KUDOS KNITTING (HK) CO LTD v. ZAMIRA FASHION LTD

DCCJ 5393/2009

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 5393 OF 2009

--------------------

BETWEEN

---------------------

JUDGMENT 

Background

1.  The Plaintiff ("KK") agreed to manufacture and sell to the Defendant ("ZFL") 7722 pieces of ladies' cardigans ("Goods"), at the price of US $14.80 per item. This is evidenced by a written Sales Contract made between KK and ZFL, dated 3 September 2008 ("Contract"). The originally agreed delivery date was 16 October 2008. It is not in dispute that the date for delivery of the Goods was subsequently extended to 25 October 2008, and the price of the Goods reduced to US $14.06 as a result.

2.  The payment terms, as modified by agreement made between the parties, were that a cheque postdated for 30 days was to be issued by ZFL to KK upon KK's delivery of the shipment documents for the Goods. It is not disputed that, after 2 inspections which took place on 25 October 2008 and 28 October 2008, only 6445 pieces of the Goods were delivered under the Contract on 31 October 2008, and shipped to ZFL's customer in Germany. A cheque dated 4 December 2008 for the sum of HK $697,903.39 ("Cheque"), equivalent to US $90,052.05, was issued by ZFL for payment of the price of the Goods delivered, and some other agreed charges.

3.  1529 pieces of the Goods delivered were found by ZFL's customer to be defective upon their arrival in Germany. As a result, ZFL countermanded payment of the Cheque, and only made payment of a total sum of US $63,368.96 for the 4916 pieces of the Goods accepted by its customer, less inspection costs and storage costs incurred as a result of KK's delivery of the defective Goods.

4.  KK issued these proceedings for recovery of the sum of US $32,886.75, being the balance of the price of the Goods delivered under the Contract, and sample and computer tape charges, the latter of which are not disputed by ZFL. On an alternative basis, KK claims the amount of $32,247.75 as the balance due under the Cheque which was dishonored.

5.  In essence, ZFL claims that it is entitled to withhold payment of the price of the 1529 pieces of the defective Goods delivered, and counterclaims for damages, in the sum of US $10,000 as the loss of profits in respect of the defective Goods, 5 months' storage charges of US $5,000, and administrative expenses of US $1,000 incurred in dealing with the defective Goods. ZFL alleges that it is entitled to set-off its damages against KK's claim under the Cheque.

Issues

6.  In determining the key issues of whether KK is entitled to payment of the sum of US $32,886.75 sought, and whether ZFL is entitled to the set-off and counterclaim relied upon, the issues for determination at trial are:

(1) Had ZFL accepted the Goods and hence lost its right to reject the Goods?

(2) Were the 1529 pieces of the Goods delivered defective?

(3) Is ZFL entitled to damages, and if yes, the amount of damages payable by KK in respect of the defective Goods?

Were the 1529 pieces of the Goods delivered defective?

7.  I will deal with this issue first, as it forms the basis of all ZFL’s defences.

8.  ZFL claims that upon inspection of the Goods in Germany, 1529 pieces were found to be defective, which defects include the cardigans being found with broken threads, loose threads, zipper pullers missing, and with holes. Photographs of the defective Goods were taken in Germany, and about 11 photographs were sent by e-mail to KK in November 2008.

9.  KK claims that it never received samples of the allegedly defective Goods for inspection or verification, and that there is no independent evidence of the defects in the Goods, save for ZFL's bare assertions. Mr. Chan who appears for KK argued that there is no expert report of the alleged defects, that ZFL had failed to investigate and verify the allegation of defects made by ZFL's customer, and that the only evidence of the defects is hearsay.

10.  It is true that there is no expert report on the alleged defects, but in my judgment, this is not fatal to ZFL's claim. The issue is whether ZFL is able to prove, on a balance of probabilities, on the available evidence that the 1529 pieces of the Goods were defective and had no value, as ZFL and its German customer claim.

11.  Under the terms of the Contract, the Goods were to be sent to an independent inspection house "for 100% checking" before a final inspection to be made by Specialized Technology Resources (HK) Ltd. ("STR"). It is not in dispute that ultimately, in view of the tight production and delivery schedule, the Goods were not in fact sent to the independent inspection house for thorough inspection before they were sent to STR, for inspection prior to shipment to Germany. However, various random inspections were made in the course of production, and these had consistently revealed defects in the Goods, as the contemporaneous documents show.

12.  On 4 September 2008, a fax was received from ZFL's German buyer, referring to defects found in the counter samples of the Goods. The defects include broken flatlock seams and loose ends, and referred to the workmanship being "untidy" and "inaccurate".

13.  As early as 8 October 2008, a random inspection of the Goods produced under the Contract was made by an independent inspection house ("Tian Ying"). According to their inspection report dated 8 October 2008, 45 pieces of the Goods were inspected, and all of them were rejected. Defects found in the Goods included broken seams, dropped stitches and missed stitches.

14.  On 18 October 2008, Gary Li of ZFL ("Gary") made an inspection of 80 pieces of the Goods produced under the Contract, and again, all were rejected. The defects recorded in Gary's report referred, again, to missing stitches, broken stitches and altogether 4 types of major defects, as well as 8 types of minor defects found in the Goods inspected.

15.  On 25 October 2008, STR conducted an inspection of the Goods. According to the STR inspection report, 125 pieces of 4697 pieces of the Goods which were available were inspected, and all were rejected. Major defects discovered included missing zipper pullers, loose stitches, broken stitches, open seams, holes, raw edges and broken stitches. In total, there were 14 major defects and 7 minor defects. Photographs were attached to the report. All defective samples were recorded to have been reviewed by KK.

16.  On 28 October 2008, a further inspection was conducted by STR. Of 5531 pieces of the Goods which were available for inspection, 125 pieces were inspected. Broken stitches, open seams, yarn ends and loose yarns were still detected in the Goods. According to the STR inspection report dated 29 October 2008, all the defective samples and results were reviewed by KK, and under "inspection result", the report states: "On Hold - Shipment release subject to the instruction of client".

17.  It is not disputed by the parties that notwithstanding the STR inspection report dated 29 October 2008, 6445 pieces of the Goods were eventually shipped on 31 October 2008 to Germany. Of these, 1529 pieces were found by ZFL's customer to be defective.

18.  On 11 November 2008, ZFL e-mailed KK to say that upon inspection of the Goods in Germany, defects were found including broken threads, loose threads and missing zipper pullers. 11 photographs taken by the German customer were sent to KK in November 2008. These photographs show holes in the woollen garments, broken flatlock seams, broken stitches and loose stitches - the same major defects which had been discovered in the Goods inspected at different stages during the course of production.

19.  Having considered all the evidence, I am satisfied, on a balance of probabilities, that the defects discovered upon arrival of the Goods in Germany and as notified by the German customer to ZFL, and by ZFL to KK in the e-mails of November 2008, were defects caused by KK in the course of production of the Goods. The defects referred to by the German customer and as shown in the photographs were consistent with the defects discovered in the course of production and during the inspections carried out by Gary, Tian Ying and STR in October 2008. It is more probable that the defects were caused by defective workmanship than any other cause, such as deliberate or malicious damage, or after arrival of the Goods in Germany, as suggested by KK.

20.  On the evidence, ZFL's customer had made attempts to utilize as many of the Goods as possible, despite the delay in the delivery, by selling the Goods of acceptable quality in the stores at full price first, and then at discounted prices after two weeks, and by utilizing the zipper pullers of the defective Goods for the acceptable quality Goods with the missing zipper pullers. I am satisfied that the 1529 pieces of the Goods which were rejected by ZFL's customer were rejected because of the defects found and as complained of.

Had ZFL accepted the Goods and hence lost its right to reject the Goods?

21.  KK relies on the fact that the Contract provides that the Goods were to be sent to the independent inspection house for "100% checking before final inspection taken by STR". According to KK's evidence, ZFL had on its own accord waived the 100% checking by Tian Ying, and STR's inspection of the Goods on 25 and 28 October 2008 were final.  KK claims that irrespective of the results of the STR inspection, ZFL had agreed to ship the 6445 pieces of the Goods to ZFL's German customer, and had accepted the Goods.

22.  It cannot be disputed that ZFL had agreed not to send the Goods to Tian Ying for inspection, in view of time pressure and the delay in production. ZFL relies on an e-mail from Sophia Lee of ZFL to KK of 20 October 2008, in which it is stated that there would be no inspection by Tian Ying, but that KK would "need to take full responsibility of the quality" of the Goods. ZFL does not dispute that after the STR inspection of 28 October 2008, ZFL agreed to KK's shipment of 6445 pieces of the Goods to ZFL's customer in Germany.

23.  I am satisfied on the evidence that ZFL had been given a reasonable opportunity to examine the Goods prior to its shipment to Germany, as evidenced by the 2 inspections made by STR, and that it had agreed to 6445 pieces of the Goods being shipped.

24.  ZFL's e-mail of 20 October 2008, stating that there was no need for an inspection by Tian Ying, but that KK "need to take full responsibility of the quality and order must ship on time", means just that on its plain reading. It is a reservation of KK's liability for the quality of the Goods. It may be a reservation of ZFL's rights and remedies in respect of any breach by KK in relation to the quality of the Goods, but this can be either a right to damages for breach of warranty, or a right to reject for breach of condition.  In agreeing to 6445 pieces of the Goods being shipped on 31 October 2008 after the 28 October 2008 inspection, I consider that ZFL had intimated to KK its acceptance of the Goods, and I do not accept that ZFL's email of 20 October 2008 is sufficiently unequivocal to indicate otherwise.  In his testimony in court, Mr. Kelvin Yue of ZFL ("Kelvin") also acknowledged that the Goods had been accepted by ZFL.

25.  The Contract is not a severable contract. Having accepted 6445 pieces of the Goods on 31 October 2008, without any reservation of the right to reject the Goods should they be rejected by its customer in Germany, I agree with Mr. Chan that ZFL lost its right to reject the Goods, and can only treat KK's breach of any condition to be fulfilled under the Contract as a breach of warranty, and to claim damages for such breach (s.13(3) of the Sale of Goods Ordinance).

Is ZFL entitled to damages, and if yes, the amount of damages payable by KK in respect of the defective Goods?

26.  The key issue is whether ZFL is entitled, under its Counterclaim, to set-off, against the outstanding price for the Goods, the sum of US $21,750, as its damages sustained as a result of KK's breach of Contract in supplying defective Goods.

27.  KK makes an alternative claim for the sum due under the Cheque. To this, ZFL claims that it has a good defence of partial failure of consideration, as the amount it seeks to deduct is in fact a fixed sum capable of definite computation. I do not agree. On its pleaded case, ZFL claims a sum of US $21,750 by way of set-off, and such sum does not simply represent the Contract price of the 1529 pieces of the defective Goods, but comprises ZFL's computation of its alleged loss of profits, which is disputed by KK, and other expenses incurred. ZFL's purported set-off is by way of unliquidated damages, and Agra and Masterman’s Bank v. Leighton (1866) LR 2 Exch. 56 is distinguishable.

28.  By way of Counterclaim, ZFL seeks: (1) under paragraph 29 of the Counterclaim, loss of profits of US $10,000 in respect of the 1529 pieces of the defective Goods; (2) under paragraph 30, administrative expenses of US $1,000; (3) under paragraph 27, inspection and checking costs of US $5,750; and (4) under paragraph 28, storage charges of US $5,000. On ZFL's pleaded case, the total amount of its Counterclaim is US $21,750.

29.  According to paragraph 29 of the Defence and Counterclaim, ZFL claims that it was able to sell the original Goods at a price of US $20, whereas under the Contract, it paid US $14.80 for the Goods, which was later reduced to US $14.06. On this computation, ZFL was to make a profit of US $5.94 on each item purchased from KK.

30.  On the question of its alleged loss of profits, there is nothing in the evidence adduced to show the price at which ZFL had sold the Goods to its customer. This is accepted by Counsel for ZFL. In the absence of any evidence, ZFL has failed to discharge its burden of proving the profit it claims it had lost on the sale of the defective Goods.

31.  I have found that ZFL had accepted the Goods under the Contract and had lost the right to reject the Goods. Nevertheless, under s.55(1) of the Sale of Goods Ordinance, ZFL is entitled to claim damages for KK's breach of warranty, in diminution or extinction of the price for the Goods. Under s. 55 (2) of the Ordinance, the measure of damages for breach of warranty is the estimated loss directly and naturally resulting, in the ordinary course of events, from the breach of warranty. In the case of breach of warranty of quality, by virtue of s.55 (3) of the Ordinance, ZFL's loss is prima facie the difference between the value of the goods at the time of delivery and the value they would have had if they had answered to the warranty.

32.  According to Kelvin's witness statement, the Goods sold under the Contract carried the German customer's brand name, and were sold at a price higher than usual. The 1529 pieces of defective Goods delivered were rejected by the German customer, and according to Kelvin, the defective Goods were unmerchantable and had no value. They could not be sold on the market with the German customer's brand name, as it would jeopardize the reputation of the German customer and its brand name. They were ultimately donated to charity with the labels removed.

33.  On the evidence of the defects complained of, and having regard to the photographs of the defective cardigans with holes, open seams and broken stitches, I accept that the defective Goods could not be sold and had no commercial value at the time of delivery. Hence, on the question of ZFL's damages in respect of KK's breach of warranty of quality, the difference between the value of the 1529 pieces of the defective Goods at the time of delivery and the value they would have had if they had answered to the warranty is US $21,497.74 (1529 x US $14.06, their value under the Contract which they would have had if they had answered to the warranty).

34.  I also accept that as a result of KK's supply of the defective Goods, the loss directly and naturally resulting in the ordinary course of events from KK's breach would include the administrative costs incurred by ZFL in having to send its representative to Germany to deal with the defects, and the inspection costs incurred in Germany as a result of the discovery of the defects. According to Kelvin's e-mail dated 10 December 2008 to Raymond Lui and Paul Lui of KK, ZFL's "boss" had gone to Germany to discuss the matter of the defective Goods with the German buyer, in an attempt to settle the matter. The sum of US $1,000 claimed by ZFL appears to me to be reasonable and I will allow this item. I also allow the discounted inspection costs of US $5,750 referred to in Kelvin's e-mail of 10 December 2008.

35.  On 5 December 2008, Kelvin had sent an e-mail to KK, advising that the German customer had found about 1529 pieces of defective Goods, and that these would be rejected. Kelvin claims that he had also telephoned the representatives of KK in an attempt to discuss the defective Goods, but that KK was not prepared to do this and instead referred the matter to its solicitors.

36.  ZFL's evidence is that it had asked KK for instructions as to how the 1529 pieces of the defective Goods should be returned, but did not receive any indication from KK. In a letter dated 21 January 2009 from KK's solicitors to ZFL's solicitors, reference was made to ZFL's intention to sell the defective Goods. In the letter, KK's solicitors demanded that the defective Goods should not be removed, sold, or released to any party other than KK, and that any dealings in the Goods had to be notified to and agreed by KK. However, no further instructions were since received from KK on the manner of disposal of the Goods.

37.  ZFL's evidence is that in the absence of instructions received from KK, the defective Goods were eventually donated to charity after 5 months in storage, by way of mitigation of its damage.

38.  On KK's own evidence, it had demanded ZFL not to remove, sell or otherwise deal with the defective Goods. The letter dated 21 January 2009 from its solicitors made this clear, in strong tones.  As such, ZFL had no alternative but to store the Goods until, in the absence of any further communication from KK after 5 months, ZFL took steps to mitigate its further loss and disposed of the defective Goods.  I cannot see how KK can now complain about the storage charges which ZFL had to incur, and allow the sum of US $5,000 claimed.

39.  It can be seen from the above that I would have allowed a total sum of US $33,247.74 in respect of ZFL's damages. However, ZFL's Counterclaim, as pleaded and as argued, is only for the sum of US $21,750. To avoid any injustice to KK, I will restrict the award on the Counterclaim to the pleaded amount of US $21,750.

Conclusion

40.  The sum of US $32,886.75 is allowed on KK's claim against ZFL in the main action for the balance of the price due under the Contract.

41.  ZFL's Counterclaim is allowed in the sum of US $21,750 as pleaded, in respect of the damages sustained by ZFL as a result of KK's breach in the supply of defective Goods under the Contract.

42.  After deducting the sum of US $21,750 allowed on the Counterclaim from the sum of US $32,886.75 sought by KK in the main action, I make a net award of US $11,136.75 to KK.  

43.  On the question of costs, even on ZFL's pleaded case, if it should succeed on its Counterclaim, a balance of US $11,136.75 remains payable to KK and the amount should have been paid before trial to avoid costs. Bearing in mind the orders made, I will make an order nisi that the costs of the main action and of the Counterclaim are to be paid by ZFL to KK, to be taxed if not agreed. The order nisi is to be made absolute after 14 days in the absence of any application for variation of the order on costs.