HONG KONG HOUSING SOCIETY v. BANK OF CHINA GROUP INSURANCE CO. LTD.

HCCT103/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CONSTRUCTION AND ARBITRATION PROCEEDINGS

NO.103 OF 1999

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D E C I S I O N

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1. The issue in this summons relates solely to the payment of interest. The brief background is as follows. The defendant is a bondsman who was party to a bond in the sum of $39,880,000 payable to the plaintiff on proof of breach and damage by a contractor Hing Lee Construction Co. It is agreed between the parties that it is a "conditional" and not an "on demand" bond.

2. On 23 March 1998, the plaintiff gave Hing Lee notice of default.

3. On 29 September 1998, the plaintiff through an agent gave the defendant notice of the damages incurred as a result of Hing Lee's default.

4. On 13 September 1999, the plaintiff served on the plaintiff notice of default of Hing Lee and set out the damages which were in excess of the bonded sum by a considerable amount and demanded the bonded sum.

5. On 16 October 1999, a writ and Statement of Claim were served.

6. On 19 July 2001, the defendant admitted liability under the bond and on 8 August 2001 paid the bonded sum to the plaintiff.

7. The parties disagree about when interest starts to run on the sum of $39,880,000.

8. The defendant's argument is that as this is a conditional bond the liability to pay the bonded sum does not arise until there has been proof of breach and damages. In this case, it is accepted that the obligation to pay dates from the date of their admission and agreement to pay. Interest, it is said, should run from that date. Interest cannot start to run from a date which precedes the commencement of liability. Mr Peter Graham, counsel for the defendant cites Trafalgar House Construction (Regions) Ltd v. General Surety and Guarantee Co. Ltd [1995] 3 All ER at p.743 (per Lord Jauncey) :

"No distinction can, in my view, properly be drawn between the effect of this bond minus the second part of the condition and the bond considered by Lord Atkin in the Workington case and other bonds using this or similar wording which have for many years been generally treated as guarantees (see Hudson's Building and Engineering Contracts (11th edn, 1995) vol 2, pp 1499-1500, para 17-007). Thus in a second action arising out of the bond in the Workington case, Workington Harbour and Dock Board v Trade Indemnity Co Ltd (No 2) [1938] 2 All ER 101 at 105 Lord Atkin said :

'My Lords, both actions [that is the first and second actions] were brought on the money bond. It is well established that in such an action the plaintiff has to establish damages occasioned by the breach or breaches of the conditions, and, if he succeeds, he recovers judgment on the whole amount of the bond, but can only issue execution for the amount of the damages proved.'

This dictum makes it clear beyond doubt that proof of damage and not mere assertion thereof is required before liability under such a bond arises."

9. In my judgment, this case and others cited (including Kono Insurance Co. Ltd v. Tins Industrial Co. Ltd [1987] 3 HKC 71 and Dragages & Travaux Publics (HK) Ltd v. Citystate Insurance Ltd [2001] 1 HKC 196) are clear authority as to what constitutes a "conditional" bond as opposed to an "on demand" bond and what conditions have to be satisfied before a bondsman is obliged to pay. They are not authorities as to when interest on the bonded sum should start to run.

10. If Mr Graham is right and interest starts to run from the date of proof of breach and damage, namely, either as a result of an admission by the defendant or because of a judgment in favour of the plaintiff, there would be two consequences, both of which weaken his argument. Firstly, it would encourage deliberate delays in payment. Even if the plaintiff had overwhelming evidence of breach and damage it would be open to the defendant to proceed as slowly as possible to judgement and only then would interest start to run. It might be said they would suffer in costs at the end of the day but where, as in this case, the cost of interest alone exceeds $3 million per year, avoiding such a liability by deliberate delay might be tempting. Such a criticism cannot be made against this defendant because they admitted liability in July 2001.

11. Secondly, if liability in the strict sense arises only on proof of breach and damage, it is arguable that the plaintiff's cause of action only stems from that liability. That would be wholly illogical. It is not argued in this case that the plaintiff had no cause of action until the liability arose. A defence to the Statement of Claim was served. It did not dispute a cause of action, neither has there been a summons to strike out.

12. In my judgment herein lies the real flaw in the defendant's argument. The plaintiff's submission commends itself to commercial sense. The bondsman does not have to pay until a condition is satisfied. Once that condition is satisfied it establishes : (a) that payment must be made and (b) the validity of the cause of action. The validity of the cause of action depends on (i) the proper notice of demand having been made and (ii) the existence of proper evidence in support. The defendant's admission that the bonded sum is payable can only be construed as an admission that the demand was valid at the time it was made.

13. Mr Peter Clayton, counsel for the plaintiff, further submits, in my judgment correctly, that, the performance bond operates as a contract of guarantee. The authorities cited support this. Particularly the Trafalgar House case which was successfully appealed to the House of Lords on this point. He cites also from Rowlatt on Principal & Surety [5th edition].

"10. When the Liability of the Surety becomes Enforceable

General rule

The common expressions (accurate enough in their true sense) that a surety 'is only liable on default of the principal,' or 'only promises to pay if he does not,' must not be construed to convey that there must, before the surety becomes liable, be any demand and refusal between the parties of the principal contract, or any final failure to pay on the part of the principal debtor. When the subject-matter of the guarantee is conduct, some breach of duty by the principal causing damage to the holder of the guarantee must, of course, arise before there is anything which the surety can be called upon to make good. But as soon as a breach is committed of the duty performance of which is guaranteed, or in the case of a debt that day of payment arrives, the default of the principal is complete, and every surety is, apart from any term to the contrary, immediately liable to the full extent of his obligation, without being entitled to require notice of the default."

14. In the case of a performance bond there is the additional requirement that the bondsman must be informed of the default. Once he is informed, the existence of the liability is established subject to the condition of proof. Once the condition is satisfied payment becomes due.

15. In a nutshell, the only sensible conclusion to draw from all this is that although the obligation to pay is only triggered by the proof of breach and damage, once it is proved, it has the effect of recognizing that the liability under the bond existed since the notice of default. The liability has to be met upon proof of breach and damage but interest must run from the date of the service of notice of default.

16. Thus, interest does not start to run from the date of proof of breach and damage. But, when does it start to run from? The plaintiff, puts forward three alternative dates in this case.

17. Firstly, in the amended Statement of Claim it relies on 13 September 1999, the date of its letter of notice of default on the defendant claiming payment of the bonded sum.

18. Secondly, the date of the claim by writ, which was about a month later, 16 October 1999.

19. Thirdly, on the morning of the hearing of this summons, Mr Clayton applied to amend his summons to claim an earlier date, namely 29 September 1998. On that date the plaintiff had submitted to the defendant's agents (a firm of loss adjusters) a "calculation of estimated damages" which was substantially in excess of the bonded sum. The application to amend the summons was granted, albeit opposed by Mr Graham.

20. The issue of the proper date from which interest should run turns on the adequacy of the notice of default. In this case I have decided the appropriate date is 13 September 1999, the date of formal notice to the defendant. In so doing I make no judgment on the adequacy or otherwise of the form of the notice of 29 September 1998. I reject it solely on the basis that the application to amend came so late. It is true that Mr Graham had some notice of it and was able to deal with it in his written submissions. However the date of 13 September 1999 was the date originally chosen by the plaintiff in its Statement of Claim, it was not amended in its amended Statement of Claim, it is the date of formal notification and it so remained until the 11th hour.

21. In all these circumstances interest at prime plus 1% shall be payable on $39,880,000 from 13 September 1999. The solicitors for both parties have kindly agreed to calculate the sum involved. I therefore give liberty to restore.

22. As to costs, the parties agree that the plaintiff has party and party costs of the action. I further make a costs order nisi that the costs of and incidental to the application for interest be to the plaintiff save that the costs of the application to amend the summons to seek interest from 29 September 1998 be to the defendant in any event.