Hong Kong Fir Shipping v Kawasaki

The plaintiff’s main business, as its name indicates, is the letting on hire of telephone installations and ancillary equipment. The defendant, as its name proclaims, is a building society. For many years prior to 1982 the plaintiff and the defendant had enjoyed a mutually beneficial ongoing business relationship and when, in that year, a major extension of the defendant’s head office in Molesworth Street was put in train and a new telephone system required, the defendant naturally turned to the plaintiff to supply it. This it did and the parties entered into a principal hiring agreement in April 1982 and, in subsequent years, seven supplementary agreements. The defendant also hired from the plaintiff an internal broadcasting installation to supply an internal paging system. The first broadcasting contract was dated 17 January 1985 and it was followed by a supplementary contract on 3 January 1986.

The defendant terminated all their hiring contracts with the plaintiff in May 1988 claiming that the defects in both systems justified it in doing so. These proceedings resulted. The plaintiff contends that the termination was wrongful and amounted to a repudiation of the defendant’s contractual obligations. Their claim is for £70,898.27 by way of liquidated or agreed damages together with £3,607.33 in respect of arrears of rental. Alternatively they claim damages for breach of contract The facts relating to the two main contracts are different and I will deal firstly with the telephone contract.

The development of the defendant’s head office was undertaken in two phases, firstly, the offices on the Westmoreland Street side of the site and then the offices on the D’Olier Street side. Mr. Evans, the defendant’s engineer, showed the plans for the phased development to the plaintiff. From these the plaintiff was able to ascertain the total office space contemplated in the overall development, the probable number of staff when the development was completed, and the position of the floor boxes from which internal telephone connections could be made. No specification was prepared and the choice of an appropriate telephone system was left entirely to the plaintiff. The main telephone contract was dated 30 April 1982. Under it the defendant agreed to hire a ‘Mitel’ SX 200 Switchboard, an operator’s console, 20 exchange lines (that is, internal lines to staff ‘phones), 28 push button instruments, 2 ‘Kirk’ instruments. An annual rent of £1,800 (payable quarterly) was provided for, and provision was made for an annual review of this rent. The hiring was to last for 14 years. Clause 11 contained the clause on which the plaintiff’s claim for liquidated damages is based and I will return to it later in this judgment. Between April 1982 and September 1987 seven supplementary contracts were entered into under which the defendant hired additional extension lines and ‘phones bringing the total number of ‘phones hired to 78. These new contracts involved the payment of extra rentals. At the date of termination the annual rent in respect of the main contract and supplementary contracts was £12,505.16.

At the end of 1985 and on different occasions in 1986 complaints were made by the defendant to the plaintiff about the manner in which this system was working. In March of 1987 the defendant enquired what sum was payable under clause 11 should it wish to terminate the hiring and it was informed that the amount due would be £87,178.03 plus the sum outstanding for current rent of £4,823.14. Later in 1987 the defendant obtained the assistance of a telephone systems consultant who wrote to the plaintiff on 11 February 1988 sending a detailed specification for a new telephone system and requesting a quotation for the new system from the plaintiff. The plaintiff’s quotation (which included a claim for £55,980 ‘by way of premature cancellation of the existing telephone contract’) was not accepted and the defendant purchased another system from a rival firm. By registered letter to the plaintiff’s parent company of the 23 May 1988 the defendant explained why the plaintiff’s quotation was not accepted and terminated all the existing hiring contracts. The plaintiff replied on 17 June 1988 advancing the claims which are now incorporated in the present proceedings.

The system which the plaintiffs installed worked satisfactorily until about the year 1985. From 1985 however problems in relation to it arose which became progressively worse as the volume of the defendant’s business increased causing greater demands on the telephone system. The complaints which the defendants had with the system were two-fold, but inter-related. Firstly incoming callers began to experience very long delays in having their calls answered. They heard the ringing tone but the telephone operator failed to respond to it. Secondly, calls transferred internally from members of the defendant’s staff were subject to being cut off and reverting to the switch. The delays which outside callers experienced were very extensive. The defendant’s solicitor told me how he was required regularly to ‘phone his clients and how he experienced very excessive delays in attempting to do so. On one occasion he decided to time the delay - it lasted for 22 minutes during which time the ringing tone was heard but was left unanswered. The manager of the defendant’s Dundrum branch described to me how difficult he found it was to get through to head office. He was required to ‘phone on a daily basis and frequently. His estimate was that three out of every ten calls involved a delay of about five minutes before the call was answered. The consultant called in to advise the defendants gave up using the defendant’s listed number because of the delay problem. Many complaints about the delay were made by members of the public to the defendant’s telephone operator and other members of the staff.

The internal problem was related to the ‘cradle-tap’ or ‘cradle-flash’ system for transferring internal calls. Instead of a hold-button on the internal ‘phone when a call had to be transferred (for example, from a secretary to her principal or from one member of the staff to another) the cradle of the telephone had to be tapped. The tap had to be exact. It had to be held for at least a quarter of a second and not more than half a second. If the tap was for less than a quarter of a second nothing would happen. If it was for more than half a second the call would revert to the switch. This produced the phenomenon referred to as ‘backing up’ by which a great number of calls which were cut off by the cradle tapping system would queue at the switch for the operator’s attention. Incoming callers became part of the queue. The evidence satisfies me that a high proportion of attempts to transfer calls resulted in the calls reverting to the switch. Staff found the system frustrating and to avoid it a practice developed by which they requested a colleague to ‘phone the operator to effect the transfer rather than attempt to do so by the cradle-tapping method.

The situation caused by the backing up of calls was aggravated by another feature of the system. There were four hold-buttons on the operator’s console. This number was not sufficient for the volume of calls but in fact only three were operative in 1987 and 1988. This meant that on only three incoming lines could the operator answer the caller and put the caller on hold. Thus the delays suffered by callers were due to a combination of an inadequate number of hold-buttons and the backing up of calls at the switch caused by the cradle-tapping system.

Complaints about the system were made verbally to the plaintiffs by Mr. Nolan the defendant’s general manager. He complained about the system at a meeting in December 1985 and at six meetings in 1986. A letter written in May 1987 requiring information about the amount payable under clause 11 should the defendants terminate the contract was written because of dissatisfaction with the system. This dissatisfaction deepened and towards the end of 1987 an expert consultant was called in to advise the defendants. As a result specifications for a new system were prepared and tenders sought. When the plaintiff’s tender was not accepted the letter of 23 May 1988 was written terminating the contract. I am satisfied that this decision did not result from a desire to avoid contractual obligations which the defendants found to be onerous but because of defects in the system which they found to be insupportable.

In reaching the conclusion that the problems which the defendants encountered were caused by the defects which I have outlined I have not lost sight of other possible causes. I have heard the evidence of the telephone operators who were employed by the defendants at the relevant time. They were both experienced telephonists and the delays were not caused by their inadequacies. There are now two operators and a full-time receptionist employed by the defendant. But this is because of the expansion in the defendant’s business which has occurred since 1988. Prior to and at the time of the termination of the contract the telephonist acted as a receptionist. But there is a record of the level of daily calls received by the defendants at the date of termination and these could have been adequately handled had the system not been defective. The problems the defendants encountered were not the fault of the Telecom Éireann lines or of an inadequate number of lines for incoming calls at that time. I have had evidence that the Mitel System with cradle-tapping internal ‘phones has been installed elsewhere and works well. There are, however, several possible explanations as to why the system worked well elsewhere but not on the defendant’s premises. For example, the calibration on the cradle-tapping system in other premises might have been different or the requirements for transferring internal calls might have been on a lower level, so that the fact of the system working well elsewhere does not vitiate the conclusions which, on the balance of probabilities, I have arrived at on the evidence in this case.

That evidence satisfies me that by 1988 the delays experienced by outside callers were of a serious nature. As a result the installations hired by the defendants did not provide a telephone communications system which would enable persons wishing to communicate by telephone with the defendant to have their calls answered within a time which would be acceptable to a reasonable caller. The system, in my judgment, was by that time not fit for the purpose for which it was being hired.

Clause 2 of the principal hiring contract (and in the supplementary hiring contracts) provided that the agreed hiring rent was to be paid during the continuance of the contract ‘for the hire of the installation and for maintenance of same in good working order’. The defects which I have outlined seem to me to be a breach of the plaintiff’s obligation under this clause as they failed to provide installations during the continuance of the hiring in good working order. The working order of the system by 1988 could not be described as being ‘good’ and it seems to me that the plaintiffs were in breach of an express term of their contracts.

The defendants were also in breach of a term implied by the Sale of Goods and Supply of Services Act 1980. By virtue of s. 39 of that Act in every contract for ‘the supply of a service’, where the supplier is acting in the course of a business and where goods are supplied under the contract there is a term implied that the goods will be of ‘merchantable quality’. In this case the contract which was entered into between the parties was for the supply of a telecommunications service. The plaintiff entered into the contract in the course of its business as suppliers of such a service. And goods, namely, a switchboard, console and telephone sets, were supplied under it. ‘Merchantable quality’ has the same meaning in s. 39 as it has in s. 14 (3) of the Sale of Goods Act 1893 (inserted by s. 10 of the 1980 Act). Goods are of ‘merchantable quality’ if they are as fit for the purpose for which goods of that kind are commonly bought and as durable as it is reasonable to expect. The durability of the goods is not in question in this case. What the defendants contend, and I think correctly contend, is that the goods which they hired were not fit for the purpose of providing a reasonably efficient telephone system. There was, in my judgment, a breach of the term implied by s. 39 of the 1980 Act.

The issue which arises now for consideration is one which arises in many cases. It does not follow that because one party is guilty of a breach of contract that the other may treat himself as discharged from obligation further to perform the contract.

There may be many cases in which the court, when presented with a problem of this sort, may be required to consider whether the term which was broken was ‘a condition’ or a ‘warranty’ or, a ‘fundamental term’ of the contract but, as the frequently cited case of Hong Kong Fir Shipping Co. Ltd v Kawasaki Kisen Kaisha Ltd [1962] 1 QB 26 shows, this is by no means a necessary exercise to be undertaken in every case. I think the approach suggested by the judgment of Diplock LJ at pp.65 and 66 of the report is appropriate to this case. In answer to the question ‘In what event will a party be relieved of his undertaking to do that which he has agreed to do but has not yet done?’ he said:-

The contract may itself expressly define some of these events, as in the cancellation clause in a charter party; but, human prescience being limited, it seldom does so exhaustively and often fails to do so at all. In some classes of contracts such as sale of goods, marine insurance, contracts of affreightment, evidenced by bills of lading and those between parties to bills of exchange, parliament has defined by statute some of the events not provided for expressly in individual contracts of that class; but where an event occurs the occurrence of which neither the parties nor parliament have expressly stated will discharge one of the parties from further performance of his undertakings, it is for the court to determine whether the event has this effect or not.

The test whether an event has this effect or not has been stated in a number of metaphors all of which I think amount to the same thing: does the occurrence of the event deprive the party who has further undertakings still to perform of substantially the whole benefit which it was the intention of the parties as expressed in the contract that he should obtain as the consideration for performing those undertakings?

If this question is posed in this case there can be only one answer to it. The ‘event’ which occurred in this case is the development of a situation in which the installation which the defendants had hired significantly failed to fulfil its purpose. This ‘event’ has deprived the defendant of the whole of the benefit which it was intended the defendant would obtain from the hiring agreements. The defendant was therefore, in my opinion, discharged from further performing the hiring agreements and was entitled to treat the contract as being at an end and request the plaintiff to take back their installations. It follows therefore that the plaintiffs are not entitled to rely on clause 11 of the contract and that their claim for damages for breach of the hiring contracts relating to the telephone installations also fails.

The first of these contracts, designed to provide a paging system in the defendant’s head office premises, was dated 17 January 1985, a supplementary contract being dated 18 January 1989. Under these contracts the plaintiff let on hire to the defendant a 60-watt amplifier, a microphone and a number of loudspeakers for a period of 12 years, the terms of hiring being similar to those in the telephone contracts. There was a rent review clause, by the application of which the annual rent had increased to £1,438.16 when the contracts were terminated. Using the formula contained in clause 11 on agreed liquidated damages in the event of repudiation the plaintiff’s claim the sum of £7,936.27 liquidated damages for the nine years remaining of the hiring contract together with a quarter’s rent claimed to be due for 1988.

The circumstances of this part of the case are entirely separate from those relating to the telephone contract. The complaint here is that the loudspeakers were too loud and that they had no individual volume controls to enable the sound to be reduced as a result of which some had to be disconnected. Three were disconnected on Mr. Kelly’s floor and six others may have been. But the evidence also establishes that this defect could have been easily remedied by what has been referred to as ‘tapping’ the offending loudspeakers. I do not think, therefore, that the defendant has established any breach by the plaintiff of these contracts; it should have given an opportunity to the plaintiff to rectify the complaint. Even if a breach of contract had been established it was not one which would have entitled the plaintiff to terminate the contract on the basis that the breach discharged its obligation to continue the hiring.

What falls therefore now for consideration is whether the plaintiff is entitled to an award under clause 11 or whether this clause, as the defendants contend, is a penalty clause and therefore unenforceable. If it is then I must assess damages according to common law principles.

Clause 11 provides as follows:-

If the subscriber that is, the defendant shall repudiate this contract and the company that is, the plaintiff shall accept such repudiation so as to terminate this contract the company may thereupon remove the installation and the subscriber shall pay to the company all payments then accrued and also a sum equal to the present value on a 5% basis of the remaining rentals that would have been payable under this contract if not so terminated less an allowance of 25% to cover the estimated cost of maintenance and value of recovered material. The said sums shall be payable as liquidated damages it being an agreed estimate of the loss the company would suffer.

I have the following comments to make on this clause.

It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.

The application of this principle is to be seen in the majority decision of the Court of Appeal in England in Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 in which the court considered a contract for the hiring of a telephone-answering machine for a seven year period which was repudiated before the hiring began. The hiring agreement contained a clause which made provision in the event of premature termination for the payment of agreed liquidated damages equal to 50% of the total of the rentals due. In deciding that the sum of 50% was a genuine pre-estimate of loss and not a penalty Lord Diplock examined what would be recoverable by way of damages assessed on common law principles and concluded that because 50% of the gross rent would not produce a figure which was ‘extravagantly greater’ than those damages the clause was enforceable.

Before considering in greater detail the operation in this case of clause 11, I should give some more detail of how the plaintiff’s claim is made up.

The plaintiff has calculated that there were nine full years of the agreement to run from the date of termination. The annual rent at that time (which had been increased over the years pursuant to the rent revision clause) was then £1,438.16. This annual rent was discounted over a nine year period by 5% giving a discounted figure of £10,222.15. There was added to this one quarter’s rent unpaid in 1988 (that is, £359.51) giving a total of £10,581.66. A figure of 25% of this sum was then calculated, that is a sum of £2,645.42. This was deducted from the sum of £10,581.69 giving a figure of £7,936.27. It is to be noted that the gross rent for the unexpired nine year period of the hiring was £13,043.62 according to these calculations.

I have come to the conclusion that the formula contained in clause 11 does not produce a liquidated sum that can properly be regarded as a genuine pre-estimate made at the date of the contract of the loss which the plaintiff would suffer should the contract be prematurely determined and that it is in reality a penalty and therefore unenforceable. My reasons are as follows:-

The plaintiff has not produced its profit and loss account and so l do not know what it shows. But I am entitled to apply the knowledge of financial affairs which is available to every reader of the daily press from which companies’ net profits as a percentage of their turnover is shown for an extensive range of different classes of businesses. These, of course, vary widely. In the retail trade a net profit of 10% of turnover is an average figure. In some manufacturing companies it may be considerably less or considerably more. A net profit of 71% of turnover would be a staggeringly large one in any business and in the absence of proof that this is what the plaintiff earned I am driven to the conclusion that the estimate of loss contained in clause 11 is not a genuine pre-estimate but is a penalty.

I cannot therefore allow the plaintiff’s claim based on clause 11 and must assess damages based on the actual loss I think the plaintiff suffered.

The plaintiff recovered back the equipment let under the contracts but was unable to re-let or sell them. The plaintiff’s damages will therefore be an estimate of the profit lost on the transaction, appropriately discounted for accelerated payment. The gross rent which would have been received for the nine year balance of the contract was £13,043.62 (assuming no increase, in the rent, an assumption the plaintiff has made in its calculations). I have been given no information as to what the plaintiff’s average net profit is, but bearing in mind that the evidence establishes that the plaintiff’s business is a competitive one (which would oblige them to keep their hiring charges at a reasonable competitive level) and that the plaintiff is a long established firm (which would give it the benefit of a considerable good-will) I would consider it probable that a net profit of 20% of gross rents is what the plaintiff would have earned on average. There is nothing to suggest that there are any special circumstances which would justify an award for breach of this particular contract on a basis higher than average net profit and so the plaintiff’s loss of profit for the last nine years of this transaction is £2,608.72 (20% of £13,043.62). I have very little evidence to help me on how this sum should be discounted and I will, in the absence of evidence, accept the 5% figure contained in clause 11. This means that there should be a deduction of £130.47, giving an award for the loss the plaintiff has suffered for this period of £2,478.29. To this to be added the loss in relation to one quarter of the 1988 rent, namely, £359.51. 20% of this sum, discounted by 5% is £68.04. This gives a total figure for damages of £2,546.69. The plaintiff is entitled to an award of this sum.

I have assessed damages in the light of the facts established in this case. I do not think I am required to assess them on the different basis which the facts established in In the matter of Rank (Ireland) Ltd [1988] ILRM 751 required.