Futuris Industrial Products P/L v Arrow Industries P/L & Ors Arrow Industries P/L v Futuris Industrial Products P/L
[1993] FCA 490
•22 JULY 1993
FUTURIS INDUSTRIAL PRODUCTS PTY LTD v. ARROW INDUSTRIES PTY and TERRY CONROY
No. NG770 of 1991
FED No. 490
Number of pages - 25
Trade Practices - Contract
COURT
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
GENERAL DIVISION
Wilcox J(1)
CATCHWORDS
Trade Practices - Alleged misleading conduct - Circular letter issued by respondent advising customers of drop of quality in goods manufactured by applicant - Whether the statements made in the letter were false.
Contract - Agreement for supply of brake pads manufactured in accordance with a particular formulation - Whether agreement provided exclusive rights to the respondent - Whether agreement for exclusivity terminable by applicant - Alleged breaches of contract by applicant engaging in competition with respondent and supplying goods of defective or inconsistent quality - Calculation of damages.
Trade Practices Act 1974, s.52
HEARING
SYDNEY, 16-18 November 1992, 15-17 and 22 June 1993
#DATE 22:7:1993
Counsel for the Applicant: T K Tobin, QC and
R J Webb
Solicitors for the Applicant: Price Brent
Counsel for the Respondent: V B Hughston on 16.11.92 - 18.11.92
A J Philpot on 15.6.93 - 17.6.93, 22.6.93
Solicitors for the Respondent: Bowen and Gerathy
ORDER
THE COURT ORDERS THAT:
1. In relation to the claims by Futuris Industrial Products Pty Ltd:
a) the claim of contravention of s.52 of the Trade Practices Act 1974 be dismissed; and
b) judgment be entered in favour of Futuris Industrial Products Pty Ltd against Arrow Industries Pty Ltd in connection with the claim for goods sold and delivered in the sum of thirty-one thousand one hundred and sixty one dollars ($31,161).
2. In relation to the Cross-claim by Arrow Industries Pty Ltd judgment be entered in favour of Arrow Industries Pty Ltd against Futuris Industrial Products Pty Ltd in the sum of five hundred and seventy five thousand dollars ($575,000).
3. The amount payable under the judgment referred to in order 1 hereof be set off against the amount payable under the judgment referred to in order 2.
4. Futuris Industrial Products Pty Ltd pay to Arrow Industries Pty Ltd and Terry Conroy 95% of their taxed costs of the proceeding, including the Cross-claim.
Note: Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
JUDGE1
WILCOX J: This case relates to motor vehicle disc brake pads. It comprises a claim with two aspects, alleged breach of s.52 of the Trade Practices Act 1974 and moneys due for goods sold and delivered, and a cross-claim founded in alleged breaches of contract.
Background facts
2. The applicant, Futuris Industrial Products Pty Ltd ("Futuris"), is an Australian manufacturer of "friction material" products. On 1 October 1987 Futuris entered into an agreement with a United Kingdom company, Ferodo Limited ("Ferodo"), whereby Ferodo agreed to furnish to Futuris formulations - that is, specifications - for brake pads. The purpose of the agreement was to enable Futuris to manufacture brake pads, as Ferodo's licensee, in accordance with any particular formulation or formulations that it might think suitable for the Australian market. One of the formulations supplied by Ferodo to Futuris pursuant to this agreement was known as formulation 3410F. This case concerns brake pads made in purported conformity with that formulation.
The first respondent to the proceeding is Arrow Industries Pty Ltd ("Arrow"). The company's managing director is Terry Conroy, the second respondent. Over a number of years Mr Conroy has competed in car rallies, with some success. Sometime around 1986 Mr Conroy became interested in helping to develop a high performance non-asbestos brake pad. He contacted a firm known as "Better Brakes" and spoke to Terry Stephenson, the National Sales Manager. At that time Better Brakes was a brake division of James Hardie Industries Limited ("James Hardie"). Mr Conroy suggested to Mr Stephenson that his rally team should test possible brake pad formulations, in return for the right to market pads. Mr Stephenson accepted the idea and introduced Mr Conroy to Roger Carroll, Chief Chemist of Better Brakes. Thereafter, Mr Carroll provided brake pads to Mr Conroy for testing. Mr Conroy tested the pads under rally conditions and reported their performance to Mr Carroll. The tests were blind, in the sense that Mr Conroy was not told what formulation was used to make any particular pad given him for testing.
In about April 1987, James Hardie sold its brake division to Futuris. Mr Carroll transferred his employment to Futuris and became Development Manager of that company. The arrangement between Mr Conroy and Mr Carroll continued.
Following Futuris' agreement with Ferodo in October 1987, Ferodo supplied to Futuris a number of brake pad formulations. In March 1988, Mr Carroll gave Mr Conroy for testing pads made from three different formulations, one of which was 3410F. Mr Conroy tested them. He was impressed with the pads made from formulation 3410F. He reported his reaction to Mr Carroll. With Mr Carroll's support, Mr Conroy embarked upon a more extensive testing program. He formed the view that pads made from formulation 3410F would be marketable in Australia as high performance pads; that is, pads able to withstand hard use under demanding conditions. The tests upon which Mr Conroy based this conclusion were not all undertaken by himself. As his enthusiasm for the formulation grew, he supplied pads to others, mainly the New South Wales Police and colleagues in the motor industry, with a request that they use the pads and report their impressions.
There is some confusion in the evidence about the identify of formulations. Different numbers were used in the internal records of Futuris from time to time. The number variations stemmed from differences in batch sizes and, occasionally, minor deliberate changes in ingredients. Moreover, Mr Conroy was not told the identify of the formulations tested by him. In his evidence he related the pads used by him in winning the 1987 Autumn Classic Rally to the formulation used to make the pads subsequently sold by Futuris to Arrow. In this regard I think he was mistaken. Mr Carroll says that the formulation for the pads used in the 1987 rally was developed by him personally, it was not supplied by Ferodo. The latter statement must be true; the 1987 Autumn Classic Rally was held before the agreement between Futuris and Ferodo was made.
Although there was initially dispute about these matters, during the trial several points became common ground: first, that the pads sold by Ferodo to Arrow were all purportedly made from formulation 3410F (although identified by varying batch numbers); second, that this formulation was supplied to Futuris by Ferodo; third, that Mr Conroy extensively tested this formulation, before there was any sales arrangement between Futuris and Arrow, and became enthusiastic about it; but, fourth, that he was never told the content of the formulation and so had no role in the development by Futuris, during 1988 and 1989, of a manufacturing procedure for the pads.
By June 1988 Mr Conroy had reached the conclusion that there was likely to be an opening for him in the brake pad market. In that month he formed Arrow, in conjunction with William Nolan and Joe Prestia. Each man became a shareholder and director, but it seems that Mr Conroy was the most active participant in Arrow's affairs. In order to generate cash flow, Arrow commenced marketing sun roofs; but the long term objective was to distribute high performance brake pads.
In early 1989 Mr Conroy felt ready to enter the brake pad market. He had conversations with Neville Messer, then the General Manager, Services and Development, of Futuris. (There is a difference in evidence between Mr Conroy and Mr Messer as to the extent of their previous contact. This difference does not matter. It is common ground that Mr Messer was previously aware that Mr Conroy was testing pads supplied to him by Mr Carroll.) The conversations resulted in a letter, dated 13 April 1989, in which Mr Messer quoted prices for brake pads "in our 2818 material". (This number was used at that time to describe the formulation that had impressed Mr Conroy. The number was derived from a batch made up on 19 April 1988. It was described by Mr Carroll in an affidavit as "Formulation 3410F with coarser silicate".) Prices were given for five makes of cars, with some variation between front and rear brakes. They varied between $21.49 and $37.57 per set. Mr Messer commented:
"Terry, these prices are pretty sharp given that these pads contain some very sophisticated and expensive raw materials. You will appreciate that this particular pad compound will only be made for you and we really need decent sized production runs to justify the machine set-up times. However in the initial stages we will 'knife and fork' to give you a chance to establish the business. This will be a bit frustrating for both of us initially but we will do our best.
I will await your response."
Mr Conroy thought the prices satisfactory. From time to time he lodged orders with Futuris. The orders were fulfilled and Arrow made sales. At that stage Arrow's sales volume was small. But the company (and, it seems, Mr Conroy personally) put a lot of effort into the promotion of the product amongst dealers, garages, fleet owners and others in the motor trade. They promoted the product under the name "Arrow", claiming it was a "high performance" pad. Although Mr Conroy contacted some motor vehicle manufacturers, his main target at that stage was the "after" market; that is, for the supply of pads to replace the vehicle's original pads, when they became worn.
In September 1989 Mr Conroy and Mr Nolan had further discussions with Mr Messer. The three men decided to set a pad sales target. They selected the figure of 1,000 sets per month. None of them expected that figure to be reached immediately. Nor did they discuss when it would be reached; although Mr Nolan said in evidence that he then thought it would be possible to reach the figure within about twelve months.
Following this discussion, Mr Messer wrote a letter to Arrow, dated 12 September. The letter was marked for the attention of Mr Nolan. It referred to the relevant formulation as "2939"; but this is yet another pseudonym for the same product. The letter read:
"At this stage of our venture with high performance disc pads in Formulation #2939, I feel that it is appropriate to put into a more formal context our understanding of where we are and where we are going with this product range.
Firstly let me record our appreciation of your assistance during the development phase and the energy and enthusiasm which is now being directed towards its promotion - in particular the efforts of Terry Conroy.
As we discussed, I think the time has come to start to get some focus into the exercise. I believe we should select a limited range of disc pads and aim to develop sales for that range. As we go along, we may well decide to broaden that range. From our point of view, constraints are:-
(i) they must be products we are currently tooled up for
(ii) we must have minimum orders of fifty (50) sets at a time (except for new test pads)
Of course any tooling that we already have in place for general aftermarket applications can be used to manufacture formulation #2939. New tooling will require volumes which are probably out of our reach.
I agree that as discussed our next step should be to set up some targets and review these regularly. A target of 1,000 sets/month does not seem unreasonable at this point. If you can give me the part nos with which you wish to proceed initially I will break it up for you on the basis of general aftermarket sales levels. This will constitute a rough initial guide.
If we can agree on targets and can meet them, I am happy to grant Arrow exclusivity in formulation #2939 for the high performance aftermarket in this country.
In the case of exports and original equipment we would prefer to consult and proceed on a case-by-case basis. I would point out that because of the high relative cost of the constituents of #2939 I consider the O.E. prospects as being unlikely. Bill, I have every confidence that the combination of Arrow Industries and this material will be a potent brew which will find itself a substantial niche in the higher performance end of the aftermarket.
Because of the fact that I do not want any unnecessary and perhaps embarrassing conflicts between our standard products and your product I would like to be able to review any proposed advertising/promotion you might undertake. Going hand-in-hand with this is the fact that we may be able to draw on our knowledge to assist you in these endeavours.
Please be assured that we will do all we can in the way of effective support. Once we have the project securely bedded down we may change the points of contact but at this early stage it is preferable if you continue to work through myself. Bill, I believe this better covers our situation as it now stands. If you feel there are points which require expansion or clarification please do not hesitate to contact me."
During the following month, October 1989, there was a further conversation about market potential. Mr Conroy and Mr Messer discussed the size of the total Australian brake pad market (original and after) and agreed that it was about 3 million sets per year. They thought that, in the long term, Arrow might be able to capture 1% of this market; that is 30,000 sets per year or 2,500 per month.
Arrow's sales never reached 2,500 per month, or even 1,000. But they did steadily increase. Mr Conroy introduced the pad to major fleet owners such as the various State Police Departments, ambulance services, the NRMA etc. During the period September-December 1989, sales averaged only about 30 per month. They rose to an average of 127 per month in the first half of 1990 and 260 per month in the second half.
Towards the end of 1990, Mr Conroy persuaded the publisher of a motor magazine, "Modern Motor", to arrange a series of brake pad comparison tests. The tests were held at Pitt Town, near Windsor, during December. A number of observers were present, including representatives of Futuris and the NRMA. Six different pads were tested. They included the pad marketed by Arrow, a pad made and marketed by Futuris under the name "Ferodo Metal" and four pads manufactured by other companies. A car was fitted successively with each set of pads and put through a series of exercises designed to measure three factors: effectiveness in stopping, brake fade and loss of pedal feel.
"Modern Motor" reported the results of the tests in its March 1991 issue. This issue was actually put on sale in February. The article described the test results as "a real eye opener. The differences were far more marked than we had imagined". The results were also a triumph for Arrow. The Arrow pad obtained top rating in respect of each tested factor. And, for good measure, the article gave it an accolade in relation to a factor not tested: durability. The article concluded:
"We could not test wear rates in a one day test, but we have seen reports indicating police pursuit cars increase their distance between pad changes by three and four times using Arrow instead of the standard pads on Holden Commodores. This is in higher than normal speed use. In day-to-day pottering in traffic, the standard pads probably still rate well on friction, feel, wear rates and particularly cost. But when holidays and the higher average speeds of country roads arrive, there is no doubt it is safer to have the better quality pads under foot.
For continued hard use in high performance cars, or if a trailer is towed - particularly in mountainous country, the high performance pads are the way to go. And you will probably save money in the long run as well as being safer. But the real point is that all these options are available with asbestos-free materials. Asbestos? Who needs it?"
The publication of the test results was followed by a surge in sales. In the first three months of 1991, Arrow sold 1,103 sets of pads, an average of 367 per month. Over the next four months, sales averaged 701 per month (April 710; May 667; June 472; July 957) before collapsing to 249 in August. In early September Arrow ceased to market the pad.
The events of 1991
18. What caused this sudden collapse? Two factors, it seems. In the first place, Futuris determined to take advantage of Arrow's success. As mentioned, Futuris representatives observed the tests. The detailed results became known to them on the following day. They reported these results to their superiors. They were discussed in conversations that involved Mr Messer, Leo Ryan, Futuris' Managing Director, and Graham Loughlan, National Sales Manager. Mr Messer agreed under cross-examination that, during the course of these discussions, Mr Ryan said words to this effect: "How can we take advantage of the result? We can't possibly deny our customers access to our best product". Mr Messer was sure that, during the course of the discussions, someone asked about Arrow's position. He did not state what answer was given but Mr Loughlan recalled Mr Ryan saying: "As far as I am concerned Arrow has no exclusive rights to the product". Mr Ryan denied using the words attributed to him by Mr Messer. I do not accept this denial. I found Mr Ryan an unsatisfactory witness, unwilling to concede even the obvious or to confront directly the point put to him by counsel. Moreover, it is clear that Futuris did immediately set about taking advantage of the test results. A decision was made, in late December or early January, that Futuris would itself market brake pads manufactured in accordance with formulation 3410F. The pads would be promoted on the general market, not merely or specifically the high performance market, at prices significantly lower than those charged by Arrow.
Futuris commenced production of the pads needed for direct sales in January 1991. It recruited extra sales staff and, in February, began an advertising campaign in motoring journals. The advertisements highlighted the "Modern Motor" tests but associated the name "Ferodo" with the winning pads. The theme of the campaign was "Ask for Ferodo". The advertisements contained this report of the tests:
"Modern Motor
Ferodo-made pads
no. 1 and no. 2
in MODERN MOTOR test
Modern Motor, March 1991 has found Ferodo pads are consistently the best in comprehensive testing of six makes of brake pads. Ferodo-made pads cleaned up the opposition - conclusively proving the value-for-money performance of asbestos-free technology."
(Although the matter does not affect the position of Arrow, I note that the description "Ferodo-made pads" was wrong. As already mentioned, Ferodo was a United Kingdom company. It did not manufacture the relevant pads. The tested pads were made by Futuris in Australia, although supposedly pursuant to Ferodo-supplied formulations.)
On 28 February 1991 Mr Messer asked Mr Conroy to call and see him. Mr Conroy did so. Mr Messer handed him a letter dated 26 February. It read:
"This letter is to advise that it is our intention to make the friction material formulation which we currently supply to your Company for sale under the 'Arrow' brand available to our distributors under a FERODO brand for sale into the general aftermarket.
We are happy to continue to supply the current formulation to your company for sale under your brand provided that all normal commercial criteria are met."
Mr Conroy gave evidence that he read the letter and immediately protested that Futuris "can't do this, we have an agreement"; that Mr Messer responded that Futuris had obtained legal advice but added: "I don't necessarily agree with this, but I have been instructed to give you the letter". There is no reason to doubt this evidence. Mr Ryan conceded that Futuris obtained legal advice about its position. And Mr Messer agreed in evidence that he made a comment along the lines of that attributed to him by Mr Conroy. Asked to explain his comment, he said: "I guess in my mind was the thought that perhaps it could have been handled in a better fashion". He agreed that the letter was a matter of sensitivity because he had seen "Mr Conroy progressively developing a market for himself, the high performance end".
Mr Conroy informed his fellow directors of the conversation. Mr Nolan telephoned Mr Messer and remonstrated with him. Mr Messer responded that the matter was out of his hands. There was correspondence between the parties as to Futuris' right to sell in competition with Arrow. Arrow asserted that the pads supplied to it by Futuris were made from a formulation developed especially for it; Futuris claimed it was a Ferodo formulation. Arrow also claimed an exclusive right to sell the pads in the high performance market. Futuris denied that Arrow had any exclusive right. Neither of these issues was resolved in the correspondence. In the meantime, Arrow continued to purchase pads from Futuris. If it was to remain in business, it had no alternative.
It is not possible to determine the precise effect on Arrow's sales of the marketing of Futuris pads. As indicated, notwithstanding the competition, Arrow's sales continued to increase until July 1991. But it is reasonable to believe that, in the absence of competition from Futuris, the level of sales would have increased even more. Futuris' competition was fierce. It extensively advertised its pads, basing its campaign on the "Modern Motor" tests. Anybody who remembered Arrow's success in those tests, and who read Futuris' claim that Ferodo-made pads were placed first and second in them, would realise that the pads offered by Futuris must be the same as those sold by Arrow. The advertising campaign emphasised the name "Ferodo", a name well-known in Australian motoring circles from its association with motor racing. Ferodo was so prominent that, in one advertisement, Futuris described Ferodo as "the world leader in asbestos-free brake pads". The advertising was followed up by Futuris sales people who directly canvassed potential customers. They were able to claim that their pad was identical to the Arrow pad and available at about half the price. It would be astonishing if this activity did not divert a substantial volume of sales from Arrow to Futuris, as Futuris intended.
Mr Conroy began to receive complaints from Arrow distributors about lost sales, the distributors' customers saying they could buy the same product from Futuris at a cheaper price. He also heard directly from customers. Mr Conroy annexed to an affidavit a schedule containing the names of 31 customers whose representatives reported to him conversations in which Futuris sales representatives stated that the Ferodo pad they were marketing was "the same as", or "manufactured from the same compound as", the Arrow pad. This evidence was not challenged.
Serious though this situation was, from Arrow's point of view, worse was to come. Arrow had always marketed the pad as a high performance product that would sustain minimal wear even if used in cars driven at high speeds under testing conditions. Until March/April 1991 it had no reason to doubt the veracity of this claim. Arrow had received numerous reports commending the durability of the pads; and, until that time, no complaints about quality. But in March/April 1991 Arrow commenced to receive complaints. At first they were a trickle; but, by September, there was such a flood that Mr Conroy decided to suspend sales.
It is unnecessary to go to the detail of the complaints received by Arrow. The effect of the problem may be seen from an affidavit of Robert Grant, Fleet Maintenance Manager of the NRMA. In late December 1990 the NRMA had about 95 vehicles. At the suggestion of Barry Lowe, an NRMA engineer who attended the "Modern Motor" tests and was impressed with Arrow's performance, in early 1991 Mr Grant purchased six sets of Arrow brake pads. He said in evidence that he intended to try the pads on a few vehicles but, if the trial was successful, to use them on all NRMA vehicles. The six sets proved unsatisfactory. Mr Grant's experience was that a standard brake pad lasted for a minimum of 20,000km, and up to 40,000km. None of the six Arrow sets reached even 20,000km. The best result was 19,000km, the worst 3,300km. Mr Grant said in evidence that the pads wore excessively and caused damage to the rotors (the discs). The trial so affected his attitude to Arrow pads that, in an affidavit sworn as long afterwards as July 1992, Mr Grant said:
"Because the Arrow pads did not prove successful, I will not purchase any more Arrow pads on the NRMA's behalf. This is despite the fact that Terry Conroy, from Arrow Industries Pty Ltd. has subsequently given to me a number of free samples of Arrow brake pads for trial in the NRMA's fleet. I will not use those brake pads in the NRMA's vehicles, as far as I am concerned, it is a case of once bitten, twice shy."
There were two major themes in the complaints received by Mr Conroy. The first theme concerned the tendency of the pads to disintegrate. There were complaints of excessive wear, leading to the necessity for owners to discard the pads after a comparatively low mileage, complaints of pads flaking and cracking, of pads coming away from their backing plates and of excessive dust on the wheel exteriors. One witness deposed that, when he washed the wheels of his car, the water "now sent the concrete black where previously any dust from the wheels did not stain the concrete".
The second recurring problem was damage to the rotors, the discs. This was one of the matters noted by Mr Grant. It was mentioned by others as well. In a letter dated 30 August 1991, David Seldon, Arrow's Queensland distributor, listed four customers, including the Queensland Police, who complained of rotor damage problems.
At the beginning of September, Mr Conroy suspended sales of Arrow pads. He declined to make further payments to Futuris for pads already supplied or to take delivery of ordered material held by Futuris. Mr Conroy sought the assistance of the Department of Defence Materials Testing Laboratory ("MTL") in ascertaining the reason for the decline in pad quality. He took to MTL two sets of pads. The first, marked as sample "A" by MTL, was a set of Izuzu pads made on or shortly before 13 July 1989. The second was a set of Commodore pads, marked "C" by MTL, made about 15 February 1991. The pads were subjected to instrumental analysis by an MTL officer, W B Searle. The purpose of this analysis was to determine the existence of what Geoffrey Cooke, Mr Searle's superior, called "any enormous differences between materials". No enormous differences were found. The two samples were found to contain similar elements, in broadly similar quantities.
The two sets of pads were referred to the Chemistry Section of MTL. Margaret George carried out an analysis of the copper and iron content of each set; also hardness tests. She found that each set of pads contained 8% copper but that the iron content increased from 28.6% in sample A to 32.0% in sample C. She also discovered that the hardness value fell from 47 in sample A to 34 in sample C. Ms George thought this result surprising. As she explained in evidence, an increase in the iron content would tend to increase hardness value. (A possible explanation of these results was provided in a later test performed by Ms George. On 2 January 1992 she found that the average silica content of sample A was 7.5%, but 10.1% in sample C.)
Mr Conroy took the MTL September-October test results to Russell Findlay, an automotive engineer. Mr Findlay wrote a report dated 4 November 1991 in which he expressed the opinion that the differences between the two sets of pads disclosed by the tests were functionally significant:
"The brake pads are supposed to be to your material specification and to your co-efficient of friction average figure of .402. It is quite obvious from analysing these two results that there are significant differences in the material specification, so much so, that this would effectively change the co-efficient of friction, wear rate and performance rate of the two materials. The two materials differ significantly in the iron content and the average shore scleroscope hardness value. The change in the percentage of iron between the two, from 28.6 to 32.0 would significantly decrease the co-efficient of friction of the material and would also cause rapid wear of both the pad material and the disc material, when put into service. There have been some other significant changes in the material specification, which have resulted in the average shore scleroscope hardness value being decreased from 47 to 34. This clearly indicates that the material specification has also been changed, as an increase in iron would increase the hardness value.
From the results obtained, it clearly shows that a substitute has been included in the material, to reduce that hardness."
After receiving Mr Findlay's report, Mr Conroy sent a circular letter to 32 Arrow customers. The letter was dated 15 November. As it is the foundation of Futuris' claim against Arrow I will quote it in full:
"Dear Customer,
Arrow Industries wishes to clear up any misconceptions which may exist in respect of its new range of Arrow GT and High Performance Brake Pads.
The Arrow GT and Arrow High Performance Brake Pads are now manufactured by National Brake and Clutch. They should not be confused with the Brake Pads manufactured or supplied by Futuris Industrial Products Pty Ltd.
The original Arrow High Performance Brake Pad was manufactured by Futuris Industrial Products Pty Ltd and distributed by Arrow Industries. The pad proved to be an immediate success on the Australian market. Earlier this year, however, Arrow Industries became increasingly concerned at an apparent and unexplained drop in the performance quality of the Brake Pads supplied by Futuris Industrial Products Pty Ltd. Arrow Industries had the compound used in the more recent product supplied by Futuris analysed and compared with the compound used in the older product. The analysis was carried out by the Department of Defence's Materials Testing Laboratory. The results of that analysis were referred to a firm of consulting engineers for further comment and report. The end result of those tests was to show that the material specification of the compound used in the sample of the recent Arrow product, supplied by Futuris differed significantly from the materials specification of the sample of the older compound tested.
Arrow Industries no longer markets the Futuris manufactured product under the Arrow trade name. All Arrow High Performance Brake Pads now distributed are manufactured by National Brake and Clutch. The current Arrow High Performance Brake Pads should not be confused with any of the Ferodo range of products. Arrow Industries apologises to its customers for any confusion which ay have occurred earlier this year over any apparent drop in quality of the Arrow High Performance Brake Pads. Arrow Industries wishes to assure all of its customers of its continued commitment to provide the best range of products and the highest of service and expertise."
On 28 November Futuris' solicitors wrote to Arrow complaining that the letter constituted misleading conduct in contravention of s.52 of the Trade Practices Act and also the tort of injurious falsehood. The solicitors demanded a retraction statement and apology. The demand was not met. On 2 December 1991 Futuris commenced this proceeding.
Before I go to the legal claims made by the parties, I should mention two other factual matters. First, the quality problems suffered by Arrow in 1991 were experienced also by Futuris, in relation to the pads made from formulation 3410F that it marketed under the Ferodo label. Although I believe that Mr Conroy originally thought otherwise, this is not a case of a manufacturer adopting a different quality standard for its own product as against the "same" product marketed through another company. Futuris received numerous complaints about its brake pads. Mr Messer sought advice from Ferodo. In September 1991 he sent some samples to Ferodo for analysis. The analysis revealed that several of the raw materials used in the samples differed from those specified. As a result of this report, according to Mr Carroll, Futuris began to make the product in strict conformity with Ferodo's manufacturing instructions. When asked in cross-examination whether one departure from the specified formulation concerned the zircon silicate used in the manufacturing process, Mr Carroll did not directly respond. He said that the formulation had not changed over the entire period. But he added:
"but yes, when you can see that there's disc wear you tended to want to do something about it and cut down on that disc wear, so I agreed with the change".
He meant by this the change back to strict adherence to Ferodo's requirement concerning zircon silicate. Mr Carroll later said that the disc wear problem caused Futuris to contact Ferodo. He agreed that an increase in silicon could increase pad wear.
In mid-1992 Futuris ceased to use the 3410F formulation for the production of brake pads. Its reason was not revealed.
The second matter I should mention concerns a later investigation by Ms George. It provides a possible further explanation of the disc wear problem. This investigation was performed by Ms George on her own initiative, not on instructions from Mr Conroy or anyone at MTL. She was puzzled about the difference in performance of the pre-1991 and the 1991 pads. Using a hacksaw, she cut off small pieces of samples A and C. She ground each piece to a powder. Upon microscopic examination of the powders, she discovered a marked difference between them. Both powders were granulated. But sample C had numerous shiny, pointed black particles. Ms George identified these particles as silicon carbide, more commonly known as carborundum. Carborundum is extremely hard. Ms George said that it rated second only to diamonds in the hardness scale. She said that silicon carbide particles would "act virtually like a grinding wheel". In the course of his evidence, Mr Findlay elaborated on this. He was asked to assess the effect of silicon carbide in a brake pad. He replied:
"Silicon carbide is a very abrasive material and it would have high wear rates on the disc rotor that it fits against and would grind the disc rotor away rapidly compared to materials without it."
Ms George brought to Court samples of the two powders. She also produced a photograph of each sample. These photographs were taken by a colleague at MTL under her observation. Each photograph is at 40 times magnification. Bearing in mind the evidence of the effect of silicon carbide, no viewer of the photograph of sample C would doubt that a brake pad made from that material would have a savage effect on any disc with which it came into contact.
I should mention that Ms George's evidence about the powders and photographs was not included in her affidavit. But notice of the substance of this evidence was given to the applicant's solicitors seven months before she was called. So I allowed the evidence to be given orally. Despite the length of the notice, counsel did not challenge the evidence.
Futuris' s.52 claim
40. The claim made by Futuris has two aspects. First, Futuris complains of the publication of the circular letter. As this matter is expressed in Futuris' Statement of Claim, the contention is that some representations in the letter were misleading and deceptive, or likely to mislead and deceive, in that:
"(a) There is no significant or other difference in recent materials supplied by the Applicant from materials supplied by the Applicant previously for use in the Arrow product.
(b) There has not been a drop in the performance quality of brake pads supplied by the Applicant."
The Statement of Claim alleges that the letter was published by Arrow and that Mr Conroy was knowingly involved in the publication. Those allegations are undoubtedly correct. Futuris seeks orders that Arrow provide a list of all persons to whom the letter was sent and that it forward letters to those people withdrawing the allegations and unreservedly apologising to Futuris. Damages are also claimed; but no evidence has been adduced quantifying the damage said to be caused by the publication of the circular.
The second element in Futuris' case is a claim for $41,732 for goods sold and delivered by Futuris to Arrow between February and September 1991. Mr Messer verified this amount. His affidavit reveals a short payment of $2,000 in respect of deliveries made before the end of May and a further $2,000 short payment for June deliveries. The balance of the claim relates to July ($27,215.45), August ($4,690.30) and September ($5,876.25). Some of this claim appears to be for goods manufactured for Arrow which Mr Conroy refused to accept. There is no dispute as to the figures - Arrows's response to the claim is that the goods were defective. The response is to the same effect as one of the allegations made by Arrow in its cross-claim. Accordingly, it is convenient to defer consideration of this claim until later.
In their final address counsel for Futuris put a submission concerning misleading conduct narrower than that pleaded in the Statement of Claim. They did not contend that it was misleading for the circular letter to suggest that there had been a drop in the performance quality of brake pads supplied by Futuris to Arrow. They could hardly have done so. By the end of the hearing, the evidence of a quality drop was overwhelming. So hopeless was Futuris' position on the matter, that their counsel did not seek to cross examine many of the people who deposed to it.
In the end, counsel were reduced to one complaint about the letter. That complaint related to one sentence:
"The end result of those tests was to show that the material specification of the compound used in the sample of the recent Arrow product, supplied by Futuris differed significantly from the materials specification of the sample of the older compound tested."
Counsel's argument is that this sentence asserts that Futuris altered the material specification of the compound, not accidentally and because of poor quality control, but deliberately. They contend that the sentence means that Futuris was found out in this conduct and dismissed as Arrow's supplier. They say that Mr Carroll's evidence establishes that this was false; there was no deliberate alteration of the material specification.
I agree with the last mentioned contention. Mr Carroll did give this evidence and he was not challenged about it. The critical question is whether the sentence contains the assertion suggested by counsel. I do not think it does.
As I read the sentence, it contains no allegation of deliberate conduct. It merely says that tests revealed that the material specification of the compound used in the recent Arrow product differed significantly from that used earlier. The sentence is not inconsistent with the possibility that Futuris deliberately changed the materials specification. But it does not make that charge. The sentence is equally consistent with the change having occurred accidentally; for example through human error, an unnoticed variation in the nature or quality of the raw materials used in the production of the compound or a change in production technique. The sentence alleges no more than that there was a difference, for whatever reason, in the composition of the new compound, as compared with the old. This was undoubtedly true. Although Futuris never deliberately decided to depart from the 3410F formulation, there were numerous 1991 departures from that specification. Mr Carroll conceded as much. No doubt many of these departures were unimportant; but Mr Findlay thought the departures discovered by Ms George in September-October 1991 were "significant", from a functional point of view. This opinion was not challenged. It alone justified the impugned sentence. Ms George's later discoveries of increased silica content and the presence of silicon carbide merely reinforce the truth of the sentence.
The publication by Arrow of the circular letter of 15 November did not constitute misleading conduct. Futuris' s.52 claim must be rejected.
The Cross-claim: exclusivity
49. The Amended Cross-claim filed on behalf of the respondent pleads several distinct causes of action. They fall into two categories: claims alleging breach of an agreement for exclusivity and claims alleging that the pads supplied in 1991 were defective.
In relation to exclusivity, Arrow relies primarily upon the terms of the letter from Futuris dated 12 September 1989. But the Amended Cross-claim also refers to earlier matters and counsel relies on them. The earlier matters are: the active role taken by Mr Conroy in identifying the 3410F formulation as a formulation suitable for high performance brake pads operating under Australian conditions; the steps taken by Arrow to develop a market for this pad, especially amongst fleet owners; Mr Messer's letter of 13 April 1989 to Mr Conroy in which he stated that the subject pads would be made "only for you"; and the practice of Futuris executives of referring in conversations to the 3410F formulation as "the Arrow pad".
These earlier matters provide an important backdrop to the letter of 12 September 1989. But I do not think that they establish an express agreement as to exclusivity. Nor do they support an implied agreement to that effect. The development and marketing efforts of Mr Conroy and Arrow were not inconsistent with Arrow having a non-exclusive right to sell the product; even a non-exclusive right to sell a product may have value. The comment in the 13 April letter may be read as a mere statement of Futuris' intention at that time; Futuris being free to change its position later if it wished. And it is difficult to ascribe contractual significance to the fact that the product was described in a particular way in casual conversations.
However, the 12 September letter provides a stronger foundation for the claim of exclusivity. Arrow seeks to use the letter in a number of ways: as a memorandum of an express agreement; as giving rise to an implied agreement; as a representation by Futuris giving rise to liability under s.52 of the Trade Practices Act; and as creating an estoppel. I see difficulties in each of the last three arguments. But I have no difficulty in concluding that the letter contains an express (though conditional) term of exclusivity. That is what the letter says:
"If we can agree on targets and can meet them, I am happy to grant Arrow exclusivity in formulation #2939 for the high performance aftermarket in this country."
Arrow was to have the exclusive right to supply pads made from formulation 2939 (3410F) to the Australian high performance aftermarket subject to two conditions. The first condition was an agreement between the parties on appropriate sales targets; the second was the "meeting" of those targets.
There is no doubt that the first condition was fulfilled. It was common ground at the hearing that the parties agreed on a sales target of 1,000 sets per month. They realised that sales of this order would not be immediately achievable. That is why they called the figure a "target" rather than an immediate requirement. Implied in the notion of a "target" was a mutual belief that it would take time for Arrow to reach 1,000 sets per month. The second condition took that factor into account. In form, this condition was that "we can meet them"; but really it meant that Arrow can meet the target. Sales volume was Arrow's responsibility.
As I have said, nobody thought that the target could be met immediately. So it would be absurd to construe the sentence as making exclusivity depend upon Arrow immediately selling 1,000 sets per month. Counsel for Futuris do not contend that the sentence should be so construed. They summarise the effect of the sentence in the following propositions:
"a) If Arrow can achieve sales of 1,000 sets per month within a reasonable period of time then Futuris will grant it the exclusive rights to distribute the pads in the high performance aftermarket. That is, provided sales of that order can be achieved within a reasonable period then Futuris will grant the exclusive right. b) In the meantime Futuris will not sell pads made from the formulation in question other than to Arrow."
I think that this construction is broadly correct. But I would prefer to express the sense of the sentence more simply by saying that Futuris granted Arrow exclusive access to the high performance aftermarket during such period as it made reasonable progress towards the agreed sales target, and thereafter whilst it maintained sales at that level. To the extent that this construction differs from that advanced by counsel for Futuris, it is more favourable to their client. It would not require Futuris to wait until the expiration of the period during which Arrow could reasonably be expected to reach 1,000 sets per month. If Arrow was not making reasonable progress towards that goal, the right of exclusivity would earlier be lost.
It seems to me that the construction I favour makes commercial sense. It gives Arrow the exclusive right to exploit the formulation whilst it is making reasonable progress towards a satisfactory sales volume, and thereafter when it has reached that volume, thereby rewarding Arrow for its development and promotion effort and providing an acceptable return to Futuris through manufacturing profit. But, if Arrow does not make reasonable progress, the condition enables Futuris to obtain by other means a satisfactory return for its work in selecting the formulation and developing a production regime. That construction is consistent with the earlier history of the product, and especially the contribution made by Mr Conroy to the identification of the formulation as one suitable for high performance brake pads operating under Australian conditions. It is also consistent with the fact that, as both Mr Messer and Mr Carroll deposed, Futuris was not then interested in entering the high performance market itself.
Counsel for Futuris submit that any condition of exclusivity was subject to an implied term that the condition was revocable upon reasonable notice. They say that any question of breach is therefore limited to consideration of the reasonableness of the notice given by Futuris. Counsel say that the proved circumstances would not have required more than one month's notice of termination of exclusivity. They accept that no notice whatever was given, but argue that (if there was a breach by their client) damages should be assessed on the basis that Futuris was entitled to determine the condition of exclusivity on one month's notice.
In support of their contention, counsel refer to Crawford Fitting Co v Sydney Valve and Fittings Pty Ltd (1988) 14 NSWLR 438. In that case the New South Wales Court of Appeal considered the circumstances under which a commercial agreement for an indefinite period may be terminated. The principal majority judgment was given by McHugh JA who discussed the relevant authorities at length. It is not necessary for me to follow suit. His Honour summarised their effect in the section of his reasons in which he stated the applicable principles. I will come to those principles in a moment. First, it is necessary to note that the issue in Crawford Fittings was not the same as that in this case.
The agreements under consideration in Crawford Fitting were distributorship agreements made between a manufacturer and two distributors. Each distributorship agreement was exclusive, in two senses: the manufacturer gave the particular distributor the exclusive right to distribute its products within a defined territory; and each distributor agreed not to deal in other products. However, the report does not suggest that either respondent was more than a distributor. Unlike the position in the present case, neither distributor had played a part in testing the suitability of the appellant's products under Australian conditions. Perhaps because of this factor, the respondents did not contest the appellants' right to terminate the agreement. They only disputed the period of notice necessary for termination; in particular the matters relevant to determination of the period. At 441 McHugh JA identified the principal question in the appeal in this way:
"... in determining the reasonableness of a period of notice terminating a distributorship agreement, is it ever relevant to take into account expenditure or effort of the distributor which has created opportunities for consequential earnings in the future?"
Although the issue presented for determination in Crawford Fitting was very different from any arising in this case, the principles enunciated by McHugh JA provide some assistance. At 443 his Honour said:
"When the question arises whether a commercial agreement for an indefinite period may be terminated, the answer depends upon whether the agreement contains an implied term to that effect: ... The existence of the term is a matter of construction. But the question of construction does not depend only upon a textual examination of the words or writings of the parties. It also involves consideration of the subject matter of the agreement, the circumstances in which it was made, and the provisions to which the parties have or have not agreed."
McHugh JA went on to discuss the question whether there was a presumption of permanency in the case of an indefinite commercial agreement. He noted some divergence upon the matter in the authorities before concluding, at 444:
"In principle, the better view would seem to be that, although there is a presumption against implying a term that an agreement is terminable, ordinarily the nature of a commercial agreement will lead to the conclusion that the parties must have intended it to be terminable on notice."
McHugh JA did not suggest that the usual pre-conditions to the implication of a contractual term were inapplicable to the question whether a particular contract contains an implied term permitting termination. Those pre-conditions were summarised by the Judicial Committee of the Privy Council in BP Refinery (Westernport) Pty Ltd v Hastings Shire Council (1977) 52 ALJR 20 at 26 in this way:
"... for a term to be implied, the following conditions (which may overlap) must be satisfied: (1) it must be reasonable and equitable; (2) it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it; (3) it must be so obvious that 'it goes without saying'; (4) it must be capable of clear expression (5) it must not contradict any express term of the contract."
In the case of a commercial contract, the first three conditions will often, perhaps usually, be satisfied. That may have been what McHugh JA had in mind when he said that "ordinarily the nature of a commercial agreement will lead to the conclusion that the parties must have intended it to be terminable on notice". It would not ordinarily be supposed, for example, that the manufacturer of a product having commercial longevity would have intended to bind itself forever to a particular distributor, however unsatisfactory its sales performance or the relationship between the parties; particularly in a case where the distributor had played no part in developing the product or demonstrating its market potential. But the fact that it will often be possible for a court to feel satisfied about the application of the first three conditions to a commercial contract does not exclude the possibility that sometimes it may not. As McHugh JA pointed out, regard must be had to the whole of the relevant circumstances.
In the present case, there are three circumstances that suggest to me that the first three BP Australia conditions do not apply to the agreement for exclusivity. First, this is not a case where a manufacturer developed a product independently of a distributor and then found a distributor to service a particular territory. It is true that the relevant formulation was devised by Ferodo. But it was only one of a number of formulations provided by Ferodo to Futuris. Futuris appreciated that not all those formulations would be useful under Australian conditions, especially for high performance brake pads. Futuris needed to identify the formulation or formulations most suitable for use. That involved an extensive testing program. Mr Conroy played a major part in that program. He not only used formulation 3410F himself, and reported the results to Mr Carroll; he arranged extensive testing by others. It was only because of the work done by Mr Conroy that it became clear that formulation 3410F was suitable for high performance use in Australia. He played a major role in establishing the potential of the product. He did so pursuant to an agreement that he would be entitled to market any formulation which he proved to be satisfactory. Through Mr Carroll, Arrow had a claim on Futuris, and on this product, which put it in a position quite unlike that of a mere distributor.
Secondly, this is not a case of a product of unlimited life, in relation to which it might be thought unlikely that a manufacturer would grant a permanent exclusive distribution right. As counsel for Futuris point out, in another context, brake pad formulations have a limited commercial life. Mr Ryan gave evidence that it was common for Futuris to change formulations "every two years or thereabouts". He spoke of the evolutionary process of ongoing research and development whereby "we have formulations that we believe became better than their predecessors". Given the nature of the product, there is no reason to reject this evidence.
Finally, it is clear that, in September 1989, Futuris was not itself interested in entering the high performance aftermarket.
Having regard to these matters, it seems to me not improbable that Futuris would have been willing to give to Arrow an exclusive right to market pads made from the particular formulation whose suitability for the high performance market Mr Conroy had demonstrated, for the life of that formulation; provided only that Arrow made reasonable progress in achieving a satisfactory sales volume.
When the situation is considered from Arrow's point of view, the unlikelihood that it would have agreed in September 1989 to Futuris having a right of termination of the condition of exclusivity is apparent. Although Arrow was then satisfied that the formulation was a good one, with significant commercial potential, much work needed to be done to make it profitable. It would take time to generate a satisfactory sales volume. During that time Arrow would have to incur significant promotion expenses. This was not a case merely of a new product. The task before Arrow was to create a new market; to persuade fleet owners that they should pay a premium price for a premium quality brake pad. If the hypothetical officious bystander had suggested on 12 September 1989 that it went without saying that Arrow accepted Futuris' entitlement to terminate the exclusivity arrangement, thereby exposing Arrow to the risk of deprivation of the fruits of its effort and expenditure, I think Mr Conroy would have disabused him in pungent terms.
Having regard to the above considerations, it seems to me that it would not be reasonable or equitable to imply a term permitting Futuris to terminate the condition of exclusivity, in the absence of breach. Nor was such a term necessary to give the agreement business efficacy. It is true, as counsel for Futuris submit, that the agreement did not prevent Arrow selling some other product which competed with 3410F or commit Arrow to maximising sales for 3410F. But the agreement did contain a sanction - Arrow had to make reasonable progress in meeting the sales target. If Arrow competed against 3410F or failed to maximise sales, this would adversely affect its progress towards the sales target.
In the course of their submissions, counsel for Futuris referred to the Judicial Committee decision in Australian Blue Metal Ltd v Hughes (1963) AC 74, and especially to a sentence at 96:
"It is highly improbable that the respondents would have granted so much without requiring, as they did in 1942, a corresponding obligation to mine, or without at least reserving a right of termination if they were dissatisfied with the progress made."
This passage does not assist Futuris. On the contrary, it emphasises the point that the existence of a right to terminate for insufficient progress is a safeguard against the hardship that might flow from an otherwise interminable agreement.
The question what would constitute reasonable progress in reaching the agreed sales target was something that the parties were content to leave for determination, as the need arose, in the light of prevailing circumstances. The question was an objective one, capable of determination, if necessary, by a court. But, in determining it, the attitude of the parties to the progress actually made would always be a relevant matter. Although they did not put a submission in those precise terms, counsel for Futuris, in effect, adopt that approach in relying upon Mr Nolan's evidence that he expected Arrow to reach 1,000 sets per month within about 12 months. They emphasise that this target had not been reached, 17 months later, when Futuris commenced to compete with Arrow.
Mr Nolan's evidence is relevant to the question whether Arrow made reasonable progress towards the agreed target in the period September 1989 - February 1991. But it does not determine that question. Mr Nolan stated the expectation he held in September 1989. But circumstances change. An expectation reasonably held at one time may prove too optimistic an assessment of what constitutes reasonable progress under later conditions. Mr Nolan was not asked to comment upon the question whether Arrow had made reasonable progress towards the target in February 1991. Furthermore, Mr Nolan's expectation was only his personal assessment of the situation. Mr Nolan had had a long experience in the motor trade, but he was not deeply involved in this new venture. The Arrow person most actively involved in the matter was Mr Conroy. Mr Conroy was not asked to indicate when he expected the agreed target to be reached.
Even more significant, as it seems to me, is the attitude of Mr Messer and Mr Carroll. These two men knew the level of sales being achieved by Arrow; all its stock was supplied by Futuris. Throughout the whole of the relevant period, they knew the circumstances prevailing in the motor industry and in the brake pad market. At no time did either man suggest that Arrow's sales performance was unsatisfactory. Both men were content to allow the agreement to continue, taking the benefit of Arrow's gradually increasing purchases. Mr Ryan's decision to deny exclusivity, and actively enter the market, was not dictated by a perception that Arrow was insufficiently successful; but rather by his realisation that Arrow held a potential bonanza, and his desire to appropriate it for Futuris. Arrow was undone not by its lack of adequate past progress, but by its likely spectacular future progress.
In assessing whether the sales achieved by Arrow up to February 1991 constituted reasonable progress towards the target, Mr Messer's reaction to Mr Ryan's decision is of particular interest. Mr Messer had always emphasised the need for sales volume. He did so as early as April 1989, when he wrote about the need for "decent sized production runs". The need for volume was repeated in his letter of 12 September. Yet, not only did Mr Messer never suggest that the volume subsequently achieved by Arrow was insufficient; he felt that Arrow had been shabbily treated by Mr Ryan. The comments he made to Mr Conroy and Mr Nolan about the letter of 26 February 1991 are consistent only with an opinion that Arrow had fulfilled its side of the bargain and made reasonable progress in meeting the agreed target.
In my opinion, it was a term of the agreement between the parties that Arrow should have the exclusive right to market pads made from formulation 3410F in the high performance aftermarket so long as it made reasonable progress towards achieving the agreed sales target of 1,000 sets per month. That term was breached when Futuris entered the market in competition with Arrow.
The Cross-claim: defective goods
78. The Amended Cross-claim asserts that it was an express - or, alternatively, implied - term of each contract for the purchase of brake pads that the brake pads were:
"(a) manufactured from the same high performance formulation as the Arrow Brake Pads purchased prior to February, 1991;
(b) of the same high performance standard as the Arrow Brake Pads purchased prior to February, 1991;
(c) of a consistent formulation;
(d) of a consistent quality and would have a working life extending beyond 20,000 kilometres."
I think it is erroneous to say that the contracts to purchase pads included all these terms. The contract constituted by the acceptance of each of Arrow's orders was a contract to supply pads manufactured in accordance with the specified formulation; the formulation that had been tested by Mr Conroy, that is formulation 3410F. If the pads all complied with that description, there would necessarily be a consistency of formulation. So consistency of quality was inherent in the expressed description. Pads made from formulation 3410F might always have a working life extending beyond 20,000km; but I do not think there was any term to that effect.
It is apparent from my earlier findings that some, at least, of the pads delivered after February 1991 did not comply with formulation 3410F. Some may have done so; the evidence does not deal with all the pads that were supplied. But, even if some pads did comply with the formulation, the lack of consistency was a matter of concern. As Futuris knew, the pads were to be sold as high performance pads, at a premium price. It was essential, from Arrow's point of view, that its customers be able to feel confident about the likely performance of the pads. It was equally essential that Arrow feel confident about quality. Arrow had no way of knowing whether a particular pad complied with the formulation. It did not know the formulation. Any adequate chemical analysis of a pad would require its destruction. It was not good enough that some pads - even a majority of them - might be individually satisfactory. As Mr Grant's evidence illustrates, one unfortunate experience might irredeemably sour a customer.
Counsel for Futuris point to the warranty offered by their client over pads manufactured by it. They say that the extent of their client's obligation was to replace any pads that proved defective. This submission is quite unrealistic. A customer who pays a premium price for a high performance long-life pad would take little solace from the warranty right. He or she would thereafter purchase elsewhere.
It might perhaps have been unreasonable for Arrow to expect perfect adherence to the formulation; although I would have thought that proper quality controls in a high technology industry such as this would enable a manufacturer to get close to this. If Futuris had departed only occasionally from the formulation, the damage to Arrow might not have extended beyond the trouble and cost of replacing the particular pads. But, as must have been obvious, frequent departures had the potential entirely to destroy Arrow's business. This is what occurred. The frequency of defects was so great as to destroy confidence in the pads, by customers and Arrow alike.
In my opinion it is correct to say that the pads supplied after February 1991 were not in accordance with the terms of the contracts for supply made between the parties, either because they were individually unacceptable or because the degree of inconsistency in quality was as great as to make it impossible for Arrow conscientiously and confidently to supply them as a high performance product to demanding customers. This element of the cross-claim is also established.
I should mention that Arrow relies upon each of the warranties implied by s.19 of the Sale of Goods Act 1923 (NSW). I have not found it necessary to approach the matter by reference to that section. But I think that s.19(1), at least, would apply in this case.
Damages
85. A combination of factors caused Mr Conroy to suspend sales. If only one of the relevant factors had constituted a breach of duty by Futuris, the task of assessing the damages payable on the Cross-claim might have been extremely difficult. It would have been necessary to attempt to isolate the effect of that factor. But, in the view I take, this is not necessary. Mr Conroy closed the business because of the competition offered by Futuris and the complaints about product quality he was receiving. Both these factors constituted breaches of duty by Futuris. It is unnecessary to isolate the comparative importance of each element. it is sufficient to say that the business was destroyed by the breaches of duty alleged in the Amended Cross-claim and calculate damages accordingly.
Even so, the task of assessing damages is not easy. There are many imponderables. Much depends upon the view one takes about sales prospects in the wake of the "Modern Motor" article. Mr Conroy gave evidence that, during the first half of 1991, Arrow was in contact with a number of major fleet owners and retailers regarding substantial purchases, each of the order of 500 sets or more. I think it is reasonable to conclude that, in the absence of competition from Futuris, the "Modern Motor" article would have substantially increased Arrow's sales volume; coming as it did on top of the promotion already undertaken by Arrow and the acceptance of the pads (at least for trial purposes) by fleet users like the NRMA and some State Police Forces. Even with Futuris' competition, and with complaints about quality commencing, Arrow achieved sales of about 700 sets per month in April and May 1991. I have no difficulty in concluding that, in the absence of those factors, Arrow would have achieved sales of 1,000 sets per month by that time and continued to increase its level of sales over succeeding months.
In an affidavit dealing with damages, Mr Conroy expressed the opinion that, if the pattern of early 1991 had continued, "Arrow would certainly have been able to achieve the target of 2,500" sets per month "within a relatively short period ..." He set out a projection of profits based on sales at this rate. This projection showed the cost of acquiring the pads as $24 and the Arrow sale price as $60; that is, a gross profit of $36 per set. These are presumably average figures. The figures were not elaborated; neither figure was challenged. Mr Conroy allowed overheads at $20,000 per month. He assumed sales at the rate of 2,500 units per month over 15 months (apparently 1 October 1991 to 31 December 1992). Taking the figures just mentioned, he projected a net profit for that period of $1,050,000.
In another exercise, Mr Conroy made a calculation of the likely Arrow profit during the period 1 October 1991 to 31 December 1992 upon the basis of what he called a "conservative sales target". This exercise looked separately at each of the 15 months and assumed sales for the month varying from a high of 2,250 in November 1991, and again in each of October and November 1992, to a low of 750 in January 1992. The calculation makes the point that there would be a seasonal variation in the level of sales. The monthly sales figure, over the period of 15 months, averages 1,650. The gross profit on that volume of sales equals $59,400 per month or $891,000 for the full period of 15 months. Mr Conroy applied the overhead figure of $20,000 per month to produce a net profit of $591,000.
Counsel for Futuris challenged Mr Conroy's predicted sales volumes, putting to him that they were fanciful. Mr Conroy denied this, giving reasons. He referred to the discussions that Arrow was holding with major potential purchasers in early 1991. There is no reason to disbelieve his evidence on that matter. I would not describe Mr Conroy's detailed projection as fanciful, but I think it was somewhat optimistic. Nobody can say what the position would have been, but my view is that it would be reasonable to assume an average of 1,500 sets per month over this 15 month period. That volume would have yielded total sales of 22,500 sets, with a gross profit of $810,000 and a net profit of $510,000.
Mr Conroy did not calculate the profits that would have been earned earlier than October 1991. But, if Arrow commenced to sustain damage before that date, some allowance should be made for this. I think it is reasonable to assume that, absent Futuris' breaches of duties, Arrow would have averaged 1,200 sets per month over the six months from 1 April to 30 September; that is 7,200 in all. Actual sales in this period were 3,055. So there was a loss of 4,150 sales, which would have yielded a gross profit of $149,400. Overhead costs were in fact incurred for five of the six months and should not be deducted from this figure. But $20,000 should be deducted because of overheads in September, making a net loss of $129,400.
The total of these lost profit figures is $639,400. But it would be excessive to take that sum as the measure of Arrow's damage. The calculation assumes a smooth trading road until the end of 1992, a period of some 22 months after the date when Futuris commenced to compete with Arrow. I have already mentioned the evidence about the commercial life of formulations. It seems that the brake pad industry is highly competitive. I think it probable that, if Arrow had been allowed to enjoy sales at Mr Conroy's projected volume and high gross profit rate, somebody else would have sought to enter the high performance aftermarket; perhaps Futuris selling pads made from a formulation other than 3410F, as it would have been entitled to do, perhaps another company. It would have taken some time for this competition to emerge and damage Arrow. But I think that any realistic assessment has to assume some loss of sales by Arrow before the end of 1992; and/or a reduction of price to ward off competitors. In a case where precision is impossible, I can do no more than say that I think it reasonable to reduce the figure of $639,400 to $500,000, a reduction of about 21%, to allow for the effect of likely competition towards the end of the period.
The calculation I have made allows nothing for loss of profits after the end of 1992. This may appear hard on Arrow. But I think it is impossible to say that Arrow would have suffered continuing loss by reason of Futuris' breaches after the end of 1992. Formulation 3410F was a short-life product in a highly competitive industry. By 1993 it may well have been overtaken by competitors.
In making the above assessment, I have not overlooked the fact that, after the termination of its dealings with Futuris, Arrow entered into a relationship with another brake pad supplier, National Brake and Clutch ("NBC"). This company was referred to in Arrow's circular letter of 15 November 1991. Apparently, it was then supplying some pads to Arrow. But it was not until September 1992 that Arrow and NBC entered into a formal agreement. In an affidavit sworn in March 1993, Mr Conroy said that Arrow's promotion of the NBC brake pad "is still in the early stages". There is no evidence that Arrow made any profit, before the end of 1992, out of trading in pads supplied by NBC. In the absence of such evidence, it would be inappropriate to make any deduction from the amount of damages otherwise payable on account of the NBC relationship. Counsel for Futuris did not submit otherwise.
Having regard to the whole of the relevant material, it seems to me fair to assess the damages payable to Arrow on its Cross-claim at $500,000. Interest should be allowed on that sum, but it would be pretentious to calculate the amount payable in respect of each month. The assessment of damages cannot be so precise. The loss suffered by Arrow would have been sustained from month to month during the period April 1991 to December 1992. I think it would be fair to allow interest on the full amount for fifteen months. Having regard to commercial interest rates over the last fifteen months, I will allow interest at 12%; that is $75,000.
In the result Arrow is entitled to recover judgment on its Cross-claim in the sum of $575,000.
Futuris' claim for goods sold and delivered
96. Counsel for Arrow accepted that, if his client was amended damages on the basis of lost sales, it should pay the moneys due to Futuris in respect of the pads it sold. I think this is correct. The assessment I have made assumes that Arrow bears the cost of acquiring the pads in relation to which profit is allowed. Arrow received most of the pads the subject of the claim for goods sold and delivered. It resold most of the received pads at a profit. Whether or not these pads were defective, and notwithstanding that over the relevant time the quality of the pads was inconsistent, Arrow turned most of them to profitable account. As counsel concedes, it is not entitled to decline payment for those pads.
However, not all the pads, the subject of Futuris' claim, were sold by Arrow. Mr Conroy gave evidence that Arrow still holds in its possession 581 sets, having an invoice value of $14,000 ($24 per set). In addition, it holds 108 sets of brake pads returned by customers, for which I presume it has allowed credit. He said that these sets have an invoice value of $6,122.76. But that represents an average of $56.70 per set; so I assume he was speaking of the invoice price to Arrow's customers. The appropriate figure is that charged to Arrow. I will take these pads into account at the same rate as for the unsold sets, that is at $24 per set or $2,602 in total. On this basis, I deduct $16,602 from the claim of $41,732 and conclude that Futuris is entitled to recover $25,130. Interest should be added to this sum. I will allow 12% for two years and add $6,031 for interest. I will enter judgment for Futuris, in connection with its claim for goods sold and delivered, in the sum of $31,161.
Arrow has succeeded on all aspects of the case except the claim for goods sold and delivered. It should have the benefit of a general order for costs. The claim for goods sold and delivered added virtually nothing to the work required to be done or the duration of the case. The amount awarded to Futuris was conceded by counsel for Arrow in his final submissions. It is appropriate that the order for costs be adjusted to recognise Futuris' success in obtaining a judgment on this claim. But the appropriate degree of adjustment is minimal. I propose to order Futuris to pay 95% of Arrow's costs.
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