Case Study - Avoidance of Contract

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Date: 2001.12.13

Court/Tribunal: Trial court, Italy

Goods Involved: Machinery for recycling of plastic bags

Citation: http://www.cisg.law.pace.edu

Key Article(s): Arts 49(2)(b)(i), 50, 82 CISG

B, an Ecuadorian buyer, contracted to purchase from S, an Italian seller, a machine to be used for recycling plastic bags. During contract negotiations, B provided S with samples of the type of plastic materials intended for the recycling. After delivery, B notified S there were many problems of the machine. During the following period of almost two and a half years, many attempts to repair the machine had not been successful. B declared the contract avoided and claimed a refund of the purchase price and damages from S. S contested that B was not entitled to cancel the contract on the ground that B was too late in issuing both the defect and avoidance notices. The key issue here was not concerned with the seriousness of S’s breach of contract, but the reasonableness of B taking a long time to declare the avoidance of the contract. 

Through S’s agent in Ecuador, B entered in a contract with S for the purchase of a machine at a price of US$247,300 for recycling plastic bags used for packing bananas (“the Machine”). During their contractual negotiations, B gave S some samples of the type of plastic materials intended for recycling by the Machine. B drew S’s special attention to the prior problems encountered by other European recycling machinery companies in recycling this type of plastic materials. S guaranteed that the Machine would be fitted for B’s intended use and its productivity would achieve 250-300 kg/hour. The Machine was delivered to B in October 1995.  After the two-month period of testing and installation ending December 1995, B informed S’s agent that the Machine had many problems in relation to malfunctioning and low-productivity. Thereafter, S had made many attempts to repair and determine the probable causes of the problems, but all failed. During this remedial intervention process, a shipment of dirty and humid material was sent to Italy for further testing to find out whether the non-achieving of productivity level could be attributed to the percentage of humidity and dirt in the material. The test result indicated that the non-achieving was not dependent on whether the material was humid or dry. Two repair reports were then issued in May and October 1997 respectively. The second report showed that even after repairs conducted by S, the malfunctioning problem had continued and the Machine was far away from achieving the promised production capacity. In May 1998, B declared the contract avoided.

S denied any lack of conformity of the Machine. He attributed the malfunctioning problem to B’s inability to operate. The low-productivity problem was due to the difference between the materials used for the on-site processing and those submitted as samples before the conclusion of the contract. B alleged that the gravity and irremediability of the Machine’s problems constituted a fundamental breach of contract by S. He was therefore entitled to declare the contract avoided and claim restitution of the purchase price and damages from S. In defence, S contended that B had been too late in declaring the avoidance of the contract.

On the issue of nonconformity of goods, the Court found that prior to the contract conclusion B had made known to S the particular purpose for which the Machine was put to use. It was evident by the witness statements, expert reports, as well as S’s own letters that the Machine was not fitted for B’s intended use and lacked the essential qualities that were promised by S in the contract. Thus, S committed a breach of contract by delivering nonconforming goods pursuant to Art 35. 

On the issue of delay in sending defect and avoidance notices, the Court considered that B’s complaints at the end of the installation period to S’s agent had a valid effect of sending S the defect notice in the sense of Art 39(1). The character of S’s breach of contract was proven to be fundamental basing on the Machine’s complete unsuitability for the promised and agreed upon use as well as the seriousness of its various problems. Hence, B was entitled to declare the contract avoided pursuant to Art 49. The Court rejected S’s contest regarding B not having sent the avoidance notice in a timely manner on the following grounds:

- The identification of the real cause of the problems had taken a considerable amount of time, which was due to the technical complexity of the Machine as well as S’s failure to perform the inspections and interventions requested by B.

- B had good reasons to wait for all the testing and repairing results in order to ascertain the degree of uselessness of the Machine.

- Avoidance of contract should be the last remedy considered by a buyer when there are no other possible solutions left. It was justified for B to take a long span of time to decide to seek this remedy. 

- Thus, when B exercised his right to declare the contract avoided in May 1998, the declaration could be deemed to be made within a reasonable time.  

Furthermore, the Court asserted that the contract should also be deemed avoided due exclusively to the behaviour and consequent fault of S. The Court held that S was liable for refunding the purchase price and paying compensatory damages to B. 

1. “Within a reasonable time” under Art 49(2)(b)(i)

Between the time of the second repair report issued in October 1997 and B’s declaration of contract avoidance in May 1998, at least seven months had lapse. This long span of time could hardly be regarded as a reasonable period of time within which B was deemed to have timely declared contract avoidance under Art 49, even though the Machine might be claimed to be of a complex technicality nature. The Court did not discuss Art 49(2)(b)(i), which provides that a buyer loses his right to declare the contract avoided unless he does so within a reasonable time after he knew or ought to have known of the breach. It means that the starting point of the reasonable time period is dependent on the moment at which the aggrieved party realized that a fundamental breach had been committed by the other party. The “detriment” in Art 25 does not refer to the extent of loss suffered, but instead to the importance of the interests the aggrieved party is entitled to expect under the contract.

In a case decided by the French Supreme Court on 2003.09.24, it was held that though lacking evidential certainty about the cause of the defects of the goods, the buyer was obliged to sue the seller without waiting because, under certain circumstances, only a judicial expert examination ordered by the court would be able to establish the cause. Analogously, B did not need to wait for the moment at which he could ultimately realize that the Machine was completely useless. The time started to run as soon as he realized that S had committed a fundamental breach of contract, i.e. the Machine was not fitted for the particular purpose of what it was intended to be put in use or lacked the essential qualities of what had been promised by S. The second repair report could have clearly triggered B’s realization in this respect. B’s belatedness should not be excused because of his wishes to find out the root problems of the Machine or to sort out whether avoidance of contract was the remedy best suited his business interests. Arguably, the Court incorrectly ruled that B’s declaration had been made within a reasonable time under Art 49(2)(b)(i).

2. Loss of right to avoid under Art 82

The Court also did not discuss Art 82. Art 82(1) provides that the buyer loses the right to declare the contract avoided if it is impossible for him to make restitution of the goods substantially in the condition in which he received them. Art 82(2) governs three exceptional situations where a buyer who is no longer able to make restitution of the goods in kind may nevertheless avoid the contract. In theory, it won’t be difficult for B to make a successful claim for not losing his avoidance right under Art 82(2)(a) and (b) as long as he could prove that all the examinations and uses of the Machine were conducted under S’s instructions and approvals. However, arguably, it would be very difficult for B to claim the exception under Art 82(2)(c), which requires the buyer ceases to use the goods after discovering the lack of conformity.

The crucial points here were (i) when did B discover the lack of conformity? and (ii) had B ever used the Machine afterwards for his own production purpose? S’s agent did not do a good communication work for S. It only faxed B’s first complaint letter to S one month after in receipt of it, leading to a possibility that S had been kept in the dark about the Machine’s problems for months. Thus, B might argue that the advice from S’s agent was not helpful for him to learn of the Machine’s nonconformity sooner. However, B could not deny that he knew or ought to have discovered the nonconformity when he wrote to S directly about the Machine’s problems on 1996.07.03. After sending out that letter, B had to cease using the Machine on his own initiatives. Applying business common sense, it would be hard for the reasonable person in Art 8(2) to believe that B had ceased to do so during a 23-month long period of time (July 1996 to May 1998).

If B’s right to avoid the contract was forfeited under Art 82(2)(c), B might try his luck under Art 82(1). In the present case, it was almost impossible for B to return the Machine substantially in the ‘beginning’ condition after having it in possession for two and a half years. However, Art 82(1) does not require return of the goods in an unimpaired condition. In measuring the substantiality of a change of condition, the market value alone is not decisive and other factors such as the de minimis rule, the purpose of the goods and the particular circumstances of the case need to be taken into account. The decisive criterion is whether the seller can be reasonably expected to accept the return of the goods. The particular purpose of the contract supplying B with a machine for recycling the specified materials was very clear in the sense of Art 35(2)(b). Given that S had guaranteed that supply but failed to do so, S could be reasonably expected to bear the risk of deterioration and accepted the return of the Machine in a substantially deteriorated condition. Hence, the Court might hold that B had not lost the right to declare the contract avoided.

3. Price reduction to zero under Art 50

Arguably, the Court could consider the alternative remedy of price reduction combined with an award of compensatory damages to B. In practice, when the delivered goods are literally without any value, the buyer will normally declare the contract avoided. If avoidance is impossible for some reasons, the buyer may consider a claim for reducing the purchase price to zero under Art 50. Legal scholars debate over whether price reduction to zero may be claimed under Art 50. In a case decided by the German appeal court on 2006.12.14, the court, after interpreting Art 50’s wording, concluded that when the goods actually arrived at their destination were no longer of any value to the buyer at all, the reduction in price to zero was justified. After all, the wording of Art 50 does not expressly or implicitly prohibit a price reduction to zero.

In a perspective of commercial reasonableness, one would find that the Court’s holding that B, after having kept the Machine in possession for an extraordinarily long span of time, was still entitled to declare the contract avoided under Art 49(2)(b)(i) was not a safe outcome. Comparatively, a safer outcome might be: (i) If the Machine was proved to be completely useless to B, he could successfully claim a price reduction to zero under Art 50, or (ii) If the Machine had a true remaining value, B could successfully claim a big reduction in the purchase price and additional damages under the principle of full compensation in accordance with Art 74.