HSIN CHONG CONSTRUCTION CO LTD v. YATON REALTY CO LTD

Construction List No. 3 of 1986

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HEADNOTE

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                On its true construction, S.30 of the Hong Kong Standard Form of Building Contract creates an effective retention fund in the hands of the employer, and the employer's right of recourse to it extends to the whole fund and not to a proportion of it. Henry Boot Building Ltd. v. Craydon hotel & Leisure Co. Ltd. 5th September 1985 (unreported) applied;  Re Arthur Sanders Ltd. 17 B.L.R. 125 not followed.

Construction List No. 3 of 1986

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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BETWEEN

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JUDGMENT

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1. This application raises an important point of construction under the 1976 edition of the Hong Kong Standard Form of Building Contract, Private Edition (with Quantities). It is whether clause 30 creates in the hands of the employer an effective retention fund in relation to what was called, in argument, the nominated sub-contractor's proportion of the fund.

2. The plaintiff main contractor contends that in relation to these moneys, the retention fund is effective in his hand only. The employer must first accumulate the moneys in a trust account. Then when each moiety is released by certificate, the employer must pay such moiety to the main contractor without any deduction. The only party entitled to exercise any rights of deduction or set off against any particular nominated sub-contractor is the main contractor himself. This conclusion, the plaintiff contends, follows from the decision of Nourse J. in Re: Arthur Sanders Ltd.⁽¹⁾ which I am invited to follow and apply.

3. The defendant employer contends on the other hand that the clause 30 creates a single indivisible fund. The initial obligation to set aside and accumulate in the trust account was not disputed see Concorde Construction Co. Ltd. v. Colgan Co. Ltd.⁽²⁾. But in the same way that each moiety of the whole fund on release becomes due and payable to the main contractor; so the employer can resort to the whole fund and not only to a part, to recover by deduction moneys recoverable by the employer from the main contractor. The employer relies particularly upon the decision of the Court of Appeal in England in Henry Boot Building Ltd. v. The Croydon Hotel & Leisure Co. Ltd.⁽³⁾ where Nourse L.J. gave leading judgment and invites me not to follow that learned judge's reasoning in his earlier decision.

4. The point is illustrated by the basic facts which gave rise to this application. The material building contract, which related to a property in the King's Road, was entered into on 1st May 1982. The contract date for completion was 22nd June 1983. The architect certified that the contract was in fact practically completed on 11th June 1984, and under clause 22, that it ought to have been completed on 31st August 1983. This certificate left $7,740,000 payable in liquidated damages by the main contractor to the employer. The architect also issued a certificate under clause 27(c) entitling the employer to make, and to deduct as against the main contractor, a direct payment to a particular nominated sub-contractor in the sum of $1,324,123.38. The total sum covered by these two certificates was $9,064,123.38.

5. Between 24th of April and 19th of June 1984, by Certificates No. 23, 24 and 25, the architect certified the following sums as payable by employer to main contractor: -

6. The breakdown of the figures for retention moneys shows the following: -

7. The plaintiff gave notice of arbitration on 11th June 1984. It also asked for the total retention moneys to be placed in a trust account. The defendant only paid $20,048.17 into such an account. This amount was arrived at after deducting from the total of the sums certified and retained of $9,084,171.55, the total of the two architect's certificates, namely $9,064,123.38. The plaintiff took no further action then. In April 1985, Mr Alexander Hamilton was appointed arbitrator. The matter is proceeding and the hearing is due to commence in May 1987.

8. On 26th August 1986, the plaintiff applied to the court for a mandatory order requiring the defendant (in effect) to place the total retention moneys, i.e. $5,950,022.94 in a trust account. In the face, I apprehend, of the authority of the decision in Henry Boot⁽³⁾, the application was not pursued in respect of $2.305m, it being conceded that the architect's certificates under clause 22 and 27(c) entitled the defendant to deduct as against what was called the main contractor's proportion of the retention fund. It was pursued in  respect of $3,64m and what was called the nominated Sub-contractor's proportion of theafund. The crucial question which therefore arose was whether the defendant was entitled to maintain its deduction against that portion of the retention moneys also. I have set out these figures because they demonstrate the issue of principle which arises and enable me to pass over subsequent changes.

 

The appendix provided:-

"Percentage of certified value retained - 10% Limit of retention fund - HK$2,305,000 plus the retention fund held in respect of nominated sub-contractors. "

9. To put clause 30 in context, the other provisions of the contract which have to be noted are: -

10. The form of sub-contract used was that designated for use with the main contract. Its material equivalent provisions were :-

11(h) "The main contractor's interest in the Retention Money, whether it is included in the amounts retained by the Employer under the Main Contract and held by him or whether it is held by the Main Contractor, is fiduciary as trustee for the sub-Contractor (without obligation to invest) and if the Main Contractor attempts or purports to mortgage or otherwise charge such interest or his interest in the whole of the amount retained as aforesaid (otherwise than by floating charge if the main Contractor is a limited company), the main Contractor shall thereupon immediately set aside and become a trustee for the Sub-Contractor of a sum equivalent to the Retention Money and shall pay the same to the Sub-Contractor on demand; .......... "

 

13 "The Main Contractor shall notwithstanding anything in this Sub-Contract be entitled to deduct from or set off against any money due from him to the Sub-Contractor (including any Retention Money) any sum or sums which the Sub-Contractor is liable to pay to the Main Contractor under this Sub-Contract. "

11. The English forms of contract and sub-contract in use at least up to 1985 are indistinguishable from ours, so the English authorities are directly in point. The employer did not seek to question the conclusion of Vinelott J. in Rayack v. Lampeter⁽⁴⁾, that clause 30(4) imposed an obligation "to appropriate and set aside as a separate trust fund a sum equal to that part of the sum certified in any interim certificate as due in respect of work completed which the employer is entitled to retain". What is in issue is the circumstances in which such obligation ceases. The Henry Boot⁽³⁾ decision shows that the obligation ceases if a clause 22 certificate exists for a sum in liquidated damages exceeding the retention moneys. Such a certificate binds the parties unless and until it is set aside by an arbitrator. The employer can "have recourse" to the fund for this sum. In these circumstances : "There is no subsisting obligation on the defendant (employer) to appropriate and set aside a trust fund under clause 30(4)(a) or, in other words, that the defendant cannot at present be joint with the plaintiff (main contractor) in the relationship of trustee and beneficiary. At the most their relationship is ........ that of debtor and creditor." per Nourse L. J.

12. No attempt seems to have been made in argument in Henry Boot⁽³⁾ to split the retention fund or to draw the distinction sought to be drawn here between two portions of it. This, the employer asserts is because such a distinction is not valid. I think there is very considerable force in this submission that a split or division of the fund would run counter to the rationale of privity created by the contract. Clause 30(3) creates a single fund of 10% up to a stated limit. The fact that that limit is arrived at by adding two different figures together does not create two funds. The main contract carefully creates privity only between its parties and not between the employer and any nominated sub-contractor, C1 27(f). The main contractor assumes the total burden of the job, and correspondingly has the right to receive all certified payments. It is common place, as the figures here show, for the greater proportion of the work to be performed for the main contractor by nominated sub-contractors. It is therefore more than likely, and on occasion, obvious, that nominated sub-contractors have caused or occasioned particular defects or delays of which the employer complains. But the contract throws responsibility solely upon the main contractor; e.g. for non-compliance with instructions and for any financial consequences under clause 2(1) and for delay under clause 22. If responsibility is single, there is no apparent reason for apportionment in relation to retention moneys intended to ensure the discharge of such responsibility, and no basis on which it can sensibly be done. The plaintiff's contention that in face of proven default by a nominated sub-contractor, the employer can only deduct against the main contractor's proportion and must pay the balance over to the main contractor would produce the most bizarre and uneven results. The employer is I think, right in asserting that the court should hesitate before attributing such "an improbable and unbusinesslike intention" to the parties in the words of Lord Bridge in Mitsui Construction Co. Ltd. v. The Attorney General of Hong Kong, Privy Council Appeal No. 57 of 1984, p. 9 (unreported).

13. I turn to the reasoning of Nourse J. in Re : Arthur Sanders⁽¹⁾ upon which the plaintiff founds. He concluded first that a sub-contract in the form before me took effect "as an assignment to the sub-contractor, made with the authority and with the knowledge of the employer, of a due proportion of the contractor's beneficial interest in the retention moneys under clause 30(4)(a) of the main contractor ..... In other words, the position as between employer, contractor and sub-contractor under the present RIBA conditions and the FASS sub-contract is that the employer holds a due proportion of the retention on trust for the contractor as trustee for the sub-contractor" pps. 138-9. In argument it was not asserted that this was not the combined effect of the two contracts. What was challenged was the judge's apparent conclusion on page 140 that this resulted solely from the sub-contract:

"It is not the main contract or anything contained in it which renders the employer liable to the sub-contractor. "

I agree with this criticism as it seems to me that clause 30(4) plays an essential role. This does not seem to me to answer the argument based upon clause 27(f).

14. There was no clause 22 or other certificate in that case. But the crucial reasoning in the judgment which led the judge to deny the employer any right of deduction, which starts on p. 139, may be said to operate independently of any such certificate. The passage reads:

"In my judgment once a sub-contract has been entered into, the contractor no longer has a beneficial interest in the sub-contractor's due proportion of the retention. At that stage, his only interest in that proportion is as a trustee for the sub-contractor, a state of affairs for which express provision is made in both clause 27(a)(viii) of the RIBA conditions and clause 11(h) of the FASS Sub-contract, Secondly once that stage is reached, I do not see how the proportion in question can really be said to be "due" to the contractor at all. It may strictly still be payable to him under the terms of the main contract, but he must immediately pay it over under the sub-contract. "

15. I regret that I do not find this passage persuasive and am unable to follow it. Nowhere in his judgment does the learned judge refer to clause 13 of the sub-contract. This, I regard as a crucial provision. It affords the main contractor aright of "deduction or set-off" more widely framed than the right of recourse in clause 30(4). He is by no means a bare trustee : once whose "only interest ....... is as a trustee". The practical importance of this right was emphasised by the plaintiff in argument. It is one of the main reasons and justifications for the pursuit of the application in relation to the $3.645m despite its abandonment in relation to the $2.305m, and the right is relied upon to give the plaintiff locus. But unlike the present application, this right was not directly relevant to the position in Arthur Sanders⁽¹⁾, and I cannot believe that Nourse J. had his attention directed to it.

16. I take the second point first. The phrase "any sum due or to become due to the main contractor" is almost a term of art in this contract. It simply covers all certified payments payable to the main contractor. I do not see how its meaning can be affected by any equitable assignment. To say that the assignor, main contractor, "must immediately pay it over" seems to me with respect wrong. It ignores the provisions of clause 13 subject to which the assignment was made.

17. The first point seems to me to fail for the same reason. The retention trust fund has to be held by the employer as trustee until such time as each moiety is released by the issue of the certificates specified in (b) and (c). Each moiety then becomes payable by the employer only to the main contractor. As its initial recipient, the main contractor has an interest in the whole fund. The interest in "his" part is admittedly beneficial. But although he may hold other portions as trustee for particular nominated sub-contractors, in no case is he simply a bare trustee. Clause 13 gives him the right to retain or set-off for his own benefit. I therefore conclude that for the purposes of clause 30(4), the main contractor has a "beneficial interest" in the whole retention fund.

18. Accordingly in my judgment, the employer's right of recourse under clause 30(4) extends to the whole retention fund, and no valid distinction can be drawn between the main contractors and the nominated sub-contractor's proportions of it. Such recourse may be based upon a right to deduct arising under any term of the contract, e.g. clauses 2(1); 19(1)(c); 22 or 27(c). In each case the effect is the same. Up to the total amount of the permitted deduction, the employer's obligation to set aside ceases; as does pro tan to the relationship of trustee and beneficiary. The trust continues to apply only to the balance if any. I desire to reserve for further consideration the effect of section 25(d) on the employer's obligation, because for my part I cannot reconcile the wording of this clause with any continuing obligation "to appropriate and set aside". This view was, if anything, confirmed by specimen calculations submitted by the plaintiff in argument.

19. In my judgment therefore, this application fails and must be dismissed. It is therefore not necessary to deal with the other interesting points raised by both parties in their most careful and helpful arguments.

(1) [1981] 17 B.L.R. 125
(2) [1984] 29 B.L.R. 120
(3) 5th September 1985 (unreported)
(4) [1979] 12 B.L.R. 30, 37