Lessons about invalid contract, inspection and Incoterms over a lawsuit

1. Summary of the dispute

On March 28, 2014, the Claimant (a Vietnamese Company) signed a contract to buy from the Respondent (an UK company) the goods of 1,000 tons (MT) (+/- 10%) of steel scrap delivered in 3 shipments, stuffed in 29 containers with a price of USD 374,000 (+/- 10%). Article 1.5.3 of the Contract stated: " “The Scrap is free from admixtures such as  … grease, rubber …” . Article 5 of the contract stipulated:  “At Buyer’s expense, the Buyer, at his option, will be entitled to inspect Quality/Weight of the commodity after arrival at discharging port and/or Buyer’s warehouse by companies [hereinafter called CT1 and CT2]. Weight inspection and Quality inspection at Buyer’s warehouse by CT1 or CT2 shall be final and binding on both Contracting Parties […], inspection either estimate impurity by visual for all containers or take random minimum one or two containers to inspect/survey the impurity weight and ratio… ”.  

Article 5.2.1 of the Contract on compensation for impurities stated: "… Over 0.20% to 2% against actual survey’s weight: 100% unit price. From 2% to 5% against actual survey’s weight: 105% unit price. In case the impurities are above 5% against survey’s net weight, the Seller has to take back the goods within 10 working days after being informed by the Buyer and bear all the arising expenses relating to the discharging and taking back of the goods from Buyer’s warehouse, and the Seller has to refund the total amount value of the goods to the Buyer plus 20% of the goods value as a compensation to the Buyer. […]”. At the loading port in Chile, the inspection certificates indicated impurities of the three shipments were 3%, 4% and 5% respectively.

Upon receipt of the goods by and at the request of the Claimant, CT1 inspected and issued three  Certificates of Weight  on July 31, 2014 showing that impurities (rubber) were about 1.0 metric ton/container or more that could not be estimated visually. After that, the Claimant asked CT2 to inspect and was granted a Certificate of Grading dated July 26, 2014 showing 29.51% of impurities and was noted by the Claimant’s opinion that the goods were unstuffed from June 25 to July 1, 2014 from the containers of the three shipments mentioned above. On August 1, 2014, the Claimant sent a letter of claim, asking the Respondent to compensate within 14 days but no results, after that, the Claimant sued the Respondent at arbitration.

The Claimant argued that the goods had an impurity rate of 29.51% according to CT2's Certificate of Grading, so the Respondent had violated Article 5 of the Contract, and under Clause 3 Article 51 of the 2005 Commercial Law (the Commercial Law), the Claimant "had the right to suspend the payment ..." because there was evidence that the Respondent did not deliver goods in accordance with the Contract. The Respondent's violation was a fundamental one because the Claimant had failed to achieve the purpose of the Contract. According to Article 5.2.1 of the Contract, the Claimant requested the Respondent to take back the goods and return the Claimant USD 216,154,80 and related costs incurred.

The Respondent argued that the rule of delivery was CFR Incoterms 2010. The Respondent, therefore, fulfilled the obligation to deliver the goods when delivering the goods to the carrier and not when the goods arrived at the destination port. Risk to goods transferred from Respondent to Claimant under Articles A5 and B5 of CFR Incoterms 2010. The three shipments inspected at the port of loading with the maximum impurity rates were 3%, 4% and 5% respectively.  Therefore, the Respondent had delivered goods in accordance with the Contract. The Claimant did not comply with the payment obligation under Article 50 of the Commercial Law. CT2's Certificate of Grading was invalid because CT2 confirmed that the goods were unstuffed from June 25 to July 1, 2014 from containers of three shipments. So, it was impossible to confirm that the goods inspected by CT2 were the goods delivered by the Respondent because the goods were in the yard. The Respondent counter-claimed, asking for payment of the full amount of the Contract; all costs, damages related to the lawsuit, and lost profits.  

2. Analysis and Arbitral Award of the Arbitral Tribunal; lessons learned

Vietnamese law was applied in accordance with Article 8 of the Contract. Regarding the validity of the Contract, Circular No. 01/2013/TT-BTNMTdated January 28, 2013 on imported scrap (Circular 01) and National Technical Regulation No. QCVN 31: 2010/BTNMT of December 29, 2010 on the environment for imported scrap (Regulation 31) are documents that needed to be referenced. According to Circular 01, the impurity rate ought not exceed 1% of the scrap volume. Therefore, goods with an impurity content exceeding 1% were not allowed to be imported into Vietnam. Regarding the Contract, Article 5.2 stipulated that if the rate of impurities was between 2% and 5%, the Seller ought to pay the Buyer 105% of the unit price. Thus, that the parties had agreed to buy and sell scrap with the amount of impurities from 2% to 5% was a violation of the law. Therefore, the Contract for purchase and sale of scrap with an impurity amount of 2% to 5% was invalid according to Article 128 of the 2005 Civil Code (Civil Code).

The Certificate of Grading of CT2 had no photos of the goods attached. The Claimant acknowledged the pictures of the goods provided by CT2 to the Claimant after the Claimant received the request to confirm the time of obtaining the goods photos by the Arbitral Tribunal on March 12, 2015. The Arbitral Tribunal believed that CT2's Certificate of Grading was not sufficient to conclude which goods had been inspected (or in other words, the Claimant could not prove that CT2 had inspected the goods delivered under the Contract).  Therefore, the Certificate of Grading of CT2 was not considered as evidence.

With regards to impurity rates, at the port of loading in Chile certificates showed that the rates  of impurities in 3 shipments were 3%, 4% and 5% respectively. CT1 inspected three shipments at the request of the Claimant and in the CT1’s letter sent to the Claimant on June 25, 2014, the CT1 representative stated that the impurity (rubber) was about 1.0 metric ton/container or higher but could not be estimated by visual methods. Thus, according to the assessment of CT1, impurity (rubber) of the goods was about 1.0MT/container.

The Arbitral Tribunal found that there was no basis and it was not feasible to reevaluate the rate of impurity of the goods; the parties did not require to do this. Therefore, the assessment of  the impurity rate of the goods was based only on the evidence collected. The Respondent confirmed the impurity rate from 3% -5%; CT1's inspection was about 5% (after being converted). Therefore, there were grounds to conclude the impurity rate was from 3% -5%. This rate violated Circular 01 (not more than 1%) and the national technical regulation No. 31, but the parties still agreed to buy and sell, so the Contract was "invalid due to violation of law and regulation" under Article 128 of the Civil Code, leading to the legal consequence of “the parties restored the original state and reimbursed each other what was received ...” (Clause 2 Article 137 of the Civil Code).

The Arbitral Award stated that (i) the Claimant had to deliver the goods to the Respondent and the Respondent had to accept the goods from the Claimant, this had to be done within 30 days of the date of this Arbitral Award; (ii) The Claimant did not have to pay the Respondent for the goods, unless there was no goods for delivery, it had to pay USD 216,154.84; (iii) The Respondent beared all costs for the re-export of the goods from Vietnam, the Claimant was responsible for cooperating and assisting the Respondent in complying with the provisions of law and applying for a license to re-export the goods; (iv) Each party beared its own costs and losses; and (v) Other Claimant’s requests and Respondent’s counter-claim were dismissed. The lawsuit showed that the Contract was invalid due to negligence that the parties did not expect; reckless inspection of the goods had lost evidence recognized by law, and the proof of delivery under the CFR Incoterms 2010 rule did not make the buyer lose the right to claim if there was evidence that the goods could not be delivered in accordance with the Contract.

(*)Ngo Khac Le | VIAC Arbitrator