Case Study - Nonconformity of Goods

Case Study Key Information

Date: 2009.03.17

Court/Tribunal: Supreme court, Israel

Goods Involved: Ceramic floor tiles

Key Article(s): Arts 38, 39, 40 CISG

Summary

An Israeli buyer (“B”) bought ceramic floor tiles from a Spanish seller (“S”), which were for resale to his local customer, an Israeli contractor, for use in a housing complex. Several years later B was sued by his customer for compensation of the loss it suffered from the defects in the tiles. B then sued S for reimbursing the compensation he was ordered to pay his customer. S argued that B’s claim was time-barred under Arts 38 and 39. B argued that the relevant laws govern only the obligations of the seller and the buyer that derive from a sales contract, the time-bar restriction therefore did not apply to his tort-based claims basing on S’s negligence. In defence, S invoked Art 40. The key issues here were whether the alleged negligence could be proved and what constitutes the mental elements of the requisite state of awareness of the seller in Art 40.

Facts

B sold the tiles imported from S to his local customer for use in a residential building. The tiles were delivered in 1995 and 1996. The tiles were examined by Israel Standards Institute on arrival and not found to be defective. In 2001, after the residential building had become inhabited, B received a complaint about the serious defects in the tiles used in the building. B made some attempts to solve the defect problem by partly replacing the tiles but not to the satisfaction of his customer. B was sued for compensation. B then claimed that S, as the manufacturer of the tiles, was liable for the amount he was ordered to pay his customer in compensation. The trial concluded that S had been aware of the problematic tiles and noted that the two-year cut-off period in Art 39(2) only applied to contractual claims, not claims in tort. It held that S had been negligent in the manufacture of the defective tiles and was liable for paying damages to B.

S appealed to dismiss the trial’s court’s finding on several grounds including: (i) B breached his notification of defect obligations under Arts 38 and 39. B knew of the defects of the tiles on his visit to the building on 1998.12.13 but had not told S of the defects until 2001.03.20, (ii) the court erred in deducing from a self-conflicting testimony of B’s witness that S was aware of the defects, any alleged knowledge of previous defects did not establish constructive knowledge under Art 40, (iii) B testified that the causes of the defects were improper use of the tiles (tiling in public areas instead of only in private apartments) and the bad workmanship of the floor tile workers who laid them. B’s main contention included that (i) S made a false representation because he represented the tiles to be ‘grade’ A, when he was already aware of the various defects in them and (ii) S was negligent because he sold defective tiles that a reasonable person would not have sold, in breach of the duty of care to consumer.

Judgment

The governing law of the contract under dispute was ULIS, not the CISG. However, the Court considered that in substance there is no change in the relevant provisions between the ULIS and CISG. It was possible to link the two versions together for application to the facts of the case. Accordingly, the fact that B failed to give timely defect notice within the two-year time limit was subject to the scrutiny under Arts 38, 39(1), 39(2) and 40 CISG.

On the purpose and scope of the application of Art 40, the Court opined that Art 40 is intended for cases of bad faith, not intended for cases which the seller did not disclose defects of which he was genuinely unaware. In practice, Art 40 should only be used to nullify the protection available to a seller in the wrong. As Art 40 constituting an exception to the notification regime in Arts 38 and 39, foreign case law and legal literature assert that it should be narrowly interpreted and restricted to only special or exceptional circumstances. The Court considered that this restricted approach made sense because legal certainty is of great importance in international sales law.

On the requisite state of awareness to trigger Art 40’s exception rule, the Court noted that a spectrum of views ranging from fraud, bad faith, gross negligence to simple negligence could be found in various court decisions and legal comments. The Court opined that in analysing what is the requisite state of awareness of the seller in Art 40, a proper interpretation of the expression “could not have been unaware” is crucial. The expression should be interpreted as a de facto awareness requirement, not a normative awareness requirement which may include awareness of the facts of which a reasonable seller should have been aware. The wording of Art 40 does not support normative awareness or negligence but requires de facto awareness, i.e., where knowledge, if not proven, reasonably can be inferred. Even if negligence was taken as the threshold criterion for triggering Art 40’s exception rule, the Court found itself not difficult to decide that S’s conduct had not reached the threshold or amounted to negligence. It reasoned as follows:

• At the time of delivery, S did not know of a defect in any specific consignments.

• The evidence given by B’s witness saying he had bought defective tiles from S before was not convincing. First, the witness had not made a complaint to S before this transaction took place. Secondly, the witness did not specify the type of the tiles he bought or their defects.

• If a buyer relies on defects in the past to prove the seller’s awareness, he must at least show that in the past the seller had been aware of the same kind of defect being alleged in the same type of products that should have given rise to a real concern. The ignorance of such concern can prove the seller’s negligence. B did not prove so.

• Even if the fact that S had discovered problems in the past could be proved, B could not argue successfully that S was negligent because B had not given specific notice about the specific tiles.

• Expert opinions pointed out that it would be normal for a manufacturer of millions of square metres of tiles to have some manufacturing defects in one or the other consignments.

• It is a general consensus among court decisions and scholarly doctrines that a general awareness of a seller that some of his products are not of the best quality does not satisfy the awareness requirements of Art 40.

The Court further considered that in the present case there might not be a lack of conformity at all. The alleged defects might be caused by B’s (or his customer’s) improper handling of the tiles. B had not made clear to S any particular purpose he had in mind for the use of the tiles. Without stating the specific use, B could not demonstrate that the tiles delivered by S did not conform to the contract. Thus, the Court concluded that B had not discharged the burden of proving that S had in fact been negligent. Art 40 therefore did not apply. The Court held that S was not liable for paying damages to B.

Comment/Discussion Points

1. Buyer acting in good faith in invoking Art 40

The Court asserted that Art 40 concerns the application of the principle of good faith, not only giving protection to the seller acting in good faith but also precluding the ill-faithed buyer from invoking the exception rule by an ill-faithed act. In other words, the buyer’s right to make use of Art 40’s exception rule must be done in good faith. In the present case, B tried to circumvent the cut-off period in Art 39(2) by raising a claim that S had been negligent in the manufacture of the tiles, so he could claim Art 40’s protection. B’s conduct could be deemed as an example of not acting in good faith.

When invoking Art 40, the buyer needs to show he handled the transaction in good faith. In the present case, B was not an end user; he had resold the goods to his customer without conducting an Art 38 examination. Pursuant to Art 7(1), B had the burden of showing that he resold the goods to his customer in good faith himself, but that the goods had been sold to him in bad faith by S. It is a heavier burden of proof on an intermediary seller than the one imposed on an end user. When B alleged that S had acquired a bad reputation in Israel during the relevant period, B had to explain why he did not refrain from buying and reselling S’s tiles. B could be found not acting in good faith and should therefore be precluded from invoking Art 40.

The Court’s assertion corresponds to the notion that the general principle of good faith does not only play a role in interpretation of CISG provisions and the contracts it governs but also can be used to set a standard of conduct for parties in the formation and performance of the contract. This proposition is largely adopted by the civil law systems. Although the view in the common law systems is still against it, recent developments in international uniform law instruments have shown that there is a growing recognition of imposing a general duty of acting in good faith upon the parties in a contract in performance of their contractual obligations.

2. Threshold of the requisite state of awareness in Art 40

Different courts may take a different view on the requisite state of awareness basing on their interpretations of the wording of Art 40. However, in practice, courts seemed to have found it difficult to be able to invoke Art 40 rightfully in cases of mere negligence. Similar approach was adopted by the Court in the present case. Many legal scholars also support that the minimum state of awareness in Art 40 should not be set at the low level of negligence, but at a higher level of gross negligence or more than gross negligence. In a case decided by the Sweden arbitration tribunal on 1998.06.05, one of the cases cited by the Court, the tribunal considered that the requisite state of awareness in Art 40 must amount to at least a conscious disregard of the apparent facts that meet the eyes and that are of evident relevance to the nonconformity. This interpretation can be considered as setting gross negligence as the threshold of the requisite state of awareness in Art 40.

In principle, the determination of whether a seller acts grossly negligent depends on the particular circumstances of individual cases, in particular the role of the seller, the type of nonconformity, its obviousness and extent. In another case decided by the German Supreme Court on 2004.06.30, the court stated that gross negligence is to be assumed if (i) the goods deviate widely from what is required by the contract and (ii) the nonconformity results from a fact within the seller’s domain. Following this approach, the particular circumstances in the present case also did not point to an assumption that S had been grossly negligent in selling the tiles to B. First, the defects of the tiles were not obvious, otherwise they should have been discovered at the examination carried out by the Israel Standards Institute. Secondly, the tiles did not deviate widely from what was required by the contract, otherwise B’s customer would not have fixed them in the building complex.