CAMEWOULD ELECTRICAL LTD. v. EUREKA MANUFACTURING CO LTD.

DCCJ 8750/2001

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 8750 OF 2001

________

_________

_________

JUDGMENT

_________

1. The plaintiff sold and delivered to the defendant certain heating elements. These heating elements, referred to as heating tubes during the trial, were to be used in the manufacturing of grill pans by the defendant.

2. The plaintiff issued two invoices to the defendant on 31st August 2000 and 30th September 2000 for USD 1,227 (HK$9,570.60 @ 7.8) and USD 6,930 (HK$54,504) respectively for the heating tubes. Apart from a payment of deposit in the sum of USD 3,765, the invoices have not been settled.

3. The plaintiff now claims against the defendant the sum of HK$63,624.60 being the outstanding balance under these invoices.

4. The defendant denies it is liable to pay the plaintiff and alleges that the heating tubes were neither merchantable nor fit for the purpose for which they had been bought, it counterclaims for wasted expenditures as a result of the defective heating tubes.

5. In its re-re-amended Counterclaim the defendant claims for the costs for product development, tooling costs and loss of agreement with the sub-buyer of the grill pans totaling USD 454,843.98. At the hearing the counterclaim was confined to tooling costs in the respective sums of HK$334,000 and RMB 94,000.

Background facts

6. The plaintiff is a manufacturer and supplier of electrical components including the subject heating tubes. The defendant is a manufacturer of electrical appliances for export to Europe and North America.

7. In about June 2000 the defendant entered into two agreements with a company in Switzerland called Iglu ("Iglu") whereby the defendant would manufacture and supply to Iglu grill pans called "Fornello" and "Ottimo" respectively. The Fornello (D1) and the Ottimo (D2) are portable grill pans that can be used at the dining table for grilling food such as cheese.

8. Under the agreements, Iglu would order from the defendant a specified number of Fornello and Ottimo over the course of ten years beginning from 2000 until the end of 2011. In return Iglu would have the exclusive rights to sell and distribute the Fornello and Ottimo in Switzerland whilst the defendant's rights to sell and distribute, subject to the payment of royalty, were outside Switzerland. The defendant was responsible for the respective tooling costs for the Fornello and the Ottimo under the terms of the agreements.

Purchase Orders

9. Sometime in August 2000 the founder and the director of the plaintiff, Mak Hing Chung ("Mak"), approached the defendant's Tam Sze On ("Tam") offering to sell the plaintiff's heating tubes to the defendant.

10. The meeting between Mak and Tam culminated in purchase orders being placed by the defendant with the plaintiff on 16th August 2000. The order was for 7,000 units of model nos. F-0010 and 0-0020 heating tubes respectively. F-0010 are "M-shaped" whilst 0-0020 are "U-shaped" heating tubes. F-0100 (P2) was subsequently used in the Fornello whilst 0-0020 (P1) was used in the Ottimo. I shall refer to F-0010 as the Fornello heating tubes and 0-0020 as the Ottimo heating tubes.

11. The plaintiff delivered 3,840 Fornello heating tubes and 3,300 Ottimo heating tubes to the defendant on 30th August 2000 and 25th September 2000 respectively. These heating tubes were subsequently used by the defendant to manufacture the 2,920 units of Fornello and 3,078 units of Ottimo that were shipped to Iglu in October 2000 ("the October shipment").

12. The unused Fornello and Ottimo heating tubes were kept at the defendant's warehouse in China.

Complaints

13. According to Tam, in November 2000 the defendant carried out hi-pot test on a single sample grill pan. The sample was made pursuant to the request of Iglu who needed it for marketing purpose. It would be sent by airfreight thus ensuring its arrival before the October shipment. A hi-pot test is a test carried out to check the insulating property of an electrical appliance. An appliance with current leakage is said to have hi-pot or to have failed the hi-pot test.

14. The sample grill pan tested in November 2000 failed the hi-pot test. A second hi-pot test conducted on the same sample grill pan after its heating tube was replaced did not produce a hi-pot result. This led Tam to conclude the heating tube to be the cause of the hi-pot. However Tam says the defendant could not do anything since the October shipment was in transit to Iglu. In the meantime the defendant hoped the hi-pot result of the sample grill pan was merely an isolated incident. This explains why the defendant did not alert the plaintiff of the hi-pot result.

15. Mr. Koo (for the plaintiff) submits that the hi-pot test in November 2000 did not take place and was fabricated by Tam. Mr. Koo cited the lack of report or documents on the test, the fact that the test was not pleaded prior to the re-amended Defence and Counterclaim and the fact that there was no reason to conduct such a test since the October shipment was already on its way to Iglu, as evidence that the test did not take place. In addition he also relied on the defendant's failure to take any remedial action after the alleged November 2000 test as evidence that the test was fabricated by Tam.

16. Whether or not the test in November 2000 took place, like other issues in this case, is dependent upon my assessment of Tam's evidence. I find Tam to be a credible and reliable witness. He impressed me to a person with integrity who was more concerned with the quality of his goods than the money to be made from the transaction. I accept his evidence that a hi-pot test was conducted on the sample grill pan in November 2000 with hi-pot result. There was no reason for Tam to invent this test if it did not take place.

17. Given the test in November 2000 was on a single sample only, the lack of a test report is not surprising. Tam explained he was involved in the test it was therefore not necessary for a report to be prepared for himself. By November, the October shipment was already in transit to Iglu, short of recalling the entire shipment or asking Iglu to return the all the Fornello and Ottimo in the October shipment, I cannot see what the defendant could realistically have done.

18. I accept Tam's explanation that it was the defendant's practice to carry out quality control test before a sample product is sent to client. This explains why a hi-pot test was carried out on the sample in November despite the goods having been shipped in October.

19. Tam says he first learnt that there were problems with the October shipment when he attended a trade fair in Paris during the first quarter of 2001. Iglu had complained to him of current leakage in the Fornello and the Ottimo.

Events subsequent to complaints

20. In April 2001 Iglu returned four sets of grill pans with current leakage problems to the defendant.

21. Having received the grill pans, the defendant informed the plaintiff by a fax dated 9th April 2001 inviting the latter to inspect the returned goods. It is apparent from this fax that the defendant had previously given notice to the plaintiff with regard to problems with the heating tubes. The fax was written by the defendant's Mr. Ng and was addressed to Mak and a Mr. Wai. Mr. Ng has made a witness statement and was originally a witness for the defence. However shortly before this trial, Mr. Ng was taken ill and was unable to attend court. The defendant has elected to proceed with the trial without the evidence from Mr. Ng.

22. By a fax dated 18th April 2001 the plaintiff suggested the hi-pot problem would be resolved if the grill pan was left on for a few minutes so that moisture would be absorbed. The plaintiff also attributed the lapse of time to be the cause of the hi-pot.

23. Subsequent to the plaintiff's fax of 18th April 2000 there was an attempt by the defendant to resolve the matter but to no avail. Thereafter communication between the parties ceased.

24. In the meantime, Tam says the defendant and Iglu were negotiating as to who should bear the costs of returning the defective Fornello and Ottimo. The negotiations were without success. The last that the plaintiff heard from Iglu was its fax dated 9th July 2001 advising the defendant of its intention to return the Fornello units. Notwithstanding the terms of the agreements with Iglu requiring written termination, Tam says the defendant did not receive any further orders from Iglu for the Fornello or Ottimo. This is not surprising given the problems with the current leakage in respect of the grill pans shipped in October 2000.

25. Under the circumstances I find there is no prospect of Iglu placing any further orders for the Fornello or Ottimo with the defendant.

Issues

26. The following are the main issues in this case:-

a. Did the plaintiff know the intended use for which the heating tubes were purchased?

b. Did the defendant rely on the plaintiff's skill and judgment to supply heating tubes reasonably fit for the purpose for which they were purchased?

c. Were the heating tubes defective, unmerchantable and unfit for purpose?

d. What, if any, loss has the defendant suffered as a result of any defective heating tubes.

e. Is the plaintiff entitled to payment notwithstanding any defective heating tubes?

Knowledge of intended use

27. On the evidence, I find the plaintiff knew the intended use for the heating tubes purchased by the defendant. Tam says during the first meeting with Mak he had shown Mak a prototype of the Fornello and had told Mak that the heating tubes to be ordered from the plaintiff were for grill pans to be exported to the European countries.

28. Mak denies having seen the Fornello prototype nor being told the intended use of the heating tubes. Mak further denies having any knowledge that the end products for which the heating tubes were required were destined for Europe. Nevertheless Mak says, from experience, he had expected the heating tubes would be used for electrical appliances such as grill pans, cooking devices or heating devices.

29. Mak says the defendant wrongly secured the flange too closed to the end of the heating tube thereby causing cracks in the sealant. A cross-section of the heating tube drawn by Mak (P4) shows the sealant to be the material sealing the ceramic (the end of the tube) to the inner metallic sheath of the heating tube. According to Mak the moisture in the cracks of the sealant resulted in the hi-pot situation. The solution, Mak suggested, was to store these heating tubes in a "dry and cold place" or leave the tubes on for a few minutes to "evict the moisture" trapped.

30. Whilst acknowledging the possibility of hi-pot or current leakage during the few minutes he advised the tube should be left on to "evict the moisture" within the cracks, Mak considers this to be a satisfactory solution to the problem of hi-pot. He did not think an electrical appliance that failed a hi-pot test is necessarily dangerous to the end user because, he says, the sensitivity of hi-pot test meant that the user might not necessarily detect the current leakage. It is perturbing, to say the least, that a manufacturer of electrical components such as Mak could be so nonchalant about the potential consequences of hi-pot in his products.

31. In as much as I find Tam to be an honest, truthful and credible witness whose concern for the quality and safety of his goods takes priority over all other considerations, I find Mak to be the contrary. Where their evidence is at variance, I have no hesitation in preferring and accepting the evidence of Tam to that of Mak.

32. Given the fact that that was the first meeting between the parties, Mak must have been keen to forge a business relationship with the defendant. Even assuming that he was not so informed by Tam, it is most unlikely that he would not have enquired about the defendant's businesses and its market. In addition it is inconceivable that Mak would not have ascertained from Tam the type of appliances for which the heating tubes were intended for.

33. I therefore find that the plaintiff knew the heating tubes to be supplied to the defendant would be used in grill pans like the Fornello and Ottimo for export to Europe. I agree with Mr. Chin that an electrical appliance with 230V almost inevitably means that it is destined for use in Europe. It is unlikely that Mak, with his experience, would not have been alerted to this fact and thus be made aware for the need to comply with the requisite international standard. I am also satisfied that Mak was shown the prototype of the Fornello and was aware of the defendant's agreement with Iglu.

Reliance on plaintiff

34. Section 16(3) of the Sales of Goods Ordinance, Cap 26 provides as follows:-

"Where the seller sells goods in the course of a business and the buyer expressly or by implication, makes known to the seller any particular purpose for which the goods are being bought, there is an implied condition that the goods supplied under the contract are reasonably fit for that purpose, whether or not that is a purpose for which such goods are commonly supplied, except where the circumstances show that the buyer does not rely, or that it is unreasonable for him to rely, on the seller's skill or judgment."

35. Under cross-examination Mak admitted that the defendant had relied on the plaintiff's skill and judgment in the production of the heating tubes. In re-examination he sought to qualify his admission by claiming ignorance of the designs of the Fornello and Ottimo.

36. I have already found that Tam had shown Mak a prototype of the Fornello during their first meeting and that Mak knew the nature and the design of the appliances for which the heating tubes were required.

37. That the defendant was entitled to rely on the skill or judgment of the plaintiff is supported by the fact that the defendant supplied the plaintiff with the requisite technical specifications for the heating tubes without participating in their production.

38. The fact that the plaintiff had advised the defendant to lengthen the cold pin of the Fornello heating tube as the original length specified by the defendant might cause current leakage or pierce through the end of the tube is also indicative of the defendant's reliance on the plaintiff's skill or judgment in the production of these tubes.

39. Since Mak attributes the incorrect position of the flange on the heating tube to be cause of hi-pot result, I agree with Mr. Chin that the plaintiff should have given recommendation or instructions on the installation of these tubes to the defendant.

40. The fact that the defendant had carried out hi-pot test after taking delivery of the heating tubes did not negate the defendant's reliance on the plaintiff's skill and judgment: Benjamin's Sale of Goods, 6th edition para 11-09.

41. In the circumstances I am satisfied that the defendant had relied on the plaintiff's skill and judgment to supply heating tubes reasonably fit for use in grill pans like the Fornello and Ottimo. There is nothing in the evidence to bring the defendant within the exception in section 16(3) of the Ordinance. Accordingly I find that there was an implied condition as to fitness for purpose.

Whether defective, unmerchantable and unfit for purpose

42. At the end of May 2001 the defendant sent ten respective Fornello and Ottimo heating tubes to SGS Hong Kong Ltd ("SCS"), a surveyor of electrical appliances, for hi-pot test. The heating tubes were obtained from the unused batch stored at the defendant's warehouse in China.

43. The test conducted by SGS on the twenty samples on 1st June 2000 revealed a 30% hi-pot whilst a second test of the same samples carried out between 4th to 8th August 2001, under conditions prescribed by the European Standard (EN60335-1), revealed 100% hi-pot.

44. Tam Chi Chuen, staff of SGS responsible for the testing of the twenty heating tubes, gave evidence that he had carried out visual inspection fo the twenty tubes delivered by the defendant and found them to be in a normal and satisfactory condition. He was certain that there was no evident dent or scratch mark on the tubes that might affect the tests to be carried out on them.

45. The plaintiff challenged the reliability of the tests by SGS on the basis that considerable time have elapsed between the delivery of the heating tubes to the defendant and the test carried out by SGS. The plaintiff claims the tubes used in the test must have been installed and subsequently removed from the grill pans, dropped, have cracked resin or tampered with. The plaintiff also questions the cleanliness of these tubes suggesting the presence of dusts adversely affecting the test result.

46. It is to be noted that despite the plaintiff's speculative concern as to the condition of the twenty heating tubes used by SGS in the tests, it has never requested for their inspection. It was only after the end of Mak's evidence that Mr. Koo applied to inspect the twenty heating tubes. The application was refused, the heating tubes having been returned to Mr. Ng of the defendant upon completion of the tests by SGS, Tam was unable to say how the tubes have been handled or dealt with since.

47. I am satisfied on the evidence that the heating tubes used by SGS in the tests had not been previously installed to flange or grill pans nor were their condition such as to have any effect on the hi-pot test. It follows that I accept the findings of SGS with respect to the hi-pot results in the heating tubes.

Defendant's loss

48. The defendant is counterclaiming for wasted expenditures incurred for the tooling costs for the Fornello and Ottimo. The basis of the counterclaim is that money so expended had been wasted given the cessation of orders from Iglu.

49. On Tam's evidence, Iglu had to the defendant the purchase price for the Fornello and Ottimo contained in the October shipment. Despite the problem with current leakage, Iglu has so far not demanded the repayment of the purchase price.

50. In the circumstances, the defendant's counterclaim for tooling expense should take into account the pro-rata tooling costs in respect of the Fornello and Ottimo in the October shipment.

51. The tooling costs incurred for the Fornello were HK$110,000 (Bundle B p33) and RMB 69,500 (Bundle B p 39). Using the agreed exchange rate of HK$1 to RMB 1.05, the total tooling costs for the Fornello in Hong Kong currency would be HK$176,190.48.

52. The tooling costs incurred for the Ottimo was HK$114,000 (Bundle B p41), RMB 24,500 (Bundle B p39) and HK$110,000 (D5). Again, using the agreed exchange rate of HK$1 to RMB 1.05 the total tooling costs for the Ottimo in Hong Kong currency would be HK$247,333.33.

53. Had the agreements with Iglu not come to a premature end, the moulds for the Fornello and Ottimo would have been used to produce the Fornello and Ottimo over a period of ten years. Although the agreement with Iglu in respect of the Ottimo had been lost Tam says the terms were identical to that for the Fornello. Under the respective agreements, Iglu would have ordered a minimum of 6,000 units of Fornello and Ottimo respectively in the first year and 3,000 units of Fornello and Ottimo respectively for the remaining nine years. This translates to a total of 33,000 units of Fornello and Ottimo respectively in the course of ten years.

54. The October shipment contained 2,920 units of Fornello and 3,078 units of Ottimo. This represents about 9% of the Fornello and Ottimo respectively the defendant would have manufactured over ten years had the agreements with Iglu continued.

55. The pro-rata tooling costs for the Fornello in the October shipment would be HK$15,857.14, being 9% of HK$176,190.48 so that the wasted tooling costs in respect of the Fornello would be HK$160,333.34 (HK$176,190.48 less HK$15,857.14).

56. The pro-rata tooling costs for the Ottimo in the October shipment would be HK$22,260, being 9% of HK$247,333.33 so that the wasted tooling costs in respect of the Ottimo would be HK$225,073.33 (HK$247,333.33 less HK$22,260).

57. In his opening and final submissions, Mr. Chin also sought to recover the sum of HK$92,991.60. This is the price (including the deposit paid by the defendant) for the heating tubes delivered to the defendant. Apart from the fact that this item does not appear in the defendant's pleadings, recovery of this sum would mean double compensation for the defendant as the latter had already been paid for the Fornello and Ottimo for which these heating tubes were used. Therefore I reject the counterclaim for this sum.

Plaintiff's entitlement to payment

58. Mr. Chin argues the heating tubes are of no value given their defects therefore the plaintiff is not entitled to its claim.

59. I am unable to accept such an argument in light of Tam's evidence that the defendant had been paid for the Fonello and Ottimo in the October shipment notwithstanding the hi-pot problem.

60. Regardless of the complaints of current leakage and despite Iglu's termination of relationship with the defendant, the fact remains that the defendant had been paid for the grill pans in which the Fornello and Ottimo heating tubes installed. Therefore the defendant is liable to pay the plaintiff the outstanding balance of the invoices.

Order

61. In conclusion I would give judgment for the plaintiff's claim in the sum of HK$63,624.60 plus interest thereon at the commercial rate of 1% above prime from the date of issue of writ until judgment and thereafter at judgment rate until payment.

62. There will be judgment for the defendant on the counterclaim in the sum of HK$385,406.70 plus interest at the commercial rate of 1% above prime from 15th June 2001 (the date of the Defence and Counterclaim) and thereafter at judgment rate until payment.

63. I make an order nisi that the plaintiff is to have the costs of the claim and the defendant is to have the costs of the counterclaim.

64. Given the fact that virtually the entire trial was taken up by issues relating to the counterclaim I make an order nisi that the defendant is to have the costs of the trial with certificate for counsel. This is notwithstanding the fact that the defendant is awarded 75% of its counterclaim since the deductions made to the defendant's counterclaim were on matters which did not take up any of the trial time.