Kan Kwai Hing t/a Hing Kee Engineering v. Pacific Fine Engineering Ltd

HCA 1291/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1291 OF 2007

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Before: Deputy High Court Judge Carlson in Court

Dates of Hearing: 7-9 May 2008

Date of Judgment (Handed Down): 15 May 2008

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J U D G M E N T

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Introduction and Background

1.This case has brought into focus the unusual features of the building industry in Hong Kong.  The action is brought by a third tier sub-contractor who is suing the sub-contractor immediately above him in the sub-contracting chain for amounts of unpaid money due to him under two contracts.  Fortunately, there is no complaint made by the Defendant that the Plaintiff’s workmanship is in any way defective and the amounts that are said to be owing on the claim are agreed.  The real contest relates to the terms of the agreements which resulted in the Plaintiff being sub-contracted by the Defendant to carry out a series of electrical works under two separate contracts referred to as Contract A and B.

2.It is essential to begin by setting out the contractual hierarchy.  At the top is the client, in each case the Hong Kong Government through the Architectural Services Department (“ASD”) in the case of Contract A and the Electrical and Mechanical Services Department (“EMSD”) in respect of Contract B.

3.The general situation is that for government contracts its client departments will have approved contractors who qualify by virtue of having shown, amongst other attributes, financial and technical capability to perform the contract and a previous track record of successfully completing construction and engineering projects of the size that the Government would usually put out to tender.  Typically, the approved contractor, being the main contractor, will sub-contract various aspects of the work to smaller, perhaps specialist, sub-contractors retaining some of the works to itself or, it may choose to do none of the works, preferring to sub-contract all of them to a sub-contractor who will in turn sub-contract parts of the works to other sub-contructors.

4.I take Contract A first.  Since 1999 the ASD has appointed Hip Hing Construction Company Limited (“Hip Hing”), a substantial building contractor, as its Term Maintenance Contractor (“TMC”).  This required Hip Hing to carry out maintenance work on the Government’s properties over a period of years.  In turn Hip Hing has decided to sub-contract the whole of this contract to another substantial contractor, Wo Fung Construction Company Limited as well as to its related company Wo Fung Engineering Company Limited who I will refer to collectively as Wo Fung.  Wo Fung in turn decided to sub-contract a part of these works to the Defendant and it, in turn, further sub-contracted a part of what it had received from Wo Fung to the Plaintiff.  I am told that the Plaintiff was in fact one of five sub-contractors with whom the Defendant had contracted to carry out various aspects of the works that Wo Fung had entrusted to it.

5.From this brief description, one can see the proliferation of work amongst various sub-contractors.  This dispute is all about when a sub-contractor, such as the plaintiff, is entitled to receive final payment from its immediate contracting party.  One would have thought that such a fundamental term might have been put down in writing and signed by both parties but this is not the case here.  It is agreed that both of these contracts, A and B, were concluded orally and that the only documents were the technical documents such as Bills of Quantity, work orders and the Government’s price list for such works which would ultimately determine the amounts that the Plaintiff would charge the Defendant subject to a 52% discount on that price in the case of Contract A and 30% for Contract B.

6.The Plaintiff says that it is entitled to receive payment within 30 to 60 days of submission of its invoices.  The Defendant says that this is not so and that the system of payments is very much based on a series of interim payments paid to the Plaintiff in respect of work done until after the whole of the works put out under the main government contract had been completed and all the contractors’ invoices were approved, when a final settlement would be arrived at from the top down the sub-contracting chain.  Once the Defendant received an invoice from the Plaintiff, it would have that submitted up the sub-contracting chain.  In due course these invoices would be approved by the ASD who would in turn release what would be interim payments down to Hip Hing who would in turn pay Wo Fung and so on down the chain eventually enabling the Plaintiff to receive what it was entitled to at that stage.

7.As to Contract B, the issue is identical save that the chain of sub-contract is shorter.  The EMSD is the client, a company called Tridant (sic) Engineering Company Limited (“Tridant”) was the main contractor who sub-contracted part of the works to the Defendant who, in turn, sub-contracted part of its contract to the Plaintiff.  This contract was also an oral one evidenced in part by Bills of Quantity, works orders and the EMSD price list.  The Plaintiff offered to do these works subject to a 30% discount.

8.The size of the discount given by a sub-contractor such as the Plaintiff in such sub-contracts is reflective of the length of the chain of sub-contractors.  The longer the chain the larger the discount, because the cake, as it were, has to be sliced into more pieces as each sub-contractor takes its payment out of it.

The Issues

9.Before I turn to so much of the accounts as is necessary it will be helpful to first identify the issues and the rival arguments put forward.

10.The Defendant, through its director Mr Cheung Hau Chuen says that the system of payment whereby sub-contractors submit invoices which are settled by interim payments on a running account until the whole of the main contract is concluded when a final account is rendered down the sub-contracting chain is the way business is conducted in the building industry and that the Plaintiff, who had done similar business with the Defendant without disagreement going back to 1998 and 1999 well knew this.  The Plaintiff’s principal Mr Kan Kwai Hing, who has been in this industry for 20 years, is also well aware of this, according to Mr Cheung.  Mr Kan agrees that he has long experience of this kind of sub-contracting work and whilst the system of payment which Mr Cheung has described may well be common, it is not the one that applied to their contracts on this occasion.  This was not his way of doing business.  These contracts were entered into in 2000, the work was completed in 2003 and yet, five years on, he is owed over $1 million which he says is intolerable and not a situation which he would have agreed to in the course of his negotiations with Mr Cheung nor did he do so.  His version is that he would be paid within 30 to 60 days following presentation of his invoices.  Mr Cheung says that whilst initially interim payments went smoothly enough and a running account was established, there is now a problem further up the contractual line in respect of retention money and delayed payments by the concerned government department on the basis that some works either have not been done at all or, have been done in an unsatisfactory way and will need to be re-done, so that payment for these will not be made until these items have been put right.  Mr Cheung says that the parties’ agreements were “back-to-back” agreements, as a result of which, if the Defendant had not received payment from Wo Fung it could not and was not liable to pay the Plaintiff until it has received payment.  Mr Kan’s response is that there is simply no way that he would have agreed to such an arrangement.  No sub-contractor would be expected to wait in such circumstances.  Mr Cheung’s response is that this situation, apart from being the way business is usually done, means that a sub-contractor in the Plaintiff’s position, usually a smaller enterprise which may well have cash-flow problems, will be able to ease its passage through a contract by receipt of interim payments for work already done by it upon presentation of invoices, which is what has happened in this case and have materials for use in the works purchased on its behalf and supplied by the Defendant for which it will need to give credit on the running account, which is also something that has happened here and finally, in a more pressing situation, it can apply to the Defendant in writing for a loan which the Defendant will obtain on the Plaintiff’s behalf through its own bank at the usual interest rate which the Plaintiff would be liable to pay the Defendant and which loan or loans would be deducted from the final account.  And so in this way, the little man, the usually small sub-contractor at the end of the line, is able to obtain income as the contract progresses and maintain its cash-flow.  Mr Cheung says that usually this works satisfactorily but, on this occasion, the Government had decided to impose a retention money provision following a fatal accident after the contracts had got underway and has put this provision into practice with a knock-on effect down the contractual line and, even more disruptive, is a contractual dispute between Hip Hing and Wo Fung which is now before the High Court and which has largely paralysed the flow of payments down the sub-contracting chain.

11.The Plaintiff’s claim for $790,841.58 under Contract A and $132,034.00 under Contract B is admitted as a matter of arithmetic, all its invoices having been certified and approved by the Defendant.  Paragraphs 7 and 10 of the Amended Statement of Claim accurately reflect the way that the claim is calculated.  Additionally, there is also a claim in paragraph 12 in the sum of $138,574.81 under Contract B for what are said to be wrongfully withheld retention monies.  The total claim therefore is one of $1,061,450.39.

12.Whilst agreeing this, Mr Cheung says, all in due time.  Regrettably, everything is on hold until the disputes in the contracting chain above are resolved.  Once that is done the final payments will flow down and everybody will receive what they are entitled to.  Until then the Plaintiff is not contractually entitled to be paid until the Defendant itself is paid by the Wo Fung.

13.The Defendant has mounted a substantial counterclaim of $3,841,357.05 based on alleged overpayments by it to the Plaintiff but now as the evidence has developed, Mr Cheung has accepted in the course of giving evidence that the Defendant is obliged to hold off its counterclaim until the final accounting between the parties has been concluded.  He accepts that had the Plaintiff not brought this contractually premature action, the Defendant would have waited notwithstanding these allegedly substantial overpayments by it to the Plaintiff until it had received everything that is due to it from Wo Fung, after which it will present the Plaintiff with a final account in which it will deduct the value of the counterclaim as overpayments.

14.Needless to say the Plaintiff does not accept these alleged overpayments which are said to be the result of a failure by the Defendant to do its sums properly.

15.The way that these issues are presented therefore means that if the Defendant is correct and that neither party is at present entitled to press for further payments; the Plaintiff the value of its claim and the Defendant to set-off its counterclaim, then I would decide the case by dismissing both the claim and the counterclaim and the issue of the costs of the action would become paramount.  No doubt the Defendant arguing that as it has succeeded in showing that the action by the Plaintiff is unfounded on a proper interpretation of their agreements, overall it should have the costs of the action.  The Plaintiff in such circumstances perhaps saying that whilst the Defendant may succeed in getting the costs of the action, it should get its costs on the counterclaim.  I will address these arguments when I turn to the issue of costs in due course if that situation were to arise.

Conclusions as to the Basis of the Contracts

16.It seems to me that it is correct to first arrive at a conclusion on how these two parties have contracted.  If I find for the Plaintiff, its case on the amount outstanding being admitted, I would enter judgment for that amount and then go on to the decide whether as a matter of accounting the counterclaim has been correctly calculated.

17.If I hold in favour of the Defendant, I would not need to decide whether the counterclaim is as it has been pleaded because, quite correctly, Mr Cheung being consistent with the Defendant’s case on the claim accepts that on a proper interpretation of the contracts, the counterclaim is not currently maintainable and must also await a final accounting which will, in any event, undoubtedly affect its quantum as more payments are released by Wo Fung to the Defendant and therefore become payable, subject to the agreed discounts, to the Plaintiff.

18.I am bound to say that I find Mr Cheung a very reliable, honest and knowledgeable witness which unfortunately, is not a view that I am able to adopt in the case of Mr Kan of the Plaintiff.  It seems to me that Mr Kan has rather taken a perhaps understandable layman’s view of the situation.  Very regrettably the upstream dispute between Hip Hong and Wo Fung has frozen the flow of payments added to which the Government has imposed a provision for retention money and has deferred payments for some work due to defective and in some cases undone works for which neither of these two parties is to blame.  Mr Kan quite reasonably, but for the contractual position, has said to himself that the delay of five years since 2003 is far too long and it is high time that the Defendant has paid his company.  As to retention money he says firstly, that the provision is invalid because it was imposed after the start of the contract, in any event it was not agreed between the parties and, even if it is valid and I find that it is an agreed term, it is now high time that these monies were released given that any reasonable defects period will have expired.

19.For my part, having considered all of the evidence including of course the detailed documentation as spoken to by both witnesses, I am entirely satisfied that Mr Cheung has provided the correct version of the contractual arrangements between these two parties.  This was a “back-to-back” arrangement.  Only when the Defendant is finally paid is the Plaintiff to receive its final payment.  Up to now the parties have been operating a running account between them.  Unfortunately, this account is now frozen until matters above them are resolved.  Until then both are victim to the system to which they have subscribed under the hierarchy of sub-contracts.  Whilst initially attractive, Mr Kan’s complaint that he would never enter into a contract under which he would have to remain unpaid until the sub-contractor above him (the Defendant) was paid, the situation is in fact not as bad as it might at first blush appear to be.  Mr Cheung has explained that this potential hardship is ameliorated by a system of interim payments, in this case several million dollars have already been received by the Plaintiff, materials were supplied by the Defendant and in real difficulty a sub-contractor like the Plaintiff could apply in writing for a loan from the Defendant which will be taken into account once all the final figures are known and a net amount is arrived at and payable by whichever of these two parties is the debtor between them.  As to the retention monies, although this came after the event, that is to say after the contract between the two parties had started, it falls into the overall contractual mix under the back-to-back arrangements which all these sub-contractors subject themselves to.  These monies must therefore remain frozen until the current blockage upstream is resolved.  In accepting everything that Mr Cheung has told me, his evidence being overwhelmingly preferable to that of Mr Kan, I was impressed by the way in which he was prepared to follow the logic of the Defendant’s counterclaim not being presently maintainable just as the Plaintiff’s claim is not maintainable on the Defendant’s case as to the proper interpretation of the contractual arrangements between them.  I consider that the manner of his concession, he readily accepted the point that was being put him, was impressive and entirely frank as was the rest of his evidence.

20.This being my view of the effect of the contracts, both the claim and the counterclaim are not at present maintainable and therefore both fall to be dismissed.  Both must await the final accounting which cannot be known until the disputes above them are resolved and the remaining payments due to the Defendant are paid to it by Wo Fung.  Accordingly, both of these parties are required to wait.  The Defendant will have judgment on the claim and the Plaintiff judgment on the counterclaim.

Costs

21.This will be an order nisi.  Had there been no counterclaim the Defendant would have been entitled to all of its costs.  Nevertheless, it must now suffer a discount because it has pursued its counterclaim.  Overall, the Defendant has won.  It has won the argument as to the correct interpretation of the contracts which has been the main issue.  Doing my best to apportion the matter properly and to do justice between the parties on costs, I will say that the Plaintiff must pay the Defendant 70% of its costs of the action.

C Y Liu, instructed by Messrs Wong, Poon, Chan, Law & Co., for the Plaintiff

Victor Cheung, instructed by Messrs Darin Leung & Partners, for the Defendant