XCHRX AIRPORT AUTHORITY HONG KONG v. AMERICAN HOME ASSURANCE CO.

HCA17807/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.17807 OF 1999

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J U D G M E N T

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The plaintiff seeks summary judgment in these Order 14 proceedings for $19,227,015.80 on a Bond which the plaintiff contends has been properly called and upon which the defendant has declined to pay. It arises from a contract to build the Ground Transportation Centre at Chek Lap Kok Airport. The plaintiff had employed a main contractor (Nishimatsu Construction Co. Ltd) who in turn had employed a sub-contractor (UDL Kenworth Engineering Ltd) ("UDL") to install electrical and mechanical installations. As part of the sub-contract UDL procured from the defendant to this action a 10% performance Bond in favour of the plaintiff. Following alleged default by UDL the plaintiff made a call on the Bond for its full amount. The defendant's dispute liability.

There are three primary issues :-

(1) What is the proper construction of the words of the Bond?

(2) Whether the plaintiff's demand letter is valid?

(3) Are there 'other reasons' to order a trial pursuant to Order 14, rule 3?

1. THE PROPER CONSTRUCTION OF THE WORDS OF THE BOND

The material part of the Bond is Clause 2 which states :-

"If the Sub-Contractor shall be in default in respect of any of his obligations under the Sub-Contract the Bondsman shall upon demand made by the Employer in writing and without proof of the said default or conditions satisfy and discharge the amount identified in the demand of any damages, losses, charges, costs or expenses sustained by the Employer by reason of the default up to the amount of the Bonded Sum."

Counsel's competing submissions concern the meaning of the words "... and without proof of the said default or conditions ...". The court has had the advantage of detailed and helpful submission from Mr Simon Westbrook for the plaintiff and Mr Adrian Huggins SC for the defendant.

Counsel agree that there is no requirement on the Employer to prove default. The issue is how the words "or conditions" should be interpreted. Does it means :-

(a) without proof of the said default or without proof of conditions; or

(b) without proof of the said default or without conditions?

Mr Huggins contends that (a) is the correct construction. The consequence would then be that as the Bond is specific as to what need not be proved namely "default" or "conditions", then there is a presumption that other matters, such as damages, do have to be proved. As the demand letter does not prove damage, he contends, there is no liability on his lay client to pay on the Bond. To complete his argument (in outline only) the only way there would be any liability on the defendant to pay on interpretation (a) would be if the word "conditions" somehow incorporated proof of damages. The requirement for proof of which would then be excluded.

Mr Westbrook contends that (b) is the proper construction. It means, he says, the requirement to pay is triggered on demand without a need to prove default and without conditions, i.e. unconditionally. For the following reasons I have come to the conclusion that this is the correct interpretation :-

(a) The nature of the Bond

If this Bond is correctly classified, as Mr Westbrook contends, as an unconditional single obligation Bond, then it should be construed strictly, so that the defendant has no option but to pay. Mr Huggins correctly points out that there is no easy formula for the classification of such bonds. There are many varieties, some impose primary obligations on the Bondsman, some secondary and some are hybrid. This one, he submits, is a hybrid. Each one should be considered separately and on each occasion the court should consider the Bond before it. The court will rarely be assisted by the words of other Bonds because they are all different, albeit in many cases, only slightly.

In Emden's Construction Law, the author puts it as follow :-

"In construction terms, a primary obligation is autonomous, operating separately from the construction contract; whereas a secondary obligation is intimately connected with the construction contract, so that a breach of the contract will automatically be a breach of the guarantee. The court has referred to hybrid obligations, intermediate between primary and secondary obligations. These may arise where both are contained within the same document or where the document mixes terminology associated with both types of obligation. The court may then have the difficult task of making sense of apparently contradictory language."

Looking at this Bond as a whole it uses the language of a strict, unconditional on-demand Bond imposing a primary obligation on the Bondsman. The preamble states that the defendant is "irrevocably and unconditionally bound to" the plaintiff. Also, paragraph 3 states that the liability "shall remain in full force and effect and shall be not affected or discharged in any way ..." Paragraph 3 then goes on, in eight sub-paragraphs, to list various waivers given by the Bondsman, thereby further restricting his rights.

Paragraph 4 stipulates the only three circumstances in which the Bond can come to an end, none of which have occurred in this case.

(b) Commercial purpose

The parties to this Bond would, in my judgment, be in no doubt that its purpose was to finance the completion of the project without risking delays through cash flow problems. It was in relation to the construction of Hong Kong's new airport. The race to finish on time was on. Such a bond for such a project at such a time would not have been intended merely to protect the obligee's right to compensation after the project had been completed, which is the purpose of a "double" or secondary obligation bond. Emden states further :-

"The other main general function is as protection against default : in this context a primary obligation allows the obligee to call for payment on account of its loss without delay ('pay now, argue later') whereas a beneficiary of a secondary obligation has to wait until liability has been proven and quantum of loss established."

The relevance of the bond's commercial purpose was considered by Ackner L.J. in Esal (Commodities) Ltd. v. Oriental Credit Ltd. [1985] AC 546. At page 549, he said :-

"As Mr. Sumption correctly submitted, if the performance bond was so conditional, then unless there was clear evidence that the seller admitted that he was in breach of the contract of sale, payment could never safely be made by the bank except on a judgment of a competent Court of jurisdiction and this result would be wholly inconsistent with the entire object of the transaction, namely to enable the beneficiary to obtain prompt and certain payment...."

Kerr J in R.D. Harbottle (Merchantile) Ltd. v. National Westminster Bank [1977] 2 All ER 862 put the matter in strong words at page 870 :-

"... It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. They are the life-blood of international commerce. Such obligations are regarded as collateral to the underlying rights and obligations between the merchants at either end of the banking chain. Except possibly in clear cases of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts. The courts are not concerned with their difficulties to enforce such claims; these are risks which the merchants take. In this case the plaintiffs took the risk of the unconditional wording of the guarantees. The machinery and commitments of banks are on a different level. They must be allowed to be honoured, free from interference by the courts. Otherwise, trust in international commerce could be irreparably damaged."

(c) The words of Clause 2

Mr Huggins submits that the above quoted judicial and academic pronouncements are all very well provided, it is clear that the Bond in question is not a hybrid or "double" bond. He submits that the words "or conditions" in Clause 2 does, or at least could, means "without proof of conditions". Further, that the use of the word "conditions" could not incorporate the notion of damages. Therefore, as proof of damage is not excluded, it must be included.

This very bond has been the subject of litigation twice before, in 1998 in injunction proceedings before Suffiad J and in 1999 when the same main contractor sought summary judgment on a different contract against the same defendant. Although on both occasions the decisions went against the defendant, it is fair to say that in neither case was the first limb of Mr Huggins' submission (as set out above) argued or considered. In both the previous cases Counsel for the defendant conceded that the bond was an "on-demand" bond.

I cannot accept Mr Huggins' argument for the following reasons :-

Firstly, if the phrase "or conditions" meant "or without proof of conditions", the question must be asked - what conditions are they which the parties to the Bond envisage need not be proved? The only conceivable answer would be, the conditions in the contract. This raises two rhetorical questions : firstly, what possible purpose would there be in stipulating that the plaintiff is not required to prove the conditions generally of the contract before making a call on the bond? It is a "non requirement" unknown or unseen in any other similar bond. Secondly, if there is no need to prove default, i.e. the alleged breach, what purpose is there in specifying that it is also unnecessary to specify the particular condition which may have been breached?

Secondly, Clause 2 continues by stating what the Bondsman shall do, namely "satisfy and discharge the amount identified in the demand of any damages ..." etc. Why refer to the damages in this context if, as Mr Huggins contends there is a duty on the plaintiff to prove damages? If there is a duty to prove damages, the amount would form part of the proof and it would be unnecessary also to stipulate that the Bondsman must pay the amount identified in the demand. If there is no need to prove the breach it follows that there is no need to prove the damage. Or, put rhetorically again, why should there be a requirement to prove damages for breaches which need not be proved? These words in Clause 2 reinforce the contention that this is an "on-demand" bond.

(d) Presumption against demand bonds?

Mr Huggins, as part of his argument, (which has been substantially dealt with above) submits that absent a specific statement that proof of damages is not required, there is a presumption that it is required and absent any proof there can be no liability. I do not accept that such a presumption, applicable to all bonds, exists. The proper approach in determining whether a bond is "on-demand" or not, is to consider the actual bond before the court and construe it according to the words contained in their overall context and in the context of its overall purpose.

2. IS THE DEMAND LETTER VALID?

By a letter dated 21 May 1998, six weeks before the new airport was due to open, the plaintiff made a call on the bond. The material parts of the letter are as follows :-

"3. We confirm that the Sub-Contractor is in default of his obligations under the Sub-Contract.

4. We now demand immediate payment of HK$19,227,015.80 (nineteen million two hundred and twenty seven thousand and fifteen Hong Kong dollars and eighty cents) being the amount payable in accordance with the Bond in respect of damages, losses, charges, costs or expenses sustained by the Employer by reason of such default."

Mr Westbrook's case is that this demand complies with the terms of the bond. Mr Huggins submits it is deficient.

This point, unlike the previous one, was argued before Mr Recorder Kotewall in the 1999 case between the main contractor and the same defendant.

In that case the demand letter had specified an exact sum of damages which was greater than the bonded sum. In this case, the point is taken that because a sum of damages is not identified, then the demand letter is defective and therefore invalid.

Mr Huggins does not go so far as to say that an exact amount of dollars and cents has to be identified. More often than not that would be impossible. Given that the purpose of demand bonds are that they serve as a protection against cash flow problems, the quantification of the alleged defaults will rarely have been made at the time the demand is made. However, he submits, there must be some attempt to identify the damages, even if it is only by saying, for example, a sum greater than or lesser than the bond.

Mr Westbrook submits that the demand letter in Nishimatsu Construction Co. Ltd v American Home Assurance Co. (Mr Recorder Kotewall's case) went further than necessary. He submits that if the likely damage will exceed the bond, it is only necessary to claim the bonded sum as damages. Then the Bondsman may assume that the damages being claimed will exceed the amount of the Bond.

Mr Westbrook accepts, and he is right to do so, that a mere reference to the bond and no more would be insufficient and render the call invalid. However, this demand goes further than that. I am satisfied that its terms are sufficient to comply with the terms of the Bond. It says "We demand ... $19,227,015.80 ... in respect of damages ... sustained by the employer by reason of such default." It is all one sentence and the clear meaning of the above paraphrase is not changed when words which have been omitted are re-instated. The demand is seeking the full sum in respect of damages sustained by the defendant. By the last few words the plaintiff is indicating the causal link between the default relied on and the monetary loss which he claims to have sustained.

In addition, the defendant would at that time be under no illusion about the potential size of the claim against the sub-contractor as, not long before, the Airport Authority had injected $49 million to keep the job going.

Support for the sufficiency of this demand letter in the terms that it is written can be found in one of the principles, which emerges from the case of Cargill International SA v. Bangladesh Sugar and Food Industries Corp. [1996] 4 All ER 563. At 568 Morrison J said :

"However, it seems to me implicit in the nature of a bond, and in the approach of the court to injunction applications, that, in the absence of some clear words to a different effect, when the bond is called, there will, at some stage in the future, be an 'accounting' between the parties in the sense that their rights and obligations will be finally determined at some future date. The bond is not intended to represent an 'estimate' of the amount of damages to which the beneficiary may be entitled for the breach alleged to give rise to the right to call. The bond is a 'guarantee' of due performance. If the amount of the bond is not sufficient to satisfy the beneficiary's claim for damages, he can bring proceedings for his loss. As far as I am aware, and no case was cited to me to suggest otherwise, the performance bond is not intended to supplant the right to sue for damages. Indeed, such a contention would conflict with what I believe to be the commercial purpose of these instruments."

In other words, the "pay now, argue later" principle.

3. OUGHT THERE BE A TRIAL FOR SOME OTHER REASON? (ORDER 14 RULE 3)

Mr Huggins submits that the plaintiff's failure to comply with Order 41 rule 5 amounts to a sufficient other reason for there to be a trial. Order 41 rule 5 states that an affidavit may only contain such facts as the deponent is able of his own knowledge to prove. Complaints are made firstly in relation to certain passages of the plaintiff's affirmation sworn by Mr Douglas Oakervee dated 4 June 1998 and secondly of the affidavit of Mr Alan Ford dated 16 December 1999.

Mr Oakervee, in his affidavit, uses expressions such as "some of my colleagues investigated ...", "The view formed as a result ...", "such view was based on the perception that ..." and "I was informed of the view that ...". All these expressions were related to the plaintiff 's view that "there was, at least, a significant risk that the Authority had already suffered substantial damage, loss or expense by reason of the plaintiff's defaults". Mr Ford's affidavit, similarly, said "the plaintiff's view was that it had already suffered substantial damage .. not yet quantified."

The complaint is that the source of this information is not revealed and the deponent himself does not suggest he has any personal knowledge of what damage, if any, resulted from what defaults.

I do not propose to make a determination on whether or not there has been a failure to comply with Order 41 rule 5. Mr Westbrook submits that it is plain from the reading of the whole of Mr Oakervee's affidavit that his source of information is Mr Ford. He further points out that the affidavits start in the usual way :

"Save where expressly stated, the facts and matters deposed to herein are within my own knowledge and are true. Insofar as any facts and matters deposed to herein are not within my own knowledge, I believe them to be true and the sources and grounds of my belief are stated."

It is reasonable to conclude that Mr Oakervee had applied his mind to the matters he deposed to and concluded, there were good grounds for the belief.

In any event, even if these complaints do amount to breaches (about which I am not convinced), I do not consider them to provide grounds for a trial under Order 14 rule 3. Examples of good grounds given in the Supreme Court Practice are "when the defendant is unable to get in touch with a material witness" or "the claim is of a highly complicated or technical nature", or "the plaintiff may have acted harshly or unconscionably". In other words it provides a safety net where justice might be defeated by the strict application of Order 14. Here, the issue is an arguable breach of the rule governing how affidavits should be drafted. Such an issue in my judgment does not merit a trial in the face of successful Order 14 proceeding.

Summary judgment will be granted. Once the issue of construction has been decided in the plaintiff's favour and once it is determined that the demand letter is not defective, there is no defence to the action. The Defence as pleaded raised two issues that :-

(a) the demand letter was not valid because it failed :-

(i) to identify the default relied on (not relied on by Mr Huggins);

(ii) to quantify or substantiate damages (which I have found it did); and

(iii) to identify a causal link between the default and the damage (which I have found it did).

(b) the demand letter was not made in good faith (not relied on by Mr Huggins).

Although the question of interest was not argued at the time of the hearing, it may assist if I set out my provisional view on the question of interest. I consider that it would be difficult to argue against the order made by Mr Recorder Kotewall in the 1999 proceedings, namely that there should be interest at 1% over prime from the date of the discharge of the injunction, 19 June 1998. If such an award of interest is not seriously challenged, then further costs will be saved.

As to costs, I see no reason why they should not follow the event. Accordingly I make an order that the costs of the summons be to the plaintiff, to be taxed if not agreed.