Court of Appeal holds demand for bonded sum invalid

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Authored by: Stanley Lo

In West Kowloon Cultural District Authority v AIG Insurance Hong Kong Ltd, CACV 82/2020, the Court of Appeal allowed AIG’s appeal, holding that the Court of First Instance (CFI) had erred in its construction and conclusion in respect of a bond obtained by the Contractor under a construction contract. The court found that on a proper construction, the bonded sum as demanded, included future damages and losses which were outside the ambit of the terms of the bond. Therefore, the demand was not made in compliance with the terms of the bond and was thus invalid. Please see our article on the CFI judgment.

Background

A bond had been 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. Clause ‍2 of the Bond provided: “If, in the [Plaintiff’s] opinion, the Contractor is or has been in default in respect of any of his obligations under the Contract, the [Defendant] shall upon demand made by the [Plaintiff] 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 the [Plaintiff] by reason of the default, up to the amount of the Bonded Sum.” (emphasis added).

Before the CFI, West Kowloon had applied for summary judgment against AIG on the basis that it had made a valid demand on the Bond and AIG had 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: (i) they did not identify the amount of damages, losses, charges, costs or expenses sustained by West Kowloon by reason of Hsin Chong’s alleged default; and (ii) they purported to demand payment of the full Bond sum in respect of an unidentified amount of future or prospective damages etc, which were not within the terms of the Bond.

The demand in question was the 1^st Demand, the relevant part of which 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”.

The CFI held that the 1^st Demand complied with the requirements of Clause 2 of the Bond because 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: (i) a written demand by West Kowloon; (ii) in West Kowloon’s opinion, Hsin Chong was or had been in default in respect of its obligations under the Contact; and (iii) 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 1^st Demand satisfied all three requirements and was therefore a valid demand on the Bond.

The Defendant now appealed on the grounds that (i) the judge erred in finding that the Plaintiff’s failure to state that the amount demanded was in respect of losses, charges, costs or expenses sustained by reason of the Contractor’s default did not render the 1^st Demand invalid (Ground 1); (ii) the Judge erred in finding that the 1^st Demand was valid even though it plainly included a claim for losses which the Plaintiff had not yet sustained as at the date of the 1^st Demand (Ground 2).

The Court of Appeal allowed the appeal, holding:

1. There was no dispute that, as a matter of construction, the 1^st ‍Demand (in particular paragraphs‍ 2 and 3) should be read and construed together objectively and in proper context. When reading the plain words of paragraphs ‍2 and 3 together and with common sense, the Plaintiff was clearly stating in the 1^st ‍Demand that it was demanding the Bonded Sum under the Bond as it related to the Contractor’s default under the Contract.
   
   
2. The plain and express words of the 3^rd ‍paragraph of the 1^st‍ Demand objectively and reasonably inform the reader that the Bonded Sum as demanded related to damages and losses that had already been suffered by the Plaintiff as well as ones that are yet to be suffered by reason of the Contractor’s default under the Contract.
   
   
3. Under Clause 2, the Plaintiff can only validly demand payment for damages, and losses that they have already suffered and sustained at the time of demand, and objectively, it is a permissible construction of paragraph 3 of the 1^st Demand that the demanded Bonded Sum included damages and losses which the Plaintiff would continue to suffer after the time of the demand, i.e., in the future.
   
   
4. The operative words used in Clause‍ 2 are “damages, losses, charges, costs or expenses”. These are words or terms referring to actual or quantified amounts. Hence, it is intended under Clause‍ 2 that when the Plaintiff makes a demand, it should be by reference to damages, losses etc which have already been suffered and quantified, but not unquantified sums arising from or by reason of the Contractor’s default. This intention is underlined by the fact that under the Bond, the Plaintiff can make multiple and subsequent separate demands.
   
   
5. There was nothing before the court which would show and support the position that at the time of the 1^st ‍Demand, there was an objective context or basis to say that the quantified damages were already well beyond the Bonded Sum.
   
   
6. The CFI had erred in its construction and conclusion. On a proper construction, the Bonded Sum as demanded under the 1^st ‍Demand included future damages and losses which were outside the ambit of Clause ‍2. Therefore, the 1^st ‍Demand was not made in compliance with Clause ‍2 and was thus invalid.

Comment

This judgment may put great burden on those who are responsible for drafting a demand under the performance bond. In particular, it is not uncommon that at the time of issuing the demand, the loss and damage sustained cannot be properly quantified. Some performance bonds may have an expiry date e.g. after the issue of the Substantial Completion Certificate or Defects Rectification Certificate. If the demand is only held to be invalid after the expiry date of the bond, the employer may not be able to issue a fresh demand for rectifying the defects in the first demand.

Key Contacts

Stanley Lo

Consultant | Litigation and Dispute Resolution

Email or call +852 2826 5395