Falcon Insurance Co (Hong Kong) Ltd v. Isp Holdings Ltd (Formerly Known As Synergis Holdings Ltd) and Another

HCA 245/2022

[2023] HKCFI 999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 245 OF 2022

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BETWEEN

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JUDGMENT

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Introduction

1.This is the Plaintiff’s application by summons dated 11 May 2022 (“Summons”) under RHC O 14 whereby it seeks summary judgment for an Order that the Defendants do deposit a sum of HK$58,880,000 to the Plaintiff pursuant to 2 Deed of Indemnity Agreements executed by each of the 1st Defendant and the 2nd Defendant (collectively “Defendants”) in January 2016 in favour of the Plaintiff (“Indemnity Agreements”) until such time as the Plaintiff’s liability under a Surety Bond dated 3 February 2016 (“Surety Bond”) executed by the Plaintiff and the 2nd Defendant in favour of Fortune Pharmacal Co. Ltd. (“Fortune Pharmacal”) is released.

2.By letter dated 15 December 2022, Au & Associates informed this court that the parties had reached an agreement to vary the terms of paragraph 1 of the Summons as follows:

“The Defendants do deposit a sum of HK$58,880,000 within 7 days of this Order into a separate interest-bearing account in the Plaintiff’s name with a licensed bank in Hong Kong as designated by the Plaintiff, which deposit shall be kept in the account until such time as the Plaintiff’s liability under the surety bond executed by the Plaintiff dated 3 February 2016 (“the Surety Bond”) is released or until further order. Within 7 days of the Plaintiff being released from the Surety Bond, the Plaintiff shall repay to the Defendants the balance after deduction of (1) all sums paid under the Surety Bond and (2) all sums including costs due to the Plaintiff under these proceedings or pursuant to the Indemnity Agreements.”

3.The 2nd Defendant entered into a construction contract with Fortune Pharmacal dated 21 April 2016 for the construction of main contract works for Fortune Pharmacal New Factory Development in Yuen Long (“Construction Contract”). It was required to provide the Surety Bond to Fortune Pharmacal to guarantee its performance of the Construction Contract. At the request of the 2nd Defendant, the Plaintiff provided the Surety Bond to guarantee the 2nd Defendant’s performance of the Construction Contract up to a sum of HK$58,880,000. The Defendants executed the Indemnity Agreements in favour of the Plaintiff as counter indemnities.

4.Disputes arose between the 2nd Defendant and Fortune Pharmacal under the Construction Contract.

5.On 5 January 2021, the 2nd Defendant commenced arbitration proceedings against Fortune Pharmacal (“Arbitration”). By a written Undertaking dated 10 June 2021 (“Undertaking”), the Plaintiff agreed to be bound by the result of the Arbitration.

6.On 14 January 2021, Fortune Pharmacal commenced Construction and Arbitration Proceedings No. 6 of 2021 (“HCCT 6/2021”) against the Plaintiff and the 2nd Defendant to claim a sum of HK$54,369,814.10 for inter alia their breaches of the Surety Bond. Pursuant to an Order dated 21 September 2021 by Mimmie Chan J, HCCT 6/2021 is currently stayed in respect of the 2nd Defendant under section 20 of the Arbitration Ordinance and in respect of the Plaintiff as a matter of case management, while the Arbitration is ongoing. Fortune Pharmacal’s application for leave to appeal against the stay was dismissed by Mimmie Chan J on 4 November 2021 and by the Court of Appeal on 13 January 2023.

7.Separately, in November 2021, a number of indirect wholly-owned subsidiaries of the 1st Defendant were sold to a third party at the cash price of HK$539m (“Sale”). The Sale was completed in January 2022 (“Completion”). The 1st Defendant then declared the payment of a special dividend in cash to its shareholders. On 22 February 2022, the 1st Defendant distributed the special dividend of about HK$297m to its shareholders (“Special Dividend”).

8.In these circumstances, the Plaintiff relied on various clauses of the Indemnity Agreements to demand additional security by way of a cash deposit of HK$58,880,000 (“Cash Deposit”) from the Defendants (“Demand”). The Defendants did not comply and no cash deposit was made. The clauses that the Plaintiff relies upon are Clauses 4(i), 4 (ii), 5(i) or (iii).

9.The Plaintiff contends that it is entitled to require the Defendants to make the Cash Deposit pursuant to Clause 4(i) & (ii) by reason of Fortune Pharmacal’s claims, Clause 5(i) by reason of the Completion, and Clause 5(iii) by reason of the declaration and distribution of the Special Dividend. Apart from alleging the Demand was irrational, there is no dispute that Clauses 4 and 5 were triggered.

Agreed Facts

10.The relevant facts of this case are largely undisputed. At the invitation of the court, the parties have submitted the following Agreed Facts for the purpose of this application.

“B1. The contractual relationship between the Plaintiff and the Defendants

1. The Plaintiff is an insurance company. The 2^nd Defendant is a company engaged in the construction industry, and a wholly owned subsidiary of the 1^st Defendant (a company listed on the main board of the Hong Kong Stock Exchange (“SEHK”) with stock code 2340).

2. The only contractual relationship between the Plaintiff and the Defendants is governed by the Indemnity Agreements executed by each of the 1^st Defendant and the 2^nd Defendant in January 2016 in favour of the Plaintiff (“the Indemnity Agreements”) pursuant to which the Plaintiff issued the Surety Bond dated 3 February 2016 (“the Surety Bond”) in favour of the 2^nd Defendant’s employer Fortune Pharmacal Co. Ltd (“Fortune Pharmacal”), up to the amount of HK$58,880,000.

B2.The contractual relationship between the 2^nd Defendant and Fortune Pharmacal

3. In around December 2015, Fortune Pharmacal (as the employer) and ISP Construction (as the contractor) entered into the Construction Contract for the latter to carry out and complete the main contract works for the Fortune Pharmacal New Factory Development in Yuen Long Industrial estate for the contractual sum of HK$588,800,000 or such other sum that may become payable under the Construction Contract. Pursuant to the Construction Contract, the 2^nd Defendant had to provide the Surety Bond for its performance.

4. The Plaintiff issued the Surety Bond to guarantee the 2^nd Defendant’s performance of the Construction Contract up to a sum of HK$58,880,000. The Surety Bond provides, inter alia, that:

“and whereas pursuant to the terms of the Contract, the [2^nd Defendant] has agreed to obtain the guarantee of a surety to be bound unto [Fortune Pharmacal] in the sum of Hong Kong Dollars Fifty Eight Million Eight Hundred and Eighty Thousand only (HK$58,880,000) for the due performance of Contract by the [2^nd Defendant].”

5. It is common ground that the Surety Bond is not an “on-demand” bond, but a “double conditional” bond. In other words, in order to claim against the Plaintiff on the Surety Bond, Fortune Pharmacal must (i) prove a breach by 2^nd Defendant and the amount of its claim and (ii) comply with the condition stipulated by the Surety Bond, namely the claim must be accompanied by the architect’s certificate of the damages.

B3.The Indemnity Agreements

6. In consideration for the Plaintiff’s execution of the Surety Bond, the Defendants executed the Indemnity Agreements in favour of the Plaintiff in January 2016. The Indemnity Agreements contain the following terms (our emphasis):

Clause 1

“I/We (referring to the Defendants) hereby unconditionally and irrevocably agree to indemnify the Company (referring to the Plaintiff) and keep the Company indemnified against all claims, demands, actions, liabilities, damages, costs, losses and expenses of whatever nature which the Company may incur in any way as a consequence of the Company giving the Guarantee and, without limiting the foregoing, to pay to the Company on demand all sums which may be claimed from the Company or which the Company may pay or become liable to pay under or by reason of or in connection with the Guarantee including, without limitation, all costs and expenses (including legal fees and other fees on a full indemnity basis) incurred by the Company in defending or otherwise resisting any claim or threatened claim.

Clause 4

I/We undertake to deposit with the Company immediately on demand any amounts (i) for which the Company may consider it may be liable in connection with the Guarantee until such time as the Guarantee is released and returned to the Company or during the time any liability thereunder otherwise remains outstanding (ii) which the Company may consider necessary or desirable in its absolute discretion upon the occurrence of any circumstance or event which the Company considers might jeopardise this security or the Company’s ability to enforce the same. I/We hereby assign to the Company by way of additional security any such sum, together with interest accruing thereon, and hereby acknowledge that I/we shall not be entitled to withdraw, assign, charge or otherwise dispose of or encumber such sum or interest until all of my/our liabilities owing to the Company hereunder have been discharged.

Clause 5

Where I/we are a body corporate (“the Corporation”) and without prejudice to any other rights of the Company arising under this security, upon the occurrence of any of the following events:

(i) any change in the beneficial ownership of the issued share capital of the Corporation or any subsidiary or holding company of the Corporation or any other subsidiary or holding company of the Corporation’s holding company (collectively “the Group”); or

…

(iii) any change in the financial position of any member of the Group which the Company considers in its absolute discretion to be a material adverse change; then in any such event and at any time thereafter, the Company may request, whereupon I/we shall forthwith:

(a) provide additional security in favour of the Company in such form and on such terms as the Company may in its absolute discretion require (for the avoidance of doubt it is hereby expressly acknowledged that my/our obligation hereunder may include an obligation to procure the provision of additional security from other members of the Group if so required by the Company); or

(b) pay to the Company such amount as the Company may consider necessary or desirable in its absolute discretion in lieu of any such additional security. Any amount so paid shall be held by the Company on the terms set out in Clause 4 hereof.

I/we shall forthwith notify the Company in writing of the occurrence of any of the events referred to in paragraphs (i), (ii) or (iii) of this Clause.

Clause 6

Any action taken by the Company in good faith under or in connection with the Guarantee shall be binding on me/us and shall not place the Company under any liability to me/us. The Company may at any time without prior reference to me/us terminate the Guarantee or reduce its liability thereunder.

Clause 8

I/We agree to pay interest on all sums which are due but not paid hereunder (as well after as before judgement) at 3% over Hibor from time to time to the date of full and final payment. I/We also agree to reimburse the Company on demand for all costs, charges and expenses (including legal and other fees on a full indemnity basis) incurred by the Company in exercising any of its rights or powers hereunder or in suing for or seeking to recover any sums due hereunder or in otherwise preserving or enforcing the Company’s rights hereunder.”

B4. Claim by Fortune Pharmacal against the Plaintiff

7. Various disputes subsequently arose between the 2^nd Defendant and Fortune Pharmacal in relation to the Construction Contract. On 5 January 2021, the 2^nd Defendant commenced the Arbitration against Fortune Pharmacal for disputes arising from the Construction Contract. The Plaintiff is not a party to the Arbitration. The 2^nd Defendant’s monetary claims against Fortune Pharmacal total approximately HK$274,000,000 comprising (i) unpaid amounts already certified by the architect’s interim certificates and/or valued by the quantity surveyor for work carried out, (ii) outstanding retention money, (iii) unpaid variation works and (iv) prolongation costs. On 14 January 2021, Fortune Pharmacal commenced HCCT 6/2021 against the Plaintiff and the 2^nd Defendant to claim a sum of HK$54,369,814.10 (comprising liquidated damages in the amount of HK$84,660,000 and alleged water and electricity charges, minus the value of certain certified works) and/or alternatively damages as assessed by the Court allegedly for the Plaintiff and the 2^nd Defendant’s breaches of the Surety Bond and/or as damages allegedly for the 2^nd Defendant’s breach of the Construction Contract. These claims are denied by the 2^nd Defendant.

8. The parties’ solicitors engaged in correspondence starting in January 2021 about the Surety Bond. The Plaintiff’s stance in January 2021 was that there would be no need to exercise its rights under the Indemnity Agreements so long as there was a stay in place in respect of Fortune Pharmacal’s claim pending arbitration:

(1) On 11 January 2021, the Plaintiff’s solicitors Messrs Au & Associates (“AA”) set out Falcon Insurance’s stance to Fortune Pharmacal’s solicitors Messrs Hogan Lovells (copied to the 2^nd Defendant) to ask whether there was an arbitration agreement and if so, whether Fortune Pharmacal had obtained an arbitral award and stated that in the absence of an award, AA saw no reason why Fortune Pharmacal should demand payment under the Surety Bond from the Plaintiff;

(2) On 15 January 2021, the 2^nd Defendant’s solicitors Messrs MinterEllison (“ME”) wrote to AA stating, inter alia, that the dispute was presently the subject of the Arbitration as agreed under the Construction Contract, and the 2^nd Defendant was confident that it would succeed and a very substantial net amount would be awarded against Fortune Pharmacal. In any event the Plaintiff need not in any way be satisfied as to the strength of the 2^nd Defendant’s claims against Fortune Pharmacal, as the law is clear that as long as the claim is disputed and there was no arbitral award, then the Plaintiff could have no obligation to release anything under the Surety Bond. As such, without an arbitration finding default by the 2^nd Defendant causing loss to Fortune Pharmacal, there was no basis for Fortune Pharmacal to request payment.

(3) On 18 January 2021, AA wrote to ME saying:

“Falcon notes ISP’s intention to stay the court proceedings so as to resolve any disputes with Fortune Pharmacal by arbitration. Provided that Fortune Pharmacal cannot proceed against Falcon further (whether by reason of a stay of proceedings and/or any injunction application to be taken by ISP ...), Falcon does not see the need to exercise its rights under the Indemnity Agreements for the time being.

…

All rights of Falcon are reserved.”

(emphasis added).

(4) AA stated in letter dated 22 January 2021 that “[w]hile Falcon hopes that the proceedings [in HCCT 6/2021] can be stayed as soon as practicable, in the event that the proceedings are not stayed, we wish to repeat paragraph 8 of our letter dated 18 January 2021 that Falcon may exercise its rights under the Indemnity Agreements… All rights of Falcon are reserved.” (emphasis added).

(5) It was the Plaintiff’s position that these letters as stated in the last paragraphs of the two letters in sub-paragraphs (3) and (4) above reserved all rights of the Plaintiff and represented its position at the time.

9. On 16 February 2021, the Plaintiff requested a deposit of HK$58,880,000 from the Defendants pursuant to Clause 4 of the Indemnity Agreements. By letters dated 19 and 25 February 2021, the Defendants refused to make the deposit and indicated that the Plaintiff’s request was “unwarranted”. The Defendants further requested the Plaintiff “to not perform any act”.

10. On 1 March 2021, the 2^nd Defendant applied to the Court for a stay of HCCT 6/2021 pending the publication of the award in the Arbitration. On 10 June 2021, the Plaintiff gave a written undertaking that it agreed to be bound by the result of the Arbitration. The stay application was heard before Mimmie Chan J on 11 June 2021. On 21 September 2021, HCCT 6/2021 was stayed in respect of the 2^nd Defendant pursuant to section 20 of the Arbitration Ordinance (Cap. 609), and stayed in respect of the Plaintiff pursuant to the case management power of the Court pending publication of the award in the Arbitration (“the Stay”). On 5 October 2021, Fortune Pharmacal made an application to Mimmie Chan J for leave to appeal against the Stay in respect of the Plaintiff, which was dismissed on 4 November 2021. Fortune Pharmacal renewed its application to the Court of Appeal for leave to appeal on 18 November 2021.

B5. Distribution of Special Dividend of HK$297,861,500 on 22 February 2022

11. On 27 October 2021, the 1^st Defendant announced through SEHK a possible sale of its property and facility management businesses (“Sale”), to be effected by the sale of certain indirectly wholly-owned subsidiaries of the 1^st Defendant (“the Disposal Group”) to an external purchaser.

12. The Plaintiff stated in a letter to the 1^st Defendant dated 17 November 2021 that it considered that the Sale would jeopardise (among others) the Indemnity Agreements, and demanded payment of (among other sums) the Cash Deposit in the amount of HK$58,880,000.00 (i.e. the full amount of the Plaintiff’s maximum liability under the Surety Bond).

13. On 22 November 2021, the 2^nd Defendant explained (inter alia) (i) in light of the Stay there was no prospect of any court proceedings against the Plaintiff until the determination of the Arbitration, (ii) even if the Sale proceeds, it does not follow that the 1^st Defendant’s financial condition would be worse off, and (iii) the request for HK$58,880,000 was unwarranted.

14. Synergis Holdings (BVI) Limited (“the Seller”), a wholly owned subsidiary of the 1^st Defendant, entered into a Sale and Purchase Agreement dated 26 November 2021 (“the SPA”) with Central Luck Developments Limited (“the Purchaser”), whereby the Seller conditionally agreed to sell, and the Purchaser conditionally agreed to acquire 100% equity interest of True Hope Group Limited (“the Share Capital”), which in turn held the entire equity interests of the Disposal Group at cash consideration of HK$539 million. The Disposal Group was principally engaged in the provision of property and facility management services including the provision of ancillary services (“PFM”). On 26 November 2021, the 1^st Defendant announced that (i) it had entered into an agreement for the Sale, (ii) upon completion of the Sale (“the Completion”) the Disposal Group would cease to be subsidiaries of the 1^st Defendant, (iii) the 1^st Defendant intended to declare a special dividend of HK$300 million (“the Special Dividend”) to be paid out of the net proceeds from the Sale, and (iv) (under the heading “(iii) The significant gain resultant from the Disposal” at p.12) that the 1^st Defendant had sufficient cash resources to pay the Special Dividend upon Completion and “such payment of Special Dividend will not have any material adverse effect on the financial position of the Remaining Group”.

15. On 1 December 2021, the 1st Defendant made a further announcement on SEHK inter alia reiterating (at p.15) that the payment of the Special Dividend would not have any material adverse effect of the financial position of the remaining group.

16. By a letter from AA to ME dated 8 December 2021, Falcon Insurance demanded payment of the Cash Deposit stating inter alia that:

“… it is clear that the Disposal will jeopardize our client’s interest as our client considers that the change in financial position is a material adverse change.

In the premises, pursuant to Clause 5 of the Indemnity Agreement, we are instructed to request you to provide additional security in favour of our client by making a cash deposit in a sum of HK$58,880,000 being the liability of the Surety Bond issued by our client for the [Construction Contract]. …”

17. The Completion took place on 10 January 2022. 10 days after the Completion i.e. 20 January 2022, the board of directors of the 1st Defendant resolved to declare the payment of special dividend of HK$0.59 per share.

18. By a letter dated 24 January 2022, ME stated that the demand for the payment of the Cash Deposit was entirely unwarranted because inter alia:

(1) The security under the Indemnity Agreements had in fact been enhanced subsequent to the Sale as the business operations of the 1^st Plaintiff were now predominantly those of the 2^nd Defendant itself, with the latter being in a much better financial position after the Sale; and

(2) Referred to AA’s letter dated 18 January 2021 (where AA stated that where HCCT 6/2021 was stayed, the Plaintiff did not see the need to exercise its right under the Indemnity Agreements: see §8(3) above), and stated that there was no valid reason to call on the security as HCCT 6/2021 is stayed pending the handing down of the Court of Appeal’s decision (which the 2^nd Defendant was confident would be rejected).

19. By a further letter dated 14 February 2022, ME inter alia:

(1) referred to the 1^st Defendant’s announcement dated 1 December 2021 which stated that the payment of the Special Dividend would not have any material adverse effect on the financial position of the remaining group; and

(2) explained with reference to Appendix III of the 1 December 2021 announcement entitled “Unaudited Pro Forma Financial Information of the Remaining Group” that the net current assets of the remaining group stood at HK$608,142,000 and, after allowing for the payment of the Special Dividend, would stand at HK$308,142,000. This compared favourably with the pre-Sale position as at 30 June 2021 when the group’s net current assets stood at HK$146,913,000 only.

20. On 22 February 2022, the 1st Defendant distributed the Special Dividend.

21. On 23 November 2022, the 1st Defendant made an announcement that the Board of Directors of the 1st Defendant had resolved to declare the payment of special dividend of HK$0.20 per ordinary share / per convertible preference share of the 1^st Defendant to the shareholders of the 1^st Defendant (“the Further Special Dividend”), and the Further Special Dividend would be distributed on or before 21 December 2022. The total amount of the Further Special Dividend to be distributed is around HK$100 million. On 28 November 2022, AA informed ME that the Plaintiff was aware of the declaration of the Further Special Dividend.” (emphasis supplied)

Deliberation

11.Ms Cheung submits that summary judgment is inappropriate because the Defendants have a seriously arguable defence against the Plaintiff’s claim or at least there are triable issues as follows.

12.Clauses 4 and 5 of the Indemnity Agreements confer upon the Plaintiff discretionary powers to demand deposits or additional security, in such amounts as it may assess as being necessary or desirable in light of (i) its own potential liability under the Surety Bond and (ii) the occurrence of any events or circumstances which may jeopardise its security under the Indemnity Agreements. These are discretionary powers allowing the Plaintiff to make assessments and choose from a range of options.

13.There is an established body of jurisprudence which confirms that contractual discretionary powers are subject to an implied term that they must be exercised rationally, notwithstanding the contract’s use of the words “absolute discretion”. This implication of rationality is necessary to give genuine value, rather than mere lip-service, to the obligation of the party empowered to exercise the discretion, in circumstances where the parties are likely to have conflicting interests and the provisions of the contract effectively place the resolution of that conflict in the hands of the party exercising the discretion.

14.On the undisputed facts of the case, it is at least reasonably arguable that the Plaintiff could not have rationally considered that (i) it may be liable in connection with the Surety Bond for the full contractual amount of HK$58,880,000 or (ii) any circumstance or event had occurred which might jeopardise its security under the Indemnity Agreements or its ability to enforce the same.

15.It is at least seriously arguable that the Plaintiff has irrationally and thus invalidly exercised its discretion both (i) in deciding to demand the Cash Deposit and (ii) assessing the amount (if any) of the Cash Deposit.

16.As submitted by Ms Eu SC, in gist, the Defendants’ case can be summarised in one sentence: the Indemnity Agreements contain an implied term on the part of the Plaintiff to act rationally because the discretionary powers, although wide in terms, require the Plaintiff to make an assessment in the interest of both parties and that it has failed to do so on the facts of this case.

17.Ms Cheung has cited a line of authorities in a commercial, but not construction, context in support of her aforesaid contention that the exercise of discretionary powers generally is subject to an implied term that they must be exercised rationally, notwithstanding the contract’s use of the words “absolute discretion”. Suffice it for this court to refer to the following.

18.The first one cited to this court is Paragon Finance plc v Staunton [2002] 1 WLR 685 concerning mortgage loan agreements which gave the plaintiff mortgagee the power to set interest rates from time to time.

19.At [36], Dyson LJ held that this power was not completely unfettered. Rather, there were implied terms in the agreements that the interest rates would not be set “dishonestly, for an improper purpose, capriciously or arbitrarily, the implied term being necessary to give effect to the reasonable expectation of the parties and was one of which it could be said that ‘it goes without saying’”. (emphasis added)

20.However, at [41], Dyson LJ accepted that “the scope of an implied term will depend on the circumstances of the particular contract”. In other words, the implied term propounded by the learned Judge is not a one size fits all type which can be implied into any commercial contracts. This is not difficult to understand since in law, context is everything. This qualification is important since the gist of Ms Eu SC’s submission on the law is that in the context of counter indemnities commonly given in the construction industry, the authorities relied upon by Ms Cheung are wholly distinguishable. Rather, those relied upon by her are exactly on point.

21.The next authority cited to this court is Horkulak v Cantor Fitzgerald International [2005] ICR 402 involving the payment of discretionary bonus pursuant to an employment contract. The Court of Appeal held that the claimant’s bonus clause entitled him to a bona fide and rational exercise by the employer of its discretion to decide whether and if so how much to pay.

22.At [30], Potter LJ observed:

“… in cases of this kind[1], the implication of the term is not the application of a "good faith" doctrine, which does not exist in English contract law; rather is it as a requirement necessary to give genuine value, rather than nominal force or mere lip-service, to the obligation of the party required or empowered to exercise the relevant discretion. While, in any such situation, the parties are likely to have conflicting interests and the provisions of the contract effectively place the resolution of that conflict in the hands of the party exercising the discretion, it is presumed to be the reasonable expectation and therefore the common intention of the parties that there should be a genuine and rational, as opposed to an empty or irrational, exercise of discretion. …” (emphasis added)

23.Potter LJ’s observation must be viewed in its proper context.

24.First, the term to act rationally was implied into an employment contract. For such contracts, there is often a significant imbalance of power between the contracting parties. The Court is thus particularly concerned to ensure contractual powers exercisable by one party but which affect the rights of both are not abused. That this is an important factor was emphasized by the Supreme Court in Braganza v BP Shipping Ltd [2] [2015] UKSC 17 at [18] (per Lady Hale). However, in the present case, there is no evidence of the existence of such inequality of bargaining power between the Plaintiff and the Defendants such as to raise the spectre of abuse by the Plaintiff.

25.Second, that observation is qualified by the preceding [26]:

“26. So far as commercial contracts are concerned, it has been rightly said that:

‘… the authorities do not justify any automatic implication, whenever a contractual provision exists putting one party at the mercy of another’s exercise of discretion. It all depends on the circumstances …’ Gan Insurance v Tai Ping Insurance (No 2) [2001] 2 All ER (Com) 299, 322 para 62 per Mance LJ.” (emphasis added)

26.Next, Socimer International Bank Ltd (in liquidation) v Standard Bank London Ltd [2008] Bus LR 1304, a case involving the seller bank’s contractual discretion to dispose of and value certain assets on default of payment by the buyer bank. Ms Cheung relied upon the following observations by Rix LJ, after reciting authorities including Gan Insurance v Tai Ping Insurance (No 2) [2001] 2 All ER (Com) 299, Paragon Finance plc and Horkulak:

a. “It is plain from these authorities that a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused.” [66]

b. “Implications of good faith and rationality, and of lack of arbitrariness or perversity, are standard, for they represent the very essence of business and other relationships.” [106]

27.Lastly, Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd [2013] EWCA Civ 200, a case involving the provisions of services to 2 hospitals. After reviewing the Socimer International Bank Ltd line of authorities, Jackson LJ noted at [83] as follows:

“83. An important feature of the above line of authorities is that in each case the discretion did not involve a simple decision whether or not to exercise an absolute contractual right. The discretion involved making an assessment or choosing from a range of options, taking into account the interests of both parties. In any contract under which one party is permitted to exercise such a discretion, there is an implied term…In essence, however, it is that the relevant party will not exercise its discretion in an arbitrary, capricious or irrational manner.” (emphasis added)

28.Since the context under which the Surety Bond and the Indemnity Agreements were entered into is important for the present discussion, Ms Eu SC has provided the following explanations in her skeleton which should not be controversial.

29.First, the Surety Bond is a typical example of performance bonds used in the construction industry. As explained in Andrews and Millett Law of Guarantees 7^th Ed. at para 16-004:

“In the construction industry, both in England and abroad, cash-flow problems are common, particularly in a time of recession. The employer therefore runs the risk of a project worth millions of pounds being abandoned at a critical stage because the contractor or a subcontractor has suddenly become insolvent. The insolvency of a subcontractor may also leave the principal contractor in an extremely vulnerable position. He may face the prospect of having to find the money to complete the job himself, or to engage a new subcontractor, or of having to pay substantial damages to the employer, without having any effective means of recourse against the subcontractor, which may precipitate his own insolvency.

…

Traditionally in the construction industry, these problems were met by the practice of requiring the contractor to provide a guarantee from a bank or, more often, an insurance company, to secure the performance of his obligations. These guarantees would normally take the form of a conditional bond or surety bond, an extension of the concept of a fidelity bond.” (emphasis added)

30.Second, the Indemnity Agreements are examples of counter indemnity used in connection with performance bonds issued by banks and insurance companies. The learned editors of Law of Guarantees supra further explained at para 16-012:

“As a condition of giving a performance bond, the bank or surety company will invariably require a counter-indemnity from the person whose performance it secures. The indemnity is likely to be couched in wider terms than the bond itself, requiring the account party to pay the bank whatever amount it actually pays under the bond, rather than requiring him to indemnify the bank in respect of such sums as it may be obliged to pay, because the latter form would enable the account party to question the basis of payment. The bank may require the counter-indemnity to be secured, for example by the deposit of funds sufficient to cover the moneys advanced, by a personal guarantee, or by the execution of a fixed or floating charge. Thus, if the bank does pay, the account party and any surety will usually have to reimburse it. Depending on the wording of the counter-indemnity, he may even be obliged to pay the bank before there is any default.” (emphasis added)

31.Ms Eu SC then goes on to cite a number of authorities decided in the present context including: Cosmic Insurance Corporation Ltd v Prosperity Construction and Decoration Ltd & Others unrep., HCCT 39 of 2003, 9 September 2003, Burrell J; American Home Assurance Co v King Pacific International Holdings Ltd [2001] 3 HKC 673 (Sakhrani J); Conway v HCC International Insurance Plc [2006] EWHC 3646 (QB) (Cox J). Ms Eu SC then submits these authorities show nothing need to be implied in counter indemnities to restrict an insurance company’s right to demand a deposit as additional security.

32.By way of illustration, it is sufficient for this court to refer to Cosmic Insurance Corporation Ltd.

33.In that case, the plaintiff and the 1st defendant were parties to a performance bond which related to a development under construction in Beijing. The 1st and 2nd defendants were parties to supply and installation sub-contracts in that development. The bond and the sub-contracts were the subject of litigation between the Beijing developer and the defendants. At the time the performance bond was taken out, the three defendants, in consideration of the Plaintiff executing the bond, sealed and delivered three separate counter indemnities in favour of the plaintiff. The Beijing developer had made its first call on the bond against the plaintiff and commenced proceedings in Hong Kong[3]. The plaintiff then made demands against the defendants on the counter indemnities. In simple terms the counter indemnities required the defendants either to make a payment (clause 1) or provide a deposit (clause 4) to the plaintiff of the bonded sum. The plaintiff claimed the said payments or deposits under RHC O 14. The learned Judge granted summary judgment in favour of the plaintiff against the defendants for the bonded sum.

34.Clause 4 of the counter indemnities in Cosmic Insurance Corporation Ltd (identical to Clause 4 of the Indemnity Agreements in the present case) provided as follows:

“4. I/We undertake to deposit with the [Plaintiff] immediately on demand any amounts (i) for which the [Plaintiff] may consider it may be liable in connection with the [Bond] until such time as the [Bond] is released and returned to the [Plaintiff] or during the time any liability thereunder otherwise remains outstanding (ii) which the [Plaintiff] may consider necessary or desirable in its absolute discretion upon the occurrence of any circumstance or event which the [Plaintiff] considers might jeopardise this security or the [Plaintiff]’s ability to enforce the same. I/We hereby assign to the [Plaintiff] by way of additional security any such sum, together with interest accruing thereon, and hereby acknowledge that I/We shall not be entitled to withdraw, assign, change or otherwise dispose of or encumber such sum or interest until all of my/our liabilities owing to the [Plaintiff] hereunder have been discharged.” (emphasis added)

35.The learned Judge held that even if the application had been confined to Clause 4, he would have found for the plaintiff as he found no ambiguity or lack of clarity in it - the clause said the defendants undertook to deposit money in two situations and either or both would suffice. As far as Clause 4(ii) was concerned, letters from the Beijing developer to the plaintiff making demands on the bond alleging default by the defendants were sufficient to trigger its operation. Importantly, at para 21 of the Judgment, Burrell J said this: “The plain and ordinary meaning of the indemnities are clear, commercially sensible and undefendable now that the Beijing proceedings have commenced.” There was no need for the plaintiff in that case to evaluate the merits or demerits of the underlying construction disputes.

36.In reply, Ms Cheung submits that the bulk of the decisions relied upon by the Plaintiff pre-dated the body of jurisprudence on the implied term of rationality and this may explain why none of the decisions referred to in the Plaintiff’s skeleton contained a discussion on the implied term of rationality at all. But in light of the body of jurisprudence as it now stands, insofar as the Plaintiff seeks to argue that it can demand for the Cash Deposit at its absolute discretion without regard to the requirement of rationality, the law has since moved on.

37.It is not entirely clear the law has actually moved on in the way Ms Cheung suggests to this court. As this court sees it, the law governing the implication of terms in contracts was as well-established in the days of Cosmic Insurance Corporation Ltd as it is today.

38.Terms can be implied in law into a particular class of contract as between eg landlord and tenant or employer and employee, which is not relevant to the present discussion. No authorities have been cited to this court that an implied term as to rationality should be implied in counter indemnities as a class of contract.

39.Alternatively, terms can be implied in fact into a particular contract in order to give effect to the intention of the parties. As for this category, the test is traditionally expressed in 2 ways: a term may be implied into a contract (i) where it is necessary to give business efficacy to the contract, or (ii) in order to give effect to the obvious but unexpressed intention of the parties such that they must have intended it to form part of their contract.

40.A term will not be implied unless the court is satisfied that both parties would have agreed to it had it been suggested to them. The fact that a term is a reasonable one is necessary but not sufficient for it to be implied into a contract.

41.For the above obvious propositions: Chitty on Contracts 34th Ed. Vol 1 paras 16-005 - 16-012.

42.The latest summary of the principles now applied by the courts when considering whether or not to imply a term into a contract as a matter of fact can be found in the Privy Council decision of Ali v Petroleum Company of Trinidad and Tobago [2017] UKPC 2 at [7]:

“…It is enough to reiterate that the process of implying a term into the contract must not become the re-writing of the contract in a way which the court believes to be reasonable, or which the court prefers to the agreement which the parties have negotiated. A term is to be implied only if it is necessary to make the contract work, and this it may be if (i) it is so obvious that it goes without saying (and the parties, although they did not, ex hypothesi, apply their minds to the point, would have rounded on the notional officious bystander to say, and with one voice, “Oh, of course”) and/or (ii) it is necessary to give the contract business efficacy. Usually the outcome of either approach will be the same. The concept of necessity must not be watered down. Necessity is not established by showing that the contract would be improved by the addition. The fairness or equity of a suggested implied term is an essential but not a sufficient pre-condition for inclusion. And if there is an express term in the contract which is inconsistent with the proposed implied term, the latter cannot, by definition, meet these tests, since the parties have demonstrated that it is not their agreement.” (emphasis added)

43.The difficulties of Ms Cheung’s submissions are that there is little to persuade this court that the implication of a term as to rationality in the Indemnity Agreements meets either of the tests above. Why is it so obvious, not only to the Defendants but also to the Plaintiff, that it goes without saying that the term should be implied? Why is the implied term necessary to give business efficacy to the Indemnity Agreements? Are the Defendants suggesting the Indemnity Agreements would not work without it? The counter indemnities worked well in cases like Cosmic Insurance Corporation Ltd or American Home Assurance Co without the need for any implied term.

44.The fact that such a rationality term has in the past been implied into other contracts in vastly different context and under very different circumstances from the present is clearly insufficient to justify the implication of the term in the present case, as every case is decided in its own context. This is made especially clear in [26] of Horkulak quoted above.

45.While her primary position is that nothing needs to be implied into the Indemnity Agreements, Ms Eu SC indicated at the hearing she had no difficulty with the notion of an implied term not to act capriciously or arbitrarily. She also accepted that the Plaintiff must act in good faith in light of Clause 6 of the Indemnity Agreements. Given the Indemnity Agreements contain an implied term as to acting in good faith and not acting capriciously or arbitrarily (which this court cannot see how the Plaintiff can oppose), would that not be more than sufficient to give effect to the reasonable expectation of the parties, as put by Dyson LJ at [36] of Paragon Finance plc? In this court’s view, that clearly would be sufficient.

46.Further, as rightly pointed out by DHCJ Dawes SC in Habib Bank Zurich (Hong Kong) Ltd v Creation Castle Ltd [2020] HKCFI 1062 at [63] - [67], one must distinguish clearly between cases where (i) a discretion which involves a simple decision whether or not to exercise an absolute contractual right and (ii) a discretion which involves making an assessment or choosing from a range of options, taking into account the interests of both parties[4]. It is only in the latter type of discretion that a Socimer-type implied term is appropriate. For the former type of discretion, such an implied term is not reasonably necessary to give business efficacy to the contract.

47.At this juncture, one must go back to the Indemnity Agreements. Just to re-cap, Clause 4 of the Indemnity Agreements provided:

“I/We undertake to deposit with the Company immediately on demand any amounts (i) for which the Company may consider it may be liable in connection with the Guarantee until such time as the Guarantee is released and returned to the Company or during the time any liability thereunder otherwise remains outstanding (ii) which the Company may consider necessary or desirable in its absolute discretion upon the occurrence of any circumstance or event which the Company considers might jeopardise this security or the Company’s ability to enforce the same.” (emphasis added)

48.Clause 5 of the Indemnity Agreements provided:

“Where I/we are a body corporate (“the Corporation”) and without prejudice to any other rights of the Company arising under this security, upon the occurrence of any of the following events:

(i) any change in the beneficial ownership of the issued share capital of the Corporation or any subsidiary or holding company of the Corporation or any other subsidiary or holding company of the Corporation’s holding company (collectively “the Group”); or

…

(iii) any change in the financial position of any member of the Group which the Company considers in its absolute discretion to be a material adverse change; then in any such event and at any time thereafter, the Company may request, whereupon I/we shall forthwith:

(a) provide additional security in favour of the Company in such form and on such terms as the Company may in its absolute discretion require (for the avoidance of doubt it is hereby expressly acknowledged that my/our obligation hereunder may include an obligation to procure the provision of additional security from other members of the Group if so required by the Company); or

(b) pay to the Company such amount as the Company may consider necessary or desirable in its absolute discretion in lieu of any such additional security. Any amount so paid shall be held by the Company on the terms set out in Clause 4 hereof.” (emphasis added)

49.First, it seems to this court the natural and ordinary meaning of Clauses 4 and 5 is clear - in each case, the discretion given to the Plaintiff involves a simple decision whether or not to exercise a contractual right to make a demand on the Defendants. The Socimer line of authorities is clearly distinguishable.

50.Second, while Ms Cheung describes Clauses 4 and 5 as conferring wide discretionary powers to make assessments and choose from a range of options, Ms Eu SC takes issue with that description, correctly in this court’s view. As stated by HHJ Rawlings in Hodell v Clydesdale Bank Plc [2018] EWHC 1009 (QB) and quoted by DHCJ Dawes SC in Habib Bank Zurich (Hong Kong) Ltd at [66], the fact that a clause gives a party a wide discretion as to how it chooses to exercise its contractual rights, in whole or in part, does not detract from them being contractual rights. If the Plaintiff is given contractual rights by virtue of Clauses 4 and 5, why should it be under a duty to take into account the interest of both parties in the exercise of those rights?

51.Third, in any event, against the background that counter indemnities are generally there for the protection of someone in the position of the Plaintiff, it is hard to construe Clauses 4 and 5 as involving the making of an assessment or choosing from a range of options taking into account the interests of both parties, without doing serious violence to the wording of the 2 clauses. This court is not prepared to do so.

52.To conclude, as Cosmic Insurance Corporation Ltd and other similar authorities show, in the context of counter indemnities which commonly feature in the construction industry, it is unnecessary and inappropriate to imply a term as to rationality as suggested by Ms Cheung. The authorities relied upon by her were decided under very different context and are, for reasons already explained, clearly distinguishable from the present case. Looking at the issue from another perspective, applying the criteria for implication of terms recently summarized in Ali v Petroleum Company of Trinidad and Tobago, this court also does not see why the term as to rationality should be implied into the Indemnity Agreements.

53.For all the above reasons, this court is not persuaded that the Plaintiff’s exercise of its rights under Clauses 4 and 5 of the Indemnity Agreements is subject to the implied term of rationality as suggested by the Defendants. There is thus no scope for argument that the Plaintiff has acted irrationally or the 2 clauses were not triggered.

54.In any event, this court is not persuaded it is seriously arguable that on the facts of this case, the Plaintiff’s reliance on any of the 2 clauses is irrational or that there are triable issues.

55.From the plain wording of Clause 4(i), it is triggered if the Plaintiff may consider it may be liable under the Surety Bond. There is no requirement that the Plaintiff can only trigger it after the conclusion of the Arbitration or after it is held to be liable to pay out under the Surety Bond. In HCCT 6/2021, Fortune Pharmacal claims a sum of HK$54,369,814.10 plus interest and costs. After taking into account pre-judgment interest and costs, the Plaintiff may consider it may be liable to pay Fortune Pharmacal up to HK$58,880,000. There is nothing irrational about that.

56.Concerning Clause 5(i), the Defendants admit it is triggered[5].

57.The Plaintiff’s case on Clause 5(iii) is that the distribution of the Special Dividend falls within it viz a material adverse change of financial position of any member of the Group. The amount of Special Dividend was about HK$297m. As the Special Dividend was distributed in cash, the net current assets and available cash would be reduced by that sum. It is difficult to see why that is not financially adverse to the 1st Defendant. But for the distribution, the 1st Defendant would have an extra HK$297m in its pocket and the Group would see a net increase in cash and cash equivalents plus HK$297m.

58.To conclude, the Defendants having failed to establish a seriously arguable defence or there are triable issues, this court is satisfied that the Plaintiff is entitled to summary judgment as claimed.

Disposition and costs order nisi

59.This court hereby grants summary judgment in favour of the Plaintiff in terms of para 1 of the Summons as revised.

60.There shall be an order nisi that costs be to the Plaintiff, to be taxed if not agreed on an indemnity basis[6], and paid by the Defendants forthwith, certificate for counsel.

Ms Audrey Eu, SC and Mr Leon Ho instructed by M/s Au & Associates for the Plaintiff

Ms Elizabeth Cheung, instructed by M/s MinterEllison LLP for the 1^st and 2^nd Defendants