HUNG FA PLASTIC AND METAL MANUFACTORY LTD v. YIP SHING DIESEL ENGINEERING CO LTD

DCCJ 16126/2000

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 16126 OF 2000

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JUDGMENT

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Background

1. The Defendant sold a diesel electricity generator model CUMMINS ONAN 400 DFEC KTA19-G3 manufactured by Cummins Engine Company ("Cummins") to the Plaintiff under a written contract dated 21 April 1997 for the price of $380,000 to be delivered at or before end of April 1997 to a factory in China where the Plaintiff carried on the process of manufacturing kitchen and household wares and toys.

2. The generator was delivered to the Plaintiff's factory on 4 August 1997 whereupon the price was paid in mid August 1997 by hire-purchase arrangement with a finance company.

3. The Plaintiff's complaint was that the generator was defective in that water was found in the engine oil and parts of the engine were rusty. The Plaintiff now claims damages for breach of contract.

The pleadings

4. The defects were particularized in the Amended Statement of Claim:

(a) Water contamination in the engine lubricating oil;

(b) Rusted parts of the engine:

(1) Rocker levers;

(2) Upper cylinders have valve spring;

(3) Valve rotators;

(4) Camshaft lobes;

(5) 2 & 3 cylinder valves & injectors;

(6) Cylinder liners;

(7) Conrods;

(8) 2 & 5 crankshaft main bearing journal;

(9) Piston rings;

(10) Inspect injectors; and

(11) 2 & 5 cylinder block main bearing webbing and caps.

(c) Leakage of water into the engine contaminating the engine oil.

5. The Plaintiff's case is that the generator failed the test of reasonably fit for the purpose of generating electricity safety and merchantable quality under the implied term of the contract and further that the Defendant failed to provide maintenance service free of charge within one year after installation contrary to the express term of the agreement.

6. The Plaintiff alleged that the defects rendered the generator totally valueless and claims for the price of $380,000 or a reasonable sum. The Plaintiff further claims $5,000 for engaging a surveyor to examine the machine and give advice, and interest on those sums.

7. The Defendant put the Plaintiff to strict proof of the alleged defects and further says this in paragraph 12 of the Defence:

"If, which is denied, the alleged defects did exist, they do not constitute a fundamental breach, which entitled the Plaintiff to rescind the Contract."

8. Nowhere in the Amended Statement of Claim appears a claim for rescission of the agreement. Consistent with the absence of a plea for rescission the evidence showed that the Plaintiff pressed for performance. The Plaintiff's claim is for:

"7...........loss and damage namely HK$380,000 being the difference between the contract price and the actual value of the Generator (zero) ..........AND THE PLAINTIFF CLAIMS (1) The sum of HK$380,000 as set out in Paragraph 7 or such sum as the Honourable Court thinks reasonable;"

9. The issues between the parties accordingly were whether or not the alleged defects are proved and if yes the amount of damages.

The documentary evidence

10. The agreement recorded the essential terms and contained a one year warranty from testing or 14 days after delivery.

11. There were three maintenance record sheets dated 21 August 1997, 5 September 1997 and 12 September 1997 issued by the Defendant after initial testing. The record sheet dated 5 September 1997 signed by the Defendant's maintenance staff stated:

"Tested new machine. Normal. Water in the engine oil box. The customer released the oil and put in new oil. The oil changed white others were normal. Please do not use. The engine oil was mixed with water....."

12. On 20 September 1997 Cummins wrote to the Plaintiff stating that during inspection no abnormalities were found except the oil retrieved from the engine appeared milky and that some water residue molecules discharged from the engine breather after initial water contamination, and further that because the Plaintiff insisted on a new engine due to water contamination it was necessary to establish where the responsibility rested.

13. On 23 September the Plaintiff wrote to the Defendant asking for a new generator and stating all rights reserved.

14. On 26 September 1997 the Defendant's maintenance centre in Dongguan wrote to the Defendant in Hong Kong stating that there was nothing wrong with the generator after inspection and cooler pressure testing.

15. On 10 November 1997 the Plaintiff wrote to Cummins asking why there was water in the lubricating oil system and requesting:

"Your side to open up the engine for us to inspection (inspect) the set before we put it in operations OR completely clean up the engine and replace the cam bearings and other parts relate to the lubrication oil system, also to pressure test the cooling system including the oil cooler, radiator and check and test of turbochargers".

16. On 19 December 1997, the Plaintiff's solicitors wrote to the Defendant calling for a joint inspection and a solution to remedy the defects before 1 January 1998 or else legal action would be taken.

17. On 26 January 1998 the Plaintiff's solicitors wrote to the Defendant again inviting them to attend a joint inspection on 19 January 1998. It should be noted that either the date of the letter or the date of proposed joint inspection was a mistake.

18. On 23 January 1998 the surveyor, instructed by the Plaintiff, produced his first report, the original of which was made Exhibit P1. The surveyor found rusting of the No 5 piston, No 4 and No 5 side covers of the camshaft, the camshaft and No 1 to 6 cylinder heads. Rust can be seen on those parts in the photographs attached to the report.

19. On 23 February 1998 the Plaintiff's solicitors wrote to the surveyor requesting the report of 23 January 1998 "be amplified and expanded" to deal with a number of issues.

20. On 24 February 1998 the surveyor sent a fax to the Plaintiff's solicitors stating that:

(1) They were unable to say whether the generator was cable of safe use and suggested the manufacturer to carry out a detailed examination of the internal parts;

(2) The affected parts must be dismantled from the engine;

(3) The generator was in apparent good order and conditions except the rusted parts;

(4) The entitlement to reject the generator would depend on the terms of the contract;

(5) The rusty camshaft and cylinder heads would reduce the life span of the generator;

(6) The presence of water would impede the working of the generator.

21. On 6 March 1998 the Plaintiff's solicitors wrote to the Defendant enclosing the surveyor firm's report of 23 January 1998.

22. On 7 March 1998 the Plaintiff's solicitors wrote to Cummins in the United States ("Cummins USA") making a request for a brand new generator.

23. On 12 March 1998 the Plaintiff's solicitors wrote to the Defendant requesting the Defendant to take back the generator and repay $380,000 within seven days failing which legal action would be taken.

24. On 14 April 1998 Cummins USA wrote to the Plaintiff's solicitors requesting for colour photographs to assist investigation.

25. On 1 May 1998 Cummins USA wrote to the Plaintiff's solicitors mentioning the possibility of an extended warranty and asking them to wait for the result of the investigation.

26. On 13 May 1998 Cummins USA wrote to the Plaintiff's solicitors asking them to wait for the result of the investigation.

27. On 8 June 1998 Cummins USA wrote to the Plaintiff's solicitors stating that there was minor water contamination of an external origin but nevertheless they were prepared to conduct another inspection and would:

"replace any parts that will or are likely to impede the proper operation of the generator and that the warranty period will start from the day of inspection."

28. On 11 June 1998 the Plaintiff's solicitors wrote to Cummins USA asking for a twenty-four months warranty commencing from the date of repair.

29. On 18 June 1998 Cummins USA wrote to the Plaintiff's solicitors stating that they were prepared to extend the warranty by nine months.

30. On 30 July 1998 Cummins USA wrote to the Plaintiff's solicitors repeating their offer of replacement of parts and the warranty to begin from the date of inspection.

31. On 3 August 1998 the Plaintiff's solicitors wrote to Cummins USA stating that inspection should take place without any pre-condition. By a letter of 13 August 1998 Cummins USA signified their agreement.

32. On 31 August 1998 Cummins by a letter recorded the result of a detailed inspection on 27 August 1998. This letter suggested cleaning and replacement of various parts of the engine and stated the estimated time to rebuild the engine would take 15 days from the arrival of spare parts.

33. On 1 September 1998 Cummins signed a receipt for taking away some engine parts that had been dismantled for inspection. It was recorded that Cummins would return them after testing.

34. Having attended the Plaintiff's factory again on 27 August 1998 the surveyor produced a supplementary report dated 3 September 1998. The surveyor found rust on eleven parts of the engine, which are particularized in the Statement of Claim as set out earlier, and recommended eight items to be replaced and three to be cleaned.

35. Significant rusting can be seen on those parts of the engine as shown in the photographs attached to this report. The surveyor recommended:

"the manufacturer should replace a new diesel engine instead of cleaning or replacement of some damaged parts" because there might be some other hidden damage or defect and if rusted parts clean their residual life will shorten."

36. On 10 September 1998 the Plaintiff's solicitors wrote to Cummins USA enclosing the surveyor's supplementary report and demanding a new generator.

37. On 15 September 1998 Cummins by a fax confirmed that the generator was "shipped dry".

38. On 2 October 1998 Cummins USA wrote to the Plaintiff's solicitors asking for time to handle the matter.

39. On 9 October 1998 Gordon Ngan of Cummins sent an email to D D Gamroth and D E Dawes of Cummins International (presumably Cummins USA) stating that he believed there was nothing wrong after testing and that if repair is required the costs would be these:

"(1) Cost to customer, non-warrantable failure: Part (16,018-00) Incidental (1,000-00) Labour (2900-00) Total $19,918-00 USD;

(2) Cost Cummins Labour & Parts only: Parts (11,100-00), Labour (2900-00) Total $14,000-00 USD. Incidental: 1,000-00USD."

40. On 12 October 1998 D E Dawes sent a reply to G S Ngan by email stating:

"Recall that we (Cummins) indicated that we would cover the full cost of the engine repair. Therefore all repair costs referenced below by Gordon would be absorbed by us."

41. The Plaintiff objected to the admission of the document containing the above emails. I allowed it to be admitted subject to arguments on weight.

42. On 16 October 1998 Cummins USA wrote to the Plaintiff's solicitors stating that the corrosion was due to "abuse, improper maintenance and/or storage of the unit, including by not limited to your client's refusal to operate the generator". This letter also made an offer to:

"repair and/or replace engine component as indicated by our technicians in their August 27, 1998, inspection. This will be done at no cost to your client."

43. On 9 December 1998 the Plaintiff's solicitors wrote to Cummins USA stating that the proposal "not acceptable to our client".

The oral evidence

44. The Plaintiff called Mr. Lam Wai Hong, its director, and Mr. Philip Lam, the surveyor.

45. Mr. Lam gave two witness statements. He said that the Plaintiff was a manufacturer and supplier of small kitchen and household items and toys operating in a factory in the Mainland. When the generator was delivered to the Plaintiff's factory on 4 August 1997 he pulled out the engine oil measure tape and found the tip milky. He then informed Mr. Lui, the Defendant's salesman, about it. The generator was installed on 21 August 1997 and the test run on 5 September 1997 showed that the engine oil was contaminated with water. The Defendant sent its staff to dismantle the chassis to release the engine oil. About two days later the Defendant re-installed the chassis. On 12 September 1997 the Defendant installed the earthing system. In about mid September 1997 the Defendant's engineers including Mr. Gordon Ngan from Cummins inspected the generator. Thereafter he requested for replacement of the generator. In December 1997 he instructed a firm of solicitors to handle the dispute. On 19 January 1998 the surveyor, Mr. Philip Lam, inspected the generator. The Defendant was notified of the date of the inspection but they never turned up. On 27 August 1998 there was a joint inspection attended by Cummins, the surveyor and him. On 1 September 1998 Cummins took away some parts of the generator. They were never returned.

46. Under cross-examination Mr. Lam said that if Cummins was prepared to extend the warranty by twenty-four months no legal action would have been taken. The generator was only used for less than one hour. When Mr. Lam was asked why the Plaintiff did not use the generator when Mr. Lui remarked on Cummins' letter dated 20 September 1997 that the Plaintiff can use the generator with careful observation of the state of the engine oil, he said he did not know how to be careful and gave an example that if he bought a car it is not reasonable for the dealer to ask him to drive carefully.

47. The Plaintiff called Mr. Philip Lam as an expert. He said he is a member of MCW International Surveyors Ltd responsible for surveying damage for recovery and preparing survey reports. He is a shareholder of the company and started this job from 1978. 20% of his twenty-five years work experience involved inspecting machines and surveying damage. He has given evidence in Court before. He said the Court accepted his evidence but he did not give details. He studied up to From 5. Whenever there were disputes he referred them to other experts. He has knowledge of the nature and structure of the machine involved in this case and considered himself capable of dealing with this generator to find out what the problem was. He produced two reports dated 23 January 1998 and 3 September 1998 (Exhibits P1 and P2).

48. He attended the Plaintiff's factory on 19 January 1998 to inspect the machine. He said that oil lubricates the engine and water in oil is not normal and would result in faster wear and tear. On 27 August 1998 he attended another inspection of the generator and more rust was found when the engine was opened up. Even the rust was cleared it would nevertheless affect durability and the generator was not fit for operation. The scrap value was probably 10-15% of the price.

49. Under cross-examination, Mr. Lam said he had dealt with many generators but had not encountered problem of this kind in the past. In majority of cases he only acted as a witness in delivery transaction. He had only dealt with one defective generator which had a problem not similar to the problem of the generator in this case. He thought the water came through the cracks in the generator but there was no evidence to support the presence of cracks. One has to have an expert to carry out test to see if there were cracks. He knows something about pressure test and if a test done and reason not found then by implication water might have come from external source. Mr. Lam accepted that he recommended change of parts but not change of machine and that if the parts were changed the generator can be used.

50. The Defendant called one witness Mr. Lui Chi Hang. He made one witness statement. He said that he was the Defendant's sales manager. In early September 1997 Mr. Lam told him that he found water in the engine oil. He then arranged a technician to attend the Plaintiff's factory on 5 September 1997. As recorded in the maintenance report there was water found in the engine oil. He told Mr. Lam that the generator was normal and the Plaintiff should use it, and that if further problem was found the Defendant would bear all responsibilities. Despite what he said the Plaintiff demanded a new generator. The generator was a newly manufactured machine subject to strict quality control. Any rust found was probably due to the fact that the generator was left idle for long period of time. The mere existence of water in oil can be remedied by replacing the lubricating system. The Plaintiff had wrongly insisted on a replacement generator or refund. The generator was covered by a warranty given by Cummins.

51. Under cross-examination, he accepted that he was not present during the tests in the Plaintiff's factory and that it was not normal to find water in oil. Counsel for the Plaintiff suggested two possibilities of how water got into the engine oil, either water came from the water tank or water was added in. In reply Mr. Lui said that all generators had dry engine and oil was added into the engine by their buyers or users. The cost of repair was about 25% of the price.

Evaluation

52. I shall deal with Mr. Philip Lam's evidence first. The Plaintiff asked me to accept him as an expert in diesel electricity generator. Mr. Lam studied up to Form 5. 20% of his work over 25 years of experience involved inspecting machines. Most of the time he acted as a witness in delivery transactions. Whenever there were disputes he would refer them to other experts for opinion. He admitted that over the past years he had only dealt with one defective generator but which did not have a similar problem. Faced with these evidence I have immediate difficulties in accepting him as an expert in diesel electricity generator or even an expert in machines generally. Mr. Lam has not satisfied me that he has the necessary qualifications of an expert in diesel electricity generator or any expert. It seems to me that his work mainly involved in witnessing and documenting commercial transactions, surveying damage and loss adjusting. Nothing was available to suggest that he has ever been involved in mechanical science, both academically and in terms of practical experience. Accordingly, I do not accept him as an expert but would treat him as witness of fact. His factual evidence was not disputed. I accept his evidence so far as they are factual, except his estimation of the scrap value of the generator.

53. Mr. Lam Wai Hong's evidence was not controversial. I accept his evidence.

54. Mr. Lui Chi Hang's evidence was not controversial either except that Counsel for the Plaintiff raised issue on the pressure test and Mr. Lui's implied allegation that it was possible that the Plaintiff added water in the generator. Subject to those contentions, I accept Mr. Lui's evidence, except his estimation of the cost of repairing the engine.

55. There was no evidence to show that the Plaintiff added water in the engine causing contamination and rusting. Counsel for the Defendant never put any suggestion of the kind to Mr. Lam Wai Hong in cross-examination. There was no or no real issue of manufacturing rust in the engine.

56. There was no evidence to show why water was present in the engine, except Mr. Philip Lam's theory, as contained in his second report, that there were "latent defects existed causing the cooling water gained entry into the machine, resulting in rust, rubbing and scratching". Since I have rejected Mr. Lam as an expert I cannot act on this piece of evidence.

57. Counsel for the Defendant submitted that the Plaintiff had not proved the cause of water contamination and its effect on the quality of the generator. On the other hand he said that there was evidence of a pressure test as set out in the email showing no leakage and asked me to dismiss the claim.

58. Counsel for the Plaintiff specifically challenged the part of the email relating to the pressure test and the result i.e. no leakage found. He submitted that since Mr. Ngan was not called to give evidence he had no opportunity to cross-examine him on this email and the alleged pressure test. He further asked me to infer that there was a leakage in the engine.

59. I have to assess the contents of the part of the email relating to the pressure test and the result with circumspection. Mr. Ngan said in the email:

"We re-assembled the cylinder liners, heads and oil coolers to the cylinder block and thoroughly tested the unit with hot and cold water in our workshop. These are the components which would allow coolant entry into engine and no leaks were evident."

60. The obvious question is whether the re-assembled parts could accurately reflect the state of the engine as it was in the Plaintiff's factory back on the day of the delivery and soon thereafter. The Plaintiff was not able to cross-examine Mr. Ngan and the Defendant has not produced evidence from the person, possibly a technician, on the details of the test. There was no test report either. While I find it probable that a pressure test was done I have to say that I am unable to give enough weight on what was stated on the email to conclude that there were no leaks in the engine at the time it was delivered to the Plaintiff's factory.

61. Counsel for the Defendant further submitted that the extensive rusting was due to the generator being left idle for a long time. I have no doubt that this was a factor which had contributed to further rusting.

62. There was no evidence to show that the engine part or parts were rusting at the time of delivery. The evidence only showed that there was water in the engine oil before the surveyor found rusting during inspection on 19 January 1998 and extensive rusting during inspection on 27 August 1998.

63. Accordingly, there was no evidence to explain the presence of water in the engine and no evidence to show that the engine was already rusting at the time of delivery. I have to decide in the circumstances whether the Defendant had delivered a generator that was of merchantable quality and reasonably fit for its purpose.

64. Before the ultimate issue, I have to decide whether the contamination of the engine oil was due to the fault of the Plaintiff and whether there was a leakage in the engine or in the cooling system. As I said earlier there was no evidence to prove that it was the Plaintiff's fault and Counsel for the Defendant never put to Mr. Lam Wai Hong that the Plaintiff either mixed water in the oil or put water in the engine. Therefore there is no basis for me to find against the Plaintiff on this issue. Water could have got into the engine or parts of the engine in a way other than as a result of a leakage in the engine or the cooling system. The Plaintiff could have engaged a proper expert to examine the engine for leakage but they have not done so. I am unable to conclude that there was a leakage. I feel, however, able to conclude and find that at the time of delivery of the generator there was already water in the engine.

65. Counsel for the Defendant drew my attention to Section 2(5) of the Sale of Goods Ordinance Cap. 26:

"Goods of any kind are of merchantable quality within the meaning of this Ordinance if they are -

(a) as fit for the purpose or purposes for which goods of that kind are commonly bought;

(b) of such standard of appearance and finish;

(c) as free from defects (including minor defects);

(d) as safe; and

(e) as durable,

as it is reasonable to expect having regard to any description applied to them, the price (if relevant) and all the other relevant circumstances; and any reference in this Ordinance to unmerchantable goods shall be construed accordingly."

66. As to whether or not it was fit for its purpose, the evidence showed that the generator could be used despite its engine oil was contaminated with water. There was no evidence from the Plaintiff that the machine could not generate electricity. I find that the generator was fit for its purpose at the time of delivery and that the generator was of good standard of appearance and finish.

67. As to defects, I cannot say that the generator was free from defects. It seems to me that water in the engine was a defect serious enough for a complaint to be made.

68. There was no evidence to show whether or not the generator was safe and durable as it should be.

69. In the sales contract it was stated that Cummins was the world's largest manufacturer of diesel generator and various specifications were set out. The price of the generator was $380,000.

70. Standing back for a moment and ask myself the question that whether not a buyer of a new car manufactured by a large Japanese or German car company at the price of $380,000 is entitled to ask the dealer for a replacement or make good the defect when water was found mixed in the engine oil upon delivery and thereafter rust was also found. The answer seems to me to be yes. Similarly, in my view, it was reasonable for the Plaintiff to ask the Defendant to make good the defect of the present kind or to change the generator for a new one.

71. Accordingly, I find that the Defendant had delivered a defective generator in breach of the implied term of the contract.

72. As I set out earlier the remedy sought is damages calculated by reference to the difference between price of $380,000 and the "actual value" of the generator as pleaded in paragraph 7 and the Prayer of the Statement of Claim. It is this claim for the difference that I have to deal with.

73. The Plaintiff has produced no evidence for assessing the difference except the surveyor said that the scrap value of the generator was probably 10%-15% of the price. Mr. Lui said that the cost of repair would be around 25% of the purchase price i.e. $95,000. In his second report the surveyor recommended either a replacement of the diesel engine or replacement of the damaged parts. I should make it clear that I make reference to this piece of evidence not on the basis that the surveyor was giving his opinion as an expert in mechanical engineering but rather as a surveyor assessing damage and loss and making recommendation in performing his function independently. There was also evidence from the Defendant of similar recommendation. The Cummins internal email dated 9 October 1998 stated:

"To repair the current problems/defects, refer to my Inspection and recommendation report dated 27th August 98. If replacement is inevitable I believe engine is only item to be considered, not complete genset (generator set)."

74. The generator was obviously not valueless. There was no evidence to suggest that the entire engine was defective or to show the worth of the engine as being a component of the generator. There was no dispute that all other parts of the generator were up to standard. I do not accept the surveyor's evidence that the generator was a scrap with a value of 10% to 15% of its price, nor do I accept Mr. Lui's evidence that the cost of repair would be around 25% of the price.

75. As set out earlier there were two sets of costs mentioned in the email - costs to customer, non-warrantable failure and cost Cummins labour & parts only. There was no evidence to explain the two sets of costs but they appear to overlap with each other. The warranty document issued by Cummins which defined "warrantable failure" under the "Base Engine Warranty" as:

"...........any failures of the Engine, under normal use and service, which result from a defect in material or workmanship (Warrantable Failure). Coverage begins with the sale of the Engine by Cummins and continues for the Duration stated below. The Duration commences either on the date of delivery of the Engine to the first user.........."

76. It does not appear that the defect in the generator in this case constituted a "failure of the Engine". Nevertheless, I consider the costs of replacing the parts under the "Base Engine Warranty" as a "warrantable failure" i.e. US$19,918 (about HK$155,360) inclusive of parts, labour and incidental charges the appropriate costs for making good the defects. Accordingly, doing the best I can, I assess the difference between the purchase price and the actual value of the generator to be US$19,918 or HK$155,360. I shall award the Plaintiff HK$155,360, and the surveyor fee of $5,000 which I think had been reasonably incurred.

77. There will be judgment for the Plaintiff for the sum of HK$160,360 (i.e. HK$155,360 + HK$5,000) with interest at the present judgment rate from 4 August 1997 to the date of judgment and thereafter at judgment rate. There will be an order nisi that the Plaintiff is to have costs of this action to be taxed if not agreed with a certificate for counsel.