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Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
Hot & Spicy BBQ
Tracy Allen
General Information
Charmaster, Inc. is a manufacturer of barbecue grills which it sells worldwide to large home appliance retailers who then sell them to residential customers. It has several production plants, including one in Lusitania and one in Malajistan. In order to produce the grills, Charmaster has created several contractual relationships with many international and local suppliers who mass-produce various components for the grills. One such relationship was with a Danish company known as Heatco. Heatco produces the aluminium heat coil that is the source of the heat distribution system in the grills.
Two years ago, the Heatco-Charmaster contract was coming to an end. Charmaster decided to put the contract out for tender. Heatco submitted a new proposal that included a large price increase that Charmaster had not anticipated. While Charmaster was mostly satisfied with its relationship with Heatco and the quality of its coils, the 15% price increase per unit was unacceptable to Charmaster. Previously the average price per coil that Heatco charged Charmaster was US$100.
Charmaster reviewed three other tenders and elected to enter into negotiations with an international supplier based in Malajistan known as Ductoheat, Inc. Charmaster selected Ductoheat for several reasons, including its close proximity to Charmaster’s own Malajistan plant which would result in much lower transport costs and high probability that parts would arrive with less damage due to the shorter transport distance. In addition, Charmaster could improve its business presence and stature in the Malajistan market by working with a local business. Ductoheat was quoting a price per coil of US$105.
Knowing that it was likely to lose the tender, Heatco became less responsive to Charmaster’s quality and delivery requirements with the heating coils so Charmaster became anxious to complete the negotiations with Ductoheat. Further, after the Heatco written contract expired, Heatco was still willing to provide coils but only at the higher price of US$115 per coil. Charmaster was forced to pay the higher price for the Heatco coils because it was their only source for the coils at the time, pending the commencement of a new contract.
The Charmaster-Ductoheat negotiations took several weeks and were somewhat difficult, partly due to geography and language barriers. The Charmaster production manager was located in Lusitania and the top production representative for Ductoheat was living in Geneva. These party representatives made one trip to Malajistan where they each visited the other’s plant and held two days of face-to-face negotiations with each company’s chief financial officer and quality manager. These discussions resulted in agreement on many of the key terms of the relationship; however there remained some unresolved issues. These included Charmaster’s confidentiality terms that would bind Ductoheat to protect the trademark and proprietary aspects of the coil design required for the grills; how and when Ductoheat would get Charmaster’s engineering designs for the coils and what language(s) they would be written in; and whether Charmaster would actually deliver manufacturing moulds to Ductoheat at locations other than Ductoheat’s Malajistan plant.
After the meeting in Malajistan, various e-mails were exchanged between the two production representatives regarding these miscellaneous issues. There were also three conference calls in which all the people who met in Malajistan participated, as well as their respective in-house legal representatives. Thereafter, the in-house lawyers for both companies exchanged various drafts (in English) of the proposed written agreement.
Believing that the agreement was ready to be signed, Charmaster stopped placing orders with Heatco. Heatco returned the moulds to Charmaster at its own expense in accordance with their existing agreement. At the time, Charmaster had a stock of coils that would last approximately two months; however, due to increased seasonal demands in Lusitania and Europe, Charmaster anticipated placing a very large first order with Ductoheat that would provide coils for its busiest time in its annual production.
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Charmaster sent a purchase order to Ductoheat for 500,000 coils to be delivered to the Malajistan plant and 500,000 coils to be delivered to the Lusitania plant. Simultaneously, the head of Charmaster’s engineering department sent its heat coil engineering designs to Geneva and directed its production manager at the Malajistan plant to deliver Charmaster’s aluminium heat coil production moulds to Ductoheat’s Malajistan plant. It was assumed by Charmaster that Ductoheat would manufacture all the coils in Malajistan and ship the 500,000 Lusitania coils to Charmaster’s Lusitania plant.
Ductoheat did not begin production upon receiving the purchase order, in part because the written agreement had not been signed by either party. In addition, Ductoheat was not willing to manufacture the coils for the Lusitania order in Malajistan. This was due, in part, to the fact that Ductoheat felt it could not ensure the coil quality could be maintained while shipping the coils all the way to Lusitania. Further, Ductoheat had not factored such shipping costs (US$5 per coil to ship to Lusitania) into the original purchase price on which the parties had agreed (US$105) at the onset of the negotiations.
It was not until nearly two weeks before they were expecting delivery on their order that Charmaster realized Ductoheat had not started production. With only a 15-day supply of coils remaining, Charmaster made a business decision to terminate negotiations with Ductoheat and placed the same order with Heatco. Charmaster demanded return of the moulds but Ductoheat would not comply unless Charmaster made the arrangements to pick them up and pay for the cost of return, which Charmaster did.
Heatco was able to meet the demand. However, there were some delays in delivery of the coils and thus final production of the grills. This caused Charmaster to be late in meeting its contractual obligations to supply barbecue grills on time to two large retailers in Lusitania. As a result, Charmaster discounted the price of the grills to both retailers by 10%.
In the negotiations between Ductoheat and Charmaster, and in the last draft of the proposed agreement, the parties had agreed that they would first try to settle any disputes arising out of their relationship by mediation under the ICC Mediation Rules before submitting the dispute to arbitration pursuant to the ICC Arbitration Rules.
Charmaster has requested Ductoheat to mediate their dispute in the manner described in the last draft of the proposed agreement. Ductoheat has agreed. Charmaster has also sent a written demand to Ductoheat setting forth its damages (for purposes of the mediation only) as follows:
Persons present at the mediation include independent legal representatives for each party, neither of whom were part of the drafting negotiations or communications. Charmaster’s corporate representative is the Senior Executive Vice President of Charmaster who is also director of worldwide production. Ductoheat’s corporate representative is its President. Both parties have full settlement authority.
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Confidential Information for Charmaster
Requesting Party
This is one of the biggest mistakes Charmaster has ever made in its company’s history. The cost of the failed negotiation with Ductoheat is obviously millions of dollars. As a result, three senior production and engineering employees lost their employment with Charmaster. The company is facing production problems due to the terminations and the time it takes to interview, hire, train and educate their replacements. Charmaster now realizes it acted hastily in ending the negotiations with Ductoheat.
Further, Charmaster has once again sent out for tender the aluminium heating-coil contract because Heatco is too expensive. Ductoheat has a reputation for producing the best quality coils, which is one of the reasons Charmaster wanted to end its agreement with Heatco. There is now only one other competent, trustworthy coil manufacturer in the industry and it is based in Eporu — Recoil Eporu, Inc. Charmaster has no manufacturing presence in Eporu, although the price this supplier is quoting is attractive (US$113 per coil including all shipping to anywhere in the world). Nevertheless, Charmaster has no experience dealing with the governmental authorities or laws of Eporu and cannot presently evaluate whether that risk is worth the price differential that is being quoted by the Eporuan company.
Meanwhile, Charmaster is reluctant to make any promises to its retail customers because it fears delays in upcoming production. Charmaster does not want to discount its products again. The discount Charmaster gave to both customers was probably too high and maybe not even necessary, but the Charmaster decision-maker knew that the contracts with each customer were expiring soon. S/he knew they would be renegotiating the contracts with both retailers and s/he did not want to jeopardize their future relationships and business. Even so, Charmaster fears Martwal and Rejeim’s will enter into contracts with a different, competing barbecue grill manufacturer. If Charmaster has to make a price adjustment to keep the business, this will add to the damages it will seek against Ductoheat if the parties do not reach a mediated settlement agreement. If Charmaster loses Martwal or Rejeim’s as a customer, it intends to blame Ductoheat for that loss. Charmaster speculates that such loss could be up to US$1 million per year for each customer over what is normally a five-year contractual relationship with each retailer. Time is obviously of the essence to Charmaster.
Charmaster’s general counsel commenced an internal investigation with its legal staff at Charmaster to find out who was involved with and responsible for terminating negotiations with Ductoheat. In addition, counsel reviewed the series of events that caused the engineering department to prematurely send the engineering designs and moulds to Ductoheat.
The legal staff advises that it believed all the material terms of the agreement had been resolved and were included in the last draft of the proposed contract. This draft included the agreed-upon price per coil, the delivery date requirements, the payment terms (US$, net 30 days from date of shipping), the production specifications, the quality standards, the proprietary protections for each company’s products, indemnification provisions in the event of third-party lawsuits as a result of a product defect, a dispute resolution clause and contract duration (two years).
Charmaster will assert that all the material terms of the contract were agreed upon and therefore Charmaster was reasonable in expecting Ductoheat to fully perform the terms of the agreement even if it had not been signed. The negotiations in Malajistan were very amicable as were the following discussions over the telephone and in e-mails. At the meeting in Malajistan, Ductoheat told Charmaster it had room in its facility to take delivery of the moulds as soon as possible and had engineers available to review the design plans. Ductoheat even hinted that with this big order it would likely hire some additional workers to timely fulfil Charmaster’s purchase order. In addition, Charmaster believes that its purchase order and the receipt of the designs and moulds by Ductoheat created a binding obligation on Ductoheat to produce the coils, due to part performance of the last proposed draft of the agreement by both parties.
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Charmaster relied to its detriment on the alleged agreement and is thus entitled to the resulting, foreseeable damages for Ductoheat’s failure to perform.
In reviewing the actions taken by the engineering department, Charmaster’s general counsel learned that the terminated employee who made the decision to send the moulds and engineering drawings to Ductoheat had not been authorized to do so. Further, once the purchase order had been sent to Ductoheat, the internal systems at Charmaster were automatically set up to stop the orders from going to Heatco. The engineering and production departments failed to make certain that Ductoheat was actually beginning production of the coils. Had anyone known or checked, they could have manually overridden the cancellation of orders to Heatco so as to keep Heatco coils coming to stock the inventory. This negligence is not known to Ductoheat but could be discovered if the dispute goes to arbitration, resulting in a reduction in damages for Charmaster even if it prevails on the legal arguments involving the existence of the parties’ agreement. However, it is important to note that it is most probable that Ductoheat will challenge the jurisdiction of the ICC arbitrators due to lack of a binding arbitration clause if the agreement is not enforceable.
The Charmaster production manager from Lusitania who attended the meeting in Malajistan and was doing most of the negotiations for Charmaster was the (now terminated) employee who made the decision to stop negotiations with Ductoheat. He was also the person who went back to Heatco and placed the orders at the increased price to keep Charmaster from breaching its agreements with the retail customers. He also agreed to pay for the costs of getting the moulds back from Ductoheat and shipping them back to Heatco. He had no authority to cease the negotiations and was thus terminated. Subsequent to his termination, Charmaster learned this employee had been using the company’s computer to conduct personal business, some of which is rather embarrassing to the employee and thus to the company. If forced to produce his e-mail communications, it would be damaging to both his and the company’s reputations. It is not likely he will be a good or credible witness for Charmaster in an arbitration proceeding.
As the director of worldwide production, your mission is to get this matter resolved and move on. You are concerned that Ductoheat will assert that the issue of paying for shipping coils is a customary, industry term to be negotiated. You will disagree with this proposition at mediation but, honestly, you are not clear what, if anything, was discussed in the negotiations about this topic nor if it is an industry standard. You are also suspicious of Ductoheat’s true intentions since you are aware that while the parties were negotiating, the price of steel and aluminium on the international market went up 12%. You wonder if this is the true reason Ductoheat failed to perform, as it would be too costly to use the same price Ductoheat originally quoted once the price of the metal had increased by 12%.
While its seems somewhat preposterous, if the Ductoheat representative is at all credible and reasonable, Charmaster would entertain initiation of a new negotiation with Ductoheat to produce the coils, provided Ductoheat paid Charmaster at least half of what it has lost to date.
In summary, you either need to reach agreement on a dollar figure Ductoheat will pay Charmaster, or negotiate a binding, signable agreement with Ductoheat to produce coils and agree on the monetary compensation Ductoheat will pay for the losses Charmaster has incurred to date. Your legal position is that:
Lastly, as a result of the above, Charmaster will also assert that Ductoheat is contractually bound to arbitrate the dispute.
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Confidential Information for Ductoheat
Responding Party
If this matter goes to arbitration and Charmaster is successful, an arbitration award against Ductoheat that exceeds US$15 million will destroy the company. Fortunately, Ductoheat has an insurance policy that provides some funds (US$10 million) to cover liability if it loses the arbitration. The insurance carrier has agreed that these funds can be used to resolve the dispute with Charmaster but only if Charmaster gives Ductoheat a full release and agrees not to pursue any further claims against Ductoheat for breach of the alleged agreement.
Ductoheat has heard that Charmaster has issued a further request for tenders and that Charmaster does not like Heatco’s price. Ductoheat wanted to submit another tender but feels that the request for mediation is a sign that Charmaster has no intention of ever doing business with Ductoheat again. Ductoheat could produce coils at a cost of US$105 per unit but only if they are all made in Malajistan and only if the parties can work out the shipping costs to the Lusitania plant.
Originally, when the parties were negotiating, this added cost was not raised by Ductoheat and it did not come to its attention until the final round of the negotiations. This cost added US$5 per unit to the coils being sent to Lusitania and Ductoheat could not afford the US$2.5 million (500,000 x US$5) additional costs associated with shipping coils to Lusitania. As a result, Ductoheat did not begin production and was too embarrassed to admit its mathematical/ accounting error. Thus, Ductoheat’s in-house legal counsel made several overreaching demands on Charmaster to include this sum in the price, raising the price per coil for all coils from US$105 to US$110 (instead of arguing only about a US$5 per coil rise in price for the coils being shipped to Lusitania). Ductoheat’s legal counsel argued that this sum was implied all along and that while it may have been an unspoken matter, it was well known in the industry that shipping costs are always added to the agreed upon base price. Charmaster disagrees that this is an industry standard.
In addition, during the time the parties were negotiating the agreement, the price of steel and aluminium on the international market went up 12%. In the initial response to Charmaster’s request for tenders, Ductoheat quoted a price to Charmaster of US$105 per coil. The increased price of aluminium was cutting into the 9% profit margin Ductoheat had anticipated in its contract with Charmaster. When working out the new price of aluminium and steel, Ductoheat’s margin dropped to 3%, and that margin was assuming Charmaster would pay all the shipping costs to the Lusitania.
Ductoheat realizes that the material terms of the agreement had been agreed upon and reduced to a writing acceptable to both parties with only a few unresolved issues. Ductoheat’s representative at the meeting in Malajistan even told Charmaster it intended to hire more workers to fulfil the contractual needs and had room in the facility and was ready to receive delivery of the moulds as soon as possible. The parties had agreed to the price per coil, the delivery date requirements, the payment terms (US$, net 30 days from date of shipping), the production specifications, the quality standards, the proprietary and confidentiality protections for each company’s products, indemnification provisions in the event of third-party lawsuits as a result of a product defect, dispute resolution clause and contract duration (two years). It is more probable than not that if this dispute is forced into arbitration, the arbitrators will find that an agreement had been reached; however, since the agreement was not signed,
Ductoheat will challenge the jurisdiction of the ICC arbitrators. Depending on who (arbitrators or court) is the legal body that determines jurisdictional challenges, there could be a judicial proceeding that could be very costly and time-consuming for both parties. Consequently, Ductoheat’s best legal position is to challenge the damages Charmaster asserts it incurred as a result of the breach of the agreement.
Ductoheat can argue that the discounts Charmaster gave to its customers are not a foreseeable or direct consequence of a breach of the agreement. Further, Charmaster had a
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duty to mitigate its loss. By merely going back to Heatco and paying its price, Charmaster did not properly mitigate. It should have investigated other coil suppliers, including Ductoheat’s biggest competitor, a company in Eporu known as Recoil Eporu, Inc. Lastly, Ductoheat has a weak but presentable argument that the increased price in steel and aluminium made it impossible to perform the agreement and therefore either party should be able to rescind the agreement without liability or damages. The problem with this assertion, however, is that everyone in the industry knows that price fluctuations are common practice and only the less experienced manufacturers fail to build the probability of a price differential into their quotes. In this case, the person at Ductoheat who quoted the original price was inexperienced and did not factor the changing price of supplies or the shipping costs into the price Ductoheat quoted. This negligence would have to be revealed to Charmaster in the pre-hearing stages of any arbitration and thus become part of the evidence Charmaster could use against Ductoheat if the case goes to arbitration or court adjudication. While the arbitration process is confidential, the embarrassment to Ductoheat, even if it wins the arbitration, is politically and culturally unacceptable.
The biggest issue for Ductoheat is whether there is any prospect of entering into a new agreement with Charmaster. It appears all the parts of an agreement are suitable to both parties except a new price per coil and the shipping costs to send coils to Lusitania. Ductoheat is also satisfied with the confidentiality provisions and protections Charmaster requested as set forth in the final draft of the agreement the parties exchanged. Ductoheat would like Charmaster to pay for the cost of delivering moulds to Ductoheat’s plant but that is a negotiable item. Ductoheat’s flexibility on the allocation of shipping costs of coils and costs for delivery of moulds is highly dependent on how much Charmaster expects Ductoheat to pay to settle the dispute.
In summary, Ductoheat needs to agree with Charmaster on the terms of a binding, enforceable agreement with a release provision in order to obtain the insurance funds to help pay whatever damage figure Ductoheat will pay to Charmaster. Obviously the damage figure could be much lower if the parties are able to negotiate an actual contract that would be binding and enforceable for Ductoheat to produce coils. Your legal position is that:
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Colin J Wall
Case Analysis
This role-play covers the all-too-common scenario of parties entering into an international agreement before all terms and conditions are finally agreed, either by way of a letter of intent, or, as in this particular case, an unsigned contract. This raises the very real issue as to whether the contract was actually concluded and whether or not the arbitration agreement is valid, and exerts pressure on the parties to try and find a business solution and settle the dispute in mediation, notwithstanding the lack of trust and a considerable information gap.
This mediation is intricately linked to the legal issues and the facts that surround the dispute and it might be necessary to explore these matters in some detail with the mediator and lawyers of each party, so each decision-maker has a better understanding of what the no-agreement alternative is before attempting to put these matters to one side and concentrate on the true business interests of the parties.
In addition to the concern that the arbitration agreement might be invalid, neither party actually wishes to arbitrate the dispute for a variety of reasons. Fictitious countries are used in this role-play but there is an underlying assumption that the procedural law governing the arbitration and the disputed contract itself is based on common law because of the concern each party has about discovery and the disclosure of embarrassing documents. It may be helpful to let students, particularly those from a civil-law background, know of this assumption.
The role-play is likely to lead each of the lawyers and decision-makers to conclude that the parties are diametrically opposed on all the major legal issues. The resultant impasse should lead the way to the mediator and/or the parties agreeing to put the legal considerations to one side for the purposes of the mediation and concentrate on the wider business issues. At some stage it will be necessary for the parties to enter into discussions relating to the amount of compensation that Ductoheat will pay to Charmaster. This should lead to caucuses with the mediator and provide the opportunity to be creative in how and when the financial compensation is paid.
Although there is a considerable amount of distrust in this dispute, neither decision-maker was involved in the negotiations which led to the dispute and both can therefore be somewhat objective. Ultimately each party really needs to put the present dispute behind them and to enter into a new and clear contract which will have mutual benefits. Again, the mediator should be able to assist the parties in achieving this objective, perhaps by conditionally linking the various strands of the wants and needs of the parties together. This might lead to the discussion on financial compensation being the last matter to be resolved in the mediation.
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Greg Bond
Commentary for Training
When and What to Disclose?
In this case, neither party can afford to take the matter to arbitration. Each has an interest in not having their clumsy and embarrassing business procedures come to light, and neither wants the uncertainty of fighting a case in which the dispute would begin by one party — Ductoheat — contesting the jurisdiction of the arbitrators. Each has business interests that need to be resolved imminently and that arbitration cannot address. Charmaster is still looking for a supplier. Ductoheat needs a release from claims and faces serious financial problems if a damages claim succeeds. In other words, both parties have weak alternatives to a mediated settlement. Moreover, a mediated settlement here can do more than just settle Charmaster’s claim for damages. It has the potential for a new business deal.
For mediation training, this raises several options. In preparation for the mediation simulation, the trainer can encourage the parties to consider what information to disclose when, particularly concerning the opportunity for a new deal. Is it better to fight the damages claim first, and see if there is any chance of moving forward if there are signs of goodwill at this stage? Or would one of the parties be advised to risk stating straight out that they are interested in a new sales contract? This may enable them to work out the damages claim more easily. And if they do manage to discuss new business, there should probably be exchange on how to ensure better communication and a much clearer understanding of what has been agreed. The two companies’ lawyers will want to back up claims for damages, on the one hand, and the refusal to accept arbitration, on the other, and these statements can be made firmly. But once this has been said, it is in both parties’ interest to talk business and to explore options beyond settlement.
The mediator has a number of options too. Most training programmes teach caucus and shuttle mediation, while some do not. In this case, a series of caucuses might be a way for the mediator to hear that in fact both parties have a future deal in mind, and be able — with the parties’ permission — to make that mutually known. A trainer may wish to try this both ways: how can the mediator help the parties explore whether they can move beyond the damages claim, both with and without using caucus? To work on this without caucus, a mediator can help the parties to recap what the original intention was in Charmaster and Ductoheat doing business with each other. If they respond well to this, it should be possible to talk about whether those business interests are still relevant. If the trainer has parallel groups working on the same case, debriefing and feedback could be fruitful if one role-play uses caucus and the other does not.
If the parties do move on to talk business, the mediator can help them secure a sales deal by inviting them to reflect on what went wrong first time around. This may be done in a new mediation session — first giving the parties the time to do some work on the business parameters of the offers they may wish to make. By helping the parties to jointly identify past mistakes and not lose face in the process, the mediator can see these mistakes translated into future options. There are ways to factor some kind of compensation for Charmaster into a new deal, particularly as Ductoheat has a considerable insurance sum at its disposal. It would not be advisable for Ductoheat to reveal this too early, and they may not need to disclose this to Charmaster at all. Nonetheless, it makes a deal easier, and Ductoheat may wish to inform the mediator in caucus, with the aim of achieving settlement and perhaps even future collaboration.
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