Hong KongConstruction Newsletter July 2016

Introduction Welcome to Clyde & Co’s regular Construction Newsletter.

Legal UpdateA Constitutional Challenge: Wing Bo Building Construction Company Limited v Discreet Limited (HCA 146/2015)

In Wing Bo v Discreet, Hong Kong’s Court of First Instance (“CFI”) dismissed the contention that the Arbitration Ordinance (Cap 609) was unconstitutional, and confirmed Hong Kong’s position as a pro-arbitration jurisdiction.

The building contractor, Wing Bo, challenged the constitutionality of Section 20(8) of the Arbitration Ordinance (“s.20(8)”), which provides that a Court’s decision to stay proceedings in favour of arbitration is not subject to appeal. In dismissing Wing Bo’s contention, the court held that the provisions of the Arbitration Ordinance (Cap. 609) are in line with Hong Kong’s legislative policy “to promote the use of arbitration, to facilitate the fair and speedy resolution of disputes by arbitration without unnecessary expense, and to promote Hong Kong as an arbitration friendly jurisdiction”.

The dispute arose from a building contract using the domestic standard form of building contract containing an arbitration clause. Wing Bo commenced legal proceedings in the High Court against the employer, Discreet, to recover a final account balance of HK$3,700,000. Discreet then applied for a stay of proceedings in

favour of arbitration. The CFI allowed the stay as Discreet has established a prima facie case that an arbitration agreement existed, covering the scope of the dispute, binding the parties.

Notwithstanding that s.20(8) expressly provides that a decision of the CFI to refer the parties to arbitration is not subject to appeal, Wing Bo applied for leave from the CFI to appeal, arguing that the provision was unconstitutional, being inconsistent with Article 82 of Hong Kong’s Basic Law, which provides that “the power of final adjudication” should be vested in the Court of Final Appeal.

In determining this constitutional challenge, the CFI applied the proportionality test laid down by the Court of Appeal in China International Fund Ltd v Dennis Lau & Ng Chun Man Architects & Engineers (HK) Ltd. The CFI concluded that the restriction on appeal imposed by s.20(8) is no more than necessary to accomplish the legitimate aims of the Arbitration Ordinance, which are to “facilitate the fair and speedy resolution of disputes by arbitration without unnecessary expense”.

This decision once again confirms Hong Kong’s pro-arbitration stance, and fully embraces the principles of party autonomy and minimal judicial interference.

We hope you find this month’s newsletter an informative and useful read.

Should you have feedback or suggestions for future topics, please contact infrastructure@clydeco.com. Similarly, to hear more from our global projects & construction group, email us providing your area(s) and region(s) of interest.

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The UK Supreme Court Devises a New Test for PenaltiesWith the landmark decision in the joint judgment of Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67, the UK Supreme Court has established a slightly different test for penalties. Although neither case was a construction dispute, the decisions will have important ramifications on the enforcement of liquidated and ascertained damages (“LADs”), commonly found in construction contracts.

LADs are typically used to deal with delay, whereby the compensation for delay will be pre-determined, often as a daily or weekly sum. The great benefit of LADs is that the innocent party is not required to quantify their loss; they simply recover the ascertained sum as determined under the contract. LADs also limit the liability of the defaulting party.

Formerly, in order to be enforceable, LADs simply had to reflect a “genuine pre-estimate of loss”. If the compensation went beyond that, for example if it was considered to exist as a deterrent, rather than as a mechanism for compensating the innocent party, then that clause would be considered penal, and was thus unenforceable.

In these two cases, the Supreme Court considered whether particular contractual clauses were penal. The Court also considered if the “genuine pre-estimate of loss” test was an appropriate way to determine if a clause was penal.

The Court rejected the old test for penalties, and revised this penalty rule, limiting the scope whereby a contractual clause may be found to be penal, and thus unenforceable.

The principle changes are two-fold:

1. To be penal, the consequence of a breach must be out of all proportion to the legitimate interest of the innocent party; and

2. The penal rule will not apply to primary obligations of a contract

The Cavendish case concerned a share purchase agreement containing restrictive covenants preventing the seller of the company, Mr. Makdessi, from competing activities for a number of years. Breaching those restrictions led to the purchaser, Cavendish, withholding the last two payments, and exercising the call option over the rest shares at a price excluding the value of goodwill – worth some US$44M.

The Court of Appeal, overturning the High Court’s decision,

held that the provisions were penalties because they were “extravagant and unreasonable” and not genuine pre-estimates of loss. However, the Supreme Court reversed this decision. The Supreme Court considered that the provisions were enforceable because they existed to preserve the buyer’s legitimate interests that had gone beyond the measure of loss attributable to the breach. Furthermore, the contractual restrictive covenants against competing activities were found to be primary obligations, as they operated as price adjustment clauses, and could not be treated as invalid without effectively re-writing the contract.

In the ParkingEye case, the Supreme Court held that the charge for overstaying a permitted period of free parking was not penal because it was neither extravagant nor unconscionable. Beavis had been charged £85 after overstaying a free two hour period on a carpark managed by ParkingEye. ParkingEye conceded that the £85 invoice sent to Mr Beavis was not a pre-estimate of damages, and in fact ParkingEye would have been unable to show that they had suffered any damage.

However, ParkingEye did have a legitimate interest in obtaining an income stream to meet its costs, and the landowner who employed ParkingEye to manage the carpark had a legitimate interest in ensuring the efficient use of parking spaces in the car park to ensure a good turnover of customers in the retail outlets. Furthermore, the approach taken of charging those who overstayed was common practice in the UK, and the charge was comparable to those imposed by local authorities. Thus according to the new test, the consequence of breach, i.e. an £85 fine, was not penal because it was not out of all proportion to the legitimate interest of the innocent party

The old penalty rule has long been criticized for interfering with contractual freedom. The new test, focusing on legitimate interests indicates a more flexible approach, whereby contracting parties will be allowed to determine what they consider is a legitimate response to a breach of contract. It will consequentially become harder to strike down LADs as penal.

Hong Kong Courts have traditionally shown reluctance to interfere with party autonomy, and these English cases lean towards that preference for contractual freedom. It is yet to be seen whether the Hong Kong Courts will uphold these decisions, but if they do it will become more difficult for contractors to set aside LADs, especially when legitimates interests and primary obligations have been spelled out in the contract.

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Hong Kong NewsBelt and Road ConferenceOn 18 May 2016 Hong Kong played host to the Belt and Road Summit, bringing together stakeholders from across the APAC region and further afield, to discuss China’s “One Road, One Belt” trade initiative.

In his keynote speech, Zhang Dejiang highlighted the professional and financial services required, and the need for “people-to-people exchanges” and cooperation with the mainland, in order to develop businesses along the land and sea routes connecting China to Asia, the Gulf, and Europe, in an initiative which could involve over 65 countries.

Twenty officials from around the world were in attendance, including former chief executive Tung Chee-hwa, and the economic chief of the UAE, Sultan Saeed al-Mansoori, whose attendance perhaps indicates that Islamic finance will

become increasingly important.

The summit was attended by finance, trade and infrastructure development professionals in force; hardly surprising, given the fact that Financial Secretary John Tsang Chun-wha indicated that a Hong Kong Monetary Authority office will be set up to facilitate infrastructure investments under the initiative. The Asian Development Bank has predicted that US$800 billion will be needed every year until 2020, just to cover the infrastructure investments in Asia.

It is also expected that Hong Kong will remain a forefront provider of legal services, and according to Zhang Dejiang “the central government would support Hong Kong’s role as a centre of dispute resolution and arbitration for the Asia-Pacific region, as well as for belt and road countries.” Clyde & Co will be well placed to provide such legal support, with offices across many of the Belt and Road countries.

Clyde & Co Construction Newsletter July 2016

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BD HighlightsThe Hong Kong Office 35th AnniversaryClyde & Co’s presence in the Asia Pacific region stretches back 35 years, as the Hong Kong office celebrates its 35th anniversary this year. The firm has changed a lot since 1981 when our first international office was established in Hong Kong: the firm now spans the continents, with 46 offices worldwide, which reflects Clyde & Co’s determination to provide comprehensive global legal services to our clients, wherever they may operate.

In other news the Chambers Asia Pacific Results 2016 recognise Clyde & Co as a major Construction presence in China and Hong Kong, with both Ian Cocking and Gilbert Kwok noted amongst the leading individuals. We also had our construction partners David McElveney (Australia) and Eugene Tan (Singapore) named in the individual rankings.

The Hong Kong Construction team prides itself on being able to offer a seamless service to clients in Hong Kong and across the Asia Pacific region, working closely with the firm’s network of offices, in particular the Beijing, Chongqing, Shanghai and Singapore offices, and our growing presence in Australia. We are very much looking forward to working with our clients over the next 35 years; in Hong Kong, China and the broader Asia Pacific region.

HKIAC Training Programme in preparation for Statutory Adjudication (SOPL)

Four of our team, Ian Cocking, Gilbert Kwok, Phyllis So and Dennis Wong, have all recently successfully qualified as Hong Kong adjudicators under the HKIAC’s first round of adjudicator training.

25 May 2016: “Construction Arbitration in Hong Kong – Never too Late to Change?”To mark the publication of the 13th edition of Hudson’s Building and Engineering Contracts, Ian Cocking joined Atkins Chambers and other construction industry stakeholders for a legal symposium discussing the good, the bad and the ugly aspects of Hong Kong construction arbitration, and what there may be to learn or fear from the impending adjudication regime which is soon to hit Hong Kong.

26-27th May 2016: International Construction Conference – Caring Construction, Collaborative Contracting, Continuing Professional DevelopmentCelebrating 30 Years in Asia, the Lighthouse Club hosted a two day conference covering a wide array of matters affecting Hong Kong’s construction industry. The afternoon session on the 27th dealt with Legal Matters of Importance to the Construction Industry, including a presentation from Ian Cocking.

28 June 2016: Hong Kong Construction Association – Seminar on Industrial SummonsesPhyllis So, a Legal Director at Clyde & Co, Arbitrator and former Quantity Surveyor, led a seminar on Industrial Summonses alongside her Clyde & Co colleagues, including a trained engineer and a former court prosecutor.

The seminar explained common regulatory or industrial offences, means to properly handle such summonses, and potential effects of accidents or incidents on site.

The seminar was beneficial to contractor employees, such as site safety officers, who need to deal with site safety issues, and management of construction companies who would want to ensure a safe working environment whilst focussing on timely completion of their projects.

6 July 2016: NEC APAC Users’ Group Breakfast BriefingOn the morning of Wednesday 6 July Clyde & Co played host to a breakfast briefing session to celebrate and share the successes of NEC3 in Hong Kong.

Clyde & Co partner Gilbert Kwok moderated a panel discussion between engineers of the Drainage Services Department, the MTRC, and a Senior Project Manager of Paul Y Engineering Co., who shared their success stories and gave insights on how they adopted the partnering approaches in managing their projects, including the MTR’s HK$600 million Kennedy Town Swimming Pool Phase 2 construction works, and the leading role of the DSD in the use of NEC3 contracts in HK.

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Security of Payment Legislation for the Construction IndustryWhat SOPL may mean for foreign parties involved with Hong Kong Construction Activities.

Parties involved in construction projects in Hong Kong should keep watch, for the Development Bureau’s SOPL proposals indicate that the legislation will be very broadly drafted, meaning the SOPL mechanism will cover many aspects of a project, whether or not the work is done in Hong Kong, or whether the parties are based here.

The proposals assert that all relevant construction contracts will be subject to the legislation, “whether they are subject to Hong Kong law or another law and regardless of the nationality of the parties” so long as the relevant construction activities are carried out within Hong Kong. Furthermore, contracts for services carried out outside Hong Kong and materials made abroad will be covered by SOPL provided the services and materials are supplied to parties who are procuring or undertaking construction activities in Hong Kong. The Report on Public Consultation has revealed that there was “overwhelming support” for this proposal, so it seems very unlikely that it will be amended.

There’s a broad brush approach to the definition of both “construction contracts” and “construction activities”, albeit with significant carve-outs mooted, such as where the main contract value is below HK$5m (£439,340). However, foreign contractors with contracts in Hong Kong will almost certainly fall under the SOPL, unless particular exemptions apply.

As expected, on-site activities involving the provision of labour, plant or services will be covered, but so will contracts for supply, where the plant/material is going to a Hong Kong construction site. The proposals also cover contracts for services relating to “construction activities” – covering elements such as design work. This means where architectural or engineering design work is outsourced to foreign parties, if the actual construction site is in Hong Kong, SOPL will apply.

Any party involved in construction activities in Hong Kong is advised to keep abreast of developments, and when SOPL is enacted – the Development Bureau has indicated its intention to place it before the Legislative Council in 2017 – it will be vital to take advice as to whether a contract falls under the SOPL mechanism, if it is SOPL compliant, and the implications regarding the timeframes and procedures parties must operate under.

For more detail the DEBV Report on Public Consultation on Proposed Security of Payment Legislation for the Construction Industry was released in April 2016, and can be found here: http://www.devb.gov.hk/en/publications_and_press_releases/Consultation_Papers_Reports/sop/index.html

Clyde & Co Construction Newsletter July 2016

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Third Party Rights in Construction ContractsThe Contract (Rights of Third Parties) Ordinance (CAP.632)

The privity of contract is a long-standing common law doctrine, establishing that a contract can only grant rights or impose burdens upon parties to that contract. However, the Contract (Rights of Third Parties) Ordinance (the “Ordinance”) which came into effect on 1 January 2016 alters this doctrine.

The Ordinance creates a mechanism whereby third parties (i.e. parties who have not signed up to a contract) can be granted enforceable rights under a contract. However, it will not be possible to impose obligations upon a third party. This allows the law to reflect commercial realities, so that contracts can be drafted to extend certain benefits to interested third parties.

To put this in a construction context, if an employer and a contractor sign a development agreement, it may be necessary to confer step-in rights to the project funder. It may also be desirable to grant rights to the future tenants or purchasers, who would not invest in a property or project without rights against the contractor should the works prove defective.

Previously, in order to confer such rights upon third parties, it was necessary for the parties to enter into ancillary contracts known as ‘collateral warranties’.

The Ordinance, largely modelled on the UK’s equivalent legislation the Contract (Rights of Third Parties) Act (the “Act”), provides a statutory mechanism allowing rights to be conferred upon third parties. Where contracting parties adopt this new mechanism, we can expect to see schedules of third party rights, in much the same form as collateral warranties, appended to building contracts and appointments.

In order to create third party rights under the Ordinance, which does not have retrospective effect, there must either be an express provision creating such rights, or the contract must “purport to confer” such rights. Importantly, the provisions of the Ordinance can be expressly excluded.

It is also necessary for third parties to be “expressly identified”; by name, class, or answering a particular description. This allows rights to be extended to parties who are unknown at the time of contracting, for example future tenants/purchasers. These precautions ensure that a carefully drafted contract will not unwittingly give rise to third party rights.

Once a third party has a right, they can be enforced against the contracting party in much the same way as they would be as rights created by collateral warranty, with all the same remedies, subject to any defences and set-offs.

Furthermore the Ordinance allows for the rights, once created, to be assigned. This is what you would expect to see, and collateral warranties would commonly provide the right of assignment, allowing for example a tenant to assign his rights, should he sell his interest in a property.

The experience of the UK when their version of the Ordinance was enacted – some 17 years ago – was that the construction industry responded conservatively, and simply amended contracts to expressly exclude the provisions of the act. Thus it is still common in the UK to find clauses in construction contracts excluding third party rights, and collateral warranties remain the preferred method of granting such rights. One of the reasons collateral warranties are preferable is that by creating a direct contractual link, they can establish obligations as well as rights.

Third parties who want to rely on rights created under the legislation will also have to be cautious, and a recent English case has highlighted this. The judge in Hurley Palmer Flatt Limited v Barclays Bank PLC distinguished contractual liabilities from procedural rights, such as the right to adjudicate. For third parties who intend to rely on rights acquired under the Ordinance, they will have to pay very close attention to the drafting of the contracts to establish exactly which benefits they have accrued.

It is important for the construction industry to be familiar with the workings of the Ordinance, and how it can be used to grant third party rights. It will take careful drafting if parties are to ensure that third party rights, where they are created, are given the intended effect. Given that the UK experience shows that the industry has been slow to adopt the legislation, it would not be unreasonable to expect a slow response in Hong Kong before the use of third party rights becomes commonplace.

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Partner Profile – Gilbert KwokGilbert has been a cornerstone of the growth of the Clyde & Co Construction team since he joined the firm as partner in 2011, bringing with him vast experience in both contentious and non-contentious construction matters across Asia Pacific and beyond.

Gilbert specialises in construction disputes and has been handling mediation, arbitration and litigation cases for developers and contractors for over 20 years.

Representing clients across Asia Pacific, Gilbert is widely known for his knowledge and expertise in dealing with construction issues in mainland China. His network throughout the construction industry in China has been key in offering legal support to clients throughout the region; he speaks fluent Mandarin, and is the Chief Representative of our Beijing office.

Gilbert has extensive experience in advising developers and contractors on a variety of construction projects, including infrastructure, commercial, residential and industrial projects. He supports clients throughout the entire life of a project, and regularly drafts and advises on construction contracts, consultancy agreements and supply contracts, across numerous jurisdictions, including Hong Kong, Beijing, Shanghai, Macau, North Korea and Angola.

Further to his legal expertise (Gilbert qualified as a Hong Kong solicitor in 1993), Gilbert is also a technical specialist,

having qualified as a chartered quantity surveyor of the Royal Institution of Chartered Surveyors before becoming a lawyer. This is one of his great strengths as a lawyer, having a real commercial insight into the needs of his clients. He is also Fellow and Past Chairman of the Hong Kong Institute of Surveyors (HKIS), the Quantity Surveying Division of HKIS, and is currently its honorary legal advisor.

Gilbert is a ranked individual in the Chambers Asia Pacific 2016 guide as well as being ranked as a leading individual by Legal 500, where he has attracted praise for his knowledge of mainland China issues, “his strong technical background” and for being “very responsive and communicative”.

Clyde & Co Construction Newsletter July 2016

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Ian CockingPartner, Hong KongT: +852 2287 2802 E: ian.cocking@clydeco.com

Gilbert KwokPartner, Beijing & Hong KongT: +852 2287 2804 E: gilbert.kwok@clydeco.com

Phyllis SoCounsel, Beijing & Hong KongT: +852 2287 2820 E: phyllis.so@clydeco.com

Dennis WongCounsel, Hong KongT: +852 2287 2803 E: dennis.wong@clydeco.com

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Clyde & Co

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Further advice should be taken before relying on the contents of this Newsletter.

The information contained herein is for general guidance only and should not be treated as a substitute for specific advice. If you would like advice on any of the issues raised, please speak to any of the contacts listed.

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