CANNING INTERNATIONAL LTD v. FREENET ASIA LTD

DCCJ 433/2010

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 433 OF 2010

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J U D G M E N T

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1.  The Plaintiff (“Canning”) commenced the present action for outstanding cost of goods sold and delivered at the request of the Defendant (“Freenet Asia”) in 2009. Freenet Asia raises the defence of, among others, delay in delivery; and claims damages.

Background

2.  Canning is a garment manufacturer in Hong Kong.  Freenet Asia in Hong Kong and its associated company in Italy, Freenet Fashion s.r.l. (“Freenet Fashion”), trade in garment.  Since about 2007, Freenet Asia and Freenet Fashion had placed orders for garment to be manufactured and sold by Canning for their customers in Italy.  At the material time, the persons in charge of Canning and Freenet Asia were Carl He (“Carl”) and Livio Pigozzo (“Pigozzo”) respectively.

3.  The dispute arose out of the delivery of the garments by Canning ordered by Freenet Asia for fall-winter season of 2009 (“FW09”).  Part of the garments was shipped between June and August 2009 after the dates of delivery as per the purchase orders.  Due to the delay, Freenet Asia requested the goods to be shipped to Italy by air instead of by sea; and Canning agreed to bear 50% of the air freight.  The share of air freight was reflected by reduction in the FOB unit prices of the goods under the subsequent invoices from Canning.

4.  Nevertheless, Freenet Fashion eventually refused to settle various invoices from Canning on the basis of the delay in delivery and short shipment.  These outstanding invoices form the major part of Canning’s claim:

5.  When the trial began, Mr Fung for Freenet Asia conceded that his client had accepted the garments delivered under the invoices in question; and therefore Canning is entitled to the amount of the invoices.  Freenet Asia now seeks to set off the amount by the amount of the counterclaim.

6.  Among the above invoices, delivery of the garments under INV-974 and INV-977 were covered by letters of credit whereby Canning was supposed to get paid.  Due to the delay, the letters of credit had already expired by the time when the documents were presented to the banks for payment after the shipment.  The bank refused to honour the letters of credit and rejected the documents presented.  Upon that, Canning was charged by the banks a total sum of US$582.92.  This forms the other part of Canning’s claim.

7.  Freenet Asia disputes Canning’s entitlement to claim for damages representing the above bank charges.  As pleaded, Freenet Asia attributes the refusal of the bank to honour the credit to firstly the late delivery and secondly quality problem.

8.  Freenet Asia has allegedly suffered loss and damage being the amount of the contractual penalty for delay in delivery that was invariably stipulated in the purchase orders placed with Canning.  This forms the first and major part of the counterclaim.

9.  Upon the cessation of business relationship between the parties, Freenet Asia had also demanded but Canning refused to hand over the paper patterns and prototypes of the garments that had been developed.  The second part of the counterclaim is the alleged cost of redeveloping the paper patterns and prototypes in Italy.

10.  Freenet Asia has issued to Canning 2 debit notes both dated 29 September 2009: DN-0046/09 for the penalty in the sum of US$96,366.54; and DN-0047/09 for the cost of redeveloping the paper patterns and prototypes in the sum of US$77,462.92.

11.  The last and the minor part of the counterclaim is for the reimbursement of the cost of materials and accessories that Freenet Asia has purchased for Canning earlier in 2009, for which Canning is said to be responsible.  The sum involved is HK$555.  This Canning in fact conceded by pleading; and is therefore not in issue.

The issues

12.  I have to determine the dispute in respect of:

(1) the delay in delivery;

(2) the short shipment;

(3) the bank charges incurred by Canning;

(4) the loss and damage suffered by Freenet Asia (including the issue of the contractual penalty); and

(5) the right in the paper patterns and prototypes (and thus the alleged cost of redeveloping them).

The delay in delivery

13.  Freenet Asia’s claim for delay in delivery relates to 3 purchase orders for various styles of garments for FW09, namely PO 42 for Toy G; and PO 43 and PO 44 for Pinko Black.  The delivery terms under the purchase orders were invariably “FOB Hong Kong”.  The shipment mode under PO 42 was by sea or by air while that under the other 2 purchase orders was by sea.

14.  The deliveries are evidenced by 8 invoices issued by Canning.  There is no dispute that the deliveries took place after the dates of delivery stipulated in the purchase orders.

15.  The correspondence show that by late June 2009, the parties were expecting to deliver the garments under PO 42 by the end of June 2009; and the garments under PO 43 and PO 44 in 2 lots by the end of June and 10 July 2009 respectively.

16.  As a result of Canning’s delay, Freenet Asia by email in mid-July 2009 informed Canning that the customer required all the garments yet to be delivered to be shipped by air.  This Canning eventually did during the period between late July and mid-August 2009.  The last delivery took place on 20 August 2009.

17.  Freenet Asia has set out its calculation of, among other things, the extent of the delay in a document known as ‘Appendix B’ [*] and hence its debit note DN-0046/09.  The calculation reflects a comparison between the delivery dates specified in the purchase orders and the actual delivery dates:

Invoice No.	PO delivery date ex HK	Actual delivery date ex HK	Length of delay
INV-0961	30/6	27/7	20
INV-0913	30/6	24/7	17
INV-0963	10/7	5/8	19
INV-0962	10/7	31/7	14
INV-0949	10/7	24/7	7
INV-0974	10/7	20/8	33
INV-0976	30/6	5/8	29
INV-0977	30/6	14/8	38

18.  However the comparison failed to take into account the significant difference in the transportation time and thus the time of arrival by the 2 modes of shipment.  Indeed according to Carl, garments shipped by sea would have arrived at Italy in about 22 days whereas shipment by air only took a day to arrive.  In his statement and in court, Pigozzo also confirmed that shipment by air would save transportation time by over 20 days compared to shipment by sea.

19.  In other words, mere comparison of the delivery dates as per the purchase orders and the actual delivery dates is fair and correct only if the mode of shipment remained unchanged.  Otherwise, deliveries after the delivery dates as per the purchase orders might well lead to no actual delay if the delay could be compensated by the air shipment.  This was probably what Freenet Asia intended to achieve when they requested air shipment in mid-July 2009.

20.  On this basis, Carl calculated the extent of the real delay, which I consider to be fair in the circumstances:

Invoice No.	PO delivery date ex HK	Expected arrival date in Italy if shipped by sea	Actual delivery date ex HK	Expected arrival date in Italy by air	Delay
INV-0961	30/6	22/7	27/7	28/7	6
INV-0913	30/6	22/7	24/7	25/7	3
INV-0963	10/7	1/8	5/8	6/8	5
INV-0962	10/7	1/8	31/7	1/8	0
INV-0949	10/7	1/8	24/7	25/7	0
INV-0974	10/7	1/8	20/8	21/8	20
INV-0976	30/6	22/7	5/8	6/8	15
INV-0977	30/6	22/7	14/8	15/8	24

The short shipment

21.  As to the short shipment, the complaint is about 168 pieces of one style of garments for FW09 for Pinko Black.  The quantity ordered under PO 44 was 1,190 pieces whereas the quantity shipped was 1,022 pieces (as evidenced by Canning’s invoice INV-963 dated 12 August 2009).

22.  It can be seen that by INV-963, Canning indeed billed Freenet Asia for the price of 1,022 pieces of that style of garments for Pinko Black actually shipped.  The invoiced amount was settled by Freenet Asia on 20 October 2009.

23.  That Freenet Asia has never paid for the 168 pieces not actually shipped is one question.  Whether it is entitled to the damages claimed as a result of such short shipment is another question that will be discussed below.

The bank charges incurred by Canning

The letters of credit (“LC”)

24.  2 LCs were involved, both drawn by the customer of Freenet Asia.  Freenet Asia was the first beneficiary and Canning was the secondary beneficiary of the LCs.

25.  The first LC covered the garments ordered for Toy G to be shipped on or before 30 June 2009. The relevant purchase order from Freenet Asia was PO 42 dated 22 May 2009.  For payment, the documents prescribed by the LC should be presented after shipment and before the LC expired on 10 July 2009.

26.  The second LC covered the shipment of the second lot of garments ordered for Pinko Black on or before 10 July 2009.  The relevant purchase order was PO 44 dated 18 June 2009.  The documents prescribed by the letter should be presented for payment after shipment and before the LC expired on 20 July 2009.

27.  Under both LCs, partial shipment was permitted.

28.  Due to the delay, when the garments covered by the LCs were shipped, the LCs had already expired.  The bank refused to accept Canning’s presentation of the documents.

29.  Canning is contending that Freenet Asia should have caused the LCs to be honoured notwithstanding the late shipment and the expiry of the LCs.  Failing to do so, Freenet Asia was liable for the consequential loss and damage to Canning including the bank charges.

30.  The crux of the matter is whether there was any consensus between the parties that after shipment, though later than the delivery dates specified in the LCs, Canning was nevertheless expected to present the documents for payment by way of the LCs.

Payment under the first LC

31.  Freenet Asia had arranged the garments under PO 42 for Toy G to be shipped by sea.  The proforma invoice (P-INV-0177) from Canning dated 5 June 2009 evidences that.  On this basis, the first LC was forwarded to Canning on 26 June 2009.

32.  Due to the delay, Freenet Asia informed Canning on 16 July 2009 that its customer had decided to have all the garments shipped by air.  The first delivery of the garments under PO 42 eventually took place by air on 5 August 2009.  Canning then issued invoice INV-0976 for US$38,660.60 being the price of the garments delivered.  All these happened well after the first LC had expired on 10 July 2009.

33.  The contemporaneous correspondence shows that on 12 August 2009, Freenet Asia, whilst acknowledging that the LCs had expired, still urged Canning to present the documents to the bank in order to obtain payment for the garments shipped.  On the same day, Canning replied and indicated that it would issue invoice for, among others, the first delivery of the garments for Toy G under PO 42.  Hence INV-0976 mentioned above.

34.  There is no dispute that Canning was able to obtain payment for INV-0976 from the bank on or about 27 October 2009.  Due to the autonomy of the LCs, this could not have happened unless Freenet Asia had caused instruction to the bank to extend the LCs or to waive discrepancy and to accept the presentation of documents by Canning for payment.

35.  The fact was that on 20 August 2009, Freenet Asia confirmed by email (from Freenet Fashion) to Canning that it would authorise the payment for the invoices already submitted.  However, Freenet Asia would hold Canning responsible for 50% of the air freight incurred.  Such share of the air freight for the garments already shipped, including those under INV-0976, would be taken into account by adjusting the unit prices of the garments delivered subsequently, including the second delivery of the garments for Toy G under PO 42.  Specifically Canning was instructed to submit to the bank the documents regarding the second delivery of the garments for Toy G under PO 42 by 24 August 2009.

36.  On 21 August 2009, Freenet Asia provided Canning with the calculation of the adjusted unit prices of the garments for the purpose of preparing revised invoices.  Specifically Freenet Asia requested Canning to send the revised invoices to it for checking before presenting the same to the bank.

37.  The second delivery of the garments for Toy G under PO 42 actually took place on 14 August 2009; and Canning issued invoice INV-0977.  As suggested, the unit prices of the garments delivered under that invoice were indeed adjusted.  Hence INV-0977 (Revised) for the adjusted amount of US$13,149.48 dated 21 August 2009.  Canning also presented the documents for payment under the first LC.  Unlike INV-0976, Canning could not obtain payment for INV-0977 as the bank rejected the documents on 17 September 2009.

Payment under the second LC

38.  The garments for Pinko Black were ordered to be delivered in 2 lots by different dates under PO 43 and PO 44 respectively.  The proforma invoice (P-INV-0183) subsequently issued by Canning on 25 June 2009 evidences that.  The second LC concerned the second lot which was originally arranged to be shipped by sea by 10 July 2009.  On this basis, the second LC was forwarded to Canning on 29 June 2009.

39.  As mentioned, Freenet Asia informed Canning on 16 July 2009 that its customer had decided to have all the garments shipped by air, in view of the delay.  By then, none of the garments for Pinko Black under PO 43 or PO 44 had been shipped.  The fact was that part of the garments for Pinko Black was shipped on various dates between late July and the first week of August 2009 after the second LC had already expired.

40.  As mentioned, on as late as 12 August 2009, Freenet Asia, whilst acknowledging that the LCs had expired, still urged Canning to present the documents to the bank in order to obtain payment for the garments shipped.  On the same day, Canning replied and indicated that it would issue invoices for, among others, the garments for Pinko Black that had been shipped.

41.  Invoice INV-0974 in question was issued on 20 August 2009 relating to shipment of the last style of the garments for Pinko Black under PO 44.  As mentioned, it was also on that day when Freenet Asia informed Canning that payment for the invoices already submitted to the bank by then would be authorised.  However, Canning would be required to give credit to the 50% share of the air freight for those previous deliveries by adjusting the unit prices of the garments under the invoices yet to be submitted to the bank for payment.

42.  In the email dated 20 August 2009, Freenet Asia specifically suggested that the adjustment had to be made to the invoices for the second delivery for Toy G (mentioned above) and the last delivery for Pinko Black mentioned above.  Further, Canning was requested to submit to the bank the shipping documents for these 2 deliveries by 24 August 2009.

43.  As mentioned, Freenet Asia sent to Canning on the following day its calculation of the adjustments to be made to the unit prices of the garments that were covered by INV-0977 (for Toy G) and INV-0974 (fro Pinko Black).  Canning was also requested to send the revised invoices to Freenet Asia for checking before submission to the bank.  Canning accordingly revised the 2 invoices on the same day.

44.  Like INV-0977 under the first LC, the documents presented by Canning for payment for INV-0974 under the second LC were rejected.  This was notwithstanding the settlement of other invoices covering other deliveries for Pinko Black (such as INV-0962 and INV-0963 on or about 20 October 2009).

45.  Considering all the circumstances, I find that there was at the time consensus between the parties that Canning should present the documents to the bank for payment for INV-0977 and INV-0974 by way of the LCs notwithstanding their expiry.  The change of mind on the part of Freenet Asia, I find, was due to the breakdown of negotiation between the parties and Freenet Asia’s decision not to settle the outstanding invoices.

46.  Whilst Freenet Asia might take the view that it was not liable to settle the outstanding invoices as a result of the alleged right to set off, it had already caused Canning to believe that obtaining payment by way of the LCs, notwithstanding their expiry, was still available; and therefore to present the documents to the bank.  The rejection and hence the consequential charges levied by the bank subsequently was indeed caused by Freenet Asia.  The amount, as evidenced by the documents, was US$582.92.

Quality

47.  As mentioned, Freenet Asia also attributes the refusal of the bank to honour the credit to the issue of quality. Its pleading suggests “some quality problem” without any particulars.  No quality dispute is actually raised as the basis for the defence or the counterclaim.  No further and better particulars have been supplied.  In the joint list of issues dated January 2011, no mention was made in respect of the alleged quality issue.

48.  It was in his statement where Pigozzo first suggested that the sum of contractual penalty being claimed somehow also included a sum of US$7,738 being damages for 212 pieces of garments having quality problem.

49.  The 212 pieces of garments in question belonged to PO 43 for Pinko Black Bobbio style within FW09.  That quantity of garments was described as “second choice”; and the parties indeed negotiated for their disposal back in July to August 2009.

50.  Eventually, Canning agreed to give a 50% discount on the original unit price of these 212 pieces of garment.  This formed part of Canning’s invoice INV-0961 dated 13 August 2009. The discounted price of the 212 pieces of ‘second choice’ garment was US$7,738, i.e., the amount referred to by Pigozzo.  Freenet Asia settled INV-0961 on 7 October 2009.

51.  The above is evidenced by the contemporaneous documents.  In the ‘Appendix B’, the calculation suggests that the penalty in the sum of US$96,366.54 included damages due to short shipment in the sum of US$6,132.  But when asked in court, Pigozzo corrected himself in this respect.

52.  In my judgment, there is no real issue of quality of the garments.

The penalty

53.  Freenet Asia has allegedly suffered loss and damage as a result of the delay in shipment.  The claim is based on the following provision invariably contained in the purchase orders issued by Freenet Asia to Canning:

“PENALTIES:

In case of delay in shipment after 7 days of tolerance without penalties, we will apply the following penalties:

(1) For each day of delay 1% of penalties;

(2) After one month of delay we will have the rights to cancel the order or to agree higher discount.”

54.  There is dispute as to whether the above provision was a liquidated damages clause or a true penalty. Essentially the sum fixed by the former is recoverable whereas that fixed by the latter is not.  ‘Penalty’ was the label adopted loosely by the parties in their course of dealings.  In the following discussion, I propose to adopt the same loosely as the description of the provision, of course subject to the determination of its true nature.

55.  The following sub-issues arise out of this part of the counterclaim:

(1) what was the agreement between the parties regarding the penalty;

(2) whether the penalty is enforceable;

(3) whether Freenet Asia is estopped from claiming on the basis of the penalty; and

(4) the amount of the penalty.

The agreement between the parties regarding the penalty

56.  Whether they were signed by both parties, the purchase orders issued by Freenet Asia and the proforma invoices issued by Canning suggest that Canning accepted the penalty provision.  However Canning contends that it had reached a verbal understanding regarding the inclusion of the penalty as a term of the agreement prior to embarking on the business relationship with Freenet Asia and Freenet Fashion.  Strictly, evidence of pre-contractual negotiation or concurrent verbal agreement between the parties with a view to contradicting the agreed written terms is inadmissible.

57.  In any event, what Canning referred to was the discussion between the parties back in September 2007.  The contemporaneous correspondence show that among other things, Freenet Asia made clear that for all its customers, a penalty for delay in shipment would be required under the LC.  Canning indicated its agreement to the inclusion of the penalty but asked the parties to be flexible about that.

58.  Any understanding that the parties would be prepared to be flexible in the enforcement of the penalty, in my judgment, did not alter the fact that they, driven by whatever reasons, did agree to include such provision as one of the terms of the dealings between them.

Whether the penalty is enforceable

59.  The following guiding principles were laid down in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, at 86-88 per Lord Dunedin:

(1) How the parties label the provision is no conclusive.

(2) The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine pre-estimate of damage.

(3) The question of whether a provision is a penalty or liquidated damages is one of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the contract, not as at the time of breach.

(4) Various tests were proposed: The clause will be struck down if the sum stipulated is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach or if the sanction prescribed for a failure to pay money is payment of a sum greater than that which ought to have been paid.  A clause is to be presumed (but not necessarily be held) to be a penalty if a lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage.

See also Chitty on Contracts (30^th ed) Vol.1 at 26-125 to 26-129; McGregor on Damages (18^th ed) at 13-08 to 13-20.

60.  Mr Fung for Freenet Asia referred to what the Privy Council said in Philips Hong Kong Ltd v AG [1993] 61 BLR 41 per Lord Woolf at 58:

“Except possibly in the case of situations where one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract, it will normally be insufficient to establish that a provision is objectionably penal to identify situations where the application of the provision could result in a larger sum being recovered by the injured party than his actual loss. Even in such situations so long as the sum payable in the event of non-compliance with the contract is not extravagant, having regard to the range of losses that it could reasonably by anticipated it would have to cover at the time the contract was made, it can still be a genuine pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage provision. The use in argument of unlikely illustrations should therefore not assist a party to defeat a provision as to liquidated damage.”

And at 63: 

“…… should not be allowed to divert attention from the correct test as to what is a penalty provision – namely is it a genuine pre-estimate of what the loss is likely to be? – to the different question, namely are there possible circumstances where a lesser loss would be suffered?”

61.  In Polyset Ltd v Panhandat Ltd (2002) 5 HKCFAR 234, the Court of Final Appeal, in distinguishing the consideration of a forfeiture of deposit clause from that of a liquidated damages clause, reiterated the principles in Dunlop insofar as the consideration of a liquidated damages clause was concerned: see at §§70-79.  The final court highlighted the nature of a liquidated damages clause, i.e., the amount prescribed by such a clause represents the agreed sum of damages payable, regardless of the quantum of actual loss.  This applies where the actual loss is in fact less than the liquidated damages amount (provided the clause represents a genuine pre-estimate of loss and has not been invalidated as a penalty).  This also holds good where the actual loss exceeds the amount payable under that clause.  In this context, the final court approved what Mr Fung cited from Philips above.

62.  Mr Lam for Canning accepted that it is Canning’s burden to show that penalty was indeed penalty in nature.  However it was Freenet Asia that raised first by pleading that the penalty of 1% of the cost of the garments for every day of delay in delivery (excluding the first 7 days) was a genuine pre-estimate of the loss and damage that Freenet Asia might suffer as a result of delay.  In reply, Canning contends that the penalty was extravagant and unconscionable and thus a true penalty.

63.  According to Carl, Canning was given to understand that the imposition of the penalty originated from the requirement of the customers of Freenet Asia and Freenet Fashion for the LCs.  As mentioned, this was Freenet Asia’s explanation in the correspondence between the parties in 2007.

64.  In court, Pigozzo explained that the penalty was imposed because the customers did the same in the contract with his company.  On the one hand, this could be an inference from the understanding of the parties that the customers of Freenet Asia and Freenet Fashion required a penalty in L/C for delay in shipment.  On the other hand, this could have been verified by contractual document such as the purchase orders placed by the customers of Freenet Asia or Freenet Fashion.  No such document has been produced.

65.  My attention was drawn to the circumstantial evidence including how the customer was said to have dealt with Freenet Asia as a result of the delay in shipment and thus breach on the part of Freenet Asia. In court, Pigozzo explained that as a result of the delay, his company had to pay damages assessed on the basis of the identical penalty to its customers in Italy.

66.  But this was not what Pigozzo has stated prior to his evidence in court.  According to his statement, his company was forced to give big discount and to offer refund to its customers in Italy.  There was no suggestion of the enforcement of an identical penalty by the customers.  Nor was there suggestion that the alleged discount and refund actually reflected the sum payable under the penalty.

67.  As long as the penalty was a valid liquidated damages clause, it could be enforced upon breach irrespective of the actual loss suffered by Freenet Asia.  But the actual practice of the parties was never like that.  Delay in delivery indeed happened before in respect of the garments for the previous fall-winter season of 2008 (“FW08”). According to Pigozzo, the same customer, Cris Conf, was affected then.  On that occasion, Freenet Asia provided the debit note from the customer charging a sum of US$13,500 as compensation for the delay.  The correspondence between the parties in November 2008 suggests that this was the result of a compromise between Freenet Asia and the customer.  As agreed between Canning and Freenet Asia, they split the responsibility for paying such compensation.

68.  But in court, Pigozzo suggested that after the above payment, his company still had to account to the customer the substantial balance of the penalty in excess of US$100,000 by way of discount for the garments for the following season.  This was never alleged in the parties’ correspondence in 2008 or at all until his evidence in court. More importantly, it is difficult to understand why Freenet Asia felt obliged to absorb the substantial balance of the penalty payable to its customer that was caused by Canning’s delay.  Again no documentary evidence is available to verify the recent assertion.

69.  Considering all the circumstantial evidence, I have grave doubt as to whether the customer of Freenet Asia in question indeed impose and enforce an identical penalty in their contracts that was allegedly the reason for Freenet Asia to impose the same on Canning in the first place.

70.  As far as this was Freenet Asia’s original idea, there is no evidence on what it based to fix the penalty at 1% (of the invoiced amount per day of delay) but not any other amount. As far as this was fixed with reference to the possible range of loss and damage that Freenet Asia might be exposed to as result of the potential liability to its customers, there is likewise no evidence of the terms of the dealings between Freenet Asia and its customers that could cast light on such the possible range of loss and damage in case of late delivery.

71.  In his statement and in court, Pigozzo stressed that the percentage fixed was lenient in the industry. Mr Fung added that account had also to be taken of the tolerance of 7 days’ delay before the penalty would come into play.  But there is no proper evidence of the custom in the trade.  The court cannot form its own view in this respect, even assuming that timing of delivery of the garments was probably essential to catching up with the seasons.

72.  The effect of the penalty that Freenet Asia contends is also contrary to a genuine pre-estimate of loss and damage.  Freenet Asia claims to be entitled to the penalty for the period of delay between the delivery dates ex Hong Kong per the purchase orders and the actual delivery dates ex Hong Kong.  As mentioned, there is no dispute that the delay in shipping the garments by sea could be compensated by air shipment due to the substantial difference in the transportation time entailed by the two modes of shipment.  A penalty imposed without regard to that can hardly be genuine pre-estimate of the loss and damage.

73.  The available evidence, objectively assessed, fails to show that the penalty was a genuine pre-estimate at the time of the contract between the parties of the likely loss and damage in case of delay in delivery.  I find that the penalty is unenforceable.

Settlement and estoppel

74.  It is contended that Freenet Asia and Canning had in any event already settled their dispute in respect of the delay by the agreement to ship the garments by air and Canning’s agreement to bear 50% of the air freight.  Therefore Freenet Asia is estopped from claiming any further damages.

75.  As mentioned, due to the delay, Freenet Asia requested Canning in its email dated 16 July 2009 to ship the balance of all the garments by air; and the parties should share the air freight.  At that moment, such arrangement was apparently proposed to avoid the situation where the customer of Freenet Asia would demand penalty.

76.  By its email dated 27 July 2009, Freenet Asia explained to Canning that because the delay had become substantial, the customer could not tolerate but demanded penalty.  The subsequent correspondence between the parties in August 2009 shows their negotiation in respect of, among other things, the share of air freight, discount for “second choice” garments delivered and the issue of penalty.

77.  In the email correspondence on 20-21 August 2009, Freenet Asia confirmed the adjustment of the unit prices of the garments to reflect Canning’s share of the air freight for shipment of the garments by air.  Freenet Asia confirmed that Canning was not required to pay both the air freight and penalty.  But that should be understood to mean, as Freenet Asia explained there, that credit would be given to the air freight that Canning contributed to; and that the issue of the penalty remained outstanding.  Freenet Asia made clear that the penalty issue would be discussed in the meeting on 1 September 2009.

78.  The meeting between the parties was apparently held as scheduled.  This led to the email from Freenet Asia dated 5 September 2009.  Proposal was made to deduct from the amount of the outstanding invoices the penalty amount less the contribution to air freight paid by Canning.  In its reply dated 15 September 2009, Canning accepted that there was delay; and reiterated its stance as expressed in the meeting that Canning would be responsible for the penalty claimed by the customer of Freenet Asia if the relevant documents were provided for approval.

79.  In my judgment, the contemporaneous evidence suggests that Canning should be aware that at the time when it was asked to make contribution to the air freight, the issue of penalty remained alive.  As much as what was accepted in Canning’s email in September 2009, Carl stated in his evidence that Canning did not really object to bear part or even all the responsibility of any claim by the customer of Freenet Asia if proof was provided.  I do not find unequivocal conduct on the part of the parties that constituted the basis for the alleged estoppel against Freenet Asia to claim further damages for the delay in delivery.

80.  But I find that what Canning had in mind when acknowledging its responsibility to compensate was the claim by the customer that Freenet Asia might have to face as a result of the delay in delivery, instead of Freenet Asia’s claim on the basis of the penalty clause in the purchase orders in question.  This, I find, was consistent with Canning’s experience in FW08.  This also explains why Canning had repeatedly, including through its solicitors in October 2009, requested Freenet Asia to provide proof of the customer’s claim against Freenet Asia.

81.  In my judgment, Freenet Asia is prima facie entitled to claim against Canning for damages for the delay in delivery.  Only that Freenet Asia has chosen to rely solely on the penalty clause in the purchase orders for its claim.  Now bound by the pleadings, Mr Fung accepted that his client is not in a position to put forward such alternative claim for damages.

The amount of the penalty

82.  Assuming that I am wrong above, and the penalty is enforceable as a genuine pre-estimate of the damage in case of late delivery, I find that the amount claimed by Freenet Asia on that basis is nevertheless incorrect.

83.  On the basis of the calculation above, and taking into account the tolerance period of 7 days provided in the purchase orders, there should be no real delay in the arrival of the garments delivered under 5 out of the 8 invoices covered by the counterclaim.  These were also the invoices already settled by Freenet Asia. On that basis, Carl calculated the penalty payable, if the penalty clause is enforceable, to be a sum of US$14,003.88 [**].

Short shipment

84.  In his statement, Pigozzo referred to ‘Appendix B’ that suggests that the short shipment of 168 pieces of ‘Pinko Black Bobbio’ style of garments resulted in damages in the sum of US$6,132.

85.  Mr Lam pointed out that PO 44 expressly allowed a room of shipment of +/- 3% the contractual quantity of the goods.  He submitted that adherence to that would mean Canning would not be treated as in breach unless the quantity shipped fell short of 97% of the quantity ordered.  In my judgment, this is not entirely correct.

86.  The starting point must be what quantity of the goods the seller has contracted to sell and to deliver.  This must be the quantity stated in the contract.  What PO 44 (as were the cases of the other purchase orders placed by Freenet Asia) provided was that “+/- 3 % PCT in quantities must be considered by you as per L/C requirement”.  This was obviously a specification with reference to range of discrepancy acceptable under the terms of the letter of credit.

87.  Nevertheless, it is for Freenet Asia to prove the loss and damage as alleged.  As to how the amount of US$6,132 was arrived at, it is unknown from the pleading or Pigozzo’s statement.  Mr Lam pointed out, and I think correctly, that the sum of US$6,132 happened to be 50% of the price of those 168 pieces of garments that should have been shipped under PO 44.  Even so, Freenet Asia was still silent in its pleading or the statement of Pigozzo as to why the damages resulting from their non-shipment should be so calculated.

88.  In court, Pigozzo did not come up to proof of such apparently arbitrary calculation.  Nor was his explanation by reference to the profit margin of his company in the resale of the garments, which was suggested for the first time, supported by any documentary evidence.

Paper patterns and prototypes

89.  By way of further and better particulars of its pleading, Freenet Asia set out the paper patterns and prototypes it claimed to have been entitled to recover.  They were those of the garments for 2 customers for FW09 and those for 3 customers for Spring/Summer of 2010.  As Canning refused to return them, Freenet Asia had allegedly re-developed those patterns and prototypes in Italy and incurred expenses in the total sum of €52,400 or US$77,462.92.

90.  As revealed in court, the paper patterns in question were actual size patterns of the garments to be manufactured. In their evidence, the senior merchandiser of Canning, Lin, and the person in charge of the sample room of Canning, Ling, explained the process of manufacturing commencing with working out the paper patterns up to the production of actual sized samples.  After the cessation of production, the paper patterns have been discarded; but the electronic versions remained in the computer.

91.  Canning admitted that they were prepared in accordance with the sketch and design on paper provided by Freenet Asia.  Canning did not deny the input of Freenet Asia during the process of developing the final paper patterns.  As far as I can understand, Canning also never disputed Freenet Asia’s intellectual property in the designs according to which the actual size patterns were made.  This should be apparent from the correspondence between the parties in September 2009.

92.  However, in issue is not the intellectual property right in the designs of the patterns and prototypes which, as mentioned, may still be stored in Canning’s computer.  In issue is the property right in the patterns and prototypes as chattels.  The basis for the alleged property right in the paper patterns and prototypes is not apparent from Freenet Asia’s pleading at all.  There is certainly no assertion of any agreement between the parties or trade custom in that respect.

93.  The contemporaneous correspondence shows that Freenet Asia brought about the subject of the paper patterns in early September 2009, including during the meeting between the parties on 1 September.  As repeated in his evidence, Pigozzo believed that his company was entitled to the paper patterns and prototypes.  Apart from founding his belief on the effort and expenses that Freenet Asia has spent on developing the final paper patterns and prototypes, Pigozzo never asserted that Freenet Asia actually paid for their making.

94.  As stated in the correspondence and explained in the evidence of Canning’s witnesses, paper patterns of garments always belong to the manufacturer that had them made, unless there is specific agreement to the contrary.  Freenet Asia has never ordered and Canning has never charged for the paper patterns or prototypes.  Lin confirmed that in her evidence.  Unlike the salesman samples (otherwise known as “SMS”) that had to be paid for, Freenet Asia has never paid for the patterns and prototypes.  The correspondence between the parties back in 2007 recapitulating their consensus regarding the manner of conducting business and the subsequent invoices evidence that.

95.  Lin also confirmed from her almost 9 years of experience at Canning involved in the manufacturing for various named brands that none of the customer had ever claimed ownership of the paper patterns produced in the manufacturing process.

96.  The only exception so far was the provision of the paper pattern for a particular style of garment for Pinko Grey for FW09 in response to Freenet Asia’s pledge for urgent assistance.  This was explained in Canning’s email in mid-September 2009 and Carl’s statement.

97.  I prefer the evidence of Canning’s witnesses in this respect.  As far as the paper patterns and prototypes as chattels are concerned, I find that Freenet Asia has failed to prove either ownership of or right to possess them.  It follows that Freenet Asia was not entitled to demand Canning to hand them over as of right (however much the articles might cost).  In principle, Canning should not be held responsible for the alleged cost of re-making the patterns and prototypes.

98.  Canning also disputes the alleged cost of re-developing the paper patterns and prototypes.  I can understand why.  As mentioned, Freenet Asia set out in its further and better particulars of its pleading the names of the styles of the garments manufactured by Canning of which the paper patterns and prototypes were said to have to be re-developed subsequently in Italy.  Pigozzo repeated them in his statement.  However, the invoices from the 2 Italian companies for the alleged re-development cost in fact referred to different names of styles of garment.

99.  In court, Pigozzo broadly explained that 20% of the styles referred to in those invoices were new while 80% were similar to those styles of garments set out in his statement.  New names would also be given for the styles for the new season.  In any event, they were not identical to the styles manufactured by Canning.  More importantly, there was no identification of which styles recorded in the Italian invoices in fact corresponded to which styles manufactured by Canning; and the extent of their alleged similarity or difference.  Strangely, at least one invoice from one of the Italian companies was issued at the end of August 2009 for pattern and prototype created apparently even before Freenet Asia raised the subject with Canning in the meeting between the parties on 1 September 2009.

100.  Further, the invoices from the Italian companies were addressed to Freenet Fashion and were said to have been settled by Freenet Fashion.  No documentary proof of the payment is available.  How Freenet Asia in Hong Kong may be said to have been out of pocket in the circumstances is unknown.

101.  Some invoices relied on somehow came from Freenet Fashion.  But they referred to certain “screen cost and search”.  Pigozzo accepted in his evidence that screen printing was not paper pattern making.  He sought to explain that the description in the invoices was entered for the purpose of customs requirement and was in fact inaccurate.  This hardly helps substantiating the case of Freenet Asia in this respect.

102.  In a nutshell, the evidence adduced in support of the alleged cost of re-developing the paper patterns that Freenet Asia has failed to obtain from Canning is simply problematic.  Mr Lam submitted that such evidence is unreliable proof of the allegations of Freenet Asia.  On balance, I agree.

Conclusion on the counterclaim

103.  The claim for damages as a result of the delay in delivery on the basis of the penalty clause in the purchase orders fails.  The claim for loss and damage as a result of the short shipment is not proved.  Nor is the claim for the loss and damage as a result of Canning’s refusal to hand over the paper patters and prototypes of the garments.

104.  Mr Lam accepted that HK$555 is equivalent to US$71.61 as pleaded by Freenet Asia.  This part of the counterclaim is therefore allowed by admission.

Order

105.  I allow the claim by Canning in the sum of HK$US$97,684.98; and the counterclaim by Freenet Asia in the sum of HK$555 (accepted to be equivalent to US$71.61).  After set-off, I give judgment in favour of Canning in the net sum of US$97,613.37 or its equivalent amount in Hong Kong currency.  The judgment sum carries interest at 1% above the HSBC prime rate from the date of writ until today; and thereafter at the judgment rate until full payment.

106.  Following such event, I make a nisi order that Freenet Asia shall pay Canning’s costs of the claim and those of defending the counterclaim, including any cost reserved.  Costs shall be taxed if not agreed.  For the avoidance of doubt, I certify the engagement of counsel.  In the absence of application within 14 days to vary, the nisi costs order shall become absolute.

[*] p.101 of Trial Bundle B

[**] § 6 of the 2^nd Supplemental Statement of Carl (pp.74-75 of Trial Bundle A)