LAW TING PONG SECONDARY SCHOOL v. CHEN WAI WAH

CACV 517/2019

[2021] HKCA 873

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 517 OF 2019

(ON APPEAL FROM HCLA NO 22 OF 2018)

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J U D G M E N T

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Hon Lam VP:

1.  I have read the draft judgment of Chu JA. I agree that for the reasons given by her the appeal should be allowed and the judgment entered against the Defendant be restored.

2.  I would only add a few words of my own on the penalty point. First, I agree that this Court should adopt the modern approach as discussed by Supreme Court of the United Kingdom in Cavendish Square Holdings v Makdessi [2016] AC 1172.  In two previous decisions, this Court had already embraced a broad and flexible approach in determining if a clause is a penalty: Ip Ming Kin v Wong Siu Lan CACV 201/2012, 28.5.2013 at [60] and Brio Electronic Commerce Ltd v Tradelink Electronic Commerce Ltd CACV 271/2013, 5.5.2016 at [16] to [17].  The breakthrough in Makdessi was that the inquiry is no longer subject to what Lord Neuberger PSC and Lord Sumption JSC characterized as the unsatisfactory distinction between a penalty and genuine pre-estimate of loss originated from the over-literal reading of the tests of Lord Dunedin in the Dunlop case.

3.  The rationale for such breakthrough was set out at [31] in Cavendish Square Holdings v Makdessi, supra,

“… The real question when a contractual provision is challenged as a penalty is whether it is penal, not whether it is a pre-estimate of loss. These are not natural opposites or mutually exclusive categories. A damages clause may be neither or both. The fact that the clause is not a pre-estimate of loss does not therefore, at any rate without more, mean that it is penal. To describe it as a deterrent (or, to use the Latin equivalent, in terrorem) does not add anything. A deterrent provision in a contract is simply one species of provision designed to influence the conduct of the party potentially affected. It is no different in this respect from a contractual inducement. Neither is it inherently penal or contrary to the policy of the law. The question whether it is enforceable should depend on whether the means by which the contracting party’s conduct is to be influenced are ‘unconscionable’ or (which will usually amount to the same thing) ‘extravagant’ by reference to some norm.”

4.  As further elaborated by Chu JA in her judgment, the focus is now placed on the legitimate interest of the innocent party and whether the detriment placed on the contract-breaker is out of proportion to such interest.

5.  Second, as highlighted by Chu JA, the Supreme Court in Cavendish Square Holdings v Makdessi, supra, reiterated that the law of penalty only applies to a provision operating on a breach of contract because the courts have no jurisdiction to review the fairness of primary contractual obligations.

6.  In this respect, Lord Neuberger PSC and Lord Sumption JSC also stressed that the classification of terms for the purpose of the penalty rule depends on the substance of the term and not on its form or on the label which the parties have chosen to attach to it, see [15] of Cavendish Square Holdings v Makdessi, supra.

7.  I respectfully agree with Chu JA’s application of these principles to the facts of this case.  Whilst initially I have some doubts if the Termination Provision (adopting the nomenclature of Chu JA) should in substance be regarded as a provision operating on the breach of the primary obligation under the employment contract, I ultimately come to the view that it is a clause qualifying the primary obligation since it provides for a means to terminate the contract without any breach on the party who wishes to end the employment earlier.  In view of the fact that personal services are to be provided under a contract of employment involving confidence and trust, it is indeed useful to have such a qualifying provision in such contract.  Actually, there is a statutory protected right to termination of an employment contract by notice under Section 6 and by payment in lieu under Section 7 of the Employment Ordinance Cap 57.  As Chu JA said, there are different combinations for a party to terminate under the Termination Provision. In the context of employment contracts, termination by advance notice or payment in lieu of such notice is quite common.  I do not think it is in the interest of the development of employment law to complicate the matter by bringing the concept of penalty to such a common practice.

8.  In any event, a notice period of three months or payment in lieu of notice cannot be said to be extravagant and employers have legitimate interest to have such requirement in place in order to maintain a stable and steady workforce.  Hence, even if the law of penalty is engaged, I agree with Chu JA that the Defendant cannot succeed in the present case.

Hon Yuen JA:

9.  I agree with the judgment of Chu JA.

Hon Chu JA:

A.  Introduction

10.  This is the claimant’s appeal against the judgment of Wilson Chan J (“the Judge”) given on 12 September 2019[1]. By the judgment, the Judge allowed the defendant’s appeal from the decision of Deputy Presiding Officer Gary Chu (“the Presiding Officer”)[2] ordering the defendant to pay the claimant $139,593.20 as payment in lieu of notice for the termination of the employment contract between them together with interest.  Leave to appeal was granted by Lam VP.[3]

11.  The appeal was initially scheduled to be heard on 7 April 2020, when court proceedings were generally adjourned because of the public health situation due to COVID-19.  With the parties’ agreement, this appeal is now processed and determined on the papers.

B.  The facts

12.  The facts underlying the dispute between the parties are not controversial.  They had been broadly set out in the Presiding Officer’s decision and the details can be gleaned from the transcript of the trial in the Labour Tribunal.[4]

13.  The claimant is a direct subsidized school.  From 6 to 8 and 10 June 2017, the claimant put up a newspaper advertisement for the recruitment of a teacher. The defendant, who was then a teacher with another school, sent in a written application in response to the advertisement.  After two interviews held on 16 June and 17 July 2017 and a trial lesson conducted by the defendant on 14 July 2017, the claimant decided to recruit the defendant as its teacher for the school term commencing on 1 September 2017.

14.  On 17 July 2017, the claimant issued to the defendant three documents: (1) a letter of offer of appointment as teacher dated 17 July 2017 (“Letter of Offer of Appointment”); (2) Conditions of Service for Teachers in Law Ting Pong Secondary School (“Conditions of Service”) in duplicate; and (3) Letter of Acceptance in duplicate. 

15.  On the same day, the defendant signed and returned to the claimant one copy each of the Conditions of Service and the Letter of Acceptance. 

16.  The defendant was due to report to duty on 1 September 2017.  On 22 August 2017, however, he informed the claimant by email that he would not report to duty on 1 September 2017 as he had decided to stay on with the school in which he had been teaching.  The claimant replied on the same day reminding the defendant of the requirement to give three months’ notice or make payment in lieu of notice to terminate the employment contract and asked him to reconsider his decision.  Later on the same day, the defendant emailed to, among other things, offer to reimburse the claimant for the expenses of re-advertising the recruitment.  

17.  By letter dated 24 August 2017, the supervisor of the claimant drew the defendant’s attention to the Letter of Acceptance under which he acknowledged that the conditions of the contract would come into effect immediately, and demanded the defendant to make payment in lieu of three months’ notice as provided in the Conditions of Service.  The defendant replied by email on the same day saying he would follow up and revert.

18.  The defendant did not report to duty on 1 September 2017.  Neither did he correspond with the claimant.  The claimant managed to recruit another teacher who reported to duty on 5 September 2017.

19.  By letter dated 18 October 2017, the claimant demanded the defendant to make payment in lieu of notice by 30 October 2017.  The defendant replied by email on 1 November 2017, saying that he had been advised the three months’ notice period stipulated in the Conditions of Service did not apply as his contract had not come into effect.  He, however, apologized for the inconvenience caused and reiterated the offer to pay for the expenses incurred by the claimant in re-advertising the recruitment.

20.  By letter dated 22 November 2017, the claimant rejected the offer, pointing out that the loss occasioned by the defendant’s termination went far beyond the advertising costs in that the termination was made so close to the start of the school term and without regard to the interests of the claimant’s students. The letter demanded the defendant to make payment in lieu of notice by 30 November 2017.  Not having received a reply from the defendant, the claimant, through its solicitors, issued a letter of demand on 3 January 2018.  The defendant did not respond.

21.  Subsequently, the claimant brought a claim in the Labour Tribunal against the defendant for payment in lieu of 82 days’ notice[5] in the sum of $139,593.20.

C.  The dispute

22.  The dispute between the parties revolves around the content of the three documents given by the claimant to the defendant on 17 July 2017.  The first is the Letter of Offer of Appointment issued by the Supervisor of the school, which states:

“Offer of Appointment as Teacher, Law Ting Pong Secondary School

The Incorporated Management Committee of Law Ting Pong Secondary School (“LTPSS”) hereby offers you an appointment as a Teacher in the school.

If you wish to accept this offer of appointment in the above school under the conditions set out in the attached Conditions of Service for Teachers in Law Ting Pong Secondary School, please sign both copies of the Letter of Acceptance, and both copies of the Conditions of Service for teachers in Law Ting Pong Secondary School and return one copy of each document to me direct or through the Principal. The second copy is for your retention.

If no reply is received on or before 19^th July 2017, the offer shall be considered withdrawn. If you accept this offer, you are required to report for duty at 7:50 A.M. on 1^st September, 2017.”

23.  The second document is the Letter of Acceptance, a copy of which had been signed by the defendant and returned to the claimant.  It states as follows:

“I accept the appointment offered in your letter dated 17^th July 2017 in accordance with the attached Conditions of Service for Teachers in Law Ting Pong Secondary School.

I also understand that once I accept this contract, the conditions of the new contract will come to [sic] immediate effect e.g. I need to give three months’ notice to terminate my employment with the school.

I confirm that I have read and understood all the above conditions and hereby agree to abide by them.” 

24.  The third document is the Conditions of Service which was signed by both the supervisor of the school and the defendant.  It contains the following terms that are relevant to the present dispute:

“Period:

From 1^st September 2017 to 31^st August 2018”

“Termination of Appointment and Period of Notice:

Without prejudice to LTPSS’s right of summary dismissal, the Teacher’s employment may be terminated during the contract period by either party, by giving to the other three months’ notice in writing or by making a payment equal to the amount of three months’ salary in lieu of notice. A combination of notices and an undertaking to pay wages in lieu of notice to satisfy the three months’ notice period would also be accepted.

Any such payment in lieu of notice shall be in full and final settlement of all and any claims which the Teacher has or may have arising from or in connection with his/her employment and/or the termination of this employment contract”

“Conditions for Payment of Salary on Commencement or Termination of Appointment:

Salary shall be paid from the date of assumption of full duties and shall cease immediately after the last day of performance of full duties except as provided below.

…”

25.  The issues at the trial in the Labour Tribunal were:

(1)  Whether the “Termination of Appointment and Period of Notice” provision in the Conditions of Service (“Termination Provision”) became legally binding upon the signing of the Letter of Acceptance and the Conditions of Service; and

(2)  Whether the Termination provision was unenforceable as a penalty clause.  

D.  The Presiding Officer’s decision

26.  The Presiding Officer found in favour of the claimant on both issues, and awarded the claimant the amount claimed together with interest, but made no order as to costs[6].

27.  On the first issue, the Presiding Officer held that the Letter of Offer of Appointment, the Letter of Acceptance and the Conditions of Service together constituted the employment contract between the parties.  He referred to the principles of construction of contract in the oft-cited passage of Hoffmann NPJ in Jumbo King Ltd v Faithful Properties Ltd & Ors [1999] 3 HKLRD 757 at 726-727.  He considered that although the Conditions of Service provided that the period of employment commenced on 1 September 2017, the Letter of Acceptance stated that the terms in the Conditions of Service came into immediate effect before the commencement of the employment period.  He was further of the view that the document was couched in ordinary language, such that the defendant should have understood and agreed, thus there was a consensus between the parties, that the Termination Provision would come into immediate effect.  He rejected the defendant’s argument that the Termination Provision, hence the requirement to give three months’ notice to terminate the employment contract, only applied during the employment period (i.e. from 1 September 2017 to 31 August 2018).

28.  On the second issue, the Presiding Officer had regard to the fact that the Termination Provision applied equally to both the claimant and the defendant and conferred on both parties the right to terminate the contract by giving three months’ notice or making payment in lieu of notice.  He considered that three months was a genuine estimate by the claimant of the lead time required to recruit and to plan and arrange the duties of a new teacher.  He held that the requirement to pay three months’ wages in lieu of notice in the Termination Provision was a clause providing for liquidated damages and not a penalty clause, relying on 戴作民v無綫收費電視有限公司 [2010] 2 HKLRD 761[7] at §§16-17, and Checkmate Enterprises Limited v Kung Fan Bun (unreported) LDLA 416/1984, 6 September 1984, at §§6-7 and distinguishing the authority relied on by the defendant, 梁子平v 龍記運輸工程有限公司  (unreported) HCSA 34/2017, 14 August 2017.

E.  The Judge’s decision

29.  The defendant appealed the Labour Tribunal’s decision to the Court of First Instance.  On 16 November 2018, the Judge gave leave to appeal on two grounds as follows:

(1)  The Presiding Officer erred in applying the legal principles related to interpretation of contractual terms; and

(2)  The Presiding Officer failed to adequately deal with the defendant’s submissions at trial that the term relied on by the claimant should be regarded as a penalty clause instead of a liquidated damages clause.[8]

30.  By his judgment handed down on 12 September 2019, the Judge allowed the appeal, set aside the order of the Labour Tribunal and dismissed the claimant’s claim with costs of the appeal to the defendant.

31.  On the first ground, the Judge accepted the defendant’s argument that three questions should be considered before applying the principles in Jumbo King Ltd v Faithful Properties Ltd & Ors, supra, namely, (1) what were the terms of employment offered by the claimant; (2) what were the terms of offer accepted by the defendant (and leading to the formation of the employment contract): and (3) what was the function of the Letter of Acceptance in relation to the employment contract.[9]

32.  On question (1), the Judge applied JLT Specialty Limited v James Craven [2018] EWCA Civ 2487 at §35 and considered that an offer consisted of (i) an expression of willingness to contract by the offeror, and (ii) the willingness to contract is subject to specified terms.[10]  Applying this to the Letter of Offer of Appointment, the Judge was of the view that the first paragraph set out the claimant’s willingness to contract with the defendant while the second paragraph stated the terms of the offer, which were those set out in the Conditions of Service but not the Letter of Acceptance.[11]  The Judge therefore concluded that the terms of the offer made by the claimant consisted only of the provisions in the Conditions of Service, which provided, inter alia, that the period of employment was from 1^st September 2017 to 31^st August 2018.[12]

33.  On question (2), the Judge applied the passage in Day Morris Associates v Voyce & Anor [2003] EWCA Civ 189 at §35, namely, “A contractual acceptance has to be a final and unqualified expression of assent to the terms of the offer.”  He held that since the terms in the Letter of Acceptance did not form part of the offer made by the claimant, what the defendant could (and which he did) accept was an offer subject only to the Conditions of Service, and that if the defendant were to accept the terms stated in the Letter of Acceptance, it could not have been an acceptance according to the above principle stated in Day Morris Associates v Voyce & Anor, ibid.[13]

34.  As to question (3), the Judge accepted the argument that in signing the Letter of Acceptance, the defendant was simply complying with the mode of acceptance prescribed by the Letter of Offer of Appointment, and the Letter of Acceptance therefore did not form part of the offer made by the claimant.[14]

35.  The Judge concluded that: (1) the terms contained in the Letter of Acceptance did not form part of the employment contract because they were not included in the offer made by the claimant; (2) the acceptance of the offer by the defendant in the manner prescribed by the Letter of Offer of Appointment could not have included any terms in the Letter of Acceptance; and (3) the Letter of Acceptance merely served as a document to be signed by the defendant to complete the acceptance process, and did not add further terms to the offer made by the claimant.[15]  

36.  The Judge also had regard to the fact that the Letter of Acceptance stated, in the second paragraph, that the defendant needed “to give three months’ service to terminate my employment with the school” (emphasis supplied), and that under the Conditions of Service the defendant’s employment did not commence until 1 September 2017.[16] He accordingly held that the defendant was not liable to make any payment in lieu of notice when he backed out on 22 August 2017 when the employment had not commenced.[17] 

37.  The Judge considered that, in view of his conclusion on the first ground, it was not necessary to, and he did not, deal with the second ground of appeal relating to whether the Termination Provision was unenforceable as a penalty clause.[18]

F.  The claimant’s appeal to the Court of Appeal

38.  The claimant appeals the Judge’s judgment to this Court on two issues.  The first issue, which relates to the two questions of law raised by the claimant, concerns contractual interpretation. The second issue concerns whether the Termination Provision is unenforceable as a penalty clause.  Leave has been given to the parties to argue this issue, but no specific question of law has been formulated by the parties. 

G.  First issue: Contractual interpretation

39.  The first issue of contractual interpretation is directed at the Judge’s conclusion that the Letter of Acceptance, and the defendant’s acknowledgement in it that the terms of the contract came into immediate effect, do not form part of the employment contract. 

G1.  The arguments

40.  Two questions have been formulated by the claimant (respectively “Question (1)” and “Question (2)”) as follows:

(1)  The degree of relevance of the context and/or background underlying an employment contract in the process of contractual interpretation, particularly to what extent the legal distinction between “employment contract” and “employment” should be given weight in contractual interpretation when there is no evidence suggesting that the term in question was professionally drafted and the same was presented to a layman for consideration and/or acceptance; and

(2)  The extent of the Court’s power, if any, to correct a drafting mistake (if that exists) to give effect to the contracting parties’ true intention through contractual interpretation.  

41.  The crux of the claimant’s arguments is that in construing the employment contract, the Judge should have regard to the context and/or background underlying the employment contract, including there is no evidence that the three documents were professionally drafted or that either party was legally assisted, and the legal distinction between the terms “employment contract” and “employment” is not apparent to them as laymen.  Reliance is placed on Lo Yuk Sui v Fubon Bank (Hong Kong) Limited (formerly known as International Bank of Asia Limited)[2019] HKCA 261 at §29; Eminent Investments (Asia Pacific) Limited v DIO Corporation [2019] HKCA 606 at §§7.1 to 7.3[19]; and Chong Cheng Lin Courtney v Cathay Pacific Airways [2011] 1 HKLRD 10 at §§25 and 53.  The claimant contends that had the relevant context and background been taken into account, the Judge should have reached the proper conclusion that the terms in the Letter of Acceptance were part of the employment contract. 

42.  It is also contended that the practical consequence of the parties’ intention (as contained in the Letter of Acceptance) that the terms in the Conditions of Service would come into immediate effect could be given effect by a finding that there was a collateral contract and/or a variation of contract. 

43.  Furthermore, if there was a drafting mistake, the Judge ought to have applied Chartbrook Ltd v Persimmon Homes Ltd [2009] 1 AC 1101 at §§21-25 and to have corrected the drafting mistake in the process of contractual interpretation so as to give effect to the parties’ true intention.  

44.  The defendant does not dispute that a contextual approach, taking into account the surrounding circumstances, should be adopted in interpreting the employment contract between the parties.  There is also no disagreement with the principles set out in the authorities cited by the claimant.  The defendant, however, argues that there is no evidence on whether the three documents were professionally drafted, and that it is immaterial that he is a layman and whether he had legal assistance at the material time. 

45.  Relying on Hoffmann NPJ’s passage in Jumbo King Ltd v Faithful Properties Ltd & Ors, supra, the defendant, while accepting the fact that the parties might not have expressed themselves well (regardless whether they are legally represented) could have been taken into account in construing their contract, contends that, in the context, the terms stated in the Letter of Acceptance do not form part of the employment contract.  Specifically, the defendant argues that it was not the mutual intention of the parties that the employment contract would come into immediate effect.  It is said that had it been otherwise, the defendant would have been entitled to be paid his salary as from 17 July 2017, but he did not receive any salary from the claimant. 

46.  The defendant also suggests that the Letter of Acceptance is a unilateral document signed only by him and it is questionable whether it can create a bilateral obligation on both parties not to terminate the employment contract before the employment period begins. 

G2.  Relevant legal principles

47.  One starts with the basic principle of interpretation as stated in Investors Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896 at 912H-913F.  It is that interpretation is the ascertainment of the meaning which the document would convey to a reasonable person having all the knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract.  In Jumbo King Ltd v Faithful Properties Ltd & Ors, supra, at 296D-I, Lord Hoffmann pointed out that “the overriding objective in construction is to give effect to what a reasonable person rather than a pedantic lawyer would have understood the parties to mean”, and this “involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve.” 

48.  The process of interpretation is thus a unitary exercise and the Court does not consider the words in a vacuum but always in the context of the background, even if the words are unambiguous and sensible.  The focus is on the meaning which the three documents would reasonably have conveyed to the parties in the situation in which they were at the time of the making of the contract. 

49.  These principles of interpretation of contracts have recently been reiterated by the Court of Final Appeal in Eminent Investments (Asia Pacific) Ltd v DIO Corporation (2020) 23 HKCFAR 487 at §§43-46 as follows:

“43. It is a truism that the starting point is the ordinary and natural meaning of the words of the contract, and of course in the vast majority of cases that is the ending point also. But, as Ma CJ pointed out in Fully Profit (Asia) Ltd v Secretary for Justice[20], in the more difficult cases it is not particularly helpful to refer to the "ordinary and natural meaning" of words because in such cases there can be much debate over exactly what is the ordinary or natural meaning of words; and in those cases the surer guide to interpretation is context.

44. In Wood v Capita Insurance Services Ltd[21], Lord Hodge JSC reviewed the many cases on interpretation and emphasised that interpretation was a unitary exercise. That is why, where there are conflicting interpretations, account should be taken of the natural and ordinary meaning of the provision in question, the purpose of the contract and of the provision, other relevant provisions, the facts and circumstances known or assumed by the parties at the time that the contract was executed, the quality of the drafting of the instrument, and commercial common sense.

45. The following points emerge from the judgment of Lord Hodge JSC:

(a) it does not matter whether the more detailed analysis commences with the factual background and the implications of rival constructions or a close examination of the relevant language in the contract, so long as the Court balances the indications given by each;

(b) the Court must be alive to the possibility that one side may have agreed to something which with hindsight did not serve its interest, or that a provision may be a negotiated compromise or that the negotiators were not able to agree more precise terms;

(c) some agreements may be successfully interpreted principally by textual analysis, for example because of their sophistication and complexity and because they have been negotiated and prepared with the assistance of skilled professionals, whereas the correct interpretation of contracts which are marked by informality, brevity or the absence of skilled professional assistance may be achieved by a greater emphasis on the factual matrix;

(d) but negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example, the conflicting aims of the parties, failures of communication, differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement; and

(e) commercial common sense and surrounding circumstances should not be used to undervalue the importance of the language of the provision which is to be construed, and the mere fact that a contractual arrangement, if interpreted according to its natural language, has worked out badly for one of the parties, is not a reason for departing from the natural language.

46.  In our view, there is no substance to Eminent's criticism of the Court of Appeal. The Court of Appeal plainly rejected the notion that there was a conflict between a "textual" and a "contextual" approach, specifically relying on Lord Hodge's judgment in Wood v Capita Insurance Services Ltd. It is true that on one reading of [7.4], the Court of Appeal may be taken to have suggested that, in the case of professionally drafted documents, the context was relevant only to dealing with inconsistencies or gaps. There is no such limitation, but a fair reading of the judgment as a whole shows that the Court of Appeal was not excluding context in the whole process of interpretation.”

G3.  Discussion

50.  The real dispute between the parties on Question (1) is whether the judge was right in concluding that the terms contained in the Letter of Acceptance did not form part of the employment contract because they were not included in the Letter of Offer of Appointment or the Conditions of Service.  Although the Letter of Offer of Appointment referred only to the conditions set out in the Conditions of Service, it is significant that it said that if the defendant wished to accept it, he was required to sign the Letter of Acceptance which was in a prescribed mode which said “I also understand that once I accept this contract, the conditions of the new contract will come to immediate effect e.g. I need to give three months’ notice to terminate my employment with the school”.

51.  I am unable to agree with the Judge’s approach in construing the words in the three documents and his conclusion that the Letter of Acceptance did not form part of the claimant’s offer of employment, and that its content should be disregarded when deciding whether the defendant was bound by the Termination Provision before 1 September 2017.  It would appear that, in ascertaining the terms of the offer and the employment contract, he had focused only on the words used in the Letter of Offer of Appointment, and had not considered the words in all three documents in the context of the background facts.    

52.  The Judge interpreted the words in the Letter of Offer of Appointment “If you wish to accept this offer of appointment in the above school under the conditions set out in the attached [Conditions of Service]” as meaning the terms of the offer of employment were only those in the Conditions of Service.  He therefore considered that the Letter of Acceptance was a mere medium for accepting the offer and its content had no relevance.  This, however, is taking the meaning of these words too literally when these words, and the terms of the offer, ought to be considered against the surrounding circumstances. 

53.  In the first place, it is common ground that the defendant was given all three documents together when the claimant’s offer of employment was made to the defendant.  The Letter of Offer of Appointment was accompanied by both the Conditions of Service and the Letter of Acceptance.  In addition to offering the defendant an appointment as a teacher in the School, the Letter of Offer of Appointment also required the defendant to sign and return a copy each of the Conditions of Service and the Letter of Acceptance as well as to report to duty on 1 September 2017.  It is a general principle of contract law that where there is a prescribed mode of acceptance, the offer could be accepted only in that way: Chitty on Contracts, 33^rd ed, vol. 1, para 2-064. Thus the terms of all three documents were accepted as a “package deal”.  Viewing the circumstances as a whole, the Letter of Acceptance was not a mode of acceptance simpliciter and meaning must be given to its contents. 

54.  The Letter of Acceptance began by stating that the defendant accepted the appointment offered in the Letter of Offer of Appointment in accordance with the Conditions of Service attached to it.  Importantly, it went on to state that once the defendant accepted the contract, the conditions of the new contract would come into immediate effect.  A specific example was given, namely, the defendant had to give three months’ notice to terminate the employment.

55.  In these circumstances, it must be plain, and reasonably understood by the defendant, that the claimant was offering (and only ready to offer) employment on the basis set out in all three documents.  In other words, the claimant’s offer of employment was that as contained in the Letter of Offer of Appointment read together with the Conditions of Service and the Letter of Acceptance.  In signing the Letter of Appointment, the defendant accepted that the terms of the Conditions of Service would come into immediate effect.  

56.  The fact that the contract stated the “period” from 1 September 2017 (as per the Letter of Offer of Appointment) only means that the defendant’s performance of teaching duties is to commence on a future date.  In general, a valid contract has legal effects, for example, as to repudiatory or anticipatory breach, and is enforceable immediately when it is made, irrespective of the time of performance.  Hence, although performance of teaching duties is to commence on a future date (i.e. 1 September 2017), as from 17 July 2017 both the claimant and the defendant were both legally bound to perform their obligations under the contract.   

57.  The defendant argues that had it been the parties’ intention that the terms of the contract would come into immediate effect, he should have been entitled to be paid his salary as from 17 July 2017.  The argument has overlooked the provision in the Conditions for Service that salary shall be paid only from the assumption of full duties (see §24 above).  The defendant has not drawn the attention of this court to any other conditions which would support his contention that the contract has (or could) not yet come into effect.   

58.  The claimant seeks to rely on the fact that the three documents were not professionally drafted and that neither party was legally assisted as a relevant background to be taken into account in construing the words in the documents.  It is argued that the legal distinction between “employment” and “employment contract” (if there be such) was not apparent to the parties, who are laymen.  The defendant argues, and I agree, there is no evidence in the case as to whether the three documents were professionally drafted.  This, however, is not material.  What is important is what a reasonable person would have understood the parties to mean, having regard to the parties’ agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve: Jumbo King Ltd v Faithful Properties Ltd & Ors, supra.  Here, a reasonable person would have no difficulty understanding the sentence in the Letter of Acceptance to mean that the terms of the contract would come into immediate effect such that the defendant would have to give three months’ notice to terminate his contract of employment with the claimant.  Indeed, the notice requirement under the Termination Provision was used as an example of the terms of the contract taking immediate effect.

59.  In short, applying the principles of contractual interpretation set out above, the Letter of Acceptance (and its content) forms part of the contract between the parties.  It follows that it was the parties’ agreement that the Termination Provision was to take effect immediately upon the creation of the contract on 17 July 2017.  Accordingly, either party was bound by the terms of the contract to give three months’ notice or make payment in lieu of notice should it/he wish to terminate the contract, even before the commencement of the period on 1 September 2017.  

60.  In light of the above conclusion, it is not necessary to deal with the arguments about collateral agreement and also the arguments under Question (2) concerning correction of drafting mistake to give effect to the parties’ contractual intention.  Reading the Letter of Offer of Appointment and the Letter of Acceptance as a whole and against the context and the relevant background, there is no clear mistake on the face of the document that requires correction as a matter of construction: see Chartbrook Ltd v Persimmon Homes Limited, supra, at §§22-24. 

H.  Second issue: Penalty clause

61.  I turn next to the second issue of whether the Termination Provision, in particular, the provision on payment in lieu of notice, is unenforceable as a penalty clause.

H1. The arguments

62.  The defendant accepts that he bears the burden of establishing that the requirement to pay three months’ salary in lieu of the three months’ notice (“Payment-in-lieu Provision”) in the Termination Provision is a penalty.  The thrust of his arguments is that the amount involved (i.e. over $150,000) is wholly disproportionate to the monetary loss that the claimant may suffer, and any legitimate interests of the claimant as a school.  It is said that the provision is to deter him from changing his mind before he was due to report to duty.

63.  In support of his argument that the amount of payment in lieu is extravagant and disproportionate, the defendant relies on the fact that (i) the claimant incurred no loss in terms of salary payment since it did not have to pay him salary in the period between the conclusion of the contract (17 July 2017) and when he gave notice of termination (22 August 2017); (ii) although the claimant’s staff had to incur extra time on recruiting a replacement teacher and re-allocation of the teachers’ duties, there is no calculation or quantification of the extra monetary costs; (iii) the claimant did not have to incur extra advertisement expenses since the replacement teacher was appointed from the candidates who had responded to the June 2017 advertisements, and the new teacher reported to duty on 5 September 2017; (iv) any financial costs for employing supply teacher or rearranging the teaching schedules can be drawn from the sum originally budgeted for hiring him, especially when none of the budgeted amount had been paid to him; and (v) it is too far-fetched to take into account negative impact on students’ learning progress because the claimant could have made other plans to cope with the shortage of a teacher and there are many factors affecting the students’ learning progress.

64.  The claimant, on the other hand, argues that the provision is a genuine pre-estimate of loss that serves both parties’ legitimate interests.  It made six points in support, namely, (i) time is needed to recruit a suitable new teacher; (ii) the School has to make preparation and carry out administrative works to assist a newly recruited teacher to adapt and fit into its structure and setting, and this is cost-consuming; (iii) identifying a suitable teacher within a short time is difficult and also cost-consuming; (iv) the School may have to engage temporary teacher(s) before a suitable replacement teacher is found, and this will generate additional costs; (v) termination without sufficient notice has potential negative impacts on the students’ learning and the school management; and (vi) the Payment-in-lieu Provision applies to both parties.  It is recognized that termination by the School without sufficient notice will similarly cause hardship to, and adverse impacts on, the teacher. 

H2.  Relevant legal principles

65.  Although counsel do not have much disagreement over the legal principles on the doctrine of penalties, it is necessary to consider the principles and development in the law on penalties that are relevant to the dispute between the parties. 

66.  The fundamental aspects of the law on liquidated damages and penalties were set out in the authoritative decision of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co [1915] AC 79.  It established that a clause would be invalid as a penalty if it was unconscionable and calculated more to discourage breach than facilitate compensation.  The essence of a penalty is a payment of money stipulated as in terrorem of the offending party, or was extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach, rather than a genuine covenanted pre-estimate of the damage (at p 86).  

67.  It was also held in the Dunlop case that the question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged as at the time of the making of the contract, not as at the time of the breach (at p 87).  This point was highlighted in Ip Ming Kin v Wong Siu Lan, (unreported) CACV 201/2012, 28 May 2013, at §27, in which Kwan JA (as Kwan VP then was) pointed out that although the issue is one of construction of contract, the court is not confined to the terms of the contract and may examine the inherent circumstances of the contract, judged as at the time of the contract.  Reference was also made to the judgment of Arden LJ (as Lady Arden then was) in Murray v Leisureplay Plc [2005] IRLR 946 at §55 that if there is no evidence on the reasons for the inclusion of the clause, the court may draw inferences of fact as to the reasons and the genuineness of those reasons; the test of genuineness is objective and a pre-estimate is genuine if it is not unreasonable in all the circumstances of the case.

68.  Murray v Leisureplay Plc, supra, concerns a provision in the claimant’s employment contract which provided for payment of a year’s gross salary, pension contributions and other benefits in kind if the employment was determined without one year’s notice.  The employer argued that the clause was unenforceable as a penalty, since it provided for the payment of a greater amount than could conceivably have been recovered by the claimant as damages for breach of contract.  The UK Court of Appeal upheld the clause.  Buxton LJ (with whose approach Clarke LJ agreed) considered that the court should take a broad view of the matter instead of concentrating solely on the difference between the amount payable under the clause and the measure of damages recoverable at common law (at §114).  This broader approach was considered by Kwan JA in Ip Ming Kin v Wong Siu Lan, supra, at §§46, 47 and 58, with Lam JA (as Lam VP then was) expressly indicating a preference for it (at §60).  

69.  The law in relation to penalties was reviewed by the UK Supreme Court in the conjoined appeal of Cavendish Square Holdings v Makdessi and ParkingEye Ltd v Beavis, supra, in which it undertook a comprehensive review of the authorities on liquidated damages and penalties.  It considered that while the traditional test (see §66 above) was a useful tool in a simple case, it was not easily applied to more complex cases (at §22).  The true test was held to be whether the clause is out of all proportion to the innocent party’s legitimate interest in enforcing the contract.  It further recognized that an innocent party could have a legitimate interest in the performance of the contract or some appropriate alternative to performance that goes beyond compensation.  It was said by Lord Neuberger and Lord Sumption (with whom Lord Carnwath and Lord Clarke agreed) that (at §32)[22]:

“The true test is whether the impugned provision is a secondary obligation that imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach, and we therefore expect Lord Dunedin’s four tests would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations.”

70.  In applying the test, the court should first identify the legitimate interest of the innocent party that is being protected by the clause, and then assess whether the clause is out of all proportion to the legitimate interest by considering the circumstances in which the contract was made.  Notions of whether the clause has a deterrent purpose or whether it is a genuine pre-estimate of loss would be subsumed by the broader enquiry into the legitimacy of the interest that supports the provision. 

71.  Another aspect of the decision in Cavendish Square Holdings v Makdessi which is relevant to the present context is its discussion on the threshold requirement of a breach of contract.  It held that the doctrine of penalty is only engaged when there had been a breach of contract.  It is not applicable to contractual provision which stipulates an obligation to pay certain amount of money by way of a primary obligation.  This means a clause can only be a penalty if, as a matter of substance, it operates upon a breach of contract.  In other words, it is a secondary obligation triggered by a breach of a primary obligation.  Lord Neuberger and Lord Sumption (with whom Lord Carnwath agreed) explained that there is a “fundamental difference between a jurisdiction to review the fairness of a contractual obligation and a jurisdiction to regulate the remedy for its breach”, pointing out that the penalties doctrine is a rule for controlling remedies for breach of contract that should not be transformed into a jurisdiction to review the content of the substantive obligations which the parties have agreed (at §§12-13).    

H3.  Discussion

72.  To start with, the relevant part of the Termination Provision states: “the Teacher’s employment may be terminated during the contract period by either party, by giving to the other three months’ notice in writing or by making a payment equal to the amount of three months’ salary in lieu of notice.  A combination of notices and an undertaking to pay wages in lieu of notice to satisfy the three months’ notice period would also be accepted.” 

73.  The first issue to address is the nature or contractual status of the provision: whether the Payment-in-lieu Provision is a secondary obligation arising from breach of a primary obligation of performance, or a primary obligation to pay.  Although this matter was neither discussed in the decisions of the Tribunal and the Judge nor in the submissions of counsel in this appeal, this according to the approach discussed in Cavendish Square Holdings v Makdessi, supra, should be the first question to be addressed as it goes to the applicability of the doctrine of penalties.

74.  As discussed above (see G3 above), the Termination Provision provides a mechanism for the parties to terminate the contract before its expiry on 31 August 2018. Under the Termination Provision, early termination may be effected by one of three means, namely, (i) serving three months’ written notice of termination: (ii) paying a sum equivalent to three months’ salary; and (iii) giving written termination notice combined with paying a sum in lieu of notice to satisfy the required notice period.  The Termination Provision therefore gives the parties a right to terminate by notice or by payment in lieu of notice or by means of a combination of the two.  The payment of a sum in lieu of notice is a contractually agreed method of lawful termination of the employment contract; it is not in the nature of damages for breach of contract.  It is a primary obligation to pay rather than a secondary obligation arising upon the breach of a primary obligation of performance.  Thus analyzed, the claimant’s claim is not a claim for liquidated damages; rather it is a claim for recovery of a contractual debt arising from a contractually agreed method of lawful termination.  This being the case, the doctrine of penalties is not engaged (see Cavendish Square Holdings v Makdessi, supra, and §71 above). It follows that the defendant’s contention that the Termination Provision, especially the Payment-in-lieu Provision, is unenforceable as a penalty cannot stand.

75.  Even if the Payment-in-lieu Provision under the Termination Provision is to be regarded as a liquidated damages clause, I do not think that the defendant has succeeded in showing that the provision constitutes an unenforceable penalty clause. 

76.  There are two inherent problems in the defendant’s arguments.  The first is that they have concentrated solely on comparing the amount of payment in lieu and the actual monetary loss suffered by the claimant.  Such an approach is too narrow and inapt, whether taking the broad approach of the majority in Murray v Leisureplay Plc, supra, or applying the test formulated in Cavendish Square Holdings v Makdessi, supra.  As recognized in the Cavendish Square Holdings case, an innocent party can have a legitimate interest in the performance of the contract, or some appropriate alternative to performance, that goes beyond compensation.  The defendant’s approach, however, has failed to give consideration to this.

77.  Second, the bulk of the defendant’s arguments are directed at the state of affairs after the defendant terminated the contract. This is contrary to the authorities which require the provision to be judged in the light of the circumstances at the formation of the contract, and not at the time of breach (see §§67 and 70 above).  

78.  In my view, if one were to take a broad view of the matter, it will not be difficult to appreciate that as a school with responsibilities to a substantial number of students, it must be important to the claimant to have suitable, steady and sufficient number of teaching staff at all times so as to ensure proper operation of the school curriculum and extra-curriculum programme as well as appropriate attention to the students’ learning needs.  In this connection, I do not agree with the defendant’s submission that it is far-fetch to consider the students’ learning progress.  A school has a primary duty of care to its students, including their learning needs and progress.  Minimizing or avoidance of adverse impacts on the students’ learning progress is surely a matter that the claimant is entitled to, and should, be concerned with.  Although students’ learning progress may be affected by a number of factors, the potential adverse impacts caused by a teacher’s termination of contract at short notice must be a relevant consideration for the claimant when formulating the terms of the employment contract with its teachers.   

79.  There is also the unchallenged evidence adduced by the claimant at the trial regarding the problems and difficulties posed by the termination of a teacher’s employment.  The claimant’s evidence shows that: 

(1)  The claimant has to incur considerable time and efforts to help a newly appointed teacher to adapt to and to fit into the structure and culture of the school, including providing an induction programme for the new teacher.  The appointment of a new teacher also entails administrative and clerical work, such as revising the booklet called “teacher organizer” and the school’s staff list, to say the least[23].    

(2)  It is a difficult task to identify and appoint a suitable and qualified replacement teacher within a short time frame[24].  I would further observe that it is probably even more difficult when the termination takes place just at the beginning of an academic year when teachers will generally have already found employment and settled in.

(3)  Pending the appointment of the replacement teacher, temporary teacher(s) will have to be recruited to take up the teacher’s responsibilities while related administrative and other arrangements will also have to be made to deal with the situation[25].

(4)  All these tasks are time and cost consuming.

80.  It can be readily inferred from the above that at the time of entering into the employment contract with the defendant, the claimant would be concerned, and legitimately so, to ensure that the defendant would perform his contractual obligations, including reporting to duty on 1 September 2017 and carrying out his teaching duties until 31 August 2018, and that adequate notice in advance would be given in the event he decided not to perform his contractual obligations.  The claimant’s concern in this regard is borne out by the Letter of Acceptance which stated that the terms of the contract would come into immediate effect, using the Termination Provision as an illustration.  

81.  It follows that, apart from compensation for monetary loss, the claimant has a legitimate interest in enforcing the performance of the employment contract.  The three months’ notice period and the Payment-in-lieu Provision under the Termination Provision cannot be said to be out of all proportion to the claimant’s interest in enforcing the contract, having regard to the problems and difficulties that the School will face in appointing a replacement teacher.  It is also relevant to consider that when the claimant concluded the employment contract with the defendant, it was already quite close to the commencement of the new school year, being about six weeks from 1 September 2017.  It is further to be noted that there is reciprocity in the sense that the Termination Provision also binds the claimant who is similarly required to give three months’ notice or make payment in lieu should it wish to terminate the defendant’s contract.

82.  Accordingly, even if the Payment-in-lieu Provision is to be regarded as a liquidated damages clause, I would reject the defendant’s arguments that it is unenforceable as a penalty clause.  

I.  Conclusion and costs

83.  For the reasons set out above, I would allow the claimant’s appeal, set aside the Judge’s order, restore the Labour Tribunal award by entering judgment for the claimant on its claim together with interest on judgment rate from the date of the award.

84.  Applying the usual rule of costs follow the event, I would make an order nisi that the costs of the appeal together with the costs of the leave application (which has been ordered to be in the cause of the appeal[26]) be paid by the defendant to the claimant. 

85.  Having considered the claimant’s statement of costs for summary assessment dated 22 October 2019[27], and taking a broad-brush approach, I would assess the claimant’s costs at $70,000.

86.  In conclusion, I would make the following orders:

(1)  The appeal be allowed.

(2)  The order of the Judge dated 12 September 2019 be set aside.

(3)  Judgment be entered for the claimant against the defendant in the sum of HK$139,593.20 together with interest at judgment rate from the date of the award until full payment.

(4)  There is an order nisi that the defendant pays the claimant the costs of the appeal and the costs of the leave to appeal application summarily assessed at $70,000.