Evaluate the worldwide damages in the epidemic of defective computer graphic cards in the international sales of goods disputes – #40

I have participated in the 18th CIETAC Cup Commercial Arbitration Moot Competition as an arbitrator last week on a videoconference platform named VooV Meeting. It has been my great honour and privilege to sit with the experienced arbitrators and lawyers from different jurisdictions during this event. And we are glad to see that the students in China are able to plead the CISG related matters fluently in English and to answer our questions directly and effectively during their deliberations (See my one-minute speech as the Arbitrator of CIETAC Cup).

As you may already know, this year, the Problem concerns the applicability of United Nations Convention on Contracts for the International Sale of Goods (“CISG”) on the purchase and license agreement on the viral sectors for the production of vaccines against respiratory diseases, such as COVID-19. In the Problem, Claimant only requires the arbitral tribunal to declare the existence of a breach of contract of the Respondent as Claimant is not yet in a position, to exactly identify the specific remedy required. Out of curiosity, I have read a recent decision of Superior Court of Quebec to learn how the Quebec courts evaluate the worldwide damages in the epidemic of defective computer graphic cards litigation.

Key Facts

In early 1998, Plaintiff purchased Defendant’s graphic cards for new Kayak and Vectra personal computers. The worldwide Business Desktop Division (“BDD”) of Plaintiff operates primarily in Grenoble, France.

In late 1998, Plaintiff started to install Matrox’s G-100 and G-200 graphic cards in Kayak and Vectra personal computers.

In the Spring of 1999, Plaintiff reported that a high number of failures were occurring on an unpredictable random basis as some Kayak and Vectra computer screens could suddenly go totally black.

By June 1999, Plaintiff considered this problem to be “epidemic”.

In May 2000, Plaintiff sent a letter of demand to Defendant containing a monetary claim identifying damages at US$6.2 million.

In early 2001, Plaintiff filed its initial lawsuit against Defendant before the United States District Court, Eastern District of California. However, the district court ruled that Quebec court is a more appropriate forum to adjudicate this dispute.

In early 2002, Plaintiff sued Defendant before the Superior Court of Quebec to seek an award of damages in the amount of $24 665 429.30 CAD in relation to the sale of defective computer graphics cards without having retained an independent expert to evaluate damages.

In June 2002, Defendant called the STMicroelectronics Inc. (ST) in warranty as ST was the manufacturer of the components of the graphics cards.

In May 2003, Defendant instituted its parallel Direct Action against the ST seeking an award of damages in the amount of 21 344 297,31 $.

In September 2004, Plaintiff, Defendant and the ST agreed to retain the services of LBC International Investigative Accounting Inc. (“LBC”) to provide independent opinion as to the actual damages. The cost of the expertise was shared on a one-third basis for each party involved in this litigation.

In 2010, LBC issued the expert opinion regarding the actual damages of this epidemic of defective computer graphic cards. The Defendant retained the services of Richter Advisory Group (“Richter”) to critique the methodology, reports and opinions of LBC and to underscore the absence of documentation.

In September 2014, a Coordinating Judge for all the actions among the parties was appointed.

In November 2014, the Court ordered that the principal action be split from both Defendant’s warranty action and direct action against ST.

In February 2015, Defendant filed Richter’s independent expert opinion on the actual damages to the court.

In preparation for trial, the Court ordered that Richter and LBC meet and prepare a joint report, identifying their points of agreement and of disagreement. While LBC considered that the actual damages should be US$5,292,436, Richter claimed that the actual damages could be US$1,823,033 at most. During the trial, Richter expressed the view that the solid proof available only establishes damages in the amount of US$ 119,394. 

In March and May 2019, the Superior Court of Quebec held the hearings on the merits of the case.

Applicable Laws

Art. 74 CISG provides that the objective of compensatory damages is to fully indemnify a party for all damages that it has suffered. The claimed damages must be foreseeable and result from the seller’s breach of his contractual obligations.

Art. 77 CISG provides that it is the defendant who has the burden to prove a failure to mitigate damages as well as the amount by which the claim should be reduced as a result.

In the Quebec Court of Appeal decision on Cohen v. Hill Samuel & Co. [1989] R.J.Q. 2078, the court recognized that the choice of the conversion date of the foreign currency belongs to the creditor.

Le créancier, dans telle situation, doit faire la preuve d’un taux de conversion.  Si sa réclamation est reconnue comme justifiée, il peut bénéficier de la date qui lui semble la plus favorable.  Après tout, le débiteur pouvait toujours payer plus tôt. Une réserve nécessaire serait le cas où l’inaction ou la négligence du créancier porterait préjudice au débiteur, en raison de l’évolution du taux des changes.

Art. 339 (2) C.C.P. provides that expert fees include the costs related to the drafting of the report and, if applicable, preparing testimony, and remuneration for the time spent testifying and, to the extent useful, attending the trial.

Art. 340 (1) C.C.P. provides that the expert fees are owed to the party that wins the lawsuit unless the court decides otherwise. Art. 340 (4) C.C.P. provides that the costs related to joint expert opinion are apportioned equally the parties unless they have agreed otherwise.

Analysis of the Court

What award in damages is appropriate in the present case, if any?

In this case, the Court condemns Defendant to pay Plaintiff the sum of $2 586 126.80 plus interest and the additional indemnity according to Art. 1619 C.c.Q., calculated as of May 29, 2000 and the legal costs, including an amount of $536 514.79 in expert fees.

First, it is worth to note that Plaintiff is a publicly traded company subject to strict reporting requirements and the GRACES database pertaining to the customer service orders (“CSO”) is used by Plaintiff in the ordinary course of business to perform important management activities, including the interventions relating to replacing defective graphic cards (Art. 2832 C.c.Q.). The CSOs are created by the phone technicians located in call-centers worldwide for the purpose of recording the complaints against the products from the customers of Plaintiff (para. 144 of the decision). Thus, the Court considers that the extracts from GRACES to have probative value (para. 139 of the decision).

How many graphic cards were repaired and replaced?

In the present case, Defendant is generally considered to have shipped 913 112 G-100 graphic cards to Plaintiff and 276 476 G-200 graphic cards to Plaintiff. Besides, it is agreed by Plaintiff and Defendant that not all the graphic cards provided by Defendant were defective, although possibly all of them eventually could appear defective. During the pre-trial discovery, an employee of Defendant stated that the failure of the graphic cards was totally unpredictable, not only as to which ones would fail but also as to when they would fail (para. 154 of the decision). Although most clients’ complaints were recorded in GRACES database generated by the technicians in the call centers, some important clients would prefer to call their contacts at Plaintiff to obtain resolutions without leaving any records in the call centers (para. 155 of the decision). Thus, the number shown in the GRACES database cannot reflect all interventions relating to the defective graphic cards.

LBC and Richter’s joint expert report uses 51 914 as the number of excess G-100 graphic cards and 14 194 as the number of excess G-200 graphic cards repaired or replaced. The Court concludes in favour of the joint expert report in light of the preponderance of proof although Defendant considers that the number should actually be reduced substantially without providing a precise number of its own.

What are the costs of purchasing new graphic cards to replace the defective products?

These costs include not only the purchase price but also certain related transport, warehousing and distribution costs.

There was no available itemized list. But Defendant’s records show that approximately 23 700 new cards were sold to Plaintiff from August 1999 to February 2001. Having considered other information, the joint expert report estimated that 21 690 G100 cards and 2810 G-200 cards were purchased by Plaintiff due to the defective cards. On the other hand, LBC determined that each G-100 graphic card purchased by Plaintiff costs an average of US$ 31.26. As for G-200 cards, the average cost was determined by LBC to be US$60.03. Therefore, the Court concludes that the amount of US$846 713 provided by LBC is a reasonable evaluation of the costs of purchasing new graphic cards to replace the defective products (para. 180 of the decision).

What are the costs incurred in the warehousing and distribution of the graphic cards required for repairs?

These costs apply not only to graphic cards purchased by Plaintiff but also those supplied to it free of charge by Defendant. LBC also considered Plaintiff’s supply chain costs, over and above the parts costs, including freight incurred in shipping parts, warehousing costs, network logistics costs, packaging of parts, purchasing and planning costs, as well as certain country costs. As a result, LBC estimated that the total overhead costs for the parts varied from US$488 382 to US$917 579 based on a full-costs method as opposed to a range of US$151 300 to US$284 264 based on an incremental costs method (paras. 187 to 188 of the decision).

What are the labour and travel costs associated with interventions on the graphic cards defect?

LBC estimated an average unit cost of US$113.55 per complaint in the CSO according to the GRACES database. In doing so, it relied on fixed labour costs relating to HP engineers and subcontracted engineers performing repairs at customer locations, which varied by country, type of intervention and the type of computer. The travel costs are covered in labour costs.

Accordingly, LBC concluded that the total cost of repair/replacement for graphic cards is around US$4 844 075 according to the full-costs method. These amounts are far below the US$11 636 543 calculated in house by Plaintiff. The Court noted that LBC’s analysis respects the principles set forth in Article 74 CISG.

What are the costs of the call-centers?

The claim for call-center costs is based on the premise that the graphic card defect resulted in increased telephone calls by Plaintiff’s customers. LBC analyzed the average length of call assessment by Plaintiff and concurs that the average length was 9.17 minutes. LBC also took into consideration a draft report prepared by Anderson Consulting entitled “Hardware Warranty Benchmark Study”, dated September 26, 2000, which refers to average call-centre calls (See par. 205 of the decision).  LBC considers that the per-minute cost should be US$0.43. The result is that LBC estimated the per-call cost to be US$3.94 as opposed to HPF’s claim of US$30.54.

The Court considers that LBC’s calculations in relation to call-centre costs as a result of the graphic card defect are reasonable.

What are the costs of hiring a full-time engineer to cope with this epidemic?

LBC analyzed the revenue data for the engineer and concluded that 25% would yield an amount of US$34 317 for that same period. For the overhead costs, it received no documentation and accordingly used an “arbitrary” rate of 30%, resulting in a total amount of US$44,612. LBC treats this as a full cost item only, expressing no incremental amount.

In the Court’s view, LBC’s damage assessment is a reasonable calculation in relation to the cost of hiring an engineer to cope with this epidemic.

What are the division management and employee costs?

LBC used a full-cost method to calculate the management costs. LBC adopted the $75/hr to calculate these costs. In addition, LBC calculated an estimated 30% overhead costs with respect to that labour charge, which gives rise to an amount of US$92 294 for division management costs during the period from April 1999 to November 2000.

The Court is of the view that LBC’s calculations in relation to management and employee time dealing with the epidemic defect problem are reasonable, being reflective of the recovery principles in CISG.

What is the cost of the loss of reputation of the Plaintiff?

No specific proof is submitted in this regard. Moreover, the proof demonstrates that other computer manufacturers encountered similar problems due to the defective graphic cards, which would render even more difficult the evaluation of HPF’s alleged loss of reputation.

The Court does not recognize any amount of damages in this regard.

Should the Court apply the full-cost method or the incremental cost method to evaluate the damages?

According to LBC, it is appropriate to use the “full-cost method” when claiming costs and expenses. However, Richter argues that the “full-cost method” is inappropriate as it includes certain management and employee costs that would have been incurred regardless of the graphic card problem. The Court emphasizes that one must acknowledge that without the defective graphic cards problem, Plaintiff’s management would have been focusing on its regular business functions and on seeking ways to improve the business. In the present case, not only was Plaintiff required to acquire additional graphic cards at a cost for a period of time and to coordinate transport, warehousing and repairs, it also participated actively in testing and finalizing the solution with Defendant. Therefore, it would be inappropriate for Defendant to benefit at no cost for such additional business activity caused by the graphic cards defects.

In the Court’s view, LBC’s full-cost method is not keeping with applicable accounting principles or with Article 74 CISG. Nevertheless, the Court is prepared to recognize a limited portion of full costs on the calculation of the management and employee costs. All other headings of damages will only be treated on an incremental-cost basis (para. 250 of the decision).

Did Plaintiff make effort to mitigate their damages?

Art. 77 CISG stipulates that it is Defendant who has the burden to prove a failure to mitigate damages as well as the amount by which the claim should be reduced as a result.

In the present case, even if the Plaintiff could have acted sooner and put an end more quickly to replacing cards, Plaintiff was not obliged to conduct itself perfectly with a view to saving money for Defendant. Plaintiff was entitled to reasonably satisfy its customers’ needs, or even desires, to avoid as much as possible any long-term impact on its reputation resulting from the defects.

In the Court’s view, the preponderance of proof establishes that Plaintiff acted reasonably and did not fail to mitigate its damages. Defendant has failed to satisfy its burden under Article 77 CISG in this regard.

What interests and the additional indemnity should be rendered?

In the present case, Plaintiff demands that the accrued interest itself bear interest at the same rate plus the said additional indemnity according to Art. 1619 C.c.Q. and Art. 1620 C.c.Q. In other words, Plaintiff demands compound interest instead of simply interest. The Supreme Court of Canada’s decision on Bank of America v. Mutual Trust, [2002] 2 S.C.R. 601 states that compound interest compensates the creditor for the decrease in value of all money which is due but as yet unpaid because unpaid interest is treated as unpaid principal (paras. 23 to 24 of Bank of America v. Mutual Trust, [2002] 2 S.C.R. 601).

Defendant pleads that Court should not award either additional indemnity or compound interest as Plaintiff’s pattern of conduct is lack of transparency, diligence and good faith combined with gross negligence.

The Court sees no valid basis in the proof for Defendant’s position. Moreover, the Court is unaware of any serious attempts by Defendant to settle this matter over the course of almost 20 years since the problems surfaced or to seriously advance the proceeding so that they could be heard earlier. Further, Defendant has not alleged nor made the case of abusive proceedings. Thus, the additional indemnity should be awarded. And the starting date for both interest and the additional indemnity is the date of the receipt of the demand letter, May 29, 2000. However, the compound interest is not appropriate in the present matter (Hébert c. Centre hospitalier affilié universitaire de Québec – Hôpital de l’Enfant-Jésus, 2011 QCCA 1521, at pars. 100-108).

Reflection

It is worth to mention that Plaintiff did not claim any loss of profit in the present case. Second, neither Plaintiff nor Defendant pleaded the issue of a product recall in this matter. Third, [145] the joint expert report provided by LBC in 2010 has created three different categories of estimates, being “A”, “B” and “C”, with “A” including the least number of CSOs and “C” containing the most. LBC’s evaluation of damages includes three items which have both a full-cost and a separate incremental-cost calculation (parts overhead costs, labour and travel costs and call-centre costs), as well as three other items where there is no corresponding incremental-cost calculation (engineering costs, division management costs and employee costs). This comprehensive expert report provides the Court a reliable resource to render well-informed decision to terminate this legal saga of 20 years.

(Reminder: The purpose of this article is to provide general legal information. It does not contain a full analysis of the law nor does it constitute a legal advice on the points of law discussed. To minimize the legal risk for your business, you must take specific legal advice from a lawyer on any particular matter which concerns you. Thanks for your attention. 😊)