Summary

The recent TCC decision of Fluor Ltd v Shanghai Zhenhua Heavy Industries Ltd [2016] EWHC 2062 provides valuable guidance on fitness for purpose obligations and will be useful to parties who contract to buy or sell goods, regardless of the nature of those goods. The decision also provides a stark reminder that parties should be careful when considering compromising their rights to future claims.

The facts

The employer, an offshore wind farm company, engaged Fluor to engineer, procure and construct the foundations and infrastructure to support 140 wind turbine generators, which were to be installed in the North Sea. Each foundation comprised a steel monopile consisting of rolled steel plates, which were welded together to form a steel column, and a transition piece, which was to provide the connection between the monopile and the tower above.

Fluor contracted ZPMC, a steel fabricator based in Shanghai, to fabricate the monopiles and transition pieces.

Fluor's contract with the employer required non-destructive testing to be carried out to ensure the quality of the welds. This included two types of ultrasonic testing: 'D Scanning' where welds were ground flush and 'E Scanning' where they were not. Fluor's contract with ZPMC contained similar provisions, but crucially did not require a ground weld to be tested using D Scanning if it had already been tested using E Scanning prior to being ground. The parties were unaware that D Scanning was much more effective at identifying certain types of crack and, as a result, welds that were passed as satisfactory in Shanghai were only found to have imperfections when retested following delivery at a staging port in the Netherlands.

The employer issued a non-conformance report ("NCR") in relation to the first shipment, requiring Fluor to retest the welds and carry out any necessary repairs. Following delivery of the second and third shipments, further NCRs were issued.

Fluor, with the assistance of ZPMC, embarked upon further extensive testing and repair works, delaying the installation works. Fluor and ZPMC subsequently concluded that the additional retesting went beyond their contractual obligations and was unnecessary in terms of the monopiles' structural integrity. In other words, Fluor and ZPMC contended that notwithstanding the cracks, the monopiles and transition pieces were structurally sound.

Fluor and ZPMC therefore entered into an agreement whereby ZPMC assigned its claims for the costs of the additional testing to Fluor (so that Fluor could, in effect, pursue the employer for both its claims and ZPMC's claims) and Fluor waived its claims against ZPMC for the additional costs it had incurred as a result of the NCRs. ZPMC also warranted that the foundations would perform satisfactorily in service for 25 years.

Fluor commenced arbitration proceedings against the employer for the cost of the additional testing. It may be inferred that those proceedings were not entirely successful as Fluor, despite the agreement that had been reached with ZPMC, brought a claim for US$400m against ZPMC for the costs it had incurred in relation to the additional testing and repair work, on the basis that the foundations were not fit for purpose.

The parties had agreed that the goods to be supplied would be fit for their intended purpose and it was not in dispute that the goods had to meet this contractual requirement as at the date of delivery. However, Fluor also contended that the goods supplied:

i. Should be suitable for installation in the seabed and perform in satisfactory service for 25 years (although Fluor did not contend that ZPMC was in breach of this requirement); and

ii. Should be in a condition that allowed a reasonable buyer in the position of Fluor to load them out and install them in the seabed without further examination or remediation.

In contrast, ZPMC contended that the test for fitness for purpose is objective. The purpose of the goods was to support the wind turbine generators for 25 years. Once that purpose had been identified, the only question was whether the goods supplied were fit for that purpose. Whether or not the buyer considers the goods to be fit for purpose is irrelevant. They either are, or they are not.

Three issues fell for consideration, namely:

  • Whether the monopiles and transition pieces were fit for purpose;

  • If not, whether that was caused by breach of contract by ZPMC; and

  • If ZPMC was in breach of contract, whether Fluor's claims had been settled or whether Fluor was estopped from pursuing its claims.

Decision

Surprisingly, there was no previous authority on the objective or subjective nature of the test to be applied. The court relied instead on the following test for merchantability, which was formulated in an Australian High Court case and approved by the Privy Council:

"The condition that goods are of merchantable quality requires that they should be in such an actual state that a buyer fully acquainted with the facts and, therefore, knowing what hidden defects exist and not being limited to their apparent condition would buy them without abatement of the price obtainable for such goods if in reasonably sound order and condition without special terms."

The court found that where goods only have one use, as in this case, issues of fitness for purpose and merchantable quality amount to the same thing. In those circumstances, the court asked itself what the positon is where a buyer knows the goods are in a defective condition but is unable to discover, without lengthy investigation, whether or not that condition affects the intended use.

The court held that a buyer would impose a condition that the necessary investigations be carried out before it would agree to buy the goods, and that would amount to a special term requiring the satisfactory outcome of the investigation. As the experts had agreed further investigation was reasonably justified, the court concluded that the only reasonable option available to Fluor was to investigate and establish the extent to which the issues that had been identified might affect the goods’ performance in service.

Edwards-Stuart J held that there was no doubt in his mind that the goods had to be in such a condition on delivery that any reasonable purchaser, in Fluor's position, could load them out for installation without any further enquiry or investigation. The foundations were not delivered in such a condition and were, accordingly, not fit for purpose. The court also found that ZPMC was in breach of contract but, despite Fluor's success, the court found that it had waived the vast majority of its claims against ZPMC and was estopped from contending to the contrary.

Conclusion

Fitness for purpose obligations are fundamental to many commercial contracts for the supply of goods and, given the lack of any previous authority, the court's guidance on the interpretation of fitness for purpose obligations is to be welcomed. In the light of this judgment, it is not sufficient for suppliers to merely demonstrate that the goods are in fact fit for purpose. Where legitimate concerns arise regarding fitness for purpose, a buyer may be justified in ensuring that this is the case prior to the goods being used for the intended purpose, potentially at significant cost to the seller.