Hong Kong – Court Upholds Validity Of Calls On Contractor’s Bond.

24 April 2020

 

Introduction

 

West Kowloon Cultural District Authority v AIG Insurance Hong Kong Limited [2020] HKCFI 569, concerned a bond obtained by the contractor, Hsin Chong Construction Company Limited (Hsin Chong), from the Defendant, AIG Insurance Hong Kong Ltd (AIG), in favour of the Plaintiff, West Kowloon Cultural District Authority (West Kowloon), as required under a construction contract. The Court rejected AIG’s argument that demands upon the bond were invalid because they did not comply with the terms of the bond. It also rejected its argument that demands on the bond were made in bad faith. 

 

Background

 

By General Conditions of Contract for Building and Civil Engineering Works (Contract), West Kowloon engaged Hsin Chong as contractor for a project.

 

Clause 14(1) of the Contract required Hsin Chong to obtain and provide to West Kowloon a bond in its favour from a bank or other financial institution, valid until completion of the works. Hsin Chong procured AIG to issue to West Kowloon a Form of Contractor’s Bond for HK$297,198,000 (Bonded Sum).

 

Clause 2 of the Bond provided that “If, in [West Kowloon’s] opinion, [Hsin Chong] is or has been in default in respect of any if its obligations under the Contact, [AIG] shall upon demand made by [West Kowloon] in writing and without conditions or proof of the said default or amount demanded, pay the amount identified in the demand in respect of the damages, losses, charges, costs or expenses sustained by [West Kowloon] by reason of the default, up to the amount of the Bonded Sum” (emphasis added).

 

West Kowloon issued a formal notice to Hsin Chong under the Contract advising that it was terminating its employment under the Contract on the basis that a default had occurred because Hsin Chong had become insolvent. It also delivered a letter to AIG demanding payment of the Bonded Sum (1st Demand) followed by two chasers (2nd Demand and Final Demand), which AIG failed to comply with. The relevant part of the 1st Demand stated:

 

“We refer to the above bond issued to you in our favour, under which you are the Bondsman.

 

We hereby demand that you pay to us the full bonded sum of HK$297,198,000.

 

We are of the opinion that the Contractor is and has been in default in respect of various of its obligations under the Contract between the Contractor and us, and by reason of such defaults we have suffered and sustained and will continue to suffer and sustain damages, losses, charges, costs and expenses”.

 

Applications before the Court

 

West Kowloon applied for summary judgment against AIG on the basis that it had made a valid demand on the Bond. AIG applied to strike out the action on the ground that the demand letters relied upon by West Kowloon did not constitute valid demands upon the Bond as:

 

The Court said that the first issue was to determine the true construction of the bond to ascertain whether it was a “single bond” (i.e. a simple demand bond payable on demand or upon whatever additional evidence the bond itself may specify, usually called a “demand bond”) or a “double or conditional bond” (i.e. consisting of two parts, first the obligation and secondly the condition, usually called a “default bond”).

 

The Court said that the wording of the Bond in this case pointed to it being a demand bond.

 

Issues before the Court

 

The issues before the Court were:

 

(1)	Whether the demands complied with the terms of the Bond when they did not identify the amount of damages sustained by reason of Hsin Chong’s default and referred to future damages, losses etc. AIG’s case was that the demands were non-compliant and therefore invalid (Formality Issue).
(2)	Whether the demands were made fraudulently in that West Kowloon could not have formed a bona fide opinion that Hsin Chong was insolvent and therefore in default, or that by reason of such default the Plaintiff had sustained damages, losses etc of or exceeding HK$297,198,000. AIG argued that the demands were fraudulent and should not be enforced (Fraud Issue).

 

Formality Issue

 

The Court held that the 1st Demand complied with the requirements of Clause 2 of the Bond. It held:

 

• The formality issue was a question of construction of the terms of the Bond and whether the demands (or more precisely the 1st Demand) complied with Clause 2 of the Bond.

 

• It was very clear that proof of Hsin Chong’s default or amount demanded was not necessary and all that was required under Clause 2 was:
   
  • a written demand by West Kowloon;
     
  • in West Kowloon’s opinion, Hsin Chong was or had been in default in respect of its obligations under the Contact; and
     
  • the amount stated in the demand was in respect of the damages, losses, charges, costs or expenses sustained by West Kowloon by reason of the Contractor’s default.
     
• The 1st Demand satisfied all 3 requirements and was therefore a valid demand on the Bond.

 

• Specifying a particular breach/ default by Hsin Chong or particularizing the amount of damages, losses etc sustained was not a requirement under Clause 2.

 

• The 1st Demand must be read as a whole and not in a truncated manner. If one reads the 2nd and 3rd paragraphs of the 1st Demand as a whole, and putting two and two together, it was reasonably clear that West Kowloon was saying expressly, or at least in substance, that the basis for the demand for the full Bonded Sum was that Hsin Chong’s default had caused West Kowloon to suffer and sustain damages and losses etc to the tune of HK$297,198,000, the only figure which appeared in the1st Demand.

 

• As long as the demand states in substance what is required in the bond, and is understood by its recipient as such, the demand will be treated as a valid one. This approach is wholly consistent with the importance of preserving the certainty and reliability of demand bonds, which are their essential and defining characteristics. 

 

• Although the 1st Demand also referred to damages, losses etc that West Kowloon would continue to suffer and sustain by reason of Hsin Chong’s default, reference to future damages, losses etc did not vitiate or render nugatory that part of the 1st Demand which did refer to damages, losses etc sustained by reason of Hsin Chong’s default which were within the ambit of the Bond. Since Clause 2 did not require particularisation or proof of the amount demanded as damages, losses etc sustained, the additional reference to future damages and losses was at most redundant and surplus and could be ignored. 

 

• It might have been different if the 1st Demand only referred to future damages and losses but omitted to mention damages, losses etc already sustained. In that case, AIG’s argument that the 1st Demand was thereby rendered defective would have had more force.

 

Fraud Issue

 

The Court was not satisfied that West Kowloon’s Demands were made in bad faith. It held:

 

• There are special considerations for a summary judgment application based on a performance bond and particularly cogent evidence is required to establish the fraud exception. The evidence of fraud relied upon by AIG was little more than a mere assertion, rather than cogent evidence.

 

• AIG simply could not make good the assertion, even in a summary judgment context, that West Kowloon did not genuinely believe that Hsin Chong was insolvent. 

 

• It was West Kowloon’s belief of the amount of its damages, losses etc which was relevant, not what a court or tribunal subsequently determined the amount should be. The beneficiary under a demand bond may genuinely believe it has suffered damages, losses etc within the meaning of the bond, entitling it to make a demand for a certain amount before there is a precise and detailed computation of the quantum. Otherwise, the express wording of Clause 2 i.e. “If, in the Plaintiff’s opinion…the Defendant shall upon demand…and without conditions or proof of the…amount demanded pay the amount identified in the demand” would be rendered meaningless.

 

Comment

 

This judgment is a good reminder of the importance of the wording used in bonds and also in demands for calls upon them. It also confirms the Court’s approach that as long as the demand states in substance what is required in the bond and is understood by its recipient as such, the demand will be treated as valid. As the Court said, being hypercritical of the wording of a demand and an overzealous insistence of strict compliance will only serve to undermine the certainty and reliability of demand bonds and should be rigorously resisted.