SAFE STEEL FURNITURE FACTORY LTD. v. LAMEX TRADING CO. LTD.

HCA12172/96

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.12172 OF 1996

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J U D G M E N T

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The Agreement

1. The Plaintiff is a furniture manufacturer and the Defendant is a retailer of furnitures. By a written agreement dated 4th October 1991 ("the Agreement") made between the parties, the Plaintiff agreed to manufacture for the Defendant "a tambour door cabinet system with its accessories". The cabinet system was made up of panels. The Plaintiff was to manufacture the panels and accessories of the cabinet for the Defendant who would then assembled them into cabinets.

2. The Schedule of the Agreement set out the price of the goods to be manufactured by the Plaintiff. Clause 2 of the Agreement provided that the price would be valid until 31st December 1992 (Clause 2(ii)) and the price for the following years, i.e. from 1st January 1993 "shall be adjusted annually and shall not exceed the local inflation rate...." (Clause 2(iii)).

3. Clauses 5 and 6 of the Agreement dealt with the quantity of the goods :-

"5. The Manufacturer (the Plaintiff) warrants that the Manufacturer has the ability to manufacture the following minimum quantity of goods :-

		Minimum Quantity
(i)	1992	250 pieces per month
(ii)	1993	300 pieces per month
(iii)	1994	360 pieces per month

6. The Company (the Defendant) estimates that the Company will order from the Manufacturer the following minimum quantity of goods :-

		Minimum Quantity
(i)	1992	200 pieces per month
(ii)	1993	250 pieces per month
(iii)	1994	300 pieces per month"

4. Clause 7 dealt with the service of written default notice requiring a defaulting party to make good its breach :-

"7. If either the Manufacturer fails to make and deliver the goods to the Company as ordered or the Company fails to place Purchase Orders for the said minimum quantity or to pay for the goods in manner aforesaid the other party (not being in default) shall be entitled to give to the defaulting party a written Default Notice regarding the defaulting party to make good its breach within the following month. If the defaulting party shall again be in default in the following month or any of the subsequent month or shall fail to make good the breach in the following month (to make payment or delivery of the goods to the extent defaulted, as the case may be), then the other party not being in default shall be entitled to treat this Agreement as repudiated by the defaulting party and to accept such repudiation."

5. Clause 9 imposed a restriction on trade on the Plaintiff :-

"9. The manufacturer shall not copy or manufacture or supply to others, products similar to the said goods directly or indirectly within 10 years after termination or sooner determination of this Agreement."

6. The Agreement did not provide for the duration of the Agreement but under Clause 10, the Agreement could be terminated by six months' written notice:-

"10. Notwithstanding anything hereinbefore contained to the contrary either party hereto shall have the right by giving to the other party not less than 6 months' prior written notice to terminate this Agreement."

7. Clause 11 dealt with the remedies available to the Defendant in the event of breach by the Plaintiff on the terms of the Agreement :-

"11. In the event that the Manufacturer shall :-

(i) without the knowledge and written consent of the Company disclose to any third party the technology referred to in Clause 5 above; or

(ii) fail to make delivery of the said goods pursuant to the terms of this Agreement; or

(iii) deliver goods that are not up to the standards as defined in this Agreement; or

(iv) sub-contract the manufacturing work (except painting) to other manufacturer without the consent of the Company; or

(v) commit any breach of the provisions of this Agreement.

It shall be lawful for the Company to terminate this Agreement by a written notice to the Manufacturer and to order the said goods from other manufacturer and to claim against the Manufacturer for damages for breach of this Agreement."

8. Clause 12 dealt with the remedy of the Plaintiff in the event of breach by the Defendant :-

"12. In the event that the Company shall :-

(i) fail to make punctual payment for the goods delivered; or

(ii) place order which is 30% lower than the minimum quantity referred to in Clause 6 hereof; or

(iii) commit any breach of the provisions of this Agreement.

It shall be lawful for the Manufacturer to terminate this Agreement by a written notice to the Company and to claim against the Company for damages for breach of this Agreement including but not limited to claim for recovery of capital investment."

Termination of the Agreement

9. After the parties entered into the Agreement, the Defendant placed orders with the Plaintiff for the manufacturing of the goods. The orders continued until January 1996 when the Defendant ceased placing new orders with the Plaintiff. In April 1996, the Defendant informed the Plaintiff that the order would be resumed, but despite discussions between the parties, the Defendant did not resume placing the order. In mid-August 1996, the Plaintiff was informed by the Defendant that the Defendant had decided to use another manufacturer in the Mainland to manufacture the cabinets in order to cut the cost of production.

10. The Plaintiff, pursuant to Clause 2 of the Agreement terminated the Agreement by a letter dated 2nd August 1996. The Plaintiff now claims damages against the Defendant for breach of the Agreement. The present trial is on liability only. The Defendant has chosen not to give evidence.

The Plaintiff's case

11. The Plaintiff's case is that the Agreement was for an indefinite term. It was an implied term of the Agreement that "for the years subsequent to 1994, the minimum quantity of the goods were subject to further negotiations between the parties". The Defendant was further required to place orders exclusively with the Plaintiff.

12. That the Agreement was for an indefinite term is based on the construction of its terms. This is the only basis of the Plaintiff's claim. It is not saying that a new contract arose after 1994 which incorporated the terms of the Agreement.

The Defendant's case

13. The Defendant's case is that the Agreement was for a period of three years or alternatively one year. During the three-year or one-year period, either party may terminate the Agreement by giving a six months' notice (Clause 10). Also during this period, the Plaintiff may terminate under Clause 12 without the six months' notice. Likewise, the Defendant may terminate under Clause 11 without the six months' notice. The rights of each party under Clause 7 was exercisable in respect of orders placed during these period. There was no obligation under their Agreement to obtain the goods exclusively from the Plaintiff.

Agreement for an indefinite term

14. To resolve the issues in this case, it is not necessary for me to decide whether the Agreement was for one or three years. The Agreement did not provide for the length for its duration. However, that by itself does not mean the Agreement was for an indefinite term. One has to examine the terms of the Agreement to see the obligation of the parties in order to determine its duration. In my view, the Plaintiff's contention is incorrect. The Agreement was not for an indefinite term. The Agreement's provisions for the obligations and rights of the parties were only up to 1994. These provisions were not capable of being extended beyond 1994.

15. Under Clauses 5 and 6, the provisions for the minimum quantity of goods were only up to 1994. The breach of these two clauses gave rise to remedies under the Agreement. For example, in Clause 7, if the Defendant failed to place the purchase order for the minimum quantities, then certain rights were given to the Plaintiff in nature of a Default Notice. Clause 12(ii) gave the Plaintiff the right to terminate the Agreement in the event that the Defendant placed orders which was 30% lower than the minimum quantity of the goods under Clause 6. Clauses 7 and 12(ii) were essential terms of the Agreement. Unless there was a mechanism in place which would allow these two clauses to operate beyond 1994, then clearly it cannot be said that the Agreement could continue indefinitely.

Forecast of orders

16. In 1994, the Defendant ordered a modified version of the cabinet system from the Plaintiff. There were discussions about the quantity of the goods to be ordered. In a letter dated 27th May 1994, the Defendant informed the Plaintiff that the projected forecast for the modified version would be 750 kits per month. The letter also stated that a more accurate figure could be obtained upon implementation of the modified version.

17. The projected forecast cannot be treated as the minimum quantity referred to under Clause 6 of the Agreement. The 750 kits were only a projected amount. The purpose was to enable the Plaintiff to order raw materials in advance to meet the purchase orders that might be eventually placed by the Defendant.

18. After 1994, there simply is no room for argument that the Agreement continued indefinitely with the same terms as before. Because there clearly was no agreement on the minimum quantity of goods to be placed by the Plaintiff. There was also no agreement about the capacity of the Plaintiff to manufacture a minimum quantity of goods. In the absence of these terms, the protection given by other terms such as Clause 12 could not be invoked.

Implied term

19. In order to steer around this problem, the Plaintiff contends that there was an implied term in the Agreement that the quantity of goods to be ordered by the Defendant after 1994 would be subject to negotiation between the parties. Ms Sze, Counsel for the Plaintiff, submits that the implication arises to give efficacy to the Agreement in order to make it a workable agreement. She relies on the well-known principle set out in the Moorcock [1898] 14 PD 64; Chitty On Contracts, Vol.1, 1994 Ed., para.13-004, 13-005, 13-006, 13-007 and the case of Shell v Loostock Garage [1996] 1 WLR 1187.

20. Mr Chan, S.C., Counsel for the Defendant, submits that this argument puts the cart before the horse. One should first decide whether there was a contract for an indefinite term before considering whether there was an implied term.

21. In my view, it is permissible to consider the question of implied term first because ultimately, it is a matter of construction of the terms of the Agreement which included both the express and implied terms to see whether it was for an indefinite duration. However, I have to say immediately that this approach would not assist the Plaintiff. The implication is pleaded in a rather vague and general manner. To succeed in its case, the Plaintiff must show that the implication applies to both the Plaintiff warranting the minimum quantity of goods it has the ability to manufacture and also the estimate by the Defendant of the minimum quantity of goods it will place with the Plaintiff. These, after all, were the terms that the parties had expressly agreed upon. However, the Plaintiff merely relies on one limb of the provisions relating to minimum quantity of goods.

22. Furthermore, what is fatal to the Plaintiff's contention is that even if there is such an implied term as contended for by the Plaintiff, it would necessarily be void for uncertainty. It is merely an agreement to agree something in the future.

23. It is pointed out in Chitty on Contracts, 27th Ed. Vol.1, para.2-039 that an agreement is not incomplete merely because it calls for some further agreement between the parties. Of course the parties may later fail to agree on the matters left outstanding. But this failure only vitiates the contract if it makes it "unworkable or void for uncertainty." Often, the failure will not have this effect, for it may be possible to resolve the uncertainty by, for example, applying the standard of reasonableness; or the matter to be negotiated may be of such subsidiary importance as not to negative the intention of the parties to be bound by the more significance terms to which they have agreed.

24. In this case, the quantity of the goods cannot be determined by applying the standard of reasonableness. Certainly, quantity is not a matter of subsidiary importance. It is, on the contrary, one of the essential terms of the Agreement. In the circumstances, this so-called implied term must be void for uncertainty.

Prior negotiation between the parties

25. PW1 Mr Lai stated in his witness statement that the Agreement did not provide for the minimum quantity after 1994 because it was too early to give a meaningful estimation. The parties intended that the Defendant should update the figures after 1994. The Defendant eventually did this by letters.

26. Mr Lai explained in evidence that that was the wish of both parties when the parties were negotiating on the draft Agreement. He asked why it only provided for figures for three years. The Defendant's response was to the effect that since they were in 1991, with the question of change of sovereignty in 1997, whatever figure that might be given would not be applicable in the future. The parties would look at how the market receive the new product and it was too early at that stage to talk about the updated figures.

27. Mr Lai denied that it was the intention of the parties to make provisions only up to 1994 and no more. As to the suggestion that the intention of the parties was to deal with matters in the future, Mr Lai said it was partly so. The parties had to look at how the market would receive the goods. He agreed that in 1991, they could not see the position in 1994. But he disagreed that neither parties decided to be bound after 1994. In the event that there was no market for the product after 1994, Mr Lai said that then the Defendant could, according to the procedure, notify the Plaintiff of the situation.

The principle

28. Ms Sze accepts that pre-contractual negotiation is not admissible evidence but she submits that Mr Lai did not refer to any negotiation or the intention of the parties about the duration of the Agreement. He was merely testifying to what he had raised when he saw Clause 6 in the draft and the explanation offered by him.

29. In my view, these are clearly pre-contractual negotiations and are not admissible evidence. The rationale for excluding this type of evidence in the construction of a contract is fully set out by Lord Wilberforce in Prenn v Simmonds [1971] 1 WLR 1381 at page 1384 :-

"The reason for not admitting evidence of these exchanges is not a technical one or even mainly one of convenience, (though the attempt to admit it did greatly prolong the case and add to its expense). It is simply that such evidence is unhelpful. By the nature of things, where negotiations are difficult, the parties' positions, which each passing letter, are changing and until the final agreement, though converging, still divergent. It is only the final document which records a consensus. If the previous documents use different expressions, how does construction of those expressions, itself a doubtful process, help on the construction of the contractual words? If the same expressions are used, nothing is gained by looking back; indeed, something may be lost since the relevant surrounding circumstances may be different. And at this stage there is no consensus of the parties to appeal to. It may be said that previous documents may be looked at to explain the aims of the parties. In a limited sense this is true : the commercial, or business object, of the transaction, objective ascertained, may be a surrounding fact. Cardozo J. thought so in the Utica Bank case. And if it can be shown that one interpretation completely frustrates that object, to the extent of rendering the contract futile, that may be a strong argument for an alternative interpretation, if that can reasonably be found. But beyond that it may be difficult to go : it may be a matter of degree, or of judgment, how far one interpretation, or another, gives effect to a common intention : the parties, indeed, may be pursuing that intention with differing emphasis, and hoping to achieve it to an extent which may differ, and in different ways. The words used may, and often do, represent a formula which means different things to each side, yet may be accepted because that is the only way to get 'agreement' and in the hope that disputes will not arise. The only course then can be to try to ascertain the 'natural' meaning. Far more, and indeed totally, dangerous is it to admit evidence of one party's objective - even if this is known to the other party. However strongly pursued this may be, the other party may only be willing to give it partial recognition, and in a world of give and take, men often have to be satisfied with less than they want. So, again, it would be a matter of speculation how far the common intention was that the particular objective should be realised." (my emphasis).

30. In any event, the evidence given by Mr Lai does not support the Plaintiff's case that there was an Agreement for an indefinite period. The response of the Defendant to the query by Mr Lai equally shows that it did not wish to be committed after three years. This illustrates distinctly the unhelpfulness of this type of evidence.

Price

31. If the price in a contract is to be agreed upon subsequently between the parties, there will ordinarily be no binding contract unless or until they later reach an agreement on the price : Benjamin's Sale of Goods, para.2-045. In May and Butcher, Limited v The King, February 22, 1929 (reported as a note to Foley v Classique Coaches, Limited [1934] 2 KB 1), the contract provided that the price was to be agreed between the parties from time to time. Lord Buckmaster held that :-

"In my opinion there never was a concluded contract between the parties. It has long been a well recognized principle of contract law that an agreement between two parties to enter into an agreement in which some critical part of the contract matter is left undermined is no contract at all. It is of course perfectly possible for two people to contract that they will sign a document which contains all the relevant terms, but it is not open to them to agree that they will in the future agree upon a matter which is vital to the arrangement between them and has not yet been determined."

32. In Foley, the Court of Appeal discussed this case and the subsequent House of Lords' case of Hillas & Co. v Arcos 147 LT 503, Scrutton L.J. at page 10 stated that :-

"In Hillas & Co. v. Arcos the House of Lords said that they had not laid down universal principles of construction in May & Butcher v. The King, and that each case must be decided on the construction of the particular document, while in Hillas & Co. v. Arcos they found that the parties believed they had a contract. In the present case the parties obviously believed they had a contract and they acted for three years as if they had; they had an arbitration clause which relates to the subject-matter of the agreement as to the supply of petrol, and it seems to me that this arbitration clause applies to any failure to agree as to the price."

33. In this case, the Defendant accepts that there was a contract but it was a contract for three years only. There was no arbitration clause in which the price after 1992 could be ascertained. Furthermore, unlike Foley, the price in this Agreement cannot be ascertained by reference to the reasonable price. In Benjamin's Sale of Goods, 5th Ed., para.2-045, it is stated that :-

"Moreover, an agreement to leave the price open to further negotiation will normally exclude any inference that the price should be a reasonable price in accordance with the provisions of section 8(2) (of the Sales of Goods Act). But, in accordance with the principle that the courts will endeavour to uphold bargains which the parties believe themselves to have concluded, especially in the case of executed or partially executed contracts, it may sometimes be possible either to infer an intention that at any rate a reasonable price should be paid if no price is later settled, or to have regard to other circumstances, such as the course of dealing between the parties. Where an approximate price has already been agreed, the inference that the sale shall be at a reasonable price near the sum or within the range mentioned may readily be drawn.....

... The reasonable price of goods for the purpose of this subsection (i.e. s.8(2)) is usually ascertained by reference to the current market price at the time and place of delivery, even although some other figure (e.g. the cost of production) may also be in a sense 'reasonable'. But the market price may not be the sole or conclusive test. This was made clear in the leading case of Acebal v. Levy, where it was said that a reasonable price 'may, or may not, agree with the current price of the commodity at the port of shipment, at the precise time when such shipment is made. The current price of the day may be highly unreasonable from accidental circumstances, as on account of the commodity having been purposely kept back by the vendor himself, or with reference to the price at other ports in the immediate vicinity, or from various other causes."

34. In the present case, there is a restriction in the Agreement on how the price was to be determined. Under Clause 2(ii), the price of the goods set out in the Schedule of the Agreement was valid only until 31st December 1992. Clause 2(iii) stated that :-

"The price for the following years that is as from 1st January 1993 shall be adjusted annually and shall not exceed the local inflation rate as announced by the Government Authority."

35. The price that may not exceed the local inflation rate for one particular year may well be different from the current market price of the goods. Relying on the market price as the reasonable price, may run contrary to the provisions of Clause 2(iii).

36. In any event, I am not convinced that after 1994, which is the last year in which the parties have specified the minimum quantity of goods to be placed by the Defendant, the formula adopted by them in relation to the fixing of price was intended by them to apply to subsequent years as well.

37. It is clear from the correspondence that in 1995, the price of the goods was still subject to negotiation between the parties. An illustration is found in the correspondence in May 1995, in which the question of the increase in price of the goods was raised. Certainly, at that stage, the Plaintiff was only prepared to supply goods at a certain price if the Defendant was able to provide them with the information on the quantity they would place with the Plaintiff. In relation to one purchase order, namely, P.O.5058, the Plaintiff was only prepared to supply part of it at the old price. Although, eventually the Plaintiff delivered the goods under this purchase order with the old price, it was done as a matter of concession. Mr Lai described this as being in the spirit of co-operation. He accepted that it was not a matter of right for the Defendant to purchase at the old price. In the absence of agreement in price for subsequent years, there is no room for argument that the Agreement was for an indefinite term.

Six months' notice

38. Ms Sze relies on Clause 10 of the Agreement which enables both parties to give a six months' notice to terminate the Agreement to support her argument that the absence of a provision on future price is not fatal to the Plaintiff's claim.

39. Clause 10 is not an arbitration clause which may help the parties to ascertain the price of the goods after 1992 or 1994. It is merely a termination clause. If the parties fail to agree on the price by negotiation then Clause 10 would not assists the parties at all. Clearly, Clause 10 is not a clause in which one could derive assistance in determining whether the Agreement was for an indefinite duration.

Subsequent conducts of the parties

40. It is clearly stated in James Miller and Partners Ltd v Whitworth Street Estate (Manchester) Ltd [1991] All ER 796 that the parties' conduct since the contract is not admissible in aid of the construction of the terms of the contract. However, the conduct is admissible and relevant to show any estoppel or the existence of a new contract. See also the case of Yuen Ching Yuen v Union Insurance Society of Hong Kong Limited [1998] 2 HKC 294.

41. The rationale of this principle is stated by Lord Reid in James Miller and Partners Ltd as follows :-

"Otherwise one might have the result that a contract meant one thing the day it was signed, but by reason of subsequent events meant something different a month or a year later."

42. Ms Sze seeks to distinguish this principle by saying that this restriction does not apply when one is trying to determine whether an implied term exists or not. Support for this approach is found in the case of The Marko Polo [1983] 1 Lloyd's Rep, 481. Parker J. recognized the authority that one must not look at subsequent conduct in order to determine the construction of a contract, but he considered that when one is considering an officious by-standard test or business efficacy, it is legitimate to consider surrounding circumstances including subsequent conduct. In my view, this approach is incorrect. Whether one is construing a contract or determining whether a particular term exists by reason of implication, one is in effect trying to ascertain the objective intention of the parties. This being the case, clearly the same principle of construction will apply.

43. There is no doubt that after 1992, the parties managed to agree on the price of the goods to be supplied by the Plaintiff and for the year 1995, the parties also agreed on the quantity and the price of the goods. However, these matters are not admissible to show that as of 1991, the parties intended the contracts to be of an indefinite period. I agree with Mr Chan S.C.'s submission that what really happened after 1991 was that the Defendant continued to order goods from the Plaintiff by individual purchase orders and the Plaintiff accepted those orders. Thus each new order was a new contract of sale.

Plaintiff an exclusive manufacturer for the Defendant?

44. Ms Sze refers to Clause 11 which provided that in the event of a named breach by the Plaintiff, the Defendant was entitled to terminate the Agreement and to order the goods from other manufacturer. She submits that by this clause the Plaintiff was an exclusive manufacturer for the Defendant because, otherwise, it would be superfluous to provide in the Agreement that the Defendant was entitled to order goods from other manufacturers after the termination of the contract.

45. In my view, Clause 11 does not support the Plaintiff's contention. The parties were clearly entitled to provide expressly their remedies in the event of a termination of the Agreement. Clause 11 is such a clause. Under Clause 11(v), any breach of the Agreement by the Plaintiff would entitle the Defendant to terminate the Agreement. Under common law, the Defendant may not have such a right because the breach may just be a breach of a warranty or the breach is not a serious breach of an intermediate term. The parties may well wish to overcome the restriction by having this clause.

46. Furthermore, in order to be given such an exclusive right, there must be a corresponding obligation on the part of the Plaintiff to provide a minimum quantity of goods for the Defendant. As indicated in the earlier part of my judgment, there was simply no agreement in this regard after 1994.

Silence of the Defendant

47. Ms Sze submits that between February and August 1996 the Defendant did not expressly inform the Plaintiff that it would not place further orders. This supports the Plaintiff's case that the Defendant knew that it was bound by the Agreement to give a six months' written notice of termination.

48. I am unable to come to such a conclusion. On the contrary the conduct of the Defendant wholly supports the contention that the Agreement did not extend beyond 1994.

Other matters

49. The Plaintiff further submits that in July 1996, the Defendant requested the Plaintiff to provide information about the material in stock, so that it could make arrangements to help to dispose of them. This is not an indication that the Defendant considered itself to be bound by an agreement for an indefinite term.

Conclusion

50. In the end, the Plaintiff fails to show that the Agreement was for an indefinite term. The Plaintiff's case is accordingly dismissed with costs nisi of the action to the Defendant.