CLA ENGINEERING LTD v. DBS BANK (HONG KONG) LTD AND ANOTHER

HCMP 273/2018

[2018] HKCFI 626

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 273 OF 2018

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JUDGMENT

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Introduction

1.  On 2 March, the plaintiff, CLA Engineering Ltd (“CLA”), applied ex parte for an order restraining the 1^st defendant, DBS Bank (Hong Kong) Ltd (“the Bank”), from paying the sum of $8.2 million to the 2^nd defendant, Leighton Contactors (Asia) Ltd (“Leighton”), under a performance bond issued by the Bank at the request of CLA in favour of Leighton.  In case that sum had already been paid to Leighton, CLA also sought an order compelling Leighton to hold the sum as security and on trust for the Bank.  An order in those terms was made by Deputy Judge To that day.  He fixed 16 March as the return date.  No originating process had then been issued.

2.  The order did not specify what the return date was for, but what Deputy Judge To must have had that date in mind for was the hearing of an inter partes summons for the continuation of the order. No such summons was issued.  Instead, CLA issued an originating summons seeking the relief which Deputy Judge To had granted until a final award had been made in proposed arbitration proceedings between CLA and Leighton.  That was one of the summonses returnable on 16 March.  Also returnable on that day was a summons issued by Leighton for the discharge of the order of 2 March, and since the skeleton submissions filed in support of that summons referred to the absence of any summons for the continuation of the order, CLA filed such a summons on 14 March, asking for the time for it to be served to be abridged. This is the court’s judgment on the latter two summonses, no arguments having been addressed on the originating summons.

The relevant facts

3.  The facts can be stated relatively shortly. Leighton is the contractor for the design and construction of the Wynn Palace casino resort on the island of Kotai in Macau.  Leighton subcontracted the work relating to the landscape and façade lighting of the project to CLA.  The price for the work was $82 million, and CLA was required by the subcontract to provide a performance bond (“the Bond”) in favour of Leighton equal to 10% of the price for the work, namely $8.2 million.  The Bond was duly issued by the Bank with whom CLA’s parent company had an account.  Broadly speaking, the Bank agreed to pay to Leighton the sum of $8.2 million if CLA failed to perform its obligations under the subcontract.

4.  The validity of the Bond was extended from time to time.  It was due to expire on 26 August 2017, but shortly before its expiry a dispute arose between CLA and Leighton over whether the validity of the Bond should be further extended. That was because CLA was unwilling to sign a document (described in the subcontract as a “Final Release and Waiver of All Claims and Lien Rights”) (“the Release Document”) which acknowledged that it had no claims against Leighton. CLA was saying that it had not been able to complete the works it had agreed to do because Leighton and the employer had delayed in giving CLA’s workforce access to particular parts of the site.  That had resulted in additional expenditure for CLA.  However, CLA acknowledged that in view of the terms of the Bond, the Bank would ultimately agree to a further extension of the Bond, and the Bond’s validity was duly extended for six months to 26 February 2018.

5.  Shortly before 26 February, representatives of both CLA and Leighton met.  There is a difference of emphasis between them about what was said.  CLA says that its representatives were told that Leighton wanted the Bond extended for a further month, and that during that time, Leighton would call in the $8.2 million, use the funds to buy “outstanding light fixtures” and get CLA to install them at CLA’s cost.  Leighton says that that possibility was only raised by its representatives when they were discussing one way in which the parties’ differences might be resolved.  The upshot of the meeting was that CLA was not prepared to agree to an extension of the Bond’s validity.

6.  As a result of that, on 21 February Leighton wrote to the Bank requiring it to pay to it the whole of the $8.2 million payable under the Bond on the basis that CLA had failed to perform some of its obligations under the subcontract.  For its part, the Bank informed CLA that if no instructions were received from CLA by 27 February, it would “debit” CLA’s account with the sum of $8.2 million together with “all related charges”.  In other words, the Bank proposed to pay the $8.2 million to Leighton.  The Bank subsequently confirmed that that was what it would do if the validity of the Bond was not extended.  Faced with that ultimatum, CLA reluctantly offered to extend the validity of the Bond, and informed the Bank of that on 1 March.  CLA’s willingness to extend the validity of the Bond was expressed to be “without prejudice”.  It did not identify what that willingness was without prejudice to, but presumably CLA was saying that its willingness to extend the validity of the Bond should not be treated by Leighton as an admission by CLA that the validity of the Bond should have been extended.

The ex parte application and its aftermath

7.  The ex parte application to Deputy Judge To was made by counsel who had been called relatively recently.  The skeleton argument for the hearing of the application was drafted by him.  It explained that the reason for the application was that CLA had not received any response from either the Bank or Leighton to its offer to extend the validity of the Bond, and CLA feared that Leighton would require the Bank to pay to it the $8.2 million, which Leighton would use for what it had threatened at the meeting on 21 February to use it for.   

8.  The skeleton argument went on to assert that on its proper construction the Bond was a “conditional” bond, not an “on demand” one.  It did not spell out the relevance of that distinction, but it added that if the Bond was an “on demand” one, it would be “unconscionable” for Leighton to require the Bank to pay the $8.2 million to it.  In addition, the skeleton argument referred to the injunction being sought as an interim proprietary injunction.

9.  In the event, the $8.2 million had not been paid by the Bank to Leighton, and in due course CLA invoked the provisions in the subcontract for resolving disputes by issuing a notice of arbitration dated 15 March.  CLA says that this arbitration is the appropriate forum for the dispute over the extension of the validity of the Bond to be resolved in, and that the injunction (or something similar) should remain in place so that the status quo can be preserved for the time being. 

The relevance of the nature of the Bond

10.  Performance bonds are not uncommon in the construction industry.  They protect the contractor against the subcontractor’s insolvency or the subcontractor’s inability or unwillingness for other reasons to perform its obligations under the subcontract.  But they will generally only be a valuable safeguard for the contractor if payment under the bond has to be made “on demand” and is not conditional upon proof of some primary liability—in other words, where a demand for payment under the bond is not conditional on the subcontractor’s liability to the contractor for sums which the bond was intended to secure having been established.  The reason why such bonds will generally be unacceptable to the contractor is that there will have to be an extensive investigation of the facts, and possibly a lengthy trial, before payment under the bond has to be made. 

11.  An “on demand” bond used to be rare: see what Hunter JA had to say about them in Tins’ Industrial Co Ltd v Kono Insurance Ltd [1988] 2 HKLR 36 at p 39F–H. But they were revived in the 1970s, and their utility was encapsulated in the classic statement of principle in the judgment of Kerr J (as he then was) in R D Harbottle (Mercantile) Ltd v National Westminster Bank Ltd [1978] QB 146 at pp 155G–H and 156A–C:

“ 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 …. 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.

   … Banks are not concerned with the rights or wrongs of the underlying disputes but only with the performance of the obligations which they themselves have confirmed.”

That led Hunter JA in Tins’ Industrial to say at p 40A that the courts have:

“ … allied these performance bonds payable on demand with confirmed letters of credit. They said that you have to look to the terms of the separate contract between the bankers, in the same way as you do in looking at confirmed letters of credit, and that for those reasons you were not concerned with the underlying contract.”

12.  The important feature of performance bonds is that a bank which provides a performance bond must honour the bond according to its terms.  So if a performance bond provides for payment on demand, and the bank’s obligation to make that payment is unconditional, it is obliged to make that payment save in very limited and exceptional circumstances such as fraud.  On the other hand, if the bank’s obligation to pay on demand is conditional— for example, on the actual performance of the underlying transaction or the contractor having suffered loss—it is only obliged to make the payment if the conditions are satisfied.  It follows that if the bank’s obligation under the bond to pay the sum in question on demand is unconditional, the courts will not interfere, by way of an interim injunction or otherwise, to restrain the bank from paying that sum.  To do so would be to prevent the bank from honouring its obligations under the bond.  On the other hand, it may well be appropriate for the courts to prevent payment under a performance bond if the bank’s obligation to make the payment is conditional—for example, if there were express conditions limiting the circumstances in which the contractor could draw on the bond—and if any of the conditions for its payment have not been satisfied: see, for example, Sirius Insurance Co v FAI General Insurance Ltd [2003] 1 WLR 2214, and the discussion about the case in Jack: Documentary Credits, 4^th ed, para 9.78.

13.  These are relatively well-known principles.  They were not spelt out to Deputy Judge To, but he is an experienced judge, having sat for many years as a substantive High Court judge, and he might have known them.  However, it would have been prudent to remind the judge of them, so that he would have been clearly alive to the need for CLA to satisfy him that there was “a serious question to be tried” over whether (a) this was a bond under which the obligation to pay Leighton was conditional, and (b) the conditions had not been satisfied in their entirety.

14.  I put the words “a serious question to be tried” in inverted commas because it is recognised that a higher threshold is called for when an application is made to restrain a bank from making a payment under a performance bond.  As Chow J said in Grande Cache Coal LP and anor v Marubeni Corporation and anor (HCA 2136/2015) at [32]: 

“ … [a] higher threshold is required to be met [in such a case]—that threshold has variously been described as ‘it is positively established that the party was not entitled to draw down’, or ‘a strong case’ has been shown, or ‘the “serious issue to be tried” threshold is in practice a more difficult one to overcome’, or ‘it has clearly been established that the beneficiary is precluded from making a call by the terms of the contract’.”

It does not look as if this was drawn to Deputy Judge To’s attention either.

The nature of the Bond

15.  Both Mr Nigel Kat SC for CLA (who was not involved in the case at the time of the hearing before Deputy Judge To) and Mr Richard Zimmern for Leighton agree that the critical issue is the proper construction of the Bond.  Was this an “on demand” one or a “conditional” one?  The Bond was required by clause 26 of the subcontract, and the Bond had to be in the form appearing in the Tenth Schedule to the subcontract.  Apart from a few words which are not material for present purposes, the Bond was in that form.  

16.  Mr Kat accepted that the first few paragraphs of the Bond are consistent only with it being an “on demand” bond.  The Bond took the form of a letter from the Bank to Leighton.  Ignoring those words which are either repetitious or not material, and focusing on the core language of the Bond, the key paragraph reads as follows:

“ We…hereby irrevocably and unconditionally guarantee the payment to you…of a sum…of…$8,200,000.00 (the ‘Guaranteed Sum’) and accordingly…agree that upon receipt of a written demand in the manner specified below, and notwithstanding any objection made by [CLA] and without any right of set-off or counterclaim, we shall pay you…such amount…as shall have been so demanded…up to, but not exceeding, in the aggregate the Guaranteed Sum.”

The Bank’s obligation to pay was therefore triggered by “a written demand in the manner specified below”, and once such a demand had been made, the obligation to pay was unconditional.

17.  The Bond stipulated that the demand for payment had to:

“ … be accompanied by a written statement signed by [Leighton] … certifying that [CLA] had failed to perform all or any of its obligations under the [subcontract] (with the identification of such obligation which has not been performed) and the amount of the damages claimed by [Leighton] as a result of such failure, which amount shall be paid to you in connection with such demand … (but not to exceed, in aggregate …, the Guaranteed Sum).”

The Bond went on to say that any such statement:

“ … shall be conclusive evidence … [of](a) the occurrence or non-occurrence of any failure by [CLA] to perform any of its obligations under the [subcontract], and (b) the amount of any such damages …, and we shall have neither the right nor the obligation to challenge the accuracy or sufficiency of such statement.”

That accords with common practice.  A bank issuing a performance bond of this kind is not concerned with the commercial relationship between the contractor and subcontractor, nor with the question whether the subcontractor has performed its obligations under the subcontract.

18.  Mr Kat does not dispute that Leighton’s letter to the Bank of 21 February amounted to a written demand of the kind contemplated by the Bond, or that the statement accompanying it satisfied the requirements of the Bond for what such a statement should contain.  The damages set out in that statement were in excess of $8.2 million, and that was why the demand was for the payment of $8.2 million.  Subject, therefore, to two later paragraphs in the Bond, the Bank’s obligation to pay the $8.2 million to Leighton had been triggered.

19.  The first of those paragraphs reads:

“ This Bond shall remain valid and in force until, and our liability hereunder shall cease and terminate, … on whichever of the following first occurs:

(a) the date [CLA] has finally performed all of its obligations under the [subcontract] as confirmed by [Leighton] in writing; or

(b)   such date at it may be extended as provided below, the ‘Long Stop Date’ ie 26 February 2018.”

Something has gone wrong with the drafting of (b).  It only makes sense if it is read as saying “such date as it may be extended [to] as provided below [beyond] the ‘Long Stop Date’ ie 26 February 2018”.

20.  Leighton never confirmed in writing that CLA had performed all its obligations under the subcontract.  Accordingly, the Bond could only be extended beyond 26 February in accordance with any subsequent provisions in the Bond.  The only subsequent provision in the Bond which dealt with the circumstances in which the Bond could be extended beyond the “Long Stop Date” of 26 February was the next paragraph.  That is the paragraph which CLA says makes this a “conditional” bond.

21.  The paragraph reads:

“ Notwithstanding the foregoing, we hereby irrevocably agree that if [the Release Document] is not [executed and] issued by [CLA] … on or before the date (the ‘Renewal Date’) that is thirty (30) days prior to the Long Stop Date then-in-effect, and if [CLA] has not provided to you a replacement or renewal letter of guarantee satisfactory to you … on or prior to the Renewal Date, then we shall,upon written request made by you not earlier than the Renewal Date, renew this Bond by extending in writing the Long Stop Date to a date that is no earlier than one year from such Renewal Date. We further agree that if we fail to so to extend the Long-Stop Date within three (3) business days following such request you may make demand for, and we shall immediately pay to you, the entire remaining balance of the Guaranteed Sum not theretofore advanced; provided that by making such demand you shall be deemed to have agreed that (i) the amounts so paid to you shall be held by you as security for the full and faithful performance of each of the obligations of [CLA] under the [subcontract], and (ii) subject to the full and faithful performance of such obligations, you will return such amounts (or the remaining balance thereof) to [CLA] upon the issuance of [the Release Document] in accordance with the [subcontract], or as otherwise required by applicable law. The provisions of this paragraph shall apply, and we hereby agree to continue to extend the Long Stop Date, until [the Release Document] is [executed and] issued in accordance with the [subcontract].” (Italics supplied)

The only parts of this paragraph which were quoted in the skeleton submissions considered by Deputy Judge To were those which I have put in italics.

22.  CLA points to two things which are said to show that this provision made the Bond a “conditional” one.  First, the initial words “[n]otwithstanding the foregoing” are said to show that this provision was in contrast to what had gone before, so the fact that this had hitherto appeared to have been an “on demand” bond was no longer the case. Secondly, this paragraph is said to have made the payment of the $8.2 million subject to three conditions:

  (i)   CLA had not to have executed and issued the Release Document by 27 January;

  (ii)   CLA had not to have provided Leighton with some other form of guarantee by that date; and

  (iii)   after that date Leighton had to have requested in writing the extension of the validity of the Bond to 27 January 2019 at the earliest.

Mr Kat did not suggest that the first two of these conditions had not been satisfied.  But it is plain that the third had not been, because by its letter of 21 February Leighton had sought payment of the $8.2 million, rather than an extension of the validity of the Bond. The argument therefore is that since that condition had not been satisfied, the Bank’s obligation to pay the $8.2 million to Leighton had not been triggered.

23.  I cannot go along with this argument at all.  It falls down at the first hurdle.  The paragraph on which CLA relies is not about the circumstances in which Leighton can call for payment of the $8.2 million.  It is all about the circumstances in which the validity of the Bond had to be extended.  It says nothing about any conditions to be placed on any demand by Leighton prior to 26 February for the payment of the $8.2 million.  So when the paragraph in question talked of “[n]otwithstanding the foregoing”, it was referring to the Bond’s validity up to 26 February.  In other words, it was saying that, notwithstanding the expiry of the Bond on 26 February, its validity had to be extended in the circumstances set out in the following paragraph, and that if the Bank failed to extend its validity, it would make such payment to Leighton as the second sentence in the paragraph in question required.  It follows that there was nothing in the paragraph in question to make the Bond something other than an “on demand” bond.

The unconscionability of the demand for payment of the $8.2 million  

24.  As I have said, the contention before Deputy Judge To was that even if the Bond was an “on demand” bond, it was unconscionable for Leighton to demand payment of the $8.2 million in view of what CLA claims its representatives had said the $8.2 million would be used for.  Mr Kat did not develop this argument orally. He was right not to do so.  Para 15-029 of Gee, Commercial Injunctions, 6^th ed, explains why unconscionability is not recognised by our courts as a sufficient basis to restrain a payment due under a performance bond.

The alternative relief

25.  Perhaps recognising the difficulties faced in relying on the arguments which appealed to Deputy Judge To, Mr Kat advanced an alternative form of relief if the court took a different view about whether there was a serious issue to be tried over the proper construction of the Bond.  He needed to have the court’s leave to amend CLA’s inter partes summons if he was to seek this relief.  The relief sought permitted the Bank to pay the $8.2 million to Leighton, but it sought to restrain Leighton from dealing with the $8.2 million “other than as security and in accordance with the terms of the … Bond”.

26.  The argument is predicated on the language of the provision in the Bond that, if the Bank paid the $8.2 million to Leighton, the sum would “be held by [Leighton] as security for the full and faithful performance of each of the obligations of [CLA] under the [subcontract]”.  Mr Kat beguilingly argued that this revised form of relief merely required Leighton to do that which it had already been required to do under the Bond.  I do not agree.  The flaw in the argument is that Leighton’s obligation to hold the money as security for CLA’s performance of its obligations under the subcontract only arose on the occurrence of the event specified in the material paragraph in the Bond, namely if the Bank did not comply with a request from Leighton to extend the validity of the Bond.  Leighton did not request the Bank to extend the validity of the Bond beyond 26 February.  Instead on 21 February it required the Bank to pay $8.2 million to it.  When the Bank does that following the discharge of the injunction—as it must do to comply with its obligations under the Bond—it will be doing so, not because it did not comply with a request to extend the validity of the Bond, but because it had already been requested to pay the sum to Leighton.  When it does so, Leighton will not be bound to hold the sum as security for CLA’s performance of its obligations under the subcontract, because that obligation on Leighton’s part only arose if the Bank had been requested to extend the validity of the Bond, and no such request had been made.

27.  The position might have been different if the clause in the subcontract requiring CLA to have a performance bond issued in favour of Leighton had expressly provided that it was to secure CLA’s obligations under the subcontract.  But in the absence of such a provision and the non‑applicability of the provision in the paragraph in question in the Bond, CLA has to rely on the general law to say that Leighton would be holding the money on trust for CLA.  The law suggests otherwise: see the compelling judgment of Tomlinson LJ in Wuhan Guoyu Logistics Group Co Ltd and anor v Emporiki Bank of Greece SA (No 2) [2014] 1 All ER (Comm) 870.

Material non-disclosure

28.  Mr Kat realistically accepted that Deputy Judge To had not been given the assistance he had been entitled to expect, and he did not challenge the assertion made on Leighton’s behalf that there had been material non-disclosure at the hearing before Deputy Judge To.  His attention should have been drawn to the whole of the material paragraph in the Bond and not just the italicized words identified above.  Had the whole of the paragraph been brought to his attention, he would have understood the important context in which the italicized words had been used.  He should have been given some explanation of the relevance of the distinction between “on demand” and “conditional” bonds, and why the courts were keen to enforce them according to their terms irrespective of the merits of any underlying dispute.  He should have had drawn to his attention the view which the law takes about the extent to which the courts permit an attack on a demand for payment under a performance bond on the ground that the demand is unconscionable.  He should have been told of the higher threshold test which applies to applications of this kind.  And he should not have been told that this was an application for a proprietary injunction.  As Gee, op cit, says at para 15-033:

“ If payment is made under a performance bond …, [i]t is implicit that there will be mutual accounting, with the beneficiary repaying any excess over any loss caused by failure to perform or breach of contract. The right to mutual accounting gives rise to a creditor/debtor relationship and not to any proprietary right in the proceeds.” (Emphasis supplied)

29.  In the circumstances, I would have discharged the order made by Deputy Judge To on this ground had I not been discharging it for the reasons set out in this judgment, but I would not have let this non-disclosure prevent me from making a new order had I thought one to be appropriate.  There is no reason to think that the non-disclosure was anything other than entirely innocent, and was the result of inexperience on the part of counsel who had not been called for very long.

Conclusion

30.  I am prepared to abridge CLA’s time for serving its inter partes summons, because there is no reason to suppose that it was not just overlooked.  I assume that CLA’s legal team thought that the issue of the originating summons returnable on 16 March was sufficient.  In any event, no prejudice was suffered by Leighton.  Mr Zimmern was able to marshal all his arguments despite having insufficient notice of the filing of the summons.  The same applies to the amendment of the summons.  I give leave for the summons to be amended.  I imagine that the desirability of claiming the alternative relief was only appreciated when Mr Kat joined CLA’s legal team, and again Mr Zimmern was able to deal with the amendment.

31.  However, for the reasons I have endeavoured to give, I discharge the order made by Deputy Judge To, and I dismiss CLA’s applications for (a) a new order in the terms of the previous one or (b) an order in the terms of the alternative relief sought by CLA.  At the conclusion of the hearing, I continued the order of Deputy Judge To until judgment on the summonses before me was handed down in order to maintain the status quo for the time being.  It goes without saying that the continuation of the order for these few days does not affect the dismissal of CLA’s applications.

32.  I turn to costs.  At present I see no reason why CLA should not pay to Leighton its costs of and occasioned by both summonses, to be taxed if not agreed, and I make an order nisi to that effect. However, I am not inclined to order that those costs be taxed on the indemnity basis.  There is no reason to think that this was a deliberate attempt to steal an unfair march on Leighton.  On the contrary: there is every reason to suppose that there was here a genuinely, albeit misguided, belief that there was nothing more to disclose than what was being disclosed.