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Legal case study: A Free On Board contract

This piece will evaluate the legal issues involved in the case between Look Natural Leather Products Ltd and Skin Deep (Fashions) Ltd before advising Skin Deep (Fashions) Ltd as to the best course of action. In considering their position, this piece will examine the relevant jurisdiction for enforcement of the contract, the type of contract made, any rights of rejection of the goods, and the passing of risk in the goods.

Under the Rome Convention on the Law Applicable to Contractual Obligations (1980) the parties to a contract are able to choose which law will apply to the contract.[1] The choice must be expressed or appear with reasonable certainty from the terms of the contract.[2] In this case the contract specifically states that in case of dispute the courts in London are to hear the matter. This is an express choice of law and therefore the law of the UK will apply to the contract.

Look Natural Leather Products Ltd and Skin Deep (Fashions) Ltd have entered into an agreement which they describe as an ‘extended FOB contract’. A simple definition of the term FOB contract was provided by Lord Brougham in the case of Cowasjee v Thompson:[3] “It is proved beyond all doubt, indeed it is not denied that when goods are sold in London “free on board”, the cost of shipping them falls on the seller, but the buyer is considered the shipper”.

The basic principles of a Free On Board (FOB) contract are therefore: (a) the seller’s duty is to deliver the goods over the rails of the ship, the issue of a bill of lading or mate’s receipt is irrelevant to the issue of property and risk; (b) the buyer’s duty is to ensure that the seller is properly notified as to the vessel to ship the goods; (c) the buyer remains the legal shipper of the goods, he is the main contracting party in the contract of carriage; (d) property and risk pass when the goods are taken over the rails of the ship; and, (e) when the risk passes, this means that the buyer has an insurance interest in the goods and is entitled to insure them.[4]

It may immediately be seen that the terms negotiated by the parties in this case do not appear to comply with the standard FOB principles. However, under an ‘extended’ FOB contract, the seller agrees also to arrange the shipping and insurance provisions.[5] This type of contract is very difficult to differentiate from a Cost, Insurance and Freight (CIF) contract. The distinction between an extended FOB and a CIF contract is that in the extended FOB contract, services connected with the provision of the vessel and prepayment of freight and insurance must be treated as having been provided on account of the buyer. Under a CIF contract the agreed price will therefore include the cost of carriage and insurance whatever they may in fact prove to be. On the other hand, where the seller under an FOB contract arranges for carriage and insurance, their cost is not part of the price and will normally be charged as separate items on the invoice.[6] In a FOB contract, the prime duty of the seller is the delivery of gods on to the ship, whereas in a CIF contract it is the delivery to the buyer of the requisite shipping documents.[7] The distinction, although difficult, is often important. The court will have regard to the classification of the contract by the parties and interpret any ambiguous clauses in line with this classification.[8]

In this case it is unclear whether the freight and insurance arrangements were being made on account of the buyer or not. It is therefore uncertain whether the parties were in fact contracting under a FOB or a CIF contract. However, the parties declaration that it was a FOB contract will be taken into consideration by the court.

Generally speaking, where parties contract under an FOB contract, property and risk passes on shipment (Colonial Insurance co of New Zealand v Adelaide Marine Insurance[9]). In contrast, property in CIF contracts does not normally pass until the transfer of the documents in exchange for payment of the price.[10] The reason the question of when the property has passed is relevant is because it is at this point that the seller becomes entitled to be paid. Section 49 of the Sale of Goods Act (SGA)1979 provides that where the property has passed to the buyer and the buyer wrongfully neglects or refuses to pay for the goods according to the terms of the contract, the seller may maintain an action against them for the price. Generally therefore, the seller in a FOB contract can sue for payment upon shipment.

However, where the FOB sale is characterised by documents, the intention of the parties is presumed to exclude the passing of property on shipment. Where the bill of lading is made out to the seller, he has to be paid before property in the goods can pass. Thus, in Mitsui & Co Ltd v Flota Mercante Grancolumbiana SA; The Ciudad De Pasto and Ciudad DeNeiva[11] it was clear that if the bills of lading were deliverable to the order of the seller, the presumption would be raised that the passing of the property was postponed. Where the bill of lading is made out in the buyer’s name or to his order, delivery of the goods to the carrier will be deemed an appropriation of the goods.[12]

Where a buyer wrongly refuses to pay under the contract, this may amount to a repudiatory breach. However, where the seller is in prior breach, the obligations on the part of the buyer to pay for the goods will cease. In this case two points regarding the tender of the documents must be established. Firstly, was the seller in breach of contract and secondly, did the buyer have a right to reject the tender of the documents?

Where documents which do not conform on their face are tendered, the buyer may reject them.[13]In this case, the documents do appear to conform with the contractual provisions, even though the date of shipment on the bill of lading is actually incorrect.

In Gill & Duffus SA v Berger & Co Inc[14] the contract for sale was for 500 tonnes of Argentine Bolita beans under a CIF contract, with a quality certificate to be issued at port of discharge. The correct quantity was shipped, but the incorrect quantity was delivered, 55 tonnes having been transhipped. The sellers could not obtain the quality certificate and the buyers refused to pay against the bill of lading and insurance documents alone. This was a wrongful rejection which the sellers could have treated as repudiatory. However, they did not and instead obtained a certificate for the 445 tonnes discharged and attempted a second tender. The buyers again rejected. The buyers contended that when the goods arrived they did not conform to the contractual description. It was held that the buyer was bound to accept the documents even where the seller shipped goods which were defective, but presented documents for them which conformed on their face to the contractual requirements.

This position relates to a CIF contract. However, where a FOB contract is in issue it is less clear whether there exists a right to reject the documents, as it is the goods which form the substance of the contract, rather than the documents.[15] In this case, whether Skin Deep Fashions were unable to reject the documents as the documents themselves conformed with the contract, even though they misrepresented the actual shipping date.

However, this will not affect any right which Skin Deep Fashions will have to reject the goods themselves. Unless a different intention of the parties is expressed in the contract, the buyer’s right to reject the goods is postponed until the goods arrive and he has a reasonable opportunity of examining them.[16]

Section 14 of the SGA 1979 implies a term of satisfactory quality into sale of goods contracts. It requires that all goods sold in the course of a business must be of satisfactory quality. Section 14(2A) states that the goods are of satisfactory quality if they meet the standard that a reasonable person would regard as satisfactory, taking account of any description of the goods, the price, and all other relevant circumstances. Section 14(2B) further provides that the quality of the goods includes their state and condition and the following may be treated as aspects of ‘quality’ in appropriate cases: (i) fitness for all the purposes for which the goods of the kind in question are commonly supplied; (ii) appearance and finish; (iii) freedom from minor defects; (iv) safety; and (v) durability.

Similarly, under the Convention on the International Sale of Goods (CISG) (Vienna 1980) the conformity of the goods is important in terms of quality,[17] quantity and description.[18] It is also provided that the goods must be packaged in a manner required for performance of the contract.[19] This means that the goods must be packaged in a manner customary for such goods or in a manner adequate to preserve and protect the goods.[20] However, the UK is currently not a signatory to the CISG.[21]

In this case, the hides and skins are rotting and therefore it would appear that they are not of satisfactory quality. This would give Skin Deep Fashions a right to reject the goods. However, the bill of lading suggests that the skins and hides were in apparent good order and condition.

It appears on the facts of the case that the damage to the cargo may have occurred in transit. The question of who bears the risk of this occurrence is therefore relevant. This is because the seller is not generally responsible for loss of or damage to the goods after risk passes. In Leigh & Sillivan Ltd v Aliakmon Shipping Co Ltd (The Aliakmon)[22] it was said that “the true analysis [of the goods being at the buyer’s risk] is that he has contracted to buy and pay for the goods in whatever state they may be when the voyage ends”.[23]

Thus, where the goods are lost or damaged after risk has passed, the buyer should sue the carrier or on the insurance policy, and not the seller. If the insurance policy does not cover the loss and the carrier is not liable then the buyer must bear the cost.

The general rule is that risk passes to the buyer on shipment.[24] In Colley v Overseas Exporters[25] it was decided that, in relation at least to FOB contracts, neither property nor risk will pass until the loading is complete. Therefore, if the damage to the goods happened during loading, Skin Deep Fashions will be able to claim against the seller, at least once they have satisfied payment on the contract. However, damage may have occurred later than this.

Risk and property normally pass together. Section 20 of the SGA 1979 provides a general statement of the law:

  1. Unless otherwise agreed, the goods remain at the seller’s risk until the property in them is transferred to the buyer, but when the property in them is transferred to the buyer the goods are at the buyer’s risk whether delivery has been made or not.

It may be seen from the discussion above in relation to the passing of property that in extended FOB contracts the seller may take the bill of lading as his own and the passing of property will be postponed. The passing of property may have been postponed in this case.

In Inglis v Stock a bulk consignment of sugar was shipped FOB from Hamburg to Bristol. The property was unascertained and therefore property in the goods did not pass to the buyer when they were shipped. The ship and the sugar were subsequently lost. The buyers claimed under the insurance policy. The insurers contended that the buyers had not suffered any loss because they were not the owners of the goods. The court held that although the property had not passed to the buyers, the risk had. The case therefore provides that risk does pass on shipment, regardless of when property passes.

Indeed, the Vienna Convention on contracts for the International Sale of Goods 1980 does not link the passing of risk with the passing of property. Article 67 states that: “If the contract of sale involved carriage of the goods and the seller is not bound to hand them over at a particular place, the risk passes to the buyer when the goods are handed over to the first carrier for transmission to the buyer in accordance with the contract of sale. If the seller is bound to hand the goods over to a carrier at a particular place, the risk does not pass to the buyer until the goods are handed over to the carrier at that place. The fact that the seller is authorised to retain documents controlling the disposition of the goods does not affect the passage of the risk.”

In this case, applying the above, the risk will have passed to Skin Deep Fashions upon shipment. If the damage to the goods occurred subsequent to this point then Skin Deep Fashions will have to rely on the insurance document or an action against the carrier in negligence to recover their loss.

Reliance on the insurance document will not be possible until Skin Deep Fashions have accepted tender of the documents. Currently, as discussed above, they are in breach of their contract with Look Natural Leather for failure to pay. Look Natural Leather may decide to treat the contract as repudiated, in which case they will no longer be under a duty to perform the contract and tender the documents, but may still sue for damages for loss against Skin Deep Fashions.

Skin Deep Fashions would therefore be advised to pay the contract price immediately before establishing the cause of damage to the goods. If the goods were damaged before shipment, Skin Deep Fashions could then sue Look Natural Leather for damages for the goods not being of satisfactory quality. If on the other hand, the goods were damaged subsequent to shipment, Skin Deep Fashions could then rely on the insurance document or an action against the carrier.

However, as mentioned earlier, the good were not actually shipped in accordance with the contract, in that they were shipped one day late. Section 13 of the SGA 1979 provides that where the goods do not meet the contractual description, the buyer may reject the goods. This would absolve Skin Deep Fashions from the requirement to pay under the contract. The contractual description does include time of shipment.[26] In Kwei Tek Chao v British Traders & Shippers Ltd [1954] 2 QB 459 it was held that the failure to ship within the shipment period was a repudiatory breach and that this failure can not be excused generally.

Yet this is now subject to a qualification. Section 15A of the SGA 1979 states:

Where in the case of a contract of sale:

  1. the buyer would, apart from this subsection, have the right to reject goods by reason of a breach on the part of the seller of a term implied by section 13, 14 or 15 above, but
  2. the breach is so slight that it would be unreasonable for him to reject them, then, if the buyer does not deal as consumer, the breach is not to be treated as a breach of condition but may be treated as breach of warranty.

If the breach is seen by the courts as only a breach of warranty then Skin Deep Fashions will only be able to claim damages on any loss they have suffered as a result of that breach and will not be able to treat the contract as repudiated. On this basis the advice to Skin Deep Fashions should be to perform the contract and then seek a remedy for their loss.

Bibliography

Chuah, J., Law of International Trade, 3rd Edition (2005), Sweeet & Maxwell

Dalhuisen, J., Dalhuisen on International Commercial, Financial and Trade Law, 2nd Edition (2004), Hart

Griffin, B., Day & Griffin: The Law of International Trade, 3rd Edition (2003), Oxford University Press

Moss, S., “Why the United Kingdom Has Not Ratified the CISG”, (2005) 25 Journal of Law and Commerce, 483

Murray, C., Schmitthoff: Export Trade: The Law and Practice of International Trade, 11th Edition (2007), Sweet & Maxwell

Niggeman, F., “Error about a substantial quality of the goods and the application of the CISG” (1994) IBLJ 395

Todd, P., Cases and Materials on International Trade Law, (2002), Sweet & Maxwell

van Houtte, H., The Law of International Trade, 2nd Edition (2002), Sweet & Maxwell

Veneziano, A., “Non conformity of goods in international sales. A survey of current caselaw on CISG” (1997) IBLJ 39

Whincup, M.H., Contract Law and Practice, 5th Edition (2006), Kluwer Law International

1


Footnotes

[1] Article 3

[2] Dalhuisen, J., Dalhuisen on International Commercial, Financial and Trade Law, 2nd Edition (2004), Hart, pg 381

[3] (1845) 5 Moore PC 165

[4] Chuah, J., Law of International Trade, 3rd Edition (2005), Sweeet & Maxwell, pp 113-114

[5] Whincup, M.H., Contract Law and Practice, 5th Edition (2006), Kluwer Law International, pg 126

[6] Griffin, B., Day & Griffin: The Law of International Trade, 3rd Edition (2003), Oxford University Press, pg 67

[7] Griffin, ibid

[8] Murray, C., Schmitthoff: Export Trade: The Law and Practice of International Trade, 11th Edition (2007), Sweet & Maxwell, pg 21

[9] (1886) 12 App Cas 128

[10] Chuah, supra, pg 188

[11] [1988] 2 Lloyd’s rep 208

[12] Chauh, supra pp 185-186

[13] Todd, P., Cases and Materials on International Trade Law, (2002), Sweet & Maxwell, pg 344

[14] [1984] AC 382

[15] Murry supra pg 42

[16] Bergerco USA v Vegoil Ltd [1984] 1 Lloyd’s Rep 440

[17] Niggeman, F., “Error about a substantial quality of the goods and the application of the CISG” (1994) IBLJ 395

[18] Veneziano, A., “Non conformity of goods in international sales. A survey of current caselaw on CISG” (1997) IBLJ 39

[19] van Houtte, H., The Law of International Trade, 2nd Edition (2002), Sweet & Maxwell, pg 158

[20] Article 35,2

[21] see Moss, S., “Why the United Kingdom Has Not Ratified the CISG”, (2005) 25 Journal of Law and Commerce, 483

[22] [1985] QB 350

[23] per Donaldson MR

[24] Todd, supra, pg 143

[25] [1921] 3 KB 302

[26] Chuah supra pg 161


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