JAN ALBERT (H.K.) LTD v. SHU KONG GARMENT FACTORY LTD

Commercial law - contract for the sale of garments together with quota for export from People's Republic of China to West Germany - The contractual quota Category 4 not accepted by PRC quota issuing authority or originally by West Germany's customs under PRC-EEC Textiles Agreement - plaintiff refused to amend Letter of Credit to conform with PRC classification and obtained alternative garments from Sri Lanka at a loss of US$105,139.12 - whether defendant in breach of contract and if so liable to pay defendant actual loss of US$105,139.12 or lesser sum of 25% of contract price for non-delivery as provided in contract - whether because of quota differences contract void for parties common mistake or discharged by frustration - if not whether plaintiff in breach of contract by refusing to furnish amended letter of credit with PRC determined quota classification within a reasonable time - Held: 1. The parties quota classification common mistake resulted in the contract being void; 2. Alternatively the contract was discharged by frustration; 3. Plaintiff's claim dismissed; defendant's counter claim dismissed.

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

H.C. Action No. 4434 of 1986

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BETWEEN

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JUDGMENT

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1. On 19th December 1985 the plaintiff entered into a contract to buy from the defendant 146,250 unisex ski turtle neck pullovers together with quota to be manufactured in the People's Republic of China ('PRC') at a price of US$301,396.88 CIF Hamburg. The plaintiff in turn was under contract to resell the pullovers, at a profit, to Wachsmuth & Krogmann, a wholesaler carrying on business in West Germany. The defendant, in order to supply the garments to the plaintiff, entered into a contract with the Guangdong Branch of China National Textiles Import & Export Corporation ('Chinatex') for the garments to be manufactured in the PRC. The garments were to be delivered by the defendant to the plaintiff at the end of July 1986.

2. In fact the garments were never manufactured. The plaintiff in its Amended Statement of Claim pleaded that at the end of July 1986 the defendant repudiated the contract. The plaintiff further pleaded that it mitigated its loss by then arranging for the garments to be manufactured in Sri Lanka. The additional cost of the replacement garments together with freight, makes up the loss of US$105,139.12 now claimed.

The facts

3. The alleged repudiation of the contract arose from difficulties relating to the quota under which the garments were to be shipped from the PRC to West Germany. The export of garments manufactured in the PRC to West Germany is governed by an agreement between the PRC and the European Economic Community ('EEC') approved by the latter on 8th April 1986. Under the Agreement textile goods are divided into a large number of categories. The quantity of goods in each category, which may be exported to an EEC country, is bilaterally negotiated. The agreed quantities are described as quotas.

4. Under the present contract it is undisputed that the defendant was obliged to supply sufficient quota to enable the garments to be exported from the PRC through Hong Kong to West Germany. The contract expressly provided that the garments were to be shipped to West Germany under Catgory 4. Category 4 is defined in the agreement between the PRC and the EEC to cover:

 

"Shirts, T-shirts, lightweight roll or turtle neck pullovers, undervests and the like, knitted or crocheted, not elastic nor rubberized, other than babies' garments, of cotton or synthetic fibres

a)    T-shirts

b)    Shirts other than T-shirts."

5. A sample of the garments to be supplied under the contract was produced as Exhibit D1.As the contract expressly indicated, these garments were to be used as ski wear. On inspection the garment was clearly a turtle neck pullover with long sleeves. The garment could be opened at the neck by a zipper 9 inches in length. The plaintiff had successfully exported similar garments from the Philippines to West Germany, under Category 4. While those garments would have been subject to a different EEC agreement, Mr. H.J. Reichle, the Managing Director of the plaintiff, when he gave evidence, stated that the category definition was the same.

6. The contract between the parties although dated 19th December 1985 was executed on 27th December 1985. Payment was to be made by irrevocable letter of credit. Under the plaintiff's contract with Wachsmuth & Krogmann the plaintiff was to ship the garments by 10th August 1986. A Letter of Credit was to be opened by Wachsmuth & Krogmann no later than 15th February 1986 by which date the plaintiff had agreed to open its own letter of credit in favour of the defendant. The plaintiff opened the Letter of Credit in favour of the defendant, on 26th February 1986. The Letter of Credit expressly referred to the fact that it covered the 146,250 garments plus the Category 4 quota.

7. On 28th February 1986 the defendant having received the Letter of Credit, telexed the plaintiff with a number of queries.These included a request for an earlier shipping date to avoid storage charges and other more minor requests which are not material to the present dispute. The major query, relating to the appropriate Category number, was raised by the defendant in these terms:

 

"Original China Export Licence for West Germany Cat.83 instead of West Germany Cat. 4 because material quota no. used in China is Cat. 83. Your clarification before amendment is made is appreicated."

The plaintiff replied on 5th March 1986 that it was checking the category query with its West German customer. Mr. Reichle was at this time in West Germany and his customer undertook to ask West German Customs to clarify which category was correct. Before any reply was received, the defendant again asked that the Letter of Credit be amended.

8. This led the plaintiff on 17th March 1986 to ask Wachsmuth & Krogmann if it had received advice from West German Customs whether Category 83 was correct. In the PRC-EEC Agreement, Category 83 appears to be a residual outer garment classification and is defined as:

 

"Outer garments knitted or crocheted, not elastic nor rubberized, other than garments of categories 5, 7, 26, 27, 28, 71, 72, 73, 74 and 75."

9. Wachsmuth & Krogmann first made enquiries of the West German Customs at Hamburg and by telex informed the plaintiff of the result:

 

"Ski sweater: The latest development is that the article supposedly belongs to Category 5 on the basis of the turtleneck and not to 83 (other outerwear) X as everything seems a little vague to us, we have now requested a binding advice from Frankfurt which will take another 14 days X we must at all costs be 100% certain."

Wachsmuth & Krogmann's own Customs Agent stated that it had been extremely difficult to classify the garment and they could not guarantee that at the time of clearance it would still be classified as Category 5 hence the suggestion that a binding classification be obtained from Frankfurt.

10. Category 5 garments are defined in the PRC-EEC agreement as:

 

"Jerseys, pullovers, slip-overs, twinsets, cardigans, bed-jackets, and jumpers, knitted or crocheted, not elastic nor rubbersized."

There is considerable similarity between the definitions of Categories 4 and 5. One difference is that Category 4 does include a reference to undervests while Category 5 contains no express reference to any form of underwear.

11. Category 83 is solely concerned with residual categories of outerwear and by excluding Category 5, supports the construction that the garments within Category 5 are also outerwear and not underwear. Category 4, considered in isolation, appears to include both outerwear and underwear garments. I further note that while Category 4 is the only one of these three categories, which expressly includes turtle neck pullovers, surprisingly that was the feature which appears to have led Hamburg Customs to classify the garment as Category 5 and not Category 4.

12. Mr. Reichle stated that throughout his principal concern was to supply garments to his West German buyer which complied with the contractual quality requirements and the specified delivery date. The designated category number was of lesser importance provided the garments were able to proceed through West German Customs in accordance with the PRC-EEC Agreement. In practice the important obstacle to overcome under the PRC-EEC Agreement was the customs requirement of the importing country, rather than the issue of quota by the exporting country. However Mr. Reichle under cross-examination agreed, that it was a necessary requirement under the PRC-EEC Agreement that quota of the appropriate category first be obtained from the PRC issuing authority. Under the contract with the defendant, the provision of that quota was the defendant's contractual responsibility.

13. During the next 4 months the parties were almost constantly engaged in trying to resolve the category problem. I would also record that on 18th March 1986 the plaintiff entered into a similar contract with the defendant for the supply of 5000 unisex ski turtle neck pullovers. This contract was for a very much smaller quantity of garments. The interesting difference is that the parties in this contract stipulated that the garments were to be shipped to West Germany under Category 83. Mr. Reichle's explanation was that this was a relatively small order and the correct category number was of less importance so far as West German Customs was concerned. The garments under this contract were successfully exported to West Germany under Category 83.

14. Returning to the disputed contract, on Mr. Reichle's return to Hong Kong, he telexed Wachsmuth & Krogmann that the garments were not Category 5 and that China was insisting that Category 83 was correct. In reply Wachsmuth & Krogmann stated that they were waiting for clarification from West German Customs. Counsel for the defendant submitted that the plaintiff's telexes of this kind, were evidence that it had by then accepted that Category 83 was the correct category.

15. I reject that submission. I accept Mr. Reichle's evidence that as soon as Category 4 was queried by the defendant, he thereafter merely conveyed the defendant's views to the plaintiff's West German buyer, in the hope that the categorisation problem would be resolved. If Wachsmuth & Krogmann had agreed to amend its contract with the plaintiff to Category 83, then the plaintiff was always ready similarly to amend its contract with the defendant. I find that the plaintiff never obtained Wachsmuth & Krogmann's approval to accept Category 83 and the plaintiff in turn never agreed with the defendant to change their contract to Category 83.

16. Wachsmuth & Krogmann's position at this stage was summed up in a telex to the plaintiff on 19th March 1986 when it observed:

"....what use is it to us to have an Export Licence for goods under Category 83 if we then stand there at Customs and can't get our good cleared because the Customs authorities insist on an Import Licence for Category 5...."

The telex in effect also indicates that it was not simply a matter of complying with the import requirements of West Germany but that under the PRC-EEC Agreement, the export requirements of the PRC had also to be satisfied.

17. The defendant was still pressing for amendment of the Letter of Credit and on 2nd April 1986 telexed the plaintiff that if the amendment was not made that week the PRC quota would be delayed. In an attempt to clarify the matter, the plaintiff submitted the garment to the Hong Kong Government's Trade Department for classification. Mr. Reichle stated that he recognised that export of garments from Hong Kong to EEC countries was under a separate Hong Kong-EEC Textiles Agreement but he understood that the categorisation was the same. The Trade Department on 8th April 1986 classified the garment, under the Hong Kong-EEC Textiles Agreement, as Category 5.

18. On 9th April 1986 the plaintiff wrote to the defendant recording that the defendant had requested that the contractual Category 4 classification be changed to Category 83 to satisfy the export requirements of the PRC but that both West Germany and Hong Kong classified the garment as Category 5. The plaintiff's letter requested the defendant to supply an official letter from the PRC in respect of its Category 83 classification, to assist Wachsmuth & Krogmann to contest West Germany's classification. Later during April the defendant supplied to the plaintiff a letter in Chinese characters from the Guangdong Branch of Chinatex, the defendant's PRC manufacturer, stating that "Category 83 can be used after negotiation between two parties and recognition by your customer."

19. Mr. Reichle on receipt of this letter was understandably concerned that it was not from the PRC export authority but from the defendant's manufacturer; it was handwritten and unsealed; and its contents were equivocal. A meeting between the parties was then held when these matters were discussed and the defendant agreed to request an official letter in English from the appropriate PRC export authority.

20. The defendant in fact obtained a further letter from Chinatex on its official letterhead, in English and signed with Chinatex's chop. The letter was dated 23rd April 1986 and stated that because of their back length, the garments should he classified as Category 83. On 24th April 1986 the plaintiff sent that letter to Wachsmuth & Krogmann to contest the Category 5 classification. In fact that letter crossed with a telex of the same date from Wachsmuth & Krogmann which stated that there was hardly any chance of having the garments classified in West Germany as Category 83 but that a reclassification to Category 4 was a possibility.

21. On 25th April 1986 the Defendant wrote to the plaintiff pointing out that as it had supplied the official letter from Chinatex confirming that Category 83 was correct, it required the Letter of Credit to be amended to Category 83 by 30th April 1986. The plaintiff replied on 28th April 1986, that if the West German Customs accepted Category 83, the Letter of Credit would be amended but that a ruling was not likely to be available by 30th April 1986.

22. On 30th April 1986 the plaintiff received a telex from Wachsmuth & Krogmann advising that due to their overlength the garments could now be classified in West Germany as Category 4. The overlength refers to fact that the garments were longer that a standard sports shirt. The garments were intended to be worn under a ski-jacket. The overlength was designed to facilitate the lower part of the garment being tucked inside ski-trousers at below waist level. I note that this was this same overlength feature, which is referred to in the Chinatex letter of 23rd April 1986, as being the reason which conversely resulted in the garments being classified in the PRC as Category 83.

23. The new advice from West Germany led the plaintiff to telex the defendant on 1st May 1986 informing it that the garments would now be accepted if shipped from the PRC under either Category 4 or 5. By this time the plaintiff was also concerned that its enquiries had indicated that PRC Category 4 and 5 quotas were no longer available and that the defendant had already taken steps to cancel its contract with Chinatex. The defendant in a telex dated 1st May 1986 denied that any contracts with Chinatex had been cancelled and referred to the alleged agreement of the plaintiff to accept garments under Categories 83 or 4 or 5.

24. The plaintiff replied that it had never agreed to Category 83. It repeated that it would accept garments under Categories 4 or 5 and that as the Letter of Credit was for Category 4 garments, shipment should be made under that category. No amendment of the Letter of Credit was necessary. On 6th May 1986 the defendant replied by telex that it was confused by the plaintiff's changing position on the correct category and that in terms of Chinatex's letter, Category 83 was correct. It asked for the Letter of Credit to be amended accordingly. The plaintiff by its letter of 8th May 1986 relied on the written contractual provisions which stipulated Category 4 and it requested the defendant to comply with those terms.

25. The defendant continued to ask the plaintiff to amend the Letter of Credit to Category 83 and the plaintiff repeated that the Letter of Credit already complied with the contractual Category 4 stipulation. The plaintiff refused to amend the Letter of Credit. The defendant refused to arrange for production of the garments to commence until the Letter of Credit was amended. The plaintiff finally gave notice that if the garments were not shipped to West Germany in terms of the contract by 31st July 1986, it would treat the contract as repudiated, purchase the garments from another manufactuer and hold the defendant liable for any loss. The plaintiff in terms of that notice later arranged for the garments to be manufactured in Sri Lanka.

26. After the present action was commenced, the parties continued to pursue enquiries to clarify the classification issue. On 13th November 1986 the Hong Kong Government's Trade Department supplied the defendant's solicitors with details of the similar Categories 4 and 5 classifications in the Hong Kong-EEC 1983-6 and 1987-91 Textile Agreements. The Trade Department also advised that the categories were in effect mutually exclusive. On 14th June 1988 the Guangzhou Branch of Chinatex wrote to the defendant advising that at the material time it had sufficient quantities of Category 83 and Category 4 but that it specified Category 83 as that was the correct category. It also denied that it had informed the plaintiff that supplies of Categories 4 and 5 were not available.

27. The Guangzhou Branch of Chinatex, I confirm, throughout maintained that the Category 83 was the correct category. However, its Head Office in Beijing on 21st September 1988, wrote to the plaintiff's solicitors expressing the opinion that the correct classification was Category 4. The plaintiff also sought the opinion of the China Global Law Office, Beijing, who are lawyers qualified to practice in the PRC specialising in international trade law. In addition to reviewing the provisions of the PRC-EEC Agreement, they interviewed in Beijing the Deputy-Director of the Cotton Knitwear and Manufactured Goods Department of Chinatex. The Deputy-Director informed then that the correct classification for the garment was Category 4 which would automatically exclude it from being exported under Category 83. The China Global Law Office also expressed the opinion that the correct classification was Category 4.

28. I record that Chinatex, while a state corporation, is not a government department. The defendant also approached the Guangzhou Branch of the Ministry of Foreign Economic Relations and Trade ('Mofert') which is the PRC government department dealing with export quotas under the PRC-EEC Agreement. Mofert's Guangzhou Foreign Trade Administration Quota Office on 21st September 1988 certified that the correct classification for the knitted outerwear garments, under the contract between the defendant and Chinatex, was Category 83. The Official Journal, Annexure 2, of Mofert was produced which appears to summarise the provisions of the PRC-EEC Agreement. In that summary Category 4 is described as referring to "Knitted Undervests" whil Category 5 refers to "Knitted Outerwear". This summary makes a clearer distinction between the categories, than the more detailed descriptions in the full Agreement. The abbreviated nature of the summaries in the Annexure, is indicated by the description of Category 83 which is the same words as Category 5, namely "Knitted Outerwear". A further document from Mofert dated 23rd September 1988 was also produced by the defendant which contained the following certificate:

"TO WHOM IT MAY CONCERN,

                    I hereby certify to have seen the sample garment and its photo copy, which is long sleeve of red colour, high collar with 9" zipper in front. According to CCCN coding based on the which the classifications of the current China-EEC Textile Agreement were made, and the normal trade practice of our supplier with their buyers, this product should, in the opinion of us as an issuing authority for textiles Export License, be classified as Cat.83.

 

The Certificate was signed and chopped by the Guangzhou Branch of Mofert.

29. Mr. Charles Ko, who in 1986 was the Manager of the Garment Production Department of the defendant, gave evidence confirming that Chinatex classified the garments as Category 83 and that although repeated demands were made, the plaintiff refused to amend the Letter of Credit from Category 4 to Category 83. As a result the defendant was unable to proceed to have the garments manufactured. In Mr. Ko's opinion the garments were outerwear and not underwear.

30. The defendant also called Mr. S.O. Chow to give evidence. Mr. Chow has recently come to Hong Kong as the Manager of the Trade Department of a Hong Kong-PRC Joint venture company. Earlier he was a Manager of the China National Garment Corporation in Beijing, responsible for economic co-operation with foreign countries, including dealing with export quotas to EEC countries.I accept that as a result of his experience and responsibilities when employed in Beijing, he acquired knowledge of the procedures whereby goods are exported from the PRC to EEC countries. Mr. Chow examined the sample garment Exhibit Dl and was of the opinion that the correct export classification was Category 83. He stated that Categories 5 and 83 cover knitted outerwear and Category 4 was for knitted underwear.In his opinion Category 5 was for heavier more expensive knitted outer garments while Category 83 was for thinner and lower priced knitted outerwear.

31. Mr. Chow was in no doubt that Exhibit Dl was outerwear and not underwear. The appearance of the garment as a sports shirt and the existence of the zipper were among the factors he took into account in making that classification. When it was put to him that a light weight knitted garment might in the tropics be used as outerwear but in colder climates used as underwear, he stated that was not a relevant classification factor. If the garment were an undergarment he agreed that it could not come under Category 83 but was emphatic that the garment was outerwear and that its proper classification was Category 83.

32. The defendant also called Mr. Zang Junwei who formerly lived in Beijing where he was a lawyer but now resides in Hong Kong where he is Deputy-Managing Director of China Legal Service (Hong Kong) Ltd. One of Mr. Zang's duties is to render assistance on legal matters to persons doing business with the PRC. Mr. Zang stated that Mofert is the authoritative government department in the PRC dealing with economic affairs. Mr. Zang had no personal experience of the application of the PRC-EEC Agreement but I accept his evidence that Mofert is the authoritive government department. I also accept his evidence that where there is any conflict between any statement by Mofert and a statement by merely a state trading corporation such as Chinatex, the statement of Mofert prevails.

33. After considering the lengthy and often conflicting evidence on classification under the PRC-EEC Agreement, the position is fortunately tolerably clear. First, the classification of the garments, contractually agreed upon between the parties under the written contract, was Category 4. I am satisfied that when the parties executed the contract they each believed that Category 4 was the appropriate category. Secondly, so far as the PRC is concerned, its official view as declared by Mofert, was that the correct classification is Category 83. Thirdly, the official view of West Germany as confirmed by the documentary evidence, was initially that the correct classification was Category 5.

34. At no stage did West Germany recognise Category 83 as the correct classification. The only qualification to West Germany's initial Category 5 classification was the telex received by the plaintiff from Wachsmuth & Krogmann dated 30th April 1986, that due to overlength the garments could also be classified as Category 4. I record that while at certain stages the plaintiff was prepared to accept Category 5, it never agreed to Category 83. The plaintiff finally insisted on the defendant providing Category 4 quota in accordance with the written contract between the parties.

35. There was also evidence from the plaintiff that the defendant rejected Category 4 as the appropriate classification, and insisted on Category 83 because it was unable to obtain in the PRC adequate supplies of Category 4 or even Category 5. There were also allegations that the defendant's refusal to supply Category 4 was advanced because it was unable to supply the garments up to the standard and quality required by the contract. I reject both these allegations. I am satisfied that the defendant's insistence on the contract being changed from Category 4 to Category 83, was because its PRC manufacturer informed it that Category 83 was correct and the only category for which quota would be approved and issued by the PRC export authority.

The Law

36. Under the contract the clear obligation of the defendant was to supply 146,250 unisex ski turtle neck pullovers together with sufficient Category 4 quota to enable the garments to be shipped from the PRC to Hamburg, West Germany. It is undisputed that the defendant failed to discharge those contractual obligations. I accept Counsel for the plaintiff's submission that in these circumstances, the burden is upon the defendant, to establish that it has been released from those contractual obligations.

37. The defendant in attempting to discharge that burden advanced a threefold defence. First, it submitted that the contract was entered into upon the basis of a common mistake and is therefore void. Secondly, that the contract has been discharged by frustration. Thirdly, if the contract is not void or frustrated, it has been discharged by the plaintiff's breach in failing to furnish a letter of credit within a reasonable time. I will consider each of these defences in turn.

Mistake:

38. The defendant submitted that the contract was entered into on the fundamental assumption that the garments could be exported from the PRC to West Germany under Category 4 in compliance with the PRC-EEC Agreement.Unknown to the parties at the time the contract was executed, the garments to be supplied under the contract, were classified by the PRC under Category 83 and not under Category 4. The defendant submitted that neither the PRC nor West Germany accepted the Category 4 classification agreed upon by the parties.The PRC classified the garments as Category 83 and West Germany classified them as Category 5. The fact that at a later date West Germany was prepared to accept Category 4, as well as Category 5 was, according to the defendant, irrelevant. This was because the garments could only be exported from the PRC under Category 83 but could not be imported into West Germany under that category. In the defendant's submission the parties were blameless. Further it was not open to this Court to go beyond the PRC classification and attempt to determine the correct classification. The ruling by the PRC was beyond the parties control and not reviewable by this Court.

39. The plaintiff considered it essential for the Court to determine the correct classification which it submitted was Category 4. Categories 5 and 83 were limited to outerwear but Category 4 was a wider classification including both outerwear and innerwear. The garments, it was submitted, were clearly not outerwear and so could only fall within Category 4. In any event, it was submitted, the defendant had by entering into the contract assumed the risk that it could supply Category 4 quota. Further, the defendant could have protected itself from that risk by making the contract conditional upon Category 4 quota being available. Finally, it was submitted that any mistake concerned the provisions of the PRC-EEC Agreement which was a question of law and not of fact and therefore could not avoid the contract.

40. I prefer the submission that this Court merely has to consider the legal consequences of the contracting countries classification and does not have to embark upon a classification of the garments. If the Court had to make its own classification determination, then obviously that task is not without difficulty. The confusing classification position which arose is clear from the evidence. All three categories are concerned with knitted non-elastic and non-rubberised garments. Category 5 by implication and Category 83 expressly, cover outerwear. Category 4 includes undervests but also extends to some varieties of outerwear such as shirts, T-shirts, and light weight turtle neck pullovers.I accept that as a matter of trade practice, at least in the PRC, Category 4 is looked upon as principally dealing with underwear, Category 5 with heavier outer knitwear and the residual Category 83 with lighter weight outer knitwear. However, the wider range of Category 4 garments does expressly include light weight turtle neck pullovers which is similar to the contractual description of the garments.

41. The PRC's official ruling was that Category 83 was the correct classification although I recognise that Chinatex, through its Beijing office, at one stage classified the garments as Category 4. There is also the conflicting legal opinions of PRC lawyers. The official PRC view was that the garments were outerwear and fell into Category 83. The overlength of the garments appears to have taken them out of Category 5. West Germany first classified them as Category 5 but after representations, was prepared also to classify them under Category 4. The later classification was less well documented than the former and would contradict the evidence that the categories are mutually exclusive.

42. The overlength,in the case of West Germany, appears to have been the factor which 1ed to the later supplementary Category 4 classification. The garments do include a deliberately designed overlength to allow them to be tucked inside ski-trousers. Perhaps it was this feature, when explained to West German Customs, which resulted in the later varied classification.

43. Mr. Chow's uncontradicted evidence was that classification is carried out by examining the nature of the garment and not its purpose. This objective approach simplifies the difficulties which can arise where a garment which in tropical climates would clearly be outerwear, if used in colder climates, might more often be used as underwear. An inspection of the garment suggests that it is unisex sportswear suitable for use as outerwear. The 9 inch zipper reinforces this assessment. A zipper is not normally used for underwear worn next to the skin. At the same time I take into account that the garment is form fitting and has an overlength suitable for tucking inside trousers.

44. There are clearly features of the garment which point to both a Category 4 and Category 83 classification. There must also be features, less apparent to this Court, which led West Germany to classify as Category 5. The Category 5 classification is at least evidence that West Germany considered the garment outerwear and perhaps was only willing to include it in Category 4, when representations emphasised that it was to be sold for wearing under outer ski clothing. On the evidence I am satisfied that the defendant has established that the Category 83 classification is not necessarily wrong while I am not satisfied that Category 4 is the correct classification.

45. The law is well settled that only in very limited circumstances does mistake result in a contract being void. First, the mistake must be one of fact and not of law. This distinction does not assist the plaintiff's submissions, for any mistake concerning the meaning of PRC-EEC Agreement would involve foreign law. Foreign law in our Hong Kong Courts is a question of fact.

46. Secondly, the mistake of fact must be of the kind recognised by law, as resulting in the contract being void. The present mistake falls into the category which is more aptly described as common mistake. Common mistake occurs where there is no lack of agreement but in arriving at agreement both parties make the same mistake. Common mistake may be contrasted with mutual mistake, where both parties are at cross-purposes and each are mistaken over a different element of the contract. There may also be unilateral mistake, where only one of the parties is mistaken, but that does not arise on the instant facts. Unfortunately the position is at times confusing because, common mistake in a number of textbooks and in even more judgments, is often called mutual mistake, for there is no definitive classification.

47. The law on mistake is also complicated by the fact that the leading case of Bell v. Lever Bros. Ltd. (1932) AC 161 is open to at least two interpretations. The narrower interpretation of the House of Lords decision is that common mistake only avoids a contract, where the mistaken assumption is the existence of the very subject matter of the contract. The wider interpretation of the decision, is that common mistake also avoids a contract where the parties have proceeded on a false and fundamental assumption irrespective of the character of the fact assumed to be true. In the present case the provision of the Category 4 quota was clearly part of the subject matter of the contract.

48. The parties therefore entered into the contract on a false assumption relating to a fundamental element of the contract, namely that Category 4 was the correct category. Counsel for the plaintiff submitted, to the contrary, that the defendant's Mr. Ko was aware at the time the contract was entered into that Category 4 quota might not be correct. If the defendant knew at that time that Category 4 was not accepted by the PRC as the correct category, the defendant could not now claim that it was mistaken. However, Mr. Ko's evidence did not go that far. Before the contract was executed he did have quota discussions with Chinatex but those concerned quota availability not issuability. I find that at the date the contract was executed by the defendant it did not know that the PRC would not issue Category 4 quota for the garments.

49. I am satisfied that the common mistake the parties shared, that Category 4 was the correct classification, was of the kind which falls within both the narrower and wider interpretations of the judgments in Bell v. Lever Bros. Ltd. Lord Warrington at page 206, accepted that a mistake rendered a contract void if it was of the kind described by the trial judge, Wright J., in the following words:

 

"Some mistake or misapprehension as to some facts ... which by the common intention of the parties, whether expressed or more generally implied, constitute the underlying assumption without which the parties would not have made the contract they did."

Lord Thankerton's more precise description of the nature of the underlying assumption is also wider than the more stringent requirement of the non-existence of the subject matter, when at page 235 he declared:

 

“... in my opinion it can only properly relate to something which both must necessarily have accepted in their minds as an essential and integral element of the subject-matter."

Although at certain stages of his judgment Lord Atkin expressed qualifications, generally he accepted the following proposition formulated by Counsel:

 

"Whenever it is to be inferred from the terms of a contract or its surrounding circumstances that the consensus has been reached upon the basis of a particular contractual assumption and that assumption is not true, the contract is avoided: i.e. it is void ab initio if the assumption is of present fact and it ceases to bind if the assumption is of future fact."

50. The present parties contract was dependant upon the PRC granting sufficient quota under a PRC-EEC Agreement category, acceptable to West Germany. One of the express fundamental contractual assumptions, was that the appropriate category to enable the garments to be lawfully exported from the PRC and imported into West Germany, was Category 4. That assumption was wrong. On either of the tests enunciated in Bell v. Lever Bros. Ltd this mistake was of the fundamental kind which avoids the contract. I therefore hold that the present contract, because of the common categorisation mistake of the parties, is void.

Frustration:

51. If I am wrong in holding that the contract is void for common mistake, the defendant relied alternatively on the defence of frustration. There is a close relationship between common mistake and frustration. Common mistake arises where the parties contracted on the basis of some pre-existing mistake. Frustration arises where some subsequent event intervenes, after the contract is formed, which so changes the circumstances, that it is impossible for the contract to be performed in its original form. The test for the application of both doctrines is otherwise the same.

52. Counsel for the defendant submitted that if the contract was capable of being performed at the date of execution, then upon the PRC subsequently refusing to grant Category 4 quota and ruling that Category 83 was the correct classiciation, it was thereby discharged by frustration. Although there are several more modern cases which help to explain the doctrine of frustration, I was referred to the old case of Baily v. de Crespigny (1869) LR 4 QB 180. In that case a lessor covenanted not to allow the erection of any building on a paddock fronting the demised premises. The paddock was later compulsorily acquired and a railway station built on the paddock. The Court held that upon the paddock being compulsorily acquired, it became impossible for the lessor to perform the covenant and it was therefore by operation of law discharged.

53. The related submission was also made that where part of a contract is to be carried out in a foreign country, Hong Kong Courts should not enforce the contract, if it becomes impossible for that part to be performed in the other country. On this point I was referred to Ralli Brothers v. Compania Naviera Sota Y Aznar (1920) 1 KB 287. In that case an English charterparty to be construed according to English law, provided for payment of freight at a rate higher than the maximum freight rates legally permitted under Spanish law. Payment under the contract was to be made in Spain. The Court of Appeal held that the ship owners could not recover from the charterers, freight in excess of the maximum permitted under Spanish law. In the present case, it was submitted, the defendant should not be found to have repudiated the contract when the sole reason why the garments were not shipped from the PRC with a Category 4 quota, was that the PRC refused to grant the quota, ruling that Category 83 was the correct classificiation.

54. Ralli Brothers v. Compania Naviera Sots Y Aznar was also cited as an authority for the proposition that the defendant had not assumed the absolute risk of obtaining a Category 4 quota. In rejecting the ship owners contention that the contract imposed an absolute obligation on the charterers to pay the agreed upon freight, Lord Sterndale MR at page 291 observed:

 

"But I do not think that his contention correctly states the charterers obligation. I think the clauses as to place of payment constitute part of the obligation to pay and are not merely instructions. The contract and the obligation therefore are to pay on delivery in Spain in cash, that is Spanish currency ... it was illegal in Spain to pay or receive more freight for imported jute than 875 pesetas a ton and therefore the performance of the contract was illegal by the law of the place of its performance. In my opinion the law is correctly stated by Professor Dicey in his work on the Conflict of Laws,2nd ed., at p.553 where he says: 'A contract...is, in general, invalid in so far as... the performance of it is unlawful by the law of the country where the countract is to be performed."

I am, of course, not concerned with illegality but with impossibility. But the crucial factor before the Court of Appeal was that the illegality rendered the contract impossible to perform.

55. Counsel for the plaintiff emphasised that frustration can only arise where after the formation of the contract, a change of circumstances intervenes to make performance impossible. On the facts, it was submitted, the defendant knew there was a risk that the PRC would not grant a Category 4 quota, so there had been no post-contract change in circumstances. I accept on the authority of Walton Harvey Ltd v. Walter and Homfrays Ltd (1931) 1Ch 274 that where one party foresaw the risk but the other did not, it will be difficult for the former to claim that the of the risk frustrated the contract.

56. I have already considered a similar submission advanced by the plaintiff in relation to common mistake. I repeat that the enquiries the defendant made before executing the contract were concerned with the availability and not the issuability of Category 4.The evidence indicates that it was only on visits to the PRC after the contract was executed, that Mr. Ko was told that Category 4 was the incorrect Category. I reject the submission that at the time of entering into the contract the defendant foresaw the risk.

57. On the evidence the grant of a Cateogry 4 quota was essential to the fundamental object of the contract, namely the lawful export of the manufactured garments from the PRC to West Germany.The impossibility of obtaining Category 4 quota arose not from any action or default on the part of the defendant but by the extraneous act of a third party, namely, the PRC export authority. These facts satisfy the well settled test for frustration which was restated by Lord Simon in National Carriers Ltd v. Panalpina (Northern) Ltd (1981) 2 WLR 45 in these terms:

 

"Frustration of a contract takes place when there supervenes an event (Without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance."

58. If the PRC's classification ruling were post-contract, then I would alternatively be well satisfied, that the contract had been discharged, not by common mistake but by frustration. In either event the defendant is not liable for further performance.

Breach of contract:

59. The remaining defence was that the contract had been discharged by the plaintiff's breach in failing to furnish a letter of credit within a reasonable time. I confirm that a letter of credit was furnished by the plaintiff to the defendant on 26th February 1986 for the contract sum of US$301,396.88. The conditions of the Letter of Credit substantially corresponded with the provisions contained in the contract. One of the documents required to be produced by the defendant, before the letter of credit could be negotiated, was described as a:

 

"Copy of export licence valid for West Germany Cat. 4."

I also record that the Letter of Credit shipping date, was in more generous terms for the defendant than the contract, permitting shipment between 10th July and 31st July 1986.

60. The defendant on receipt of the Letter of Credit, replied by the telex already referred to raising several matters, largely of a minor nature, except the query in respect of Category 4. Although the defendant raised the possibility of an amendment to Category 83, the plaintiff never agreed to that amendment and the Letter of Credit remained in its original form unaltered. Counsel for the plaintiff citing Soprama s.p.a. v. Marine & Animal By-Products Corporation (1966) 1 Lloyd's Rep 367 submitted that there was nothing in the Letter of Credit inconsistent with the contract or unreasonable.Counsel further submitted that the plaintiff never agreed to any amendment of the Letter of Credit and that the defendant's subsequent requests to change the category number amounted, at most, to counter offers.

61. Counsel for the defendant, after drawing my attention to the fact that the contract included no time clause within which the letter of credit had to be furnished, submitted that in those circumstances it had to be furnished within a reasonable time. In the present circumstances it was submitted that a reasonable time would have been some time before the garments were due to be shipped.The defendant's submissions were based on the allegation that the parties had agreed to amend the contract to Category 83 but no amended Letter of Credit in those terms was ever furnished.

62. I do not need to go on and consider this submission or the several authorities cited, for I am satisfied that there was never any agreement to amend the contract to Category 83.The terms of the Letter of Credit were also consistent with the contract and otherwise reasonable. I am satisfied that if the contract was not void by common mistake or discharged by frustration, the defendant would have been in breach of the contract to supply the garments together with the Category 4 quota.

Conclusion

63. As I have held that the contract was void because of the parties common mistake or in the alternative was discharged by frustration, it is not necessary to deal with the parties further submissions on the position as to damages. If I had found the defendant to be in breach of contract, those submissions were concerned with whether a special condition in the contract for payment of a sum equal to 25% of the contract sum in the event of non-delivery, was agreed liquidated damages or a penalty.

64. In view of my having held that the contract is either void for common mistake or discharged by frustration, the plaintiff's claim for damages founded on that contract must fail. The defendant's counter-claim was also founded on the same contract, and for the same reasons, it too must be dismissed. I will hear the parties as to costs and any other consequential matters for which leave to apply is reserved.