AMERICAN HOME ASSURANCE CO. v. JAMES STAINLESS STEEL LTD.

HCA 11833 of 1994

IN THE HIGH COURT OF HONG KONG SAR

COURT OF FIRST INSTANCE

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REASONS FOR JUDGMENT

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1. At the conclusion of the Trial of this Action. I gave Judgment in favour of the Plaintiff and indicated I would give my Reasons for the Judgment later. I now hand down my Reasons.

2. The Defendant, James Stainless Steel Ltd. was a construction sub-contractor. Mr. James Man was the top man of the Defendant. In mid-1992, the Defendant wished to secure a sub-contract from the contractor Paul Y. Sogeta Ltd. (hereinafter referred to as "PY") in relation to the installation of aluminium cladding for Bridges 4, 5 and 6 of the Hillside Escalator Link. PY required the Defendant to procure a surety bond for the amount of 10% of the Sub-Contract value. It was in these circumstances that the Defendant turned to the Plaintiff, an insurance company with a capacity to issue appropriate performance and surety bonds. The Defendant however did not go directly to the Plaintiff. Sun Hung Kai Insurance Consultants Ltd. ("SHK") acted as the agent of the Defendant in obtaining the surety bond. Benny Wong, the person in SHK dealing with this matter, sought and received from the Defendant appropriate financial and business details of the Defendant and supplied these to the Plaintiff. This was done so that the Plaintiff could properly assess whether it was willing to issue the requested surety bond and if so, to decide at what price and on what terms it was willing to do so. After receiving the financial information from Benny Wong in early August 1992, the Plaintiff indicated to Benny Wong a willingness to consider issuing the surety bond, subject to satisfactory receipt of various documents including a completed application. The Plaintiff also asked for the requested bond wording. By Fax dated 8th August 1992, the Defendant supplied to SHK the bond wording required by PY (see pages 7-8 of Bundle) which bond wording was passed on by SHK to the Plaintiff by the Fax of SHK dated 10th August 1992 but with Clause 5 relating to expiry of Guarantee on 31st March 1992 deleted.

3. By Fax dated 12th August 1992 ("Quotation Fax") from the Plaintiff to SHK, the Plaintiff offered to issue the requested surety bond on, inter alia, the following terms:-

1. Bond sum $942,500;

2. Collateral deposit of 25% of bond amount in either cash or letter of credit from an acceptable bank;

3. Duly Executed Corporate Indemnity from the Defendant company;

4. Duly Executed In-Fund Letters from two major directors of the Defendant;

5. .........;

6. Premium rate is 1% on Bond amount;

7. .........

By Fax of the same date, SHK informed the Defendant of the above stated terms of the Quotation Fax. On behalf of the Defendant, SHK by its Fax dated 15th August 1992 ("Acceptance Fax") accepted the terms for the issue of the surety bond contained in the Quotation Fax and SHK asked the Plaintiff to issue and forward the policy document, namely the surety bond on or before 17th August 1992.

4. The next stage in the development was the step taken to satisfy the security requirement of the Plaintiff to furnish the Letter of Credit. On 17th August 1992, SHK sent a Fax to the Defendant attaching the sample wording of the Letter of Credit required by the Plaintiff and included in the sample Letter of Credit wording was the Evergreen Clause which was a provision whereby the credit would be automatically renewed from year to year. There were subsequently a great deal of activities involving the furnishing of Letter of Credit by Sin Hua Bank at the request of the Defendant to satisfy the Letter of Credit requirement of the Plaintiff under the Quotation Fax. On the 8th of September 1992, Sin Hua Bank issued a Letter of Credit in favour of the Plaintiff. On the 9th of September 1992, Michael Yuen of SHK telephoned Liang of the Plaintiff and requested that the Surety Bond be issued and undertook that the Defendant would execute and return all the necessary documentation as soon as possible. By a later fax of the same date, SHK reminded the Plaintiff to have the surety bond ready for collection the next day and that at that time SHK would also hand over the Sin Hua Bank Letter of Credit, copy of which was sent with the fax. There was a conversation between Gladys Fung of the Plaintiff and Sidney Ku of SHK in the morning of the 10th September 1992 about the necessity to amend the Sin Hua Letter of Credit with an Evergreen Clause and an undertaking by the Defendant to make a cash deposit should such Sin Hua Amended Letter of Credit not be furnished. Later that day on the 10th of September 1992, Gladys Fung of the Plaintiff handed to Sidney Ku of SHK the Surety Bond, the subject matter of this Action ("Surety Bond"). Also handed over at the same time by the Plaintiff to the Defendant through the Defendant's agent, SHK were the Corporate Indemnity and the Directors' In Fund Letters which were to be signed by the Defendant's side and returned to the Plaintiff, as had been earlier agreed and as made further clear by a letter dated 10th September 1992 from Gladys Fung addressed to Benny Wong which letter was given to SHK at the meeting. The original of the Sin Hua Bank Letter of Credit was given by SHK to the Plaintiff also at the same meeting.

5. On the 19th of November 1993, PY made a claim under the Surety Bond against the Plaintiff. By letter dated 29th November 1993, SHK requested the Defendant to deliver the signed Corporate Indemnity and Directors In Fund letters as required at the time of the handing over of the Surety Bond. By letter dated 8th December 1993, the Defendant asked that no payment be made to PY under the Surety Bond. On 23rd December 1993, an High Court Action was commenced by PY against the Plaintiff for the enforcement of the Surety Bond and on 7th January 1994, accepting that the Surety Bond was a demand bond and that therefore the Plaintiff was obliged to make payment, the sum of $942,500 was paid by the Plaintiff to PY.

6. By Fax dated 21st January 1994, SHK informed the Defendant that the Plaintiff had paid out under the Surety Bond and reminded the Defendant to furnish the signed Corporate Indemnity and Directors' In Fund Letters. There was a reminder on 15th May 1994. By letter dated 25th August 1994, the Plaintiff asked SHK to look through SHK files to see whether it has in its file, the signed Indemnity and In Fund Letters said to have been returned by the Defendant to SHK (as suggested by SHK in an earlier telephone conversation) and if such documents were in the SHK file to send them to the Plaintiff. SHK was also asked to seek confirmation from the Defendant that such signed documents had been sent to SHK, should SHK be unable to find these documents in its file. By letter dated 6th September 1994, SHK asked the Defendant for confirmation that the Defendant had already sent to SHK the signed application form, Corporate Indemnity and In Fund Letters. By letter dated 8th October 1994, the Defendant informed SHK that the Defendant had returned the application form but that in respect of the Corporate Indemnity and In Fund Letters, as SKH had given the Letter of Credit, there was no need to give the Corporate Indemnity and In Fund Letters and there was agreement by the staff of SHK with the Defendant not to require these documents. It is common ground that the Defendant refused to return to SHK and to the Plaintiff, any signed Corporate Indemnity or In Fund Letters. It is in these circumstances that the Plaintiff is now suing the Defendant for its liability in respect of its Corporate Indemnity which the Defendant had undertaken and agreed to.

7. The issues in this case, as clearly put by Mr. Wong for the Plaintiff in his closing submissions, are simple and limited to what he called the Agreement Issue and the Construction Issue. The Agreement Issue is on the question of whether the Defendant had agreed to give the Corporate Indemnity, in other words to indemnify the Plaintiff. The Construction Issue is on the question of whether on the true construction of the Surety Bond, the liability of the Plaintiff to PY is simply on demand basis or dependant on PY establishing Defendant's fault and liability to PY under the Sub-Contract.

AGREEMENT ISSUE

8. At the early stage of the Trial, there was a concession by Mr. Chong, Counsel for the Defendant that arising out of the implication of law, the Plaintiff as surety has a right of indemnity against the principal debtor for reimbursement of the sum paid to the creditor. I agree with Mr. Wong, that once this concession had been made by the Defendant, the Agreement Issue must be decided in favour of the Plaintiff. Strictly speaking therefore it is wholly unnecessary for me to further consider the other basis on which Mr. Wong has argued that I should find liability to indemnify. But as the matter had been ventilated, I will briefly indicate my conclusions on these other grounds for founding indemnity liability.

9. The terms of the Quotation Fax of the Plaintiff containing the requirement for Corporate Indemnity were accepted by the Acceptance Fax of SHK. It follows therefore (and the contrary is unarguable) that the Defendant was liable to give the Corporate Indemnity. This is the second basis for founding liability under the Agreement Issue.

10. Mr. Wong submits that the third basis for establishing liability under the Agreement Issue is the admission by the Defendant in its letter dated 8th October 1994 (page 104 of Bundle) that it had executed and returned the Application for Surety Bond which contained the Indemnity requirement. I accept his submission.

11. The fourth basis for liability against the Defendant is that by the oral agreement on 9th of September 1992 between Michael Yuen of SHK and Kenneth Liang of the Plaintiff, SHK on behalf of the Defendant had agreed to deliver to the Plaintiff the Corporate Indemnity in consideration of the Plaintiff issuing the Surety Bond. Kenneth Liang gave brief but good oral evidence before me and I accept him as a truthful and reliable witness. In this context I should also mention that I also accept the evidence of Miss Gladys Fung who gave much fuller evidence for the Plaintiff. On the other hand, I reject the evidence of Mr. James Man who for me was not a witness of truth. I reject all his evidence in so far as they purport to deny liability for the Surety Bond.

12. The fifth and last basis for liability on the indemnity point is the acceptance by Sidney Ku of SHK on behalf of the Defendant on the 10th September 1992 that the Surety Bond was only delivered to SHK on the basis of the letter dated 10th September from Gladys Fung to Benny Wong, namely that the Defendant was obliged to return the signed Corporate Indemnity and In Fund Letters to the Plaintiff. Again in this connection, there is the solid evidence of Miss Fung supported by contemporaneous documentation and nothing credible from the Defendant's side to overcome such evidence.

13. Mr. Chong for the Defendant valiantly attempted to make various points to cast doubt on the existence of the liability of the Defendant to indemnify the Plaintiff but I do not find these points have any substance. I have no doubt that it was the agreement of the parties that the Defendant would indemnify the Plaintiff. I hold therefore in favour of the Plaintiff on this first Issue.

CONSTRUCTION ISSUE

14. The second Issue on the nature of the Surety Bond turned out to be eventually the real battle ground between the parties. It turns on the construction of the Surety Bond which reads:-

"NOW WE, JAMES STAINLESS STEEL LTD. and AMERICAN HOME ASSURANCE COMPANY called collectively "the Surety" HEREBY JOINTLY AND SEVERALLY GUARANTEE TO PY SOGEA LTD. punctual true and faithful performance and observance by the Sub-Contractor of the obligations terms and conditions to be performed and observed by him under the terms of the Sub-Contract and of any agreement entered into between the Contractor and the Sub-Contractor pursuant to the Conditions of Sub-Contract forming part there of (hereinafter called "the Sub-Contract Agreement") and jointly and severally undertake to be responsible to the Contractor as Sureties for the Sub-Contractor and irrevocably undertake to pay immediately to the Contractor upon written demand any sums up to HK$942,500.00."

Before embarking on the task of construction, it is important to bear in mind the commercial reality and reason behind the Contractor PY requiring such a Surety Bond from the Sub-Contractor Defendant before the Contractor would enter into the Sub-Contract with the Sub-Contractor. It is well known that disputes often arise with construction agreements between the contractors and sub-contractors and these disputes are known to take a long time before it can be determined whether the subcontractor is liable to the contractor and for how much. To avoid this sort of prolonged difficult dispute, this kind of demand bond was introduced into the commercial arrangement between contractors and sub-contractors. The contractor would refuse to go into any subcontract with the subcontractor unless the subcontractor can put up a surety bond (up to usually 10% of the subcontract value) which will enable the contractor to obtain payment on demand without proof of default by the subcontractor. The underlying commercial purpose is that the contractor will have the immediate cash flow of the 10% sum under the Surety Bond and the larger dispute between the parties if any under the sub-contract can take its time to resolve itself. If liability under the Surety Bond is dependent on establishing default of the Sub-Contractor under the Sub-Contract, the whole value of the Surety Bond to the Contractor would be either nil or largely lost. If the Surety Bond is not a demand bond in nature, then the whole commercial purpose of the Surety Bond would be frustrated. In my view, in construing the relevant provision of the Surety Bond, I must firmly have this commercial reality in mind and that I should give a commercial life to the document if I can and not seek to interpret the document so as to substantially deny its purpose or meaning.

15. For me the relevant provision of the Surety Clause is quite simply. It contains two parts, the first part is a guarantee of the Defendant and the Plaintiff as Sureties to perform the Sub-Contract and its terms and the second part is an unconditional undertaking by each of the Defendant and the Plaintiff to PY that each will on written demand of PY pay immediately to PY the sum demanded not exceeding HK$942,500. The first part can be said to be a promise with a condition but the second part relating to the payment on demand is simply an unconditional agreement without condition. The argument of Mr. Chong is that the second part is qualified by the first part and therefore the second part is with a condition, namely default of the Sub-Contractor. There is a very important "and" which separates the first part from the second part and as I read the provision, the second part is an independent undertaking in no way related to the first part. I have no doubt therefore that the Surety Bond is not a conditional bond but is a demand bond.

16. I have been referred to examples of the various types of bonds from the decided cases, some are of the demand bond variety and some are of the conditional bond variety. Each of these cases has its own factual matrix and different document wording. Their assistance to me is limited but having considered them carefully, I am reinforced in my conclusion that the Surety Bond under consideration is a demand bond without condition and is not an "on default" guarantee or bond. It follows therefore that the Defendant's second objection to enforcement of the Surety Bond also fails.

17. In the circumstances, I ordered that judgment be entered against the Defendant in the amount claimed together with interest thereon at 2% above prime from 7th of January 1994. The Plaintiff was also granted the costs of the Action.