CISG Counterfeit Goods Case: Satel vs. Elcom Legal Analysis

Contractual Relations Between Satel and Elcom

The contractual agreement into which Elcom and Satel entered is well documented via the emails exchanged between the parties, and it is the body of those emails that will serve as the legally binding contract. It should be stated at the outset that Elcom, the seller, rejected both German law and Satel's specific purchase conditions. Therefore, for the purposes of determining appropriate legal action following the unsatisfactory conclusion and voiding of the contract, the guiding body of rules and remedies will be the United Nations Convention on Contracts for the International Sale of Goods (CISG) — a legally binding set of regulations ratified by both the United States and Germany, the two states in question.

On 15 January 2009, Mr. Leiber of Satel initially contacted Mr. Lewis of Elcom requesting 50 pieces of specialized electronic equipment. Mr. Lewis responded on 17 January 2009, indicating that the pieces would be produced via a third-party contract with a company called H.S. Semiconductor Corporation, based in Miami. The price quoted was $5,000.00 per piece, with goods to be delivered FOB from Miami Airport, with delivery expected one week following the conclusion of the contract.

Following this exchange, it was agreed that the two men would meet in person in Palm Beach to further negotiate terms. At this meeting both parties discussed lowering the price over dinner. Price being a primary impediment to finalization of the offer, Mr. Leiber indicated that the proposed decrease was positive but not yet a figure he was comfortable with. On 1 February, Mr. Leiber extended a revised yet firm offer indicating his intent to conduct a business transaction with Mr. Lewis. Mr. Leiber stated that he was interested in purchasing 60 parts with product number HS 9567 at $3,500.00 per part. He further indicated that he wanted German law as well as Satel's purchasing conditions to apply, and that the first named carrier would be DHL.

On 5 February, Mr. Lewis replied that the minimum possible price was $4,000.00 per part and that, as a result of the financial crisis, a bank guarantee of $100,000.00 was required prior to receipt of the products. The total purchase price would be due within five days of delivery. Mr. Lewis further stipulated that neither German law nor Satel's policies would be honored within the contract. The final aspect of Mr. Lewis's counteroffer addressed Mr. Leiber's assertion that defect or delay would result in high damages: Elcom would limit its total liability to 20% of the purchase price ($48,000.00). On 21 February, Elcom received the bank guarantee, which had been issued by Bank of America; the full amount was withdrawn that day.

The products were received by Satel on 1 March 2009. Upon incoming inspection, half of the received goods were found to be defective. The remaining half, which had to be sent for further testing, were found not only to be defective but also to have been counterfeited. Upon inquiry, it was discovered that some of the damage was attributable to an accident involving the truck transporting the products to the Satel factory. The originally contracted third-party producer, H.S. Semiconductor Corporation, indicated that it would be unable to produce replacement parts in time for Satel's deadline, resulting in late charges of $240,000.00. The additional testing cost Satel a further $20,000.00 in expenses.

Upon discovery of the defective and counterfeit components, Satel informed Elcom of both problems within two months of receipt. Satel proceeded to void the contract, citing breach of contract and a loss of confidence in Elcom, further justified by H.S. Semiconductor Corporation's admitted inability to produce replacement components within a reasonable timeframe.

Rights and Obligations of the Parties, Including the Right to Claim Damages

Although not explicitly stated, Satel has taken action to void the contract and has sought reimbursement in the amount of $260,000.00 — the total of losses and expenses resulting from the delivery of defective and counterfeit components — as well as a refund of the $100,000.00 bank guarantee. The following analysis sets out the rights and obligations of both Elcom and Satel under the applicable legal framework.

Satel has the right to void the contract under Article 25 of the CISG, which states that any failure by one party to supply the other with what they are entitled to — absent an unforeseeable mitigating event — constitutes a fundamental breach of contract. Elcom delivered 30 defective and counterfeit components to Satel, who had provided a $100,000.00 good-faith bank guarantee with the reasonable expectation that 60 authentic, working components would be delivered on time. Under Article 81, section 1, voiding the contract frees both parties from all associated obligations, subject to any damages owed. Should Satel void the contract, it would not be required to pay for the 30 non-counterfeit but still defective components.

Satel also has grounds for voiding the contract because 50% of the goods delivered did not conform to the contract under Article 35, section 1. Section 2 of that article further clarifies that goods do not conform to the contract unless they are fit for the purposes for which goods of the same description would ordinarily be used — a standard the defective components clearly failed to meet. Section 3 of the same article provides the only exemption from liability: if the seller made the buyer aware of the non-conformity and the buyer elected to proceed with the order. That was clearly not the case here. Elcom is further liable under Article 36, section 1, which holds the seller responsible for any lack of conformity existing at the time risk is transferred to the buyer, even if the defect only becomes apparent afterward.

Under Article 41, Elcom was contractually obligated to deliver components produced by H.S. Semiconductor Corporation. The delivery of goods manufactured elsewhere, in an effort to deceive the buyer, does not constitute fulfillment of that obligation. Additionally, there is potential for H.S. Semiconductor Corporation to bring legal action against Satel should it attempt to use or sell the counterfeit parts — a conflict over intellectual property rights that represents a further liability for Elcom. Although the third-party supplier was contacted about producing replacement components, Article 46 provides that, following the expiration of the agreed-upon timeframe, Elcom is not entitled to a grace period for repair or replacement. This position is further reinforced by the fact that Satel has already invoked one of the provisional remedies available under the CISG.

Article 45 grants Satel the right to claim damages even if it voids the contract, as well as the right to request repair or replacement. That option has been rendered impossible by H.S. Semiconductor Corporation's confirmed inability to fulfill the order within the timeframe needed to prevent Satel from incurring penalties resulting from its own downstream obligations. Because Satel communicated its desire for restitution and contract avoidance within two months of delivery, it is protected under Article 49, subsection 2(b)(i). This provision holds that a seller is not deemed to have fulfilled its obligations merely by having delivered goods, if the seller was aware of the breach at the time of shipment. Elcom's knowledge that 30 parts were counterfeit places it squarely in breach. Under Article 71, section 1, subsections (a) and (b), Satel is entirely within its rights to suspend final payment in light of Elcom's breach and the complete collapse of trust between the parties, as well as the confirmed impossibility of timely replacement.

With respect to the quantum of damages, Article 76, sections 1 and 2 entitles Satel to claim the difference in value for the 30 counterfeit pieces — approximately $1,000.00 per piece, representing the difference between the contract price and the current market price. If that price changes during arbitration, the claimed amount should be adjusted accordingly. Furthermore, under Article 50, should Satel ultimately be required to pay for the 30 non-counterfeit but defective pieces, it may reduce the price per unit to reflect their actual value relative to what fully functional components would be worth.

Elcom is, however, protected against liability for damage that occurred in transit. Under Articles 66 and 67, section 1, the components damaged in the road accident must be paid for by Satel, as risk had already transferred to the buyer at the time of the accident; Satel is therefore liable for the full price of those pieces despite their defective condition upon receipt. These provisions do not, however, diminish Satel's ability to seek remedies for the other breaches — specifically, the 30 counterfeit and separately defective components. Article 70 preserves the buyer's right to seek redress even where additional subsequent circumstances may have further compromised the goods.

One complicating factor concerns the apparent tension between Articles 86 and 82, section 1, which govern the conditions under which the parties may withhold refund and final payment, respectively. Under Article 82, Elcom is entitled to withhold restitution until the delivered goods are returned in the condition in which they were received — excepting any damage caused by testing. Should Satel have damaged the components in any way prior to return, Elcom might have grounds to refuse a refund. Article 86, section 1, however, permits Satel to retain the goods until it has received restitution. It is therefore suggested that a documentary credit be opened, in which the $100,000.00 is held by a bank until the goods have been confirmed as received at the Elcom facility, at which point the funds would be released to Satel.

Ultimately, Satel is entitled to damages equal to its total losses, including potential or projected profit. Article 74 of the CISG clearly states that in the event of a breach, the party that failed to fulfill its obligations is liable for the losses incurred by the other party, provided those losses do not exceed what the breaching party could reasonably have foreseen at the time of contracting. Furthermore, under Article 84, section 1, Satel is entitled to reclaim not only the $100,000.00 bank guarantee but also interest on that amount for the entire period during which Elcom has held the funds.

Given Elcom's clear culpability, and the potential additional criminal liability arising from H.S. Semiconductor Corporation's likely claims of trademark and patent infringement, it is unlikely that Elcom would prevail in any judicial or arbitral forum. To conclude, Elcom will in all likelihood be required to pay Satel the $100,000.00 plus interest, as well as the $260,000.00 minimum in damages. Although the contract initially stipulated that Elcom's total liability would be capped at 20% of the purchase price, that limitation ceases to apply if Satel successfully voids the contract, allowing Satel to pursue the full extent of its claims against Mr. Lewis and Elcom.

Mr. Leiber,