CHUNG FAI ENGINEERING CO. (a firm) v. MAXWELL ENGINEERING CO. LTD.

HCA10504/1996

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.10504 OF 1996

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J U D G M E N T

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Background

1. In 1996 a printing factory was being built in Tseung Kwan O. The builder was W. Hing Construction Company and its subsidiary Anpoint Engineering Ltd was the main contractor. The plaintiff ("Chung Fai") had been sub-contracted to carry out all air-conditioning works and it, in turn, had sub-contracted the mechanical ventilation air-conditioning system ("MVAC") to the defendant ("Maxwell").

2. Both parties commenced proceedings which were consolidated. The written contract between the parties was dated 2 April 1996. Maxwell undertook 13 itemized tasks for an agreed contract price of $14 million. The terms of payment in the contract were :

"Monthly progress payment on percentage workdone 5% of the amount certified by the Architect/Q.S. should be held for retention. Half of the retained value to be released on practical completion. The remaining balance to be released 12 months after the practical completion and all defects rectified."

3. After commencement of the works disputes arose concerning Maxwell's applications for interim payments. They were submitted but, largely, unpaid.

4. On 18 July 1996, a "supplementary agreement" was signed by both parties which stated :

"1. Chung Fai unconditionally withdraw their following letters :

1.1 L95230/014 dated 24th June, 1996

1.2 L95230/023 dated 15th July, 1996

1.3 L95230/024 dated 16th July, 1996

1.4 L95230/025 dated 17th July, 1996

2. Maxwell shall complete the contract works to meet the Fire Services Department Inspection arranged on 12/8/96 and the overall completion date of 10/9/96.

3. The first payment claim submitted by Maxwell was 5/5/96 and the payment due date shall be 25/6/96. The payment due date for the consecutive payment claim shall be 25th of the following months."

5. On the same date, Chung Fai handed to Maxwell two cheques. One for $245,000.00 as an additional payment in respect of Maxwell's 1st interim payment application (which was for $944,300 made on 3 May). A sum of $500,000 had already been paid on 26 June. The second was for $2.05 million and was post-dated to 10 August 1996. This second cheque related to Maxwell's second application which had been for $2,568,325 made on 5 June. The cheque was dishonoured when Maxwell presented it. Maxwell made two further applications for interim payments, for $3,311,590.00 on 5 July and $801,435.00 on 5 August. No payments were made under these applications.

6. On 12 August 1996, Chung Fai terminated the contract with Maxwell pursuant to clause 13 of the contract which stated :

"13. If in the opinion of Chung Fai Engineering Company the Contractor shall be or shall have been in breach of the terms or conditions of the Contract. Chung Fai Engineering Company may give a written notice to the Contractor requiring him to remedy such breach within a period of not less than 7 days. In the event that within the period stipulated in Chung Fai Engineering Company's written notice, the Contractor has not remedied the breach. Chung Fai Engineering Company may give a further written notice to the Contractor forthwith determining the Contractor's employment under the Contract."

7. They had written a letter dated 2 August which contained a list of complaints made by Chung Fai and which concluded by saying :

"We expect a reply from your side for the above queries and a substantial improvement of your work progress by latest 5:00pm 5th August 1996 or we have no choice but to exercise our contractual entitlement in this contract."

8. Thus Chung Fai gave Maxwell three days to remedy the alleged breaches, not the seven days stipulated in Clause 13. The notice was therefore defective. However, Maxwell's defence to the claim is on stronger grounds than this alone.

9. Arising out of these facts, four core issues fall to be resolved. They are :

(a) The original contract :

10. Chung Fai claims the original contract contained a provision, made orally, that it was "back to back" with its contract with Anpoint. Chung Fai's contract with Anpoint did contain a "back-to-back" provision (or "pay when paid"). Chung Fai therefore only paid Maxwell such sums that it had received from Anpoint regardless of the merits of Maxwell's interim application. Maxwell claims there was no such provision.

(b) The supplemental agreement :

11. Chung Fai denies it is a valid or binding agreement because it was made under economic duress. Maxwell relies on its terms.

(c) The dishonoured cheque for $2.05 million :

12. Chung Fai claims it was given conditionally on Maxwell completing works necessary for a Fire Services inspection on 12 August. The say they stopped the cheque because the condition had not been fulfilled. Maxwell deny that this or any conditions were applied.

(d) Delay :

13. Chung Fai claims that in any event Maxwell were in breach of contract because the works were behind schedule. In particular certain works in relation to the Fire Services inspection had not been completed within time.

14. Issues 1, 2 and 4 are all issues of fact and turn on the court's assessment of the oral and documentary evidence produced at trial. Issue 3 is partly factual and partly legal. For the reasons which follow, I have concluded that all four issues should be resolved in Maxwell's favour.

The original contract

15. It cannot be disputed that there is no written clause in the contract which states that Chung Fai's payment to Maxwell shall be on a "pay when paid" basis. Neither is there any reference to such a provision in the contemporaneous correspondence. Its first appearance, in writing, in this case is in Chung Fai's Statement of Claim. It is also clear that Chung Fai's contract with Anpoint did contain such a written clause. The high point of Chung Fai's case is Mr C.K. Chan's evidence that it was agreed orally before the contract was signed. I am satisfied that such is the importance of the clause that it would have been included in writing had it been agreed. I also accept Mr C.K. Yum's evidence (for Maxwell) that had a "back-to-back" provision been proposed, he would not have entered into the contract. Such a clause, he said, would be very dangerous for a 3rd or 4th sub-contractor down the contractual chain. This makes sense and I accept it. A sub-contractor such as Maxwell needs regular stage payments to carry out its contractual obligations in a timely fashion. It would be commercially imprudent to put itself in a position whereby it had to wait for payments because of disputes higher up the contractual chain which did not involve them.

16. Mr C.K. Chan accepted that the total sum paid to Maxwell, namely $745,000 was paid, not because it was an accurate reflection of the work done by Maxwell but because that was the amount he had received from Anpoint. By August 1996, Maxwell's interim payment applications exceeded $7 million.

17. Because I found Mr C.K. Yum for Maxwell to be commercially prudent, I accept that one provision was agreed orally between himself and Mr C.K. Chan. Contrary to a "back-to-back" provision, Mr Yum's evidence was that Chung Fai had agreed to make payment under each interim application within 45 days of the application being made. It was because Chung Fai was not honouring the 45 day agreement that the supplementary agreement was negotiated on 18 July. Prior to that Maxwell's first application for $944,300 should have been paid on 17 June. In fact, $500,000 was paid on 26 June. The second application was due to be paid on 20 July. Maxwell, under the terms of the contract were entitled to monthly progress payments. It was Chung Fai's obligation to assess the applications and arrange for the work to be certified whereupon 5% could be retained. The bona fides of Maxwell's applications is well demonstrated by the fact that the sum total of their four applications for work done up to 5 August exceeded $7 million and the expert valuation of the work done, made after they had left the site approaches $7 million.

The supplementary agreement

18. The evidence from each side was in conflict over the events leading up to the signing of the supplementary agreement. Mr Chan for Chung Fai said the terms were agreed orally over the phone on the evening of 17 July and his partner, Mr Ho, merely visited Maxwell's office on 18 July to hand over the two cheques. The terms of the written agreement, he said, differed from the oral agreement. The version given by Mr Yum for Maxwell, which I accept, is more logical and reliable. He said there was no telephone agreement. Mr Ho came to his office to negotiate on behalf of Chung Fai. The negotiations took about two hours after which his secretary typed out the agreement. A draft agreement had been provisionally typed out beforehand but a second one had to be typed because one provision in the first draft was not agreed to by Mr Ho. Before signing, Mr Ho made a phone call to someone concerning its terms. The agreement is short, simple and easy to understand. Mr Yum said he and Mr Ho went through it line by line. I have no doubt that Mr Ho understood it and knew what he was signing. The prime purpose of the agreement was to clarify and further formalize the payment terms. The reason it was necessary was because Chung Fai were seriously behind with the interim payments and this was placing Maxwell in serious difficulties. The agreement dispelled any suggestion that the payments were on a "pay when paid" basis and specifically dealt with the time frame for payments to Maxwell.

19. Chung Fai further seek to avoid any liability arising out of supplementary agreement by relying on their letter of 26 July which purports to refute its validity. The letter complains that it was Mr Ho and not Mr Chan, the project manager, who signed the letter and that it did not reflect the terms which had been agreed by telephone on 17 July. I find that this letter has no such effect. What is more illuminating about the letter is as follows. It was written, not on the 19th, the day after the agreement, but on the 26th, the day after Maxwell's next application for payment in accordance with the agreement, it did not seek the return of the post-dated cheque. It did not suggest that Mr Ho had not been authorized to sign the agreement or had not understood the agreement or had been induced to sign it. Finally it did not say what the purported verbal agreement of the 17th had been.

20. Mr Ho's evidence on the incident, in some respects was consistent with a plea of non est factum. He said he was compelled to sign it and furthermore did not understand it because it was in English. I found Mr Ho's evidence to be disingenuous. He was a partner in the firm and daily dealt with correspondence and documents in English. Mr K.L. Kong clarified that non est factum was not relied on but the defence of economic duress was.

Economic duress

21. Maxwell said no more than that they would be compelled to stop work on site unless their legitimate demands for payment were met. If pressure was applied, it was lawful pressure born out of a commercial necessity. Maxwell's belief that they were entitled to larger and speedier payment was an honest and genuinely held belief based on facts. If Chung Fai seriously objected it was open to them not to sign the supplementary agreement, let Maxwell go and engage a new sub-contractor.

The cheque for $2.05 million

22. At the 18 July meeting, a cheque for $2.05 million dated 10 August 1996 was handed to Maxwell. When presented, it was dishonoured. The only basis upon which Chung Fai could avoid judgment on the cheque would be that it had been given conditionally and that Maxwell had failed to comply with the condition. On this issue, once again, the evidence of Maxwell is preferred for the following reasons :

23. Chung Fai's case is that payment on the cheque was conditional on Maxwell completing the work necessary for the Fire Services inspection in time. Paragraph 2 of the supplemental agreement, which refers to the inspection, makes no reference to the cheque. Had it been part of the agreement, paragraph 2 would plainly have been drafted differently to include a reference to the cheque. Further, paragraph 2 refers to the date of the anticipated Fire Services inspection as being 12 August, whereas the cheque had been stopped by Chung Fai on or before 10 August. Finally, had it been the case, Chung Fai had an obvious opportunity to clarify the conditional nature of the cheque, when it wrote the letter of 26 July (supra) by which it purported to put in writing its position with regard to the 18 July meeting. It failed to do so.

Delay

24. Even if the court finds, as it has, that the original contract was not back to back, the supplementary agreement was valid and binding and the $2.05 million cheque was not conditional, it is nonetheless necessary to examine the circumstances of the alleged delay because it would still be possible to find Maxwell in default as alleged and therefore liable wholly or in part on Chung Fai's claim.

25. The reason Chung Fai terminated the contract on 12 August 1996 was that Maxwell had failed to meet the target date for the Fire Services inspection, namely, 12 August. For the reasons which follow Chung Fai has failed to establish that their termination of Maxwell's contract was lawful.

26. In a letter written by the Architect on 6 December 1996, the date for the Fire Services inspection was stated to be 21 August, not the 12th. The only reference, in the documents, to the date being 12 August is in the supplementary agreement, a deadline required by Chung Fai and accepted by Maxwell. In fact, the inspection did not take place until much later. Also in the Architect's letter was a recommendation (not a certification) that 65 days delay be allowed because of late installation of electricity and water. Electricity and water were essential prerequisites to a fire services inspection. Both temporary and permanent supplies were necessary. Electricity was eventually connected up on 10 October and water on 5 November. There is plentiful evidence in the correspondence showing Maxwell was complaining about the lack of power on site hindering its progress. Thus, the problems with power and water rendered both Chung Fai's deadline of the 12th and the actual target date of 21 August unrealistic.

27. A specific complaint against Maxwell was its failure to complete the ventilation system and install the smoke extraction fans in time. I accepted Mr Yum's evidence that the smoke extraction fans had been ordered by them in good time and a 25% deposit had been paid. They were not supplied in time and had not been supplied by 12 August. Had they arrived in time, Maxwell could have and would have installed them in two to three days. I am satisfied that Chung Fai must have known about both the delay in delivery of the fans and the problem with electricity and water when they terminated the contract.

28. Mr Yum's knowledge and experience concerning fire services inspections was also a matter which weighed in his favour. He informed the court that a fire services inspection is in two parts. (Neither had taken place by 12 August). The first part would be in relation to installations which did not concern Maxwell's work (such as fire alarms). The part which concerned installations such as the smoke extraction fans would be in the second inspection (which usually takes place about two weeks later) and is carried out by the Electrical & Mechanical Services Department.

29. The final matter worthy of mention in the Architect's letter of 6 December is the recommendation that liquidated damages for a period of 10 days was due (a total of $1,000,000). This covered the period from 25 November to 4 December. The reason it is worthy of note is obvious, namely that the period is 31/2 month after Maxwell left the site and was not attributed to any default by Maxwell.

30. In spite of the various difficulties which Maxwell faced the evidence showed that by 12 August they had completed the installation of fire dampers and the fire resistance panels for duct work. Also their enquiries about lack of temporary power went unanswered.

31. For all the above reasons, I find in Maxwell's favour. Their contract with Chung Fai was wrongly terminated.

Quantum

32. For their work done up to 12 August 1996, Maxwell were paid $745,000. The court has had the advantage of considering very detailed reports and helpful evidence from the two experts Mr Y.Y. Ho for Maxwell and Mr K.O. Wong for Chung Fai. They differed only in the methodology of their assessments. Neither had the advantage of visiting the site, both worked from drawing and information supplied by their respective clients. Mr Ho had the added advantages of numerous photographs taken at the material time.

33. Because of the court's findings, it is unnecessary to quantify the costs incurred by Chung Fai in completing the contract. As far as the value of Maxwell's work is concerned, two figures are to be considered. Firstly the total of the interim payment application which remains unpaid. This is the sum claimed in the pleadings, namely $7,482,000. Secondly, the experts' assessments and valuations. The safer course is to concentrate on the second figure. I adopt Mr Ho's figures. His approach to his task impressed the court as being objective and professional. In cross-examination he made some concessions when he thought it fair to do so.

34. There were four items about which there was some difference between the experts. Taking account of the concession made by Mr Ho, I find the valuation of work done by Maxwell to be :

		$
Items 3,4 and 5	Water pumps	167,000
Item 6	Fan costs	200,000
Item 8	Chiller system	1,312,000
Item 9	Ventilation system	3,787,000
Item 12	Air Handling Units	1,350,000
		6,816,000
	Less amount paid	745,000
		6,071,000

35. The plaintiff's claim is dismissed with costs and there will be judgment for the defendant on the counterclaim in the sum of $6,071,000 plus interest at prime +1% from the date of the writ in HCA 10631, namely 17 September 1996, plus costs.