of black garments delivered under the first shipment and all the 1,376 pieces of black garments delivered under the second shipment as the samples have all failed the crocking tests. With the Plaintiff's rejection of the Defendant's offer to accept garments of the other colour, the remaining 60 pieces could not constitute a complete stock as to be useful to Limited Inc. Limited Inc was entitled to reject them as well. Thus the Defendant is entitled to reject the entire lot of 1,495 pieces of garments delivered.

36. For reasons as explained, the failure in the black garments is a substantial breach which entitled the Defendant to reject or to refuse to take delivery of all the garments. Further, on the fact, the Plaintiff had not delivered the balance of 7,729 pieces. Mr Kirn's explanation for not shipping the garments because he had no assurance of payment in view of the dispute about the lab test reports simply could not stand as the black garments failed the crocking test and he cannot force on the Defendant to accept substandard garments and pay for them. The Plaintiff's claim must therefore be dismissed on its entirety.

37. In my view, on the above finding of fact, the Plaintiff has not been prejudiced by its failure to amend the pleadings, though the position may be different if the black leather samples had passed the crocking test.

The counterclaim

38. As the Defendant is entitled to reject the garments, it has a valid counterclaim against the Plaintiff in respect of handling and storage charges for the 1,495 pieces of garments delivered. The Defendant counterclaims for handling charges in the amount of US$59,967.88 and storage charge of US$200 per month. The Defendant did not appear to be serious in prosecuting this counterclaim. The evidence on the counterclaim is given by Mr Peter Fong who has left the Defendant's employment and has no idea of the current status of the 1,495 pieces of garments delivered. The documents he tendered in support of the monthly storage charges are mixed as to what months were actually paid for and do not identify the garments involved. There is no breakdown of the handling charges, which on the face is excessive as compared with the value of the garments involved. Also, the Defendant has not taken adequate steps to mitigate its loss by arranging a timely sale of the garments. I consider six months is a reasonable time for the Defendant to agree with the Plaintiff on the disposal of the garments or failing agreement to have the garments sold. Hence I award the Defendant on its counterclaim US$1,200, being six months storage charges for the 1,495 pieces of garments.

Conclusion

39. Accordingly, the Plaintiff's claim is dismissed and I award the Defendant US$1,200 on its counterclaim together with interest at judgment rate from 12 February 1999 until payment. The Plaintiff shall also pay the Defendant's costs, to be taxed if not agreed.