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Commodity specification breach – can I reject?

23 January 2018. Published by Stuart Shepherd, Partner

A common question which arises in day to day commodity trading is whether a buyer can reject goods which do not meet the specifications set out in the contract. This blog discusses the factors which commonly come into play in determining that question.

Importance of the contract terms

In determining whether a buyer can reject goods which do not meet the contract specification the starting point will always be the terms of the contract. In particular the contract terms may:

(i) provide guidance as to whether the failure to comply with the specification will result not only in the goods not being of contractual quality but also result in them not meeting the contract description;

(ii) expressly provide a remedy for breach of specification; for example by providing for an adjustment in the price to be paid for the goods in the event they are off-specification and

(iii) indicate whether the specification is intended to be a condition, warranty or innominate term of the contract.

Quality or description?

The first step in any analysis of a breach of specification claim is to determine whether the aspects of the specification with which the goods do not comply can be said to be not only an aspect of quality but also description. This is important because if the specific breach of the specification also means the goods do not meet the contract description then, absent any contrary provision in the contract, the buyer will, in  principle,  be entitled to reject the goods on that basis.

Words in a contract which identify the goods are words of description; requirements as to quality which do not serve that purpose are not. In some cases terms as to quality can also be part of the description of the goods. For example in Tradax Export  SA v European Grain & Shipping Co [1983] 2 Lloyd's Rep.100, which concerned a contract for solvent extracted toasted soyabean meal, it was held that the words "maximum 7.5 per cent fibre" not only went to the quality of the goods but also formed part of the contractual description of them.

Express terms providing a remedy for breach of specification?

Some commodity contracts, in particular soft commodity contracts, specifically provide for the buyer's remedy in the event the goods supplied do not meet the specification. In particular there are clauses which provide for an adjustment (generally downwards) in the price dependent on the degree by which the goods fail to meet the specification. Such clauses often also provide that the goods can be rejected if they fail to meet the specification by a specified margin.  What is a little surprising is that such clauses are not more prevalent in other types of commodity contracts as they usually bring certainty to the issue of rejection.

Condition, warranty or innominate term?

Assuming that (a) the element of the specification which is not met does not also form part of the description of the goods and (b) there are no express allowances in the contract, the right to reject will be determined by the characterisation of the contract terms containing the specification. If the relevant term is a warranty the buyer will not be entitled to reject; if it is a condition then, in principle, it will. If an innominate term, the right to reject will depend on the seriousness of the breach; a minor breach will not permit rejection but a serious breach going to the root of the contract will.

The starting point, in categorising the specification, will be the terms of the contract although the use of the words "condition" and "warranty" are not necessarily determinative in this respect. It is necessary to consider all the relevant provisions in the contract and, deploying all other accepted aids to construction, seek to determine into which category of legal term the parties intended the specific terms as to quality to fall. In most cases there will be little guidance to be found in the contract and the default position, in the absence of guidance, will be that the specification is an innominate term and it will all turn on how bad the breach is.

Section 14 of the Sale of Goods Act 1979

One must also bear in mind, however, that if the contract is governed by English law, then unless excluded (which is often the case), the buyer may be able to rely upon the implied condition in S.14 of the Sale of Goods Act 1979 that the goods supplied will be of satisfactory quality. Of course, a breach of the contractual specification will not necessarily render the goods “unsatisfactory”. It will be a question of whether the failure of the goods to meet the specification renders the goods “unsatisfactory” applying all the factors which are to be taken into account, in accordance with S.14, in determining that question. But if it does the buyer will, in principle, be entitled to reject.

RG Grain Trade LLP (UK) v. Feed Factors International Limited

The judgment in RG Grain Trade LLP (UK) v. Feed Factors International Limited [2011] EWHC 1889 (Com) provides a useful illustration of the interaction of many of the above considerations.

(i) The background facts

This case concerns the FOB sale by RG Grain Trade (Sellers) to Feed Factors (Buyers) of a cargo of sunflower expeller. A dispute arose in relation to whether the goods supplied under the contract were in accordance with the contractual specification and whether the Buyers were entitled to reject them and claim damages. The GAFTA First Tier Tribunal found for the Sellers but the GAFTA Board of Appeal allowed the Buyer's claim.

The Board of Appeal and the Court concluded that, by virtue of the various contractual provisions, the goods had been determined not to comply with the contractual specification.

So far as is relevant for present purposes, the contract provided as follows:

Commodity: UKRAINIAN ORIGIN SUNFLOWER EXPELLER

In bulk, sound, loyal and merchantable quality.

Specifications: protein min 32% moisture max 7% - fiber (sic) max 23% - fat min 11%

Special Conditions: Other terms and conditions not in contradiction with above as per GAFTA 119…“

Clause 5 of GAFTA 119 provides as follows:

“5. Quality

Official … certificate of inspection, at time of loading into the ocean carrying vessel, shall be final as to quality.

Warranted to contain not less than ….% of oil and protein combined and not more than 1.5% of sand and/or silica. Should the whole, or any portion, not turn out equal to warranty the goods must be taken at an allowance to be agreed or settled by arbitration as provided for below”.

The Board of Appeal found that a certificate issued by Salamon & Seaber was final and binding and Mr Justice Hamblen agreed. That certificate stated that the protein content of the cargo (referred to in Clause 5 of GAFTA 119) was 26.8%  (less than the minimum of 32% specified in the contract) and the fibre content (not referred to in Clause 5 of GAFTA 119) was 26.57% (more than the maximum of 23% specified in the contract).

In light of this finding, the Board of Appeal said in its Award:

“If a contract does not contain a scale of allowances for deficiency in certain specifications (viz fibre) and the goods subsequently fall outside this then it must follow that the goods can be rejected unless the parties agree to any other course of action”.

The Sellers contended before Mr Justice Hamblen that this conclusion was wrong on two grounds;

(1) The Board had failed to give effect to clause 5 of GAFTA 119 which is a non-rejection clause.

(2) The Board had proceeded on the erroneous basis that any failure of the goods to meet the specification would justify rejection.

(ii) The Commercial Court decision

With regard to ground (1), the Court agreed with the Board of Appeal that the provision in clause 5 of GAFTA 119 referring to the goods being taken at an allowance applied only to the warranties in respect of oil and protein combined and sand and/or silica as expressly referred to in that clause. The clause did not, therefore, apply to the specification in relation to fibre. Accordingly, the clause did not assist in determining whether the Buyers were entitled to reject on account of a failure of the goods to meet the contractual specification in relation to fibre.

With regard to ground (2), the underlying issue was whether the contractual requirement that the goods have a maximum fibre content of 23% was (i) a condition or (ii) a warranty or (iii) an innominate term.

The Buyers contended that the Board had in fact determined that the breach was one of a condition, alternatively that the Board's conclusion could be upheld on that basis. In particular, the Buyers argued that the breach in respect of fibre content was a breach of condition giving them a right to reject. Mr Justice Hamblen noted that there was no suggestion in the Board's reasons that they regarded the fibre content provision as a matter of description. Indeed, it was clear that the Judge was of the view that it was a matter of quality, referring as he did to the fact that the fibre content provision appeared under the heading “Specifications” and next to a specification characteristic which was clearly a matter of quality rather than description, namely protein.

As to the contractual nature of the provision with regard to fibre content, Mr Justice Hamblen referred extensively to the judgment of Mr Justice Slynn in Tradex v. Goldschmidt SA [1977] 2 LLR 604, where the Judge found that a contractual provision providing for “4% foreign matters” was an innominate term. Mr Justice Hamblen commented that there is “no hint in the Board's reasons that they have addressed their minds to the issue of whether the fibre content provision should properly be regarded as a condition, as opposed to a warranty or an innominate term. They have assumed that the term is a condition unless there is an indication to the contrary. That is not the law”.

As a result the Judge referred the matter back to the GAFTA Board for further consideration; in particular as to the contractual nature of the provision in respect of fibre content.

Comment

There may be cases where there would be a legitimate debate as to whether a contractual requirement in respect of goods to be supplied under a contract amounts to a matter of description or quality – and there may be cases where it will be a matter of both. However, the requirements of a contractual specification will normally be a matter of quality not description. If so, one will usually then need to determine whether that aspect of the contractual specification amounts to a condition, warranty or an innominate term. This will depend upon the intentions of the parties derived from the wording of the contract. However, all things being equal, in most cases the requirements of a specification will amount to an innominate term, the breach of which will only give rise to the right to reject the goods if the breach is such as to deprive the buyer of substantially the whole benefit of the contract. In most cases, this is unlikely to be the position.