GEALEX TOYS MANUFACTURING CO LTD v. PROMOTIONAL PARTNERS GROUP LTD

HCA2577/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2577 OF 2002

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J U D G M E N T

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THE DISPUTE

1. The plaintiff manufactures children’s toys.  The order, which is the subject matter of this dispute, was to make and supply 250,000 “Star Wars” walkie-talkies for the defendant.  The defendant was an importer and exporter of such merchandise and had a client in the Philippines named “Jollibee” to whom the walkie-talkies were to be sold.  The film “Star Wars II” premiered in the Philippines in May 2002 and these toys were being marketed in advance of the film being screened.  The two walkie talkie hand sets were models of the well known Star Wars stars, “R2D2” and “C3P0”.

2. In a nutshell, the goods were duly manufactured, tested and inspected in Hong Kong and China.  They were then shipped, in 17 separate consignments, to the Philippines.  By two letters of credit, part payment was made by the defendant to the plaintiff.  However, at the end of May 2002, Jollibee complained to the defendant that the goods were defective.  As a result, the defendant failed to make further payment to the plaintiff.  The plaintiff now sues for the unpaid balance.  They deny the goods were defective.  The defendant counterclaims for loss of profits, the cost of settling its dispute with Jollibee and storage charges for the unsold defective goods.

3. The plaintiff’s case is that when the goods were put on board for shipment to the Philippines, they were of merchantable quality and fit for the purpose.  The purpose being a toy for children to play with at home or in an outdoor domestic environment.  The range of the walkie-talkies was specified to be a maximum of 50 feet.  The goods were at the ‘low end’ of the toy market.  The plaintiff suspects, but there is no onus on them to prove, that Jollibee misjudged the market in the Philippines and having ordered too many, exaggerated complaints about the quality of the toys so as to avoid payment for unwanted stock.

4. At trial, the plaintiff called two witnesses as to fact and one expert; the defendant called four factual witnesses and one expert.  Both parties were ably represented by counsel; Mr Anthony Cheung for the plaintiff and Mr Alan Ng for the defendant.

5. The outcome of the dispute depends very largely on findings of fact.  I will state the court’s findings on each of the key factual issues and, in each case, briefly explain the reasoning behind the finding.  The entire story will unfold if I deal with each dispute of fact in chronological order.

Findings of fact

(1)     The defendant played an active role during the manufacturing stage

6. Discussions commenced in mid 2001.  A satisfactory sample was produced in November 2001.  Early negotiations were based on a potential order of 600,000 sets.  The price of US$2.10 was calculated accordingly.  The defendant scrutinized and ultimately approved mock-up samples, clay models, functional models, prototypes, mould tooling charges and costs breakdown, as time went on.

7. In April 2002, after an initial minor problem, the defendant tested and approved six sets which were sent to Jollibee for the purpose of a TV advertisement.  They also, on 25 and 26 April, inspected the manufacturing production lines and selected two approved samples.

8. At each stage the parties progressed without dispute.

(2)     The size of the order dropped significantly at the request of the defendant/Jollibee

9. Mr Henry Chua, for the defendant, said in evidence that his initial target was an order in the range of 600,000 to 800,000.  Ultimately the contract was for 250,000.  The price had been based on an anticipated order of 600,000 in November 2001.  During the first half of 2002, the figure went first from 600,000 to 500,000, then to 300,000.  At one stage, the defendant sought to reduce it again to 200,000, but the parties finally agreed on 250,000.

10. This issue of falling numbers was due to Jollibee.  They had realized they had unsold stock from similar earlier projects.  The plaintiff reluctantly agreed to the downsizing but would not go below 250,000 because they already had purchased materials for such a quantity.  Jollibee’s overestimation of the market was to the plaintiff’s disadvantage because the price had been calculated on the basis of the original figures and, accordingly, their final profit margin was as low as 5%.

11. I find also that Jollibee’s miscalculation of the market was a key factor in the post shipment events to which I turn later.

(3)     Payment by letters of credit was delayed

12. Letters of credit should have been issued, according to the contract, 14 days ahead of shipment.  The defendant did not do so.  However, because of the importance of time and the need to market the toys in the Philippines ahead of the Star War film, the goods were shipped ahead of the issuance of letters of credit.  The two letters of credit which were opened were both late, one on 16 April 2002 and one on 11 May 2002.  No more letters of credit were issued by the defendant because they feared they would not get paid by Jollibee.  The goods, however, had been shipped.

(4)             The toys were tested and inspected before shipment for, inter alia, functionability and appearance.  They passed the standard quality control tests in this regard

13. The dispute in this case is about the toys’ functionability.  They were subjected to and passed testing for functionability before shipment.  The contract specified that the appropriate level of “AQL” (acceptable quality level) was “2.5 and 4.0”.  It is not necessary to elaborate on what this means.  The fact is that the tests were duly carried out in accordance with industry standards.  As a matter of fact, the “AQL” actually applied at the inspection stage was more stringent (namely, “1.0 and 2.5”) than was required by the contract.  The failure rate, even at the higher more stringent level, was very small indeed.  The functionability was satisfactory even at the higher rate.

14. It should be noted that there was another unrelated problem concerning the packaging.  However, this problem is not the subject matter of this dispute and in any event it was remedied.

(5)     Save for one consignment, the acceptance of the goods by the defendant prior to shipment was not conditional

15. The defendant claimed that, regardless of the inspection results, Mr Nelson Ma of the plaintiff agreed that the acceptance by the defendant was conditional on the goods being accepted as merchantable by Jollibee in the Philippines.  I reject this.

16. I do accept that there was a conversation between Mr Ma and Mr Lam of the defendant in relation to conditional acceptance.  This arose specifically because one of the 17 consignments was not inspected and tested.  The defendant, understandably, did not want to accept liability for an untested consignment.  The plaintiff, understandably, did not want to lose time in respect of this untested consignment.  Previous consignments had been satisfactorily tested.  The plaintiff therefore, understandably, was willing to let this particular consignment be shipped untested and was willing to take the risk as to its quality by agreeing to a “conditional acceptance” by the defendant.  There is every reason why Mr Ma would agree to a conditional acceptance in respect of the one untested shipment.  There is no reason why he would agree to conditional acceptance of all the other tested, inspected and certified consignments.

17. The defendant further sought to rely on the words printed on the bottom of the inspection report, namely ;

“…. THIS REPORT DOES NOT RELIEVE SELLERS / MANUFACTURERS FROM THEIR CONTRACTURAL LIABILITIES OR PREJUDICE BUYER’S RIGHT FOR COMPENSATION FOR ANY APPARENT AND/OR HIDDEN DEFECTS NOT DETECTED DURING OUR RANDOM INSPECTION OR OCCURRING THEREAFTER. ….”

18. For two reasons this does not advance the defendant’s case.  Firstly, the effect of this small print has to be weighed against the evidential fact that not only were the inspections carried out in accordance with approved industrial standard but also that the certificates of satisfactory quality were in fact issued to the knowledge of the defendant.  Secondly, the court’s findings in relation to the events in the Philippines, to which I now turn, do not assist the defendant and thus the applicability of this exemption clause, if any, is not triggered in any event.

(6)     The tests carried out in the Philippines were flawed and should not be relied on

19. In late May or early June 2002, after 233,376 sets had been shipped, the defendant was informed by Jollibee that there was a 7% failure rate of the goods and that payment would not be made.  As a matter of urgency, it was agreed that representatives of the plaintiff, the defendant and Jollibee would meet and carry out further tests and inspections in the Philippines.

20. I reject the defendant’s claim that the plaintiff attended these tests as a party to an agreement that the plaintiff would be liable if a failure rate of 5% or worse resulted.  There was no reason for Mr Ma to agree to such terms.  He had completed his part of his contract when the goods were shipped.  He had no control over the goods thereafter.  I accepted his evidence that he went to the Philippines as an interested party, to witness the testing and to offer assistance.  Had his participation been any more than that he would have taken the company’s quality controller, which he did not do.

21. On arrival in the Philippines, in the first week of June, they were shown 98,000 sets of walkie-talkies stored in a warehouse.  The other 135,376 sets had been delivered to retail outlets and played no further part in this case.

22. A sample of 500 sets was duly and properly extracted from the 98,000.  This apart, Mr Ma had every reason to complain about all the other circumstances of the testing and he did.

23. The box containing the handsets states “Keep in a dry place”.  The temperature in the warehouse was approaching 35º Celsius, there were no windows, it was June near the Equator.  The warehouse itself was a metal building and there were many antennae and other sources of electronic interference scattered about.  The building was on a quayside in an industrial area and the tests were carried out inside, not outside, the building.  All these matters were legitimate causes for complaint which went unheeded by the Jollibee staff who carried out the tests.

24. In the afternoon, 50 of the 500 were tested.  Only 20% were found to work satisfactorily.  As far as Jollibee was concerned, that was the end of the matter.  Both Jollibee and the defendant declined the plaintiff’s request to conduct the tests in a sensible location.

25. Undeterred, Mr Ma and his staff took the 40 “defective” sets to another location and conducted their own tests.  Jollibee did not attend and the defendant’s staff chose to look on from a distance.  The sets worked satisfactorily when tested by the plaintiff.  The result was conveyed to the defendant but the defendant chose not to tell Jollibee.

26. The defendant chose to accept Jollibee’s rejection based on the flawed and unfair test carried out in the warehouse.  Surprisingly, they accepted the rejection of not only the 98,000 in the warehouse but also of the balance which had gone out to the shops and have not been seen since.  The uselessness of the test is emphasized by the fact that Jollibee’s original complaint related to a 7% failure rate whereas the warehouse test result was an 80% failure rate.

27. The above findings are the key issues of fact.  Both sides also called an expert witness.  The court’s findings in relation to the expert evidence fortifies the overall conclusion that in almost every respect the plaintiff case is to be preferred to that of the defendant.

Expert evidence

28. In February 2003 “Intertek Testing Services” carried out a test of the 98,000 sets of walkie-talkies which had lain idle in the same warehouse since June 2002.  Ms Raquel Lejarde-Sese gave evidence and produced her company’s report.  A sample of 500 sets were taken or tested in four different locations, 2,000 tests in all.  They reported a failure rate of over 50% and concluded that “Items did not meet the required AQL at all conditions”.

29. In November 2003 “Poly U Technology & Consultancy” carried out tests on the 40 “defective” sets which the plaintiff had brought back to Hong Kong after the June 2002 testing in the Philippines.  Unlike the 98,000 these had not been stored in a hot and humid warehouse in the interim.  Dr Mark Ho gave evidence and produced his report.  The report’s executive summary contains the following remarks :

“The tests carried out on the walkie-talkie sets in the report focused on their communication quality, vulnerability to interference and electrical properties; and offered an objective performance evaluation on the basis of technical measurements, in addition to human sensory judgement.  This report thus does not comment on product aesthetic, safety standards or package requirements.

The results from this study point to the conclusion that the walkie-talkie samples under test meet the requirement of reasonable communication quality with 50-feet distance when subjected to human audio and audio frequency tests in an open-space environment.  An operable walkie-talkie set may find its communication quality deteriorating in an enclosed environment with substantial electrically-earthed installation, in the presence of external electromagnetic transmitter with similar transmission frequency, or the use of weak batteries.

It should be noted that the authors of the report were made aware of the existence of a report on the quality of the walkie-talkie sets from the Defendant.  However, the authors chose not to read the report before and during the preparation of this report.”

30. For the following reasons the plaintiff’s expert evidence is preferred.  The weight I am able to attach to Dr Ho’s evidence and report adds compelling support to the plaintiff’s contention that the toys were of merchantable quality when they were shipped and that no reliance can be put on the June 2002 testing by Jollibee.

(a)    Dr Ho’s expertise was superior.

According to his report he is :

“… specialised in railway signalling, which heavily involves telecommunication, analogue and digital circuit design and testing; and electromagnetic compatibility.  He is a Chartered Engineer and he was the member of the Electrical & Mechanical Training Board of the Vocational Training Council.”

He possesses six relevant professional qualifications.

Ms Lejarde-Sese had some experience in quality control but her academic background was in business administration and chemistry.

(b)    The defendant’s expert’s method of testing was more subjective.  The team of four simply took the samples to different locations and made a personal judgment on what they heard.  Dr Ho however conducted very thorough laboratory tests and produced far more detailed and scientific results.

(c)    The defendant’s sample had been stored in the same hot and humid conditions for eight months.

(d)    Although he concentrated his testing on a small sample the results are more reliable.  Ms Lejarde-Sese and her team admittedly tested all 500 sets but in the overall time spent on the exercise the time spent on each set at each location could not have been more than one to two minutes per pair of walkie-talkies.

(e)    Dr Ho impressed me as an expert and his evidence assisted the court in coming to its conclusion in the plaintiff’s favour.

The legal consequences

31. The legal consequences which flow from the above findings of fact and evaluation of experts are as follows :

(a)    The terms of contract as evidenced by the revised purchase order dated 26 April 2002 were complied with by the plaintiff.

(b)    The defendant accepted the inspection certificates of the goods prior to shipment save in respect of one consignment of approximately 1,400 sets.  That consignment was never subsequently separately inspected or tested.  It has no bearing on the defendant’s overall liability.

(c)    In any event, by virtue of section 37(1) of the Sale of Goods Ordinance, Cap.26, “acceptance” has been proved.

(d)    The plaintiff’s decision to attend the testing in the Philippines has no effect on the defendant’s liability to pay for the goods in full.

(e)    The defendant has failed to establish any breach of contract on the part of the plaintiff.

(f)    Whether or not the Terms and Conditions which appear in minute print on the reverse of the Purchase Order were incorporated into the contract need not be addressed because, in any event, they have not been breached.  Even if the issue did arise the defendant would face two difficulties.  Firstly, the relevant purchase order was only faxed to the plaintiff in the first instance.  Thus they received only the details of the order on the front page.  The original, with the Terms and Conditions on the reverse side, was not posted until after the shipments had commenced and after the deal has been struck.  Secondly, the Terms and Conditions are in such small print that they are almost illegible.  The photocopy is illegible.  The defendant’s solicitors felt it necessary to provide a magnified copy for the court bundle.  It was magnified by a factor of four for the purposes of being readable.

Conclusion

32. There will be judgment for the plaintiff on the claim in the sum of US$143,003.88 plus interest at the rate of 8.125% from 16 August 2002 to the date of this judgment and thereafter at judgment rate until payment.  The defendant’s counterclaim is dismissed.  The costs of and occasioned by the action will be to the plaintiff, to be taxed if not agreed.